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Stewart Anderson

Quality Insider

Linking Improvement to Strategy

Not all improvements provide a permanent and sustainable competitive advantage.

Published: Thursday, May 27, 2010 - 06:30

I am often struck by a remark of W. Edwards Deming that the aim of a system must include plans for the future. As Deming wrote in The New Economics (Massachusetts Institute of Technology, 1994), “A system must have an aim. Without an aim, there is no system. The aim of the system must be clear to everyone in the system. The aim must include plans for the future. The aim is a value judgment.” This remark, it seems to me, goes right to the heart of needing to think about continuous improvement strategically, rather than tactically as a program or initiative to be undertaken.

Many firms undertake improvement initiatives to improve quality or, in the case of lean manufacturing, to increase added value by reducing and eliminating the amount of nonvalue adding activity. The rationale for many of these initiatives is the desire to reduce costs, thereby improving a firm’s profitability. However, high quality and low costs are no guarantee of profits.

To see why this is so, consider the ways in which a firm may position itself to compete in the marketplace. As outlined by Harvard Business School’s Michael Porter in Competitive Advantage (The Free Press, 1985), there are essentially three generic strategies through which a firm may position itself to compete in the marketplace:

Cost advantage. A firm seeks to be the low-cost provider in its industry. The firm reduces its costs across a broad product line, while providing to customers the same benefits in its product or services as are offered by competitors. Through gaining a cost advantage, a firm offers its product or service to customers for the same, or slightly lower, price than competitors. Due to the firm’s lower cost structure, it gains a larger per unit profit margin from each unit sold than the competition.

Differentiation advantage. A firm seeks to gain a competitive advantage through unique characteristics that have high appeal to many customers. Because a differentiation strategy is based on some significant uniqueness that many customers value beyond the purchase price, a firm employing such a strategy can charge a premium price for its product or service. Through the higher price point, the firm may thereby generate additional revenue per unit of sale than the competition.

Focus advantage. This is where a firm seeks to employ a cost or differentiation strategy that is limited to a specific market niche and therefore does not appeal to most customers.

The above framework doesn’t imply that companies always must choose between using a cost advantage strategy or a differentiation strategy—there is no reason why a company cannot employ a cost advantage and differentiation advantage simultaneously to enhance its competitive position. Firms can offer unique benefits to customers through differentiation, or decrease costs, or do both.

Excellence in quality has become part of the strategic objectives for many companies in many industries. Top management in these firms has deemed high quality to be essential for business success. Quality may be wielded as a weapon that enables product or service differentiation and allows a firm to charge a price premium; or it may be used to drive costs savings through reduced scrap, rework, and warranty repairs. Much the same can be said for lean manufacturing, where there is a broader emphasis on achieving velocity and speed through the waste reduction.

Toyota is an example of the type of firm that has sometimes been called a “lean-differentiator”—it offers (or offered, until recently) better quality than the competition at the same or lower prices, while enjoying lower cost structures that come from more effective and efficient production achieved through the Toyota Production System (TPS).

For the top management of many firms, the key question has not been, “Is quality excellence a desirable strategic objective?” but rather, “How should we execute our quality strategy effectively?”

In addressing this question, we have to be mindful of two key concepts in strategic thinking. The first is that the creation and maintenance of competitive advantage is a continuous cycle, as Deming alluded to in the quote above. The second is that competitors may choose to respond to moves made by a firm seeking to gain an advantage, and companies making such moves need to consider how the competition may respond.

Taking the first concept, the sources of competitive advantage for a firm are to be found in two areas: assets and capabilities. Assets are the things a company has—equipment and technology, human resources, capital, etc. Capabilities are how the assets are used. Superior assets and capabilities are the source of positional advantages in the marketplace. Where a company has such superior assets and resources, it should seek to use them to have an advantage over the competition.

However, sources of competitive advantage are never permanent. A firm’s sources of advantage will always be subject to erosion by changes in customer perceptions and by the moves of competitors. This brings us to the second concept—competitors are likely to imitate, or otherwise blunt, a firm’s source of competitive advantage, meaning that a company must always be replanning for the future, and re-investing in creating new assets and capabilities.

With respect to these concepts, it is instructive to look at the automotive industry. As noted above, until fairly recently, few would dispute that Toyota enjoyed a significantly differentiated position in the auto industry due to the high quality and reliability of its vehicles. In addition, the company’s approach to production through the Toyota Production System allowed it to enjoy higher profit margins per unit of sale than its competitors due to lower costs enabled through more effective and productive operations. Most important, Toyota had created a set of distinctive capabilities, or characteristics that weren’t easily replicable by competitors which allowed it to compete successfully in the marketplace.

However, during the last few years, competitors have been closing the quality and reliability gap on Toyota, thanks in no small measure to imitating some of the features of TPS, and these competitors now enjoy lower cost structures due to the industry restructuring that has taken place recently. In short, Toyota’s competitive position no longer seems as unassailable as it once was, and the company now has to embark on a process of renewal to maintain its industry position.

