2. A Model of Business Practices and Performance
Understanding Business Practices and Business Excellence
The overall premise of the study is best summed up by the definition and logic of "best practice" used in the 1994 Leading the Way and 1999 Gearing Up studies:
International research on business capability issues demonstrates that there is a link between the practices adopted and processes within businesses and their performance. Those businesses that adopt a coordinated and cooperative approach to development generally outperform firms that do not follow this approach. This coordinated and cooperative approach has often been denoted "best practice"3
And:
The cooperative way in which firms and their employees undertake business activities in all key processes - leadership, planning, people, customers, suppliers, community relations, production and supply of products and services, and the use of benchmarking. These practices, when effectively linked together, can be expected to lead to sustainable world class outcomes in quality, customer service, flexibility, timeliness, innovation, cost and competitiveness.4
And:
The logic behind best practice is simple: because operational outcomes are a key contributor to competitiveness and business performance, and because best practice should improve operational outcomes, by implication good practice should lead to increased competitiveness. Best practice should lead to world-class performance.5
This seems simple and commonsense enough, but the term "best practice" has become a well-worn buzzword, used frequently by industry, advisors, quality proponents and academics, in a variety of ways: becoming the best competitor in at least one aspect of business process; out-pacing competitors in responding to market shifts and pricing changes, and in developing new products; the practices used by firms achieving world-class performance; and having operational performance equalling or surpassing top international companies. It has also been particularly associated with the manufacturing sector and the use of specific production processes such as Just-In-Time management, Materials Resource Planning and Kanban systems.
In addition, as noted in the 1999 study, "best practice" is, in a sense, a misnomer. Best practice is a moving target - what was regarded as best practice in the 1990s is not necessarily regarded as best practice today (Perry et al, 1995). Similarly, in attempting to manage the complex relationships between and within firms, there is no single set of "best practices" - there are too many variables.
Hence, for the 2001 survey, we have moved away from the concept of "best practice" to good practice, business improvement and business excellence. This reflects both that we are interested in practices that are regarded internationally as beneficial to business performance - not necessarily the "best" - and that we have expanded our scope of analysis beyond the manufacturing sector. These are practices that in combination (this is the general consensus in the literature, diagnostic tools and quality/business excellence organisations) consistently appear to provide firms who adopt them with an advantage over those that do not (Lamming, 1996).
Business Practices and Competitive Advantage
Business managers, advisors and academics alike can be forgiven for being confused when trying to establish how the large array of concepts and theories related to business management fit together. Examples include concepts such as: core competencies (e.g. Prahalad and Hamel, 1990); distinctive capabilities (e.g. Stalk, Evans and Schulman, 1992; Kay, 1993); competitive strategy (e.g. Porter, 1980); organisational culture (e.g. Kotter and Heskett, 1992; Collins and Porras, 1994), and learning organisations (e.g. Senge, 1990). The following discussion attempts to bring these concepts together and position business excellence within them.
A firm creates competitive advantage if it succeeds in becoming different from its competitors in a way that is recognised and appreciated by its (existing and potential) customers (Henne, 1997). Competitive advantage for a business derives from building what are known as distinctive capabilities (this term is used interchangeably in the literature with core competencies).
Distinctive capabilities refer to stocks of strategic resources or assets that are accumulated through a pattern of investments over time, applied to a market purpose, and that cannot be easily imitated or acquired by competitors, nor readily substituted (Ward et al, 1996; Grant, 1995). Examples include some processes, reputations and brands, workforces, and networks of relationships. The most potent of these are thought to be intangible or tacit (this derives from the resource-based view of the firm as described by Nelson and Winter, 1982; Prahalad and Hamel, 1990; Barney, 1991; Peteraf, 1993; among others).
Sustained competitive advantage refers to competitive advantage that lasts long enough for the firm to harvest the potential benefits (Barney, 1991; Henne, 1997). In attempting to create and sustain a competitive advantage, a firm determines and pursues an overall business strategy in relation to the competitive environment it faces, and the business assets and structure it has to deal with (e.g. technologies, basis of ownership, internal structures, the nature of its industry).
Strategy essentially relates to choices about products, markets, and positioning. An important part of business strategy is the choice of competitive priorities, or the choice of areas a firm wishes to excel at in order to meet customer demands, or win orders against the competition (Voss, 1995). Competitive priorities often include quality, cost, innovation, flexibility, and delivery, and firms typically consider and compete, to some extent, on each competitive priority - although each firm will tend to emphasise, and excel at, certain priorities compared to others.
