MCE Chapter 7

MCE Chapter 7

1. Escaping Perfect Competition

   • 2. Process Enhancement (Chapter 7 Part II)
     • Process Enhancement: making investments to reduce the cost of manufacture, to increase the capabilities of the manufacturing system, or both
       • Process Enhancement may affect product characteristics directly and perhaps provide an opportunity to differentiate
         • 1. Increasing the Capabilities of the Production System
           • If a firm can develop innovative capabilities faster (and/or better) than its rivals, it can convert this into product characteristics that provide differentiation opportunities
             • Example: Technology - (1) to provide faster or new forms of distribution
               • (2) to have online access to ordering product or obtaining technical assistance
       • Process Enhancement may reduce the average cost of production (Productivity/Efficiency Improvement
         • 2. Reducing Costs of Producing the Good/Service
           • a.k.a Productivity or Efficiency Improvement
             • If a firm can reduce the cost or production before or more rapidly than its rivals, it can reduce the price for the consumer (before or more rapidly than its rivals), which results in gaining competitive advantage
               • Basically, to reduce prices we can: (1) make more stuff at the same total cost
                 • (2) make the same amount amount of stuff at a lower cost
                   • (or both)
                     • Either way, the average cost of the good/service goes down
     • Production/Manufacturing System: specialized set of resources used by a firm to produce the firm's products
       • includes: plant, equipment, and systems to measure and control the system (ex. labor usage, material usage, flow, etc.)
         • In recent years, the supply chain has been viewed as directly or indirectly part of the production system
           • Especially the portion linking:
             • suppliers to the firm
               • parts of the firm to each other
                 • the firm to customers
             • Porter's Value Chain
       • Process Enhancement changes the Production System, not the Product
     • Production (or "output" or "throughput"): the quantity produced
       • Example: # of Customers Served
     • Production Rate: output produced per unit of time
       • Example: # of Customers Served per Bank Hour
     • Productivity: output produced per input consumed
       • Example: # of Customers Served per Employee Hour
       • Labor Productivity
         • Production, Production Rate, and Productivity are DIFFERENT!
           • Production Rate could be higher at Firm B, but Productivity could be higher at Firm A
             • If both firms pay workers the same wage, say $10/hr, then direct labor costs at Firm A are ($10 per hr/12.5 customers per hr) $0.80 per customer & direct labor costs at Firm B are ($10 per hr/5 customers per hr) $2.00 per customer (assuming no other direct labor costs)
               • Labor: the only critical input resource consumed in the production of the banking services
         • This view of productivity is not always useful; it depends on the firm's view of the critical input resource
     • Why Is Productivity Important? (Chapter 7 Part III)
       • At the Firm Level
         • Productivity is a measure of efficiency by which it converts certain assets of the firm into a product
           • Generally, a firm that is more productive than others in its industry is more competitive, since it needs fewer units of input to produce the same number of units of output
             • Another way of looking at this is: all other things equal, the net income of the more productive firm is higher than the net income of the less productive firm
             • CONCLUSION 1: All other things equal, the greater the productivity of the firm, the greater the net income
             • CONCLUSION 2: Greater productivity implies (usually) lower variable costs
             • Greater productivity my allow us to produce more units (larger Q) per unit time
       • At the National Economy Level
         • Productivity is a measure of the relative efficiency of converting a nation's resources (inputs) into a nation's ouput
           • Generally, other things equal, "a country's ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker"
     • Improving Productivity (Chapter 7 Part IV)
       • Improving Firm-Level Productivity
         • Productivity: output produced per input consumed
           • Output can be measured in terms of units produced ("How many do we make?") or by the value of the output ("How much is the output worth?")
           • Input can be measured in terms of units consumed ("How many labor hours?") or by the cost of the input (ex: labor cost)
           • Measures of Productivity Vary by Industry - each one has the (output per unit of input) form, but each focuses on issues of particular importance to the specific industry
             • Retail Industry - a common measure is "Revenue (or profit) generated per square foot of floor space"
             • Steel Industry - a common measure is "tons of steel produced per labor hour"
             • Consulting & Professional Services - a common measure is "billable hours per man-week"
       • Improving Productivity Concerns Getting More Units (or value) Out Per Unit (or value) of Input Extended in the Creation Process
         • Productivity increases if output increases with no increase in input
         • OR Productivity increases if input decreases with no decrease in output
         • More generally, Productivity Increases if...
           • the rate of increase in output > the rate of increase in input consumed (productivity & production both increase)
             • the rate of decrease in output < the rate of decrease in input consumed (productivity increases & production decreases)
               • In either case, productivity increase implies lower consumption of input per unit of good produced
       • So, the issue then turns to either Increasing Output (relative to input) or Decreasing Input (relative to output) How is this Accomplished?
         • Increase the motivation or skill level of the workforce
           • Modify workflow to avoid unnecessary steps or procedures
             • Increase the speed of processing by getting faster equipment
               • Decreasing the amount of scrap or wasted material
         • Each of these involves some sort of expenditure (investment in better or more training, etc.)
           • Usually, this investment increases fixed cost, at least in the short run
             • The investment is risky because it is incurred before any benefits accrue and it may not result in the desired effect
       • Conclusions About Productivity
         • All else equal, the greater the productivity, the greater the net income
           • Greater productivity implies (usually) lower variable costs
             • Usually increasing productivity involves increases in fixed costs (at least short term)
         • Productivity improvements increase net income if the benefits of improvement (in terms of a reduction in variable costs or an improvement in quality produced per unit time or both) exceed the fixed costs of making the improvement
           • If variable cost decreases, then, all other things equal, contribution margin increases and breakeven quantity decreases
             • Firms can use incremental earnings in many different ways, including: retaining it in the form of higher net income, passing it on to customers in the form of lower prices, give higher wages to employees, invest it in process enhancement projects, donate it, pay owners dividends, or pay off debt)
               • Most typically, firms do some combination of these; however, the most popular is lowering prices
       • Multi-Factor Productivity
         • Productivity is the ratio of outputs to inputs - obviously there can be multiple inputs
           • Multi-Factor Productivity addresses the observation that a firm may be able to improve productivity by decreasing only a subset of these inputs, even if this may result in an increase in others
             • Example: "Substituting Capital for Labor" investing in machinery that can do the job much better or faster than people
               • If this substitution decreases labor units while increasing output, labor productivity will also improve
                 • This all leads to complex indices of productivity, covering (usually) the simultaneous, aggregate effects of changes in various inputs (including labor, capital, energy, and intermediate goods inputs) on change in output
   • 1. Product Differentiation (Chapter 6)
   • 3. Business Model Change