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Mutualist Blog: Free Market Anti-Capitalism

To dissolve, submerge, and cause to disappear the political or governmental system in the economic system by reducing, simplifying, decentralizing and suppressing, one after another, all the wheels of this great machine, which is called the Government or the State. --Proudhon, General Idea of the Revolution

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Monday, June 09, 2008

Book Review: Rebirth of American Industry

William Waddell and Norman Bodek in Rebirth of American Industry: A Study of Lean Management (Vancouver, WA: PCS Press, 2005).

Most of the material in this review will appear in a future version of Chapter Eight of the org theory book, and most of the rest in other chapters. All page numbers in brackets, unless otherwise noted, are from the book being reviewed.


Most of the objectionable features of rule by MBAs that I discussed in Chapter Eight ("Managerialism: Irrationality and Authoritarianism in the Large Organization"--sorry, old version), especially their irrational approach to cutting costs and increasing productivity (which actually amounts to stripping the organization of human capital and other assets, and gutting its long term productive capability, in order to game the short term numbers and inflate their own stock options and bonuses), are strongly reinforced, in American corporate culture, by the Sloan management accounting system. That system is described, in unflattering clinical detail, by William Waddell and Norman Bodek in Rebirth of American Industry.

I owe Eric Husman a debt of gratitude for first drawing them to my attention, through enthusiastic endorsements at his blog. He blamed Corporate America's mismanagement on "the imposition of the DuPont definition of profit, the Sloan management method, and the Brown accounting method onto American industry."

In fact, Sloan and Brown were picked by DuPont and their methods reflect his definition of profitability, so all the evil essentially flowed from one man. At the end of World War II, with Ford Motor Company having faltered as Henry lost his mind, the DuPont/Sloan/Brown system stood at the pinnacle of the most important industry in the only country in the world left relatively unscathed by the war. Their system was adopted by every other American business for this bit of luck, not because of any inherent merit.

Of course I would argue (and later do) that it did have one inherent merit, from management's standpoint: it reinforced their careerist and pecuniary interests very nicely. I'd a hell of a lot prefer to be making Jack Welch's salary to that of his counterpart at Toyota.

The Sloan system (the common, short-form name) essentially transformed manufacturers into marketing companies with a manufacturing function.

Husman attributed American management's dumbed-down approach to Kwality and other similar fads, which I addressed in Chapter Ten, "Attempts at Reform from Within," to the fundamental contradiction of "trying to become lean with a Brownian accounting system."

That, like the "management by numbers" stupidity of Sloan "management", serves only the near-sighted and non-manufacturing-minded DuPont definition of profit. Deming was right: the idea that someone could graduate with an MBA and step into the front office of a manufacturer without ever having spent time on the factory floor is a fraud. It was a fraud allowed to flourish in a time when Sloan companies were competing against other Sloan companies: marketing vs. marketing. Once a Manufacturer stepped into the ring, they were doomed to fail. Unless they change their definition of profitability and the management and accounting systems that support that, the Sloan companies are not going to compete with a Toyota

Waddell and Bodek contrast the Sloan system to the Toyota Production System, or lean manufacturing, which measures profitability by revenue stream. If there's more money coming in this week than going out, the operation is profitable. Assets are of interest only when applying for a loan or liquidating the enterprise. Inventory that isn't bringing in real cash from outside is a cost, not an asset. The best way to reduce costs is to fully utilize equipment and reduce cycle time through increased flow, to avoid waste and rework through designing defects out of the production process rather than inspecting for quality after the fact, and to minimize inventory through just-in-time production. And these things are all achieved mainly with the help of the company's chief asset, its human capital.

The Sloan system (or DuPont/Sloan/Brown system), on the other hand, attempts to maximize Return on Investment (ROI), which translates into share value: i.e., the book value of the company divided by the number of shares. The larger the sum that could be raised by auctioning off the company's assets in the event of bankruptcy, the better managed it was. [pp. 68-69]

Pierre DuPont devised a system to be sure that the salvage value of the companies in which he invested was high. From one end of the country to another, GE and GM plants can be had for salvage value. [p. 108]

And corporate management's primary activity for the last twenty years has been living off the salvage value of the organizations whose assets it has gutted.

The Sloan System on Inventory

Perversely, the Sloan system counts inventory toward this book value (a metric that works directly at cross-purposes to the lean system, which treats inventory as a cost).

With inventory declared to be an asset with the same liquidity as cash, it did not really matter whether the next "cost center," department, plant, or division actually needed the production output right away in order to consummate one of these paper sales. The producing department put the output into inventory and took credit. [p. 75]

This is referred to as "overhead absorption," which means fully incorporating all production costs into the price of goods "sold" to inventory, at which point they count as an asset on the balance sheet. [pp. 135-141] American factories frequently have warehouse shelves filled with millions of dollars worth of obsolete inventory, which is still there "to avoid having to reduce profits this quarter by writing it off." [p. 132]

The Sloan approach to inventory is very useful for massaging the numbers to appeal to those on the outside. In Chapter Seven, "Economic Calculation in the Corporate Commonwealth," I used Bob Nardelli and "Chainsaw Al" Dunlap as examples of Mises' hubris in proclaiming such confidence in the magic of double-entry bookkeeping as an instrument of entrepreneurial control of the corporation. Bookkeeping is a doubtful means for countering the principal-agent problem when the agent is keeping the books. After Dunlap left Nitec Paper, it turned out he'd used "creative accounting" ("expenses, inventory, and cash on hand had all been adjusted") to transform a $5.5 million deficit into a $5 million increase in profit. He did the same at Sunbeam, with the help of the magicians of Arthur Andersen. [Arianna Huffington, Pigs at the Trough: How Corporate Greed and Political Corruption are Undermining America (New York: Crown Publishers, 2003), pp. 62-65.] Such inventory jugglery, albeit to a lesser degree, is SOP under the Sloan system. In colorful language, it amounts to "goosing the numbers by sweeping overhead under the rug and into inventory." [p. 143]

By defining the creation of inventory, including work-in-process, as a money-making endeavor, any incentive to encourage flow went out the window. The 1950s saw the emergence of warehouses as a logical and necessary adjunct to manufacturing. Prior to that, the manufacturing warehouse was typically a small shed out behind the plant.... By the 1960s warehouse space often equaled, or exceeded, production space in many plants....

