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Tom Johnson: Financial results such as revenue, cost, and profit are by-products of well-run human-focused processes

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Dear “Lean Edge” Colleagues:

The cause of Toyota’s current crisis is found, in my opinion, in its very recent surrender to Wall Street pressure to grow continuously, as virtually all large publicly-traded American businesses, including those that pursue “lean” practices, have attempted to do for the past 30 years or more.  Steady growth in size and scale presumably improves profitability by conferring increased control over market prices and decreased costs. Unfortunately, as Toyota has discovered, the strategy never works.

The flaw in this finance-oriented growth strategy is the belief that profitability improves by taking steps aimed at increasing revenue and cutting costs.  While such steps embody impeccable arithmetic logic, they ignore the reality that long-term profitability results from satisfied customers and focused operations.  However, boosting output as a means to increase revenue and cut costs invariably results in impaired quality, unhappy customers, higher overhead costs, and diminished long-term profitability.

The reason why American businesses pursued this apparently self-defeating growth strategy for so many years is that they believed their purpose to be maximizing profits in the next calendar quarter, not sustaining adequate profits over generations.  Following the path laid out by Wall Street, they saw their purpose as achieving bottom-line targets defined by financial models, not continuously improving work processes aimed at producing satisfied customers.

Toyota, of course, held to a quite different set of beliefs for at least the last 40 years of the 20th century.  Their purpose, broadly construed, was to sustain human livelihoods and serve human needs while earning sufficient profit to continue in business indefinitely. Financial results of their activities such as revenue, cost, and profit were seen as by-products of well-run human-focused processes.  Those results were not viewed as targets to be reached whatever the consequences to the integrity of the company’s processes.

Why the company’s top management chose around 2000 to sacrifice that long-held sense of purpose for the ephemeral growth-for-growth’s-sake financial goals they pursued in the past decade is not clear at this time.  Historians will no doubt debate the issue for years to come.  What is clear today is that the change has brought the company virtually to its knees.  It may take decades to recover, if ever.

Where does the “lean edge” sit in all this?  To answer that question properly one must consider that “lean” was not a term Toyota people ever used (until very recently) to define their distinctive management system.   Indeed, Taiichi Ohno expressed a preference for the term “limited” as opposed to “lean.”  His point was that resource consumption should not be mindlessly reduced as a means to cut costs, but limited to what is needed to properly satisfy customers.  As far as I know the term “lean” was first applied to Toyota’s practices in the 1980s by American writers who were among the earliest outsiders to observe and write about what they saw in Toyota’s Japanese plants.  The problem, as we now know, is that what those observers saw was not what Toyota’s people regarded as most important in their system.  It has taken nearly 25 years of continuing research and writing by countless people to effectively close the gap between what Westerners (including most of those employed in Toyota plants outside Japan) and Toyota insiders (primarily those whose first language is Japanese) view as “the” Toyota system.    I think the best sources on the closing of this gap are Mike Rother’s new book Toyota Kata and Steve Spear’s new book Chasing the Rabbit.  I am biased toward these sources since they (especially Mike’s book) build on the “manage by means” concept that I introduced in my Profit Beyond Measure book over 10 years ago.

When examining this difference in viewpoints between Western and Toyota (pre-2000 Japanese) observers, it is important to consider the very different view each group has about the purpose of a business. As noted above, the Toyota people in Japan who founded and grew the company down to the 1990s saw the company as a disciplined organization of “employee/suppliers” whose purpose is to serve “customers” in a way that earns sufficient profit to ensure the long-term survival of the organization.  Those of us from the West, on the other hand, for the past 30 to 40 years have viewed the purpose of business as making profit, by any means considered legal.  Note that this is the view held by virtually all people who have written about “lean management” in the last 25 years or so. The contrasting view held by Toyota people who founded and built that company from the 1950s to 2000 considers that a business exists to provide opportunity for humans to exercise their inherent creativity in gainful employment serving needs of other humans. The people who held that view saw the purpose of the business to be continuous improvement of a system designed to enable humans to serve other humans gainfully and sustainably.

Reflecting on these thoughts from the personal perspective of 20 years writing about the differences between Western and Toyota management practices, I view a key aspect of those differences to be the way that each group thinks about “cost.”  To Westerners, cost is a financial quantity that is managed by adding and subtracting parts to and from a business (or by changing the price coefficients used to measure cost).  This thought reflects a mechanistic “whole equals sum of parts” view of reality.   To Japanese people in Toyota before 2000 cost is a financial quantity that reflects patterns of relationships among the parts in the business. To change cost you change relationships, not individual parts.  This thought reflects a “whole resides in every part” natural-system view of reality.   In a natural system, quantity such as cost can describe features of the system (like your body temperature) but it can’t explain or aid understanding of how that feature emerges from the working of the system.  For that you have to go to a language beyond quantity.  This is why for years and years I have said that management accounting (and its lean counterpart “lean accounting”) is a meaningless concept – an oxymoron in fact.  You can use accounting quantities to describe, but never to explain, understand, or control.

Tom Johnson

February 18, 2010

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