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Additional Readings

Contents
Reading 1.1: The Purpose of the Firm, A. Campbell.
Reading 1.2: Why do Companies Over-Diversify? A. Campbell.
Reading 1.3: Manufacturing Strategy Part 1 - Setting the Strategy, Tangram
Technology

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Additional Reading 1

The Purpose of the Firm, A. Campbell.

UNSW, Copied under Part VB of the Copyright Act 1968, as amended,


on December 1993.

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Brief Case:
The Purpose of the Firm
Andrew Campbell

In recent weeks I have been involved in a


number of discussions about the purpose of
business. These nearly always lead to a
disagreement between people who argue that
the purpose of the firm is to create value for
shareholders (i.e. to make money) and people
who argue something else. The second group of
people consist of a broad church. Some have no
clear view about what the purpose of the firm
should be, but they are convinced that making
money should not be the ultimate purpose.
Some have strong views in favour of a variety
of other purposesserving customers, longterm survival, to be the best in the industry etc.
Some believe that the focus on shareholders is
appropriate so long as it includes a recognition
that the company must behave responsibly
towards other groups and Stakeholders. These
discussions normally generate more heat than
light and most managers feel the discussions
have very little to do with the running of a
successful commercial organization. So why is
it worth devoting a Brief Case article to the
topic?
First, I believe that a clear understanding of the
purpose of the firm in our society will help to
improve management thinking on a number of
issues ranging from corporate governance to
corporate objectives.
Second, the current emphasis on creating value
for shareholders is causing managers in many
companies to run their businesses in a way that
makes them unwitting hypocrites. Managers
proclaim shareholder wealth as their objective,
and then take some decisions that can clearly be
shown to have a negative impact on shareholder
wealth.
Third, there is a deep suspicion of big business
both among employees and in society at large.
This saps employee commitment, undermines
management self-confidence and leads many
school leavers and graduates to look for careers
outside the commercial sector.

If we could develop a better understanding of


the role of business in society and of what is a
legitimate purpose for the firm, I believe we
could help eliminate a cause for discord and
confusion in industry and commerce.
I find it useful to start an analysis of purpose by
thinking about small business, if we ask the
purpose question of a three person consulting
business, can we get an unequivocal answer?
Let us assume that this consulting business
consists of two principals and an administrative
assistant, and the focus of their work is giving
companies advice on business strategy. What is
a legitimate purpose for this business? Is it to
create value for shareholders? Is it long term
survival? Is it to maximize the value received
by clients? Is it to provide interesting and well
paid work for the two principals? Is it to be the
best business strategy consulting team in
Britain? The answer is that the purpose of the
three person consulting business depends on the
desires and aspirations of the two principals,
influenced no doubt by the administrative
assistant. It is likely to be a complex purpose
that reflects the complex needs of the people.
The principals may have a requirement that the
business generates a certain amount of wealth
for them. They will also want to have
stimulating work to do. They may want the
business to survive for at least a certain period,
but they may have no desire for it to exist
beyond their retirement.
The important point from this example is that
the choice of the business's purpose is the
responsibility of the owner/managers who
created the business. There are some constraints
on their choice of purpose: it must be legal; it
must enable them to generate sufficient
revenues to cover costs and satisfy their salary
needs; it must be attractive to their
administrative assistant, etc. Within these
constraints they are free in our economic
system, to choose whatever purpose they like.

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Now if we increase the size of the business


