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Conquering the costs of complexity
Conquering the Costs of Complexity James A. Gingrich and Horst J. Metz
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any of today's most successful corporations are prospering by offering an unprecedented variety of products sold through multiple distribution channels to carefully differentiated customer segments. Other companies, pursuing the same goal, are choking on the complexity of their operations. What makes the difference? Flexible technologies help, but fresh management approaches are crucial. That the marketplace of the late 1980s rewards variety is beyond dispute. To cite but one example: Kellogg, the cereal manufacturer, has found that the more new products it introduces, the higher its growth rate. In the cereal industry overall, greater breadth of product line has been unmistakably associated with market share gains in the 1980s. Such product proliferation has become a way of life in nearly every manufacturing and service industry. AT&T manufactures more than 1,000 types and colors of telephones; Revlon markets 157 lipstick shades; persnickety pets can choose among 23 flavors of Nine Lives cat food. In the service sector, hamburger outlets must compete with fast-food pizza, fried chicken, and numerous international cuisines. Traditional hospitals find some of their customers departing for health maintenance organizations, specialty surgery centers, and outpatient clinics. Distribution channels and retail formats are also multiplying. Today's consumers make purchases in airports, on planes, by mail, phone, computer, or television. Traditional retailers share
Flexible manufacturing can help in today's complex markets, but flexible management is an oft-forgotten key.
64
customers with warehouse clubs, discount stores, boutiques, and outlets focusing on a particular line of merchandise. A recent survey shows, for example, that many people regularly buy food at a range of outlet types. Even within a given retail format, distinctions are becoming finer. The Target Stores chain positions itself as an upscale discounter. Von's, a successful West Coast grocery chain, has developed multiple formats targeted toward particular customer segments (Figure 1). Managing a business successfully in today's complex marketplace has its costs, and there are pitfalls in attempting to be all things to all customers. For example, we recently spent time with a packaged food company that was trying to defend its market share through an aggressive innovation program. As the product line grew more complex, however, costs rose drastically: the marketing staff increased by 20 percent, inventory levels soared, and soon almost one-third of available machine time was being devoted to changeovers. Worse, as the company produced new low-volume items in large, "economical" lots, products grew stale before reaching the consumer. The innovation strategy threatened to destroy both the company's cost position and its market franchise. THE COSTS OF COMPLEXITY
I
n a traditionally managed organization, added complexity generally means significantly higher cost. This effect is seen in virtually every industry. In manufacturing, for example, direct labor costs per unit tend to increase substantially as operations become more complex. F i g u r e 2 shows the amount of direct labor required to assemble an automobile at each of eight plants as a function of plant throughput. As the dispersion of data points shows, economies of scale alone cannot explain cost behavior. But when the plants are divided into categories defined by Business Horizons / May-June 1990
Figure 1 Von's Format Delineatiotv--Existing and P l a n n e d Store Name
Segment Served
Format Spec~cs
VoWs
Middle income
20,000 square feet Some specialty departments
Von's Food and Drug Centers
Middle income Onestop shoppers
30,000 square foot combo stores Pharmacy Some specialty departments (eg, bakery, deli)
Vons Pavilion
Middle to upper income One-stop shoppers
50,000 square foot "food bazaar Specialty departments (eg, dell, bakery) Food boutiques (eg, freshly prepared sushi, espresso bar)
Tianguis
Lower to middle income Hispanic market
60,000-80,000 square foot combo stores Hispanic grocery selection Specialty departments: • Sausage shop • Taqueria (Mexican grill)
Unnamed
Lower to middle income Onestop shoppers
100,000 square feet, warehouse format
Source: Forbes, American Demographics, Supermarket News, Los Angeles Times
Figure 2 Direct Labor Assembly
"
I P21,23t01 ]
, ] Plant 5] Plant 6 88 ~ X ~ Plant7 i ~ P l a 5 0 6 1 ~ 5,3 /
Direct Labor Content (hours)
,
4,958 ] Plants ] ~ / Plan~2 ~ 2,750 I
4,500 ~ ,_ [ Plant 3 [ 5,017 ] ~ - -
P71'a39t44 ]
Number of Active Parts
7,500
5,000
2,500
Production Volumes (Thousands) Source: Booz, Allen Client F~perience
Conqueringthe Costsof Complexity
65
complexity, the expected relationship between plant volume and cost is revealed within each group. (Complexity was defined here as the number of active parts within a plant--a crude measure, but somewhat more meaningful than the number of final assemblies. Plants 1 and 2 have low complexity; plants 3, 5, 7, and 8 are moderately complex; and plants 4 and 6 are highly complex.) Within a complexity category, unit costs decline as volume increases. But complex plants have disturbingly higher costs than their less complex counterparts. This effect is due to both "mistakes" (such as parts shortages) and the inherent shop floor requirements of complexity (more setups, less learning). Overall, doubling ~ . _ the number of parts within a plant increases the direct labor requirements to "The key to corporate assemble any given unit by about oneagility is the way the third. Even more draenterprise is m a n a g e d matic diseconomies of complexity occur the 'software," if you in overhead costs, as will, driving the organiadditional accountzational machine. " ants, dispatchers, expediters, maintenance personnel, and the like become needed. Our client work has documented the costs of complexity in industries from glassware to food processing to electronics. On balance we have found that unit costs increase by 20 to 40 percent with each doubling in the complexity of a plant, distribution system, or overhead organization. In companies that have introduced many new products, entered new markets, or added distribution channels, costs of complexity may represent the fastest-growing category of total costs. CREATING THE AGILE ORGANIZATION
ome companies have proved it possible to combine innovation and variety in their product offerings with agility in operations. In this way they limit the cost penalty of complexity. As Kellogg pursued its market strategy of product innovation, it also implemented an operations strategy designed to enhance its flexibility and responsiveness and minimize the costs of complexity. Kellogg's new London, Ontario plant, for example, does not use traditional integrated lines; it decouples processing and packaging operations. This design change reduces both changeover and inventory costs. Changeovers in processing are driven by the type of cereal; changes in packaging by the size
