July, 2011

115-117 S. Main St. Suite A Celina, Ohio, 45922 USA

567-510-5200 www.avanulo.com

Applying Operating Cost Leadership,

The Fourth Generic Strategy

By David I. Cahill

Avanulo White Paper #143

Summary of Contents

The Fourth Generic Strategy The most effective strategy in mature markets is Operating Cost Leadership

The Scissors Curve A trap for mature industries

Safe, Ethical Profit The Universal Yardstick

The Four Managerial Elements The Keys to Relentlessness

The Creativity Curve A structured way of thinking

The Hidden Factory The source of hidden wealth

The Opportunity Tree The most effective improvement tool available

Enhancing Revenue Using the Tree to rev up sales

Summary

Our Average Project: $31,000,000 USD of annual, sustainable improvement in 79 days, with the people & technology in place and w/o capital investment. Our average fee is less than 0.50% of annual improvement. To the reader: We hope you find this Avanulo White Paper valuable. We know that your time is precious, so we have structured the format of this document to accommodate your needs. For a quick read, refer to the “in a Nutshell column” on the left. For more detail, read the right hand column

About Avanulo Avanulo means progress, and our passion lies in helping our clients progress their goals. Our partners all have at least 20 years of experience in their fields of expertise. Our Motto is “Enjoy the Business Result” or ETBR. We believe every improvement action should have a tangible result, and we structure our solutions to achieve measurable results within a specific timeframe. We believe so strongly in ETBR that it s embedded in our logo. Our chief focus is to help our clients increase their Safe, Ethical, Profit or SEP. To us, that means to make as much money as possible without occupational injury, and without moral or physical harm to the community.

Helping you through the tough times

In a Nutshell . . . What is it? Operating Cost Leadership

• Avanulo’s name for the 4th Generic Strategy.

Why is it important? Strategy is paramount

• The biggest advantages any organization has are a clear strategy and an imperative to embrace it.

How do you apply it? Fully embrace the strategy

• Explain the strategy to everyone and make it imperative that they embrace it.

Supporting Concepts • Mature Industries • The Four Managerial

Elements • Safe, Ethical Profit

The Fourth Generic Strategy For many years, famous authors, like Michael Porter, espoused a simple truth – there are only three generic business strategies; Segmentation Strategy (niche market), Differentiation Strategy (unique aspect), Cost Leadership Strategy (low cost producer). This truth also espoused a limiting principle – to be successful, you could only apply one of these strategies at a time. In the new millennium, successful business leaders have proven this truism to be erroneous. A fourth, generic strategy has emerged and the evidence shows it to be the superior approach for mature industries. This strategy is a combination of Differentiation and Cost Leadership. It is often referred to as the “Best Cost Strategy”. At Avanulo, we call this strategy Operating Cost Leadership or OCL. Applying OCL is not difficult and does not take years of cultural redesign. It simply requires a new way of thinking about the Four Managerial Elements; Goal-Setting, Prioritization, Accountability and Deployment. As companies struggle in this tough business climate, the widely-known solutions like Lean Manufacturing and Six Sigma fall flat. They are too specialized, too limited in scope, and too cumbersome. Worst of all, they don’t address revenue enhancement. Even when a company realizes this, it often does not ensure that employees embrace its generic strategy. Because of this oversight, improvement tools fill the vacuum, and become the de facto generic strategy in the minds of employees. This leads to a case of “the tail wagging the dog”, and success becomes defined by how well a popular tool is applied. At Avanulo, we know how to help you focus on the real goal – Maximizing Safe, Ethical Profit. This white paper explains our proven approach to saving your way to stability while simultaneously enhancing revenue to secure your prosperity.

Helping you through the tough times

In a Nutshell . . . What is it? The Scissors Curve

• An unfavorable condition that often occurs in mature industries in which, cost to produce is on the rise, but the sales price of the product or service is on the decline.

