Assignment 2: Designing Value-Based Service

Assignment 2: Designing Value-Based Service

As the rate of innovation increases, companies face expanding product/service lines, shorter product and service lifecycles, and more frequent product/service transitions. All of these can bring tremendous value but also pose enormous challenges and risks.

The article “The Art of Managing New Product Transitions” by Erhun, Gonclave, and Hopman from the readings for this module includes a matrix titled “Product Factors and Risk Drivers” which focuses on Intel, a company that manufactures high-tech products. Based on your readings and research, address the following issues:

  • Redesign the product risk factor matrix so that the factors are appropriate for a services firm that delivers traditional tax accounting and audit services. For example, among the supply risks, assume that the company relies on individuals with specific knowledge of the tax law in the jurisdictions where its clients operate, be it state, federal, or foreign. 
  • Now, assume that the firm wants to develop a management consultancy practice. (Alternatively, you may choose to add a legal services line instead.). Create a separate new matrix that summarizes the additional risk factors for this firm launching a management consultancy or legal services line. What additional risk factors are you adding to your matrix? 
  • Explain how the business risks differ between traditional tax and audit services and management consulting services. In your opinion, what are the three biggest risks the firm faces if it diversifies into the new service line?
  • Recommend whether the firm should organically grow into a consultancy service or acquire a third party to achieve new goals. Justify your recommendations.

Develop a 10-slide presentation in PowerPoint format. Apply APA standards to citation of sources. Use the following file naming convention: LastnameFirstInitial_M4_A2.ppt.

Be sure to include the following in your presentation:

  • A title slide
  • An agenda slide
  • A reference slide
  • Headings for each section
  • Speaker notes to support the content in each slide

By Saturday, March 30, 2013, deliver your assignment to the M4: Assignment 2 Dropbox.

16

12

12

12

8

Assignment 2 Grading Criteria Maximum Points

Redesigned the product risk factor matrix for a services firm that has traditionally provided tax and audit services and now wants to develop into a management consultancy.

Created a new matrix that summarizes the additional risk factors for this firm launching a management consultancy or legal services line. Identified additional risk factors to add to the matrix.
Explained how the business risks differ between these two types of services. Listed and ranked the three biggest risks if the firm diversifies into the new service line.
Made recommendations with appropriate justification on whether the firm should organically grow itself into a consultancy or acquire a third party to achieve its goals
Wrote in a clear, concise, and organized manner; demonstrated ethical scholarship in accurate representation and attribution of sources; displayed accurate spelling, grammar, and punctuation.
Total: 60 

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SPRING 2007
VOL.48 NO.3
) (
Please note that gray areas reflect artwork that has been intentionally removed. The substantive content of
the
article appears as originally published.
REPRINT NUMBER 48311
)

F

eryal Erhun, Paulo Conçalves and Jay Hopman

The Art of Managing

New Product Transitions

PRODUCT DEVELOPMENT

The Art of Managing
New Product Transitions
F

aster time to market and shorter product life cycles are pushing companies into more frequent product transitions, requiring managers to confront the potential rewards and challenges associated with product introductions and phaseouts. Several studies show that most new products fail in the marketplace for a variety of reasons,1 and both academics and practitioners have identified strategies for improving the chances of success.2 With a few exceptions, these studies focus on the success of a single product.3 However, companies often struggle with product transitions even when the new product meets all the requirements for success. Consider, for example, two consecutive generations of high-volume micropro-

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)cessors that we observed at Intel Corp., the U.S. semiconductor manufacturer. For the sake of this discussion, we will refer to the

products as X and Y. (See “About the Research,” p. 74.)

Intel originally designed X as a transitional product to pave the way for a stronger performance trajectory than was occurring with the previous platform. While X itself performed only slightly better than the previous generation at launch, its design allowed for performance gains later based on a wide array of computing benchmarks. Intel planned to move a substantial portion of the market to X and then complete the transition to Y, which offered similar performance at lower cost.

(
New product launches are highly complex and can pose major challenges to companies. But managing the interplay between product generations can greatly increase the chances for success.
Feryal Erhun,
Paulo Gonçalves and
Jay Hopman
)Unfortunately, the transition to X did not go smoothly. With capacity in place to support a moderately strong ramp up, early production led to excess inventory. X’s failure to meet customers’ needs and inability to usurp sales from its predecessor resulted in continued demand and short supply for the prior product. Consequently, competitors succeeded at increasing unit sales of their products.

Intel quickly realized that there were problems with X’s components and pricing strategy. Management seized upon several measures to improve sales, including rebates, but X continued to languish. As the introduction of Y approached, the company started an ambitious marketing campaign and price cut to spur sales and regain market share. These actions led to record demand for Y, exceeding all expectations. With limited production capacity, Intel

Feryal Erhun is an assistant professor of management science and engineering at Stanford University, in Palo Alto, California. Paulo Gonçalves is an assistant professor of management science at the University of Miami, in Coral Gables, Florida. Jay Hopman is a strategic analyst and researcher at Intel Corp., in Folsom, California. Comment on this article or contact the authors through

smrfeedback@mit.edu

.

PRODUCT DEVELOPMENT

(
About the Research
) (
Our research is based on a three-year study between 2001 and 2004 at Intel Corp. on the risks and drivers affecting product transitions. We conducted about 40 semi-structured inter-views with managers in supply chain management, demand forecasting, sales,
marketing and product development. After studying multiple historical and current product transitions at Intel, we learned that smooth transitions are difficult to achieve. The complexity of de-mand and supply dynamics causes tremendous uncertainty before
a product launch that is not fully resolved until several quarters after it. We observed that functional teams across the organization had access to specific information (for example, about macroeconomic condi-tions in Asia or the availability of a particu
lar part) that had significant bearing on the relative demand and supply of old and new products. However, the lack of a formal mechanism to ag-gregate and utilize such diverse information frequently caused misalignment. We saw the need for a new process t
o overcome this obstacle. The process we designed begins with de
fining a specific market objective. Subsequent steps involve identifying and measuring a set of factors across departments for each product (old and new) to assess product drivers and risks;
exploring possible risks arising from interactions between products using the transition grid; and developing a transition playbook, including prevention and contingency strategies with which to manage and mitigate transition risks.
)higher-end products. As a result, sales of higher-end products suffered, but the new product revenue did not compensate for the lost sales.s

Companies must learn to manage transitions to sustain their competitive advantage. Our field studies at Intel show that while numerous factors affect the rate and success of product transitions, inadequate information sharing and coordination among groups is one of the more important challenges to successful transitions.6 Lack of information can prevent managers from adequately assessing the state of the transition and impair the effective design and implementation of contingency planning in the face of unexpected

struggled to meet demand for some products within the Y family. Finally, after several months, Intel succeeded in balancing demand and supply, eventually regaining the market share it had lost.

Coordinating supply and demand between two product generations can be a difficult and costly problem. Although Intel’s Y met all the requirements for a successful product introduction, marketing and pricing decisions enacted in response to limited market acceptance of X significantly shaped the outcome of the Y launch. Intel’s operations management team did its best to satisfy customers through the transition. However, customers were frustrated by supply shortages, and the transition had substantial costs: lost revenues from discounting Y, marketing campaign expenses, significant investments in capital equipment and expedited shipping.