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of the box. In a decoupled system, Kellogg can dedicate packaging lines by size of box, thus significantly reducing packaging changeover. A larger, more complex product line would normally require higher levels of finished goods inventory. But by storing product at the in-process stage and then packaging on nearly an "onorder" basis, Kellogg can wait to learn a particular month's requirements by package size. Now the plant can carry a smaller inventory of much less value, since packaging material represents a large part of product cost. Kellogg's new product introductions shifted the basis of competition in the cereal food category to innovation. In that mode of competition, the company enjoys a cost advantage, because its operations strategy emphasizes flexibility and responsiveness. The costs of complexity--still plaguing rival firms--have become a source of competitive advantage for Kellogg. Other companies in the United States, Japan, and Europe have pursued similar strategies, competing through innovation, flexibility, and responsiveness while managing the costs of complexity. Benetton has created a retail-to-plant information system that, together with advanced manufacturing technology and an interconnected set of suppliers, allows the company to make last-minute decisions on style and color. Japanese producers now require only two to three years to design an automobile, enabling them to refresh their products routinely every four years, while U.S. automakers remain on a six- to ten-year cycle. Campbell's Soup is producing regional formulations of its products and decentralizing its advertising and promotion efforts. Many athletic shoe companies use computer design systems of such flexibility that product life cycles are often one year or less. New technologies--such as compute>based information systems, computer-automated design, computer-integrated manufacturing, and flexible manufacturing systems--have played an important role in these strategies. Still more important, however, is the company's broader operating strategy and structure. The key to corporate agility is the way the enterprise is managed--the "software," if you will, driving the organizational machine. We have been studying and working with a number of firms that have found ways to compete on the basis of responsiveness and innovation without becoming swamped by the costs of complexity. Our observation suggests four rules for managing the agile organization: • Implement a "bottom-up" organization-knock down the walls of functionalization and compartmentalism; • De-emphasize scale and emphasize focus; • Plan for uncertainty, and structure accordingly; and Business Horizons / May-June1990
• Overhaul the organization and its culture. None of these concepts is a panacea in itself. But taken together, and combined with the right "hardware," they permit a level of flexibility, innovation, and responsiveness that the traditionally managed company, oriented toward mass production, simply cannot match. Together, these rules define a new set of operating economics. ORGANIZING FROM THE BOTTOM UP
he traditional organization model cannot handle either the type or volume of transactions required in today's fragmented market. Its centralized, functionally oriented structure, with eight to 12 tiers and spans of control of six to eight people, does an exceptional job of building critical mass and scale within a specialty or function. By centralizing maintenance departments within a facility, for example, a company can make specialized skills available to all parts of the organization at economical levels of utilization. The traditional organization is also extremely efficient at executing "vertical" transactions: communications, information, and decisions that flow up and down the organization. Middle managers serve as information filters, reporting exceptions up the line, and giving direction to the workers below. Top-down planning and control systems such as MRP, maintenance dispatch, and labor reporting systems help support this effort and maximize utilization of the productive workers and assets. Unfortunately, the mass-production organization is very inefficient in processing "horizontal" transactions: communications that flow between functional departments and between the company and its suppliers and customers. In today's fragmented marketplace, the volume of horizontal transactions has been expanding very rapidly, leading to "transaction overload" in many organizations. Consider the effort required in the massproduction factory to change from one component to the next. Schedulers, working with a complex MRP program, develop a rough-cut schedule; an area dispatcher sets the daily schedule; an expediter changes the schedule; a tool crib attendant releases the tool; a forklift driver transports the parts from the previous operation; a changeover team sets up the machine (probably a several-hour exercise); an inspector checks the first part; and, yes, an operator then runs the machine. An equally complex process is required to conceive, design, prototype, market test, and tool a new product. And in most organizations, new product development remains a sequential process of function-to-function handoffs that end up taking an extraordinary amount of time--a
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Conquering the Costs of Complexity
severe handicap in a world of eve>shrinking product life cycles. With greater emphasis on product variety and innovation, the number of horizontal transactions has multiplied. In response, many organizations have created new layers of mechanisms to improve horizontal information transfer. Unfortunately, the appointment of coordinators, expediters, steering committees, and task forces does little to improve the fundamental horizontal efficiency of most organizations, and merely exacerbates the cost inefficiency. Today's fragmented market requires a more decentralized, "bottom-up" organization, in which: • Structure is defined by horizontal transaction requirements as well as vertical transactions; • Workers have multiple skills; • There are few tiers; • Formal functional boundaries and barriers are minimized; and • Decisions are made at the lowest possible level. More and more companies are discovering the value of "More and more comempowering the work force with panies are discovering "management" rethe value of empowers p o n s i b i l i t y - combining the thinking, ing the work force with doing, and evaluation 'management" responprocess. Often the result is both greater sibility-combining the flexibility and producthinking, doing, a n d tivity. Consider the matter of machine evaluation process. " changeover. If the machine operator is responsible for many of the setup, maintenance, inspection, and material movement tasks, fewer transactions are required, the right decision is more likely to be made, and the worker is more productive. This bottom-up model can then be supported by horizontal information systems such as Kanban, in which communications flow directly from one cell operator to another, possibly including suppliers or customers. Such a system offers significant efficiency gains over an MRP environment. In the bottom-up organization, the cost of horizontal complexity is drastically reduced. The benefits of a bottom-up approach can be realized by service organizations as well as manufacturers. For example, hospitals have historically been organized functionally, with patients segmented by type into units supported by centralized services such as the radiology lab. To maximize use of these resources, most hospitals have developed elaborate scheduling procedures 67
that require extensive communication between the unit and the lab. Similar systems relay laboratory information about the patient back to the unit. In one hospital we studied, a simple chest x-ray required a sequence of 38 steps, of which 30 were tasks devoted to moving "Attempting to serve mul- things (such as gettiple missions within a ting the patient's file to the lab), recording single operating structure information, or coorusually results in lowestdinating activities. Of the two hours of staff common-denominator time required for an performance: excellence x-ray, only 20 percent was devoted to actual in nothing, mediocrity in patient care. Horizoneverything. " tal transactions were swamping the organization. The hospital is now experimenting with several approaches to reducing complexity costs. Xray care will be largely decentralized, for example. Each unit will have a portable x-ray machine under direct control of its staff. Unit nurses, rather than a radiologist, will administer routine x-rays (70 percent of the total). The central x-ray lab will administer only the more esoteric, highly capital-intensive procedures that require skilled technicians. The benefits of this approach are projected to be h u g e - - a 50 percent reduction in staffing plus more timely and effective information flow and patient care. In today's complex, fragmented market, horizontal communication costs between functions are often more important than economies of scale within a function. Therefore, just as the dominance of mainframe computers has been undercut by changes in computing requirements and the economics of computing, so must the traditional, pyramid organization model give way to a network of powerful mini-organizations structured around horizontal transactions. SCALE VERSUS FOCUS
