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