In one of the greatest ironies in American business history, the Chrysler Corporation at one point had over 400,000 finished cars in finished goods inventory. Not only did they report a profit that year, they rented the abandoned Ford plant at Highland Part--the birthplace of lean manufacturing--to store many of them.... Yet the professional managers, confident in their mastery of the Sloan model and their money making prowess, recorded the figures in the 'good' column and collected their bonuses. [p. 97]

The whole point of overhead and inventory jugglery is concealment.

Every dollar of overhead that is added to the cost of a product for inventory valuation purposes increases the incentive to produce in volume rather than eliminate waste....

The further the overhead gets from production, the more the rationalization passes from ridiculous to sublime. Donaldson Brown has everything, including the kitchen sink if the factory has one, thrown in....

The explanation for this--the reason accounting defends the status quo--is to match expenses with sales. If production is fairly level, the profits will look a little too bad when sales are down and a little too good when sales are up. Sloshing all of this overhead expense around flattens out the profit graph.

Of course, it's common sense that "the company actually is more profitable when sales are strong and less so when sales are down." But the Sloan system of juggling inventory enables management to fool the markets. Rather than the painful approach of driving "management and production to eliminate unnecessary costs," the Sloan system enables management to "leave the unnecessary costs in place--in fact, encourage them to grow--but smooth the profit (or loss...) graph...." [pp. 233-234]

On the other hand, the first stages of implementing lean production (the real thing, not the Jack Welch crap) show up as bad numbers.

When a plant has a Kaizen Blitz, and makes substantial improvements in cycle time, the short term financial numbers can get clobbered. Converting inventory to cash makes book profit look worse. [p. 130]

The Sloan System on Production Workers as "Direct Cost"

Besides its creative use of inventory, the Sloan system's other main defect is its definition of production labor as the primary "variable cost"; as a result, all "cost-cutting" and "efficiency" measures focus almost entirely on downsizing the labor force. This, despite (as I discuss in Chapter Nine, "Special Agency Problems of Labor") how vital, central importance of human capital to both the productivity of an organization and the organization's book value. Yet other intangibles, like "goodwill" and "intellectual property," are treated, oddly, as assets, on the grounds that they contribute to book value. Since inventory is as good as cash, and management salaries are a fixed rather than variable expense, management understandably filters out overhead when it comes to finding ways to cut costs; the overall effect is that corporate management automatically thinks of downsizing production workers, as the first and only alternative, when it comes time to reduce costs.

Brown's contribution was primarily that he could take this definition of ROI, look out over General Motors operations and envision islands of cost awash in a sea of assets. Those islands of cost were basically people. Well-supervised, they could turn one form of inventory into another with little of their time left over to detract from profits. Left uncontrolled, however, they could waste a lot of money with nothing to show for it. So "responsibility accounting" came to be, when each of those islands was deemed to be a cost center, which added up to plants which added up to divisions which added up to corporate. [p. 168]

...While Sloan, Brown and the rest may have looked out over the plants and seen islands of cost in a sea of assets, they knew that around the edges and lurking beneath the surface there were other costs in the form of overhead. The problem was that these costs, such as the costs of moving things around, fixing machines, inspecting parts, and supervising, were awfully hard to assign to a specific operation. They went along with everything in general, but nothing in particular. Without any means of directly assigning and controlling them, these costs were simply assigned percentages in the hope that they would stay reasonably in proportion to the direct labor costs which could be controlled, and that was good enough.

Without any direct link, all that could be measured with great confidence was the direct, easy to correlate part of the job: labor. It did not take much of a mathematician to figure out that, if all you really care about is the cost of performing one operation to a part, and you were allowed to make money by doing that single operation as cheaply as possible and then calling the partially complete product an asset, it would be cheaper to make them a bunch at a time.

It stood to reason that spreading set-up costs over many parts was cheaper than having to set-up for just a few even if it meant making more parts than you needed for a long time. It also made sense, if you could make enough parts all at once, to just make them cheaply, and then sort out the bad ones later.

Across the board, batches became the norm because the direct cost of batches was cheap and they could be immediately turned into money--at least as far as Mr. DuPont was concerned--by classifying them as work-in-process inventory. [p. 98]

Or, to put it in more colorful terms, "the typical factory went from Ford's flowing river of material to a Sloanesque oozing swamp..." The obsession with lowering direct labor costs, and direct labor costs only, caused costs from correcting defects and storing inventory to skyrocket.

This standard corporate approach to labor costs is the direct cause of what is called "dumbsizing." It treats human capital, which takes years to build up and years to acquire its network of human relationships and distributed knowledge, as a "variable cost" to be fired and rehired as often as demand shifts--and meanwhile treats management as a fixed expense to be paid in both fat times and lean. A major theme of Chapter Nine is that human and organizational capital--the human relationships, trust, and tacit knowledge of processes that take years to build up, and cannot rebuilt in a short time at any cost--are the reason a firm's equity is greater than the book value of its tangible assets. It really is capital, and a productive asset. "Dumbsizing" disrupts and mutilates this human capital, and guts an organization's long-term productive capability. It's understandable, when the Sloan system treats labor as "the biggest profit detractor [a] company [has]..."

Harold Oaklander, (a specialist on workforce reductions at Pace University, argues that "many 'cost-cutting' layoffs are actually counterproductive," because they interfere with "the firm's knowledge system." [Alvin Toffler, Powershift: Knowledge, Wealth and Power at the Edge of the 21st Century (New York: Bantam, 1991), p. 222.]

The Sloan system's "arrogant and demeaning" approach to people "assured that employee involvement in production would not happen." [pp. 152-153] An article at Wall Street Journal by Alex Markels and Matt Murray, "Some Call it Dumbsizing," quotes a laid off Kodak employee working for a Kodak contractor:

Kodak's layoffs have left its engineering group in Rochester, N.Y., overworked and demoralized, Ms. Ford contends. "They're burned out and they don't even care. When they send a job over here and we say, `It's going to cost you X,' they just say `Go ahead,'" she says....

Markels and Murry describe the effect on human capital:

Despite warnings about downsizing becoming dumbsizing, many companies continue to make flawed decisions -- hasty, across-the-board cuts -- that come back to haunt them, on the bottom line, in public relations, in strained relationships with customers and suppliers, and in demoralized employees. Sweeping early-retirement and buyout programs sometimes eliminate not only the deadwood but the talented, many of whom head straight to competitors. Meanwhile, many replacements arrive knowing little about the company and soon repeat their predecessors' mistakes.