anufacturers often centralize production to maximize scale and, in theory, reduce cost. But in a complex, unstable environment where flexibility is at a premium, the monolithic, mass-production organization is no longer competitive. Many manufacturers are finding that small, flexible production operations not only are more agile than their larger, more bureaucratic counterparts, but also operate at lower cost. This happy coincidence is partly due to new material and process technologies that reduce the minimum economic scale of processes and
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plants. Witness the ease with which GM can change the look of its plastic-bodied Fiero, and the proliferation of film processors, steel minimills, and Macintosh "publishers" throughout the United States. Moreover, focused organizations and plants--and at a more micro level, focused production cells facilitate horizontal communication across functions. They help instill a sense of ownership in the organization, focus employees on enhancing customer satisfaction, and make problems more visible. In our view, however, the most important factor in the success of small, focused plants is their unitary mission. Over time, as a company enters new market niches and distribution channels and proliferates its product line, it typically develops multiple missions. The costs of this form of complexity often outweigh any scale benefits that a large facility might have over a small, single-mission plant. By "mission," we mean a unique, limited set of objectives and goals. H~iagen-Dazs, for example, seeks to be the highest-quality ice cream on the market. If other dimensions of performance must be compromised to meet this mission, H~agen-Dazs will do so. Accordingly, the comp a w has established a costly direct-to-store delivery system to ensure the best-quality product on the retailer's shelf. Ideally, the entire organization--its structure, management practices, culture, information systems, and the like--will be geared to achieving the goals and objectives implicit in its mission. Attempting to serve multiple missions within a single operating structure usually results in lowest-common-denominator performance: excellence in nothing, mediocrity in everything. For example, most consumer product companies today sell through a variety of distribution channels, each with distinctive service requirements. A warehouse club, which sells on the basis of low price, tends to rank items such as trade promotion m o n e y above service criteria such as sales force quality. Conversely, sales force quality is very important to mom-and-pop grocery stores. Lacking the sophisticated systems of the larger chains, they need help in tracking inventory, rotating stock, and setting merchandising plans. Attempting to serve both channels with a single sales force strategy is courting disaster. One channel is likely to be overserved while the other finds its needs unmet. The benefits of focusing an organization on a single mission are significant. Consider the experience of "XYZ" Corporation's petroleum division, a major supplier of oil field equipment such as pipes and v a n e s for capping wells. Historically, XYZ produced all its components in a single large plant that maximized potential scale economies. This manufacturing strategy led to disapBusiness Horizons / May-June 1990
pointing performance, however. The plant was tremendously complex, offering over 20,000 catalog items plus an uncounted number of "specials." More than 42,000 active part numbers existed and rush orders were an everyday event. It was not unusual to see a helicopter landing in the parking lot to pick up a spare part for a downed rig. XYZ found that the answer was to split its large-scale plant into three smaller operations, each focused on a unique mission. A stock shop now produces catalog items in a very stable, planned environment, where the culture is to "keep hummin'." A project shop focuses on large, specially designed and engineered projects with lead times of six months to one year; its motto is to "make it right." Finally, a "hot shop" produces the short-lead-time, high-priority items that previously disrupted operations on the shop floor. Its culture is to "jump through hoops." Each plant has tailored its technology, systems, and organization to its own mission. This focused approach to manufacturing improved overall performance significantly: • Direct labor productivity rose 80 percent; • Capacity utilization was up 40 percent; • Inventory turnover quadrupled; and • Delivery reliability improved by 40 percent. Performance varied tremendously across the three plants. For example, the hot shop's direct labor productivity and capacity utilization were both about 25 percent below the level achieved by the stock shop. In fact, the hot shop did less well than the overall performance average before focusing. Thus the reorganization shed light on the costs of serving different market n i c h e s - information that XYZ found quite useful in setting prices. Unfortunately, mixed missions are rarely obvious. Rather, they tend to penetrate a plant, sales force, distribution system, or administrative organization over time through a sort of "creeping incrementalism." This is one reason why we advise clients to de-emphasize scale while continually testing their degree of focus. ALLOWING FOR UNCERTAINTY
he fragmentation of today's marketplace compounds the problems of uncertainty and instability that have always confronted organizations: What products should be produced? Through which technologies? Who are potential competitors? What skills are required within the organization? Uncertainty adds costs in two primary areas: obsolescence/startup and excess capacity. These costs are exacerbated in a mass-production organization that, fine-tuned for a stable environment, can be sent out of control by the shocks of market change. In today's dy-
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Conquering the Costs of Complexity
namic environment, production, engineering, and organizational systems must be designed to minimize the costs of uncertainty. Obsolescence and startup costs occur because of unpredictable stops and starts. For instance, as a new product replaces an old one, investments in tooling, machinery, and inventory may have to be written off. Huge initial investments in production equipment, inventories, and learning are also typically associated with a new product. A certain amount of excess capacity (safety stock inventories or additional production equipment) must be built into any system to allow for an unexpected surge in demand. For instance, a manufacturer that maintains excess capacity in several countries can shift production in response to exchange rate fluctuations. The costs of uncertainty are multiplied many times in a mass-production operation tooled for a stable mass market. For example, we recently advised a producer of artificial joints that was suffering from both poor customer service and excess inventories. Segmenting its product line by life cycle stage revealed that service problems were largely confined to newer products, while inventory excess was concentrated in products that had begun to decline. The implications were obvious--this manufacturer could not respond quickly enough to the dramatic volume swings in its markets. Additional analysis traced this inflexibility to the method of manufacture. Lead times were too long, lot sizes too large, agreements with vendors too inflexible. For instance, the combined manufacturing and procurement lead time for one popular new product was 215 days--this in a market where product life cycles often lasted three years or less! The priorities for this company were relatively straightforward: cut lot sizes and lead times, reorganize the shop floor into production cells, and develop more flexible relationships with its vendors. In doing so, it shrank its 215-day lead time down to 50 days. As the Japanese have known for some time, the manufacturing methods embodied in approaches such as "just-in-time" and "quality at the source" can greatly reduce the cost of uncertainty. Toyota developed its production system in the 1950s as it sought a cost-effective way to manufacture a
"in today's dynamic environment, production, engineering, and organizational systems must be designed to minimize the costs of uncertainty."
