Loaves and fishes and hoshin kanri

Tom Jackson
Portland, Oregon
November 22, 2009

I have often wondered about the parable of the loaves and fishes (Mark 6:30-44) in which Jesus and his disciples feed five thousand with just five loaves of bread and only two fishes. I believe that it may be a tale told by an economist, at least an economist at heart, and a very smart one. Overlooking for the moment the very meager number of loaves and fishes and the fulsome multitude in the story related in the Gospel of Mark, isn't it true that when we exchange one thing we value less for another that we value more, in the right spirit of course, we nearly always feel more satisfied?

What I believe happened long ago was that the five thousand realized that they were being selfish, and that, encouraged by Jesus, they opened to each other and shared what they had been sheltering in the belief that no one else would would be willing to do so. An apparent shortage was a potential abundance, and it became reality through exchange with one another.

What does it mean, really, to love one another? Perhaps it means to conduct our exchanges with each other in the right spirit. And what would that be? (This might fly in the face of Jesus' violent reaction to money lenders in the Temple in Jerusalem, except for the fact that the money lenders were set up within the Temple compound.)

Respect for people, naturally. "Love thy neighbor as thyself." Well, that goes beyond respect for people, doesn't it, because it includes respect for yourself. It also means that you understand that your neighbor is just as limited as you are. Or, as the Buddha put it earlier, "Everyone suffers." My point is only amplified.

So how is the Gospel of Mark related to hoshin kanri? In hoshin kanri there may be a replicable methodology to achieve something like the miracle of the loaves and the fishes. As James Womack recently pointed out at Italy's first Lean Summit, held in Vicenza (home of Renaissance architect Palladio), the hoshin process is about surfacing and resolving conflicts regarding the allocation of (scarce) resources.

Much of the miracle of hoshin kanri is achieved by individuals' relinquishing pet projects that skew the allocation of resouces in ways that disadvantage the community. The more time we spend solving shared problems instead of our own, the better off we are collectively.

Actually, it turns out that we may be a lot better off. When we work together to solve a common problem such as "not enough to eat," there is a kind of speedup in the problem solving akin to the speedup related to parallel processing in computer science. Each of us is, after all, a kind of information processor not unlike a computer chip, however slow. According to Amdahl's law, the law that explains how fast parallel computers can go, to the extent we can "parallelize," or in other words decentralize, information processing we can expect to speed up information processing but 5, 10, 20 times, even more. Something like this happens in organizations when we decentralize problem solving by involving more and more people in the job--assuming of course that we do it with respect. So, what may seem like an intractable problem may literally disappear in a relative flash when a large number of people focus on it appropriately.

So, in the case of hoshin kanri, what does "respect" mean exactly? Well, it means that we recognize that everyone has something of value to contribute, be it a loaf, a fish, a vital piece of information, or a bright idea. It also means that we recognize each other's limitations and not ask too much of each other. In information processing terms, this means that we factor the problem appropriately by breaking it down into something each of us can deal with. Respect also means that we do our best to communicate clearly with one another and that we synchronize our activities. The original miracle of the loaves and fishes did not take place over the course of several days--the fish would have spoiled. The miracle of the loaves and fishes happened, as it were, instantaneously, through a process of mutual discovery.

Respect for people

Thomas L Jackson, JD, MBA, PhD
Portland, Oregon, USA
November 15, 2009


I finally solved a puzzle I've been working on for a long time. Followers of this blog will know that I contend that radical decentralization and the control system of hoshin kanri define a new type of organization that solves problems in real time. I call it the C-form or Cybernetic Form. The economic theory upon which my hypothesis rests is the transaction cost economic theory of Oliver Williamson, who will soon collect a Nobel Prize for his amazing work.

One of the features of Williamson's theory is an emphasis upon "asset specificity." To put it simply, Williamson says that when one party commits "specific assets," i.e., assets that he or she cannot retrieve after commitment to redeploy to other productive uses, the other party to the contract will have an incentive to "hold up" the agreement, human nature being what it is.

In the case of lean enterprise the puzzle is where are the specific assets and how do lean enterprises guard against hold up?

This is actually quite simple when we stop to consider that the major "asset" involved in a lean enterprise is a lean enterprise system or, to borrow a phrase from Toyota, a "thinking production system" (TPS). The TPS is highly specific in the sense of transaction cost economics because once it its imparted by the employer, through training, coaching, and experience, it cannot be redeployed by the employer. This only means that the TPS cannot be removed--literally and physically--from the employee and the same system imparted to another employee. Instead, should the employee decide to leave its employer, the employee could take the TPS with her and apply it elsewhere. In the extreme, the employee might choose to leave the employer and set up a consulting company to impart the TPS to other companies, even to the origiinal ower's competitors! In the language of the academic literature, the employer has a high risk of being "held up" by the employee who has acquired the speciific asset of the TPS.

In this sense, the imparting of TPS to an employee is exactly like the classic example of a specific asset: the building of a mine by a large multinational company in a remote area of a resource-rich but politically unstable developing country. Let's say the mine is constructed and large pieces of equipment are transferred (at great cost), and then there is a change in the government, a swing from far right to far left. The result is nationalization of the new mine and the "holdup" of the multinational company's specfici assets. Once again, the assets are "specific" because they cannot be redeployed. In this case, the multinational company would have to rely on the army of its country of origin to physically seize the mine, or at least the equipment (assuming it could be moved to more productive uses).

My implicit metaphor is almost complete. The mind of the employee is the mine site. The employer's TPS is the heavy equipment. The imparting of the TPS to the employee represents the transfer of the "specific asset" from the employer to the employee.

We certainly understand the risk. Training of any kind anywhere is a specific asset, because it can "walk out the door." People are smart; what can I say? Nowhere is this more true than in Northern Italy, from which I have just returned.

Returning to our Nobel Prize-winning friend, Professor Williamson: He would say that, given the  knowledge that the recipient of the specific asset--in this case the recipient of the TPS--can and indeed might easily "hold up" the employer by "walking out the door," the terms of the employment contract should be drafted carefully by the employer to securely bind the employee.

Now we have a problem. Courts of law--at least in Anglo countries--are unwilling to enforce noncompete agreements, because otherwise disgruntled employees who chose to leave their employees might starve. This is a humanitarian consideration of the Law, from which I have benefited personally on more than one occaision. An employee takes his/her knowhow and Godspeed. The only thing that the employer can actually protect is that body of knowledge protected under the law of copyright, which pertains to specific words, images (logos, photos, graphics), and outlines. The law of copyright does not pertain to words, images, and outlines that can be obtained from alternative sources. And, as we all know, the TPS has to a large extent been very well documented in the works published by Produtivity Press (of which I was for a short time CEO) and other venerable publishing houses.

It would seem, then, that any company contemplating investment in TPS should seriously question how it plans to avoid the "holdup" cost of "defection," i.e., the cost of its employees "walking out the door" with the specific asset of TPS. Indeed it should!

Lean thinkers leave their employers every day, taking with them a vast encyclopedia of how to navigate organizational development. Is there some bright young PhD student out there, somewhere, measuring the rate of defection of lean thinkers? I digress.

To come back to my original point: Hold on to your lean thinkers, or be "held up" (as in Jesse James) by your lean thinkers.

Your lean thinkers hold the "specific asset" of the TPS (Thinking Production System).

GOOD NEWS: These people are very very smart (assuming that they have been trained and coached by a competent Sensei).

