Recession Time is a chance for reform - 2
Mainstream Toyota Way

November 27, 2008 Masatomo Tanaka

Following on from the last article, I would like to continue introducing Toyota’s way of pursuing reform in its manufacturing plants during recession times. Previously, I have explained the following measures:
(1)Set a clear target of “ideal image.”
(2)First, “reform the evaluation indicators.”

This time, I am going to explain:
(3)Do not cut expenses immoderately.
(4)Reduce inventory first when production volume is cut.
(5)Deploy the “Pull and Hold” improvement.

(3)Cost reduction increases inventories

In view of the company as a whole, in a time of recession, what merits attention most is to avoid what they call “black-ink bankruptcy.” In this situation, although showing a profit on the books, your company goes bankrupt as you fail to retain cash in hand due to poor sales, resulting in insolvency.

Considering that there is no end to the number of above-mentioned bankruptcies although everybody knows that, we must assume that something is wrong with the inventory control systems and evaluation indicators that are generally adopted by businesses.

One of my seniors was once asked to rescue a company going out of business. According to him, there is a mistake that failing companies tend to make: to give an across-the-board command of cost reduction out of fear of deficit.

As a result of the shortsighted response: “Cut the cost!” → “Cut labor cost!” → “Cut man-hours!,” the factories are driven to perform superficial work improvement -- reduction in the numbers of setup and the manpower for the conveying process. Then, the factories start to produce and convey large lots, leading to accumulation of products in process.

To meet the company’s demand for reducing purchase prices, the department of material procurement is obliged to follow the recommended conditions proposed by the procurement source, thus ending up with large-lot purchases. As a result, the warehouses are crammed with materials.

To realize reduction in freight cost, the logistics department selects carriers that comply with transportation by large trucks with full load, resulting in the warehouses becoming filled with completed products. Thus, even after the manufacturing process starts to reduce production, stocks continue to increase, while the amount of sales is decreasing. This is the reason why the cash flow is disrupted.

By repeatedly asking “Why?” for the reason of increasing inventories, you can finally find the true cause: management accounting based on the “absorption accounting system,” in which even labor cost and expenses are included in the cost price.

(4)Reduce inventory first when production volume is cut

Now, let’s perform several calculations to see what would happen to cash flow if inventories, rather than personnel, were reduced.

Let’s assume that we have a factory manufacturing a product with the manufacturing cost “\10,000/piece,” on the basis of 10,000 pieces per month. Since the production is fully undertaken at the factory, stocks for two months are carried to avoid shortage.

The in-house process cost(payroll cost) accounts for 15% of the cost price, so the payroll cost per piece is \1,500, i.e. \15 million per month. On the other hand, the material cost is \8,500 per piece, i.e. \85 million per month to pay.

Therefore, the present stocks in the factory for two months, in terms of cash, are:
2 months × \85 million = \170 million

Now, from the next month, the production is going to be reduced from 10,000 pieces to 7,000 pieces per month. According to that reduction, the stocks are going to be reduced to that volume for a month or less.
The amount of stocks for a month is then:
\8,500 × 7,000 pieces = about \60 million

In short, this reduction in stocks saves the amount of cash:
\170 million-\60 million = \110 million

Since 3,000 pieces of the product are to be reduced, the production line decides to transfer the surplus personnel from the production process to the newly-organized Quality Improvement Team (QIT), so that they can tackle reforms in preparation for the time when they successfully break out from recession. If the material cost saved by reducing stocks is allocated to this QIT, for how many months can the team be retained?

The payroll cost per month for the QIT is equal to the process cost for 3,000 product pieces.
3,000 pieces × \1,500= \4.5 million/month

Accordingly, \110 million in cash is saved by reducing stocks.

\110 million ÷ \4.5 million = 24.4 months

Although with very rough calculations, this example shows that the personnel who leave the production line can be retained for about two years by reducing inventories of the factory, rather than by dismissing employees, even when the company has to reduce production.

From the above-mentioned case, we can learn that, at the time of reduction during a recession:

(A)To reduce costs would be the method to reduce personnel and to save inventories, and
(B)To reduce production would be the method to reduce inventories and to save personnel.

As a recession occurs, most products undergo a model change. Even if you managed to leave inventories, according to (A), they become of no use and are disposed of. On the other hand, by adopting (B) and retaining the personnel, you can develop staff with multiple skills through repetitive training to be helpful after economic recovery. Since the Mainstream Toyota Way does not assume dismissal, we always adopt method (B) without hesitation. It is up to you to determine which is better, (A) or (B), according to the actual conditions of your company.

(5)Deploy the “Pull and Hold” improvement

Once deciding not to reduce personnel even when production reduction is required, the Mainstream Toyota Way launches the “Pull and Hold” improvement.

As I mentioned previously, the Mainstream Toyota Way never allows employees to work without an aim: we place value on challenging tasks at all times, breaking through the barrier, improving ourselves and our own workplace.

For example, suppose when a product is fully manufactured by 11 employees, the production is to be reduced by 30%. This time, you decide to transfer four out of the 11 excellent members to the QIT and run the product line with the other seven, for a new challenge. Similarly, if you are undertaking production with 11 facilities, four of them are to be shut down.

In short, if reduction by 30% is to be carried out, you are expected to pull out (30 % + α) of equipment and personnel, and make an effort to improve productivity, pursuing a goal set a little higher than the present ability of you all. We call this method “Pull and Hold.”

During the period of “Pull and Hold,” you have enough time to have the suspended equipment checked and refitted to improve working efficiency. If you find bottlenecks in any part of the facilities, you should remove those to realize an operation with higher speed and more precision than the manufacturer’s nominal values show. Furthermore, if you have surplus energy, you may try to develop a next-generation technology.

As for the seven employees left in the production line, you should try to encourage them to acquire a variety of skills, with the support of those transferred out of the production line. In this way, you can make various preparations at the time of reduction, waiting for eventual upturn of business. Such preparation allows you to outdo your competitors right away as business picks up again.

As I have shown in this article and the previous one, based on my own experience, this is how Toyota has gone through reduction with the Mainstream Toyota Way. I hope the methods help you find some that match well with your company in preparation for the upcoming great depression.