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Art Smalley

Art Smalley: Toyota Insourcing For Competitive Advantage

By Art Smalley, - Last updated: Friday, December 6, 2013 - Save & Share - Leave a comment

I honestly don’t know if there is a specific “lean way” for organizing value through out the supply chain. Lean is a pretty subjective term these days and I find as much difference of opinion on the topic as I do agreement. I expect a lot of different responses on this topic depending upon differing backgrounds. Speed, quality, value, feel good, profits, etc. take your pick and state your beliefs and reasons why. On the flip side I do know some things about how specific Toyota is when it comes to making these types of decisions. Also there is history behind these decisions and that is quite different from the lean literature you will mostly read.  While working for Toyota in Japan I had some very fortunate experiences. I will relate two stories that pertain to this topic specifically when it comes to the supply chain and in-sourcing outsourcing discussions.

The first story deals with a discussion I had with a General Manager by the last name of Chiharu who was in charge of production control, cost accounting, and a few other departments in our largest engine facility in Japan. He also spent time in the purchasing organization as well. He is long since removed from the company and into retirement. From time to time in the late 1980’s and early 90’s I had meetings with him involving various aspects pertaining to the start-up of Toyota’s plant in Kentucky.

On one such occasion we wound up in a conference room with just three people waiting for some others to join us who had been inadvertently delayed. Mr. Chiharu took the time to pontificate on some topics I did not fully appreciate at the time. Even back then Toyota was hosting a lot of tours and fielding requests from academics, consultants, competitors and various interested parties in the vaunted Toyota Production System.

Mr. Chiharu was quite amused to point out that all such visiting parties tended to come away with superficial views about how Toyota really operates at the detailed level. For example every book and person touring Toyota tends to come away enamored with the “flow”  or “velocity” or “JIT” aspect of the system. Take a look at the literature and presentations and this set of themes will always jump out. And I agree that fundamentally it may be the easiest to see and most visually impressive part of the system.

However as Mr. Chiharu pointed out that is not really the strategy that makes Toyota successful in his opinion. Toyota roughly outsources about 70% of the parts of the overall vehicle. Roughly 30% or so are made in-house for very specific reasons. There is often a strategic reason for technology and performance. You can’t make a car without having engineering knowledge about the engine, transmission, chassis, body, paint, plastics, and assembly, etc. Toyota focuses on the few things that matter for reasons of technology, quality control, and competitive advantage. I’ll get more detailed on this in a minute with some examples in an engine.

Secondly as he pointed out there was really no way to compete long term in a competitive industry if your plan is just to outsource and merely operate on low cost.  He stated that was merely walking straight into a commodity trap where you were forced to chase ever low cost suppliers in order to compete. He viewed that as short sighted and wrong-headed. Toyota in his view was trying throughout its history to get away from merely making commodity entry level products and competing on cost. They wanted to be known for quality and reliability to the extent that consumers would pay for that reputation and stay with the company with their next purchase.

In Toyota’s case he did not believe that the fancy JIT and flow things that visitors tended to fixate on were the core of Toyota’s strength at all. In fact he pointed out that the purchasing departments of Toyota’s competitors were more advanced than Toyota at that point in time. They were often obtaining components at lower prices than Toyota was. And if they so desired most competitors could buy the exact same external component from Toyota suppliers that Toyota was buying a the same cost if they so opted to do so…So in his view this could never be a source of true long term competitive advantage for Toyota no matter how well a JIT flow type of system might work.

Instead all his research and experience on the matter showed that Toyota’s greatest source of quality, cost, and productivity advantage was in the internally sourced and produced components. Toyota could produce engines, transmissions, bodies, etc. better than the competition by far and this was considered far more proprietary knowledge than the JIT system and logistical aspects of the system. I think companies would be wise to reflect on this point and how they will be competitive long term.

The second story is much more recent and deals with an on-going set of discussion I have with some retired engineers from Toyota in Japan. All are veterans of the engine design, development, and production side of Toyota’s business as was I during my time. I always pay heed to the engine people in particular as that is where TPS started picking up steam internally back in the 1950’s under Eiji Toyoda and Taiichi Ohno.

I asked one of the engineering managers what was the source of Toyota’s strength and what he thought of all the books on Toyota published today. (Side note: that includes my work as well). This particular gentleman Mr. Miyazaki formerly did the internal versus external sourcing decisions for Toyota in engines from a technical and cost point of view. Mr. Miyazaki though that it was comical for people to believe they could replicate Toyota’s success in product by focusing on logistics, speed, flow, standardized work, and that sort of stuff.