BAD NEWS: The people are at least smart enough to evaluate the value-add of their contribution--to your organization or--for that matter--to any other organization. And without the right kind of contract, they are going to "walk out the door." If you are a good manipulator, you may be able to frighten those of your employees without competent legal representation to sign nincompoop, er, "noncompete" agreements that the courts will not enforce. All the courts will do is to control your former employees' utterance of certain words or their showing of certain documents or images--assuming the same are not readily available elsewhere from, say, the internet?


THE RIGHT KIND OF CONTRACT

So, what is the right kind of contract (from the employer's point of view, naturally)? What knid of contract can keep people from walking out the door. This is really important, because they walk out the door, courts of law are on their side, not yours. The only thing you can really protect are specific words, images, and outlines--which ain't much.

• You may be able to "protect" more, depending upon how much you are willing to spend upon legal intimidation, which of course forces intimidated parties (former employees) to spend money (perhaps considerable amounts) for legal advice.
• Ultimately, however, restrictive noncompete agreements (restrictive or not) run out (the law requries them to be relatively short term); now what?

RESPECT FOR PEOPLE

Toyota's TPS or Thinking Production System ultimately rests upon respect for people. Oliver Williamson's Nobel Prize winning economics explains why.

TPS requires the transfer of a very specific asset--the TPS itself--to each employee. If that weren't bad enough, to achieve a lean supply chain, you must transfer TPS to each supplier as well.

• I know a little bit about this subject, having been rather deeply involved in the transfer of TPS to the suppliers of global sportwear giant Adidas to its suppliers all over the world.
  

So, how do we keep our "specific assets" from "walking out the door"? Again, it's simple:

• Respect people

Yes, it sounds like a cliche. Yet, how powerful!

It is known that Toyota and Honda do not pay the highest wages in the U.S. But they are relatively low turnover rates. Think about it.

Employer A says, "I will pay you very well, but neve tell me how to run my company."

Employer B says, "I can pay you well, but not top dollar, But, I respect your opinion and expect you to speak up."

Who would you work for?

A poka yoke for strategy

Tom Jackson
Portland, Oregon
26 October 2009

What is hoshin kanri?

It is, essentially, a way to create a new organizational structure.

What is organizational structure?

According to economists like the new Nobel Laureate, Oliver Williamson (see my previous post), organizational structure is a structure for processing information. This makes complete sense if we stop but a moment to consider that organizational structure is about who makes the decisions. And decisions, as we know, require information and a set of priorities. Voila! Information processing.

So what kind of organizational structure does hoshin kanri create?

Simple. It's a poka yoke for strategy.

Come again?

A poka yoke. A mistake proofing device.

To quote Shigeo Shingo, a poka yoke or mistake proofing device "builds the function of a checklist into the process." Shingo illustrated his concept as a system of nested Deming cycles. (Actually, Shingo used the more economical Plan Do Check cycle, but never mind.)

Here we see how it works. We start a Deming cycle or cycle of organizational learning. To ensure flawless execution, in the very act of DO-ing, we embed another learning cycle. We do this for two reasons:

1. To be certain that we are doing it the right way, i.e., according to standard work; and
2. Just in case the "right way" isn't good enough, because you never know....

We can add checklists to checklists ad nauseum, depending only upon how much risk we want to wring out of any given system. The structure is sometimes called a nested Deming cycle. It's a checklist within a checklist within a checklit....

In military craft we refer to this design strategy as redundancy.

Back to checklists. Think of checklists as a form of memory. This is very much like computer memory.

In the case of operations, the checklist is about not forgetting how to do a job right the first time. The checklist can be literal (as in an airline pilot's checklist) or physical (as in a rumble strip or the alarm that is triggered when you leave your keys in your car).

In the case of strategy, the checklist can be literal, but it is essentially a metaphor for a system of constant reminding and recalibrating. Through the process of catchball, we agree to return to the "checklists" or action plans that we built into our A3 team charters, when we first built our annual hoshin, our strategy, our policy for improvement. Moreover, we remind each other. And when things don't work out quite as we had originally strategized, we regroup, refocus, and on we go.

Once a month, once a quarter, once a week (and by extension, once or more every day in our standup meetings), we revisit our "checklist."

Are we in control or out of control.

It is easy enough to see how this might apply to daily work, but to strategy? Well, why not? And that is precisely what hoshin kanri does.

The example of pilot and co-pilot double-checkling the aircraft before pushback comes very close to capturing the spirit of hoshin. The pilot checks the plane and checks the co-pilot's checking of the plane. Likewise the co-pilot checks the plane and checks the pilot's checking. Top down; bottom up. This is the essential structure of every hoshin review meeting.

And the checklist?

The organizational "checklist" is the list of priorities, as expressed in the organization's mission and vision and in every A3 team charter drafted during the catchball process. (As every game theorist knows, strategy is one very big checklist.)

Hoshin kanri is about remembering what we all agreed was important and what to do together to promote the interests of the organization. And if we should forget, or if circumstances should invalidate our agreements, hoshin is about starting over (and over) again, remembering what went wrong, what went well. Hoshin is about honoring the very human endeavor of nothing ventured, nothing gained.

Trial by fire, the fire of intelligence.

Oliver Williamson

Although I have never met Professor Williamson, who won a Nobel Prize for Economics this week, I have long been under his influence. I was very broadly educated in the New Institutional Economics at Indiana University (no, I didn't study with this year's other winner, Professor Elinor Ostrom, of, oh yes, Indiana University), where I was tutored by the late Professor David Martin in Williamson's fine theory. Incidentally, in the year before Williamson switched from Yale to UC Berkeley, he spent at year at I.U., which attempted to recruit him, unsuccessfully. (Alas, I had already graduated the year before.)

Williamson's theory goes something like this:

• Business firms exist to minimize the costs of doing business, called transaction costs, which are the costs of searching for good partners, negotiating contracts, and then enforcing them.
• Although we would like to find business partners who are not difficult to find, easy to get along with when we do, and who routinely live up to their agreements without being bothered by litigation, human nature is such that this is not always, or even often, the case. Human beings have very specific, often severe limitations, among them: a) small slow brains that can only handle several (7) chunks of information at a time; and b) sneakiness, that is, a tendency to withhold valuable information when it will benefit us individually, and to heck with you.
  
• Given this unfortunate situation (our lack of mental acuity, and/or that of our potential partners--and the fact that everyone is out to get us) the enforceability of contracts is a really big deal. Especially when assets are highly "specific," as they often are. "Specific" means specific to the contract. An example of a "specific" asset is, say, your construction of a large mine in a foreign country--a very expensive proposition. And, let's say, the government of this country decides to nationalize the mine. You lose your shirt. Because, your shirt was specific to the contract. In other words, the value of the asset depended upon the participation of the other party, in this case, the government.
• Or, closer to home, consider the case of other people "taking credit for your work." Let's say that you are a functional manager in possession of specific information about a process. Or let's say that you have a brilliant idea that you need help to realize. The value of that information or idea may well depend upon the willingness of manager's from other business functions (in the first case) or a joint venture partner (in the second case) to cooperate in pursuing a common goal. Your information or idea is a "specific asset" in the contracts (largely informal, in many many cases) that you make with your fellow managers or joint venture partners.

Okay, what does this have to do with hoshin kanri and the A3 process?

Everything!

Hoshin kanri exists to minimize the transaction cost of doing business, and Williamson's theory is a near perfect guide to explaining how, and why, hoshin works.