If the success of a single product is highly uncertain and can pose a major challenge to companies, the interplay between generations of products greatly increases the level of complexity. For example, when General Motors Corp. redesigned its Cadillac Seville and Eldorado models in 1992, supply and demand problems followed. Based on its initial forecasts, GM had allocated half of the capacity of its Detroit-Hamtramck plant to the redesigned Cadillacs, with the remainder going to Buicks and Oldsmobiles. But demand quickly exceeded supply, leading to the loss of thousands of potential customers. By the time GM was able to produce enough of the most popular models, the damage had already been done.4 Cisco Systems Inc. had a similar experience in early 1998 with the launch of product 3S-0, which was designed to appeal to the lower end of the market. Unfortunately, because of its impressive performance-price ratio, it cannibalized sales from

changes. For instance, during Intel’s product X-Y transition, the marketing team did not thoroughly investigate the production capacity upside to support the new marketing plan for product Y, leading to supply shortages.

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)The alignment of actions and decisions across different internal groups and across organizations helps level expectations and synchronize responses across the various teams involved in the transition, thereby improving the company’s ability to anticipate and react to environmental changes. The ability to adapt to change while meeting market objectives is a critical aspect of managing product transitions. To promote alignment across groups and the development of prevention and mitigation strategies, we have developed a framework and a process for helping managers make decisions during product transitions.

Using our framework, managers can design and implement appropriate policies to ramp up sales for new products and ramp down sales for existing products, balancing the supply and the demand for both so that combined sales can grow smoothly. (See “Smooth and Troubled Product Transitions.”)

Although the approach does not eliminate the uncertainty of product transitions, it provides managers with an overall understanding of the risks and challenges and suggests possible courses of action. Early experience suggests that the process can lead to more robust, efficient and effective product transitions. 7

Managing Product Transitions

The process of managing product transitions begins by identifying specific market objectives. Once these have been selected, companies need to understand the product drivers and risks and

(
Smooth and Troubled Product Transitions
) (
New product transitions should be organized to allow
companies to increase sales over time without disrupting sales or profitability.
When transitions are rocky, total revenues decline.
) (
Total Sales
) (
SALES
(
units/month
)
) (
New
Generation
) (
Old
Product
) (
New
Product
)conduct a factor assessment, which involves monitoring and measuring the factors affecting both old and new products. The process also necessitates a detailed analysis of the risks arising from interactions between products and the development of a transition playbook, which amounts to a catalog of primary and contingency strategies for preventing and mitigating transition risks. As market conditions change, managers need to be prepared to initiate the process again.

Identifying Product Drivers and Risks Our research on multiple generations of products at Intel suggests numerous factors that affect the adoption rate and success of a new product. The factors fall into two general categories of risks and drivers: demand and supply. Although either a demand risk or a supply risk can lead to a complete product failure, successful product introductions depend on a balance between demand and supply. Demand risks reflect the market’s uncertainty about a new product (for example, concerns about product attributes and transition policies). Supply risks often stem from the challenges of utilizing new manufacturing processes or product designs, or the difficulties of producing and distributing the product. Across demand and supply risks, we focused on a set of factors that influence the success of product transitions. (See “Product Drivers and Risk Factors,” p. 76.)

The eight factors cover most of the risks affecting the adoption rate of a new product. They encompass product features (product capability); process features (internal execution); supply chain features (external alignment and execution); managerial policies (pricing, timing and marketing); and externalities (environmental indicators and competition).

Although organizations may have access to detailed information about the product drivers and the risk factors affecting them, individual functional groups rarely have a complete picture of the overall forces impacting a product introduction. Our process provides a method for developing a cross-organizational transition assessment. This structured and repeatable process benchmarks the prospects and sales forecasts of new products against the experience of current and prior generations of products.

Assessing Relevant Factors Effective planning depends on collaboration and shared insight across the organization. If the best information is distributed among many different groups, the most one can expect is disjointed decisions. During the fac-tor assessment phase, managers conduct a complete evaluation of the risks impacting a product, highlighting the different challenges. This provides

managers with an opportunity to make decisions based on specific information.

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)To assess the actual values of specific factors, it is necessary to interview key players in functional groups involved in managing the new product (including marketing, sales, planning and forecasting). Each group scores all eight factors from their particular vantage point, using a five-point scale (with one very favorable and five very unfavorable). The scores can be compared with baselines from past products. Since different functional groups typically have privileged understanding and information about specific areas, each group scores every factor and documents the reasons motivating their scores. Sharing the comments and consolidating the information provides everyone with an understanding of how each group assesses the overall risks for a given product. After meeting with all groups, a cross-functional product management team can develop a composite score for each factor, providing a simple metric for the state of a product. (See “Mapping Intel’s Transition from X to Y,” p. 78.)

Since managerial and environmental changes continually im-pact product sales, updating factor assessments allows managers to identify risky areas and evaluate the results of previously implemented strategies. In our experience, however, updating information too frequently can be a distraction since it often takes time for strategies to kick in. Frequent updates may also induce managers to take premature or unnecessary actions. The frequency of updates should depend on the industry in question and the life expectancy of the products. For example, in high tech, the appropriate interval between updates might be monthly, whereas in other industries it might be no more than every quarter or any time a significant change occurs in one of the factors

1 2 3 4 5 6 7

TIME (years)

PRODUCT DEVELOPMENT

(such as competitors launching a marketing campaign or lowering their prices). Managers should balance the availability of new information and the amount of time required for decisions to have a measurable impact.

Looking Across Product Generations To understand the risks of a transition from one product to another, it is important to evaluate the interplay between products. A simple method for doing this is to study the interactions between demand and supply risks for the products. Using the composite factor analysis, managers can assess an overall demand risk and an overall supply risk for each product by assigning weights to each factor that composes demand and supply, and then creating a weighted average. For example, by comparing the overall demand risk of a given product to a threshold value, managers can rate the risk above that level as high and below it as low. As a result, the demand and supply risks for either the old or the new product can be either high or low. For any product transition, there are 16 possible combinations of risks, which can be represented in something we call a transition grid. (See “A Sample Transition Grid: Demand and Supply Risks of Two Products.”)

Generally, comparative rankings of demand and supply risks indicate that risks for the new product have a stronger impact on

profitability than risks for the old product and that companies have less ability to manage demand risks than supply risks. Therefore, demand risks and new product risks tend to have higher risk scores than supply risks and old product risks, respectively. Based on comments from the functional groups, transition team members can use these comparisons to gain insight into key questions, including: Are we producing the right products? Can we meet customer demand? And do customers want the products we supply?

Positioning a particular product transition within the grid enables transition teams to look beyond a single product and evaluate the potential impact that products may have on each other. Even when only one of the products is prone to supply or demand risks, managers should consider potential demand cannibalization and spillover effects on the other product as well as the potential for supply imbalances.

