Monday, September 21, 2009

Hoshin kanri lowers the cost of doing business

Hoshin kanri lowers the cost of doing business.


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?

1 comment: said...

Interesting for sure.
I thought A3 was a ledger paper size. We employed catchball with MBPC: Mgmt By Policy Control. Completeness is helped by way of PDCA, Reflection,TQM principles and continuous review.
Thanks Tom,
Mike Davis