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broad line of automobiles in low volumes to compete with its larger competitor, Nissan. To excel in today's fragmented and volatile market, however, manufacturers will need to go beyond Japanese manufacturing methods, which are generally well understood and easily duplicated by most producers. Some innovative producers are experimenting with a concept we call "distributed" manufacturing, which dramatically shortens the supply chain. As a rule, complexity in the product line is most costly w h e n it occurs furthest from the customer (as measured by distance, time, and process steps). That gap between end user and production adds considerable uncertainty. When audiophiles assemble the components of a stereo system, they are engaging in distributed manufacturing. Paint provides another example. Many paint stores now have low-cost color analyzer systems attached to a personal computer. When presented with a color--that of your tie, for instance--the analyzer determines how basic color paints can be mixed together to produce an exact match. This formula can be electronically transferred to an automatic paint mixer for instantaneous mixing. This technology provides value to the customer while also benefiting manufacturer and retailer: • Consumers can specify a virtually infinite variety of paints, exactly matching the color shade desired; • The time a customer must wait for a mixed paint is cut severalfold; • Paint stores can stock fewer colors of paint and capture a greater portion of the value added in the supply chain; • Paint manufacturers potentially can produce only a few basic colors of paint, actually reducing complexity in the factory. A centralized manufacturer can sometimes effectively simulate distributed manufacturing by using information technology to cut the supply chain response time--as Benetton is demonstrating. Similarly, a leading retailing chain and its major appliance suppliers are combining, with the aid of a sophisticated telecommunications system, to offer customers three-day delivery on any version of an appliance ordered in a number of markets. In both cases, the result is the s a m e - greater choice in less time for the customer, and lower costs of uncertainty in the plant and distribution network. OVERHAULING THE ORGANIZATION
n the operational model described here, a company's human assets may be its key source of competitive advantage. If the organization has decentralized decision-making authority to serve a market that values creativity
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and innovation, the work force must be smart, self-motivated, and comfortable dealing with a range of functions and issues. Further, the organization must be able to change form and structure as the market evolves. That, in turn, requires flexible, multiskilled employees. Assembling a work force of this caliber is not easy. Training alone typically cannot do the job. Not surprisingly, most well-publicized successes (Goodyear's Lawton, Oklahoma plant or Honda's plant in Marysville, Ohio) were green field sites-the work force, culture, and organizational structure could be built from scratch. In hiring for Marysville, Honda screened an enormous number of people through an elaborate series of interviews and tests, including simulated work tasks to test the applicant's innovativeness and creativity. Established plants have seldom succeeded in implementing such an approach unless the organization's survival seemed threatened. Nevertheless, such "brown field" successes as General Motors' and Toyota's NUMMI plant suggest that most organizations already possess the required talent. The challenge, it seems, is to unleash it. Conversely, these experiences also suggest that most organizations have considerable deadwood that needs to be pruned before a new culture can take root. Some companies have succeeded by establishing an "organization-within-an-organization"-a separate entity with its own systems, procedures, and philosophies. This new organization "hires" from the existing labor pool, often using strict and intensive screening criteria like those employed at green field sites. For example, General Motors' new Saturn operation is an attempt to set up a new organization with a new way of operating within the GM structure. One problem with this approach is that it may spark counterproductive rivalries and ill feeling between the two organizations. With or without structural change, many organizations will benefit from an injection of passion and creative tension. In innovative companies, workers take personal responsibility for continually improving products, processes, and service. Such passion typically comes from commonly held visions and missions. Indeed, a commonly held vision is essential to give direction to the bottom-up organization. As organizations empower employees with responsibility, they must give them vision as well. There are many ways to impart an energizing tension to the work force: • Focusing attention by measuring the organization's "flexibility" (lead times, changeover times, number of new products); • Comparing performance with that of the competition; • Putting the organization into direct contact Business Horizons/ May-June 1990
with the customer (such as by locating order processing and customer service at the plant site). Managers can be a major roadblock to implementation. Instead of planning, checking, evaluating, and administering the work below and filtering information to superiors above-their traditional role in a hierarchical organization-managers must now become facilitators, trainers, and cheerleaders. The managerial reward system should be adjusted to encourage this reorientation. For example, compensation might be tied to such factors as people development instead of short-term profits. hese four rules amount to a recipe for revolution. Together they make possible efficient and effective delivery of the variety, innovation, and value demanded by today's niche-based market. By reshaping the
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Conquering the Costs of Complexity
economics of production, agile manufacturers can turn complexity from a cost burden to a source of competitive advantage. Today's changed environment demands that operating managers rethink how they compete. Only by coming to grips with the new operating imperatives and economics of "agile" manufacturing will U.S. producers prosper. To the pioneers will go the rewards. O
James A. Gingrich is a principal, and Horst J. Metz is a vice president, both at
Booz, Allen & Hamilton, Chicago.
