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Chapter 3 Flexible Technologies, Fluid Organisations and Digitisation 3.1 Introduction The ‘fluid’ organisation is a 21st century phenomenon. In less than a decade, the forces of globalisation, digitisation, technological advance and novel information exchange possibilities have altered the nature of organisational structuring and flows. Depending on business models, industries and markets, some companies today can be free from most physical asset investments and can manifest extreme flexibility and fluidity. They can be rapidly designed and then re-configured and again re-organised to tap into altering markets, products, customer segments and economic opportunities. Not only can fluid organisations alter their cost structures from high fixed cost leverage to variable cost intensity over very short time periods, but they can also redirect corporate strategy almost instantaneously alongside cost re-alignment. But organisational investments in flexibility long preceded the emergence of fluidity. The fluid organisation is a radical transition from the 20th century industrial enterprise. Its flexibility has been enabled by transitioning from a structure that is heavy in fixed assets and that has functional managerial demarcations into one that is eminently changeable and capable of real-time product shifts, service diversification and competitive re-orientation. At times, competition as well as co-operation can be present with other market incumbents. From the early 1970s to the late 1980s, manufacturing and service enterprises invested extensively in a variety of flexible organisational technologies (FOTs). Logistics-based technologies, such as material requirements planning (MRP), developed into comprehensive rationalisation systems such as enterprise resource planning (ERP) systems (Mouritsen and Hansen, 2006). Just-in-time (JIT) purchasing and production approaches, refined in Japanese firms, were adopted in a variety of forms by enterprises in developed economies. Intelligent machines first found form as numerical control machines and subsequently, with the advent of computerised systems, they became more sophisticated as computer-aided design (CAD), testing 54 Flexible Technologies, Fluid Organisations and Digitisation and manufacturing systems. Flexible manufacturing systems (FMSs) investments made by some firms during the late 1980s and 1990s were conceptualised so as to enable investment in production capacity before actual products were produced and sold. A few firms sought to implement computer integrated manufacturing facilities, which represented the most extreme level of automation available during the early 1990s (Bhimani, 2008). This chapter discusses the advances which have reshaped organisations and made them more flexible and ultimately fluid. It draws out the significance of this transformation for management accounting. 3.2 A Trajectory of Flexibility Extensive advances over a 30-year period have altered the face of service and manufacturing environments. Specifically a variety of significant changes have, over this time, been witnessed in the management of organisational resources: ■ Products and services have become more diverse, thereby requiring enhanced facilities to co-ordinate and service the wider range of offerings to customers. ■ The rate at which product and service innovations can be mounted and offered to customers has vastly increased. This has required new infrastructures to be developed for manufacturing, distribution, marketing and servicing of products. ■ The life of products has diminished with more frequent replacements demanded. This required the search for both retail customers and industrial customers, and more capable and diversified resources and technological capabilities. ■ Products have become more complex, requiring more intense design efforts and the provision of greater resources at the product inception stage. This, combined with shortening product life cycles, has led to a very high proportion of product costs being committed prior to utilisation in production or the actual incursion of costs. Facilities, technologies, marketing resources and sales infrastructures have had to be set up at the product design stages to confront products’ shortening life cycles and the associated shorter time frames over which product sales could deliver profits. ■ The internationalisation of trade has enabled many firms to reach wider markets, but profitability depends on the capacity to customise products to suit local tastes and needs. Thus differentiated products have attained a second further level of differentiation in local markets which further enhances the need for technologies and management resources to support intensifying differentiation. Management Accounting: Retrospect and Prospect 55 These aspects of changing markets and products have very particular implications for cost management. Growing investments to enable diversified products to be made has led to overhead cost increases. Higher fixed cost investments into FOTs and into production capacity enhancement have translated into a growing overhead cost base as a proportion of total product costs. Investments into automated processes have reduced the need for direct labour inputs. In the mid-1980s, it was realised that these factors were creating a ‘double whammy’ for traditional accounting systems, which were founded on there being a