That it has taken Toyota’s competitors a long time to close the gap on quality and reliability should come as no surprise. Capabilities that are rooted in specialized know-how, learning, and knowledge, such as the Toyota Production System, are difficult to copy and imitate quickly—as many companies who have tried to implement these principles and techniques in their own operations, through lean manufacturing initiatives, have discovered. The experience-curve effects are real.

Nonetheless, it should be noted that certain capabilities can be recreated and reproduced by other firms. Technical capabilities are especially vulnerable to reproduction and imitation. For this reason, it is important for top management to appreciate that only truly distinctive capabilities that aren’t easily reproduced can be the basis of sustainable competitive advantage. Because they may not be truly distinctive and therefore more easily reproduced, capabilities that enable high quality and low cost production should not be considered as guaranteeing sustainable profitability.

Deming knew that firms need to be concerned with continuously understanding and addressing the causes of variation in their systems. But he also knew that the aim of a system had to be continually revisited and altered in response to changed conditions.

It is right and beneficial for companies to use best practices drawn from Six Sigma to improve quality, and lean manufacturing to improve operations and their costs. However, in many industries, achieving high quality and lean operations have become the price of admission to compete in those industries. By themselves, these approaches are no longer sufficiently strong sources of uniqueness to assure a firm’s business sustainability. Rather, it is the aim of a firm’s system that must continuously change and adapt in response to a changing market environment and customer perceptions, and this is a strategic issue. In business, as in nature, it is not the strongest (or the leanest) who survive, but those who are most able to adapt to changes in their environment.

The key question for companies to address, therefore, is how they will continually adapt to their changing environment to sustain themselves. Throughout the years, managers have been inundated with a flood of management fads and programs, from total quality management, to reengineering, to leaders as philosophers, and companies as symphony orchestras and football teams. Companies have been exhorted to become “networked organizations,” “hyper competitors,” “lean enterprises,” and “learning organizations.” While all of these concepts have merit and provide powerful insights and benefit, none alone is an effective substitute for strategic management.

The following questions might be useful for companies to consider for ensuring that improvement of their system is linked to, and flows out from, a strategic perspective:

1. What are your current sources of competitive advantage in terms of assets and capabilities? How are these assets and capabilities distinctive, unique, and different from the competition? Do these assets and capabilities translate into valuable benefits for the customer, lower costs, or both?

2. Does your firm’s business environment allow you to turn your unique assets and capabilities into profit? To what extent might your competition erode your sources of profit, and how might competitive rivalry need to be managed to sustain profits over the long haul?

3. Where does your strategic value proposition lie? Does it lie in innovating or creating new products or services? Or is it in competing more effectively through agility and speed? Or is it in efficiency, where you create and deliver the needed value more cheaply? Or perhaps does it lie in developing and leveraging your internal capacity to collaborate effectively around customers and their needs? The strategic value proposition may give you a clue to the assets and capabilities you need, or need to develop and improve, to compete more effectively.

4. What barriers can you erect to prevent competitors from eroding and imitating the advantages conferred by the assets and capabilities in your system? For example, if you enhance your operational capability through lean manufacturing, can you institutionalize the widespread knowledge and learning gained to make it difficult for competitors to imitate, even if they were to hire some of your employees away?

5. As you deploy your strategy for gaining competitive advantage, how will you anticipate competitor’s actions and reactions, as well as changes in customer perceptions? For example, if you are able to enjoy lower costs through quality improvement or lean initiatives, and you choose to pass some of these savings through to customers in the form of lower prices, how is the competition likely to react? Might you enjoy a period of gaining market share at their expense, or might you trigger a price war where nobody wins and lower profits result?

6. While profitability is considered to be a necessary condition for ensuring a firm’s survival, making an accounting profit is not enough to ensure sustainability. Companies should focus on generating an economic profit from their continuous improvement activities. Economic profit goes beyond accounting profit to consider the cost of capital tied up in a firm’s inputs and assets. Firms making a positive economic profit are creating wealth—generating a greater return than if they would have if they put their capital to its next best alternative use. Economic profit only results from real value creation and its importance lies in the fact that it generates clean surpluses which can be reinvested back into the business.

7. Remember that improving profitability is not just about reducing costs. Reducing costs is only one way to improve profitability. Rather than using approaches such as lean to simply reduce costs, consider how revenues may also be increased. Together with asking employees to take waste and costs out their system through lean, companies should also be asking employees to consider how their lean processes will contribute to revenue generation.

8. How will your firm avoid becoming homogenized into sameness with the competition? What makes companies truly competitive are their unique advantages. If your advantages become diluted or copied, how will preserve your uniqueness? As Deming might say, “What will be your plans for the future?”


About The Author

Stewart Anderson’s picture

Stewart Anderson

Stewart Anderson is a partner with Anderson Lyall Consulting Group, a Toronto-based consulting and advisory firm that helps firms develop their competitive advantage. Anderson’s background and expertise includes competitive strategy and value chain engineering. He has advised companies in the manufacturing, service, and contract manufacturing industries. Anderson is completing his bachelor of arts in economics and he is a certified trainer in lean manufacturing principles and techniques.