Productivity and Globalization

Firms who are competing globally should be very concerned about their productivity. Productivity differences translate into performance differences between firms. Firms with lower productivity have higher marginal costs, meaning they are less profitable when competing in integrated markets.

Market integration through globalization exposes firms to increased competition from international trade. In this arena of intensified competition, performance differences between firms matter a great deal. Firms which suffer from poor performance are hit hardest and, in some cases, may be forced to exit the industry. The corollary to this is that the best performing firms will benefit from access to the larger integrated market, and are likely to grow as a result.

Cost differences between firms can translate into performance differences. If all firms in an industry are facing the same demand curve, the firms which have lower productivity will be at a disadvantage. This is because these firms will be producing with different (i.e., higher) marginal cost levels than rivals. Compared to higher marginal cost producers, firms with higher productivity and therefore lower marginal costs will be able to set lower prices with a higher markup over marginal cost, produce more output, and earn higher profits. In international trade, productivity can be the difference between being in the game and having to sit out.

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External Economies and Regional Clustering

External economies are a key driver in international trade, but they are even more important in interregional trade. External economies of scale arise when the cost per unit of output depends on the size of the industry, and not on the size of any one firm within the industry. With external economies of scale, the efficiency of firms within an industry is increased with a larger industry. This is the opposite of internal economies of scale, where the cost of a unit of output depends upon the size of the producing firm, but not necessarily on the size of the industry to which it belongs.

An industry that has purely external economies of scale will be made up of many small firms and tend towards a market structure that is closer to being perfectly competitive. Internal economies of scale, in contrast, provide large firms with a cost advantage over smaller firms and tend to lead to an imperfectly competitive market structure.

External economies of scale play an important role in determining the location of production. Firms that are subject to external economies of scale will tend to cluster together where they can benefit from each other’s presence. Clustering will allow these firms to gain from access to larger base of specialized suppliers, a pooled market for workers, and knowledge transfer among firms. In short, external economies of scale tend to promote the creation of specialized clusters within local regions.

External economies of scale may be more important in driving regional cluster development than either access to factors of production or resources. Factors of production such as labour and capital play a less decisive role in interregional trade because these factors tend to be relatively mobile within countries, and will go to where the industries are rather than the other way about.

Why Doesn’t Lean Work?

So proclaimed the title of the latest e-newsletter received recently from Norman Bodek. Let me say at the outset that I have tremendous respect for Norman Bodek – more than anyone else, he brought Japanese management and production techniques to North America in the 1970’s through his company, Productivity Press, and I was fortunate enough to attend the very first “lean” events he ran in North America with Japanese experts.

Many of us would agree with Norman’s newsletter title, especially if by “lean” we mean the philosophy, principles and techniques of the Toyota Production System (TPS). The thrust of Norman’s argument is that lean doesn’t work because most of the firms trying to do lean are failing, unlike Toyota, to empower their people to achieve self-reliance as true problem-solvers.

While I agree with Norman that many firms doing lean are failing to empower employees to the degree Toyota does, for me this is a symptom and not a cause.

Several reasons stand out to me. First, TPS as popularized by the lean movement is quite unlike the TPS I observe and see in Toyota facilities. Where Toyota focuses on its people and their relationships in problem solving, firms I see trying to do lean are focused on copying the tools and techniques of TPS. Secondly, the popularizers of TPS have failed to realize that TPS is a distinctive capability of Toyota’s that cannot be easily copied or replicated. Both of these issues are connected.

At its heart, TPS is based on tacit knowledge derived from Toyota’s relationship system – the system of implicit relationships which links, engages and empowers all employees within the production system. While the tools and techniques of TPS can be copied, the relationship system that underpins it cannot, and this is why there are not more Toyotas.

Distinctive capabilities are just that – distinctive. They are distinctive because they cannot be easily reproduced. If they could be easily reproduced, they would cease to be distinctive and cease to be a source of sustainable competitive advantage. You may be able to do lean, but it won’t be TPS as Toyota does it.