1. The PDCA process at the heart of hoshin speeds up our small slow brains, courtesy of the scientific method--PDCA effectively offsets our unfortunate lack of gray matter;
2. The catchball process of hoshin is slow and deliberate, which levels the playing field between mental tortoises and mental hares (this has other benefits, because sometimes the slow are deep)--on the one hand catchball is a very effective search process, and it makes it more difficult for the sneaky to take advantage of the honest;
3. The use of A3 documentation (an A3 is essentially a contract--A3 team charter--"charter" is another word for "contract") in the catchball process makes it very difficult, if not impossible, for sneaky people to withhold vital information--the process of hoshin kanri is transparent and this rather effectively offsets the human being's natural tendency to be sneaky;
   
4. Hoshin's reporting system of short, frequent, focused meetings again makes it difficult to withhold vital information. Also, individuals who are not compliant with the terms of their "contracts" are discovered almost immediately, and encouraged to comply;
5. Finally, compliance is further encouraged by hoshin's drive-fear-out-of-the-organization approach, because noncompliant participants have relatively little to lose as well as little to gain from gaming the system.
   

There are other, more subtle ways, in which hoshin kanri and, indeed, the traditional tools of lean operations reduce the transaction costs of doing business. Some of the more subtle methods address the costs of searching for information. Take, for example,

• Standard work
• Successive and self-checks
• 5S and visual control
• Poka yoke or mistake proofing

All of these methods are designed to bring "defects" (which, because of standard work, may be understood as "breaches of contract") to the surface. Keep in mind, according to Williamson, transaction costs are the costs of:

1. Searching for information;
2. Negotiating contracts, formal or informal; and
3. Enforcing contracts.

So efficient is hoshin kanri's system of achieving organizational alignment and encouraging members of the organization (including those pesky suppliers!), that I and others have spoken of Toyota's marvelous system as a system of self-organization. Another word for this is cybernetic. Toyota is a cybernetc or self-organization system.

You've had enough? Williamson's theory is about as clear as mud. And reading his wonderful books only makes it worse! But his theory is correct. It rests upon a profound understanding of human pyschology and markets that has been awarded the Nobel at least twice before (to Herbert Simon and Ronald Coase, with whom Williamson studied). And, if you really, really want to understand what makes Toyota tick, you need Williamson's theory.  Maybe one day, after I put my darling daughter through college, I'll write a book about it. It explains Toyota's miraculous supply chain, too.

In the meantime,

Congratulations, Professor Williamson!

Ferrari + hoshin kanri = lean enterprise

As I watch Toyota's leadership go through its latest bout of hansei (deep reflection), I am struck again by how conservative Toyota is. Compare Toyota's apology for it floormats to how Ford swept the Pinto's exploding gas tanks under the carpet!

Is this profoundly conservative attitude rooted in Japanese culture? Well, maybe. Or maybe it's rooted in modern portfolio theory.

All of us have retirement accounts and most of them are managed by brokers who have been trained to do one of two things, depending upon our appetite for risk. 1. Our brokers can maximize the return on our portfolio for a given level of risk preference; or 2. They can minimize the risk that we will fail to achieve a given rate of return.

When we are young masters of the universe, we tend to prefer risky investments that maximize our return, because if we experience losses we still have time to start over. But our appetite for risk diminishes as we get older and acquire more obligations to family and business partners. At some point we may pile up enough money and then we ask our brokers to minimize the risk for a given rate of return.

So what does this have to do with running a business? We can easily view a business organization like Toyota as a portfolio of "real" (as opposed to financial) "investments" in people, processes, and relationships. Just like stock broker, what a business does with those investments is governed by the risk/return tradeoff discovered by Markowitz in the 1950s.

At the same time, however, this is inconsistent with the microeconomic theory of the firm, which states that businesses maximize profits. What gives?

I'm going with Markowitz.

Toyota, it seems to me, behaves like a good family man--maybe even like a grandfather. Toyota is not a profit maximizer! Instead, Toyota is a risk minimizer. Indeed, properly understood, the 7 Deadly Wastes are sources of risk, and that is why Toyota strives to eliminate them. And the method of hoshin kanri? It is essentially a method of portfolio selection and management.

That explains Toyota's dull styling. Or does it? Actually, even Ferrari can be explained by the same theoretical idea. Ferrari is the young man who stands in contrast to Toyota's grandpa. Both are governed by the risk/return tradeoff.

No one would ever call Ferrari lean*, but the analogy raise an interesting possibility. Ferrari could well employ lean techniques--in particular the technique of hoshin kanri--to tweak its portfolio of real investments. While Toyota uses hoshin to minimize the risk of hitting a target profit--and thus builds dull but reliable cars, Ferrari could take on more risk and maximize its return by building sexier cars. It makes sense, surely. If Ferrari did not take risks, we would not love their cars, nor would we be willing to pay so much for them! The question is: Precisely how much more risk can Ferarri take on?

Modern portfolio theory tackles just this sort of question. And the portfolio theory of lean enterprise suggests that there is an answer to Ferrari's question. The benefit to Ferrari of employing hoshin kanri would be to calibrate its risk/return tradeoff scientifically to please its customers as well as its bankers.

And, dear reader, if Ferrari did this, we might just have to call Ferrari a lean enterprise, despite having much more "waste" in its processes, relative to Toyota. Why? Because Ferrari would have optimized its portfolio of investments in people and processes to provide the best value for its very particular clientele. With higher risk, there will tend to be more waste. But there will also be more daring curves, more moving parts, more sex appeal. After all, Ferrari's customers are not shopping for a ride to the grocery store.

* Deming Prize-winner Ryuji Fukuda once visited Ferrari and offered to help them reduce rework, lead time, and cost. Ferrari's response was: Why? Fukuda opined that, "If there is a more expensive way to do something, Ferarri will find it."

How is a lean enterprise like a Picasso?

A cubist painting, such as Picasso's Three Musucians, pictured here, was intended to convey in two dimensions all of the essential information about a three dimensional object or event. Some observors saw something more, namely, a version of reality from multiple perspectives.

Picasso's Three Musicians

Consider Picasso's painting, Violin and Guitar,  and you can see for yourself how these paintings might make this impression.

Picasso's Violin and Guitar

Picasso and his cubist collaborator Braque denied the multiple perspectives theory of cubism. Never mind. I like the multiple perspectives theory, and apparently so does American artist David Hockney. Compare the cubist paintings here to Hockney's photographic collage of the Merced River in Yosemite Valley.

Hockey's  Merced River, Yosemite Valley

Now, my point about lean enterprise. Although we can plainly see in Hockney's collage that there are many different pictures taken--and assembled--at different angles, the overall impression is one of unity. Of course here we're dealing with artistic unity. In a lean enterprise, through the catchball process of hoshin kanri, we collect many more snapshots of reality that Hockney has ventured to put together. And the more widely we deploy our policy, the more perspectives we must integrate. Clearly, there is the temptation to forego catchball and simply dictate top down a nice, neat version of reality all tied together from a Renaissance perspective, focused on a "vanishing point" known as the CEO. Here we see Piero della Francesca's famous painting, The Ideal City.

della Francesca's Ideal City

And, clearly, this is how many companies are still run today, even those that claim to be lean. It is certainly how almost all ERP systems are designed! But note what's missing: INFORMATION!