A good example is Digital Equipment Corp., which eliminated hundreds of sales and marketing jobs in its health-industries group.

But in the health-industries group, the cutbacks imposed unexpected costs. Digital disrupted longstanding ties between its veteran salespeople and major customers by transferring their accounts to new sales divisions. It also switched hundreds of smaller accounts to outside distributors without notifying the customers....

Many Digital customers turned to International Business Machines Corp. and Hewlett-Packard Co., and so did some employees of Digital's downsized healthcare group. Mr. Lesica says some laid-off workers went to Hewlett-Packard and quickly set about bringing Digital clients with them. "That's another way DEC shot itself in the foot," he says....

The question is, to what extent are [payroll] savings offset by the new hires' lack of experience? Ms. Shapiro, the consultant, contends that a company is set back severely by the loss of "knowledge and judgment earned over the years. That's the stuff that gives you a real competitive advantage in the long run." Human-resources experts estimate that it typically costs $50,000 to recruit and train a managerial or technical worker....

"Direct labor is not a variable cost as a result of some mystic truth or a law of either nature or physics," Waddell and Bodek write.

It is a variable cost because management decided it would be so. Calling inventory an asset, while people are not an asset is also a distortion of the truth. [p. 207]

The Sloan system is at the heart of the American MBA curriculum, and the ruling paradigm in American corporate governance.

As leader of a Dana Corporation management study group visiting Japan, Bodek--who had been a frequent visitor to the country for many years and had become familiar with the Toyota Production System--let slip that he considered the ROI a faulty measure that Dana should abandon.

You would think that I just allowed the dam to break. Virtually every manager on the bus shot me down and made me feel like two cents. In one short moment I lost all credibility with them. The Japanese managers taught me that ROI was misleading because it leads you to focus only on the short-term, to the long-term detriment of the company.

A few months later, Woody Morcott, the next chairman of Dana, keynoted one of my Productivity "The American Way" conferences and told the audience that ROI was key, and the only important measure for his managers. I knew then why I had been so quickly shot down in Japan. [p. 65]

Sloan cost metrics, which focus almost entirely on reducing the "direct cost" of labor involved in every operation, have seriously skewed the direction of production technology.

...[M]anufacturing engineers... were directed more and more to focus only on direct labor savings. Machines that were more accurate or flexible could not be justified in a batch environment. Where Ford's engineers built machines to speed flow and assure quality, American engineers were pushed more and more into focusing on labor elimination technology. [p. 106]

As an illustration of the Sloan system's obsession with reducing the cost of every operation, regardless of its effect on the overall production process, was illustrated by the conversational stalemate between Ernie Breech (whom Eleanor Ford brought in in 1946 to impose GM methods on Ford) and a Ford manufacturing manager. Breech demanded to know the cost of mounting steering wheels, attempting to figure the "profit" resulting from steering wheel assembly independent of its necessary role in the overall manufacturing process.

The production manager didn't know how much the specific operation cost, and was utterly perplexed as to why Breech wanted to know. Was Breech suggesting the steering wheel assembly operation was the source of a bottleneck in the flow of the line? No. Was there some inefficiency in the operation? No. Since it had to be done, and done right, it could only be considered as part of the overall process. And the only proper way to increase efficiency, and reduce costs, was to lower unit costs by improving the flow of the overall process.

The lean accounting companies define making money as receiving cash. Incremental work is not good--it is a waste of money.... Money is made only by selling to customers, not by transferring dollars between accounts or by moving parts from one inventory pile to another. [p. 92]

Between the accounting people Breech brought in from GM, and the "whiz kids" Bob McNamara brought in from the war department, Ford was cured of that kind of thinking. [pp. 89-90]

The Sloan system focuses, exclusively, on labor savings "perceived to be attainable only through faster machines. Never mind that faster machines build inventory faster, as well." [p. 119] As the authors of Natural Capitalism argue, batch production results from attempts to optimize each separate step of the production process in isolation ("optimizing one element in isolation from others and thereby pessimizing the entire system"), without regard to its effect on the flow of the overall production process. A machine can reduce the labor cost of one step, by running at enormous speeds, and yet be out of sync with the overall process, so that it simply produces excess inventory that waits to be used by the next step in the process. [Paul Hawken, Amory Lovins, and L. Hunter Lovins, Natural Capitalism: Creating the Next Industrial Revolution (2000), pp. 129-30.] The Toyota Production System, on the other hand, emphasizes takt: pacing the output of each stage of production to meet the needs of the next stage, and coordinating all of the stages in accordance with current orders. [pp. 122-123]

As Waddell and Bodek argue, lean production isn't primarily a matter of shop floor organization. Shop floor organization, rather, tends to follow automatically from the incentives the management accounting system puts in place.

However the accounting system is set up, it defines "making money" for the company and becomes the basis for all decision making. The quality system, production and inventory control systems and policies, people policies and so forth are all structured to enable the company to make the most money. How these systems are structured is a direct result of how the management of the company defines making money.

....Early Ford and later Toyota defined money in a lean accounting manner and lean practices resulted. General Motors defined making money as optimizing ROI and we all know the practices that arose as a result. Henry Ford and the Toyoda family did not personally go out and implement assembly lines or kanbans any more than Alfred Sloan went out and personally created batch production. These men defined 'profitability' for their companies, then urged and pushed their organizations to aggressively and creatively attain that version of profitability. [pp. 92-93]

Success, in lean terms, barely shows up as such by Sloan metrics. Of the United Defense plant in Aberdeen, South Dakota (one of the few American lean experiments that actually "got" the Toyota system), Waddell and Bodek write:

A balance sheet prepared according to DuPont would miss the value of the plant in Aberdeen entirely. According to the statistics in the most recent Best Manufacturing Practices award from the Navy, inventory is down 78% from where it was just a few years ago, and it was low by industry standards to begin with. A balance sheet, however, would not reflect that as much of an accomplishment. The same balance sheet would assign no value to the 150 cross-trained,, self-directed, customer-focused employees who generate very profitable, sustained manufacturing results. [p. 159]

Indeed, most American companies would lay half of them whenever business slowed down, warn the remaining workers to work hard to pick up the slack (with a little Fish! Philosophy thrown in to jolly them into being screwed), and figure they could hire more help from a temp agency when things picked up.

