Saturday, August 1, 2009

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

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