Operations and Managerial Accounting Madhav Rajan Stanford Graduate School of Business MAS 2006 Meeting.

Operations and Managerial Operations and Managerial Accounting Accounting

Madhav RajanMadhav RajanStanford Graduate School of BusinessStanford Graduate School of Business

MAS 2006 MeetingMAS 2006 Meeting

OutlineOutline

Operations and Managerial Accounting Operations and Managerial Accounting Why are inter-firm relations importantWhy are inter-firm relations important Why are we in a unique position to Why are we in a unique position to

examine these issuesexamine these issues

Classic Hold-upClassic Hold-up Accounting in OperationsAccounting in Operations Operations in AccountingOperations in Accounting

Importance of SuppliersImportance of Suppliers

Outsourcing has increasedOutsourcing has increased From 1973 to 1993, the median Fortune From 1973 to 1993, the median Fortune

500 industrial company has shrunk 37%500 industrial company has shrunk 37% Over the past 50 years the value of

purchased materials and services has grown from 20% to 56% of the selling price of finished goods

As tasks become outsourced, intra-As tasks become outsourced, intra-firm relationships are replaced with firm relationships are replaced with inter-firminter-firm relationships relationships

Why Managerial Accountants Why Managerial Accountants are a Perfect Fitare a Perfect Fit

Managerial Accounting has covered Managerial Accounting has covered many intra-firm issuesmany intra-firm issues

Inter-firm issues are very similar, Inter-firm issues are very similar, only no “Selected Intervention”only no “Selected Intervention”

DivisionA

DivisionB

HQ.Firm A

DivisionA

DivisionB

Firm A

Firm B Selected

Intervention

Contracts

Hold-UpHold-Up

Classic Hold-up problem (Inter-firm) Classic Hold-up problem (Inter-firm) Edlin and Reichelstein 1996Edlin and Reichelstein 1996 Che and Hausch 1999Che and Hausch 1999

Intra-firm asymmetric informationIntra-firm asymmetric information Baldenius 2000 Baldenius 2000 Vaysman 1998Vaysman 1998

Inter-firm asymmetric informationInter-firm asymmetric information Your name hereYour name here

Testing incoming products (single Testing incoming products (single supplier)supplier) Baiman et al. 2001a: TestingBaiman et al. 2001a: Testing Baiman et al. 2001b: DesignBaiman et al. 2001b: Design

Buyer-Supplier contracting with Buyer-Supplier contracting with multiple suppliersmultiple suppliers Baiman et al. 2003Baiman et al. 2003

Accounting and ProcurementAccounting and Procurement

Opportunism across the Opportunism across the Supply-ChainSupply-Chain

Buyer-Supplier Moral Hazard (Dual):Buyer-Supplier Moral Hazard (Dual): Role of WarrantiesRole of Warranties Balachandran and Radhakrishnan 2005Balachandran and Radhakrishnan 2005 Saouma 2005Saouma 2005

Sharing Private Innovations:Sharing Private Innovations: Asymmetric informationAsymmetric information Baiman and Rajan 2002Baiman and Rajan 2002

Capacity and Cost AllocationCapacity and Cost Allocation

Full CostingFull Costing Never optimal for price settingNever optimal for price setting

Why use it?Why use it? Is it useful for making capacity decisions?Is it useful for making capacity decisions? If so, then price and cost decisions should If so, then price and cost decisions should

be made simultaneously…be made simultaneously…

Very computationally intensive

Full Costing ResearchFull Costing Research Find scenarios where it is optimalFind scenarios where it is optimal

Banker and Hughes 1994Banker and Hughes 1994 Gox 2002Gox 2002

Examine Full Costing as a pricing and Examine Full Costing as a pricing and capacity heuristiccapacity heuristic Balakrishnan and Sivaramkrishnan 2001Balakrishnan and Sivaramkrishnan 2001 Balakrishnan et al. 1997Balakrishnan et al. 1997

Questions from Operations:Questions from Operations:Accounting AnswersAccounting Answers

Why do we observe revenue sharing Why do we observe revenue sharing contracts?contracts? Cachon and Lareviere 2005Cachon and Lareviere 2005

How share private information across How share private information across the supply chain?the supply chain? Cachon and Lareviere 2001Cachon and Lareviere 2001

Who should carry inventory risk?Who should carry inventory risk? Cachon 2004Cachon 2004

A Sampling of A Sampling of Operations Management Operations Management

ResearchResearch

Erica PlambeckErica PlambeckStanford Graduate School of Stanford Graduate School of