Developing a Transition Playbook Companies often resort to contingency strategies to rescue a product after it is launched. However, their ability to rescue a product using contingency strategies is limited.$ Factor analysis and the transition grid provide strategic and tactical assessment tools for anticipating potential challenges in launching new products. However, they do nothing to generate

(
Product Drivers and Risk Factors
) (
Eight factors significantly contribute to demand and supply risk during product transitions.
) (
Risks
) (
Demand Risks
) (
Supply Risks
) (
Timing
) (
Competition
) (
Factors
) (
Environmental Indicators
) (
Product/Platform Pricing
) (
Marketing Indicators/Policies
) (
Product Capability
) (
External Alignment and Execution
) (
Internal Execution
) (
Timing relative to past, present and future alternative products (time since last introduction, time until next introduction)
) (
Acceptance and drive from supply chain partners
(
partners
’ ability to manufacture products using state-of-the-art technology an
d standards, acceptance of the new product within the product platform)
) (
Ability to supply the product in volume
(
execution
of internal design, designing products for manufacturability, manufacturing (or testing) capacity and flexibility, distribution)
) (
Overall threat posed by competitive products (market share, manufacturing capacity)
) (
Positioning and measures of market response
(
market
size, number of potential product applications, budget size, breadth and timing of advertising, promotions)
) (
Product capability relative to alternative products
(
performance
, quality, longevity, reliability, compatibility with previous generations, complementarity with other products)
) (
Definition (Example)
) (
Demand due to macroeconomic and business forces/cycl
es (overall business climate)
) (
Product/platform price relative to alternative products (bill-of-material cost, expected price changes)
)

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(
The table below provides a snapshot assessment of a typical transition. When both products have high demand or supply risks, the product interactions may further intensify the risks. For example, demand risk
is high for both generations of products in rows 10, 14, 15 and 16, suggesting that managers need to monitor inventories closely.
) (
A Sample Transition Grid: Demand and Supply Risks of Two Products
) (
Rank
) (
10
) (
15
) (
16
) (
11
) (
12
) (
13
) (
14
) (
4
) (
2
) (
3
) (
5
) (
6
) (
7
) (
8
) (
9
) (
1
) (
Demand Risk
) (
High
) (
High
) (
High
) (
High
) (
High
) (
High
) (
High
) (
High
) (
Low
) (
Low
) (
Low
) (
Low
) (
Low
) (
Low
) (
Low
) (
Low
) (
Old Product
New Product
) (
Supply Risk
) (
High
) (
High
) (
High
) (
High
) (
High
) (
High
) (
High
) (
High
) (
Low
) (
Low
) (
Low
) (
Low
) (
Low
) (
Low
) (
Low
) (
Low
) (
Demand Risk
) (
High
) (
High
) (
High
) (
High
) (
High
) (
High
) (
High
) (
High
) (
Low
) (
Low
) (
Low
) (
Low
) (
Low
) (
Low
) (
Low
) (
Low
) (
Supply Risk
) (
High
) (
High
) (
High
) (
High
) (
High
) (
High
) (
High
) (
High
) (
Low
) (
Low
) (
Low
) (
Low
) (
Low
) (
Low
) (
Low
) (
Low
) (
Customers want old product; challenging to supply old and new.
) (
Can only supply new product, but cus
tomers do not want it.
) (
Can only supply old product, but cus
tomers do not want it.
) (
Customers do not want old product (indifferent to line below).
) (
Customers do not want old product; challenging to supply it.
) (
Challenging to supply new product.
) (
Customers do not want new product.
) (
Customers do not want new product; challenging to supply it.
) (
Challenging to supply new product; customers do not want old.
) (
Challenging to supply either product.
) (
Customers do not want either product.
) (
Customers do not want new product; challenging to supply old.
) (
Customers want new product; challeng
ing to supply it.
) (
Customers do not want either product; challenging to supply them.
) (
Limited availability of old product indifferent to line above).
) (
Most desirable transition.
) (
Comment
) (
Risk
Category
) (
4
) (
4
) (
2
) (
2
) (
3
) (
3
) (
5
) (
5
) (
5
) (
5
) (
5
) (
5
) (
5
) (
1
) (
1
) (
1
)specific strategies or fallback alternatives when the original plans

specific strategies or fallback alternatives when the original plans

factors at once, but only in a longer time frame. As such, these

factors at once, but only in a longer time frame. As such, these

don’t materialize. By assessing the state of a transition early on,

holistic levers target the product road maps rather than the im-

don’t materialize. By assessing the state of a transition early on, holistic levers target the product road maps rather than the im-
companies can gain an overall understanding of the risks impact-

mediate transition. Others affect specific factors that hinder

companies can gain an overall understanding of the risks impact mediate transition. Others affect specific factors that hinder
ing the transition and factors requiring immediate attention,

supply or demand during the transition at hand. Managers con-

ing the transition and factors requiring immediate attention, supply or demand during the transition at hand. Managers con-
allowing them to adopt prevention strategies.

sidering prevention strategies need to consider cost as well as ease

allowing them to adopt prevention strategies. sidering prevention strategies need to consider cost as well as ease
Rather than having to react to problems in the heat of battle,

of implementation, recognizing which levers are available and

Rather than having to react to problems in the heat of battle, of implementation, recognizing which levers are available and
companies can use prevention strategies to help identify the le-

which ones they control. For example, companies can have strong

companies can use prevention strategies to help identify the le which ones they control. For example, companies can have strong
vers that may have the most direct impact on the outcomes they

influence over pricing, the timing of product introductions,

vers that may have the most direct impact on the outcomes they influence over pricing, the timing of product introductions,
are trying to achieve. Some levers can impact several high-risk

product capability and internal execution but only indirect con-

are trying to achieve. Some levers can impact several high-risk product capability and internal execution but only indirect con-

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PRODUCT DEVELOPMENT

trol over what their competitors do. Managers need to be mindful that prevention strategies can have unintended consequences; once they signal a new strategy, competitors might follow suit.

Weighing these kinds of considerations in advance allows managers to address potential weaknesses before they become crippling. Although a well-designed strategy often takes several

factors into account, companies are frequently most vulnerable to factors they have the least control over and rely too heavily on the factors they can control most easily. For instance, a company might have several different ways to mitigate the risk of a supply problem caused by development or production issues. One option may be to increase prices, thereby reducing the likelihood

(
In transitioning from product X to product Y, Intel’s primary market objective was to reco
ver market share lost by X. The transition was built on four main factors. On the demand side, the product/platform pricing risk fell from high (for X) to medium (for Y) based on lower component costs and price cuts that accompanied the launch of Y. The ri
sk linked to marketing indicators also improved, from medium to low, since the price-performance ratio made Y an attractive mainstream product. In addition, external alignment improved from medium to low as customers, many of whom had resisted X, looked fo
rward to using Y. On the supply side, risk asso-ciated with internal execution rose (from low to medium) for two main reasons: Capacity for producing Y was limited, and the higher-speed products in the Y family reduced factory output. (Since Y was larger t
han X, it required more factory runs to produce the same number of units.) Overall, the factor assessment process highlighted the differences between the two products: There was high demand risk for X, whereas for Y there was little demand risk but some ne
w supply risk.
Based on this analysis, it should not have been surprising that Y would cannibalize sales of X. In fact, that is what happened: Intel faced shortages of Y and excess inventory of X. An effective strategy for Intel would have been to set a hi
gher price for Y rather than of
fering it at a discount. As contingencies, Intel could have lowered the price of X in hopes of promoting sales and allocated more manufacturing capacity to Y. Such actions would have rebalanced demand between the two product
s both in the short term and in the long term. Although price discounting and a marketing campaign potentially might have helped X, using them on Y led to shortages.
Intel recouped its lost market share in the quarters following the launch of Y, so the transition achieved some success. However, the lack of supply strained customer relationships, and by pushing factories to the limit and operating with insufficient inve
ntory, Intel’s operating costs rose during that period.
) (
Mapping Intel’s Transition
From
X to Y
) (
Timing
) (
External Alignment and Execution
) (
Competition
) (
Product Capability
) (
Factor
) (
Environmental Indicators
) (
Product/ Platform Pricing
) (
Marketing Indicators
) (
Internal Execution/Risk
) (
Competing products are better aligned to mainstream market
) (
Positioned toward higher end of market with higher price and performance
) (
Strong resistance to adopting some new technologies in the platform; higher materials cost; platform architecture will change with Y
) (
Released less than one year after prior generation; Y known to be only a few quarters away
) (
Supply positioned for moderately paced ramp up
) (
Product X
) (
Demand and economy relatively slow; no imminent improvement on horizon
) (
Platform cost significantly higher than prior generation
) (
Faster clock speed than prior generation, but benchmarks sh
ow only modest performance gains in many applications
) (
4
) (
Score
) (
3
) (
3
) (
3.5
) (
2.75
) (
3.5
) (
3.5
) (
1
) (
Competitors’ sales strong relative to historical levels but limited by manufacturing capacity
) (
Potential clock speed is high, but overall speed gains are impaired by localized bottlenecks
) (
New architecture and accompanying plat
form materials cost reduction bring record number of design wins; price cuts enable greater performance at lower price points
) (
Decreased supply capability due to less efficient production and lower yields associated with road map acceleration
) (
Product Y
) (
Demand and economy relatively slow; no imminent improvement on horizon
) (
Reduction in overall platform cost and marketing decision to cut prices
) (
Release closely follows X; Y will not be replaced in the near term
) (
Price reduction brings p
roduct back to mainstream market segments
) (
Score
) (
3
) (
2.75
) (
2.5
) (
3
) (
2.5
) (
2
) (
2
) (
1.5
)