The realisation, or otherwise, of competitive priorities is reflected in a business's operational outcomes. Competence refers to the alignment of intended competitive priorities (strategy) and realised competitive priorities (outcomes); i.e. a firm has a particular competence if it has strong capability in an area that is also regarded as important (Kim and Arnold, 1992). Of course, the realisation of competitive priorities is dependent on how the firm interacts with its environment. This includes the demands made in the market, the nature of customers, suppliers and competitors, and economic, social, environmental, technological and governmental trends. Realising competitive priorities, in terms of operational outcomes, builds distinctive capabilities over time, though this requires investments in various business activities or practices.
It is through business practices and how a firm operates to achieve outcomes that a firm builds distinctive capabilities, which are capable of providing competitive advantage. Good business practices can be thought of as the base or foundation on which distinctive capabilities and hence competitive advantages are built. Maintaining or enhancing these capabilities and advantages demands continued reinvestment and development of processes and practices.
A firm's reputation, for example, is a function of the history of its customer service practices, among other things, and its customer satisfaction and delivery outcomes. But this reputation will diminish unless it is reinvigorated by improving customer practices.
There are obviously inter-relationships throughout. A business develops a strategy in relation to its unique capabilities and the competitive environment in which it operates. This strategy will guide and influence key choices, such as the development of business practices. The implementation of processes and practices will assist the development of a firm's capabilities, which may in turn enhance or change the way it chooses to compete and thereby affect the competitive environment in which it operates. Recent literature explicitly recognises these inter-relationships and suggests that a holistic approach to business practices is necessary for a firm to achieve overall alignment all the elements must be in place and linked together to achieve improved business outcomes and competitive advantage.
Figure 1: The Firm, Business Practices, Distinctive Capabilities, and Competitive Advantage
If we visualise a firm's ultimate goal as international competitiveness, as illustrated by the globe, we can picture business practices as segments of the base of the globe, where each must be in place and effectively linked with the others to provide a strong foundation (see figure 2). The absence of one may make the whole breakdown, threatening competitiveness and stability.
Successful companies compete by leveraging off their capabilities and aligning these with their strategy, competitive priorities, practices, outcomes and the demands of the market; i.e. there is both internal and external consistency. This is an evolutionary and iterative process, and cooperation between management and stakeholders (owners, customers, suppliers and employees) in all aspects of business is critical.
Companies that are successful in achieving this alignment and developing this cooperative culture have been called learning organisations. A learning organisation is one with the abilities or processes to continually improve performance and actions through experience, knowledge and understanding. This can only occur when knowledge becomes institutionally available - the organisation learns collaboratively - rather than knowledge remaining the property of certain individuals or groups, and where all employees are involved and encouraged to look for improvements in every area of the firm (Nevis et al, 1995; La Rooy, 1998).
Figure 2: Firm Foundations6
In summary, the competitive advantage of a firm is based upon its business processes or practices, which shape its distinctive resources/capabilities. These, in turn, are shaped by a firm's assets and the environment (endowments of technology, intellectual property, customer base, finances, regulations, policy), the business paths available (strategic choices) and also where the firm has come from (path dependency). This all takes time to build and depends on a cooperative business culture and organisational learning.
So there are some important subtleties and caveats to the logic (as expressed in the opening quotes) that, if a firm has adopted a range of good business practices, it will tend to achieve better outcomes than those who have not. These need to be noted when interpreting the results of the survey.
The BPPS aimed to collect and interpret information on a number of the elements important for business success - the competitive environment, competitive priorities, and business strategy - but the core of the study focused on business practices and operational outcomes. The survey did not look at the development of a culture geared towards continuous improvement or learning, nor at the development of distinctive resources or capabilities. However, both of these elements will, by definition, be unique to each firm, so would be difficult to discover via a mail-out survey (although some insights were obtained from the follow-up interviews). Further caveats to the interpretation of the results are discussed in Strengths and Limitations of the Study.
Figure 3: Business Practices and Performance Survey Model (2001)7
The Business Practices and Performance Model
In designing the survey questionnaire, we adopted the Business Practices Models used in the Leading the Way (1994) and Gearing Up (1999) studies with some adaptations. Like the 1994 and 1999 Business Practices Models, the 2001 survey model comprises key modules or components:
- Structure
- Strategy
- Practices
- Outcomes
- Business Results.
