Financial Accounting Blog

Wednesday, February 25, 2004

"Best Practice Doesn't Equal Best Strategy", analyses the impact of best practice and differenciation on profit margins.
Best-practice benchmarking—the measurement and implementation of the most successful operational standard or strategy available in an industry—can be one of the most effective tools for increasing a corporation's efficiency, productivity, and, ultimately, earnings. To see the benefits such benchmarking can yield, you need look no further than the US automobile industry, which transformed itself during the 1980s by adopting Japanese manufacturing techniques. More recently, Ericsson and Motorola copied the Finnish cell phone maker Nokia's use of the same phone chassis across different technologies to achieve economies of scale in design and production.
A strategic-differentiation index (SDI) can document the herding phenomenon and gauge the ensuing decline in industry margins. An analysis of the impact of such crowding indicates that a 10 percent decline in the wireless industry's SDI resulted in an 11.2 percent decline in margins. The entry of E-Plus into the market in mid-1994 reduced margins by some 19 percent. Between 1992 and 1998, however, the SDI tumbled 83 percent, pulling margins down 50 percent from their peak. In short, it was the low degree of strategic differentiation engineered by the incumbent operators, not the entry of new companies into the market, that was primarily responsible for the lost earnings, which amounted to more than $780 million in 1998 alone.