71
M
any of today's most successful corporations are prospering by offering an unprecedented variety of products sold through multiple distribution channels to carefully differentiated customer segments. Other companies, pursuing the same goal, are choking on the complexity of their operations. What makes the difference? Flexible technologies help, but fresh management approaches are crucial. That the marketplace of the late 1980s rewards variety is beyond dispute. To cite but one example: Kellogg, the cereal manufacturer, has found that the more new products it introduces, the higher its growth rate. In the cereal industry overall, greater breadth of product line has been unmistakably associated with market share gains in the 1980s. Such product proliferation has become a way of life in nearly every manufacturing and service industry. AT&T manufactures more than 1,000 types and colors of telephones; Revlon markets 157 lipstick shades; persnickety pets can choose among 23 flavors of Nine Lives cat food. In the service sector, hamburger outlets must compete with fast-food pizza, fried chicken, and numerous international cuisines. Traditional hospitals find some of their customers departing for health maintenance organizations, specialty surgery centers, and outpatient clinics. Distribution channels and retail formats are also multiplying. Today's consumers make purchases in airports, on planes, by mail, phone, computer, or television. Traditional retailers share
Flexible manufacturing can help in today's complex markets, but flexible management is an oft-forgotten key.
64
customers with warehouse clubs, discount stores, boutiques, and outlets focusing on a particular line of merchandise. A recent survey shows, for example, that many people regularly buy food at a range of outlet types. Even within a given retail format, distinctions are becoming finer. The Target Stores chain positions itself as an upscale discounter. Von's, a successful West Coast grocery chain, has developed multiple formats targeted toward particular customer segments (Figure 1). Managing a business successfully in today's complex marketplace has its costs, and there are pitfalls in attempting to be all things to all customers. For example, we recently spent time with a packaged food company that was trying to defend its market share through an aggressive innovation program. As the product line grew more complex, however, costs rose drastically: the marketing staff increased by 20 percent, inventory levels soared, and soon almost one-third of available machine time was being devoted to changeovers. Worse, as the company produced new low-volume items in large, "economical" lots, products grew stale before reaching the consumer. The innovation strategy threatened to destroy both the company's cost position and its market franchise. THE COSTS OF COMPLEXITY
I
n a traditionally managed organization, added complexity generally means significantly higher cost. This effect is seen in virtually every industry. In manufacturing, for example, direct labor costs per unit tend to increase substantially as operations become more complex. F i g u r e 2 shows the amount of direct labor required to assemble an automobile at each of eight plants as a function of plant throughput. As the dispersion of data points shows, economies of scale alone cannot explain cost behavior. But when the plants are divided into categories defined by Business Horizons / May-June 1990
Figure 1 Von's Format Delineatiotv--Existing and P l a n n e d Store Name
Segment Served
Format Spec~cs
VoWs
Middle income
20,000 square feet Some specialty departments
Von's Food and Drug Centers
Middle income Onestop shoppers
30,000 square foot combo stores Pharmacy Some specialty departments (eg, bakery, deli)
Vons Pavilion
Middle to upper income One-stop shoppers
50,000 square foot "food bazaar Specialty departments (eg, dell, bakery) Food boutiques (eg, freshly prepared sushi, espresso bar)
Tianguis
Lower to middle income Hispanic market
60,000-80,000 square foot combo stores Hispanic grocery selection Specialty departments: • Sausage shop • Taqueria (Mexican grill)
Unnamed
Lower to middle income Onestop shoppers
100,000 square feet, warehouse format
Source: Forbes, American Demographics, Supermarket News, Los Angeles Times
Figure 2 Direct Labor Assembly
"
I P21,23t01 ]
, ] Plant 5] Plant 6 88 ~ X ~ Plant7 i ~ P l a 5 0 6 1 ~ 5,3 /
Direct Labor Content (hours)
,
4,958 ] Plants ] ~ / Plan~2 ~ 2,750 I
4,500 ~ ,_ [ Plant 3 [ 5,017 ] ~ - -
P71'a39t44 ]
Number of Active Parts
7,500
5,000
2,500
Production Volumes (Thousands) Source: Booz, Allen Client F~perience
Conqueringthe Costsof Complexity
65
complexity, the expected relationship between plant volume and cost is revealed within each group. (Complexity was defined here as the number of active parts within a plant--a crude measure, but somewhat more meaningful than the number of final assemblies. Plants 1 and 2 have low complexity; plants 3, 5, 7, and 8 are moderately complex; and plants 4 and 6 are highly complex.) Within a complexity category, unit costs decline as volume increases. But complex plants have disturbingly higher costs than their less complex counterparts. This effect is due to both "mistakes" (such as parts shortages) and the inherent shop floor requirements of complexity (more setups, less learning). Overall, doubling ~ . _ the number of parts within a plant increases the direct labor requirements to "The key to corporate assemble any given unit by about oneagility is the way the third. Even more draenterprise is m a n a g e d matic diseconomies of complexity occur the 'software," if you in overhead costs, as will, driving the organiadditional accountzational machine. " ants, dispatchers, expediters, maintenance personnel, and the like become needed. Our client work has documented the costs of complexity in industries from glassware to food processing to electronics. On balance we have found that unit costs increase by 20 to 40 percent with each doubling in the complexity of a plant, distribution system, or overhead organization. In companies that have introduced many new products, entered new markets, or added distribution channels, costs of complexity may represent the fastest-growing category of total costs. CREATING THE AGILE ORGANIZATION
ome companies have proved it possible to combine innovation and variety in their product offerings with agility in operations. In this way they limit the cost penalty of complexity. As Kellogg pursued its market strategy of product innovation, it also implemented an operations strategy designed to enhance its flexibility and responsiveness and minimize the costs of complexity. Kellogg's new London, Ontario plant, for example, does not use traditional integrated lines; it decouples processing and packaging operations. This design change reduces both changeover and inventory costs. Changeovers in processing are driven by the type of cereal; changes in packaging by the size
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of the box. In a decoupled system, Kellogg can dedicate packaging lines by size of box, thus significantly reducing packaging changeover. A larger, more complex product line would normally require higher levels of finished goods inventory. But by storing product at the in-process stage and then packaging on nearly an "onorder" basis, Kellogg can wait to learn a particular month's requirements by package size. Now the plant can carry a smaller inventory of much less value, since packaging material represents a large part of product cost. Kellogg's new product introductions shifted the basis of competition in the cereal food category to innovation. In that mode of competition, the company enjoys a cost advantage, because its operations strategy emphasizes flexibility and responsiveness. The costs of complexity--still plaguing rival firms--have become a source of competitive advantage for Kellogg. Other companies in the United States, Japan, and Europe have pursued similar strategies, competing through innovation, flexibility, and responsiveness while managing the costs of complexity. Benetton has created a retail-to-plant information system that, together with advanced manufacturing technology and an interconnected set of suppliers, allows