ROIC Driven product Rationalization:
We will probably need to apply this skill in the second quarter of 1997 to
one or two acquisitions
1. What are our past experience levels
2.What clients do we now perform this task for
3.What holes exist in our methodology
4.How are we going to fix any holes
Please address the issues defined below in your response, and any others
you may have
Please give me your thoughts by Jan 15
Dec31,1996: Ashby's law of requisite variety: "The survival of a system
depends on its ability to generate at least as much variety(entropy) within
its boundaries as exists in the form of threatening disturbances from its'
environment"(Krippendorff,p19). Thus we want to increase our product line's
complexity to match the demands of the market.
Example: Ford's Model T(1908-1923): Initially there was a huge potential
demand for cheap utility transportation. Other fancier cars(threatening
disturbances) had no impact since they did not impinge on the demand.
However, Sloane's 1922 Chevrolet strategy provided variety which did impact
Model T demand from above, while used Model T's impacted demand from below.
Ford's refusal to increase complexity into his product line caused "variety
to destroy lower variety".
Cost of Variety: Variety exacts a cost in terms of engineering design,
documentation, production control,inventory, manufacturing engineering,
capital equipment,manufacturing setups, quality control, purchasing,
marketing and distribution cost etc. In some large markets, (e.g.
Bearings), competitors have attained a low cost position by only offering a
small portion of the spectrum, becoming the low cost producer. thus the
addition of product lines not only creates the costs specific to the new
product defined above, but also creates overhead costs which impact the
previous products. Viewed another way, Chainsaw Al proceeds by cutting 80%
of the product lines(duplication(3 kinds of paper towels),low GPM high
invested capital( S.D, Warren) out of a business, outsourcing to the
max(low ROIC processes), and focusing capital on core competencies in which
the company can build a competitive cost advantage on a branded product
which will carry a higher GPM.
ROIC: Viewed another way, Al is "calculating" the ROIC of each product,
sorting them in descending order, and eliminating those that will not make
the >5% EVA cut(Scott moved from -3% to +3% in one year). This is merely a
sudden ROIC product rationalization of a company which had not been managed
around EVA.
Increasing Variety: So far it sounds like less variety wins. No, its ROIC
that wins. Ford's persistence with a single product in the face of
Chevrolet, and his vertical integration at the Rouge plant forced his EVA
to be negative. After the initial pruning, we want to increase product
complexity such that the ROIC>5%EVA on the new products (including the cost
they impose on the other products,ie, they must carry all their own
costs) . Costs will be lowest if the product line grows like branches of a
tree, where the new product is a modification of an existing one,
minimizing the costs above, and using the same marketing channels, and
going to the same customer base. To the extent this is not true, costs
will have to be estimated for each item, and will impact the decision to go
forward
________________________________________________________________________
Dr. Francis Heylighen, Systems Researcher fheyligh@vnet3.vub.ac.be
PESP, Free University of Brussels, Pleinlaan 2, B-1050 Brussels, Belgium
Tel +32-2-6292525; Fax +32-2-6292489; http://pespmc1.vub.ac.be/HEYL.html