from three people to three hundred or three
thousand or three hundred thousand, but still
have only two principals and keep all other
aspects similar, does the purpose or the way in
which it is created change? The answer is no.
As owner/managers of this larger business, the
two who founded it still have the responsibility
and freedom to choose its purpose within the
constraints of the law and the various market
places the business will operate in. Size of itself
does not change the nature of the purpose issue.
It imposes additional constraints, for example
three thousand employees rather than one
employee will need to be comfortable with the
purpose, but it does not change either the
responsibility of the owner/managers to
determine the purpose nor the fundamental
freedom they have to choose whatever purpose
they want.
A problem occurs however if these
owner/managers make their business into a
'public limited company' and sell the shares to
individuals and institutions. Now ownership is
separated from management and it is no longer
clear whether the managers or the owners
should determine the purpose of the company.
If the owners determine the purpose of the
company, and the owners are financial
institutions seeking to maximize the financial
value of their investments, they will set a
purpose of maximizing the return they get from
ownership. They will impose an owner's
perspective on the company and its
management. Financial institutions and other
financially driven investors will choose
maximizing shareholder value as the purpose.
If the founding managers (the two individuals
who were previously principals) determine the
purpose of the company, it is likely to remain
the same as it was prior to becoming a public
limited company, except that these founding
managers now have additional constraints to
satisfy. They must generate a return for the
owners that is reasonable in light of the risk
they are taking.
The disagreement between those who believe
that the purpose of the firm should be
maximizing wealth for shareholders and those
who believe that it should be something else
can be attributed to the problem created by
public limited companies. Those who argue in
favour of shareholder wealth feel that the
owners should sec the purpose. Those who
argue for something else feel that management

or society should set the purpose. Yet in our


system of corporate governance there is no need
for the debate. It is clear that it is the
responsibility of the Board of Directors to set
the purpose. It is also clear that these directors
may chose any purpose they like within the
constraints of the law and the market places
they chose to operate in.
But placing the responsibility on the directors
does not resolve the dilemma. Should the
directors choose shareholder value to reflect the
fact that they know this is the preferred view of
their institutional investors, or should they
choose something that reflects their own,
personal desires, needs, and ambitions and treat
the owners' needs as another constraint? Their
choice is between deciding to maximize returns
to owners or deciding to maximize something
else, knowing that the owners will require at
least a reasonable return on the risk they arc
taking. Much of the debate about purpose is
focused on this issue. What should directors do?
Fortunately we do not have to make any hard
and fast rule. Directors can legitimately decide
either to focus on maximizing returns to owners
or to focus on something else. The choice is
theirs. Lord Hanson and his Board have
repeatedly argued that they favour focusing on
the returns owners receive, and they are disliked
by some other managers because they have
helped to raise the expectations of owners.
Anita Roddick and her Board, on the other hand
favour focusing on something other than
shareholder value. She considers the attitudes
of managers like Lord Hanson to be wholly
inappropriate. Lord Sainsbury is also on the
side of those not primarily driven by
shareholder value. The company's objectives
are first To discharge the responsibility as
leaders in our trade and, second To
generate sufficient profit to finance continual
improvement and growth of the business whilst
providing our shareholders with an excellent
return on their investment.
The strength of our system is that it allows for
and in fact encourages all of these views. There
is no need for us to attempt to resolve these
dilemmas. Each board of directors is free to
make its own choice and will not be penalized
unless it fails to meet the constraints imposed
by the market places it trades inthe market
place for owners, the market place for
employees, the market place for customers, the
market place for suppliers, and so on. We do
not have to agree about what is or should be the

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purpose of business. Each management team or


each board of directors has the responsibility
and freedom to choose its own purpose.

Directors who fail to address this critical


question fail to put in place the foundation
stone of their management philosophy.

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Additional Reading 2

Why do Companies Over-Diversify?, A. Campbell


Long Range Planning, Vol 25, No 5, pp 114-116, 1992

UNSW, Copied under Part VB of the Copyright Act 1968, as amended,


on December 1993.

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Brief Case: Why Do Companies OverDiversify


Andrew Campbell

The last 12 months has seen a number of


companies humbled as a result of excessive
diversification. British Aerospace plunged into
cars, property, construction and munitions and
the result exit the chairman and finance
director. British Petroleum has been selling its
diversifications into minerals and nutrition in an
attempt to bring some stability to its oil and
chemicals businesses. Moreover, the last three
major hostile bids Ultramar, Hawker
Siddcley and Dowty are all stories of
excessive diversification. It has become clear
that over-diversification is one of the most
dangerous hazards that a modern corporation
has to face.

don't understand? Clearly the cause must be


deeply rooted.

