Management Practices and Performance Reporting in ...

Management Practices and Performance Reporting in the Sri Lankan Apparel Sector

Anton Malmadana Kapuge and Malcolm Smith School of Accounting, Finance & Economics Edith Cowan University

Corresponding Author Professor Malcolm Smith School of Accounting, Finance & Economics Edith Cowan University 100 Joondalup Drive Joondalup WA 6027 Western Australia Tel: (08) 6304 5263 Email: [email protected]

Management Practices and Performance Reporting in the Sri Lankan Apparel Sector

ABSTRACT

An increasing number of organisations in developing countries are implementing management accounting innovations in order to generate improvements in accounting practices, which should ultimately impact on financial performance. This study focuses on the implementation of one such innovation, total quality management (TQM), among apparel companies in Sri Lanka. A survey is conducted of Sri Lankan companies to identify differences in their business strategy, management practices and performance reporting, depending on whether or not they have implemented TQM. The results demonstrate a significant difference in the business strategy implemented by the two groups, with those companies adopting TQM regarding quality as more important than cost efficiencies. Significant differences in both quality management practices and performance reporting systems were observed, except in the area of employee empowerment. Key words: Total Quality Management, Apparel companies, Multi Fibre Agreement, Management practices, Business Strategy, Performance Reporting, Sri Lanka

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1. Introduction

On 26th December 2004, Sri Lanka faced a devastating tsunami which resulted in extensive losses of both lives and the property. Financially and economically the tsunami had a big negative impact on the country, causing untold misery and hardship to the people, while severely disrupting economic activity across the country. The apparel sector is one of the few industrial activities to remain largely untouched by the tsunami, and it has the capacity to contribute to the rebuilding of the economy by maintaining export momentum. In order to do so the redevelopment of infrastructure and the export competitiveness of the industry require priority attention.

Just six days after the tsunami, on 1st of January 2005, the Multi Fibre Agreement (MFA) came to an end. Protectionism in the form of Multi Fibre Agreement (MFA) quotas had helped Sri Lanka and many other developing countries to develop their export oriented garment industries by insulating them from direct competition from established producers. The abolition of this allocated quota system for each country meant that the market would once again be based on the forces of supply and demand; while countries like China and India will gain from the abolition of quotas, other countries, including Sri Lanka, will lose out, with job losses predicted to be between 70,000 to 135,000, mainly concentrated amongst the small and medium sector. In the longer term the Institute of Policy Studies predicts that strong competitive factories are likely to create more jobs as uncompetitive enterprises go out of business. On top of job losses expected within the country there will be approximately 125,000 to 150,000 workers returning from overseas where Sri Lankan garment manufacturers went to take advantage of quotas. 3

The apparel industry is the biggest in Sri Lanka, and the quality of garment is vital to its survival in an increasingly competitive apparel industry, so that the production of high quality garments and improved productivity in the apparel industry are very important. Many Sri Lankan garment factories have realised the importance of quality and implemented management accounting practices, like Total Quality management (TQM). On the other hand some have chosen not to, largely because the costs of doing so are regarded as too large relative to the perceived benefits.

The increase in competition has led to an increased focus on customer satisfaction as a means of obtaining competitive advantage and survival of the company in the long run. TQM is one approach to improving the competitiveness, effectiveness and flexibility of a whole organization, its most important characteristic being a focus on the satisfaction of the external customer, defined as the immediate customer of the organization and all other customers in the distribution chain for products and services, right through to the final customer. In the textile and apparel field this plays an important role in evaluating performance in the industry. Current and future customer requirements have to be identified with regard to economic, social, and technological factors, and a clear separation between short and long term development specified. Many third world countries have adopted quality management practices, such as TQM and in this research we highlight how the Sri Lankan garments industry has implemented such practices.

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2. Background to the Sri Lankan Apparel Industry

The garment industry in Sri Lanka grew rapidly after the introduction of free trade in 1977, mainly as a result of quota-hopping East Asian garment exporters attracted by the country’s liberal trade regime, and able to relocate their already well established garment businesses to Sri Lanka. This relocation encouraged local entrepreneurs to start their own garment enterprises to exploit markets guaranteed by quotas, assisted by the liberal trade regime for importation, and subsequently, incentives granted by the Board of Investment (BOI) to selected industries. Sri Lanka did not have a well developed export quality textile industry base at that time, since garment production was based on imported inputs and value added remained low (close to 30%). By the early 1980s, garment exports were growing rapidly and by 1986 garments accounted for the largest share of all exports (27%).