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(
A Sample Transition Playbook
) (
A transition playbook identifies relevant scenarios and maps their impact on old products (OP) and new products (NP) to outline possible prevention and contingency strategies. Scenarios should be developed in response to risks identified in the factor asse
ssment and the transition grid.
) (
Events/ Scenarios
) (
Expected Outcome
) (
Prevention Strategies
) (
Contingency Strategies
) (
Impact on OP
) (
Demand for NP higher than expected
) (
Demand cannibalization
) (
Supply shortage for NP
Excess supply for
) (
Supply portfolio
Product pricing
Internal execution
) (
Gradually phase out OP
Outsource OP
Decrease OP price
Increase NP price
Allocate more capacity to NP
) (
OP
) (
Supply problems for NP
) (
Demand spillover
) (
Excess demand and hence possible supply shortage for OP
Supply shortage for NP
) (
Product design
Internal execution (process yield)
Product pricing
) (
Gradually phase out OP
Outsource OP or NP
Decrease OP price
Increase NP price
Allocate more capacity to NP
) (
Demand for NP lower than expected
) (
Demand spillover
) (
Supply shortage for OP
Excess supply for NP
) (
Product characteristics
External alignment and execution
) (
Gradually phase out OP
Increase OP price
Increase production of OP
Accelerate road map
Decrease NP price (rebates/promos)
Heavy marketing of NP
Work on external alignment and execution
)that the products customers order are out of stock. This approach could shift demand to the future, but it may prompt customers to buy competing products. In considering their options, companies need to evaluate the costs. Rather than increase prices, the company may be better off outsourcing capacity to other producers. But that is not always feasible in light of concerns about proprietary infor-mation and lead times. To preserve the option of using outsourcing as a contingency strategy when the need arises, companies may need a corresponding prevention strategy to line up alternative resources ahead of time.

Once companies complete their transition risk assessments, managers can create playbooks containing relevant transition scenarios, prevention strategies and contingency strategies. A good playbook identifies events or scenarios that lead to major risks, assesses the impact these events may have on new and current products and lays out prevention and contingency strategies for the transition team. (See “A Sample Transition Playbook.”)

Even well-planned and well-executed product transitions often require strategy updates. By mapping out prevention strategies, risks and contingency strategies in advance, a transition playbook can minimize risks. It allows managers to monitor key supply and demand risk indicators, so they can make strategy revisions and invoke contingency strategies as needed.

Although companies place enormous emphasis on new product introductions, products with many successful attributes still experience difficulty when they interact in unexpected ways with current products. Transition mapping provides a structured approach to collecting information and coordinating actions across the organization. It pulls together the key differences in perspectives from different functional groups, saving companies from some of the second-guessing and manipulation that often occurs when important information is revealed later. While our process was developed at Intel and has been used successfully in transitions there, it can be applied broadly to different settings. The

implementation details will change depending on the industry, the company and the product, but the overall methodology will stay essentially the same.

(
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79
)EVALUATING PRODUCT INTERACTIONS is central to the success of product transitions. By anticipating risks, companies can seek ways to align their products. Playbooks can help managers develop robust prevention and contingency strategies to deal with the supply and demand risks identified by the transition grid. They can help managers see potential shifts in the business environment before they occur, allowing managers to make timely adjustments that are particularly critical for products with short life cycles and long production delays.

REFERENCES

1. See, for example, G.S. Lynn and R.R. Reilly, “Blockbusters: The Five Keys to Developing Great New Products” (New York: HarperBusiness, 2002); E.E. Bobrow and D.W. Shafer, “Pioneering New Products: A

PRODUCT DEVELOPMENT

(
80
MIT SLOAN MANAGEMENT REVIEW
SPRING
2007
) (
SLOANREVIEW.MIT.EDU/SMR
)Market Survival Guide” (New York: Irwin, 1987); and R.M. McMath and T. Forbes, “What Were They Thinking?” (New York: Crown Business, 1998).

2. See R.G. Cooper, “How New Product Strategies Impact On Performance,” Journal of Product Innovation Management 1, no. 1 (January 1984): 5-18.

3. See N.P. Trepanning, “Understanding Fire Fighting in New Product Development,” Journal of Product Innovation Management 18, no. 5 (September 2001): 285-300. See also C. Billington, H.L. Lee and C.S. Tang, “Successful Strategies For Product Rollovers,” Sloan Management Review 39, no. 3 (spring 1998): 23-30.

4. M.L Fisher, J.H. Hammond, W.H. Obermeyer and A. Raman, “Making Supply Meet Demand in an Uncertain World,” Harvard Business Review 72, no. 3 (May-June 1994): 83-93.

5. The Cisco Systems transition example is based on a 2001 white paper, “Strategizing for Success: Cisco Systems Overcomes a Product Transition Dilemma,” ZDNet UK, London, February 20, 2001,

http:// whitepapers.zdnet.co.uk/0,39025945,60045032p-39000468q,00.htm.

6. Billington, Lee and Tang corroborate this finding and present a high-level process for managing new product transitions. They recommend dual-product rollovers (that is, introducing the new product before the end of life of the old one) for transitions with high demand and supply risks and solo-product rolls (the new product introduction concurring with the old product’s end of life) for low demand and supply risk environments. Oftentimes, however, the industry dictates the choice of solo versus dual roll. Dual-product roll is standard in the high-tech industry where product platforms are common, even for products with low demand and supply risks. Further, the process proposed by Billington, Lee and Tang does not provide much insight into tactical and operational decisions regarding pricing, capability, marketing budgets or product deployment, all of which can have a substantial impact in the success of a transition.

7. We tested the transition mapping process, particularly the factor analy-sis process, using a large-scale product transition at Intel. For this transition, Intel’s central business planning group felt that sales of the new product would come in fairly strong. Defining x as the realistic “whisper” estimate among forecasters, a figure of roughly 1.2x was circulated to drive supply. Meanwhile, estimates aggregated from the geographical sales organizations suggested lower sales, ranging over time from 0.65x to 0.9x. Based on the results of the factor analysis and historical sales in the same product family, the transition mapping team predicted that sales were unlikely to exceed 0.93x and would likely be lower. The drivers for this recommendation included solid evidence that component cost would reduce demand early in the transition and that the complexity of the new platform posed significant supply risk. Sales forecasts were revised downward from 1.2x prior to the launch to about 0.9x six weeks after launch and then dropped even lower. By the beginning of the second quarter after launch, the forecast, informed by the transition mapping process, was trimmed to 0.79x for the first two quar-ters’ total sales. This helped avoid overbuilding supply for the new product while maintaining sufficient stocks of the old product. The process also supported decisions, such as increasing the marketing budget, that helped drive product sales early in the life cycle.