Not only is there ample evidence of the dangers


of diversification, but managers are being
continually bombarded with advice against it.
The best read management book of all timeIn
Search of Excellence by Tom Peters and Robert
Watermandevotes a chapter to the topic.
Using the sort of language that only Tom Peters
can get away with, the chapter is titled 'Stick to
Your Knitting'. Tom Peters' ranting against
diversification is legendary. One of his targets
has been US Steel. Along with a diversification
into oil the company changed its name to USX
and Peters commented, 'of all the 26 letters
available, US Steel could not have chosen a
better one to symbolize a management team
which has clearly lost its way'.

For whose benefit is the manager seeking to


spread risks? The shareholders are unlikely to
benefit. Fund managers can spread their risks
much more efficiently than corporate managers.
Employees are unlikely to benefit. Their skills
are unlikely to be easily transferred from one
business to another. The main beneficiary is the
corporate manager. He or she gains job
security. If one leg of the-business collapses,
the corporate manager is still needed to look
after the other legs.

Andrew Campbell

Peters is not a lonely voice. Every textbook,


article and researcher concludes that
diversification is to be treated with caution.
Diversification is not wrong. The danger is
over-diversification: getting into businesses
managers do not fully understand.
So why do companies over-diversify? Why do
otherwise well-adjusted, well-educated and well
intentioned managers insist on risking their own
reputation and the independence of their
companies by acquiring businesses that they

The first cause of over-diversification is


reasonably familiar. Managers diversify to
spread risk, and this can lead to acquisitions of
businesses that turn out to be unfamiliar.
Managers are concerned to avoid excessive
focus. 'We mustn't be too dependent on the
U.K. economy.' Or, 'We mustn't have more than
40 per cent of our portfolio exposed to the
building cycle.' Or, 'We are too reliant on sales
to Marks & Spencer.' The desire for a spread of
interests is very strong.

Yet this additional security is a fallacy. By


getting in to businesses they don't fully
understand, corporate managers make their jobs
less secure rather than more secure. They
increase the risk by spending cash reserves or
taking on extra debt. They also increase the
probability of unexpected performance hiccups
by taking on businesses they do not know how
to control.
To reduce risk managers should stick to the
businesses they know how to manage,
protecting their future by out-performing
competitors rather than hedging their bets.
Furthermore, the best defence against
'outrageous fortune' is a low debt position, or
better still, money in the bank.

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So why do managers pursue risk spreading with


such vigour? At a recent gathering of chief
executives, we were discussing a hypothetical
acquisition opportunity which had the potential
of creating ~50m in shareholder value. The
target company would be bought at a
reasonable price and the acquiring company
knew how to raise the target's performance
through better management and through
synergies. Yet the chief executive of the
acquiring company rejected the opportunity
because it would have 'unbalanced' his
portfolioit would have made it more than 75
per cent dependent on the car industry. The
other chief executives involved in the
discussion agreed with this position.
The reason for this kind of thinking is not job
protection or a self-serving attitude. It stems
from a belief chat the chief executive's job is to
make sure that the corporation survives. By
balancing the portfolio, chief executives think
they arc giving the corporation a better chance
of survival in the longer term. As one manager
put it, 'we have been in business for 127 years
and my job is to make sure we are in business
in 137 years time'.
Unfortunately diversification to achieve balance
most usually reduces the life expectancy of the
corporation because it introduces inefficiencies
and opportunities for mismanagement. The only
factor that increases corporate life expectancy is
an increase in competitive advantage: the ability
to create more wealth than competitors ensures
chat the company has more resources than
competitors and hence improves the chances of
survival.
The second cause of over-diversification is less
familiar and somewhat counter intuitive. It
comes from managers' deeply held belief in
growth and it can lead managers into acquiring
businesses they do not understand. In a recent
conversation, when I challenged the company's
assumed growth objective, one board member
commented. 'If you don't want to grow your
business, you should become a civil servant'.
Growth thinking is not wrong. Shareholders
want growth in the value of their investments
and employees like growth because it provides
career security and advancement opportunities.
But growth thinking can be dysfunctional when
the business that the managers know well is
mature, stable or decliningcigarettes, bricks,
beer, etc.