BusinessBusiness

Gentlemen, we’re sitting on a hell of a lot of inventory

Roots of O.M. ResearchRoots of O.M. Research

Recent O. M. ResearchRecent O. M. Research Empirical ResearchEmpirical Research

forthcoming focus issue in forthcoming focus issue in Manufacturing & Manufacturing & Service Operations Management Service Operations Management

Revenue ManagementRevenue Management

Service OperationsService Operations call center focus issue forthcoming in call center focus issue forthcoming in

Management ScienceManagement Science Dynamic Supply Chain ManagementDynamic Supply Chain Management

Recent O. M. ResearchRecent O. M. Research Empirical ResearchEmpirical Research

forthcoming focus issue in forthcoming focus issue in Manufacturing & Manufacturing & Service Operations Management Service Operations Management

Revenue ManagementRevenue Management

Service OperationsService Operations call center focus issue forthcoming in call center focus issue forthcoming in

Management ScienceManagement Science Dynamic Supply Chain ManagementDynamic Supply Chain Management

relational contractsrelational contracts product returnsproduct returns

During development process, product design changes substantially. Delaying capacity investment ‘til product is well-defined would cause unacceptable delays:

“If we waited until we were sure of every final detail, and drew it [a contract] up beautifully so anyone could read it, we would be 6 months to 12 months later in the marketplace” –Toshiba purchasing manager

Toshiba and supplier instead adopt relational relational contractcontract: informal agreement about terms of : informal agreement about terms of trade, enforced by the future value of a trade, enforced by the future value of a cooperative relationship.cooperative relationship.

Relational Contracts Relational Contracts (Toshiba)(Toshiba)

Research QuestionsResearch Questions

How does repeated interaction affect capacity investment and profitability?

How should a buyer make promises to purchase? If promised terms are highly

generous, supplier may not find promise credible

If stingy, supplier may invest little

Model: Model: Repeated New Product Repeated New Product Intro. Intro. and Capacity and Capacity Investment Investment

supplier builds K units of capacity at cost cK

buyer realizes demand

formal contract: -price-quantity

production & retail sale at price r

discount factor

buyer pays T,supplier builds K units of capacity at cost cK

buyer realizes demand &orders q()

formal contract: if both firms cooperate, codify q, d(q)

otherwise, Nash bargaining

production,retail sale at price r

Relational ContractRelational Contract specifies: specifies: terms: terms: T, dT, d((qq)) buyer strategy: buyer strategy: qq(()), , cooperate until supplier cooperate until supplier renegesreneges supplier strategy: supplier strategy: KK,, cooperate until buyer cooperate until buyer renegesreneges

strategies must bestrategies must be perfect public perfect public equilibriumequilibrium

Relational Contract Design Relational Contract Design = Fixed Point Problem= Fixed Point Problem

buyer pays

supplier builds capacity

buyer orders specified quantity

))1(),min()( }ˆ)({1

)) ()1()())((}(ˆ)({1 maxarg

),min())(1( ))( ()),(min(

)}(),min(max{arg)(

:subject to

)}(),(,{

)]()),(min([max

]

}{

1

1

0ˆ K

Kq

ˆ Kc

KprKq

pqqdKqEK

Kprqdqr

qdqrq

qqdK

cKpqqrE

S

B

max expected profit

discount factor

0.25 0.50 0.75 1.0

95-100%65-95%

5-35%35-65%

0-5%

first best achieved

10.0 7.5 5.0 2.5

r = 10p = 0= 0.5uniform(0,1)

cap

aci

ty c

ost

c

discount factor

Increase in Expected Profit Increase in Expected Profit (Relational Contract – Nash bargaining)/(First Best)(Relational Contract – Nash bargaining)/(First Best)

Research QuestionsResearch Questions How do informational links influence How do informational links influence

structure and performance of optimal structure and performance of optimal relational contract? relational contract?

Who is responsible for relationship? Who is responsible for relationship?

Product Returns - Product Returns - CommercialCommercial

Internet purchase “Not what I expected”Internet purchase “Not what I expected” Zappos.com lets you return unworn shoes for Zappos.com lets you return unworn shoes for

60 days for any reason60 days for any reason Banana Republic.com offers free returns to Banana Republic.com offers free returns to

customers that spend $800+/yr customers that spend $800+/yr Obsolescence (electronics)Obsolescence (electronics) can’t resell can’t resell

QuestionsQuestions What is cost and frequency of returns: by What is cost and frequency of returns: by

product type, customer type, returns policy? product type, customer type, returns policy? Resell (speed, price, channel) or recycle or…? Resell (speed, price, channel) or recycle or…?