8. For example, refer to H.L. Lee and C. Billington, “Managing Supply Chain Inventory: Pitfalls and Opportunities,” Sloan Management Review 33, no. 3 (spring 1992): 65-73; or G.A. Zsidisin, A. Panelli and R. Upton, “Purchasing Organization Involvement in Risk Assessments, Contingency Plans, and Risk Management: An Exploratory Study,” Supply Chain Management 5, no. 4 (2000): 187-198.

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(
SPRING 2004
VOL.45 NO.3
)

MITSloan

Management Review

Jeffrey H. Dyer and Nile W. Hatch

Using Supplier Networks

to Learn Faster

(
REPRINT NUMBER 45311
)Please note that gray areas reflect artwork that has been intentionally removed. The substantive content of the article appears as originally published.

Using Supplier Networks
to Learn Faster

(
Many companies keep their suppliers at arm’s length. But partnering with vendors — sharing valuable knowledge with them through organized networks — can be a sustainable source of competitive advantage.
Jeffrey H. Dyer and Nile W. Hatch
) (
SPRING 2004 MIT
SLOAN MANAGEMENT REVIEW
57
)Last year, Toyota Motor Corp. posted profits that exceeded the combined earnings of

its three largest competitors. In today’s world of hypercompetition, how did Toyota

accomplish this? In searching for the answer, many business gurus and researchers have

overlooked — or have not fully understood — the importance of knowledge-sharing

networks. Certainly, knowledge management has become a hot topic. But how exactly do

firms learn, and why do some companies learn faster than others? Furthermore, does

learning go beyond the boundaries of the organization?

Many companies keep their suppliers and partners at arm’s length, zealously guarding

their internal knowledge. In sharp contrast, Toyota embraces its suppliers and encourages

knowledge sharing with them by establishing networks that facilitate the exchange of

information. By doing so, Toyota has helped those companies retool and fine-tune their

operations, and the results have been stunning: 14% higher output per worker, 25% lower

inventories and 50% fewer defects compared with their operations that supply Toyota’s

rivals. Such improvements have provided Toyota with a significant competitive advantage,

enabling the company to charge substantial price premiums for the enhanced quality of

its products. As Koichiro Noguchi, a Toyota director and former purchasing head, puts it, “Our suppliers are critical to our success. We must help them to be the best.”

Toyota is not alone. More and more, companies are recognizing the competitive advantage that springs from the manner in which they work with their partners. Even powerful Microsoft Corp. has to rely on companies around the world to localize and translate its products in markets as diverse as those of China, Chile and the Czech Republic. Ultimately Microsoft’s speed to market and even the quality of its offerings in those countries depend directly on how well it works and shares knowledge with those firms. For computer-systems company Dell Inc., suppliers are the very lifeblood of its business, and effective knowledge sharing with those partners is crucial for the company’s success (see “Knowledge Sharing at Dell,” p. 59). Other firms like Boeing, Harley-Davidson and Xilinx, a semi-


Jeffrey H. Dyer

is the Horace Beesley Professor of Global Strategy and Nile W. Hatch is assistant professor of strategy at the Marriott School, Brigham Young University, in Provo, Utah. They can be reached at

jdyer@byu.edu

and

nile@byu.edu

.

conductor manufacturer headquartered in San Jose, California, have also realized the importance of knowledge sharing with partners, and they are looking at strengthening those processes. As Xilinx vice president Evert Wolsheimer states, “I think our partnership relationships will evolve in a similar direction over time to look like what Toyota has done.”

Learning at Toyota

So what exactly has Toyota done? To answer this, we performed an in-depth study of Toyota and its suppliers (see “About the Research”) and found that the company has developed an infrastructure and a variety of interorganizational processes that facilitate the transfer of both explicit and tacit knowledge within its supplier network. (See “Two Types of Knowledge,” p. 60.) The effort, headed by the company’s purchasing division and its operations management consulting division (OMCD), consists of three key processes: supplier associations, consulting groups and learn-ing teams. (See “

How Toyota Facilitates Network Learning

,” p. 61.)

(
About the Research
) (
Toyota has long excelled at transferring productivity-enhancing knowledge throughout its ne
twork of
suppliers.
i

From
1965 to 1992, for example, the company and its sup
pliers increased their labor productivity by roughly 700%. In contrast, during the same time period U.S. automakers and their vendors achieved productivity increases of 250% and less than 50%, respectively.
To examine the mechanisms that Toyota and its sup
pli
ers have successfully employed to share knowledge with each other, we conducted an extensive study, consisting of more than 100 hours of interviews with more than 30 Toy
ota executives. We also surveyed more than 80 of Toyota’s suppliers in both Japan
and the United States, and we con
ducted interviews with dozens of their senior executives. The investigation looked not only at how Toyota trans
ferred knowledge to its suppliers but also at how the com
pany was able to tap into the potential of knowledge
located
outside
the organization. Further, we examined the ways in which that system of knowledge sharing had cre
ated superior competitive advantage and profits for both Toyota and its suppliers.
) (
i
.
T.
Nishiguchi
, “Strategic Industrial Sourcing” (New
York: Oxford Univer
sity Press, 1994); and M. Lieberman, “The Diffusion of ‘Lean Manufactur
ing’ in the Japanese and U.S. Automotive Industry,” presented at the New Imperatives for Managing Revolutionary Change Conference in Shizuoka, Japan, Aug. 29, 1994.
)Supplier Associations In 1989, Toyota started an association for its U.S. suppliers. Named the Bluegrass Automotive Manufacturers Association (BAMA), the group was modeled after Toy-

ota’s supplier association in Japan (called kyohokai). The initial objective was to provide a regular forum for Toyota to share information with and elicit feedback from suppliers. Membership was voluntary, but word gradually spread about the value of joining the association. By 2000, BAMA had grown to 97 suppliers from an original membership of just 13. According to Toyota’s Chris Nielsen, general manager for purchasing planning, “We really didn’t know if this would work in the U.S. … Before BAMA, it was not very natural for supplier executives to talk and share information…. Over the years, that has changed as suppliers have built relationships at senior levels.”

Details of the kyohokai reveal the various mechanisms through which knowledge is shared. The supplier association holds both general-assembly meetings (bimonthly) and topic committee meetings (monthly or bimonthly). The former enable high-level sharing of explicit knowledge regarding pro-duction plans, policies, market trends and so on within the sup-ply network. The latter allow more frequent interactions on four specific subject areas — cost, quality, safety and social activities — which are generally of benefit to all members of the network. The quality committee, for example, picks a theme for the year, such as “eliminating supplier design defects,” and meets bimonthly to share knowledge with regard to that particular topic. The quality committee also sponsors various activities, including basic quality training for more than 100 engineers each year, tours of “best practice” plants both inside and outside the automotive industry, and an annual conference on quality management that highlights in-depth supplier cases of quality improvement selected by a panel. Such efforts, in conjunction with those of the other committees, not only provide a forum for sharing valuable knowledge, they also help develop relationships among the participating suppliers.