If the prospects for the industry are low growth,


managers start looking for higher growth
opportunities. It is called gap analysis. If the
current businesses cannot produce enough
growth to meet corporate objectives, there is a
gap that needs to be filled by other businesses.
The solution is to look for higher growth
businesses to diversify into.
Unfortunately, when low growth is the
motivation for diversification, the prospects for
success are particularly low. Management of a
maturing business usually have little experience
outside their core business and all the adjacent
opportunities, where management is likely to be
familiar with the business issues, have been
fully exploited by other companies or are
themselves mature. This causes managers to
take risks in less familiar areasthe classic
over-diversification problem. It is not
surprising, therefore, that the failure rate is
high. Take the oil industry. Every major oil
company lost confidence in the oil industry in
the 1970s and set out to find other, ideally high
growth, businesses to exploit. The list of what
has been tried reads like the SIC code book. But
the record of success, based on 15 years'
experience, has been very poor. If the biggest
and best companies in the world, able to attract
the best management talent, hire the best
advisers, and spend billions of dollars, are not
able to succeed, it is unreasonable for us to
expect lesser companies to do better.
So what is the solution? Should managers in
mature businesses focus on managing their own
decline? The answer, frequently, is yes.
Focusing on maturity can be far preferable to
risking all in unfamiliar areas.
Unless there are growth areas where the
company has or could create some clear
advantage, managers should avoid the macho of
high growth-objectives. Investors can be just as
content with stable performance and high
dividend yields. There is no reason why a
company should not be ambitious to produce a
performance similar to an undated government
bond (i.e. low growth but secure returns).
Moreover, so long as managers run their
businesses better than other management teams,
there is no 'under performance' and hence no
room for a takeover bid. Managing in a stable
environment can be attractive to shareholders.
Clearly some shareholders want growth. But
this is not true for all shareholders. Many prefer
security.

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A Stable environment can also be attractive to


employees and other stakeholders. Not all
employees and managers are happy working in
a stable environment. But many are. By
attracting stakeholders satisfied with stability a
company need not have growth as an objective.
One of the best-documented examples is a
company called Crown Cork & Seal. Spotted as
a Harvard Business School case in the 1970s, it
has been a model for others to follow.
Unlike its competitors, Crown did not diversify
away from the mature canning business into the
higher growth packaging businesses. Instead,
Crown focused on becoming the most flexible
and most service-orientated canning company.
It also invested in developing countries where
canning operations still provided small growth
potential. It decided to stay in familiar
businesses. Excess cash flow was used to pay
attractive dividends and grow the share price by
buying back shares. During the 1980s the
company bought back more than half its total
issued share capital.
The quality of Crown's strategy was underlined
in the late 1980s when most of its U.S.
competitors decided to separate their canning
operations from their other packaging
businesses through demergers and leveraged
buy-outs. This helped to underline something
that Crown managers had known all along, that
canning and plastic packing do not lie
comfortably in one portfolio: the skills needed
in the two businesses are different.
The distaste managers have for managing
decline is one of the evils of our current
management cadre, and has provided
companies like Hanson and BTR with easy
stepping stones to the top of British industry. If
the average manager's ego was less tied to
growth we would not need Hanson, Williams
Holdings, or KKR to do other people's dirty
work.
Taken together, the fear of excessive focus and
the desire for growth are likely to continue to
lead the unwary board of directors into trouble.
It is only by vigilantly rooting out the woolly
thinking that surrounds risk spreading and
growth objectives that directors can keep their
companies safe from one of industry's most
deadly diseases.

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Additional Reading 3

Manufacturing Strategy Part 1 - Setting the Strategy, Tangram Technology, 2001

UNSW, Copied under Part VB of the Copyright Act 1968, as amended, on December
1993.

