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

2. Outline Operations and Managerial Accounting Operations and Managerial Accounting Why are inter-firm relations important Why are inter-firm relations important Why are we in a unique position to examine these issues Why are we in a unique position to examine these issues Classic Hold-up Classic Hold-up Accounting in Operations Accounting in Operations Operations in Accounting Operations in Accounting

3. Importance of Suppliers Outsourcing has increased Outsourcing has increased From 1973 to 1993, the median Fortune 500 industrial company has shrunk 37% From 1973 to 1993, the median Fortune 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-firm relationships are replaced with inter-firm relationships As tasks become outsourced, intra-firm relationships are replaced with inter-firm relationships

4. Why Managerial Accountants are a Perfect Fit Managerial Accounting has covered many intra-firm issues Managerial Accounting has covered many intra-firm issues Inter-firm issues are very similar, only no Selected Intervention Inter-firm issues are very similar, only no Selected Intervention Division A Division B HQ. Firm A Division A Division B Firm A Firm B Selected Intervention Contracts

5. Hold-Up Classic Hold-up problem (Inter-firm) Classic Hold-up problem (Inter-firm) Edlin and Reichelstein 1996 Edlin and Reichelstein 1996 Che and Hausch 1999 Che and Hausch 1999 Intra-firm asymmetric information Intra-firm asymmetric information Baldenius 2000 Baldenius 2000 Vaysman 1998 Vaysman 1998 Inter-firm asymmetric information Inter-firm asymmetric information Your name here Your name here

6. Testing incoming products (single supplier) Testing incoming products (single supplier) Baiman et al. 2001a: Testing Baiman et al. 2001a: Testing Baiman et al. 2001b: Design Baiman et al. 2001b: Design Buyer-Supplier contracting with multiple suppliers Buyer-Supplier contracting with multiple suppliers Baiman et al. 2003 Baiman et al. 2003 Accounting and Procurement

7. Opportunism across the Supply- Chain Buyer-Supplier Moral Hazard (Dual): Buyer-Supplier Moral Hazard (Dual): Role of Warranties Role of Warranties Balachandran and Radhakrishnan 2005 Balachandran and Radhakrishnan 2005 Saouma 2005 Saouma 2005 Sharing Private Innovations: Sharing Private Innovations: Asymmetric information Asymmetric information Baiman and Rajan 2002 Baiman and Rajan 2002

8. Capacity and Cost Allocation Full Costing Full Costing Never optimal for price setting Never 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 be made simultaneously… If so, then price and cost decisions should be made simultaneously… Very computationally intensive

9. Full Costing Research Find scenarios where it is optimal Find scenarios where it is optimal Banker and Hughes 1994 Banker and Hughes 1994 Gox 2002 Gox 2002 Examine Full Costing as a pricing and capacity heuristic Examine Full Costing as a pricing and capacity heuristic Balakrishnan and Sivaramkrishnan 2001 Balakrishnan and Sivaramkrishnan 2001 Balakrishnan et al. 1997 Balakrishnan et al. 1997

10. Questions from Operations: Accounting Answers Why do we observe revenue sharing contracts? Why do we observe revenue sharing contracts? Cachon and Lareviere 2005 Cachon and Lareviere 2005 How share private information across the supply chain? How share private information across the supply chain? Cachon and Lareviere 2001 Cachon and Lareviere 2001 Who should carry inventory risk? Who should carry inventory risk? Cachon 2004 Cachon 2004

11. A Sampling of Operations Management Research Erica Plambeck Stanford Graduate School of Business

12. Gentlemen, were sitting on a hell of a lot of inventory Roots of O.M. Research

13. Recent O. M. Research Empirical Research Empirical Research forthcoming focus issue in Manufacturing & Service Operations Management forthcoming focus issue in Manufacturing & Service Operations Management Revenue Management Revenue Management Service Operations Service Operations call center focus issue forthcoming in Management Science call center focus issue forthcoming in Management Science Dynamic Supply Chain Management Dynamic Supply Chain Management

14. Recent O. M. Research Empirical Research Empirical Research forthcoming focus issue in Manufacturing & Service Operations Management forthcoming focus issue in Manufacturing & Service Operations Management Revenue Management Revenue Management Service Operations Service Operations call center focus issue forthcoming in Management Science call center focus issue forthcoming in Management Science Dynamic Supply Chain Management Dynamic Supply Chain Management relational contracts relational contracts product returns product returns

15. 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 relational contract: informal agreement about terms of trade, enforced by the future value of a cooperative relationship. Toshiba and supplier instead adopt relational contract: informal agreement about terms of trade, enforced by the future value of a cooperative relationship. Relational Contracts (Toshiba)