Consulting/Problem-Solving Groups As early as the mid-1960s, Toyota began to provide expert consultants to assist its suppliers in Japan. To that end, the company established the OMCD for acquiring, storing and diffusing valuable production knowledge residing within the Toyota Group. The OMCD consists of six highly experienced senior executives (each of them has responsibility for two Toyota plants and approximately 10 suppliers) along with about 50 consultants. About 15 to 20 of those consultants are permanent members of the OMCD, while the rest are fast-track younger individuals who deepen their knowledge of the Toyota Production System (TPS) by spending a three- to five-year rotation at the OMCD. Toyota sends these inhouse experts to suppliers, sometimes for months at a time, to help those companies solve problems in implementing the TPS. Interestingly, Toyota does not charge for its consultants’ time, instead making the OMCD a resource available to all members of the Toyota Group. Our survey of 38 of Toyota’s largest first-

58 MIT SLOAN MANAGEMENT REVIEW SPRING 2004

(
Knowledge sharing with partners is the foundation of Dell Inc.’s efforts toward “virtual integration.” According to CEO Michael Dell, “‘Virtual integration’ means you basically stitch together a business with partners that are treated as if they’re inside
the
company.”
i
To achieve that, Dell has implemented a variety of measures.
First, Dell has taken minority equity stakes in a few key vendors. Second, it encourages its top suppliers to locate their resources inside or near Dell’s design centers and factor
ies. Third, it has implemented a certification program that is unique among major PC manufac
turers. According to Scott Perry, senior director of global sales at Maxtor Corp., a manufacturer of computer hard drives, “Dell’s certification process teaches ou
r engineers the language, processes and metrics used by Dell. In short, it teaches them how to think like Dell. This is criti
cal because Dell wants our engineers to monitor processes both in our factories and at Dell factories using the tools, processes a
nd metrics preferred by Dell.” Fourth, Dell engineers routinely visit sup-
) (
Knowledge Sharing at Dell
) (
plier
plants to monitor performance, share process knowledge for improving quality and yields, and encourage the better vendors to share their know-how with others. Fifth, Dell has worked on its own internal operations to facilitate greater and faster know
ledge transfer. For example, the company returns defec
tive parts much more quickly than its competitors do, providing suppliers with valuable data earlier on. “Returned parts on Dell’s products usually reach us in 30 days versus 90 days for competitors,”
says Maxtor’s Perry. “As a result, we can work together to fix problems quickly, which keeps warranty costs low.” Sixth, suppli
ers’ engineers visit Dell plants to help both Dell and the suppliers improve product quality and process capabilities. These eng
ineers conduct failure analyses at Dell’s factories, after which they trans-
fer
the resulting knowledge to their own facilities for corrective and preventive actions. Seventh, Dell coordinates its knowledge-sharing activities by meeting weekly with key sup
pliers and by holding quarterly business reviews with their top executives. Lastly, Dell is one of the first
) (
PC makers to establish a Web portal for supplier collaboration, providing vendor partners with access to Dell systems and key information regard
ing product design and engineering, cost manage-
ment
and quality. This system is part of a greater effort to share important
infor-mation
with suppliers, including detailed data regarding product demand, back
logs, pipelines and inventories.
The importance
of such knowledge-sharing practices at Dell should not be underestimated. “Our business model is based on direct relationships, not only with our customers but also [with] our partners,” notes Dell President and COO Kevin B. Rollins. “Close supplier relat
ion
ships influence everything from planning and forecasting to improved quality, pricing, inventory management, produc
tion and fulfillment. We’re constantly looking for ways to integrate our
suppli-ers
and partners more closely into our business through
substituting informa
tion for inventory and cost.”
) (
i
.
J.
Magretta
, “The Power of Virtual Integration: An
Interview With Dell Computer’s Michael Dell,”
Har

vard
Business Review 76 (March-April 1998): 72-84.
)tier suppliers in Japan revealed that, on average, they received 4.2 visits per year, each lasting 3.1 days.

In 1992, Toyota established the U.S. version of the OMCD. Originally called the Toyota Supplier Support Center (now TSSC Inc.), the group has since grown to more than 20 consultants and is headed by general manager Hajime Ohba, who is a former OMCD consultant. Like the OMCD, the TSSC requires that participating suppliers share their project results with others. This policy allows Toyota to showcase “best practice” suppliers that have successfully implemented various elements of the TPS, and it encourages the suppliers to open their operations to one another. This is critical because the ability to see a working template dramatically increases the chances that suppliers can successfully replicate that knowledge within their own plants. Companies can, however, designate certain areas of their plants — where Toyota hasn’t provided any assistance — as off-limits to visitors in order to protect their proprietary knowledge.

To date, transfers of TPS know-how have been difficult and time-consuming. Although the goal is to achieve success in six

months, no project in the United States has been completed in less than eight months and most consume at least a year and a half. “It takes a very long time and tremendous commitment to implement the Toyota Production System,” says Ohba. “In many cases it takes a total cultural and organizational change. Many U.S. firms have management systems that contradict where you need to go.” Consider Summit Polymers Inc., a manufacturer of plastic interior parts, based in Kalamazoo, Michigan, which was one of the first U.S. suppliers to use the TSSC. According to Tom Luyster, who was vice president of planning at the time, “The TSSC sent approximately two to four consultants to our plant every day for a period of three to four months as we attempted to implement TPS concepts in a new plant.” And after that initial phase, Toyota continued to provide ongoing support to Summit Polymers for more than five years.

(
SPRING 2004 MIT SLOAN MANAGEMENT REVIEW 59
)But the results have been impressive. On average, the TSSC has assisted suppliers in increasing productivity (in output per worker) by 123% and reducing inventory by 74%. These improvements clearly demonstrate that, although the TSSC’s

knowledge-transfer processes require considerable effort, they can dramatically improve supplier performance.

(
Two Types of Knowledge
) (
Most scholars divide knowledge into two types:
explicit
and
tacit.

The former can be codified easily and transmit
ted without loss of integrity once the rules required for deciphering it are known. Examples include facts, axiomatic propositions and symbols that provide informa
tion on the size and growth of a market, prod
uction sched
ules and so on. In contrast, tacit knowledge is “sticky,” complex and difficult to
codify
,
ii
and it often involves expe
riential learning. One example is the know-how required to transform a manufacturing plant from mass production to flexible
operation. Because tacit knowledge is complex and difficult to imitate, it is most likely to generate com
petitive advantages that are sustainable. In fact, in
The Knowledge Creating Company,
researchers
Ikujiro

Nonaka
and Hiroyuki Takeuchi make the case
that the really power
ful type of knowledge is tacit because it is the primary source of innovative new products and creative ways of doing business.
”’
) (
B.
Kogut
and U.
Zander
, “Knowledge of the Firm, Combinative Capa
bilities, and the Replication of Te
chnology,” Organization Science 3, no. 3 (1992): 383-397; R. Grant, “Prospering in Dynamically-Competitive Envi
ronments: Organizational Capability as Knowledge Integration,” Organi
zation Science 7, no. 4 (1996): 375-387; and G. Ryle, “The Concept of Mind
” (Chicago: University of Chicago Press, 1984): 29-34.
R. Nelson and S. Winter, “An Evolutionary Theory of Economic Change” (Cambridge: Belknap Press, 1982); B.
Kogut
and U.
Zander
, “Knowledge of the Firm” (1992); and G.
Szulanski
, “Exploring Internal Stic
kiness: Impediments to the Transfer of Best Practice Within the Firm,” Strategic Management Journal 17 (1996): 27-43.
I.
Nonaka
and H. Takeuchi, “The Knowledge Creating Company” (New York: Oxford University Press, 1995).
)Take, for example, Continental Metal Specialty (CMS), a supplier of metal stampings, such as body brackets. The consulting process began with Toyota sending people to teach the TPS to CMS personnel, after which the two companies jointly examined CMS’s production process to identify each step, flagging those that were value-added versus those that were not. Out of 30 steps, four were designated as value-added: blanking, forming, welding and painting. Toyota and CMS then reconfigured the production system to eliminate as many of the non-value-added steps as possible. One important change brought welding into the plant and placed it next to the forming process, thereby eliminating 12 non-value-added steps. Over time, CMS has eliminated a total of 19 non-value-added steps, reducing setup times from two hours to 12 minutes. In addition, inventories on most parts have been reduced to almost one-tenth of previous levels. Then CMS chairman George Hommel described the benefits: “We wouldn’t be

where we are now if we hadn’t worked with Toyota. I’d say that 75% to 80% of all that we’ve learned from customers has come from Toyota.”