majority of costs that were driven by direct labour activities. This meant that direct labour was appropriate for most allocation purposes, and there was a lower overhead cost base to begin with which could rely on volume-based allocation mechanisms. Costs in the contemporary environment were bound to be regarded as distorted by the application of traditional cost allocation rationales which were designed for very different purposes. Enterprises with growing product diversity and production complexity would witness not only increased overhead costs but also cost growth that could not effectively be allocated under traditional means. The overwhelming existing emphasis on scale was at odds with the extensive level of scope which represented the new reality. In the mid-1980s, the popularisation of activity-based accounting was predicated on the realisation that product costs reported by traditional costing systems privileged volume over scope, which was deemed inappropriate (Ax and Bjornenak, 2007; Bhimani, 2009a; Major, 2007). But the argument was also made that, as product innovation rates grew and as product life cycles became shorter, a doubly urgent need for timely information that was devoid of cost distortions emerged. Decisions had to be made concerning product lines, resource allocations, product offerings and prices and they had to be made fast – sometimes in real time – or market opportunities could be missed at great expense. Furthermore, the greater proportion of costs committed by the start of the production stage in a product’s life cycle left little room for further cost containment post-production. Thus the onus was on managers to manage costs effectively from the beginning of the product conception stage. Cost management techniques such as target cost management, functional costing and quality function deployment matrices (see Bromwich and Bhimani, 2004) were deployed to deal with the need to link customer value and requirements to product features and functions and their costs, and to seek to achieve profitability of individual products over ever shortening product life cycles. In general the growth of publicity surrounding an array of cost management techniques during the 1980s was a reaction to the changing nature of product markets and the more complex needs of managers. But in effect, organisational restructuring over the 1960–1990 time frame had not been extensive across most manufacturing organisations, 56 Flexible Technologies, Fluid Organisations and Digitisation because the nature of products had not extensively changed. Although more sophisticated products like PCs, cameras and portable CD players were developed, there was still relative constancy in product domains and organisational forms. In large part, existing industrial organisational structures remained prevalent until the early 1990s. The rise of the fluid organisational form is a phenomenon tied to the advent of digitisation and network centricity. Following the emergence of the internet as a transformational technology, a number of important co-related changes took place. Many new products emerged which could not find form before the mid-1990s: digital cameras, iPods, HDTVs, mobile phones, etc. Whilst digital products existed prior to this time, the internet enabled their ready global access and forged their ubiquity anywhere broadband connections could be found. But in addition the ‘internet economy’ enabled new supply chain possibilities and the virtualisation of enterprise forms, whereby most organisational activities are carried out digitally. Products which relied on digitised data for their production and their workings could be produced by different organisations in terms of their development, production, marketing and servicing. As new products emerged, so did possibilities for the customer to engage with the firms selling the products. The consumer who had been a passive ‘product taker’ became, after 1995, an active ‘product maker’ in many contexts. And in some product categories, the customer went from being a ‘price taker’ to becoming a ‘price maker’ (see Chapter 4). Under such market circumstances, managerial tasks and organisational structures shifted. These changes will be considered here, but we first discuss FOTs which are regarded as having extensively influenced management accounting practices. 3.3 Flexible Organisational Technologies The adoption of altered production technologies, changed work organisation approaches and digitised operating platforms result from managerial decisions to invest in change. Such decisions themselves are reflective of philosophies about what comprises desirable enterprise aims and often depend on financial evaluations of the impact of these decisions. The consequences will usually entail altered financial status in terms of the internal cost impacts of product diversity, technological complexity and operational flexibility. Ultimately a reorientation of financial management practices for controlling operational activities and decision making often also ensues. Many technological and process-related changes have been undertaken by firms in the recent past, leading to cost impacts within their economic architecture. One important change has been in the control of quality. Other organisational alterations include investments in JIT systems, ERP, computer aided and FMSs (CAMS and FMS) and e-business technologies. We refer to changes in organisation methods, altered