Why is it important? Properly addressing the Scissors Curve requires counter-intuitive thinking

• The gut reaction is to focus totally on cost optimization. This can be devastating for you and your competitors.

How do you apply it? Optimize revenue and cost at the same time

Supporting Concepts

• OCL works best in mature industries

• Cost optimization and revenue enhancement can be pursued at the same time, if you make them visible, tangible and comparable

• Focus your efforts on maximizing Safe, Ethical profit

Mature Industries often get caught in the Scissors Curve When the cost you incur to provide products or services to your clients is going up, but the price you can charge for those products and services is staying flat or going down, you are caught in the scissors curve. This usually occurs in mature industries in which one or more of the following apply; • Supply exceeds demand • The market is stagnant or shrinking • The product or service is perceived as a

commodity • Charging more is not an option • Innovation is not a seemingly likely remedy Often when companies are caught in the scissors curve, they focus on cost to the exclusion of all else, because the path to cost optimization is more tangible and visible than the path to revenue enhancement. So, in the pressure of the moment, the singularity of the generic strategy known as Cost Leadership feels right and wins out. “Just get the cost down and we’ll increase market share”. The reality is that price is not always the deciding factor, even in a commodity market. Additionally, because of the speed with which information flows today, your competitors can quickly see your strategy and apply it themselves, causing a death spiral. Operating Cost Leadership (OCL) is a highly effective generic strategy that works in most situations, but it is most advisable for mature industries that are caught in the Scissors Curve. This is true because cost optimization and revenue enhancement are both required to break the out of the Scissors Curve. Applying Avanulo’s approach, enables an organization to pursue cost and revenue optimization at the same time, because it makes both of them visible, tangible, and comparable, enabling the whole organization to focus on maximizing Safe, Ethical Profit.

Helping you through the tough times

In a Nutshell . . . What is it? Safe, Ethical Profit (SEP)

• Focusing the whole organization on making as much money as possible without injury and without harming the community.

Why is it important? It is the only driving reason we are in this endeavor. If profit did not occur, the endeavor would cease How do you apply it? Focus almost all, but not all, of your energy on relentlessly maximizing SEP

Supporting Concepts

• Employ a Universal Yardstick to rev up alignment and cooperation

Safe, Ethical Profit – The Universal Yardstick Business exists to generate profit. Profit is the one universal goal we all have in common, but we rarely discuss it in an operational sense. It is measurable, and tangible, but we seldom use it to prioritize our actions at the operational level. Once, when working with a large manufacturing business, we saw the downside of leaving profit out of daily operations. Like many companies, this one was sensitive about its financial information, and only a few key managers knew anything about cost or revenue. This forced employees to prioritize without the benefit of a Universal Yardstick, which resulted in wasted effort and lost opportunity. The Production Department was trying to reduce down time. The less downtime you have the better right? So the employees worked on reducing the percentage of down time. Machine A had 5% down time and Machine B had 9% downtime. They worked on the machine with the highest downtime, Machine B. That makes sense right? Wrong! The reality was that a percent of down time on Machine B was only worth about $125 a day, but a percent of down time on Machine A was worth $1,000 a day. Also Machine B was already so optimized that it would be like pulling teeth to get another percent of reduction, but Machine A often ran 3 to 4 percentage points better than average. Without the Universal Yardstick of profit, or at least lost sales, expressed in dollars, the employees could neither prioritize nor deploy wisely. When profit is the main goal for everybody, there is a means to prioritize and deploy. When a Universal Yardstick is visible to all, it promotes alignment, and cooperation. When no Universal Yardstick is visible, it promotes counter-productive efforts and hidden agendas. Avanulo teaches its clients how to install a Universal Yardstick, even if profit is too sensitive to discuss. Our approach helps you to maximize profit with only two limits; safety and ethics.

Helping you through the tough times

In a Nutshell . . . What is it? The Four Managerial Elements

• The essential elements of management that must be executed well in order to achieve Operating Cost Leadership.