It should be noted that Toyota does not ask for immediate price decreases or a portion of the savings from the improvements. Suppliers keep all of the initial benefits, in contrast with the General Motors Corp. (GM) typical practice of asking for a price decrease after offering assistance at a supplier’s plant. As one supplier executive declared, “We don’t want to have a GM team poking around our plant. They will just find the ‘low-hanging fruit’ — the stuff that’s relatively easy to see and fix. … We’d prefer to find it ourselves and keep all of the savings.” Of course, Toyota does eventually capture some of the savings through its annual price reviews with suppliers, but the company is careful to keep activities that create value completely separate from those that appropriate value. For example, Toyota has typically used a “target-pricing” system by which the company lets suppliers know the prices it thinks are fair for certain parts for the duration of a contract.l This motivates suppliers to cut costs continually to reap higher profits on those parts.

Voluntary Learning Teams In 1977, the OMCD organized more than 50 of its key suppliers in Japan into voluntary study groups (called jishukenkyu-kai, or jishuken) to work together on productivity and quality improvements. With the help of an OMCD consultant, the teams determined a theme and spent three months addressing the problems of each of its members’ plants. Jishuken are an advanced knowledge-sharing mechanism through which members learn as a group, exploring new ideas and applications of TPS. The team then transfers any valuable lessons to Toyota and throughout the supplier network.

In 1994, Toyota replicated the jishuken concept in the United States by establishing three plant development activity (PDA) core groups among 40 suppliers. As with the supplier association, membership was voluntary. For the first year, the theme was quality improvement because, as Toyota’s Chris Nielsen noted, “everyone agrees that they can improve quality.” Each PDA member was asked to select a demonstration line within a plant as a place to experiment with implementing certain concepts.

Our interviews with U.S. plant managers revealed the value of the PDA projects. According to one manager, “When you bring a whole new set of eyes into your plant, you learn a lot. … We’ve made quite a few improvements. In fact, after the [PDA] group visits to our plant, we made more than 70 changes to the manufacturing cell.”

A key reason that PDA transfers of tacit knowledge have been particularly effective is that they involve learning that is context-specific. The plant manager from Kojima Press Industry Co. Ltd., a supplier of body parts, describes an example: “Last year we reduced our paint costs by 30%. This was possible due to a sug-

60 MIT SLOAN MANAGEMENT REVIEW SPRING 2004

gestion to lower the pressure on the paint sprayer and adjust the spray trajectory, thereby wasting less paint.”

The Evolution of a Knowledge-Sharing Network

The successful structures and collaborative relationships of the three knowledge-sharing processes — the supplier association, consulting groups and learning teams — did not appear by happenstance. Rather, Toyota established these institutions in the same order in both the United States

other. Companies were motivated to participate in the supplier association primarily to demonstrate their commitment to Toyota with the hope that they would then be rewarded with additional future business. At this point, the network was just beginning to develop an identity, and suppliers did not yet perceive a strong sense of shared purpose with other members.

Next, Toyota gradually increased the strength of its bilateral relationships with suppliers by sending consultants to transfer

and Japan. The intent was first to create weak, nonthreatening ties that could later be transformed into strong, trusting relationships. As each structure evolved and the relationships matured, the processes became a vehicle for a shared identity among Toyota suppli-

As each structure evolved and the relationships matured, the processes
became a vehicle for a shared identity among Toyota suppliers.

ers. As one supplier executive put it, “We’re a member of the Toyota Group. That means we are willing to do what we can to help other group members.”

In the initiation phase of Toyota’s U.S. network (roughly from 1989 to 1992), the network structure was a collection of dyadic ties with Toyota as a hub that heavily subsidized activities. (See “

Evolution of Toyota Network

,” p. 62.) Toyota’s help came in two forms: financial (for instance, funds for planning and organizing meetings) and valuable knowledge. It was important for Toyota to subsidize network knowledge-sharing activities early on to motivate members to participate. The supplier association was the vehicle through which links to suppliers were established and explicit knowledge was transferred. In that early stage, the connections between suppliers were weak, and there were numerous holes because most suppliers did not have direct ties to each

How Toyota Facilitates Network Learning

(
General sharing of information, including Toyota policies and widely applicable best practices
) (
SUPPLIER ASSOCIATIONS
) (
TOYOTA
) (
Intensive on-site
assistance from
Toyota experts
Workshops and seminars
) (
CONSULTING GROUPS
) (
On-site sharing of know-how within small groups of 6 to 12 suppliers
) (
LEARNING TEAMS
)Toyota relies on three interorganizational processes — supplier associations, consulting groups and learning teams — to facili-tate the transfer of knowledge within its supplier network.

valuable knowledge at minimal cost. Consequently, suppliers increasingly participated in the network not only to demonstrate their commitment to Toyota but also to learn from the company. Although the supplier association facilitated the exchange of information that was primarily explicit, the personal visits of consultants were effective in transferring tacit knowledge of greater value. And the consultants created an atmosphere of reciprocity: Suppliers began to feel indebted to Toyota for sharing knowledge that significantly improved their operations.

(
SPRING 2004 MIT SLOAN MANAGEMENT REVIEW
61
)In the final phase, the PDA learning teams developed and strengthened multilateral ties between suppliers and facilitated the sharing of tacit knowledge among them. Today, suppliers have two primary motivations for participating. First, they now appreciate how important it is, as a Toyota supplier, to keep up to pace. They are aware that the profit-creating potential of past productivity enhancements declines steadily, and they know they are in a learning race with rival suppliers because business from Toyota is allocated based on relative performance improvements. This creates strong incentives for suppliers to learn and improve as quickly as possible. Second, suppliers now strongly identify with the network and feel obligated to reciprocate in the information exchange so they begin to share knowledge more freely with other members. This strengthens multilateral ties among suppliers and creates subnetworks for knowledge sharing within the larger system. In this mature stage, multiple pathways exist for transferring both explicit and tacit knowledge, and the amount of tacit knowledge being transferred is substantial (whereas in the initiation phase it was almost nonexistent).

The Competitive Advantages

For manufacturing in the United States, Toyota now buys more than 70% of its parts from U.S. companies. Consequently, the company is increasingly using the same suppliers as its U.S. competitors, which raises an interesting question: How can Toyota

Evolution of Toyota Network

In the early stages of a knowledge-sharing network, Toyota establishes bilateral relationships with suppliers (left). At this point, the supplier network resembles a hub (Toyota) with many spokes. Later, the suppliers begin to form ties with each other in nested subnetworks (right). These multilateral rela-tionships greatly facilitate the flow of knowledge so that members are able to learn much faster than rival, nonparticipating suppliers.

(
Suppliers
) (
INITIATION
) (
Suppliers
) (
MATURE
) (
Toyota
Toyota
)achieve a competitive advantage through these vendors? Traditional economic theory suggests that the only possible way is by extracting lower unit prices based on greater relative bargaining power.z In the United States though, Toyota has lower unit volumes than its U.S. competitors, placing the company at a disadvantage. But Toyota has been able to overcome that handicap and has instead achieved competitive advantages with its U.S. suppliers by providing them with knowledge and technology to improve their productivity for just their operations that are dedicated to Toyota. The results of our survey of those vendors help illuminate the reasons for Toyota’s success.