16. Research 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

17. Model: Repeated New Product Intro. and Capacity 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

18. 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 Contract specifies: terms: T, d(q) terms: T, d(q) buyer strategy: q( ), cooperate until supplier reneges buyer strategy: q( ), cooperate until supplier reneges supplier strategy: K, cooperate until buyer reneges supplier strategy: K, cooperate until buyer reneges strategies must be perfect public equilibrium

19. Relational Contract Design = 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 0 ˆ K Kq ˆ Kc KprKq pqqdKqEK Kprqdqr qdqrq qqdK cKpqqrE S B max expected profit

20. 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 = 10 p = 0 = 0.5 uniform(0,1) capacity cost c discount factor Increase in Expected Profit (Relational Contract – Nash bargaining)/(First Best)

21. Research Questions How do informational links influence structure and performance of optimal relational contract? How do informational links influence structure and performance of optimal relational contract? Who is responsible for relationship? Who is responsible for relationship?

22. Product Returns - Commercial Internet purchase Not what I expected Internet purchase Not what I expected Zappos.com lets you return unworn shoes for 60 days for any reason Zappos.com lets you return unworn shoes for 60 days for any reason Banana Republic.com offers free returns to customers that spend $800+/yr Banana Republic.com offers free returns to customers that spend $800+/yr Obsolescence (electronics) cant resell Obsolescence (electronics) cant resell Questions Questions What is cost and frequency of returns: by product type, customer type, returns policy? What is cost and frequency of returns: by 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?

23. Product Returns - Commercial Home Depot Home Depot 10% of sales returned ~ $11 B/year 10% 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 Questions Questions What is value of information about usage? What is value of information about usage? Should return logistics be centralized? Outsourced? Should return logistics be centralized? Outsourced? How to forecast? Adapt procurement and pricing? How to forecast? Adapt procurement and pricing?

24. Product Returns – End of Life EU makes manufacturer responsible for products at end of life EU makes manufacturer responsible for products at end of life Cars, electronics, white goods Cars, electronics, white goods Restrictions on Hazardous Substances Restrictions on Hazardous Substances Questions Questions Sort? What is value of information: manufacturer, product, condition, time and location of return? Sort? What is value of information: manufacturer, product, condition, time and location of return? How to estimate and internalize EOL cost in design, timing, and price of new products? How to estimate and internalize EOL cost in design, timing, and price of new products? How does RoHS influence optimal number and size of suppliers? Relational contracting? How does RoHS influence optimal number and size of suppliers? Relational contracting?

25. Summary Hot OM research areas Empirical research Revenue management Service operations Dynamic supply chain management Multi-disciplinary research opportunities Relational contracts Product returns

26. Empirical Research in Operations Management and Management Accounting Shannon Anderson Rice University & University of Melbourne Managing Costs and Cost Structure throughout the Value Chain: Research on Strategic Cost Management. In Chapman, Hopwood, & Shields (Eds.). Handbook of Management Accounting Research. Also: http://ssrn.com/abstract=869070

27. Integration isnt new… In the 1980s and early 90s, the primary domain of integrative research was performance measurement 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: Management accounting and operations management research are linked because better operating strategies are apparent when performance is properly measured

28. The domain for integration has expanded… Within the firm Performance management developing comprehensive, causal models that relate operational performance to financial performance Performance management developing comprehensive, causal models that relate operational performance to financial performance Lean operations span firm boundaries Management Control promoting cooperation and coordination between self-interested firms in settings with information asymmetry, uncertainty, asset specificity, etc. Performance measurement measuring performance of all participants in the value chain

29. Integrated Research in Performance Management Similar 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)

30. Causal Relations among Performance Indicators Financial Customers Internal Business Processes Customer Satisfaction Process Quality Shorter Cycle Time Lower Rework Employee Suggestions Employee Skills Employee Morale On-time delivery Return on Capital Employed (ROCE) Sales Operating Expenses

31. Integrated Empirical Research in Performance Management Descriptive 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)

32. Integrated Empirical Research in Performance Management Behavioral response to multiple performance 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)

33. Integrated Empirical Research in Management Control Cost-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)

34. Integrated Empirical Research in Management Control Inter-organizational Management Controls 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)

35. Opportunities for Integrative Research Extended 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 partners Customer switching costs – Keaveney (1995), Chen & Hitt (2002), Womack & Jones (2005) Customer/ Channel choice – Hitt & Frei (2002), Campbell (2003)

36. Opportunities for Integrative Research Dynamics: 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 in the (service) operations management setting Unique features of the Employee-Customer interface Judgment and decision making processes Incentive issues