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Michael Balle

Michael Ballé: Leaning processes is about seeking true cost

By Michael Balle, co-author of The Gold Mine and The Lean Manager - Last updated: Thursday, January 7, 2010 - Save & Share - Leave a comment

Lean can certainly help in getting commitment on specific financial targets and seeing that these targets are met on schedule, but not in the way one thinks, which is again one of the interesting paradoxes of this new way of management.

First, the lean approach is definitely more precise about costs. For instance, I was recently looking at purchasing practices in the automotive industry. In a traditional group, purchasing assumed a ballpark figure of a few percents of the part cost for transportation and holding. In a company that has been doing lean for years, there are tables to calculate the cost of the packaging, the amount of parts per packaging, the cost of holding parts at each point of storage, the cost of handling parts as well as the cost of transport. These cost hypotheses are first spelled out in an “ideal” lean situation: ex-works with daily quantities delivered at the factory, and half-hour delivery on the line, and the cost is worked backwards to define what the packaging and transport conditions will do. Now, clearly going from there to here didn’t happen overnight, and is the result of much step-by-step kaizen to understand the real cost of packing, handling and moving parts.

In fact, most traditional cost figures are based on implicit volume assumptions – which generally rest on the more the better as the more parts produced “contribute” more to covering the fixed cost of the machine. Back at the origins of lean, much of Ohno’s writings center around understanding the real cost of operations as opposed to overproducing just to get the apparent cost down. Certainly, one of Toyota’s most interesting reactions to the current crisis has been its redoubled effort to flexibilize fixed costs to adapt to the volume downturn – every cost, such as energy, waste, consumables is investigated with a toothpick to be reduced to the amount of real need at takt time. As one does kaizen again and again, the true nature of the cost to produce one part becomes more apparent, and hence better managed.

Another example of this detailed understanding of cost can be found in the engineering practice of target costing. Any one who has tried to set a target cost for a new product in an environment where this has not been done before will know how difficult this is. Generally people work on ballpark cost assumptions, develop the product, and hope they fall within the target range. When they don’t (usually, they don’t) they then try to shave costs off the product, often taking risks with quality and functionality. In lean companies, similar cost tables as the one described for the transport costs have been developed through years of experience, and for instance, it’s possible to compare how different materials and different manufacturing methods will impact the total product cost. When one compares traditional assembly operations to Toyota suppliers operations, for instance, one finds much costlier technical solutions (hydraulic clamp where a simple jig can be used, etc.) on the line, which, I believe, stem from a lack of detailed understanding of costs, both financially and in terms of ergonomics.

Furthermore, in terms of schedule to reach the target, the lean system has developed a policy deployment practice (called hoshin kanri or management control) which breaks down overall financial indicators into detailed input and output indicators all the way to the visual management system on the shop floor – through carefully chosen control points. In effect, once that system is in place, one can walk the shop floor and see everyday whether one is progressing towards the overall target or not. This is very helpful in helping middle managers to achieve their own objectives, because you can organize help where it’s needed real-time – as opposed to yell at people after the fact when they’ve missed their target.

So, to answer the question, yes, lean systems can help with more precise financial control. A company that has been implementing lean seriously for four or five years will have very specific ideas about how much pph improvement it can expect over the year from kaizen activities, how much cash generation it can expect from stock reduction, and how much cost reduction it can expect through quality improvement and other special cost reduction activities.

However, and this is where it gets tricky – don’t expect this right away. Lean systems have to be firmly in place to be able to deliver this kind of cost understanding because the numbers are not the result of any bean counting system (reporting, ERP, etc.) but of many hours of kaizen investigating the true nature of cost by taking waste out of each process. It’s the cumulated experience of such improvement efforts that broadly build the real cost understanding – and that process is not easy by any means. I have witnessed savage arguments between the lean guys detailing their understanding of true costs and their financial counterparts defending spreadsheet based Return On Investment assumptions. On some major decisions, such as where to locate a new plant (or indeed whether to build a new plant at all), the two modes of measuring and managing costs can differ widely, and require a lot of open minded teamwork to be reconciled.

Furthermore, and maybe the most confounding of all, Actual Toyota-led projects at suppliers were not focused on achieving financial targets on schedule. The focus was on improving the process, and watch the cost come down. This is not to say costs where not measured carefully and rigorously (actually much more so that the supplier is usually prepared to), but measures are part of the PDCA cycle: what do we want to achieve? Di we get it? Why? Did we not get it? Why not? And so on, rather than run after the goalpost to get the carrot. It’s a very different attitude to targets and schedules. Figures measure the scope of improvement, and schedule is about the pace of improvement. The targets are stretching, but it also well realized that reality exists and fights back. When people fail because they’ve hit a real snag, they can be praised for it, rather than blamed, if they’ve done the right things and followed correctly the lean problem solving process. There is no other goal than improvement, improvement, improvement.

In terms of engaging people, the lean approach is much more robust because there is little incentive to “game the system” (cut corners in order to make the target, and to hell with the fallout). When people get committed to improving their processes and watch the cost go down, and they will fight to do this again and again. The barrier to entry, of course, is having lean systems established enough in the company so that individuals can start to see for themselves the relationship between process mastery and financial performance. Unfortunately, many companies get discouraged in their lean implementation before they reach that point (mostly by failing to see lean as a system as opposed to a series of one-shot improvement events).

To a larger extent, leaning processes means seeking the true cost of designing, producing and delivering a product or a service. The closer to true cost the company operates, the more profitable it will be – but what the financiers who have involved themselves deeply into lean tend to discover is that the way finance traditionally computes costs is not very helpful in managing costs better. In fact, lean systems to help to commit and reach specific targets on schedule, but they also reveal many misconceptions (to use Ohno’s term) in the common sense attitudes to cost calculations, and open avenues to improve the financial perspective as well as the delivery perspective, which brings us back to more kaizen, open mind and teamwork!

If you have practical questions regarding lean implementation, please join me on the Gemba Coach column on lean.org

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