Compared with the Big Three (GM, Ford and DaimlerChrysler), Toyota has engaged in significantly more knowledge-sharing activities with its U.S. suppliers. Toyota sent personnel to visit the suppliers’ plants to exchange technical information an average of 13 days each year versus six for the Big Three. As one plant manager noted, “We have received a great deal of knowledge from Toyota…. We have learned about in-sequence shipping, kanban [a system for reducing inventory], one-piece production and standardized work. We have even learned some of Toyota’s HR-related training philosophy and methods.” The plant managers surveyed were unanimous in their opinion that Toyota provided more valuable assistance than their largest U.S. customer despite the fact that they sold an average of 50% less volume to Toyota.

The greater knowledge sharing has had a substantial effect. From 1990 to 1996, the suppliers reduced their defects (in parts per million) by an average of 84% for Toyota versus 46% for their

largest Big Three customer. Similarly, the average supplier slashed its inventories (as a percent of sales) by 35% in its operations devoted to Toyota versus only 6% for its largest Big Three customer. And suppliers increased their labor productivity (sales per direct employee) by 36% for Toyota versus just 1% for their largest Big Three customer. Furthermore, by 1996 the suppliers had achieved 10% higher output per worker, 25% lower inventories and 50% fewer defects in their manufacturing cells for Toyota, as compared with what had been achieved for their largest U.S. customer. These results are all the more amazing given that the suppliers were manufacturing a similar component for a U.S. customer within the same plant!

Sustaining the Advantages

If suppliers have achieved such significant improvements by sharing knowledge with Toyota, why then don’t they utilize that know-how for their other customers? In fact, one-third of the U.S. suppliers in our study reported that they did transfer the knowledge acquired from Toyota to manufacturing cells devoted to their largest U.S. customer. But the remaining two-thirds did not. Many plant managers reported that even when they wanted to transfer knowledge to other manufacturing cells in the same plant, they often couldn’t because of two types of barriers: network constraints and internal process rigidities.

Network Constraints In some instances, plant managers reported being unable to transfer knowledge because of a particular cus-tomer’s policies or other constraints. For example, one supplier was required by its Big Three customer to use large containers, approximately 4 feet by 6 feet and weighing 200 to 300 pounds when filled. By comparison, Toyota had the supplier use smaller containers, about 2 feet by 3 feet and weighing 40 pounds when filled. This had a number of important ramifications. The manufacturing process using large containers required more floor space, and the supplier needed to purchase forklifts and hire forklift operators to move the containers. Not only were the large containers unwieldy, they were also tougher to keep clean, which affected product quality. Furthermore, the large containers made it more difficult to label and sort products into a particular sequence for production at the assembler’s facility. But the large containers fit well into the Big Three assembler’s system (which also used forklifts and a lot of floor space), so the customer wouldn’t allow a change to a smaller size. Thus, the supplier was unable to replicate the processes that it was using for Toyota.

Internal Process Rigidities Suppliers were much less likely to transfer knowledge from Toyota to one of the Big Three when the manufacturing cells for that customer had a high level of automation or a large capital investment in heavy equipment. Such internal process rigidities — large machines bolted or

62 MIT SLOAN MANAGEMENT REVIEW SPRING 2004

cemented in place, trenches in the floor, utilities hardwired to equipment and so on — increased the costs of transferring knowledge. As one plant manager reported, “When you invest in automation, you do everything you can to run that job for as long as you can. When you have to change a highly automated process, you have a devil of a time. It just never works.” Internal process rigidities help explain why suppliers had relatively low rates of productivity improvement for their U.S. customers. Plant managers could not make the changes they

Consider the significant price premiums that Toyota vehicles enjoy (relative to U.S. cars in the same class): an average of 9.7% for new cars and 17.6% for used ones.3 Higher quality is a major reason why Toyota vehicles can command such prices. The J.D. Power and Associates Initial Quality studies have found that between 1990 and 2000 Toyota cars had roughly 40% fewer problems (per 100 vehicles) than did autos from the Big Three.4 The total cost of the knowledge-sharing activities that have con-

wanted, or they were forced to wait until the customer terminated a vehicle model before they could implement a new process. Thus, at the very least, internal process rigidities created a significant time lag. In contrast, Toy-ota’s production network has been

“We are not so concerned that our knowledge will spill over to competitors. By the time it does, we will be somewhere else.”

designed as a dynamic system with flexibility built directly into the manufacturing processes. Most machines, for example, are on rollers so they can be moved easily to new locations.

Other factors can also impede the transfer of knowledge to production cells dedicated to Toyota’s rivals. A number of plant managers refrained from even requesting a major change from a U.S. customer because they perceived the approval process to be time consuming and difficult. Furthermore, significant changes to a manufacturing cell often require considerable down time, which a customer might be unwilling to endure. Or the customer might refuse to accept the possibility that the new processes might initially have bugs. According to the president of one sup-plier,“Sometimes it’s just not worth the risk to try something new if the customer isn’t supportive and involved. If you cause a recall, or even if they think you caused a recall, it could put you out of business. And if you shut down their plant, they charge you $30,000 a minute.

In summary, taking know-how learned from one customer and applying it to another can be extremely difficult, mainly because knowledge is so context-dependent. But the ability to transfer and adapt knowledge can, in and of itself, be a competitive advantage. As Michio Tanaka, the general manager in purchasing at Toyota, asserts, “The ideas behind the [TPS] have basically diffused and are understood by our competitors, but the know-how regarding how to implement it in specific factories and contexts has not. Toyota Group companies are better at implementing the ongoing … activities associated with the [TPS]. … I think we are better at learning.”

The Bottom Line

The trickle-down benefits of knowledge sharing can be substantial. By transferring its know-how to suppliers, Toyota has helped those firms greatly improve their performance, and this in turn has generated tremendous competitive advantages for Toyota.

tributed to the enhanced quality of Toyota vehicles was between $50 million to $100 million for the United States and Japan. That amount might seem considerable, but it was relatively small for a $100 billion company like Toyota, and it was certainly a wise investment that has more than paid for itself in increased profits for the Japanese automaker.

(
SPRING 2004 MIT SLOAN MANAGEMENT REVIEW 63
)The experience of Toyota strongly suggests that competitive advantages can be created and sustained through superior knowledge-sharing processes within a network of suppliers. We believe those principles have broader applicability, for example, in other types of alliance networks, including those with partners in join ventures. In fact, establishing effective interorganizational knowledge-sharing processes with suppliers and partners can be crucial for any company trying to stay ahead of its competitors. As one senior Toyota executive observes, “We are not so con-cerned that our knowledge will spill over to competitors. Some of it will. But by the time it does, we will be somewhere else. We are a moving target.”

Indeed, Toyota’s dynamic learning capability, enabled through a network of knowledge sharing, might turn out to be the com-pany’s one truly sustainable competitive advantage.

REFERENCES

1. L. Chappel, “Toyota: Slash — But We’ll Help,” Automotive News 77 (Sept. 16, 2002): 4.

2. M. Porter, “Competitive Strategy” (New York: Free Press, 1980).

3. J.H. Dyer and N. Hatch, “Network-Specific Capabilities, Network Barriers to Knowledge Transfers, and Competitive Advantage” (paper presented at the Strategic Management Society Conference, Orlando, Florida, Nov. 7-10, 1998).

4. J.H. Dyer, “Collaborative Advantage” (New York: Oxford University Press, 2000).

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