Why is it important? Because a key ingredient of OCL is relentlessness and the Four Managerial Elements promote relentlessness How do you apply them? Through the use of a few tools like the Opportunity Tree

Supporting Concepts

• The ancient elements of the universe

• The Four Managerial Elements; Goal-Setting, Prioritization, Accountability, Deployment

• The Creativity Curve • The Opportunity Tree

The Four Managerial Elements

Many organizations today run too near the edge. Economic pressures, a lack of talented people, regulatory requirements, and unproductive corporate oversight (micro-management) can lock an organization into crisis mode. Over the years, Avanulo Partners have seen these stressors dramatically reduce the effectiveness of many organizations. We address these stressors by renewing focus on the Four Managerial Elements. The Four Managerial Elements are those few aspects of managing a business that must be executed well in order to achieve Operating Cost Leadership (OCL). We relate them to the four ancient elements of the universe. Goal-Setting is the life giving force in the organization – like Water. Prioritization is the source of energy – like Fire. Accountability is the tangible aspect that brings stability – like Earth. Deployment is the force that moves everything forward – like Wind. The fist managerial element is Goal-Setting. Most organizations only establish goals two or three subsets down into their business process. Operating Cost Leadership requires goals 9-11 levels deep. The second element is Prioritization. A clear system of Prioritization based on a Universal Yardstick is essential for creating energy around what is most important. The third element is Accountability. Each goal and its successive sub-goals, down to the lowest level, must be assigned to one clear owner, creating a stable, tangible platform for success. The fourth element is Deployment. Deployment includes planning, communicating, executing, and tracking. Deployment reliably ensures that the right people and the right resources are in the right place at the right time. Avanulo ensures the Four Managerial Elements are working well through a few tools such as the Creativity Curve and the Opportunity Tree.

Helping you through the tough times

In a Nutshell . . . What is it? The Creativity Curve

• A model for thinking the right way at the right time.

Why is it important? Because there are times when it is best to think in a structured way, and times when it is best to think creatively. How do you apply them? Set the expectation that structured thinking will predominate at the strategic level and the task level, and creative thinking will predominate at the tactical level.

Supporting Concepts

• Structuring repetitive tasks promotes quality and efficiency.

• Thinking creatively when striving to achieve a goal, promotes results.

The Counter-Intuitive Creativity Curve Improvement gurus claim that cultural transition, which takes years, is required to become world-class. At Avanulo, we think excellence is driven by the thinking style you employ, not culture. There is a large organization that has been ranked best-in-class for the last 66 years. This organization has high turnover, and complex work processes. Even so, in just a few months new members go on to perform critical assignments. Have you guessed the organization? This organization is able to outperform all of its competitors, without years of cultural transition. It does this by requiring everyone to use a rigorous thought process we call the Creativity Curve. This process is an efficient way of thinking that requires compliance and creativity, but expects everyone to apply each at the most appropriate time. When this organization plans a large campaign, it uses a structured approach. This is seen as counter-intuitive, because people believe that this is the time be creative. But the reality is that strategy formation is a finite exercise defining the high level “How-To” for your vision. In that context, structure is important to ensure that your strategy is well-conceived. Once the plan is set in motion, everyone is expected to apply creativity to get the job done. Only a few, well-defined rules apply – stay on budget, remain ethical, and do not hamper the missions of other teams. If you have to employ a fixed asset, like a machine or system, then you follow specific procedures to ensure efficiency and quality. In other words, the front and the back of the process require structured thinking, and the middle demands very creative thinking – a Creativity Curve.

Helping you through the tough times

In a Nutshell . . . What is it? The Hidden Factory

• The invisible, but very real waste and lost opportunity generated by ineffective decisions and policies that have been left on auto-pilot for too long.

Why is it important? Because uncovering it and dismantling it can dramatically increase profitability How do you apply it? Make performance goals visible 9-11 levels deep in your process and then listen to your people’s explanation of the causes.