the company to make last-minute decisions on style and color. Japanese producers now require only two to three years to design an automobile, enabling them to refresh their products routinely every four years, while U.S. automakers remain on a six- to ten-year cycle. Campbell's Soup is producing regional formulations of its products and decentralizing its advertising and promotion efforts. Many athletic shoe companies use computer design systems of such flexibility that product life cycles are often one year or less. New technologies--such as compute>based information systems, computer-automated design, computer-integrated manufacturing, and flexible manufacturing systems--have played an important role in these strategies. Still more important, however, is the company's broader operating strategy and structure. The key to corporate agility is the way the enterprise is managed--the "software," if you will, driving the organizational machine. We have been studying and working with a number of firms that have found ways to compete on the basis of responsiveness and innovation without becoming swamped by the costs of complexity. Our observation suggests four rules for managing the agile organization: • Implement a "bottom-up" organization-knock down the walls of functionalization and compartmentalism; • De-emphasize scale and emphasize focus; • Plan for uncertainty, and structure accordingly; and Business Horizons / May-June1990
• Overhaul the organization and its culture. None of these concepts is a panacea in itself. But taken together, and combined with the right "hardware," they permit a level of flexibility, innovation, and responsiveness that the traditionally managed company, oriented toward mass production, simply cannot match. Together, these rules define a new set of operating economics. ORGANIZING FROM THE BOTTOM UP
he traditional organization model cannot handle either the type or volume of transactions required in today's fragmented market. Its centralized, functionally oriented structure, with eight to 12 tiers and spans of control of six to eight people, does an exceptional job of building critical mass and scale within a specialty or function. By centralizing maintenance departments within a facility, for example, a company can make specialized skills available to all parts of the organization at economical levels of utilization. The traditional organization is also extremely efficient at executing "vertical" transactions: communications, information, and decisions that flow up and down the organization. Middle managers serve as information filters, reporting exceptions up the line, and giving direction to the workers below. Top-down planning and control systems such as MRP, maintenance dispatch, and labor reporting systems help support this effort and maximize utilization of the productive workers and assets. Unfortunately, the mass-production organization is very inefficient in processing "horizontal" transactions: communications that flow between functional departments and between the company and its suppliers and customers. In today's fragmented marketplace, the volume of horizontal transactions has been expanding very rapidly, leading to "transaction overload" in many organizations. Consider the effort required in the massproduction factory to change from one component to the next. Schedulers, working with a complex MRP program, develop a rough-cut schedule; an area dispatcher sets the daily schedule; an expediter changes the schedule; a tool crib attendant releases the tool; a forklift driver transports the parts from the previous operation; a changeover team sets up the machine (probably a several-hour exercise); an inspector checks the first part; and, yes, an operator then runs the machine. An equally complex process is required to conceive, design, prototype, market test, and tool a new product. And in most organizations, new product development remains a sequential process of function-to-function handoffs that end up taking an extraordinary amount of time--a
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severe handicap in a world of eve>shrinking product life cycles. With greater emphasis on product variety and innovation, the number of horizontal transactions has multiplied. In response, many organizations have created new layers of mechanisms to improve horizontal information transfer. Unfortunately, the appointment of coordinators, expediters, steering committees, and task forces does little to improve the fundamental horizontal efficiency of most organizations, and merely exacerbates the cost inefficiency. Today's fragmented market requires a more decentralized, "bottom-up" organization, in which: • Structure is defined by horizontal transaction requirements as well as vertical transactions; • Workers have multiple skills; • There are few tiers; • Formal functional boundaries and barriers are minimized; and • Decisions are made at the lowest possible level. More and more companies are discovering the value of "More and more comempowering the work force with panies are discovering "management" rethe value of empowers p o n s i b i l i t y - combining the thinking, ing the work force with doing, and evaluation 'management" responprocess. Often the result is both greater sibility-combining the flexibility and producthinking, doing, a n d tivity. Consider the matter of machine evaluation process. " changeover. If the machine operator is responsible for many of the setup, maintenance, inspection, and material movement tasks, fewer transactions are required, the right decision is more likely to be made, and the worker is more productive. This bottom-up model can then be supported by horizontal information systems such as Kanban, in which communications flow directly from one cell operator to another, possibly including suppliers or customers. Such a system offers significant efficiency gains over an MRP environment. In the bottom-up organization, the cost of horizontal complexity is drastically reduced. The benefits of a bottom-up approach can be realized by service organizations as well as manufacturers. For example, hospitals have historically been organized functionally, with patients segmented by type into units supported by centralized services such as the radiology lab. To maximize use of these resources, most hospitals have developed elaborate scheduling procedures 67
that require extensive communication between the unit and the lab. Similar systems relay laboratory information about the patient back to the unit. In one hospital we studied, a simple chest x-ray required a sequence of 38 steps, of which 30 were tasks devoted to moving "Attempting to serve mul- things (such as gettiple missions within a ting the patient's file to the lab), recording single operating structure information, or coorusually results in lowestdinating activities. Of the two hours of staff common-denominator time required for an performance: excellence x-ray, only 20 percent was devoted to actual in nothing, mediocrity in patient care. Horizoneverything. " tal transactions were swamping the organization. The hospital is now experimenting with several approaches to reducing complexity costs. Xray care will be largely decentralized, for example. Each unit will have a portable x-ray machine under direct control of its staff. Unit nurses, rather than a radiologist, will administer routine x-rays (70 percent of the total). The central x-ray lab will administer only the more esoteric, highly capital-intensive procedures that require skilled technicians. The benefits of this approach are projected to be h u g e - - a 50 percent reduction in staffing plus more timely and effective information flow and patient care. In today's complex, fragmented market, horizontal communication costs between functions are often more important than economies of scale within a function. Therefore, just as the dominance of mainframe computers has been undercut by changes in computing requirements and the economics of computing, so must the traditional, pyramid organization model give way to a network of powerful mini-organizations structured around horizontal transactions. SCALE VERSUS FOCUS