The Business Practices Models used in the 1994 and 1999 studies were based on extensive reviews of international literature, and major international quality awards and business excellence programmes. We adopted and made minor adjustments to these Models again after a review of best practice literature, surveys and diagnostic tools (see Appendix B). The components included in the survey have all been widely acknowledged in the literature as contributing to superior business performance, either explicitly or implicitly (see Statistical Evidence on the link between Business Improvement and Operational and Business Performance).
Structure
As intimated earlier, several studies and theories (e.g. Porter, 1980; Miller, 1986; Teece et al, 1997) report on the differences in adoption of business practices and the achievement of outcomes related to underlying business structures. Among others, these include:
- Size - smaller firms typically have to devote a much higher proportion of managerial time and services to operations rather than leadership and planning. They also tend to adopt less formalised practices than larger companies.
- Industry - the context of the industry that a firm operates within matters in a number of different ways. For example, in industries with rapid technological development, such as electronics, technology practices may be more advanced than in traditional industries.
The structural factors examined by this study were the industry sector, size (by employment numbers), level of overseas ownership and age of the business.
Strategy
A firm's strategy essentially relates to the choice of products, markets, positioning and focus. The survey included questions on competitive priorities and market scope.
The traditional list of competitive priorities was examined: cost, quality, flexibility, delivery and innovation.
- A firm for which cost is a competitive priority would tend to be a low or the lowest cost producer in its industry or niche. All firms attempt to compete to some extent on cost, but most do not compete solely, or even primarily, on this basis.
- When quality is a competitive priority, a firm attempts to position itself on the basis of the quality of its products and services - such as performance, conformance, serviceability, durability, features, aesthetics and reliability.
- When flexibility is a competitive priority, a firm tends to focus on design, product/service mix and volume flexibility to win orders.
- Delivery performance as a competitive priority means a firm has a focus on speed and/or reliability of delivery.
- Innovation as a priority means that a firm will emphasise product or process improvement and development to compete.
Firms can emphasise and excel at more than one competitive priority at a time (Ward et al, 1996; Stock et al, 1998).
Another major element of strategy is market scope. This relates to the markets that a firm chooses to serve. At one level this includes the decision to export, and questions on exporting were included in the survey questionnaire (Competitive Strategy discusses these results).
Conduct
Strategising
The strategising element of the conduct component encapsulates the leadership and planning activities within a firm. It examines the nature of direction setting, whether it is long-term and consultative and whether it facilitates company culture or values, and the relationship of the business with its community.
Practices
A firm's strategic direction is transformed into outcomes through its conduct or practices. This survey examined a firm's practices in terms of its:
- employee practices - the way in which human resources are managed and developed
- customer focus - processes that provide the firm with a comprehensive understanding of the current and future requirements, expectations and satisfaction of customers, and build effective customer relationships
- quality and supplier focus - those practices used to design, operate and control the production and delivery system and develop and maintain close relationships with suppliers
- innovation and technology - practices that support the adoption and development of new and improved equipment, processes, products and services
- information and benchmarking - those practices related to searching for, gathering and using information to identify risks and opportunities, measuring performance and progress against goals, comparing the performance of the firm against other organisations, and searching for and introducing business excellence into the organisation.
Outcomes
This component identifies the outcomes resulting from practices and strategic decisions. Outcomes refer to operational measures and are related to the firm's competitive priorities, such as timeliness and quality, which are largely within a firm's control.
Business Results
The business results component of the model provides a snapshot of a firm's financial performance. Firm performance is gauged through variables such as sales, cashflow, profitability and market share. As stated, in contrast to the outcomes component, these variables are more likely to be influenced by factors external to the firm, such as exchange rate and demand fluctuations.
Competitive Environment
The competitive environment includes the demands made in the market such as price, characteristics and features of products; variability in demand; the nature of customers, suppliers and competitors; and economic, governmental, environmental and technological trends, which shape the market and the capabilities of managers (Stock et al, 1998).
These factors have been well described by Porter's diamond model of the determinants of a competitive environment - demand conditions, factor conditions, related and supporting industries, firm strategy, structure and rivalry. The competitive environment also relates to the five forces model of key drivers in the industry - threat of new entrants, bargaining power of suppliers, bargaining power of buyers, rivalry among existing competitors, and the threat of substitute products or services (Porter, 1980).