work-flow initiatives and digitisation-based investments in enterprises Management Accounting: Retrospect and Prospect 57 as FOTs. Quality initiatives, JIT systems, ERP and other flexible automation approaches are briefly discussed here. 3.3.1 Quality In competitive business environments, many organisations view high quality standards as key. Formerly, quality objectives in many enterprises were confined to product quality and restricted to the shop floor where products were made. In fact quality concerns can embrace every function within organisations, from purchasing through to marketing and finance. A concern for quality entails the following considerations: ■ Accepting that the only factor that really matters is the customer: if the customer is not happy with the product or service received then, by definition, there is room for improvement. ■ Recognising the all-pervasive nature of customer/supplier relationships. Focusing on internal customers and satisfying their needs contributes to the ultimate customer’s satisfaction but places responsibilities on suppliers and agents within increasingly complex supply chains. ■ Moving from inspecting for conformance to a predefined level of quality to prevention of the cause of the defect in the first place – getting it right first time. ■ Instead of an operator causing defects which are only recognised further down the line after quality controllers have done their inspection, making each operator personally responsible for defect-free production in their own domain. In other words, making every employee a ‘quality inspector’. ■ Adopting zero defect programmes, in which an extreme drive to get things right first time is pursued. This is equally applicable to activities as diverse as raising purchase orders and generating the monthly management accounts to manufacturing defect-free components in the plant – or providing total quality satisfaction in the delivery of a service. ■ Deploying quality certification programmes that are based on independent thirdparty audits indicating the extent to which a company has complete procedural control over all its processes. If these are operating properly, they will result in the customer receiving the goods or services on time and to specification. ■ Emphasising the total cost of quality as a relevant measure of all quality-related activities. The above are considered relevant for enterprises which seek to manage the quality of processes and organisational output. 58 Flexible Technologies, Fluid Organisations and Digitisation For any quality control endeavour, some notion of what constitutes quality is desirable. The quality of a product or service may be viewed as the totality of features which determine its fitness for the use intended by the customer. It is ultimately a function and a measure of customer satisfaction. It is also a reference to conformance to requirements. These and many other views on quality exist. Often quality has to be regarded in terms that are very specific to the organisation and its customers. Customers’ needs include affordability, delivery at the right time, safety, reliability and after-sales support, and one may view quality costs as falling into one of two major classes. The first category is that of the costs incurred deliberately to maintain or improve quality – the cost of conformance. It includes the costs of both prevention and appraisal activities. The second category is that of the costs suffered as a result of insufficient quality following production – that is, the cost of non-conformance – which essentially represents failure costs. Conformance deals with what could go wrong and its costs are therefore voluntary, while non-conformance deals with what has gone wrong and are thus involuntary at the production stage. Each of these categories of quality cost can further be broken down as shown in Figure 3.1. The conformance cost of prevention refers to the cost of any action taken to investigate, prevent or reduce defects and failures. Prevention costs can include the cost of planning, setting up and maintaining the quality system, and they are incurred to reduce failures and to keep appraisal (inspection) costs to a minimum – for instance, quality planning, design and development of quality measuring and calibration and maintenance of quality measurement and tests of equipment (Dale and Plunkett, 1999). The conformance cost of appraisal refers to the cost of assessing the quality achieved. Appraisal costs can include the costs of inspecting and testing that are carried out during the production process and on completion of the product. They are incurred in initially ascertaining conformance of the product to quality requirements, and do not include costs of re-work or re-inspection following failure. Examples are pre-production verification, laboratory acceptance testing, materials Quality costs Conformance Prevention Appraisal Figure 3.1 Categories of Quality Cost. Non- conformance Internal External Management Accounting: Retrospect and Prospect 59 consumed during inspection and testing and the analysis and reporting of test and inspection results. Non-conformance failure costs (internal) are the costs arising from within the organisation of the failure to achieve the quality specified. The term can include the cost of scrap, re-work and re-inspection, as well as consequential losses within the organisation. Internal costs arise from inadequate quality discovered