Performance versus costs, part 2

Dear Gemba Coach,

I’ve read your recent column on performance versus cost with great interest, as I believe we’re currently having a similar discussion at management level. Would you clarify further the difference you see between performance management and cost cutting?

Certainly, but if you are having this debate at senior level, beware: there be dragons! A large part of the debate centers around deep-set ideas on the nature of industrial investment. What Adam Smith saw at the very birth of the industrial revolution was that if you (1) divide work into narrow tasks (2) you make astounding gains in individual productivity by rationalizing each task and (3) you can then make further gains by inventing machines to perform the task mechanically. As you go through these three steps, your cost per unit plummets spectacularly. I just saw a plant do just that separating full product assembly by one operators into separate operations according to takt time and just by dividing the work they doubled productivity, by rationalizing each step they gained forty percent further parts per person per hour, and they then mechanized one station and doubled productivity again (from 500 a shift to 1,000). The problem they hit, of course, is that the tak time being at one and a half minute (about 500 parts a shift), 1,000 component parts were double than they needed.

And ay, there’s the rub: how to resist investment envy. In the traditional cost-based vision, lowering unit cost has to be a good thing no matter what. On top of which, as a manager, investment gives you a real buzz: that’s a separates-man-from-boys decision, and it’s fun to spend big money in order to get big returns.

The demand markets of days long past would take whatever you produced. Traditional industrial thinking hinges on:

1. Making a demand forecast
2. Investing in equipment that can supply the demand at the lowest unit cost
3. And reduce direct personnel cost to a minimum (ignore engineering and logistics “overhead”)

Unfortunately, although we prefer to deal with the world as it should be rather than as it is, sometimes reality intrudes. If actual demand is lower than forecast demand, or if the mix is different from expectations, although the unit cost of producing one part is low, the total budget level results are not any better: you can make but you can’t ship, so you can’t charge. Furthermore, running at maximum local efficiency will create a lot extra activities in terms of warehousing and scheduling – in lean terms, waste – that will show up on the bottom-line but never be allocated to the machine that is overproducing.

Since some fairly senior necks hang on proving the ROI to justify the investment, operational rats are usually told to 1) run the kit “efficiently” (ie at full speed) to keep the unit cost down and 2) do what they can to control costs all around. There are two obvious ways operational guys can do this:

1. Created demand: the capacity investment can be kept running at full speed by rearranging real customer orders in order to bunch orders that go the machine (and avoid the production losses due to change overs) and reschedule all over work accordingly.
2. Tighter spending control: certain discretionary costs such as temporary work, training, external maintenance or parts, travel and so on are relatively easy to control because someone has to sign off the authorization – it’s easy to say: make without.

Does this work? Not really. The genius of the lean management model is to start with the gemba and, as Jim Womack says in his new book, make it a better place where we can create more value with less waste, variation and overburden [Gemba walks]. The first step in lean industrial thinking is to recognize that mura and muri generate muda:

• Mura, unnecessary unevenness in work scheduling means that, in order to deliver, the system is dimensioned for the peak demand and sub-optimized at every other time. Since demand is now created demand to keep the investment running at the original forecast assumptions, the entire production system suffers from stop-and-go and is therefore overall oversized but ineffective.
• Muri, overburden on people and equipment. Bt tightly controlling spending, many necessary activities fall by the wayside. A classic example is refusing to hire temporary workers to compensate for absenteeism. As a result remaining personnel are overburdened and perform poorly which affects the system as a whole. Or denying the purchasing manager a plane ticket for China to check a supplier, which might generate serious costs in short suppliers and poor quality parts (which both need to be dealt with at real costs).
• Muda, waste, is the mechanical consequence of Mura (bunching orders and rescheduling) and Muri (overburdening people and equipment). The most obvious muda is caused by overproduction, having to manhandle, store, count, reroute the parts we produce without an immediate use for them in order to maintain the unit cost down. But there are many other instances of waste due to the fact that people don’t work regularly in a created-demand driven and overburdened production system: poor quality parts due to lack of training, absenteeism due to lack of responsibility, production losses due to machines being used haphazardly and often unavailable. As lean practitioners all know, there is no end to muda and, more to the point we often create our own misery.

From an industrial perspective, Takt Time is one of the most powerful lean concepts. In order to optimize the system’s performance as a whole, the idea is to aim all efforts not at optimizing unit cost but at keeping takt time. Takt time is an average of customer demand over a period. The period depends of the facility’s flexibility. A Toyota car plant, for instance, will find it challenging to change takt time every couple of months, but Toyota’s engine plant aims to change takt time weekly. The idea here is to keep a stable volume as far as possible in line with real customer demand, and be as flexible on mix as we can.

With takt time as the production’s system central objective, all functions can work together towards this objective, and management’s problem then becomes to solve the issues stopping us from achieving takt time. Do we replace absent operators with temps? Yes, but we then investigate the causes absenteeism and try to solve them. Do we pay for needed spare parts? Absolutely, but we work on maintaining critical parts so that we don’t have to change them that often.

Does it mean that lean thinkers ignore all consumables expenses? Not at all. I recently visited a Toyota engine plant and one of the many charts on the management visual board was a tracking of consumables costs on the line. One of the other visitors pointed out that the paper was not up to date: actually it was posted but without any annotations. The tour guide pointed out that on this line, they were still focusing on the essentials:

• Their percentage of takt time achievement
• Quality issues on the line

Both of these papers were rigorously filled in. They agreed they should be tracking consumables spending as well, and doing kaizen on it, as well as other indicators such as RH training and so on. They knew they had problems on this segment of the line, so management priority was clear: first achieve takt and solve quality issues, and then move on to kaizen on consumables costs.

To summarize, I believe these are widely differing industrial paradigms. As I understand it, traditional thinking is about:

1. Break the bank on a huge investment (buy a plant, a new state-of-the-art, high-speed, multi-purpose machine, etc.)
2. Which needs to pay back, but has unexpected cost side-effects
3. So narrowly control spending
4. By specific cost reduction projects
5. In order to achieve the double constraint of reaching bottom line objectives while keeping unit costs down.

Whereas lean thinking works completely the other way around:

1. Focus on overall performance by making and good products at takt time
2. By avoiding mura and muri in your management decisions
3. And spending what you must in order to achieve quality and JIT
4. But measure carefully costs in terms of budget and extra spending and investigate thoroughly any expense above budget to understand root cause
5. To kaizen away the causes for extra spending
6. And, in doing so rethink completely what kind of investments you need.

Toyota is still leading the way on such deep lean thinking. Buffered by disaster after disaster from the financial crisis to the recall crisis and then the tsunami and nuclear crisis, the company has not lost track of its fundamentals. “60 percent of the cost of the car is the investment into the plant. 20 percent is the parts that go in the car,” says Toyota’s Executive Vice President Atsushi Niimi. In it’s newest Ohira plant in Japan, Toyota aims to reduce its capital expenditure by 40% according to what is reported. “Manufacturing accounts for 20%-30% of total vehicle cost, with facility investment representing around half of that amount,” Nimii is quoted saying “This means that (a 40% reduction in facility investment) results in a 15% lower per-vehicle cost.” (Roger Schreffler WardsAuto.com, Mar 8, 2011).

How about that for cost control, don’t you think?