This survey focused on four key elements of the competitive environment from a policy perspective - competition (particularly rivalry), regulation, access to finance, and access to skills (The Impact of the Competitive Environment discusses these results).
Inter-Relationships within the Model
As previously discussed, the components of structure, strategy, strategising, practices and outcomes are obviously inter-related. The inter-linking of these components represents the dynamic nature of business processes, where components rarely operate in isolation in the long-term. For example, the focus of practices built up by a firm often reflects its business strategy. Similarly, although the practices of a firm will have an effect on its operational outcomes, over time operational outcomes (such as customer satisfaction) will also influence practices (such as quality control).
Assessing Business Practices and Performance
As with the Leading the Way (1994) and Gearing Up (1999) studies, a comprehensive survey questionnaire was developed, based around the structure of the Business Practices and Performance Model. Respondents were asked questions on each element of the Model. Questions on strategising and practices required subjective responses while questions examining operational outcomes in some cases required quantitative responses. Detail on the questionnaire design and development process is described in Appendix A and the questionnaire can be found in Appendix F.
The survey questionnaire was distributed to a random sample of 3,378 New Zealand firms employing six or more full-time equivalents (FTEs), from a range of industries. An excellent response rate of 81.6% (2,756 firms) was achieved, meaning we can be highly confident in the reliability of the results (details on the sample selection and stratification are included in Appendix A). Non-response was low across virtually all questions.9
Figure 4: Calculation of the Indices10
The sample was segregated into 84 cells or strata using 14 industry codes, three size categories (6-19 FTEs, 20-49 FTEs and 50+ FTEs), and exporting status. Data in each cell were stratified (weighted) to reflect the underlying business population densities by size and sector.
In analysing the results, questions were grouped into the six categories of strategising/practices: leadership and planning, employee practices, quality and supplier focus, customer focus, information and benchmarking, and innovation and technology. Questions were generally based on a Likert-type (rating) scale, with the response to each question then scored on a range between zero and one with the "worst" answer given a value of zero and the "best" answer a value of one.
A similar scoring system was used for questions on operational outcomes. These scores were then summed for each firm across the different practices. Each practice score was standardised to give it a value out of 100. The six practice scores or indices were summed and standardised to provide a single score out of 100 for overall practices. The scores for the outcomes questions were also summed for each firm and standardised to generate a value out of 100.
This scoring system resulted in two main indices (see figure 4):
- the strategising/practices index provides an overall assessment of an enterprise's efforts towards business improvement
- the operational outcomes index provides an assessment of the extent to which practices have been converted into operational outcomes.
- assessing how far a firm has progressed, both indices are considered simultaneously. Businesses that score highly on the strategising/practices index have made the most progress in adopting the full range of these practices. If they also score highly on the operational outcomes index, their practices are being converted into outcomes (Australian Manufacturing Council, 1994).
The 48 site visits confirmed that questions were generally answered realistically by respondents (see Business Improvement Revealed). The methodology also ensured that the best person was selected to answer the questionnaire (see Appendix A).
As with Gearing Up (1999), the progress of each firm towards sustainable advantage can be shown by plotting its position on a set of axes representing a Business Practices and Outcomes scorecard (Australian Manufacturing Council, 1994). The horizontal axis represents the strategising/practices index values, and the vertical axis represents the operational outcomes index values. The closer a site is to the top-right-hand corner of the graph, the closer it is likely to be to achieving sustainable high performance.
The graph of the distribution of firms according to their scores is shown on figure 5. This shows the expected "oval" shape, indicating that good outcomes are associated with good practices.
Figure 5: Scorecard of the Distribution of Firms
Strengths and Limitations of the Study
In methodological terms, there are many strengths to this study:
- The size of the stratified sample across business sectors and size of firms is almost incomparable for research of this nature from both New Zealand and overseas.
- The overall response rate was excellent. Further, as stated, non-response was low for virtually all questions. This allows the results to be generalised to the underlying population of New Zealand businesses. It is likely that this study provides a more in-depth and representative snapshot of the national business community than most equivalent studies overseas.
- The partnership with Statistics New Zealand has helped to ensure robustness and quality of the data.
- The questionnaire was carefully pre-tested and piloted to ensure that responses would be as accurate as possible.
- The firm visits validated the survey results in the vast majority of cases.