In the Three Musicians, Violin and Guitar, and in particular in Merced River, there is much more information about what we are being asked to contemplate. In the Three Musicians we can see how the emsemble is literally intertwined. In Violin and Guitar, we can see the instruments from all angles simultaneously. And in Merced River, we literally see multiple perspectives on a landscape that would be impossible to integrate if the observer were to stand, as della Francesca, in a single spot. What's behind that round building at the center of the square. What's inside? All of this we could know if we let Hockney loose with his camera or Picasso with his oils and brushes.

Within a lean enterprise, because of the catcbhall process of systematically collecting the perspectives of senior leaders and all the managers--and in implementation the perspectives of all employees, we have a vision of the enterprise that is saturated with information, specifically, the lived experience and knowhow about the organization's processes.

When della Francesca painted Ideal City, mankind was undergoing a radical shift in perspective that gave birth to the individual and to the science of Gallileo, Kepler, and Newton. It is tempting to think that, with a shift in perspective so profound as we see in Picasso, Hockney, and, yes, the Toyota Production System, maybe mankind is on the threshhold of another breakthrough. Besides, we could use a breakthough right about now.

The meaning of profit management

Why is hoshin so powerful? People will tell you that it's the best way to get a company focused. No kidding!

But what does "focus" mean, apart from powerpoint slides that show all of our "arrows" pointed in the same direction.

It may be helpful to think of focus as the opposite of diversification. Diversification is what we do to minimize the risk in our portfolios of stocks and bonds. Diversification spreads the risk of losing on our investments as a whole by minimizing (at least based upon historical trends) the extent to which investment prices will go up or down together. We diversify because we are engaged in a game against the Market. To quote Peter L. Bernstein, the market is "a powerful opponent indeed and secretive about its intentions. Playing to win against such an opponent is like to be a sure recipe for losing. By making the best of a bad bargain—by diversifying instead of striving to make a killing—the investor at least maximizes the probability of survival." See Berstein, Against the Gods (New York: Wiley, 1996) p. 253.

Running a lean enterprise is in some ways the same as and in some ways different from financial investing. We can easily accept the idea the an enterprise represents investment in both real and intangible assets. The intangible assets of people and process are among the most important features of lean enterprises. And hoshin is the method by which those investments are chosen. But rather than diversifying our investments in people and processes, we focus. We can understand more clearly the meaning of focus by comparing it to the mathematics of diversification. Diversification requires us to minimize the correlation or covariance of the expected returns of investments within the portfolio. Focus requires us to do the opposite. To focus, we maximize the correlation of expected returns of investments in people and processes. Indeed, this is the whole purpose of "balanced scorecards" and the famous X-matrix.

Why would we diversify our portfolios of stocks and bonds and focus our portfolios of real investments in people and processes? The answer is: Our state of knowledge.

In the case of financial markets, we playing essentially against nature, the Market, about which we know only a little. The point to diversification is to avoid being taken by surprise. It's those surprises that prevent us from "betting the farm," i.e., from focusing on one stock a group of related stocks. In the case of lean enterprise, however, we know much more. Through QFD we know exactly what our customers want. Through hoshin we know our managers, employees, and suppliers rather well. We can afford to "bet the farm." In fact, to do anything less would be wasteful!

This becomes clear if we present this in mathematical form of modern portfolio theory, with a twist.

maximize COR (People, Process)

Subject to: Profit = X 

This says that we plan to maximize rather than minimize (that's the twist) the correlation among our investments in people and process, subject to a target profit, which we have arbitrarily set at X. In other words, we are going to choose investments in people and process that work together, the tighter the better.

This is new perspective on what Toyota calls "profit management." Normally, we think of profit management as consisting of its more familiar components, target costing of new products and kaizen costing of existing products. In most books about target costing and kaizen costing there is little discussion of hoshin and alignment (i.e., focus). That's a mistake. In this simple rewrite of Markowitz's portfolio theory, we can see what Toyota is really doing. Profit management really means that we are minimizing the risk of failing to hit a target profit. 

Moreover, the way in which we minimize that risk is to focus our portfolio, i.e., "bet the farm," on the most promising combination of people and processes, the combination that will deliver value to our customers. You've heard it before: Focus on the process, not the result. The result is but a constraint. It is given. It is the result of focusing on the right combination of people and process.

One last insight: Toyota is not a profit maximizer, at least in the short term. The company is clearly too risk averse. Like Markowitz's portfolio theory, this theory allows companies to maximize their returns (or profit), subject to some predefined tolerance for risk. In that case, the profit term becomes the "objective function," and the correlation term becomes the constraint. But we know that Toyota doesn't behave that way. 

Don Quixote, hoshin kanri, and tilting at windmills

Tom Jackson

Monterrey, Mexico

I spent the past week in Mexico, where I made a presentation about hoshin kanri and the A3 system to the Annual Shingo Prize Conference of Mexico. In preparing for my talk, I searched for a way to connect with my Spanish-speaking audience. I recalled my recent reading of Cervantes' great novel, Don Quixote. Of course it is only coincidental that there is an "x" in both "Quixote" and the "A3X matrix," (the X-matrix is the subject of many of my posts) and that "X" looks something like the windmill that Quixote tilts with to such devastating effect early in the novel. Or is it?

NOTE: You don't need to read Don Quixote to understand this post. I'll do the heavy lifting. But, if you're interested, there's a new translation of Don Quixote in contemporary English--by Edith Grossman--that you might want to take a look at.

So, here goes. Don Quixote is, among other things, a book about how we deal with multiple realities. The book was, of course, written after Gutenberg published the Bible in German, an act that, together with Luther's Reformation, split the Western world in two. In this newly fractured landscape, a landscape that has become only more fractured since Cervantes' time, the idealistic Quixote tilts at the windmills because, having read too many Medieval romances, he firmly believes that they are horrible monsters. Quixote's more realistic squire, Sancho Panza, sees things quite differently and tries in vain to warn his master of the impending doom originating not from the windmills but from the Don's fertile imagination. Two perspectives; two different versions of reality. Which is correct?

Throughout the book we proceed through multiple adventures, disasters all, with Quixote and Sancho engaged in the same conflict of perspectives. This much of the story most people know from the Broadway show and movie, Man of La Mancha. But there is more. This is of course the world of the printed word, of two Bibles (and more to follow), the world of what was to become the free press, a world in which one may share one's own perspective in one’s own language—although at considerable risk, in our own time as well as Cervantes’. Characters in the book start writing about Quixote and his squire; their fame, or should we say infamy, grows. Before the end, the whole world is reading about Quixote and his slapstick, tragicomic adventures. In fact, the new authors join in fun, actively creating new misadventures for Don Quixote and Sancho Panza. The dividing line between reality and illusion is blurred. The book culminates in Quixote visiting a bookstore in Barcelona, where he reads about himself, as seen by others, and he complains bitterly, "This is not the true Quixote." It all ends badly. Quixote dies unhappy, having seen his dreams of romantic glory come “true,” orchestrated by the new authors only to make cruel fun of the old man. But it all unravels. The multiple perspectives of the book cannot be reconciled. Everything falls apart.

Clearly, I do not do Cervantes justice, but that is not the point. My point is that this should ring a bell. Aren't many leaders a little like Quixote? Isn't leading an enterprise something like this? The advent of lean enterprise only makes the situation worse. There were always many perspectives to reconcile in leading a company. Now, in the era of empowerment, leaders have to listen to Sancho Panza as well as all of those imitation Quixotes! It is, indeed, a quixotic task. And perhaps we are as crazy as Quixote to believe in our visions, saddle our broken down horses, and stumble off to tilt at windmills.