Generous returns policy? Customer-specific? Generous returns policy? Customer-specific?

Product Returns - Product Returns - CommercialCommercial

Home DepotHome Depot 10% of sales returned ~ $11 B/year10% of sales returned ~ $11 B/year Labor cost ~ $85 M/year Labor cost ~ $85 M/year >10% of returns are destroyed >10% of returns are destroyed

$22 M/year to landfill$22 M/year to landfill

QuestionsQuestions What is value of information about usage? What is value of information about usage? Should return logistics be centralized? Should return logistics be centralized?

Outsourced?Outsourced? How to forecast? Adapt procurement and How to forecast? Adapt procurement and

pricing?pricing?

Product Returns – End of Product Returns – End of LifeLife

EU makes manufacturer responsible for EU makes manufacturer responsible for products at end of lifeproducts at end of life Cars, electronics, white goods Cars, electronics, white goods

Restrictions on Hazardous Substances Restrictions on Hazardous Substances Questions Questions

Sort?Sort? What is value of information: What is value of information: manufacturer, product, condition, time and manufacturer, product, condition, time and location of return? location of return?

How to estimate and internalize EOL cost in How to estimate and internalize EOL cost in design, timing, and price of new products? design, timing, and price of new products?

How does RoHS influence optimal number How does RoHS influence optimal number and size of suppliers? Relational contracting? and size of suppliers? Relational contracting?

SummarySummary “Hot” OM research areas

Empirical research Revenue management Service operations Dynamic supply chain management

Multi-disciplinary research opportunities Relational contracts Product returns

EmpiricalEmpirical Research in Research in Operations Management Operations Management

and Management and Management AccountingAccounting

Shannon AndersonShannon AndersonRice University & University of MelbourneRice University & University of Melbourne

““Managing Costs and Cost Structure throughout the Value Managing Costs and Cost Structure throughout the Value Chain: Research on Strategic Cost Management.” In Chapman, Chain: Research on Strategic Cost Management.” In Chapman,

Hopwood, & Shields (Eds.). Hopwood, & Shields (Eds.). Handbook of Management Handbook of Management Accounting ResearchAccounting Research. .

Also: http://ssrn.com/abstract=869070Also: http://ssrn.com/abstract=869070

Integration isn’t new…Integration isn’t new…In the 1980’s and early ‘90s, the primary domain of In the 1980’s and early ‘90s, the primary domain of

integrative research was integrative research was performance performance measurementmeasurement Relating lean operations strategies to performance and cost

structure Product design and development strategies Inventory management strategies Process quality strategies Technology investment strategies Workforce management strategies

Designing information systems to reveal hidden costs of… quality, time, customers, suppliers (ownership)

Summary: Summary: Management accounting and operations Management accounting and operations management research are linked because better management research are linked because better operating strategies are apparent when operating strategies are apparent when performance is properly measuredperformance is properly measured

The domain for integration has The domain for integration has expanded…expanded…

Within the firmWithin the firm Performance managementPerformance management developing developing

comprehensive, causal models that relate comprehensive, causal models that relate operational performance to financial performanceoperational performance to financial performance

Lean operations span firm boundariesLean operations span firm boundariesManagement ControlManagement Control promoting cooperation and promoting cooperation and coordination between self-interested firms in coordination between self-interested firms in settings with information asymmetry, uncertainty, settings with information asymmetry, uncertainty, asset specificity, etc.asset specificity, etc.Performance measurementPerformance measurement measuring measuring performance of all participants in the value chainperformance of all participants in the value chain

Integrated Research in Performance Integrated Research in Performance ManagementManagement

Similar FrameworksSimilar Frameworks

Management Accounting:Management Accounting:The Balanced Scorecard & Strategy Maps – Kaplan

and Norton (1996, 2000, 2004)

Operations:Operations:The Service Profit Chain – Heskett et al. (1997,

2002)

Marketing:Marketing:Customer Equity Framework – Rust et al. (2000)

Causal Relations among Performance Causal Relations among Performance IndicatorsIndicators

Financial

Customers

Internal BusinessProcesses

Customer Satisfaction

Process QualityShorter Cycle Time

Lower Rework

EmployeeSuggestions

EmployeeSkills

Employee Morale

On-time delivery

Return on Capital Employed(ROCE)

SalesOperating Expenses

Integrated Empirical Research in Integrated Empirical Research in Performance ManagementPerformance Management

Descriptive validity of causal modelsDescriptive validity of causal models Workforce management Ittner & MacDuffie (1995),