But "imagine," Waddell and Bodek write, a software or tech company declaring that "computer science is a commodity--"

basically any warm body from the local temp agency can do it--and that the key to success in running these technology companies is not technology, but finance and marketing. Imagine further that they all but declare war on their programmers and system design folks, classifying them as variable costs and devising a management system aimed directly at cutting their numbers and minimizing their pay. [p. 223]

Sloan and Brown were dead wrong. People are not interchangeable commodities, to be fired and laid off every time the wind blows from a different direction. Manufacturing is too complicated; there are far too many variables. There is no computer big enough or fast enough to plan and control it. Toyota knows this It takes a factory full of trained, focused, committed people to get all of the details right in the midst of so many dynamic events. They are not commodities.

A new accountant can be hired and pretty much become as effective as he or she is going to get within a month or two. A production employee is more likely to take six months or more--a year according to the self-directed teams at United Defense. Yet the accountant is a fixed expense with a fair amount of job security, while the production worker is a commodity.

....The best way to develop the work force quickly and increase balance sheet accuracy for the sake of the investor is to capitalize the cost of training and educating people....

Only in the world of F. W. Taylor, Pierre DuPont, Alfred Sloan and Donaldson Brown can kicking trained, experienced, capable people out of a company be seen as a positive move. There is nothing positive about it. It is proof of a basic failure of management. To do so within months of paying the top manager better than $10 million in performance bonuses ought to be proof enough that the system is broken.

To anticipated objections, from those steeped in the Sloan management culture, to capitalizing an intangible like human capital, Waddell and Bodek respond, "[t]hat has never stopped the Sloan companies from capitalizing goodwill and intellectual property, often on far shakier ground than capitalizing people." [pp. 240-242]

As Husman said, it's utterly pointless even to try implementing lean production in a company with Sloan accounting. Every day, Waddell and Bodek write, a Sloanist factory holds a "production meeting" which demands two figures: the value of output (i.e. by DuPont standards that include the value of goods "sold" to inventory), and the labor-hours expended to produce it. They describe one company, governed by the Sloan system, in which a "lean transformation" had been mandated. The company's CEO has a resume full of past "lean" experience.

While it may appear as though the lean team is being asked to fit a square peg into a round hole, they handle it adeptly. On the one hand, lean dictates that they drive the plant to short cycle time, high quality production with no waste, precisely leveled with customer demand. On the other hand, the daily meeting reminds them that the objective is to utilize labor without regard to inventory and marginal regard for quality. The dilemma is resolved by creating a plant that looks lean, but runs as it always has.

A U-shaped cell here and a kanban there is all it takes. When senior management comes to visit, bringing along customers or Wall Street analysts, they are shown visible proof that the plant is, indeed, lean.... The company is typical. It is one of the 98%+ that claim lean accomplishments in public announcements, but bring none of these accomplishments to the bottom line.

If you were to speak to the CEO he would undoubtedly tell you that his responsibility is to exert leadership, and he does that by talking about lean, authorizing spending on lean training, and bringing in lean consultants. The actual change to lean, however, is viewed as purely a factory issue at the end of the day. If you were to ask him exactly what has changed in his world, or anywhere at the corporate level, the truthful answer would be "Nothing." Lean at the corporate level of this and virtually every big company is a factory philosophy, rather than a management philosophy....

...Nowhere in the equation does it occur to [corporate management] that the plants and supply chain have come to exist and operate in a manner that best serves the definition of good performance laid out by the accounting system. The lean strategy they push down directs the factors to operate in a completely different, lean manner than in the manner which has proven to best meet the numbers; but they must still hit all of the numbers. [pp. 132-133]

As Waddell and Bodek put it, Sloan management culture inevitably results in kind of bastardization of lean production that occurred at General Electric under Jack Welch, who "turned Six Sigma into the strategy to outsource and offshore everything."

They value streamed the corporation and came to the conclusion that just about everyone except headquarters (of course) added insufficient value and needed to go.

Lean manufacturing gets "Sloaned." [pp. 201-202]

One thing Waddell and Bodek fail to pick up on, perhaps being more charitable than I am, is how incredibly well the Sloan system's cost and profit metrics dovetail with the class interests of management. If management is simply a fixed cost to be paid in both lean times and bad, but production work is a "direct cost" to be minimized and constantly adjusted--by layoffs and firings--to the current level of demand, management (not surprisingly) are the last to lose their jobs or suffer pay cuts. The metrics of the Sloan system coincide so closely with management's pecuniary and careerist motives, in fact, that it's a bit of a chicken and egg problem figuring out whether American managerialism as it currently exists is a result of the Sloan system's distortions, or whether the Sloan system was adopted because American management found it so conducive to their interests. There's probably a mutual synergy involved. Waddell and Bodek do see the implications of the system very clearly, however, even if they don't see how well it reinforces management venality.

It is so commonly accepted in the United States that direct labor is a variable cost that the consequences of this arbitrary decision are rarely appreciated. At the top of the hierarchy are the policy makers, strategists and those charged with controlling the factories. Their salaries are a fixed cost, which means their jobs are relatively safe regardless of business results, within a broad reasonable range. In the middle are manufacturing management whose jobs have been, as a result of refinements to the cost accounting system, categorized as semi-fixed or step function costs. Their jobs are only secure to a point. At the bottom are Taylor's workers who should have no input to how things are made. They should be expected to simply produce to the maximum efficiency. Their jobs are purely variable, meaning their job security is purely a function of sales volume.

Those variable cost people--the ones Taichi Ohno points out are not even whole people in American cost accounting--are not people at all. They are "headcount". That simple fact makes lean manufacturing virtually impossible in Sloan companies. Lifetime employment, such as that at Toyota, is nothing more than changing the system to categorize production labor as a fixed expense. [p. 153]

Just about every company says they want their people to work smarter not harder. Few of them understand that people cannot and will not work smarter when they have supervisors and industrial engineers hovering over them dictating and measuring their every move. They especially will not work harder if management has defined the ultimate goal to be a lights out factory, while they soar like hawks over the plant hunting for jobs to eliminate and people to lay off. People everywhere will work smarter and harder for the customer, but people will not work harder for someone who has defined them as a variable cost. [p. 58]

Contrast this to the Japanese approach, as described by W. Edwards Deming based on his experiences in Japanese industry.