However, several caveats to the interpretation of the results should be noted:
- The survey was obviously mainly qualitative in nature and firms will interpret the scales used in different ways. The probability is for optimistic self-assessments. This should moderate our assessment of business practice, but it should not distort relative adoption of different practices, nor relationships between them. Although the methodology ensured that the best available respondent answered the questionnaire, it would have been better to have multiple respondents11 (this was apparent from a few of the interview results - there were a few cases where interviewees gave quite different perspectives than the survey results on some practices, especially leadership and employee practices), and more objective questions (Dow et al, 1999).
- The use of good practices is not just a series of yes or no decisions. The use of practices is differentiated in terms of intervals with varying degrees of application (Morita and Flynn, 1997). The BPPS was able to capture only some of this differentiation through the use of Likert-type (rating) scales. Similarly, the use of a questionnaire meant that in many instances we could only capture the extent of adoption of the practices, not the extent of deployment of these practices throughout the organisation, nor the degree to which they are assessed and reviewed.
- Given the discussion on business practices and competitive advantage, the simple linear relationship between outcomes and practices needs to be viewed with some caution. Outcomes will tend to be affected by different combinations of practices and by strategies, competitive priorities and capabilities. For example:
- the impact of practices on firm performance and the specific techniques adopted are conditioned by an organisation's strategy
- if a firm is following a cost strategy, the best approach to employee practices might be focused on results-based performance appraisal, hourly pay, individual incentives, and training on procedures
- if a firm is following a quality strategy, the best approach to employee practices might focus on training for technical and problem-solving skills, behaviour-based performance appraisal, and group incentives
- if a firm is following a flexibility-based strategy, employee practices may be focused on skills-based pay, group-based performance incentives and team structures, and multi-skilling (Youndt et al, 1996).
- In defence of the survey, however, we examined the adoption of broad practices (i.e. do you use performance appraisals and pay-for-performance schemes) rather than specific ways of implementing these practices (i.e. do you use results-based appraisals or competency-based appraisals; group-based incentives or individual incentives).
- Similarly, business practices are contingent relationships - the use of certain practices will tend to be strongly related to the use of others (Youndt et al, 1996; Dow et al, 1999). Indeed, we discovered high correlations between different questions in the survey. In addition, it is not always clear cut to classify an activity as a particular type of business practice, and some activities relate to several practices. For example, consulting with customers on product, process and service improvement is a customer focus practice but is also closely related to innovation practices.
- Business practices, of course, do not immediately impact on all operational outcomes and financial results. Changes to outcomes can take some months to result from changes to business practices - changes to financial performance may take years. The cross-sectional nature of the study means that we cannot take account of these lags. A longitudinal study would be necessary to properly test causality (Dow et al, 1999).
- The model is not fully comprehensive and hence our methodology does not take any account of unique practices that a business may have and that significantly affect performance (Davies and Kochar, 2002), nor necessarily capture the right emphasis on certain practices. Our international peer reviewers, for example, pointed out that the emphasis on "social outcomes" could be enhanced in future.
- There are various ways in which questions could be weighted for inclusion in the indices and there is no guarantee that the simple weighting system is the most realistic. Although each element (question) in a practice index was weighted equally, some elements receive higher weightings in the overall practice index. For example, if the leadership and planning index consists of four questions, then each question or element is worth a higher proportion of the aggregated practices index than a customer focus question, if that index consisted of five questions. A simple equal weighting of each practice index was used to follow the methodology used in Leading the Way (1994) and Gearing Up (1999). More sophisticated statistical techniques can allow us to identify a smaller set of practice questions that contribute most to the business performance index and hence could be given higher weights. This is an area for future research.
- The pursuit of business improvement is not an acceptable substitute for having leading products and services that deliver new expectations or new market values (Newman and Chaharbaghi, 1998; Yarrow et al, 2000); i.e. there is not much point in business improvement efforts or "being excellent" in producing something that nobody wants to buy!
So although business practices are a fundamental element for firm competitiveness, it is important to recognise when interpreting the results that businesses need to have a lot of elements in a row to be successful. Firms must (Shin et al, 1998; Shay and Rothaermal, 1999):
- be self-aware; i.e. know who they are, what they do, the need for change, their readiness for improvement
- leverage off those particular attributes that enable them to create competitive advantage
- strengthen their market position by leveraging competitive advantages to develop, produce and sell the products/services that consumers demand
- position and manage their portfolio of products and services in the market
- understand the competitive nature of the industry in which their products and services compete.
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