On Teaming

On the surface, the standard approach to solving problems and driving continuous improvement seems straightforward: assemble teams, train them in problem solving, assign them problems, and wait for the results. The flaw in this approach, however, is that many firms are ill-prepared to handle team structures and dynamics.

Effective teams are not easy to create. In firms where there is no prior experience with teams, making the leap from no teams to teams is often too big a leap. In such firms, collaboration and coordinated effort are not the norm, and shifting to team-based structures is likely to flounder and perhaps fail.

In such cases, we have found an emergent approach to teaming to be much more effective. At Anderson Lyall, we call it our “emergent approach”, because rather than trying to impose or create team-based structures, we gradually allow teams to emerge out of incremental collaborations between small units of employees.

Under our emergent approach, we will focus on a specific process and try to establish an ethic of basic cooperation and collaboration between, say, two members of the process work group. Why two employees? Because two people is smallest relational unit of shared cooperation and collaboration that is possible. This “micro team” might be asked to investigate and resolve a simple challenge or issue within the process. The focus is not so much on solving the issue or problem, although that is important, but more on getting two people used to interacting with each other and putting their minds to work cooperatively and collaboratively.

From this initial nucleation of establishing a collaborative relationship among two members of the work group, we will then orchestrate similar interactions among other members, gradually expanding the numbers and scope of each interaction over time. Coaching is given along the way to identify impediments to cooperation and the building of productive, collaborative relationships. The emphasis is always on the quality of the interaction and the collaborative relationship, and not on the outcome or result.

Over time, this approach can allow a cooperative, collaborative, and effective team to gradually emerge out of a work group. An additional benefit of the approach is that employees who show a natural bent for guiding and leading collaborations can be identified – these employees may become the eventual team leaders.

Creating effective teams is neither easy nor quick. The emergent approach may be useful to those firms which have a low ethic of collaboration, or those whose team-building efforts have stalled or failed.

Relationships

A firm’s relationship system can be the source of its distinctive capabilities. Relationships among employees, between the firm and its network of collaborating organizations, and between the firm and its suppliers and customers, can give rise to bundles of specialized knowledge and competencies, unique organizational routines, and proprietary processes and practices – capabilities, in a word.

Because these capabilities are based on tacit learning and knowledge accumulated through numerous interactions over time, they are extremely difficult for rivals to copy and replicate. Capabilities which are distinctive, because they are difficult for rivals to replicate, can give rise to sustainable competitive advantage when they are applied to markets and segments where they are valued by customers.

Distinctive capabilities based on a firm’s relationship system cannot be created. If they could, they would not be distinctive since entities other than the originating firm would be able to recreate the capability. Instead, such distinctive capabilities, because they are the product of tacit relationships, must evolve over time. The ongoing accumulation of the learning and knowledge which results from the relationship system is what makes the resulting capabilities difficult to replicate.

Too often firms are seduced into trying to replicate distinctive capabilities developed by other firms which result from relationship systems. The Toyota Production System is one example I often cite, although there are many others. While the superficial aspects of Toyota’s distinctive capability in production can be copied, the capability as a whole cannot because it is the product of the firm’s relationship system. The underlying lesson here is that if you are trying to copy a distinctive capability derived from a another firm’s relationship system, you are likely to fail.

Wishful Thinking

A common approach to business strategy is for a firm’s management to first develop and mission statements that define what management would like the firm to become. Goals, objectives, and action plans are then developed, and the firm’s “strategy” becomes the collection of these goals and plans.

The problem with this approach is that the firm’s strategy is not grounded in the reality of a competitive environment, and instead represents a consensus of wishful thinking about what management would like the firm to become.

Strategy is less about what you want to be and more about what you can do, given your current resources and capabilities. Good strategies start from an understanding of a firm’s capabilities, including any that are distinctive, its industry (including competition), and its markets. A good strategy harnesses a firm’s capabilities, extends and deepens them where appropriate, compounds their effect with complementary assets, and focuses them onto markets where they have the potential to yield a sustainable competitive advantage.

Vision and mission statements have a role to play within a firm, but it is not in the realm of competitive strategy. Don’t confuse or conflate the two!