In Japan, when a company has to absorb a sudden economic hardship such as a 25 per cent decline in sales, the sacrificial pecking order is firmly set. First the corporate dividends are cut. Then the salaries and the bonuses of top management are reduced. Next, management salaries are trimmed from the top to the middle of the hierarchy. Lastly, the rank and file are asked to accept pay cuts or a reduction in the work force through attrition or voluntary discharge. In the United States, a typical firm would probably do the opposite under similar circumstances [except for the relative priority of dividends and management pay, of course--KC]." [W. Edwards Deming, Out of the Crisis (Cambridge, Mass.: M.I.T., Center for Advanced Engineering Study, 1986), p. 147.]

To the usual suspects at the Wall Street Journal and on CNBC money programs, it goes without saying that the Toyota approach is wrong-headed. It makes perfect sense to pay Bob "Sucks at Job" Nardelli or "Chainsaw Al" Dunlap a multi-million salary for all that "productivity." But guaranteeing lifetime employment to production workers--to the host organism rather than the parasite--is just plain wrong. As the analyst community's reaction to Costco demonstrates, even if you can afford to pay good wages and provide job security, it falls into the same moral category--vaguely decadent things that just don't seem right--as putting a diamond collar on a dog. Such pampering makes companies "bloated," "fat," and "lazy," don't you know!

Never mind that the Toyota approach to lifetime employment is perfectly consistent with their understanding of the importance of painstakingly acquired human capital as a source of organizational value. And never mind that it works. For example, John Micklethwaite reports, before a Range Rover factory made a lifetime employment pledge in the early '90s, only 11% of employees entered the annual employee suggestions competition, "because they were worried that increased efficiency might cost them their jobs; afterward the proportion rose to 84 percent." And a single one of those proposals saved the company 100 million pounds. [John Micklethwait and Adrian Wooldridge, The Witch Doctors: Making Sense of the Management Gurus (New York: Times Books, 1996), p. 209.]

When employees are a fixed cost, the source of their job security is plant profitability. When employees are a variable cost, they find job security by assuring that the work is never complete. Lean companies outperform Sloan companies because profits are in the best interests of the production employees in lean companies. It is hard to imagine how Sloan and Brown could have expected a system to work that polarized workers and management so thoroughly. [p. 169]

But again, never mind. What matters is that no decent person puts a diamond collar on a dog, and no decent company (despite all the Official Happy Talk about "teamwork" and "our most valuable asset") actually treats its production workers like valuable assets. You don't take money from starving kids to pamper a dog, and you don't take money from Nardelli or Welch to pay production workers a living wage. It doesn't matter whether it's profitable; it's a matter of decency. And in any case, when management is the de facto owner of the corporation and runs it in its own interests, it's obviously not going to hurt its own interests for the sake of productivity. It may fake productivity to game its stock options, but it won't attempt the real thing when it requires treating workers like human beings.

Sarcasm aside, the difference in companies like Toyota may have something to do with our discussion of managerialism and the corporate form at the beginning of this chapter. I argued there that while the idea of shareholder ownership, as a legitimating ideology, did not reflect any actual shareholder control over management, it did play into management's hands by insulating them from internal stakeholder control. American corporate management, by pretending to be constrained by their duty to shareholders, can actually promote their own interests without interference. Toyota, on the other hand, has no pretense of being the "property" of shareholders, and its management has no pretense of representing shareholders. Because of the prevailing capital structure in Japan, corporations like Toyota, generally, function as unabashedly self-governed entities that deal with the banks as their main source of outside finance. The Japanese corporation approaches, if not perfectly, the ideal of a stakeholder cooperative.

To the extent that companies like Toyota have problems from my standpoint, it comes from the distorting effects on their structure of their existence in a larger capitalist system. That is, profit-maximization pressure from creditors, and excessive size and hierarchy resulting from a state capitalist system that subsidizes corporate size. But Toyota is, at the very least, an example of the kind of "liberal capitalist" firm we mention in Chapter Fifteen, with high degrees of worker equity and worker self-management. And at best, it allows us to extrapolate what things would be like if the Toyota system functioned in a decentralized economy with free credit.

The End of the Quarter Shuffle: Or, Beating the Five-Year Plan

One of the central themes in my writing has been the parallel between the inner workings of the large corporation and of a Soviet-style planned economy. For your entertainment value, I'd like to quote at length from Waddell's and Bodek's description of the "End of the Quarter Shuffle." [pp. 127-130] To anyone who's ever read inside accounts of (or experienced first-hand) the workings of the Soviet planned economy, and what went on in their factories toward the end of a planning period, this should sound familiar.

During those last few days of the quarter, all of the stops are pulled out to make the numbers. Some of what is done is downright illegal. Much of it is unethical. Just about all of it is senseless. However, management salaries and promotions are driven by numbers....

Most plants have been through the drill so many times that the people need very little coaching. All the way down to the operators on the production floor, the people know how to rig the numbers.

Every machine and every production employee will run all-out if there is anything in the plant for them to work on. Supervisors who are normally lenient concerning breaks will become frenzied taskmasters. Of course, there will be no employee or safety meetings. Nothing will keep production people from their machines in the last few work days of the quarter.

There will be a steady stream of shop supervisors to the production control office demanding that production orders be written to machine, assemble, paint, or pack whatever parts they have been able to find in the plants. If there were a demand for those parts they would already have production orders, but they are not producing for demand. They are producing for the sole purpose of earning credit for direct labor hours, which, in term, earns credit for overhead on their budgets.

Quality inspection will virtually shut down. If anything produced is bad, no one wants to know about it until next week--after the books are closed on this quarter.

The folks who communicate with customers will be on the telephones trying to pull a few orders for next month into this month....

Every shipping and receiving manager and employee worth his or her salt is a master of the game. Product not scheduled to ship for days or even weeks will be pulled, skidded, wrapped, labeled and entered into the system as gone--then stacked off to the side....

With work-in-process inventory building at the plant at staggering rates, the plant inventory goal may be in jeopardy, so receiving virtually shuts down. Trucks are turned away when possible. If they have to be unloaded, their contents will be stacked on the dock, but not received into the system until the next week.

...[The plant manager] can be found behind an overflowing in-basket, because plant spending was shut down days before. Requisitions for maintenance supplies, training materials, and anything else deemed not critical to production will not be approved until the next quarter....

