Summary by Kevin Elliott
Masterof Accountancy Program
University of South Florida, Fall 2004
This article provides an illustration of how strategic cost management can make financial analysis a more powerful decision making tool. This idea is illustrated through the examination of the Levi Strauss Company’s past initiative to “lean thinking.”
The lean initiative was part of an overall strategy of sustaining a competitive advantage. Beginning in the mid-1980s, starting with the automobile industry, companies have studied techniques on how to achieve sustained competitive advantage. Companies strove to create substantial increases in wealth by challenging the ways they implemented their strategies. One such process called value-chain-based analysis was achieved by performing these five steps:
1. Value: The value chain must be identified from the customer viewpoint at a
disaggregated level - a specific product must be developed from the
perspective of a specific target customer, at a specific price, at a
specific place and time.
2. Value stream: Three elements of the value chain must be mapped - the physical stream originating with the first entity that supplies any raw input to the system, and ending with a specified customer (regardless of legal boundaries); the information stream that enables the physical stream; and the problem-solving/decision making stream that develops the logic of the physical stream.
3. Continuous flow: The focus must be on ensuring continuous flow and minimizing disruptions, such as those in a typical push-based batch-and-wait system.
4. Pull: To ensure continuous flow and to minimize disruptions, companies must create pull where the customer initiates the value stream.
5. Perfection: Finally, companies must strive for perfection by creating the virtuous circle, in which transparency in the system enables all members of the value chain to continually improve the system.
The remainder of the article examines the success Levi’s Strauss has had by implementing value-chain-based analysis and focuses of their “Levi’s Personal Pair” program which was the product of their analysis.
Levi’s Strauss was the market leader for women’s jeans in 1995. However its position as leader was coming under heavy attack. Focusing on size combination (which they offer 51), Levi’s was losing ground as more styles, more colors, and better fit became more important to its customers. Market research showed that only 24% of women were completely satisfied with their jeans purchase, at $50 a pair they were becoming a tough sell. Levi’s responded by recognizing a need to be in closer touch with their customers. They began to open stores to sell directly to their customers (rather then trough another retailer). They also implemented new technology such as EDI to help their supply chain. Unfortunately the lag time for their products was still 8 months.
Levi’s was a company that needed a way to strengthen their business. Using the value chain analysis Levi’s was a prime textbook case of a company that needed to improve its value chain in order to sustain a competitive advantage. The results of their value chain analysis are as follows:
1. Value: only 24% satisfaction rate.
2. Value stream: ROE average more then 38% lead to little improvement in their cumbersome value chain.
3. Continuous flow: 8 month lag time.
4. Pull: The customer initiated nothing, activity was driven by sales forecasts.
5. Perfection: A good ROE led management to miss opportunities in improvement.
In addition, use a pull driven distribution strategy Levi’s lost big profits when retailers had to markdown their products in order to make them more appealing. Levi’s often made good on these markdowns to their retailers. Although the opening of Original Levi’s stores helped eliminate some of these losses, it was clear Levi’s need a “better fit” with their customer.
In 1994 they were approached by Custom Clothing Technology Corp. (CCTC) with a business proposal. Specializing in client/server applications linking point-of-sale, customer-fitting programs directly with single-ply cutting programs in apparel factories, CCTC suggested a joint venture to introduce woman’s “Personal Pair” kiosks in the Original Levi’s stores. These kiosks, using a customer pull ideal, would begin the process of ordering a custom fit pair of jeans in aneight step process:
1. The Personal Pair kiosk would be a separate booth in the retail store,
staffed by trained sales clerks equipped with touch-screen PCs.
2. A sales clerk would take three measurements from each customer (i.e., waist, hips and rise) and record them on the touch screen. Working from these three measurements, 4,224 combinations would be possible.
3. The computer would then flash a code corresponding to one of 400 prototype pairs that are stocked at the kiosk, and the sales clerk would retrieve the prototype pair for the customer to try on.
4. With one or two tries, the customer would be wearing the best available prototype. Then the sales clerk would take the final exact measurements for the customer (out of the 4,224 possible combinations) and note the length required (i.e., inseam).
5. The sales clerk would enter four final measurements on the touch screen and record the order. Initially, the system would be available for only the Levi’s 512 style; however, five color choices would be offered in both tapered and boot-cut legs.
6. The customer would pay for the jeans and choose either Federal Express delivery (addition $5 charge) or store pickup. A maximum three week delivery would be promised.
7. Each customer order would be transmitted by modem from the kiosk to CCTC, where it would be logged in and transmitted daily to Tennessee (Where each pair is cut, hand sewn, inspected, and packed for shipment.) Each pair would include a sewn-in bar code unique to the customer for easy reordering at the kiosk-store that stored the bar code.
8. A money-back, full-satisfaction guarantee would be provide with every order.
Levi’s cautiously accepted CCTC’s proposal, choosing to enter a test phase before proceeding with a full scale project. This was a radical new way to retail apparel and given that this model did not have an established record in retail merchandising Levi’s was cautious. Levi’s initially price each Personal Pair at a rate of $15 more than an off-the-shelf product. The program was still popular almost immediately despite the increased price. As a result of the Personal Pair concept implementation Levi’s experienced the following positive effects:
For the styles affected, unit sales were up 49%.
Distribution costs and distribution investment per pair were virtually eliminated.
Nonmaterial manufacturing and distribution costs were cut by 47%.
The price increase of the Personal Pair coupled with the cost reduction resulted in a 467% increase in pretax profit (i.e., from $6 to $34 per pair).
Asset investment was remarkably reduced: inventory of $12 per pair of woman’s jeans sold (reflected an 8-month pipeline) was reduced to $1 reflecting only raw materials requirements.
Accounts receivable were negative since all pairs were prepaid.
The kiosk yielded a greater than tenfold increase in profitability.
By 1997 the program was responsible for 25% of the sales of the 30 U.S. company-owned stores.
Levi’s Strauss can attribute all of these gains to CCTC’s approach to improving their value chain. The fundamental ideal in this approach is customer satisfaction. By creating a system driven by customer demand and specific to the exact needs of their customers CCTC sold Levi’s a way of doing business that ultimately made their business leaner and more focused on fulfilling their customer’s needs. Without the help of and outside value-chain-analysis and improvement like CCTC (which was eventually acquired by Levi’s in 1995) Levi’s could have never grasped the scope of the opportunities they were missing.
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