The Board of Investment (BOI) of Sri Lanka offered an attractive incentive package to garment producers in 1992 to move to rural areas; a textile quota board was established in the same year to manage the allocation of quotas for the garment industry. These innovations attracted well established garment producers to rural areas, and encouraged new enterprises, with no background in garment production, to take advantage of the quotas. By 1992, the garment industry had become the largest foreign exchange earner in the country (US$ 400 million) so overtaking the tea industry. By 2002, Sri Lanka’s textile and garment sector accounted for 6% of GDP, 39% of industrial production, 33 % of manufacturing employment, 52% of total exports and 67% of industrial exports.

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The abolition of the Multi Fibre Arrangement (MFA) makes the Sri Lankan economy, already dependent on garment exports, highly vulnerable to the changes in the global trading system. In such an environment, strengthening the competitiveness of the garment industry becomes very vital if Sri Lanka is to remain one of the suppliers of choice in her major markets. The Multi Fibre Arrangement quotas have restricted exports of textile and clothing products from developing countries for over thirty years, despite being established in 1974, as a temporary measure, in part to provide industrialized countries time and space to adapt to the increasing competition from developing countries in the importation of textiles. Given the labor-intensive nature of the production process, it was relatively easy for developing countries to compete in a global market. In effect, MFA developed restraint mechanisms through the establishment of quota restrictions on specific textile and clothing items. Industrialized countries were allowed to place bilateral quotas on various textiles, balanced by an obligation to the developing countries to maintain annual growth rates. The MFA was subsequently renewed five times prior to its expiry on December 31, 2004.

One outcome of MFA has been the development of new textile industries, in seemingly unlikely countries. As exporting countries were regularly running out of quota allotment, buyers turned to a growing number of sourcing locations. This trend led to the development of emerging textile and clothing industries in new countries that otherwise may not have entered the international trade market in textiles and clothing.

Sri Lanka is highly dependent on the industry for both employment and foreign exchange earnings, and foreign direct investment (FDI) has been very significant in the sector, with 6

foreign investors now owning close to half of all garment factories. Sri Lanka remains a large export oriented garment sector, dependent on imported textile materials and with no capacity to supply the quantity or quality of yarn and fabrics required by the industry. Efforts to promote backward linkages (vertical integration) in the garment industry have largely been unsuccessful, not helped by the impact of the 1997 East Asian currency crisis which triggered devaluations in Indonesia and the Philippines (two major competitors in garment exports). Sri Lankan garment exporters found it difficult to compete without a matching devaluation, so that three privatized textile factories had to be closed down. Today, the Sri Lankan garment industry remains a low value added industry, though some backward linkages have been developed since the mid 1990s. The absence of vertical integration (associated with the lack of a fabric and accessory base) means that the turnaround time of Sri Lanka’s garment industry remains close to 90-150 days compared with an international benchmark lead time of around 60 days. This long turnaround time is an issue in the context of competitiveness, particularly at a time when “just-in-time” delivery has become an accepted principle and requirement in the global market. (Saman Kelegama, 2005) The competitive strength of the Sri Lankan garment industry is based on cheap labour, high labour standards, a literate labour force, investment friendly government policies and strategic shipping lanes. On the other hand, there are also competitive disadvantages, such as long lead times, lack of product development, weak marketing and low labour productivity partly due to outdated technology. Emerging low labour cost East Asian countries (e.g., Cambodia and Vietnam) mean that Sri Lanka cannot compete on the basis of low cost labour in the long-term, meaning that measures are necessary to secure

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improvements in the productivity and quality of the sector. Management practices like TQM, to assist the survival of the industry, have thus received renewed attention.

At the firm level, competitive issues have rarely featured in strategic planning owing to the assured market guaranteed by the quota system and the laid back attitude of some entrepreneurs. Most companies have made little effort to produce high value added and high quality garments and there is a heavy dependence on buyers to channel garments to international markets. Until recently, most garment orders were on a “No Foreign Exchange” (NFE) basis. Many garment producers preferred such orders because there was less risk involved. Little effort has been made at the firm level to reduce wastage and improve the quality of work.