This scenario, to varying degrees, happens at every plant every quarter.

Lean Production in a Sustainable, Decentralized Economy

In Chapter Fourteen, "Decentralized Production Technology," I described Murray Bookchin's ideas for decentralized, small-scale manufacturing based on general-purpose machinery, switching from one short production run to another. Eric Husman of GrimReader blog argued, in response, that the good parts of Bookchin's proposal were a reinvention of lean production, while it preserved the batch production inefficiencies of Sloanism.

Human Scale (1980) was written without reference to how badly the Japanese production methods (especially those of Toyota, but also Honda) were beating American mass production methods at the time.... What Sale failed to appreciate is that the Japanese method (derived more from Fordism than from Taylorism, and almost diametrically opposed to the Sloan method that Sale is almost certainly thinking of as "mass production") allows the production of higher quality articles at lower prices....

....Taichi Ohno would laugh himself silly at the thought of someone toying with the idea [of replacing large-batch production on specialized machinery with shorter runs on general-purpose machinery] 20 years after he had perfected it. Ohno's development of Toyota's Just-In-Time method was born exactly out of such circumstances, when Toyota was a small, intimate factory in a beaten country and could not afford the variety and number of machines used in such places as Ford and GM. Ohno pushed, and Shingo later perfected, the idea of Just-In-Time by using Single Minute Exchange of Dies (SMED), making a mockery of a month-long changeover. The idea is to use general machines (e.g. presses) in specialized ways (different dies for each stamping) and to vary the product mix on the assembly line so that you make some of every product every day.

The Sale method (the slightly modified Sloan/GM method) would require extensive warehouses to store the mass-produced production runs (since you run a year's worth of production for those two months and have to store it for the remaining 10 months). If problems were discovered months later, the only recourse would be to wait for the next production run (months later). If too many light bulbs were made, or designs were changed, all those bulbs would be waste. And of course you can forget about producing perishables this way. The JIT method would be to run a few lightbulbs, a couple of irons, a stove, and a refrigerator every hour, switching between them as customer demand dictated. No warehouse needed, just take it straight to the customer. If problems are discovered, the next batch can be held until the problems are solved, and a new batch will be forthcoming later in the shift or during a later shift. If designs or tastes change, there is no waste because you only produce as customers demand.

At the time, I expressed some curiosity as to whether the Toyota Production System could be scaled down for decentralized manufacturing in a local economy. I've since concluded, in fact, that the TPS system is ideally suited to such an economy. The Toyota system, applied to a local network of small cooperative manufacturers like that in Emilia-Romagna, will have found its true purpose.

The present association of "just-in-time" supply chains, whether in industry or in Wal-Mart's wholesale distribution model, with "warehouses on wheels" (or in container ships), is just one example of the way lean production is distorted by the larger state capitalist system within which it operates. It would be far more in the spirit of the lean system if it were organized around local supply chains. The "warehouses on wheels" supply model is really just a way of smuggling Sloanism, in disguised form, into the Toyota Production System. The whole point of the TPS's just-in-time supply chain operations is to reduce inventory costs to zero. But as practiced by a giant corporation like Toyota, it simply outsources the inventory costs to the long-haul trucks and container ships. They're not only still paying for de facto warehouses to hold inventory, they're paying the fuel costs to move it around.

Husman suggested as much himself. Although the effect of transportation costs and large market area on overall efficiency has been an obsession of mine for years, Husman beat me to the punch in grasping the relation of that principle to the lean system's emphasis on emphasis on minimizing inventory:

Bill Waddell and other lean consultants have been trying to convince manufacturers that if they would only fire the MBAs and actually learn to manufacture, they could do so much more cheaply locally than they can by offshoring their production. Labor costs simply aren't the deciding factor, no matter what the local Sloan school is teaching: American labor may be more expensive then [sic] foreign labor, but it is also more productive. Further, all of the (chimerical) gains to be made from going to cheaper labor are likely to be lost in shipping costs. Think of that flotilla of shipping containers on cargo ships between here and Asia as a huge warehouse on the ocean, warehouses that not only charge rent, but also for fuel.

So trying to integrate lean production into a conventional globalized economy of large corporations is putting new wine in old bottles (although Ohno did it as well as it was humanly possible to do it). The TPS is really meant for a decentralized world where the trucks and container ships are eliminated, the supply chains are local and composed of small firms (on the Emilia-Romagna model), and the local economy is
organized for producing on a demand-pull basis.

H. Thomas Johnson, a coauthor with Robert Kaplan of Relevance Lost: The Rise and Fall of Management Accounting (Harvard Business School Press, 1987 and 1991), argues that Toyota's lean production system, stripped of its present distortions which result from the global corporate system, can serve as the basis for sustainable local production. In his Foreword to The Rebirth of American Industry he writes:

Waddell and Bodek call for restoring American industry by replacing the Sloan model of financial management with lean management. Rightly, they refrain from describing in any detail what form this restoration might take. That issue is the next frontier of research and practice concerning lean management. Some people, I am afraid, see lean as a pathway to restoring the large manufacturing giants the United States economy has been famous for in the past half century.

Overlooked in this picture are the unfortunate environmental consequences of building such global production systems. The cheap fossil fuel energy sources that have always supported such production operations cannot be taken for granted any longer. One proposal that has great merit is that of rebuilding our economy around smaller scale, locally-focused organizations that provide just as high a standard living [sic] as people now enjoy, but with far less energy and resource consumption. Helping to create the sustainable local living economy may be the most exciting frontier yet for architects of lean operations. Time will tell. [p. xxi]

I contacted Professor Johnson requesting further elaboration on this intriguing hint, and he helpfully referred me to a couple of his articles. In one of them, "Confronting the Tyranny of Management by Numbers" [Reflections: The SoL Journal, vol. 5, no. 4 (2004)], he wrote:

Some might argue that a world economy of diverse local bioregions would cause consumers’ standards of living to fall because it would reduce the economies and efficiencies of large-scale production and distribution systems that we ostensibly have in the world today. Herein lies the importance of understanding the fallacies of scale-economy thinking. In reality, production systems designed along the lines of Toyota’s turn scale-economy thinking on its head: they make it possible to build manufacturing capacity on a much smaller scale than ever before thought possible, yet produce at unit costs equal to or lower than those of large-scale facilities now thought so necessary for cost-effective operations.