Or else we resort to the unilateral assertion of authority. But we know that Inquisitions are ultimately not very effective. Besides, they are a waste of good human resources.

In the method of hoshin kanri, there may be a happy ending for the quixotic leaders of enterprises that would be lean. For hoshin kanri is truly a method for reconciling the multiple perspectives of the enterprise in alignment with the vision of the Don, er, the leader.

The catchball process of hoshin kanri is a painstaking methodology for sharing perspectives, perspectives on the targets and the means by which the targets will be achieved. Senior management communicates its vision and establishes the results that must be achieved. Middle management responds with comments on the vision and targets and proposes the means or improvement processes by which the results with be achieved. In turn, middle management communicates to front line managers the process improvements that will be undertaken, and front line management responds with proposed schedules and identifies resource requirements. 

When catchball is a genuine process, there is what contract lawyers call a meeting of the minds, which is the core of any robust agreement, the source of organizational alignment. When done systematically and methodically, catchball results, for all intents and purposes, in “one reality” for the members of the organization. We can see this unity of perspectives memorialized on a good A3X, or X-matrix, which binds together all of the A3T team charters that define the annual hoshin or short term strategy.

It is as if Don Quixote has convinced the entire world to join him on his quest.

Naturally, the Don—and by extension, all who would be leaders—must take care to envision New Worlds that are truly valuable, namely, worlds without waste, worlds that respect people.... Even here, however, hoshin offers a checking mechanism. The Don must listen to Sancho--and all of the imitation Quixotes--and each of take them seriously. 

Luckily--in fact, deliberately--Sancho, and the catchball process, ultimately tie the Don's vision to the gemba of direct obervation.

Hoshin kanri lowers the cost of doing business

Hoshin kanri lowers the cost of doing business.

Why?

The reason is twofold:

1. Organizations are a nexus of contracts; and
2. Hoshin kanri results in what economists call "complete" contracts.

Before we go any further, let me be very clear: A3s are contracts. Moreover, hoshin kanri is essentially a method for creating and enforcing A3 contracts. (The principal A3 is Toyota's Proposal A3, which is essentially a team charter, and "charter" is just another word for "contract.")

Now, read on.



Organizations are a nexus of contracts

...and, by extension, lean enterprises are a nexus of A3s.

• nexus |ˈneksəs|
  noun ( pl. same or -uses )
  a connection or series of connections linking two or more things : the nexus between industry and political power.
  • a connected group or series : a nexus of ideas.
  • the central and most important point or place : the nexus of all this activity was the disco.
  

Economist and lawyer John R. Commons, teacher of the Nobel Prize-winning economist and psychologist Herbert Simon, pointed out that the fundamental unit of organization is the--you guessed it--contract. Business firms arise when the "external" or "spot" contracts of the free market are displaced by "internal" contracts between business owners (today's shareholders) and their managers, employees, suppliers, and of course customers. For a variety of reasons, including the standardization of tasks and the possession of an institutional history or "memory," business firms exist because they have a relative cost advantage over and above the free market. Namely, they reduce the "transactions costs" or costs of doing business. These costs consist precisely of the costs of negotiating and enforcing the contracts between shareholders, managers, employees, etc., that allow us to coordinate our behavior in a purposeful way.

Now this is very curious, for it suggests that business firms that can find a better way to negotiate and enforce the "internal" contracts associated with running a business will have lower costs of doing business than their competitors. And this has in fact been born out in at least two major cases. The first case was the Rise of Big Business in the mid to late 1800s, beginning with the building of the transacontinental railways in the United States, and again in the1920s with the invention of the modern corporation at General Motors and DuPont.

Followers of this blog will be aware that this has happened a third time, at Toyota.


Hoshin kanri results in "complete" contracts


...and, by extension, A3s are a better kind of contract.

Before we can explain what a "complete" contract is, we have to understand what is a contract. In its simplest form, a contract is a mutual promise between two or more parties, based upon a "meeting of the minds" between those parties.

So, what does it mean, a meeting of the minds? Let's say that you and I make a contract. When there is a meeting of the minds, it means that I understand and value what you have offered, and you understand and value what I have offered, and furthermore that we are both aware of this situation. In other words, there is a confirmed understanding of the mutual value we bring to the exchange. This will be true in every case, including the simple exchange of goods, as in the exchange of money for a pair of shoes, or in the more complicated case of "performance contracts" that involve the exchange of money (or some other valuable thing) for the performance of certain services, as in "I'll scratch your back if you scratch mine."

Enough about that. What makes a contract "complete"? Basically, a complete contract is a contract in which the meeting of the minds is without any gaps in mutual understanding.

Completeness is a concept that pertains to our state of knowledge about what game theorists call "the rules of the game," in other words, our knowledge of each other, our intentions, capabilities, understanding of the world, and modes of communication. There are several ways in which a contract can be incomplete. For example,

1. We can be uncertain about the true identity of the parties to the contract;
2. We can be uncertain as to the true intentions of the parties;
3. We can be uncertain about the capabilities of the parties to fulfill their obligations as specified in the contract;
4. We can have different versions of history or "reality" of which we not are fully unaware;
5. We can have different languages (or codes) and channels of communication of which we are not fully aware.
   

That's a lot of information to track. And tracking information is a pain in the the patoosh. So, clearly, there are costs associated with incomplete contracts. These costs are the costs of guessing about who the parties are, what they really want, what they can actually do, what is their version of reality, and how they mean when they attempt to communicate with us. Another way to talk about "guessing" is to talk about "searching for and processing information" to "make decisions" (the topic for which Herb Simon won his Nobel Prize).

Game theorists model the "incompleteness" all of this guessing by imagining that decision-makers generate multiple, interrelated probability distributions concerning each category of uncertainty.

• Fans of the movie, A Beautiful Mind, may be aware that economist, John Nash, played by the crazy and brilliant Australian actor, Russel Crowe, the movie's brilliant, crazy (did I mention brilliant?) protagonist collected his Nobel Prize with two other brilliant game theorists, John Harsanyi and Reihardt Selten, whose theory of completeness I am expounding here.
  

Multiple probability distributions? That's a lot of mental bookkeeping. Crikey! Obviously, mental bookkeeping does not come without a cost, the cost of gathering and processing information, the cost of "guessing." The cost of doing business...

So, how does hoshin kanri create more complete contracts?

In a word, "catchball."

As I have written in my book, Hoshin kanri for the lean enterprise, catchball is a process of negotiating A3s or internal contracts. And what is negotiation but a process of testing and confirming the identity, intention, capability, understanding (and, as necessary, communication modality or style) of the parties to the contract?

Moreover, the catchball process is a process of the careful communication and confirmation of contract particulars. In the literature, the particulars of internal contracting are often referred to as the "whats" and "hows" or, in other words, "targets" and "means," respectively, of contracts between managers and their direct reports. In a mature lean enterprise, there is very little "contract ambiguity," i.e., little misundertanding among managers about what is to be done and how it will be accomplished. Likewise, there is little misunderstanding about how the parties communicate with one another, because that is highly specified through the hoshin process of "check." (This is a topic for a future post.)