Sri Lanka’s lack of competitiveness in apparel products is not solely determined by low labour productivity, firm level inadequacies and high turnaround time but also by the high cost of infra structure facilities (e.g., electricity, water and telecommunications); Saman Kelegama (2005) note that Sri Lanka’s electricity charges remain the highest in Asia. Kelegama and Epaarachchi (2002) in a study of the productivity of the garment sector identify a number of issues relating to low labour productivity where substantial improvement is possible through upgrading the development of human skills to deal with technological change.

3. Literature Review A TQM implementation program requires several years for significant results to appear (Cole 1998). Some studies show that the impact on the bottom line may be negative during 8

the first years of implementation (Hendricks and Singhal 1995). The implicit assumption is that the organization has time to invest in resources and wait for results, and that its external stakeholders are also willing to engage in long term relationships with the company. Future orientation is supported by a comprehensive long term planning process, which is based on assumptions that organization can forecast and plan for future based on current and historical measurements. Successful implementation of TQM in a developing country like Sri Lanka may depend on variables different from those associated with western countries. Cultural differences have been identified as one of the significant contributors to the failure of TQM applications (Entrekin and Pearson, 1995), so that the transformation of the organization’s culture, processes, and beliefs, among employees is seen as the vital aspect of the successful introduction of TQM (Brown, 1995). Sun (1999) suggests that the components of a TQM programme may vary from country to country, resulting in models for different countries which are not exactly the same. A number of authors (e.g., Lawler, Atmiyanada & Zaidi, 1992; Galperin, 1995; Katz et al., 1998); Nasierowski & Coleman, 1997; Tata & Prasad, 1998) have investigated the links between culture and TQM implementation, and increased the level of understanding about national differences relating to TQM implementation. Survey based research in the area of quality management requires the development of reliable scales to measure the key aspects of quality management. Saraph, Benson and Schroeder (1989) provide a model for assessing managers’ perceptions of quality management practices at the organizational level. Their instrument addressed the role of top management leadership, the role of the quality department, training, product design, supplier quality management, process management, quality data and reporting, and 9

employee relations. Flynn, Schroeder, and Sakakibara (1995) extended this work by developing a scale for use at plant level with all job levels. These studies suggest a link between quality management practices and quality performance, with “quality leadership” and “employee involvement” having the strongest relationship to quality performance. Mann and Kehoe (1995) demonstrate the importance of management in the success of TQM. Of the seven quality critical organizational characteristics (QCOCs) considered, they found that management style and shared values were the two main characteristics

having the most impact on the successful

implementation of TQM. On the other hand, Kanji (1996) identified poor management style that inhibits a learning culture, is based on fear or intimidation, and creates barriers between departments, as contributing to failed TQM initiatives. Several authors have examined the financial effects of implementing total quality management programs. Hendricks and Singhal (2001) find that the extent of financial benefits arising from TQM depends on firm characteristics. Easton and Jarrell (1998, 1999) also show a significant improvement in performance after implementing TQM. Powell (1995) concludes that the resources often associated with successful TQM implementation improve performance, rather than the TQM tools themselves.

Dale (2001) notes that even TQM implementations in the West are at a relatively early stage of development, and that inadequate attention has been devoted to research in the developed nations, so that findings cannot confidently cross national boundaries, to developing economies like Sri Lanka. In a rare study in a developing country, Lau and Idris (2000) addressed the factors needed to ensure the success of total quality management

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implementation in Malaysia, attributing the major influences to soft elements such as ‘culture and trust’ and ‘teamwork’. Generally, there seems to be limitations of the findings of some of the earlier studies in their applicability across national boundaries (Dawson, 1994; Rao et al., 1999). Therefore, the findings of such systematic studies will generate a new way of thinking concerning total quality management in the various country contexts. This research will reflect the thoughts and strategies of many importers of clothing and textiles in implementing TQM, and provides insight to anticipated changes that may result following January 2005. The introduction of the WTO’s Agreement on Textiles and Clothing (ATC) and the ten year phasing out of quotas will mean massive changes in the Sri Lankan garment industry, which presently has a heavy reliance and was built on quota categories. Garment workers will no doubt feel the biggest impact. While the abolition of quotas will create opportunities for developing countries, it will also expose them to additional competition from other, formerly restrained, exporters. The outcome for any individual country will depend heavily on its policy response. Countries that take the opportunity to streamline their policies, and improve their competitiveness, are likely to increase their gains from quota abolition.