An example of this is found in Toyota’s organization. Compare the plant that makes Camry and Avalon models in Melbourne, Australia with the plant that makes the same models in Georgetown, Kentucky. Located within or nearby each plant are complete facilities for engine build, axle build, plastic trim and bumper production, stamping, body weld, seat build, and final assembly. According to Toyota, these two vertically integrated plants are equally efficient and effective on all dimensions that matter to Toyota customers. However, the Melbourne plant currently produces about 90,000 vehicles per year, primarily for the Australian market, whereas the Georgetown plant produces about 500,000 vehicles per year.

If a fivefold difference in capacity yields no unit-cost differences between these two plants, then what is to be said on behalf of scale economies? In fact, Toyota people have said they probably will not build another plant as large as Georgetown in the future. The company currently is building new plants, smaller in scale and located as close as possible to customer markets. Carried to its logical extent, Toyota’s example helps show how bioregional economies of 10 to 30 million people could support high-variety and low-cost manufacturing facilities for a wide range of products. Indeed, the relatively isolated Australian economy, with about 20 million people and a vast land area, supports several auto manufacturing operations in addition to Toyota’s, as well as facilities producing a wide array of other products just for Australian consumers.

There are now ample technologies available to support efficient small-scale operation of almost every commercial activity. Some examples among many include the continuous-casting, mini-mill technology that transformed steel making in the last 30 years, small-scale refineries and chemical plants for almost all current petroleum and chemical processing, and Japanese paper-products plants that efficiently produce on a much smaller scale than American papermakers, for example, might think possible.

And bear in mind: those market areas of ten million are the upper range, required only for the most capital-intensive forms of production, like the automobile industry. But as Johnson himself suggests, the present economy's dependence on internal combustion vehicles with heavy engine blocks may be an artificial circumstance. He refers specifically, in the same article, to light vehicles with electrical power trains and alternative sources of fuel, which are discussed in Natural Capitalism. The traditional automobile factory, whether on the model of Detroit or Japan, will likely wind up as the new buggy whip factory in the decentralized market of the future.

Johnson recommended, in fact, that I read the discussion of lean production in Natural Capitalism. I had already read it, actually; but when I first read the book, unfortunately, I wasn't yet fully prepared to grasp the significance of lean production. Reading Rebirth of American Industry was what made it all click together for me.

I can't recommend it strongly enough to anyone who's interested in this sort of thing.


Blogger quasibill said...

Obviously, the whole article (chapter) supports this point, but

"The Sloan system (or DuPont/Sloan/Brown system), on the other hand, attempts to maximize Return on Investment (ROI), which translates into share value:"

is a good concise summary of the refutation of the vulgar libertarian argument that "the consumer is king" in the current manifestation of state capitalism. Quite clearly, if management's no. 1 focus is to maximize ROI, the *consumer* of the product or service cannot be king.

Just as enlightening are the passages about counting inventory as an asset - no consumer is needed!

great work, Kevin.

June 09, 2008 6:36 AM  
Blogger Kevin Carson said...

Thanks, quasibill.

The problem with counting inventory as an asset is that, eventually, it runs up against the outside world. Its success depends on the assumption that the accumulated inventory will eventually be sold off, when business is good. When the inventory gets too big, eventually they reach a point where production has to be shut down until it's sold off. In the meantime, it's a great way for the Nardellis and Dunlaps of the world to make the business look profitable on paper and fool the shareholders.

June 09, 2008 4:17 PM  
Anonymous Anonymous said...

That was heavy enough and big enough that it took me this long to get through it. To do it justice I will have to do a lengthy follow up and email it in. For now I should just leave three points as food for thought, and a reservation:-

- You can compare all these approaches with the old British Army saying "first the horses, then the men, then the officers", which sets out the priorities in which needs should be attended to (not followed in, say, the Egyptian Army, in which soldiers are routinely used as unpaid and ill-treated servants for officers and their families - which isn't how you should treat servants either, come to that; when Americans unfamiliar with these things write about treating someone like a servant, they almost invariably get it quite wrong).

- You can also think about how any of these corporate methodologies work in the light of Goodhart's Law and the Lucas Critique, once you think of the corporations as microcosms that are also subject to those.

- System 24 may also be of interest.

The reservation I ought to bring out early on is, you really should not take the Australian automotive (car and related) industry as a useful neutral comparison to bring things out about what happens elsewhere. It has long been highly distorted, formally with economic measures and informally through political pressure - including some component manufacture for overseas factories and some similar imports from abroad, which muddies the waters about just what the effective market size is, too. Even the reduction of these things is, paradoxically, a significant intervention. Just within the past week one plant's closure was finally announced and a massive subsidy was announced for a different project. For what it's worth, I feel that the Australian industry and market size would have been better served by horizontal integration, with power unit and transmission manufacture each having a near monopoly of their own feeding a larger oligopoly of end manufacturers (we have a regulated small oligopoly system with vertical integration now).

June 11, 2008 6:16 AM  
Anonymous Anonymous said...

Regarding the closing comments about Natural Capitalism, I highly recommend David Blume's Alcohol Can Be A Gas!. He focuses on micro and small-plants integrated with combined cycles (see especially chapters 8 and 12). The current anti-ethanol food-vs-fuel propaganda is just another example of the Empire getting scared about the peasants being able to make their own prime-movers in the form of fractionated food and biofuels.

His sites:

June 11, 2008 9:13 AM  
Blogger Kevin Carson said...

Thanks for the comments, PML, and for the background on the Australian auto industry.

I'd never heard of any of Goodhart's Law or the Lucas critique, so thanks for making me aware of them. Their significance seems to be something like Heisenberg's law in physics, except that they seem to result from awareness on the part of the humans being measured. The Wikipedia article referred, specifically, to the applicability of Goodhart's law to org theory. William Ouchi made a similar observation: any metric used by a principal to measure an agent's performance will be gamed by the agent to maximize his returns, in a way that produces perverse outcomes.

Thanks for the information, mark. I believe PML has also referred to biomass being economical mainly when produced on a small scale at the point of consumption. Part of it, IMO, is the sheer inability of government bureaucrats to think in terms of anything but giant Stalinist blockbuster projects.

It's always struck me as ironic that one of the few of Tesla's ideas that caught on in the mainstream was alternating current, and it just happened to be an idea that promoted centralization.