Cut to the chase

Because of hoshin kanri's catchball process, A3s--the definitive internal contracts of the business firm--are highly specified, i.e., much more complete, and therefore there is a lot less guessing in the lean organization. Less guessing about what is to be done and how it will be accomplished. Less guessing about who's on first and what they may be thinking.

Less guessing implies lower costs of doing business.

Hoshin kanri implies less guessing and therefore implies lower costs of doing business.

Lower costs of doing business imply greater competitiveness.

Therefore, companies that implement hoshin kanri will be more competitive.

What are you waiting for?

A Balanced but Disconnected Scorecard

Twenty years ago, Robert Kaplan of the Harvard Business School and his business partner David Norton witnessed Analog Device's implementation of hoshin kanri and the result was the Balanced Scorecard. Of course the Balanced Scorecard was wildly popular and made many consultants a lot of money. But, the Balanced Scorecard is not hoshin kanri. This remains true despite Kaplan and Norton's dogged efforts to turn the Balanced Scorecard into a genuine strategic management system. To their credit, they have done a nice job integrating the business school literature on resource-based competition, and for this important task we thank them. But, every time--in the course of my lengthy lean manufacturing and lean healthcare consulting career--I run into it, I am always struck by the fact that the Scorecard never makes it far from the board room. I have never seen it connected to daily work on the front line. What happened?

My hypothesis about the Balanced Scorecard is that, despite Kaplan and Norton's good intentions, they didn't understand what they were looking at when they examined hoshin kanri. Perhaps Analog Devices didn't get it right in the first place, something that a short trip to Toyota would have cleared up. (This is the route that H. Thomas Johnson and Robert, old colleagues of Kaplan's, both took.) 

I believe that Kaplan and Norton made two errors:

1. The first error was to fail to understand that hoshin kanri exists mainly to make systematic adjustments to standard work. To be effective, a balanced scorecad must somehow be connected to the mechanism by which the drivetrain achieves traction. Strategic traction can only be achieved if the company's leaders make contact with the people on the front line of the organizaiton, where real value is added.
2. The second error was to fail to realize how thoroughly--no, how radically--decentralized Toyota truly is. With adherence to standard work assured through 5S, visual control, and poka yoke, things are pretty much under control at all times. And, given that standard work incorporates all elements of cost (task, sequence, time, and work-in-process inventory [staffing can be derived from task, sequence, and time]), this means that adherence to standard work amounts to auditing in real time. This is why Prof. Johnson reported that Toyota does not permit accountants on the shop floor.

The upshot of these two errors is a balanced scorecard that can be retrofitted to the pre-Toyota corporation, which was (get out your history books) invented at General Motors in the 1920s. The original "balanced scorecard" was not designed for a retrofit; it was designed for a double kaikaku of corproate structure:

• Kaikaku 1: Decentralize radically by establishing standard work and empowering front line employees to stop the process to fix problems;
• Kaikaku 2: Enable the matrix organization by abandoning functional silos in favor of cross-functional and interorganizational teams.

This is in fact the whole purpose of hoshin kanri and any balanced scorecard worthy of the name. 

Optimization, nonprice factors, risk, and the balanced scorecard

In my last post I argued in favor of optimizing returns in business by minimizing the risk of failing to meet quality, cost and delivery targets. And to blazes with profit maximization.

This post is an addendum. I wish to point out that my position is already implicit in the so-called balanced scorecard. (My readers will know that the balanced scorecard is largely derived from hoshin kanri.)

The balance in the balanced scorecard arises from the inclusion in the normal profit maximizing calculus of nonprice factors such as quality and delivery (from the so-called process perspective) as well as people development (from the so-called growth perspective).

One can easily extend the notion of "balance" to include risk, as demonstrated by McKinsey and Conference Board research on ERM (enterprise risk management) (links to follow in a subsequent post). See, e.g., Kevin S. Buehler and Gunnar Pritsch, "Running with Risk," McKinsey Quarterly, Winter 2004, pp. 7-12, and Carlyn Kay Brancato, "Enterprise Risk Management System: Beyond the Balanced Scorecard," Conference Board Report No. E-0009-05-RR.

The inclusion of nonprice factors already pushes us beyond the confines of profit maximization, at least in competitive markets. The inclusion of risk, however, moves us quite firmly into the world of optimization. We are forced to open price theory's "black box" and ask, "How to leaders really think," instead of adopting the mathematically convenient and, one might argue, socially disastrous convention of profit maximization.

-- Post From My iPhone

Be like Toyota: don't maximize profit, optimize your portfolio

Its a paradox. On a daily basis we live with two conflicting ideas: the concept of profit maximization on the one hand and portfolio optimization on the other hand.

On the one hand, many of us are business types who want to make more; perhaps we want to make as much as we possibly can. That makes us profit maximizers. On the other hand, we all have (underperforming) portfolios of stocks and bonds. And, while we hope to restore our net worth to what it was before the present recession (or whatever economic historians may finally decide to call it), we apply a different decision rule to our portfolio than we do to our businesses. Namely, we optimize our portfolio on one of two ways. If we are risk takers, we will optimize our portfolio to maximize returns, given our aggressive appetite for risk. If we are risk avoiders, we will optimize our portfolio to minimize the risk, given the financial returns we feel we must have. In neither case--risk seeking or risk averting--are we strictly maximizing profit.

Several years ago it dawned on me that Toyota is not a profit maximizer, despite its legendary hoard of cash (sufficient to buy Ford, GM, Daimler, and BMW at the pre-recession values). As far as I can tell--and I have been studying Toyota's financial control system for over 15 years--Toyota is an optimizer, not a maximizer. I would say that Toyota views its business as a system of investments--economists call them "real investments," because they are not investments in financial instruments like stocks and bonds. They are investments in brand, technology and intellectual property, business process, people, and relationships. Toyota optimizes its portfolio of real investments by minimizing the risk of achieving what it calls a "target profit." Target profit is defined as market price less target cost. Because in a competitive market there is limited control over market price, financial risk management at Toyota focuses on minimizing the risk of hitting its target cost. This is done in two ways: Target costing of new products prior to launch, and the "kaizen costing" of products after launch.

The combination of target profit, target costing, and kaizen costing is referred to as profit management. Note the choice of words: profit management, not maximization. The actual management of Toyota's financial targets is accomplished through the mechanism of hoshin kanri (or policy deployment). Through the processes of hoshin, Toyota optimizes its portfolio by establishing clear profit and cost targets that are then deployed systematically to all managers, including front line supervisors. At each level in the management hierarchy, managers prioritize their various improvement options to minimize the risks:

1. of failing to satisfy cusomters' material quality requirements in terms of form and function; 
2. of failing to deliver form and function at an attractive price;
3. of failing form, function, and price (in other words, value) just-in-time; 
4. of failing to achieve Toyota's target cost; and, consequently 
5. of failing to achieve Toyota's target profit.

Although this all may sound a bit complicated, it is really no different than what your stock broker does in picking a portfolio of stocks, assuming you as risk averse as Toyota.

The real news in this is that while leading schools of management continue to crank out graduates who are trained to maximize profit, Toyota has in fact created a brand new way to run a company. Namely, Toyota uses hoshin kanri to manage, not maximize, profit by minimizing the risk of failing to achieve targeted levels of quality, cost, and delivery.

The last time anything this big happened in the world of management thinking was Alfred Sloan's invention of the system of financial targets and internal audits that eventually became known as management accounting. Now that should give us all pause to consider....