As part of the explanation he handed me a raw forging of a connection rod. Then he gave me a final product drawing of what the connecting rod needed to be for the product to function. He then asked me how to best process that raw forging step by step from initial process through the end of the line…

The point is he stated that making this part function as intended has nothing to do with how you flow it around inside a factory. It can go in circles or in a loop or in a straight line. Now for the record most Toyota lines are straight for reasons of layout, space efficiency, and worker productivity so a couple of people can run an entire production line. However he was exaggerating to make a more fundamental point.

You can optimize flow, speed, or logistics however you want. If you can’t make a good quality part however in the first place and keep the process up and running at a high level of availability it does not matter.  You will lose to the competition due to higher costs and inefficiency every time if your quality and capital productivity is low. I often ask people the following question. Assume there are two plants in parallel universes making the same products for the same customer with the same wage rates. One has a text book “lean” layout and all the trappings of good flow and JIT all set up. However it suffers from high scrap rates and extensive down time. The second plant has near perfect quality and has extremely low downtime. However the layout is not the greatest and the flow is hard to fathom at first. Which would you rather operate? For most people the answer is easy and obvious…

From Mr. Miyazaki’s point of view it boils down to something like this. In order to make a connecting rod from scratch Toyota can do it in say 20 operations with 150 tools. The production processes through years of hard work and effort reliably run in the 90% or greater up-time range and exhibit extremely high process capability and rarely make a defect. The machines are also more energy efficient and worker friendly from a multi-handling point of view, etc. The competition takes more machines, more workers, more tools, more steps, etc. etc. etc. Toyota has standards for how to make a high quality connecting rod. Yet because this sort of technical ability is obscured and proprietary the average visitor will walk through the line remark something along the lines of “Oh what a nice clean flow this layout is with excellent material movement, and standardized work for the operator, etc. etc.”. To Mr. Miyazaki and probably Mr. Chiharu that is either funny or frustrating depending upon your point of view.

There is only one plant in the world that I am aware of where Toyota outsources the engine and that is the example Sammy Obara noted previously in Brazil. I am sure there is another I am just not aware of it. Exceptions to everything exist but usually there is cost, volume, or technology reason why for that case.

Toyota makes it engines internally but it is done again in a very smart fashion. Of the hundreds of parts that comprise an engine Toyota casts or forges and then machines the block, cylinder head, cam shaft, crankshaft, connection rod, piston, and usually intake and exhaust manifolds. A few exceptions exist here and there of course. Everything else is externally sourced from specific companies depending upon the technology and their capabilities. Local sourcing decisions often complicate this process so Toyota just can’t always us the same vendors from Japan like the good old days.

Not only does Toyota in-source these components I listed above they tightly control ownership and development of the machine tools and tooling suppliers that are used to make these complex products. Toyota does not outsource line design or even process design to 3rd parties. Production engineering follows its standards for designing processes including mundane and vital things like how to locate the part, what to locate off of, what is the datum, what are the exact tooling conditions, chip evacuation and removal, what type of coolant, hydraulics, controls, etc. etc. The exact drill used to drill a 50 millimeter hole is standard as well as the tool holder, spindle head design, and other parts. Toyota owns an internal plant called Teiho that makes final many important process machines and dies. Similarly it owns a share of Toyoda Machine Works (now part of JTekt) which makes its finish grinding machines and other precision equipment. These are elements of what is generally called Toyota Manufacturing Standards and yet you will never hear about them in any book of lean or the Toyota Way. However Toyota veterans like Mr. Miyazaki consider these items and others to be some of the most fundamental building blocks of success.

So take what you want from these two stories. I think Lean has veered too far down the path of flow, pull, speed, standardized work, etc. We can throw in leadership and culture as well. Those indeed are all part of the system. Of that there is no doubt. However we also need to be wary of the “arrow of causation” from a logic point of view. We can state with some scientific certainty that smoking is a leading cause of cancer for example. We cannot however state the reverse that cancer is a cause of smoking. Similarly there is no guarantee that merely emphasizing external parts of TPS such as flow or speed or culture will make you significantly better and incur a competitive advantage in the long run. At some level you have to first design and make a good part that satisfies the customer and gives you an actual competitive advantage.  Toyota knows what parts to do than on and how to do it for a long term advantage.

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