anufacturers often centralize production to maximize scale and, in theory, reduce cost. But in a complex, unstable environment where flexibility is at a premium, the monolithic, mass-production organization is no longer competitive. Many manufacturers are finding that small, flexible production operations not only are more agile than their larger, more bureaucratic counterparts, but also operate at lower cost. This happy coincidence is partly due to new material and process technologies that reduce the minimum economic scale of processes and
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plants. Witness the ease with which GM can change the look of its plastic-bodied Fiero, and the proliferation of film processors, steel minimills, and Macintosh "publishers" throughout the United States. Moreover, focused organizations and plants--and at a more micro level, focused production cells facilitate horizontal communication across functions. They help instill a sense of ownership in the organization, focus employees on enhancing customer satisfaction, and make problems more visible. In our view, however, the most important factor in the success of small, focused plants is their unitary mission. Over time, as a company enters new market niches and distribution channels and proliferates its product line, it typically develops multiple missions. The costs of this form of complexity often outweigh any scale benefits that a large facility might have over a small, single-mission plant. By "mission," we mean a unique, limited set of objectives and goals. H~iagen-Dazs, for example, seeks to be the highest-quality ice cream on the market. If other dimensions of performance must be compromised to meet this mission, H~agen-Dazs will do so. Accordingly, the comp a w has established a costly direct-to-store delivery system to ensure the best-quality product on the retailer's shelf. Ideally, the entire organization--its structure, management practices, culture, information systems, and the like--will be geared to achieving the goals and objectives implicit in its mission. Attempting to serve multiple missions within a single operating structure usually results in lowest-common-denominator performance: excellence in nothing, mediocrity in everything. For example, most consumer product companies today sell through a variety of distribution channels, each with distinctive service requirements. A warehouse club, which sells on the basis of low price, tends to rank items such as trade promotion m o n e y above service criteria such as sales force quality. Conversely, sales force quality is very important to mom-and-pop grocery stores. Lacking the sophisticated systems of the larger chains, they need help in tracking inventory, rotating stock, and setting merchandising plans. Attempting to serve both channels with a single sales force strategy is courting disaster. One channel is likely to be overserved while the other finds its needs unmet. The benefits of focusing an organization on a single mission are significant. Consider the experience of "XYZ" Corporation's petroleum division, a major supplier of oil field equipment such as pipes and v a n e s for capping wells. Historically, XYZ produced all its components in a single large plant that maximized potential scale economies. This manufacturing strategy led to disapBusiness Horizons / May-June 1990
pointing performance, however. The plant was tremendously complex, offering over 20,000 catalog items plus an uncounted number of "specials." More than 42,000 active part numbers existed and rush orders were an everyday event. It was not unusual to see a helicopter landing in the parking lot to pick up a spare part for a downed rig. XYZ found that the answer was to split its large-scale plant into three smaller operations, each focused on a unique mission. A stock shop now produces catalog items in a very stable, planned environment, where the culture is to "keep hummin'." A project shop focuses on large, specially designed and engineered projects with lead times of six months to one year; its motto is to "make it right." Finally, a "hot shop" produces the short-lead-time, high-priority items that previously disrupted operations on the shop floor. Its culture is to "jump through hoops." Each plant has tailored its technology, systems, and organization to its own mission. This focused approach to manufacturing improved overall performance significantly: • Direct labor productivity rose 80 percent; • Capacity utilization was up 40 percent; • Inventory turnover quadrupled; and • Delivery reliability improved by 40 percent. Performance varied tremendously across the three plants. For example, the hot shop's direct labor productivity and capacity utilization were both about 25 percent below the level achieved by the stock shop. In fact, the hot shop did less well than the overall performance average before focusing. Thus the reorganization shed light on the costs of serving different market n i c h e s - information that XYZ found quite useful in setting prices. Unfortunately, mixed missions are rarely obvious. Rather, they tend to penetrate a plant, sales force, distribution system, or administrative organization over time through a sort of "creeping incrementalism." This is one reason why we advise clients to de-emphasize scale while continually testing their degree of focus. ALLOWING FOR UNCERTAINTY
he fragmentation of today's marketplace compounds the problems of uncertainty and instability that have always confronted organizations: What products should be produced? Through which technologies? Who are potential competitors? What skills are required within the organization? Uncertainty adds costs in two primary areas: obsolescence/startup and excess capacity. These costs are exacerbated in a mass-production organization that, fine-tuned for a stable environment, can be sent out of control by the shocks of market change. In today's dy-
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namic environment, production, engineering, and organizational systems must be designed to minimize the costs of uncertainty. Obsolescence and startup costs occur because of unpredictable stops and starts. For instance, as a new product replaces an old one, investments in tooling, machinery, and inventory may have to be written off. Huge initial investments in production equipment, inventories, and learning are also typically associated with a new product. A certain amount of excess capacity (safety stock inventories or additional production equipment) must be built into any system to allow for an unexpected surge in demand. For instance, a manufacturer that maintains excess capacity in several countries can shift production in response to exchange rate fluctuations. The costs of uncertainty are multiplied many times in a mass-production operation tooled for a stable mass market. For example, we recently advised a producer of artificial joints that was suffering from both poor customer service and excess inventories. Segmenting its product line by life cycle stage revealed that service problems were largely confined to newer products, while inventory excess was concentrated in products that had begun to decline. The implications were obvious--this manufacturer could not respond quickly enough to the dramatic volume swings in its markets. Additional analysis traced this inflexibility to the method of manufacture. Lead times were too long, lot sizes too large, agreements with vendors too inflexible. For instance, the combined manufacturing and procurement lead time for one popular new product was 215 days--this in a market where product life cycles often lasted three years or less! The priorities for this company were relatively straightforward: cut lot sizes and lead times, reorganize the shop floor into production cells, and develop more flexible relationships with its vendors. In doing so, it shrank its 215-day lead time down to 50 days. As the Japanese have known for some time, the manufacturing methods embodied in approaches such as "just-in-time" and "quality at the source" can greatly reduce the cost of uncertainty. Toyota developed its production system in the 1950s as it sought a cost-effective way to manufacture a
"in today's dynamic environment, production, engineering, and organizational systems must be designed to minimize the costs of uncertainty."
