Japanese Companies

Being a Scot myself, I often think of Japanese firms and their managers as “the Scots of the Orient”. Like the Scots, Japanese firms know the value of efficiency and using scarce resources wisely.

Japanese firms are very focused on productivity. However, they hone in on productivity from a labour perspective and tend to measure it in terms of labour, such as the number of parts produced per employee labour-hour or the number of employees needed to operate a particular machine.

The best Japanese firms are continually seeking to drive productivity improvements by increasing the marginal product of labour. This allows them to either produce the same output with less labour-hours, or produce more output with the same labour-hours.

The Japanese understand the economic principle known as the law of diminishing returns. In fact, this law is the secret of Lean manufacturing. According to the law of diminishing returns, in a production system with fixed and variable inputs, beyond a certain point, each additional unit of variable input yields less and less additional output. The law of diminishing returns says that a firm’s short-run marginal cost curve will eventually increase.

Through Lean we can improve the efficiency with which a firm combines its variable factor of production (labour) with its fixed factor (capital). As these inputs are more efficiently combined, the rate of increase in total costs slows down as output increases. Japanese firms know this and work at this assiduously to improve their short-run cost performance.

We should always understand why continuous improvement approaches like Lean work as they do. It is not enough to know the tools and how to apply them. The economic rationale behind the tools should be appreciated and understood – just as the Japanese do.

Cost Reduction Dangers

Firms who choose a competitive strategy based on cost reduction due to either experience or scale must consider a difficult tradeoff: whether to choose cost-price efficiency over noncost-price marketing effectiveness.

A firm which chooses to pursue cost efficiency can  run into difficulty if end up offering a low-cost product which few customers want. In this case, the lack of demand reduces total revenue and short-circuits the attempt to achieve lower costs through either experience or scale by reducing volume.

Efficiency strategies make sense when there are significant cost advantages to be had from either experience or scale, and there are market segments with a critical mass of buyers that will reward a supplier offering a low price. In addition, the firm pursuing efficiency must consider how well equipped it is to pursue an efficiency strategy. This means have the necessary managerial, technological and financial resources with which to pursue cost reductions through either experience or scale.

Low price achieved through low cost is not always valued by the marketplace. In addition, firms can go too far with cost reduction initiatives and lose their ability to respond to changes in their environment. This is particularly true if experience is the source of cost reductions: the increased specialization required makes it difficult for an organization to adapt and respond to innovations or changes introduced by rivals. Similarly, while Lean processes can be efficient, if carried too far they may become anorexic and unable to respond to changes in  customer preferences and tastes.