Supporting Concepts

• Automated Control Points (ACPs).

• Applying the Four Managerial Elements and the Opportunity Tree can make the Hidden Factory visible.

The Hidden Factory Being in business requires speedy decision-making. To extend their reach, leaders often delegate decision-making to a few players, who quickly become overloaded by the pace and complexity of the market. Assumptions replace facts. Decisions are made, and then set on auto-pilot for months, or even years, at a time. We call such unchallenged decisions Automatic Control Points or ACPs. Most organizations are filled with ACPs. Well conceived, fact-based ACPs add great value. Poorly conceived or outdated ACPs can increase cost and reduce revenue. Over time, employees bypass ineffective ACPs, at additional expense, to get the job done. The result is “built-in” waste, which is known to some, but is invisible to decision makers. We call this waste, the Hidden Factory. Recently at a large food plant, we observed the negative impact of an ineffective ACP. The plant ran for 20 hours and then shutdown for four hours every day to clean the equipment. This dally schedule had been in place for years. Demand for the product outpaced capacity, so even a small increase in daily throughput would increase profits. Managers and employees struggled to increase capacity, and spent thousands of dollars on equipment upgrades. No one even considered challenging the four-hour, cleaning ACP. We studied this ACP. The time to clean varied from 3.25 to 3.85 hours, but the plant would always sit idle for the full four hours. 97% of the time cleaning took less than 3.75 hours. The plant could safely reduce its cleaning time to 3.75 hours and increase revenue by millions of dollars a year. We shared our findings. The plant reduced the ACP to 3.75 hours and made millions. Most organizations have hundreds of ineffective ACPs that will generate cost and revenue improvements, if productively challenged. Effectively applying the Four Managerial Elements through the use of some simple, practical tools like the Opportunity Tree, allows an organization to make the Hidden Factory visible - like one sees the reflection of an old mill in the calm waters of a pond. Once the Hidden Factory is visible, it can be dismantled. The result is a significant increase in Safe, Ethical Profit without restructuring or capital investment.

Helping you through the tough times

In a Nutshell . . . What is it? The Opportunity Tree

• The most effective improvement tool available for maximizing Safe, Ethical Profit.

Why is it important? Because it enables you to relentlessly apply the Four Managerial Elements. How do you apply it? Let Avanulo teach you in a single session using your business data.

Supporting Concepts

• The funnel of improvement.

• 3-5% reduction in operating costs in 90 days.

The Opportunity Tree Making improvement is like moving down a funnel. As you go, the path gets deeper, narrower, and darker. For improvement to occur you must finally emerge from the bottom of the funnel and cross the Line of Aligned Employee Contribution. In other words something must stop, start, or be done differently for improvement to occur. Managers often set the goals at the top of the funnel and release employees to find their own way down. This is sometimes called employee engagement, and it has limited success. The further down the funnel you take employees before releasing them to work creatively, the less distance to the Line of Aligned Employee Contribution at the bottom. Shorten the distance and employees will get to the bottom quicker, and get lost less often. Organizations typically develop goals two or three levels deep. In order to speed up the rate of improvement and increase the success rate, goals must be 9 to 11 levels deep. The Opportunity Tree is a cascade of pre-printed, post-it notes, which visually break every improvement area into categories and sub-categories. As employees break improvement areas into their sub- elements, the same four pieces of information are required on each post-it.

• The current performance • An improvement goal • The dollar value of the goal • The individual accountable

By using a Universal Yardstick and pushing Goal-Setting deep into the business process in this simple, accessible way, we can make the Hidden Factory visible, establish doable projects, and reduce operating costs by 3-5% in 90 days or less without restructuring. This simple tool only takes a few hours to learn, and provides a proven venue for effectively applying the Four Managerial Elements.

