These common pressures, claim John and Pamela Caspari in their book, Management Dynamics: Using Constraints Accounting to Drive a Process of Ongoing Improvement (John Wiley & Sons), all stem from the same single cause: the pursuit of a cost-based pricing strategy.

The Casparis observe that most conventional businesses in the Western world use some variation of product cost to establish a relationship to a target price for the product. If the revenues of each individual product cover the direct and indirect costs associated with the product, then the organization will be profitable. As long as customers are willing to pay at least as much as the target price, everything appears to be fine. However, this cost-based pricing strategy also might be masking future costs that are spiraling out of control.

Opportunity Gap

The difference between the greatest amount that customers would be willing to pay for a product and the company's target price (or asking price) is an "opportunity gap." If an organization pursues a cost-based pricing strategy, but an overall positive opportunity gap does not exist, then the organization must (1) introduce new products that do have an opportunity gap, (2) reduce costs sufficiently to create an opportunity gap for existing products, (3) change its strategy to one more suitable for the market environment that it faces, or (4) go out of business.

When the market for a product does not permit a sales price that is sufficient to recover all of the costs associated with the product, there is pressure on margins and price competition appears fierce. The company feels pressure either to drop the product, spreading the indirect costs of the dropped product over other products, or to introduce new products; all the while emphasizing cutting costs --a nd jobs.
 
Product Cost Problem

When senior decision makers are locked in the existing cost paradigm, they pursue cost reductions and new products without considering alternatives to the cost-based strategy. The pressures mount and all too often the cost reduction and new product paths are followed with inadequate success thus opening the revolving corporate door and the "go out of business" alternative is ultimately implemented.

A Different Approach

But some organizations, particularly in Europe and other countries outside the United States, have found success with introducing new paradigms of managing people instead of costs, and thus for managing the entire organization. The European beyond budgeting initiative (Beyond Budgeting Round Table) and constraint management (Guide to Implementing the Theory of Constraints) are just two of these newer paradigms.

As the tough times being experienced by many organizations have components in common, so do successful instances of the newly emerging management processes. Such evolving successful components include enlightened personalized authority, freedom from an annual budgeting control process, rapid resource availability when needed, and group rewards that are clearly linked to shareholder value for all organizational levels.

For more information: Management Dynamics: Merging Constraints Accounting to Drive Improvement