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broad line of automobiles in low volumes to compete with its larger competitor, Nissan. To excel in today's fragmented and volatile market, however, manufacturers will need to go beyond Japanese manufacturing methods, which are generally well understood and easily duplicated by most producers. Some innovative producers are experimenting with a concept we call "distributed" manufacturing, which dramatically shortens the supply chain. As a rule, complexity in the product line is most costly w h e n it occurs furthest from the customer (as measured by distance, time, and process steps). That gap between end user and production adds considerable uncertainty. When audiophiles assemble the components of a stereo system, they are engaging in distributed manufacturing. Paint provides another example. Many paint stores now have low-cost color analyzer systems attached to a personal computer. When presented with a color--that of your tie, for instance--the analyzer determines how basic color paints can be mixed together to produce an exact match. This formula can be electronically transferred to an automatic paint mixer for instantaneous mixing. This technology provides value to the customer while also benefiting manufacturer and retailer: • Consumers can specify a virtually infinite variety of paints, exactly matching the color shade desired; • The time a customer must wait for a mixed paint is cut severalfold; • Paint stores can stock fewer colors of paint and capture a greater portion of the value added in the supply chain; • Paint manufacturers potentially can produce only a few basic colors of paint, actually reducing complexity in the factory. A centralized manufacturer can sometimes effectively simulate distributed manufacturing by using information technology to cut the supply chain response time--as Benetton is demonstrating. Similarly, a leading retailing chain and its major appliance suppliers are combining, with the aid of a sophisticated telecommunications system, to offer customers three-day delivery on any version of an appliance ordered in a number of markets. In both cases, the result is the s a m e - greater choice in less time for the customer, and lower costs of uncertainty in the plant and distribution network. OVERHAULING THE ORGANIZATION
n the operational model described here, a company's human assets may be its key source of competitive advantage. If the organization has decentralized decision-making authority to serve a market that values creativity
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and innovation, the work force must be smart, self-motivated, and comfortable dealing with a range of functions and issues. Further, the organization must be able to change form and structure as the market evolves. That, in turn, requires flexible, multiskilled employees. Assembling a work force of this caliber is not easy. Training alone typically cannot do the job. Not surprisingly, most well-publicized successes (Goodyear's Lawton, Oklahoma plant or Honda's plant in Marysville, Ohio) were green field sites-the work force, culture, and organizational structure could be built from scratch. In hiring for Marysville, Honda screened an enormous number of people through an elaborate series of interviews and tests, including simulated work tasks to test the applicant's innovativeness and creativity. Established plants have seldom succeeded in implementing such an approach unless the organization's survival seemed threatened. Nevertheless, such "brown field" successes as General Motors' and Toyota's NUMMI plant suggest that most organizations already possess the required talent. The challenge, it seems, is to unleash it. Conversely, these experiences also suggest that most organizations have considerable deadwood that needs to be pruned before a new culture can take root. Some companies have succeeded by establishing an "organization-within-an-organization"-a separate entity with its own systems, procedures, and philosophies. This new organization "hires" from the existing labor pool, often using strict and intensive screening criteria like those employed at green field sites. For example, General Motors' new Saturn operation is an attempt to set up a new organization with a new way of operating within the GM structure. One problem with this approach is that it may spark counterproductive rivalries and ill feeling between the two organizations. With or without structural change, many organizations will benefit from an injection of passion and creative tension. In innovative companies, workers take personal responsibility for continually improving products, processes, and service. Such passion typically comes from commonly held visions and missions. Indeed, a commonly held vision is essential to give direction to the bottom-up organization. As organizations empower employees with responsibility, they must give them vision as well. There are many ways to impart an energizing tension to the work force: • Focusing attention by measuring the organization's "flexibility" (lead times, changeover times, number of new products); • Comparing performance with that of the competition; • Putting the organization into direct contact Business Horizons/ May-June 1990
with the customer (such as by locating order processing and customer service at the plant site). Managers can be a major roadblock to implementation. Instead of planning, checking, evaluating, and administering the work below and filtering information to superiors above-their traditional role in a hierarchical organization-managers must now become facilitators, trainers, and cheerleaders. The managerial reward system should be adjusted to encourage this reorientation. For example, compensation might be tied to such factors as people development instead of short-term profits. hese four rules amount to a recipe for revolution. Together they make possible efficient and effective delivery of the variety, innovation, and value demanded by today's niche-based market. By reshaping the
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economics of production, agile manufacturers can turn complexity from a cost burden to a source of competitive advantage. Today's changed environment demands that operating managers rethink how they compete. Only by coming to grips with the new operating imperatives and economics of "agile" manufacturing will U.S. producers prosper. To the pioneers will go the rewards. O
James A. Gingrich is a principal, and Horst J. Metz is a vice president, both at
Booz, Allen & Hamilton, Chicago.
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