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Manufacturing Strategy- Part 1: Setting the


Strategy
Introduction
Do any of these sound familiar and have you heard the same sort of thing in your
company:
'I can sell it but they can't make it'
'It's no use telling me you can make doors this week, we need windows.'
'I've got this order now so you will deliver next week.'
'Production output is down this week yet orders are stacking up.'
'What do you mean we don't have the equipment to produce it?'
'Of course I want it NOW!'
Statements such as these really show that something is wrong somewhere and that
you need a manufacturing strategy. A real problem is that you cannot buy a
manufacturing strategy off the shelf. You must create it, work on it, develop it and
make it become part of your business. It is a vital part of the business and as such
can only come from within.
The format of this series on developing a manufacturing strategy is a combination
of asking questions and prompting some questions to ask. The answers will be
different for every fabricator. There can be no right or wrong answers, only
appropriate answers to appropriate questions.
We are all facing severe competition and changing market requirements and in
addition to our existing local competitors we have new competitors or expanding
national ones. The market demand is also changing from a retail base to a
specifier or contract base thereby putting margins under severe pressure. Gone are
the good old days and the hard new days are already on us. You need to act now
before it is too late!
But before trying to create manufacturing strategy we should possibly define what
it is not.

Manufacturing strategy is not another phrase for automation.

Manufacturing strategy is not another phrase for buying new machines.

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Manufacturing strategy is not another phrase for computers.

Manufacturing strategy is not another Japanese management fad.

Manufacturing strategy is not about technological excellence.

Despite these statements manufacturing strategy can be about all of these things
but only if they are appropriate to your business.

Strategy - Tactics - Operations


Let us begin with some basic ideas and definitions of strategy, tactics and
operations.

Strategy - The art and science of the planning and conduct of a war (or in this
case, a business).

Tactics - The art and science of the detailed direction and control of
movement or manoeuvre to achieve an aim, task or objective. Plans followed
in order to achieve a certain aim.

Operations - What really happens - the dirty stuff.


The Strategy Limits
The Goal

The Tactical Moves

Figure 1 The Strategy Limits

The relationship between strategy and tactics


In a military sense, strategy is the effort to bring your forces into play
advantageously and occurs before the combatants meet. Tactics is what happens
once the battle begins and operations are how the individual units perform.
A wonderful strategy can be ruined by losing tactics. This is equivalent to setting
your boxing opponent up for a knockout punch and then missing the punch.
Most companies accept the need to develop 'sales strategies' or 'marketing
strategies' but see no need to develop a complementary strategy for
manufacturing. Without this manufacturing strategy any investment in machinery,
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systems or technology is probably a series of unrelated knee-jerk responses to


current operational problems. Who has got machinery that they bought for the 'big
order' that never appeared?'
We are often unaware that what appears to be a routine manufacturing decision is
binding us into equipment, personnel or systems which will make it difficult and
costly to adapt the business to the changing market requirements. Worse still,
having invested in an inappropriate system you may not be able to re-invest or
even have the time available to do so.
It is obvious that the manufacturing strategy must be integrated into the overall
business strategy alongside the marketing, finance, sales and other strategies.
For too long the manufacturing area has been thought of as a 'liability' in terms of
the overall business strategy and this has led to comments like those al the start of
this article. By integrating manufacturing into the overall business strategy the
more forward thinking companies can transform manufacturing into an asset.
This approach requires that all production managers become pro-active in terms
of' the business rather than reactive. For too long we have seen our role as
responding to external demands - producing what the technical department
designed in the volumes sold by sales without influencing either. Production
managers must begin to think of themselves as businessmen!
The business strategy must take into account manufacturing capabilities as well as
market needs and product design. Production management must become actively
involved in the development of the overall business strategy. Improving
manufacturing performance gives companies a competitive edge and to achieve
this, production managers must begin to think and act in a strategic manner. We
have to learn how to manage our activities strategically so that the manufacturing
function is able to give the company the competitive edge in the market place.
We will come back to this point later in the series when we examine the
implication in greater detail but at this stage we need to understand that we are
talking about a whole new ball game here. Minor improvements will not get you
through the survival stakes at this stage. Remember that in the future, excellence
will only be a ticket to the game.

Business strategy
Before we can set down a manufacturing strategy we must have some idea of the
overall business strategy after all this is the framework that manufacturing fits
into. A business strategy needs to he formed in several steps where you need to go
'around the loop' several time to ensure that it all fits together.

