Efficiency vs. Effectiveness Revisited

Where firms have opportunities to take advantage of experience curve or scale effects, pursuing a cost-price efficiency strategy may make sense. The danger arises when a cost-price efficiency strategy is misaligned with market needs – for example, when the preference of the majority of customers in the market is for advanced product or service features and technologies. In this case, a firm pursuing a cost-price efficiency strategy will find itself out-of-step with the marketplace and offering a product or service that few customers want.

There are a few screening questions that firms should ask themselves before committing to pursuing cost-price efficiency. First, does the firm’s industry offer significant cost advantages that could arise from experience or scale (some industries do, such as semiconductors, chemicals, etc.)? Secondly, will the firm be rewarded by offering low prices to the marketplace? Thirdly, how well-equipped is the firm to pursue a cost-price efficiency strategy (investments may have to be made to increase the firm’s physical and human capital)? If a firm can answer “yes” to all of these questions, then it may make sense to consider pursuing a cost-pice efficiency strategy.

A danger to be avoided is pushing the envelope of cost-price efficiency so far that effectiveness is sacrificed in the long-run. Pursuing cost-price efficiency entails specialization – specialization of a firm’s work force, facilities, technology and organization around operating at the lowest cost. This specialization can constrain and “calcify” a firm, rendering it unresponsive to changes in customer tastes or preferences, or innovations by rivals.

As with any strategy, cost-price efficiency must be rationalized economically. Too many firms are pursuing efficiency strategies without understanding how these strategies will be economically profitable.

Labour or Skills Shortage?

Do we have a labour shortage or a skills shortage in Canada? Firms are complaining that they cannot find enough skilled workers, yet the unemployment rate still stands at a healthy 7 per cent or so.

Much of the evidence about a skills shortage appears to be anecdotal rather than hard, quantifiable statistics. While firms have a tendency to complain that they cannot find workers they need at the wages they want to pay, economists would prefer to see hard evidence – evidence such as a low unemployment rate and wage levels rising well above average for those jobs that appear to be in short supply.

The forthcoming federal budget is mooted to deal with the skills shortage issue. How it will do so is not yet clear, but there are a few compelling models in use by other countries that the government might turn to for ideas. Germany, for one, has an apprenticeship program that is the envy of the developed world. South Korea is another country that has established a network of vocational schools, based on the German model, to reduce that country’s shortage of skilled plumbers and machinists. Whatever, the precise nature of the solution, it is clear that firms and the institutions that offer skills training will have to work more collaboratively and cooperatively than ever before and avoid existing in parallel universes.

Even if the skills gap is closed, firms are likely only to hire if demand and growth warrant it. Creating a surplus of skilled workers will be no better than having a surplus of unskilled workers.

 

Customizing Products

One way for a firm to differentiate itself from rivals is, of course, to tailor or customize its product to the needs of individual customers. This is a different paradigm than offering “one size fits all”.

The “one size fits all” finds its classic expression in mass production. Mass producers have an “assembly line” mentality and are concerned with efficient production where costs can be driven as low as possible. On the other hand, product customizers necessarily incur higher costs to tailor their offering, but these higher costs can be offset by extracting a price premium for the customization.

Tailoring and customizing products requires a different mindset than mass production. For one thing, processes must be stable but also dynamic and flexible, bringing together the needed technologies and skills to produce the tailoring required by the customer. To achieve this, customizers should think in terms of a network for their organizational design. A network allows information and material flows to travel down different paths, depending upon the customization being performed, and permits an organization to bring various resources and technologies together in a dynamic way, rather than being constrained by “functional silos”.

Product or service customization is an important element of differentiation – some would say, the key element. To achieve customization without incurring high costs due to mismatch or conformity errors requires giving much thought to organization and process design.

 

Toyota and Differentiation

A recent (February 13, 2013) post on Yahoo Finance (http://finance.yahoo.com/news/toyota-lost-moat-120000528.html), which is a repost of a Morningstar article written by David Whiston, exposes some strategic issues associated with Toyota.

Whiston notes that Toyota’s economic profit remains high and, although I have not done a comparison with other automakers, the strong economic profit suggest that Toyota may still enjoy a competitive advantage relative to rivals. However, as Whiston notes, this advantage may be eroding.

Whiston points out that industry-wide, quality is no longer the differentiator it once was. This is to be expected – Toyota’s rivals have improved their manufacturing capabilities and can now approach, if not equal, Toyota’s quality performance. However, rivals may be less efficient in achieving these quality levels than Toyota and that might explain why Toyota’s economic profit still remains high.

I have often stated that operational excellence cannot be the basis of sustained competitive advantage. This is because a firm’s rivals can replicate operational best practices and achieve the same results as a best-practice leader. This would appear to happening to Toyota – rivals are closing the quality gap and, one would expect, the cost gap eventually.

Value-for-money through quality and reliability was a key component of Toyota’s differentiated value proposition. As that differentiation is being eroded by rivals, it will be interesting to see how Toyota responds strategically.