Schneider et al. (2003) Quality & Cycle Time Maher & Marais (1998), Nagar &

Rajan (2001), Hendricks & Singhal (2001) Kaynak (2003), Sedatole (2003)

Inventory Mgmt & Supply Chain Balakrishnan & Linsmeier (1996), Randall & Ulrich (2001), Hendricks & Singhal (2005)

Customer satisfaction Rust & Zahorik (1993), Itter & Larcker (1998), Foster & Gupta (1999), Anderson et al. (1994), Yeung & Ennew (2000), Banker et al. (2000), Heim et al. (2001)

Multiple causal links Soteriou & Chase (1998), Behn & Riley (1999), Rust et al. (2000), Verma et al. (1999, 2001, 2005), Kamakura et al. (2002) Goldstein (2003), Roth & Menor (2003), Hitt & Frei (2002)

Integrated Empirical Research in Integrated Empirical Research in Performance ManagementPerformance Management

Behavioral response to multiple Behavioral response to multiple performance measuresperformance measures

Reallocation of work effort Ulrich & Tuttle (2004)

Cognitive processing of complex performance information Lipe & Salterio (2000), Dearman & Shields (2001), Ittner & Meyer (2003), Banker et al. (2004), Libby et al. (2004), Roberts et al. (2004)

Integrated Empirical Research in Integrated Empirical Research in Management ControlManagement Control

Cost-minimizing organizational formsCost-minimizing organizational forms Product design & development: Ulrich & Eppinger

(1995), Wasti & Liker (1997), Seal et al. (1999), Novak & Eppinger (2001), Randall & Ulrich (2001), Cooper & Slagmulder (2003, 2004)

Process development: Walker (1994), Anderson, Glenn & Sedatole (2000)

Linked supply & distribution logistics: Dyer (1996), Netessine et al. (2005)

Integrated Empirical Research in Integrated Empirical Research in Management ControlManagement Control

Inter-organizational Management Inter-organizational Management ControlsControls

Formal Contracting: Gietzmann (1996), Gulati & Singh (1998), Mayer et al. (2004), Anderson & Dekker (2005)

Decision-making processes: Clark & Fujimoto (1991), Ring & Van de Ven (1992, 1994), Nixon (1998), Ulrich and Eppinger (1995), Anderson, Glenn & Sedatole (2000), Thomke & Fujimoto (2000), Davila & Wouters (2004, 2006), Van der Meer-Koistra & Vosselman (2000), Dekker (2004)

Knowledge sharing with suppliers & partners: Tani (1995), Krishnan et al. (1995), Robertson & Ulrich (1998), Seal et al. (1999), Thomke & Fujimoto (2000), Kajuter & Kulmala (2005), Terwiesch et al. (2005)

Knowledge sharing with distributors & customers: Srinivasan et al. (1997), Anderson & Lanen (2002), Kulp et al. (2004)

Supplier selection and performance measurement: Carr & Ittner (1992), Carr & Ng (1995), Meyer et al. (1997), Dekker (2003, 2005), Wouters et al. (2005)

Opportunities for Integrative Opportunities for Integrative ResearchResearch

Extended Horizon: Lifecycle Costs & Sustainable ProfitsExtended Horizon: Lifecycle Costs & Sustainable Profits Internalizing and creating visibility for externality

costs and costs of compliance – Lanen (1999), Joshi et al. (2001), Corson (2002), Epstein & Widener (2005)

New cost and control settings: Product recovery & disposal, Reverse supply chain, Markets for pollution credits

Extended Value Chain: Customers as value chain Extended Value Chain: Customers as value chain partnerspartners

Customer switching costs – Keaveney (1995), Chen & Hitt (2002), Womack & Jones (2005)

Customer/ Channel choice – Hitt & Frei (2002), Campbell (2003)

Opportunities for Integrative Opportunities for Integrative ResearchResearch

Dynamics: Applied Risk ManagementDynamics: Applied Risk Management Operational decisions as real options

Product design – Baldwin & Clark (2000), Krishnan & Gupta (2001) Desai et al. (2001), Lee & Billington (1995), Lee & Tang (1997)

Process technology & capacity – Moel & Tufano (2002), Weiss & Maher (2005), Kallapur & Eldenburg (2005)

Measuring and managing performance volatility Incentives and controls to induce optimal risk-taking

Theory Base: Testing cognitive and behavioral theories Theory Base: Testing cognitive and behavioral theories in the (service) operations management settingin the (service) operations management setting

Unique features of the Employee-Customer interface Judgment and decision making processes Incentive issues