Tom Jackson
Principal, Rona Consulting Group

Yogi Berra, healthcare, hoshin kanri, and management accounting

Recently I have been doing most of my shopfloor work in healthcare. To quote Yankee great, Yogi Berra: It's deja vu all over again.

Today I visited the IHI's (Institute for Healthcare Improvement) web site, where it's gifted President, Donald Berwick, advocates for evidence-based medicine and lean healthcare. It is already a veritable encyclopedia of best practices. And that's the problem.

The economic hypothesis behind this blog is that lean enterprise (in any industry) represents a new organizational form. An organizational form is defined as a particular type of information processing structure characterized in at least two dimensions: a) the degree of decentralization of decision-making; and b) a unique control system. Cf. Oliver Williamson, The Economic Institutions of Capitalism. General Motor's invention of the modern corporation represented an effective decentralization of decision-making, relative to the command-and-control structure of the railroads and the Robber Barons. Sloan's new divisional structure (Chevy, Buick, Cadillac, etc.) was coupled with his invention of management accounting (financial targets and internal audits), which kept GM's strong-minded divisional presidents in check. Lean enterprise closely echoes these two innovations. First, there is the radical decentralization of decision-making, represented by Toyota's iconic andon cord and, in healthcare, Virginia Mason Medical Center's patient safety alert system. Now for the second part: the control system. Move over management accounting.

Lean enterprise has a new control system, and this would be hoshin kanri, but not just any version of hoshin. It has to be Toyota's version, known to a small audience as "profit management." Toyota's implementation of hoshin in 1960-63 displaced management accounting and resulted in the creation of kaizen costing and target costing. Because of the thoroughgoing deployment of quality, cost, and delivery targets to all managers (front line supervisors included), and the unique structure of standard work and poka yoke on the other hand, front line employees perform audits of cost as well as quality in real time. At the same time, Toyota used hoshin to pioneer cross-functional teams, also known as matrix organization.

So how does this affect healthcare and why am I quoting Yogi Berra? For the last 20 years I have witnessed manufacturing leaders try to cherry pick the best practices of Toyota. They have all failed, some spectacularly. Now, the same process is happening in healthcare. Alas, most healthcare executives function based upon the same received wisdom that continues to inform executives in manufacturing: Alfred Sloan's GM. I believe that well-intentioned healthcare executives can, and probably will, cherry pick Berwick's encyclopedia--perhaps for 20 years. And the effect will be the same. Isolated islands of excellence, and a fundamental failure to reform.

What we need is a revolution in management thinking and education that will couple best practices (almost all of which depend upon radical decentralization and matrix organization) with the correct management control system: hoshin kanri / profit management. It is indicative of the typically fragmented thinking of Western-educated execs that, on IHI's otherwise splendid website, there is listed a short paper entitled, "Execution of Strategic Improvement Initiatives to Produce System-Level Results." The paper is yet another watered-down version of hoshin kanri, something akin to Six Sigma's Breakthrough Strategy. You will have to register to IHI's site and log in to download the paper (for free). But don't bother. Everything you need to know is in the title: "Execution of Strategic Improvement Initiatives..."

As a new management system, hoshin kanri is intended not only for the execution of strategic initiatives, but for the management of everything that moves. Managers who relegate hoshin to strategic initiatives treat it mainly as a powerful project management tool (which it is), but--whether they know it or not, and apparently they don't--in the service of GM's management accounting.

This is, of course, what went so horribly wrong with Six Sigma. It also explains Six Sigma's great popularity. It's so easy, compared to lean enterprise, because the executives don't have to bother with transforming the organization or, more to the point, their own thinking. Indeed, it was Six Sigma's focus upon good old cost reduction (not quality) that made it a big hit in the C-suite. By the way, healthcare seems to be replicating manufacturing errors in this department, too.

While management accounting suited the divisional structure of 1920s GM, it is unsuited for the radically decentralized and matrixed structures of Toyota, Canon, and other faithful adopters of lean enterprise. The conflict between hoshin and management accounting is well known to lean consultants, and is increasingly well documented by leading accountants (see, e.g., H. Thomas Johnson's and Anders Broms Profit Beyond Measure and Hope and Fraser's influential Beyond Budgeting). Among management accounting's many faults are its incredibly slow response times, the incorrect valuation of inventories, the peanut butter approach of overhead allocations, the abject failure to value human resource development, and, despite the decoupling of effect (financial results) from cause (systematic process improvement) its generally punitive approach.

To simplify my message for healthcare executives--or executives in any industry who have yet to realize: You can't sustain, let alone optimize "best practices" without a suitable control system. In other words, you can't have lean or total quality methods without lean and total quality management, otherwise known as hoshin kanri.

Also, to quote H. Thomas Johnson, you must "stop accounting."

Fear of flying

So--46 years after Toyota adopted hoshin kanri as its management system--why haven't American execs copped on to it? And this despite the huge, huge success of the Balanced Scorecard (or at least the success of Balanced Scorecard consultants), derived as the Balanced Scorecard was from Analog Devices' implementation of hoshin kanri... Not to mention the success of Six Sigma's Breakthrough Strategy, again derived from hoshin... Not to mention the successes, respectively, of the Baldrige Award or the Shingo Prize, themselves based upon a technique (the President's Diagnosis), again derived from hoshin... Und so veiter, und so veiter, etc., etc., blah blah blah.

One wonders...

Actually, I think I know why: the fear of flying.

Let me explain.

To quote Jeremy Hope and Robin Fraser, authors of Beyond Budgeting and fathers of the similarly named movement, the future is about "radical decentralization."

Radical decentralizaton means that, in the enterprises of the future (Toyota, for example), front line employees are trained and empowered to discover and fix defects in real time. Moreover, if upon discovery of a defect an employee is not, unaided, able to fix said defect, he/she is empowered to interrupt production--even stop a major manufacturing process or entire production line--to call managers to come running to assist. At Virgina Mason Medical Center, my partner Mike Rona extended this practice to healthcare in the form of a Patient Safety Alert system. (Brilliant.)

Well, what American or European or, for that matter, Asian-trained fast-track MBA would be willing--in his/her right mind--be willing to do that? In any industry, let alone healthcare? There is baked in to to the degrees offered by our schools of higher management education, shall we say, a fear of flying. Which is to say that there is a fear of letting go of power. As a result, while American, European, and even Asian companies may dabble with the Balanced Scorecard, Just in Time (JIT), Six Sigma, and even Total Productive Maintenance (TPM), there is never any real empowerment of the workforce.

It looks like empowerment; but it is not empowerment.

For empowerment--aka "radical decentralization"--to work, two things must be present. Or, as John Shook put it, "It takes two to A3." First, you need a genuine delegation of responsibility to the workforce. And indeed, the tools of JIT, Six Sigma, and TPM are all designed in precisely this manner. Only an empowered workforce can make JIT, Six Sigma, and TPM work the way they are supposed to. Second, you need a management control system that respects empowerment. This would be hoshin kanri, and not its half-baked cousin, the Balanced Scorecard. Instead of embracing hoshin kanri, our managers still cling to the control system designed by Alfred Sloan in the 1920s, a system which is still the core message of the curricula of our schools of business: partial decentralization (to divisional presidents, and definitely not to the proletariat) and control by means of management accounting.

And the Balanced Scorecard? I am reminded of the brightly painted, coin-operated airplane rides my mother, arms full of groceries, used to put me in on the way to her car.

I thought I was flying; but I was not flying.