4. Hypothesis Development The TQM literature highlights the importance of top management involvement as a change agent in the introduction and establishment of TQM in their organization. Oakland (1989) argued that a way to implement TQM successfully is to issue a total quality message that clearly states top management' s commitment to TQM and outlines the role everyone must play. According to Oakland, this will enable workers to take the concept seriously since it 11

originates from the top, and shows the seriousness of the top management in implementing the concept.

Quality is an important consideration for executive thinking; the increased

awareness of senior executives, who have recognised that quality is an important strategic issue is reflected as an important focus for all levels of the organization. A number of authors (e.g., Wilkinson, 1992; Oakland, 2000) make a distinction between quality factors which embrace ‘soft aspects of management’ (e.g., top management commitment and involvement, employee empowerment and culture) and ‘hard aspects’ (e.g., improvement tools, techniques and systems). One method of optimizing the quality focus is through implementation of the TQM management tools throughout the organization. TQM is concerned with the improvement of quality in every section of the organization, so that employees are expected to be more likely to pursue a business strategy which emphasises quality rather than cost cutting. This expectation gives rise to the development of following hypothesis:

Hypothesis 1: Apparel companies who have implemented TQM are more likely to adopt a business strategy focused on quality relative to those companies without TQM.

Good management practices are associated with well developed plans, good employee and customer relations, quality products and valuable external contacts. A positive relationship is anticipated between TQM adoption and quality management practices. Management practices are considered in terms of particular functions: in the apparel field, these would normally include business management, financial management, transport management, program management, and personnel management. Garments factories who have 12

implemented TQM are expected to have better developed quality management practices, an expectation which leads to the development of a second hypothesis:

Hypothesis 2: Apparel companies which have implemented TQM are more likely to have more developed quality management practices than those of non TQM companies.

Performance reporting allows an organization to set sensible objectives and measure and monitor their degree of compliance. Such reporting will help to measure the extent to which customer requirements have been met, and assist the stakeholders of a company with an ongoing dialogue about the setting of company priorities and the allocation of resources. Efficient use of performance information implies recognition of ‘continuous learning’, so that we know what has worked before, and what has not worked, so that plans can be adjusted to improve performance. In a quality focused garment organization, measures of quality performance are vital, and would normally include the number of defective garments, response time and customer satisfaction measurements.

According to Wilkinson and Willmott (1995, p.8), the hard side of TQM has been emphasised to the detriment of the soft side. Much attention and effort has been directed at the measurement and documentation of procedures and outcomes through the use of flow charts, scatter diagrams, control charts, etc. Comparatively less consideration is given to the softer process of winning employee support for, and commitment to the TQM philosophy of continuous improvement. Such views are consistent with the findings of both Hassan et al. (1993) and Lammert and Ehrsam (1987) who suggest that more appropriate

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performance measures need to be developed to encourage employee involvement and team work. Although non financial measures are increasingly important in decision making and performance evaluation, companies should not simply copy measures used by others. The choice of measures must be linked to factors such as corporate strategy, value drivers, organizational objectives and the competitive environment. Smith (2005, p.16) emphasises that performance measurement choice is a dynamic process, and that the chosen measures need to be continually reassessed as strategies and competitive environments evolve This leads to the development of a third hypothesis:

Hypothesis 3: Apparel companies who have implemented TQM are more likely to report physical and financial quality measures than those companies without a TQM implementation.

Few studies have investigated the relationship between performance measurement systems and the new manufacturing environment. In the main, existing studies have been limited to case studies, and the findings not sufficiently comprehensive to explain the general relationship between the performance system and TQM practices.

The final hypothesis tests the impact of the implementation of traditional performance measurement systems:

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Hypothesis 4: Apparel companies who have not implemented TQM are more likely to have performance reports comprising only traditional performance measures when compared to those companies who have implemented TQM.

