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Obstacles to Economic-Chain Costing

Switching to economic-chain costing requires uniform accounting systems along the entire chain.

The real cost is the cost of an entire process, in which even the biggest company is just one link. Companies are therefore beginning to shift costing from including only what goes on inside their own organization to costing the entire economic process, the economic chain. There are obstacles in implementing economic-chain costing. For many businesses it will be painful to switch to economic-chain costing. Doing so requires uniform or at least compatible accounting systems of all businesses along the entire chain. Yet each one does its accounting in its own way, and each is convinced that its system is the only possible one. Moreover, economic-chain costing requires information sharing across companies; yet even within the same company, people tend to resist information sharing. Whatever the obstacles, economic-chain costing is going to be done. Otherwise, even the most efficient company will suffer from an increasing cost disadvantage.

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Activity Costing

Activity-based costing is a totally different way of thinking.

Traditional costing techniques are now rapidly being replaced by activity-based cost accounting. Traditional costing builds cost from the bottom up—labor, material, and overhead. It concentrates primarily on manufacturing-related costs, the so-called inventoriable costs. Activity-based costing starts from the end and asks, “Which activities and related costs are used in carrying out the complete value chain of activities associated with the cost object?” Activity-based costing includes the cost of quality and service.

By designing quality into products and services during the design stage, design costs may increase, but warranty and service costs are likely to decrease, thus overcoming any cost increase experienced at the front-end of the chain. And unlike traditional costing, it includes all costs of producing a product or service.

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Price-Led Costing

The problem is not with technology. It is with mentality.

Traditionally, Western companies have started with costs, put a desired profit margin on top, and arrived at a price. This is cost-led pricing. In price-led costing, the price the customer is willing to pay determines allowable costs, beginning with design costs and ending with service costs. Marketing provides information on the price the customer is willing to pay for the value the product or service provides.

A cross-functional team starts its analysis of costs by taking this price as a given. The team then subtracts the profit required to compensate the enterprise for capital investment and risk, and arrives at an allowable cost for a product or service. Then it proceeds to make the tradeoffs between the utility provided by a product and allowable costs. Under price-led costing, the entire economic framework focuses upon creating value for the customer and meeting cost targets while earning the necessary rate of return on investment.

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Information on Cost and Value

We cannot achieve results until we have information on cost and value.

Basic structural information is focused upon the value that is created for customers and the resources used to do so. The concepts and tools of accounting are now in the throes of its most fundamental change. The new accounting tools are not just different views of recording transactions but represent different concepts of what business is and what results are. So even the executive far removed from any work in accounting, such as a research manager in a development laboratory, needs to understand the basic theory and concepts represented by these changes in accounting. These new concepts and tools include: activity-based costing, price-led costing, economic-chain costing, economic value added, and benchmarking.

Activity-based costing reports all the costs of a product or service until the customer actually buys the product, and provides the foundation for integrating cost and value into one analysis.

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The New Entrepreneur

History moves in a spiral; one returns to the preceding position, but on a higher level, and by a corkscrew-like path.

We are again entering an era in which emphasis will be on entrepreneurship. However, it will not be an entrepreneurship of a century ago, that is, the ability of a single man to organize a business he himself could run, control, embrace. It will rather be the ability to create and direct an organization for the new. We need men and women who can build a new structure of entrepreneurship on the managerial foundations laid these last eighty years. History, it has often been observed, moves in a spiral; one returns to the preceding position, or to the preceding problem, but on a higher level, and by a corkscrew-like path. In this fashion we are going to return to entrepreneurship on a path that led out from a lower level, that of the single entrepreneur, to the manager, and now back, though upward, to entrepreneurship again. The businessperson will have to acqurie a number of new abilities, all of them entrepreneurial in nature, but all of them to be exercised in and through a managerial organization.

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Turbulent Times Ahead

In turbulent times, the first task of management is to make sure of the institution’s capacity to survive a blow.

In turbulent times, the first task of management is to make sure of the institution’s capacity for survival, to make sure of its structural strengths, of its capacity to survive a blow, to adapt to sudden change, and to avail itself of new opportunities. Turbulence, by definition, is irregular, nonlinear, erratic. But its underlying causes can be analyzed, predicted, managed.

What management should—and can—manage is the single most important new reality underlying a great deal of the turbulence around: the sea-change in population structure and population dynamics, and especially the shift in population structure and population dynamics in the developed countries of the West and Japan. These shifts are already changing the modes of economic integration throughout the world. They are likely to lead to a new “transnational confederation” based on production sharing and market control, replacing in many areas the old “multinational corporation” based on financial control. They are creating new consumer markets and realigning existing old consumer markets. They are drastically changing the labor force to the point where there will only be “labor forces,” each with different expectations and different characteristics. They will force us to abandon altogether the concept of “fixed retirement age.” And they will create a new demand on management—as well as a new opportunity—to make organized plans for redundancy.

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The Work of the Social Ecologist

If this change is relevant and meaningful, what opportunities does it offer?

Now as to what the work of the social ecologist is: First of all, it means looking at society and community by asking these questions: “What changes have already happened that do not fit ‘what everybody knows’?” “What are the ‘paradigm changes’?” “Is there any evidence that this is a change and not a fad?” And, finally, one then asks: “If this change is relevant and meaningful, what opportunities does it offer?”

A simple example is the emergence of knowledge as a key resource. The event that alerted me to the fact that something was happening was the passage of the GI Bill of Rights in the United States after the Second World War. This law gave every returning war veteran the right to attend college, with the government paying the bill. It was a totally unprecedented development. These considerations led me tot he question: “What impact does this have on expectations, on values, on social structure, on employment, and so on?” And once this question was asked—I first asked it in the late 1940s—it became clear that knowledge as a productive resource had attained a position in society as never before in human history. We were clearly on the threshold of a major change. Ten years later, by the mid-1950s, one could confidently talk of a “knowledge society,” of “knowledge work” as the new center of the economy, and of the “knowledge worker” as the new, ascendant workforce.

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Control Middle Management

Start middle-management weight control.

Now is the time to start middle-management weight control. One means is attrition. As a job becomes vacant through retirement, death, or resignation, don’t automatically fill it. Leave jobs open for six or eight months and see what happens; unless there is an overwhelming clamor for filling the job, then abolish it. The few companies that have tried this report that about half the “vacancies” disappeared after six months. A second way to reduce middle-management bulk is to substitute job-enlargement for promotion. The one and only way to provide satisfaction and achievement for young managers and executives—and for the even younger people working under them—is to make jobs bigger, more challenging, more demanding, and more autonomous, while increasingly using lateral transfers to different assignments, rather than promotions, as a reward for outstanding performance.

Forty years ago we built into the performance review of managerial people the question, “Are they ready for promotion?” Now we need to replace that question with “Are they ready for a bigger, more demanding challenge and for the addition of new responsibilities to their existing job?”

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