Recession Time is a chance for reform - 1
Mainstream Toyota Way

November 13, 2008 Masatomo Tanaka

As the global scale financial crisis began to erode the real world economy, people started to whisper their fear of the Great Depression coming back all over again on a scale as big as that of 1929. However, the major manufacturing companies’ top managements are acting opportunistic about the situation as they are all virtually holding hands proclaiming that “the recession is a chance for reform.” There is no doubt that one of the critical themes for any company is to “reduce inventory, eliminate loss, and become reborn as a lean company with smooth cash flow.”

However, reform is not an easy thing to achieve. As the word expresses, “reform” is “to form again.” This means reform of daily corporate activities in all areas of a company which is organized in a complicated system. It is not easy to smoothly shift the direction of a whole company just upon a command from its president.

Every time Toyota faced times of depression such as the Dollar Shock and the Oil Shock in the past, it further advanced through implementing reforms and strode ahead of other companies. In this article, I will explain based on my experience the actual measures taken at the “Mainstream Toyota Way” manufacturing scenes during recession times.

Here are the 4 measures:
(1) Set a clear target of “ideal image”
(2) First, “reform the evaluation indicators.”
(3) Do not cut expenses immoderately.
(4) Reduce inventory first when production volume is cut.

Recession is the time to challenge lead time reduction

(1) Set a clear target of “ideal image”
The key to the Mainstream Toyota Way’s manufacturing floor reform is to “challenge lead time (D) reduction while maintaining quality (Q). Profitability (C) will naturally follow later.”

During boom time, the company will be busy with production. Naturally, the challenge target will be to “produce as much as possible with the given manpower and equipment capability.” In this situation, the business will try to cover its lack of production capability with inventory, resulting in high volume of overall inventory.

The adverse effects of this high inventory situation will not be exposed while the absolute production quantity is high and products are sold as soon as they are made. However, the situation will be turned on its head when the production volume is lowered in recession time.

From the production point of view, the strong seller changes frequently in addition to the reduced absolute volume that can be sold in the market, but for the management, the situation will cause sales decline and disrupted cash flow.

Then how should the manufacturing floor respond in order to deal with the volatile market and ensure cash flow? The key is how they can “manufacture with less lead time (= less inventory) with given manpower and equipment capability.” “Lead time reduction” is really what companies should challenge during the recession.

The critical point in this challenge is to clearly indicate the “stance” they will take in doing so, depending on the situation the company faces, and ensure its thorough implementation throughout the company.

(2) First, “reform the evaluation indicators.”
During the booming economy time, the business performance is usually maintained within a few % of the previous year’s result or it will show an increase. Based on this assumption, the majority of companies usually manage their manufacturing profit by “Budget costing method based on absorption accounting system.”

However, in this accounting system, factories will immediately fall into deficit if they reduce the operation capacity. Meanwhile, there is also a catch: the higher the inventory volume, the higher the surplus.

Today, many corporations divide their internal divisions into their affiliates to better manage their performances, and further segmentalize the company by function. The segments are each given a target value based on this “budget costing method based on absorption accounting system,” and strictly monitored for their progress.

The president of each company is strictly audited for its performance by quarter. This means that even if the company reduces the production and inventory for the sake of the whole company, the evaluation index will end up deep in the red and a harsh evaluation will be given.

For this reason, the presidents who are approaching retirement urge their staffs to change the production plan to increase the inventory without reducing operation capacity. Not long afterwards, you will no doubt be hearing about a company president who achieved a glorious close to his career which ended in jet black ink, while he parachuted to an executive position in a supplier.

The success in inventory reduction will not be realized if companies don’t have a system whereby the manufacturing floors are acknowledged and recognized for their efforts in lowering production rate and inventory for the benefit of the whole company even if they themselves end up having deficits on their books. When the top management orders “inventory reduction,” they will be first requested for “evaluation index reform” for fair evaluation of the reform. In other words, they cannot win against their competitors unless they establish the “company-exclusive management accounting system.”

Toyota’s unique management accounting system developed by Mr. Ohno

In Toyota Motors back in the time when I was an assembly department manager, “Toyota’s unique management accounting system” was established under the strong leadership of Taiichi Ohno, a founding father of the Mainstream Toyota Way.

The system applied then was the “variable costing method.” The manufacturing cost managed by factories mainly consisted of material cost, tool cost, and labor cost, and depreciation and factory expense were completely excluded.

On the manufacturing floors, they were given the task of reducing a certain percentage of material cost and tool cost each year based on the per vehicle cost from the past result. The labor cost was calculated by [(actual process time required per vehicle) x (a common rate used in Toyota)]. Therefore, the manufacturing floors were asked to complete their production in the lowest process time possible regardless of their wage differences as a contractor or an experienced full-time worker.

During the production reduction time, a characteristic of this method becomes even more prominent. Let’s look at a simple example.

Let’s say that 16 people work 8 hours to manufacture 800 products. In this case, “the actual production time per product” would be [(16 people x 8 hours) / 800 products = 0.16 (people-time / product)]. Improvement of this factor of [0.16] is the responsibility assigned to the manufacturing managers.

What would happen when the order is reduced and production volume becomes 600 instead? The responsibility of manufacturing managers is to maintain and improve the actual production time per product. Therefore, if they can produce the amount by 16 people within 6 hours, the factor will remain as 0.16, and “satisfactory” judgment will be passed on them.

The remaining 2 hours until the end of the day will be paid by the president of the company as “extrapunitive time.” Their “Just-in-time (making only what is needed, when it is needed, and in the amount needed)” is only possible thanks to this rule.

Is your personnel system designed to be optimal even during recession?

“Manufacturing necessary amount of necessary products in necessary time” should be a matter of course for anyone. Any food stall on the street is following this method. However, large corporations are not capable of implementing this commonsense practice. One of the major reasons lies in their management accounting system mentioned earlier.

For the manufacturing managers, how they utilize this “extrapunitive time” from the production reduction becomes critical. They can use it for anything other than manufacturing, so they will think hard on how they can improve the department’s potential through “training,” “education,” and “improvement” during these hours.

The managers will order various tasks in an attempt to increase the department’s capability. They challenge their departments to manufacture 600 products in the shortest time possible. If they complete it 10 minutes or 15 minutes earlier than the allotted 6 hours, the actual production time per product is also that much shorter, and the managers will be acknowledged for that improvement. In this accounting system, they can work on the production capacity improvement even when the volume is reduced and still be recognized for their achievement as well.

There is also another method of relocating manpower. This means that they will reduce 4 people from the manufacturing processes, and attempt production of 600 products in 8 hours by only 12 people. In this case, the reduced 4 people will be moved to different departments to provide support based on a company-wide manpower plan.

When there is manpower surplus across the company, they would gather up the people and create an “improvement team” in the factory. The process time (labor cost) for this team will be covered by the company president, and the team will work on factory-wide improvement activities. This rule allows companies to maintain the “lifetime employment system.”

As explained above, a different evaluation system is sought during a recession. What do the evaluation indicators, evaluation method, and volume reduction time management look like at your workplace?

Next time, I will explain about the latter 2 key points; 3) Do not cut expenses immoderately, and 4) Reduce inventory first when production volume is cut.