6. Research Method 6.1 Development of the Survey Instrument

The study employs a mail survey, and uses a 42-item questionnaire (detailed in Appendix 1) with questions largely derived from influential works in the literature. The instrument comprises five major sections: The survey instrument commences (Q.1-4) with general questions relating to the name of the company, the number of employees, confirmation of TQM status, quality systems implemented and the position of the respondent in the company. Subsequent questions take the form of a Likert five point closed rating scale. Section 2 (Q. 5-9) measures cost leadership and is based on the instrument developed by Parthasarthy and Sethi (1993) to explore the relationship between business strategy and cost leadership strategy measures. These questions examine the importance of operating efficiency, competitive pricing, economies of scale, volume discounts and cost cutting strategies in the garment industry. Section 3 measures TQM implementation, and is based on the instrument developed by Powell (1995). Q. 10-29 are designed to provide feedback on the seven essential aspects of quality

management

practices:

quality

training,

open

organization,

employee 15

empowerment, quality management, customer and supplier focus, process improvement and corporate wide support for quality management.

Section 4 is based on Daniel and Reitsperger (1991), and includes questions (Q. 30-37) relating to the performance reporting of physical and financial measures. Their study had highlighted the ready availability of internal failure measures (e.g., rejects, scrap, rework) for every level of the factory. In the final section we seek descriptive information (Q. 38-42) on non-financial measures (i.e., garment delivery times, overseas customer satisfaction, goods returned, garments inspection activities), and on traditional efficiency measures (i.e., material, labor, overhead variances and capacity utilization rates).

6.2 Sample selection

The sampling frame for the study comprises all the garments companies located in Sri Lanka. The trade directory of ‘www.srilankabusiness.com’ was used to source the email addresses of these companies (around 500 in total). A sequential random selection from these companies was conducted, and telephone calls made to identify those companies which had a ‘quality manager’ or a person on staff with designated quality-responsibility. These companies were classified as ‘quality implemented’, those without as ‘quality nonimplemented’. Contact continued until 60 companies of each category had been identified (providing a target sample of 25 per cent). The questionnaire was emailed to the quality manager, or to a senior manager with designated responsibility for quality (in the quality-implemented group of companies) and 16

to the Managing Director, or equivalent, in each non-quality implemented company. Respondents were told of the purpose and importance of the research, and guaranteed anonymity of their answers. Follow up reminders were emailed two weeks after the initial emails. Of the 60 questionnaires sent to quality-implemented companies, 32 completed responses were received (53.3%); for the 60 questionnaires sent to non quality-implemented companies, 35 completed responses were received (58.3%). These totals include nine responses received via normal post rather than email. Tests for differences between email and mail responses, and between early and late responders, revealed no significant differences, suggesting that non-response bias was not a serious consideration in this study.

7. Results An analysis of the position held by those who completed the questionnaire indicated that only two (2.98%) held the titles of Managing Director, General

Manager or Chief

Executive Officer and 36 (53.7%) held the title of Quality Manager. The remaining responses of 29 (43.28%) were received from persons holding the positions such as accountant, merchandiser, planner, owner, marketing manager and administration manager. The number of employees in respondent companies ranged from 225 to a maximum of 4500. A t-test for the difference in size between TQM and non TQM apparel companies indicated that the TQM companies were significantly larger than non TQM companies; the average number of employees for the former being 2182, and for the latter 457.

Table 1 shows the comparison of the business strategy, quality management practices and performance reporting systems between TQM and non TQM apparel companies. For the 17

purposes of testing comparisons were made with respect to scores for that group of questions addressing: quality strategy (Q. 5-9); corporate wide quality policy (Q. 10-11), customer focus (Q.12); supplier linkages (Q.13); process improvement (Q.14-16); quality training (Q. 17-19, 29); employee empowerment (Q. 20-25); quality measurement (Q.2628); financial and physical quality measures (Q. 30-37) and traditional efficiency measures (Q. 38-42). Table 1: t-test of differences between TQM and Non TQM apparel companies (Detailed analysis)

TQM Mean (n=32)

Non TQM t-statistics Mean(n=35)

Cost Vs quality strategy

4.162

3.468

5.861

Corporate wide quality policy

4.421

3.257

4.132

Customer focus

4.156

3.342

7.161

Supplier Linkages

4.406

3.314

8.868

Process Improvement

4.270

3.314

8.401

Quality Training

4.156

3.342

5.790

Employee empowerment

3.112

3.000

1.653 *

Quality measurement

4.023

3.271

5.996

Financial and physical Quality measures Traditional efficiency measures

4.214

3.275

8.288

4.212

3.325

6.999

* Not significant at p