June 12, 2008 11:47 AM  
Anonymous Anonymous said...

"...biomass being economical mainly when produced on a small scale at the point of consumption..."

That's misleading. What I pointed out was that there was something that is not economical but can be cured, namely making biofuels in a mass process that itself uses the final fuel as an input, e.g. for farm machinery, processing equipment and artificial fertiliser. That makes a loop which it's hard to get past break even for EROI (energy return on investment). Current approaches break the loop by making fertiliser with fossil fuels, etc., which also defeats the object. However, you can run farm machinery and processing equipment in a different way that's not part of a large loop like that, e.g. off producer gas fuelled by waste from the crops with the ash going back into green manure, or even engineer them out by going back to using draught animals and more farm workers if they happen to be practical (as in third world countries).

What that does is turn the large loop into lots of smaller ones that don't eat into the final biofuel or other crops - but you still have a lot of biofuel or other crops output, and it's still practical to have large scale non-local output and final use (if you still want to). It's just the loop part that would have to be done small and local to make sense, and of course by removing the large loop you remove any internal necessity for large scale operations - but you don't prevent it if there is some outside need for it.

Digressing slightly, I have looked into possible engines and gasifiers for small scale production and use. What I did was "back to the future", looking at actual examples from the early 20th century, then I did thought experiments for possible improvements. That gives something untried in its final form, but built up from proven components and techniques. Now, I don't have the resources to test these, let alone make prototypes for them. Would it make sense for me to describe them and let people around here see what they could do with that? They would provide the 99% perspiration, so to speak, and I would only request a donation from people who thought their results justified it rather than trying to go the royalty/intellectual property route. Comments?

June 12, 2008 5:44 PM  
Anonymous Anonymous said...

Drat. I think I forgot to sign my last comment.

June 12, 2008 5:54 PM  
Blogger Kevin Carson said...


I should have said, produced at the point of consumption *from waste material that would be generated anyway*.

June 13, 2008 10:54 AM  
Blogger Michael F. Martin said...


I just discovered your blog and I love it. I share your view that accounting methods could be improved by looking at human capital more closely. But the problem goes very deep indeed, because I don't think many economists even have a good picture of how human capital translates into economic growth.

For my part, I've been trying to spread the word that the aggregate supply and demand curves (which is what most economists seem to have in mind when they think about a market) can be derived from frequency distributions that describe the patterns of consumption or production for a population within a window of time. Having this insight opens the door to a whole new way of visualizing how changes in production and consumption will affect price.

For example, one prescription that comes directly out of this insight is that balance sheet statements should include measurements of liquidity for each account. In other words, knowing how big an inventory account is isn't meaningful unless we also know how fast that inventory account is turning over. Making that information more explicit in balance sheets would promote many of the changes you would like to see in how managers and investors behave towards employees.

In addition, I want to point out that Intellectual Property, properly understood, is human capital. I know that accountants treat IP as an asset. But the best way to think about it is as a combination of property rights and inventor services.

I'll be following your blog with interest from now on. Please check mine out if you're interested:


June 16, 2008 11:56 AM  
Blogger Kevin Carson said...

That's an amazing blog, riemannzeta. I've bookmarked it and will add it to my blogroll whenever I get around to that long-neglected task. Your material contrasting liquidity with the Sloan approach seems especially interesting, although it may require math skills greater than mine.

I expect Eric Husman would find it fascinating, if he's not already aware of it.

On the IP thing, I'm afraid I'm pretty much of an anti-IP fundamentalist. A couple of recurring themes that I harp on are

1) the protectionist role that IP plays in the corporate global economy, comparable to what tariffs played for the old national industrial corporations; and

2) the percentage of commodity value that amounts to rent on artificial property rights rather than labor and material cost, and the implosion of price (and the average work week) that would result if we only had to pay for actual material and labor cost.

June 19, 2008 11:51 AM  
Blogger Michael F. Martin said...


I don't know who Eric Husman is. Please let him know about Broken Symmetry if you know him and think he'll be interested.

A few more thoughts on the IP front:

1. IP is not a protectionist tool for the U.S. anymore. First, we issue about as many patents to foreign entities as we do to domestic entities. Second, and more importantly, Europe and Asia now have functioning IP systems, albeit a few decades behind ours. Ricardo and his theory of comparative advantage applies to producing and trading ideas the same way it does to producing and trading things. Protectionism is not a valid ground to object to an IP system (at least not in the 21st century).

2. As I said, I agree that it is incorrect for accountants to treat IP as an asset. It is human capital. And as I said, I believe that with proper changes to the accounting standards -- changes that reflected the actual mechanism whereby IP is generated and transferred (i.e., through the labor of inventors and patent lawyers) -- you would see the changes in how corporations people (including inventors) that you desire.

The bottom line is that if patents don't protect IP then you have to rely on trade secrets and contract. And these are not so useful in the many, many cases in which inventors want to collaborate or move around from corporation to corporation (or be independent from any corporation!).

June 20, 2008 9:21 AM  
Blogger Kevin Carson said...

I sent Husman a link to your blog.

When I said IP was protectionist, I meant it performed an analogous function--but for the corporation directly, without regard to national territories. IP operates at the border between the TNC itself and the rest of the world, rather than at national boundaries. The fact that the ownership TNCs taking advantage of this protection is globalized is beside the point, an the adoption of more stringent IP regimes by Europe and the Pacific Rim is necessary to the phenomenon.

And it imposes artificial "comparative advantage" by erecting legal barriers to the movement of technique.

When I say IP is "protectionist," I mean it

1) enables corporations to cartelize the market through ownership of production technology and through the mutual exchange or pooling of patents, and lock a small number of firms into control of an industry through control of production technology;

2) suppresses most price competition (the large portion of commodity price that consists on what Tom Peters called "intellect," or rents on artificial property rights, rather than the actual cost of labor and materials;

3) enables companies to use IP control over the spare parts market to promote planned obsolescence at the expense of repair and recycling;

4) enables whole loose federal structures of outsourced production facilities to be controlled by a core corporation, which manages finance and marketing and controls IP and branding;

5) enables TNCs to exist geographically in a TW country, while patents on production technology prevent the emergence of indigenously owned competition, and to relegate the host country to supplying sweatshop labor and raw materials.

June 22, 2008 11:01 AM  

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