II. Knowledge Processes
❝ When Soviet nail factories had their output measured by weight, they tended to make big, heavy nails, even if many of these big nails sat unsold on the shelves while the country was crying out for small nails - Thomas Sowell
Societies are most prosperous when knowledge is plentiful, accessible, relevant, inexpensive and growing. Such conditions are most fully brought about by trade.
Trade
The foundation of trade is mutual gain. The sources of this gain over time are:
Goods move from those who value them less to those who value them more
Greater production and consumption and a greater variety of goods and services are made possible by specialization
Higher volume production by individual producers leads to improved productivity of labor and lower production costs
Throughout history, trade has been a primary determinant of a society's prosperity and progress. Rarely has a great civilization developed in isolation. The same is true for business. No company, no matter how capable its employees, can match the pace of innovation and improvement taking place throughout the world solely by internal means. Thus, for a company to keep up with its competition, it must quickly develop a mechanism to become aware of relevant developments taking place everywhere in the world. These mechanisms are:
trading
benchmarking
regular dialogue with specialists
technology origination networks
relationship with knowledgeable business servers
Knowledge fuels prosperity by signalling and guiding resources to higher-valued uses. The discovery and application of knowledge leads to the improved use, allocation and consumption of resources. A knowledge process is the method by which we develop, supplant, share and apply knowledge to create value.
To succeed in an uncertain future, a company must draw on the knowledge dispersed among its employees.
A market-based knowledge process coordinates dispersed knowledge, applying it at the appropriate time and place to enable the company to profitably satisfy changing needs. Mechanisms for coordinating knowledge are indispensable for bringing about the spontaneous order necessary for creating superior value.
A market-based knowledge process coordinates dispersed knowledge, applying it at the appropriate time and place to enable the company to profitably satisfy changing needs.
Measures
Not everything that counts can be counted, and not everything that can be counted counts. - Albert Einstein
Knowing why something is profitable is often as valuable as knowing what is profitable. This is why a business must also develop measures that help it understand what drives profit.
It is also important to understand the rate of change taking place within an industry and whether a business is improving and innovating at a pace that is equal to, or faster than, its competitors. The rate of change in market share, cost reductions, improvement or deterioration in margins, percentage of revenues from new products, etc, are all examples of such comparisons.
Having the discipline to ask, "what are the key drivers of value and cost?" and "How do we increase profit?" for any given activity is critical to achieving creative insights.
Since it is impossible to predict outcomes precisely, trying to do so is wasteful. On the other hand, it is critical to measure real drivers of profitability.
Ej 1. Energy consumption should be compared to the ideal, not to some budgeted amount.
Marginal Analysis
Marginal analysis entails weighting the costs and benefits of a change. It looks at the benefits and costs associated with a specific change rather than at the average or the whole.
Before doing marginal analysis we must optimize the current state.
Ej 2. Before estimating the profitability of an investment to improve efficiency, the current waste should be eliminated from the base case. When considering an expansion, it is wrong to conclude that because we already have excess people we don't need to include the expense of adding any. The economics should be done with the excess people removed from the base case and added to the extent required in the expansion case.
Most decisions should be made using marginal analysis.
Most decisions should be made using marginal analysis. This requires understanding the difference between costs and benefits that are marginal and those that are not, such as suck costs. Only by making decisions on the appropriate margin will a business consistently enhance its profitability and eliminate waste.
Benchmarking
This is the process of identifying, understanding and adapting outstanding practices from anywhere in the world to help us improve. We can learn from the best in the company (internal), the best in the industry (competitive) and the best in the world (world-class).
Effective benchmarking requires objectivity, so it must be done with humility and intellectual honesty.
Ej 3. When Southwest Airlines sought ways to decrease the time it took to refuel, disembark and board passengers, and unload and load baggage, it did not study other airlines. It studied NASCAR pit crews and drivers. Today, other airlines benchmark themselves against Southwest.
Opportunity Cost
The true cost of any activity is the highest-valued activity forgone - that is, the opportunity cost. Working on profitable activity is wasteful when there is another, even more profitable activity that could be performed instead. It sounds counterintuitive, but profit can be increased by eliminating some profitable, value-adding activities when doing so enables a business to capture higher-valued opportunities.
It is essential to learn how to identify this form of waste by rigorously examining all opportunities and alternatives. Waste is eliminated by prioritizing according to profitability, adjusted for risk and time.
John Wooden, a basketball coaching legend, summed up opportunity cost-based decision making when he cautioned,
❝ Don't measure yourself by what you have accomplished, but rather by what you should have accomplished with your ability- John Wooden
Every resource (not just assets and raw materials, but also talent) has alternative uses. The sales representative of the Koch Materials Company (KMC) asphalt plant, read an article about a company looking for land to build a new casino. Despite the fact this plant had been consistently profitable, he thought, "Would these people place more value on our land and location than we do for producing asphalt?". Upon analysis, KMC determined that the hold value of the asset (the present value of expected future cash flows) was much less than its value as a casino site.
Tips:
The true cost of any activity is the highest-valued activity forgone - that is, the opportunity cost.
Waste is eliminated by prioritizing according to profitability, adjusted for risk and time.
Every resource (assets, talents, raw material) should be allocated to the highest state of value creation
Free Speech
In a free society, knowledge is created and shared through different mediums of exchange. Societies that value freedom and prosperity protect their citizens' right to free speech, which greatly facilitates the discovery and dissemination of knowledge.
Knowledge is dispersed and of various kinds; therefore, we need ways to ensure the relevant kinds are considered before making important decisions. When a workplace culture of respect and trust is promoted, employees share their ideas and seek out the best knowledge to anticipate and solve problems. Verbal exchanges lead to the discovery of new and better ways to create value.
Truth is what gets results consistent and stands the tests fo evidence and criticism, not what someone in the hierarchy declares is true. Continual questioning and brainstorming to find a better way is what we call a challenge process.
❝ It is one thing to wish to have truth on our side, and another thing to wish sincerely to be on the side of truth- Bishop Richard Whately
Challenge Process
The continual questioning and brainstorming to find a better way, is what is known as challenge process. If people only communicate good news, or if everyone pretends to agree, much less knowledge is generated and fewer discoveries are made. To be most effective, a challenge process must include people with different perspectives, kinds of knowledge and expertise. The following are forms of challenge processes:
Brainstorming
Compliance audit
There are always better, faster and cheaper ways to create more value for a company and its customers. Value creation requires good economic thinking, measuring profitability whenever practical, seeking and sharing knowledge, embracing a challenge process and appropriately using proven tools and mental models. There are critical components of superior knowledge processes.
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