Unorthodox Technique Utilizes Economics to Help Teach Operations

Unorthodox Technique Utilizes Economics to Help Teach Operations

Among the current buzz-words in the business press, perhaps none is more enticing and evocative than "strategy." With mega-consultants such as Gary Hamel and C. K. Prahalad "redefining the world of corporate strategy" (as one Business Week cover story put it this year), an industry of strategy gurus and strategy consulting firms is thriving on business leaders desperate to keep their organizations sharp.

It is within this strategy-rich environment that Phillip J. Lederer, associate professor of operations management at the Simon School, has completed a new paper which takes an innovative look at operations strategy and discusses his own principles for operations research and teaching.

In "Perspectives on Operations Strategy and Economics," Lederer borrows several basic economic concepts and applies them to operations. He justifies this unorthodox approach by saying that operations strategy consists not only of decisions affecting cost (as is often assumed), but also involves decisions affecting demand for a firm's products or services. By including the demand side, Lederer says that he essentially fuses operations research (which analyzes costs) and microeconomic theory (which analyzes demand). Lederer contends that the combination of these disciplines offers greater insight into operations problems, while making good use of a knowledge base (economics) in a closely related arena.

Lederer points out, for instance, that the concept of competitive economic theory can be used to study how operations technology affects a firm's performance. Likewise, modern finance theory can be used to examine relationships between operations and a firm's risk exposure. Option theory can help evaluate one of the central operations concerns--production options--as potential "hedges against uncertainty." And game theory can be used to shed light on the correlation between operations and competitiveness.

Lederer is quick to state, however, that economics alone cannot solve the problems that operations addresses. "Without the specific details of the system you seek to optimize," he says, "you cannot solve the problems. Operations provides the specific knowledge needed about a particular company."

As for the strategy coaches who are attracting attention by providing quick and sweeping solutions to the kinds of problems that Lederer grapples with, he offers this insight: "You see managers flocking to gurus for wisdom on what the big corporate tradeoffs are. Very few of these consultants use economics to drive their prescriptions, and so quite often they are wrong. They observe success in the marketplace, and they look for ways to replicate that success.

"But the fact is that the economic models I've outlined are really at the root of the phenomena they observe, and are very complex. Research that will be useful for the long haul will devise theories about these models and will use the scientific method to test them."

Lederer concludes his paper by suggesting that principles from other management functions, such as finance, marketing, accounting and human resources, should similarly be applied to operations in order to eventually "reveal the true effect of operations decisions." (OP 96-03)