How poignant.

Glimmers of hope, but no consummating fire

Hoshin kanri and the A3 system is how Toyota manages its vaunted production system. John Shook stated in Becoming Lean (Productivity Press) that hoshin kanri is as important as the production system. Well, we've been tying our best to adopt the production system for over twenty years. How long will it take the business world to adopt Toyota's management system?

Is history any guide?

In the 1920s, Alfred Sloan invented the modern corporation by decentralizing management into the divisions of Chevrolet, Buick, Cadillac, Fisher Body, etc. Each division had its own president. Sloan brought this new system under control by inventing the system of financial targets and internal audits that became what we know today as management accounting.

Despite the fact that Sloan practically put Henry Ford out of business in 1926, it took Ford twenty (20) years to adopt Sloan's new system. And even then he did it under pressure from his daughter-in-law. Schools of business were even slower than Ford. They revised their curricula to reflect Sloan's management system only in the 1950s. European managers were even slower--much slower. They didn't get with Sloan's program until the tail end of the 1960s!

In the case of hoshin kanri, which we might call the Toyota Management System, progress has been extremely slow. There are glimmers of hope, but no fire. Under the title of "the balanced scorecard," hoshin--or at least certain aspects of hoshin--became very popular for a time. The phrase, "balanced scorecard," is repeated frequently in board rooms and schools of business, but hoshin kanri has not been implemented or even understood. Meanwhile, another version of hoshin kanri has had some effect under the title of "breakthrough strategy," which is of course an element of Six Sigma. And of course there are all those prizes modeled after the Deming Prize: the Baldrige, the Shingo, etc. All of them employ hoshin kanri's technique of the "president's diagnosis," which engages top management in the regular assessment of organization fitness based upon well defined diagnostic criteria.

But none of it adds up. Very often, anyway. The Danaher Business System is a good replication of Toyota's system, as was Masland Corporation's COMPASS system, at least prior to Masland's acquisition by Lear Corporation. Hewlett Packard was a fairly early adopter, but abandoned hoshin kanri under the glamorous Carly Fiorina.

Alas, in the case of hoshin kanri the social learning curve may be even more brutal than in the case of Alfred Sloan's system. In Sloan's case, the technology adoption process took over five decades from the time the Sloan invented the system, and at least two decades from the time that schools of business adopted Sloan's system as the gold standard of management education.

It has now been over four and a half decades since Toyota invented the version of hoshin kanri that will eventually become management's new gold standard. Moreover, it is very clear that schools of business--with a very few exceptions (notably the Ohio State University, to a lesser degree the University of Michigan, Portland State University, and perhaps MIT)--have not yet reformed their respective curricula. And they all still teach management accounting as if it were still useful. I estimate that general curricular reform in schools of business is a decade away. If the rate of turnover in the higher echelons of management has not changed, then it may be roughly 30 years before the world's companies finally embrace hoshin kanri as the successor to Alfred Sloan's management system.

That's a very long time to wait indeed.

It's the economics, stupid.

This is a post about the economics of hoshin kanri.

Over ten (10) years ago, lean guru John Shook stated in Becoming Lean that hoshin kanri--Toyota's management methodology--is just as important as Toyota's just-in-time production. Why this is true is still not well understood. Alas, this is a function of our so-called higher education system, which has failed to equip the present generation of executives with sufficient economic reasoning skills to understand.

It all boils down to is a matter of writing complete contracts.

Okay, we're in deep here.


Your company is a bundle of contracts

Economists maintain that organizations are essentially a bundle or "nexus" of contracts. This is a fancy way of saying that organizations exist because people agree to work together, whether formally or informally. These agreements are called contracts. It is a certainty that without contract law no company could exist or function. Think of your formal contracts with customers, employees, and suppliers. In addition to formal, legal contracts there are, of course, all those informal "contracts" that govern how most companies function. We normally refer to this class of contracts as "organizational politics" and "corporate bureaucracy."


Most contracts suck

Technically speaking, the typical contracts in a normal business organization are "incomplete." This is to say that most contracts are full of holes. In other words, our contracts do not fully specify, well, a variety of things, including even very basic things such as:

• The parties to the contract (who is accountable?)
  
• The reasons for the contract (why are we doing this?)
  
• The terms or performance requirements of the contract (what am I to do?)
  
• The rewards of performance (what's in it for me?)
  
• The penalties of nonperformance (what happens if I don't show up?)
  
• The exact method of performance review (who's going to make me do it?)
  

As a practical matter, this means that we poor mortals who enter into such contracts are left guessing about what these contracts mean (okay, now what?).


We are really bad guessers

Economists agree that human beings, poor sods, are really bad guessers. Technically speaking, all-too-human brains are physically incapable of handling more than seven (7) information "chunks" at a time. Think of a chunk as an information hair-ball, in which related bits of information tend to stick together. (Hey, this is Nobel Prize winning stuff...) Research has shown than, if we are idiot savants, we may handle nine (9) chunks. Woo-hoo. I say this tongue-in-cheek because, on a daily basis, our normal range of function may be between 3 to 4 chunks. Sigh. This has fairly obvious implications for contract performance and enforcement. As parties to incomplete conracts, we will--no matter how hard we try--be slower to understand and perform. As managers (or external agencies) tasked with contract enforcement, we will be less likely to understand cause and effect relationships and therefore will be less likely to take correct decisions when contracts go awry. In other words the cost of contract enforcement will rise together with the degree of contract incompleteness. The relationship between the degree of contract competeness and contract performance is probably exponential, which is really scary.


A3s are a better (much better) kind of contract

The process of hoshin kanri, as spelled out in my book Hoshin kanri for the lean enterprise (Productivity Press) and again in Pascal Dennis's Getting the Right Things Done (Lean Enterprise Institute), is a matter of creating and enforcing a lot of A3s. A3s are also known as "team charters" and "charter" is just a fancy name for "contract." To be exact, the A3s of hoshin kanri formalize the many informal contracts of organizational politics or corporate bureaucracy. A3s are a better kind of contract namely because, being based explicitly upon the scientific method (in the form of the Deming Cycle of PDCA--Plan, Do, Check, Act) they are relatively complete. I would argue that they are far more complete than the "back channel" contracts (if you can call them contracts) of normal bureaucratic processes.... A good A3 contains a clear articulation of the problem; a clear articulation of the targets to be achieved; an explanation of the cause-and-effect relationships that have resulted in the problem; a strategy for improvement; a plan of action, including milestones and a list of accountable parties; and, finally, a clear method of review (i.e. contract enforcement).


Less guessing = lower cost of doing business

It stands to reason that a system--such as hoshin kanri--that is defined by relatively complete contracts will require less time and energy to enforce, whether through self-enforcement (i.e., people adhering to the agreements that they make voluntarily) or through external enforcement (i.e., through senior managers forcing people to do what they have said they will do). This is, economically speaking, why the "flat" organizations of Japan (which adopted hoshin kanri in the 1950s and 1960s) have far fewer (perhaps three (3) times fewer!!!) layers of bureacracy than Western organizations that still employ management structures and methods developed in the 19th (i.e., the railroads) and 20th (i.e., General Motors divisionalized system) centuries.

And this, my friends, is why General Motors--which invented the modern corporation in the 1920s, went bankrupt so very recently, and Toyota, which reinvented the corporation (between 1960 and 1963) has not.

It's all about economics.

Tom Jackson
Portland, Oregon