before the transfer of ownership from supplier to purchaser. External costs arise from inadequate quality discovered after the transfer of ownership from the supplier to the purchaser. Internal failure costs may include troubleshooting or defect/failure analysis, reinspection and re-testing, modification permits and concessions and downgrading. Non-conformance failure costs (external) are the costs arising outside the organisation from the failure to achieve the quality specified. The term can include the costs of claims against warranty, replacement and consequential losses of custom and goodwill. The possibility exists for quality management efforts to blend into existing and emerging cost management practices and thereby to integrate quality costing within internal financial control systems. A quality assurance department which is responsible for producing an estimate of quality-related costs might aim to involve the finance function in order to: ■ prepare them for future responsibility for collecting the figures on a routine basis; ■ produce figures which are valid within accepted limits of uncertainty, with the objective of establishing the major areas of quality cost – which can then be reexamined if greater accuracy is needed; ■ give some measure of the cost of quality and the savings potentially achievable; ■ give a means of comparison between product and product, operating unit and operating unit and possibly between the company and its competitors; ■ give a baseline against which future goals can be set and improvements measured; ■ propose actions to control and limit quality-related expense. Some commonly useful sources of information for identifying and categorising quality costs are payroll analyses; manufacturing expense reports; scrap reports; rework or rectification authorisations or reports; travel expense claims; product cost information; field repair, replacement and warranty cost reports; inspection and test records and material review records. Organisations often perceive trade-offs between conformance and nonconformance costs. Thus if there is little or no investment in conformance costs, quality is likely to be poor and non-conformance costs will be high. Conversely, if more resources are invested in conformance activities, non-conformance costs 60 Flexible Technologies, Fluid Organisations and Digitisation will decrease and quality will improve. As quality improves, more difficulty will be encountered in achieving further improvement. Traditionally at the point where conformance cost is greater than non-conformance cost, any further improvement in cost reduction activity is uneconomic. There thus exists a theoretical point at which the sum of conformance and non-conformance costs is at a minimum. This conventionally has been seen as the optimal point of economic quality. The traditional view ignores the time element of quality activities. Preventive action has no immediate impact on non-conformance. But once in place, such action can reduce non-conformance costs throughout the life cycle of the product without further investment. Repetitive appraisal and prevention have quite different effects on non-conformance costs. The traditional view of a trade-off takes no account of changes occurring over the course of time. But conformance costs can increase and only then, though with a time lag, will non-conformance costs change. So quality improvement programmes can initially seem to incur extra expenses without returns, but typically the returns from lower failure costs ultimately do emerge. What underpins the philosophy that a lack of quality can be more costly than ensuring its presence amounts to taking a specific view on how to manage quality. The conventional view of quality management assumes that: ■ Improving quality drives up time and costs. ■ Defects and failures of less than, say, 10% (depending on industry) are acceptable. ■ Quality should be inspected ex-post. ■ Quality control should be a specialised and separate function. The more recent view of quality is different in that it considers that: ■ Improving quality reduces time and costs. ■ The goal is zero defects and failures. ■ Quality should be designed and built-in. ■ Quality control should be integral to production. The current conception of quality costs therefore suggests that there is no economic quality point other than that where the product, service or process attains 100% quality conformance. In other words, costs are minimised only when optimal quality is generated. Although managers regularly communicate using cost-based information, they often find economic definitions about quality inconsistent with their professional mindset, or simply at odds with their cultural predisposition in thinking about organisational activities. The economics of business are often seen to be based on a knowledge and appreciation of costs. Costs may be regarded as useful in guiding Management Accounting: Retrospect and Prospect 61 the actions of financially trained managers but other managers often find operational measures, including statistical process control (SPC) and other indicators, to be good predictors and measures of quality for them. Both approaches are necessary. Quality management programmes must align with contextual preferences and the management styles of individuals if they are to achieve the desired intent. Reasons for pursuing better quality controls differ. Many companies pursue product or