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 / Summer 2009 / Issue 55(originally published by Booz & Company)


Reframing Your Business Equation

Companies and industries are often driven by implicit formulas. Questioning their validity can lead to breakthroughs.

Illustration by Lars Leetaru

Business is, and always has been, a numbers game. The Phoenicians invented the number zero for “accounting” purposes and laid the foundation for the ongoing quest to quantify business, as embodied by Frederick Taylor (the American mechanical engineer regarded as the father of scientific management), the Whiz Kids (who revolutionized management science after World War II), and today’s oft-vilified MBAs. Most general managers will argue that the unquantifiable “soft stuff” presents the most daunting business challenges, but when it comes to thinking about operations strategically, there is no substitute for hard mathematics.

Operations strategy fundamentally demands trade-offs. Accordingly, equations of one sort or another often come to dominate the thinking of managers seeking to optimize the resources at their disposal to achieve the best bottom-line results. Sometimes these equations are formalized and reflect explicit trade-off decisions, as is the case with the economic order quantity (EOQ) formula, which optimizes setup cost and inventory carrying cost. But more often, managers operate with an implicit set of formulas that may be derived loosely from formal thinking but are in practice based more on trial and error. These heuristics often go unchallenged as they shape the managerial decisions that drive entire industries down a common path. Common, that is, until someone challenges the underlying assumptions and the rote thinking that results from them.

For example, when the Toyota Motor Corporation introduced its new paradigm for what became known as lean manufacturing in the mid-20th century, it might have seemed that it was dismissing the old logic of the EOQ and the mass production mind-set that it had engendered. But a deeper look shows that Toyota actually reframed the EOQ paradigm rather than dismissed it, because the logic of the equation still holds. True breakthrough operating strategies like Toyota’s, in fact, usually result from a reframing of the accepted wisdom.

To drive your own breakthrough strategies, you must first understand the implicit equations that influence management thinking in your industry. Once you define them, you can, like Toyota,  reframe the equation to produce a new model of competition. By examining a variety of case examples, we have identified a basic method you can use if you dare to challenge conventional wisdom.

From Mass Production to Lean
The EOQ formula dates back to the Industrial Revolution and a 1913 article by Ford Whitman Harris, a self-trained engineer at Westinghouse Electric Company, in Factory: The Magazine of Management, a relic of another era. The article showed how to balance the fixed cost of ordering or producing a batch of goods with the cost of carrying the inventory between order periods. Graphically displayed with cost on the vertical axis and “lot size” on the horizontal axis, the elegantly simple solution occurs at the intersection of the upward sloping straight line (for inventory carrying cost) and the downward sloping curved line (which reflects the decreasing “setup” or “one-time ordering” costs spread over the batch size). The formula allowed a manufacturing manager to find the optimal lot size given the input parameters of per-unit carrying cost and per-batch fixed costs.

Today, many practitioners think that the EOQ embodies a way of thinking that’s no longer relevant. In reality, however, the trade-off between inventory carrying cost and setup cost remains. Taichi Ohno, father of the Toyota production system, knew that — as does anyone with a deep understanding of “factory physics.” Ohno’s innovation was to reframe the equation to solve for setup time rather than lot size.

Inspired by American grocery stores where consumers “pulled” products from a shelf that was continuously replenished, Ohno concluded that the optimal lot size was one unit. So, instead of trying to find the lot size that balanced setup cost and inventory carrying cost, Ohno sought to drive down setup cost to a low enough level to justify his ideal of a single unit for the lot size. To achieve his vision, Ohno turned to his industrial engineer, Shigeo Shingo, and challenged him to find a way to reduce a stamping press setup time of 12 hours to less than 10 minutes. Shingo and his team succeeded — and, as they say, the rest is history.

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