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Personnel Strategy
Marketing
Strategy

Manufacturing
Strategy
Financial
Strategy

Technical
Strategy

Organisational
Strategy

Personnel Strategy

Figure 2 The Business Strategy Framework


We must first define the business objectives, because these are what give the
essential direction arid motivation for all the other work. They provide the
boundaries for all the other objectives.
The objectives may be:

Profit

Market Share

Growth

There should always be actual targets to aim for in both the long and short term. It
is not enough to say that you want to increase profit, you must state how much
you want to increase it by and over what period i.e. profit to increase from 1,000
to 2,000 in the next twelve months. The objectives should be bold (to provide a
challenge), measurable (to see if you get there), prioritised (to give focus) and
accepted by all staff.
Under no circumstances should these exceed half a page in length, nor should you
have more than four key objectives.

Marketing strategy
This involves looking at your market in terms of size, volume and trends, looking
at customers in terms of characteristics and needs and competitors in terms of
strengths and weaknesses. The most memorable method is to think in terms of
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S.W.O.T. (Strengths, Weaknesses, Opportunities arid Threats). The end result is a


series of identified markets, targets for these markets and actions to open up new
markets.
The choice of marketing strategy influences toe manufacturing strategy but it is
also true that the manufacturing process influences the marketing strategy.
Whilst this may seem as if we is going around in circles you need to know and
realise the interrelationship between the two strategies.

SWOT Analysis
Strengths

Opportunities

Weaknesses

Threats

Figure 3 The SWOT Grid

The key factors for success (KFS)


'These are the factors that determine growth and success in your particular market.
The KFS may be product related or system related e.g.

Price - Can you provide the required product at the market price?

Quality - Responsiveness

Lead times (absolute)

Lead times (reliability)

Product choice

Service (Technical/Sales/ Marketing)

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Every company needs to find out what the KFS are for their market and to try to
improve these. If there is nothing to distinguish you from the crowd then your
future is limited.

Manufacturing strategy
Having established the objectives, marketing strategy and KFS we can begin to
develop a manufacturing strategy to deliver the key factors for success at the
required level. The formulation of the marketing and other strategies must be
clearly understood by the engineers otherwise the design of the manufacturing
systems will not be effective.
It used to be assumed that cost-efficiency based on high machine and labour
utilisation was the way to be competitive. The market and battleground have
changed so that now total system effectiveness is the vital factor.
The new KFS are based around customer responsiveness and relate to factors such
as:

Minimal inventory

Zero defects

Low but reliable lead times

A major point in the strategy is the product itself and we need to achieve the
following:

Develop

Make

Faster

The Product

Change

Better
Cheapet

Figure 4 What we need to achieve

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This helps us to set our priorities in terms of the development of a strategy. A


strategy to achieve all of the possible combinations of the above diagram would
be a truly potent weapon in the market place.
In our development of this weapon we will need to examine how we control
production, how we control quality and how we measure our performance in all
areas. Some of the areas will require investment in hardware but most of the gains
we want can be achieved by improving the methods we use.
We must always be prepared to try new ideas and to challenge the traditions that
have built up in our factories. Almost all new ideas will work given time,
dedication and application. The real problem is the 'idea or technique of the week'
which is not applied properly and is blamed for the failure when really it was
implementation that failed - not the idea or technique itself. Despite this you must
however beware of 'experts' bearing the solution to all your problems in one easy
bag of tricks. This is like handling someone a screwdriver and some wire strippers
and then calling him an 'electrical engineer'. The real experts still have a bag of
tools but they are made appropriate to your needs.
If you ask questions (better still the right questions) then you will be well on the
way. In the final analysis only you can choose your tools, your weapons and your
strategy and work to make them appropriate.

What can we achieve?


It is important to set some overall goals in terms of what we want to achieve from
our manufacturing strategy, let's start with some big ones:
1. We want to reduce stock, work in progress and cash tied up in product by at
least 40%.
2. We want to reduce lead times from order to delivery by a factor of 10 i.e. from
6 weeks to 3 days.
3. We want to increase lead-time reliability by a factor of at least 3.
4. We want to increase quality by a factor of at least 4.
5. We want to increase overall profitability of the company by at least 20%.
These are achievable goals!

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