service quality because they believe it will improve their competitive position and, ultimately, their financial results. Others use quality as the prime competitive approach for differentiating their products or service. Quality has many facets. One facet concerns maintaining satisfied customers who thereby remain loyal to a company which has invested in building trust through effective quality of service. The service management literature has, over the past few years, suggested that customer loyalty rather than market share drives firms’ profits (Haskett et al., 1997). In web-enabled firms this has significant implications. Consider, for instance, what internet shoppers go through in making a purchase. The first point of contact for a customer approaching a company website is negotiating navigation of the site. Next, the consumer attempts to retrieve desired information. Third, some customer support may be sought, perhaps in the form of a telephone call, email communication, messenger interaction or live chat. Finally, the company’s logistics processes put into action the sales transaction, including packaging and shipping, payment processing, guarantee confirmation and other sales backup service. If the quality of service in the face of the price paid is deemed to be high, loyalty may be generated: if the effective navigation and information collection facilities are in place through effective development and investments in technology, this will encourage customers to purchase. The variable cost resource requirements to support customers at the pre-purchase stages usually are regarded as being low. However, if logistical problems occur once an order is placed in terms of, say, product availability, shipment or delivery or a query is raised prior to placement, this places demands on customer support mechanisms. Such demands can also cascade into more extensive logistical resource issues (returns, exchanges, cancellations) and ultimately extensive cost increases with detrimental competitive consequences. If all aspects of logistical processes are integrated with the requisite information exchange and operational activities, a positive customer experience cycle can result. This will translate into loyalty, and this has scale effects on per unit navigation and information costs, which are largely fixed (Hallowell, 2002). The interdependencies in online purchasing and organisational processing are indicative of the extent to which internal and external failure costs are closely interrelated. Internal failures can be regarded more and more as external failures as the internet lends transparency to internal organisational processes in an attempt to be more customer-oriented. Quality costs must then adopt a different classification of what is demarcated as conformance and what is seen as non-conformance. 62 Flexible Technologies, Fluid Organisations and Digitisation In contexts where customers engage in product design, the constitution of prevention costs may be subject to further alterations. In such instances, generalised conceptions of quality costing must give precedence to more realistic organisationspecific understandings of the connections between financial and cost information and quality issues. This is because it may not be possible, for instance, to speak of internal versus external quality failure costs since the production emanates from customer input. Even modern conceptions of quality issues are constantly being reshaped. In modern manufacturing environments with complex supply chains, as well as in sophisticated service contexts and in digitised enterprise settings, the notion of quality and its related cost implications are continuously being redefined. Static management accounting approaches may survive but their original function may not dictate or drive their survival in fast-moving enterprise environments where market demands and customer requirements affect the fate of organisational information systems and their uses. It is essential then for management accountants to take contemporary notions of proper quality cost management only as a starting point, and to make modifications to suit the context on an ongoing basis. 3.3.2 JIT Systems JIT systems for guiding operational processes have been implemented by many enterprises. JIT systems rest on the premise that production should be initiated by demand rather than prior to it. These systems in effect comprise two separate sets of activities: 1. JIT purchasing attempts to match the acquisition and receipt of material sufficiently closely with usage such that raw material stock is reduced to near-zero levels. 2. JIT production takes place only through a pull-system driven by the demand for finished products. JIT production’s aim is to obtain low-cost, high-quality and on-time production by minimising stock levels between successive processes, thereby reducing idle equipment and the deployment of facilities and workers. Some benefits of JIT purchasing include raw material stock reduction, control over delivery timing, close working relations with fewer suppliers, long-term – often informal – contracts, quality assurance and raw material/sub-component specifications. JIT production, on the other hand, stresses work-in-progress and finished goods stock reductions, decreased lead and set-up times, zero defects, a flexible workforce, continuous improvement and quality control as part of the production process and producing to order.