Helping you through the tough times

In a Nutshell . . . What is it? Enhancing Revenue

• A structured approach to driving increased sales

Why is it important? It translates the seemingly intangible and creative effort of a sales campaign into doable projects that are measured against a Universal Yardstick. How do you apply it? Let Avanulo teach you in a single session using your business data.

Supporting Concepts

• Work the three tactics; sell more to existing customers, take market share, create new markets.

• Translate creative thought into practical projects.

• Some things old can be new again.

• Realize your plan by launching projects worth 200% of the revenue goal.

Enhancing Revenue Although significant profit can be added to the bottom line by reducing costs, organizations cannot save their way to prosperity. To succeed over the long haul, they must also increase revenues. To capture all of the revenue, you must apply three principle tactics: 1. Sell more to your customers. 2. Take existing market share away from your

competitors. 3. Create new markets to create new revenue. Seize market share (go on the offensive) by doing the following: • Actually increasing your customers’ profit and

thereby creating dependency – use your talent to help them improve their process thereby creating valuable differentiation without extensive R&D or investment.

• Really knowing and capitalizing on your competitors’ strengths and weaknesses, and then selling to the top.

• Working against a prioritized, “Dollarized” plan to increase revenue and market share by making everybody accountable for a specific goal.

Even if they had 100% Market Share, and operated with Zero Gap between Actual Cost and Best Cost, the Brother Typewriter Company would have quickly become defunct, if they hadn’t started making computer printers. Leverage new markets: • Study the heck out of your customers

(and their customers). What do they want? As we say at Avanulo, if our customers want Candy Apples, and we can sell them safely, ethically, and profitably, we are in the Candy Apple business.

• Find lateral markets in which to sell your talent and products by developing similar but unheard of applications.

• Pull the canvass off an old process. One of our container clients returned an old line printer to service and made nostalgic boxes adding significant revenue.

Build a Revenue Tree, make everyone accountable to enhance revenue, and establish projects totaling at least 200% of the overall goal. Use the Universal Yardstick to set the priorities. Deploy wisely, and hold everyone accountable.

Helping you through the tough times

We want to hear from you Avanulo 115-117 South Main St. Suite A Celina, OH 45833 USA Tel: 567-510-5200 Skype: 567-510-0714 E-mail: info@avanulo.com Web site: www.avanulo.com

Summary Successful companies are now embracing the Fourth Generic Strategy. That strategy is a hybrid that combines Differentiation with Cost Leadership. At Avanulo, we call that strategy Operating Cost Leadership. Operating Cost Leadership works best for mature industries caught in the scissors curve. To achieve Operating Cost Leadership an organization must;

• Declare the Fourth Generic Strategy and insist that everyone adopt it.

• Focus on Safe, Ethical Profit. • Establish a Creativity Curve. • Optimize the Four Managerial Elements. • Build an Opportunity Tree for cost & find

the Hidden Factory. • Build an Opportunity Tree for Revenue • Link the Trees, and unite the

organization. o Revenue Opportunities become

the branches, twigs, and leaves reaching up to the sky.

o Cost Opportunities become the deep and tangled roots, buried in the ground.

o The center that connects them, the mighty trunk, represents Safe, Ethical Profit.

About the Author Dave Cahill is the Managing Partner and Founder of Avanulo, a unique embedded consulting firm with locations in the US, Mexico, and Brazil. Dave is a senior manufacturing professional who has his roots in cost control and continuous improvement. He has worked for world-class organizations like Tenneco and Groupe Danone. He has served in general, line, and staff positions and has led large teams to excellence. Dave is the inventor of several effective business tools, like Kuplo, the 1440 Management System, and the Opportunity Tree. He has taught continuous improvement and revenue enhancement to thousands of people in 10 countries. Dave has also overseen the successful resolution of several large-scale, business crises. Prior to his work in the private sector, Dave taught college level Spanish, Russian, and German, and served in the US military as both an enlisted person and a commissioned officer.