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Art Smalley

Art Smalley: Toyota’s Cost Reduction Focus

By Art Smalley, - Last updated: Wednesday, January 6, 2010 - Save & Share - Leave a comment

Prof. Austin’s most recent question strikes a chord with me as I think it unfortunately highlights an important aspect of lean or TPS that is not accurately depicted in the world today. Like most people when I started working for Toyota in Japan I sat through the standard half day introduction to TPS put on at that time by the education department. The second or third overhead transparency shown to us was the following simple equation for discussion purposes:

Profits = (Sales Price – Cost) x Volume

There are three ways to manipulate profit in this equation. 1) Increase prices, 2) Sell more units, or 3) Reduce cost. Since the automotive industry is a mature competitive business with lots of substitute products from competitors it is virtually impossible to just “raise prices” or “sell more” in the long run. Of course companies with patents or monopoly position or greater brand strength can avoid this at least for some period of time. However by advocating this principle Toyota wanted employees to realize that reducing cost through elimination of waste was a very important part of the business model.

This cost reduction concept permeated the company no matter what division you worked in as I found out over time. Cost reduction through waste elimination was a way of life in manufacturing. Annual productivity improvements of 7-8% were to norm for example in production. Maintain scrap at rates of .1% or lower was expected as well. Unnecessary overtime to get things done was a sure fire way to get lots of unwanted attention. People who did not perform in managerial positions were moved to other areas as part of the normal rotation cycle.

Toyota worked hard in product development with various initiatives to reduce cost and unnecessary features from parts and systems in the vehicle. Value Engineering, Value Analysis, and Value Improvement were programs that helped shave millions in savings over the years. Suppliers were not spared from this process either. The process of reducing cost in the supply base was more collaborative than other instances I have witnessed but no less stringent.

Somehow at least in North America the lean movement has shied away from rigorous talk about cost and performance management in my opinion…Topics of “value”, “flow”, “culture” or other aspects were perhaps more unique or interesting to talk about and certainly less controversial. I think this has been a big reason though why so many companies can apply a lot of lean techniques and still have little to show for it financially at the end of the day. Sooner or later this has to change or lean (outside of Toyota) will not survive in the long run.

It is not by accident that until recently Toyota earned industry leading profits and had several years with net income in the $15 Billion and above range. You don’t do that by accident…it is part of rigorous performance management and attention to the details of cost. As we answer this question by Prof. Austin Toyota is going through one of its more rigorous reviews in history to get costs and profits back on track in the company. I hope this focus will become more noticed and widely discussed in the lean community in the years to come.

“As a financial manager, what I’d really like from operational managers is a commitment to realizing specific targets–cost reduction, productivity improvement, whatever–on a schedule. Then I want to see people work to deliver those results on schedule. Can lean help me get that?”

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