SimpleExcellence

Organizing and Aligning theManagement Team in aLean Transformation

Adam Zak and Bill Waddell

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Productivity PressTaylor & Francis Group270 Madison AvenueNew York, NY 10016

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Contents

Preface

Authors

Chapter 1 A Different Way of Managing

SECTION I THINKING DIFFERENTLY

Chapter 2 The Mom-and-Pop Theory of Management

Chapter 3 It’s All about Value

Chapter 4 The High Cost of Poor Cost Accounting

Chapter 5 Can We Find a Few Righteous People?

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Chapter 6 People

Chapter 7 Channels and Chains

Chapter 8 You Gotta Go with the Flow

SECTION II MANAGING DIFFERENTLY

Chapter 9 Getting Sales and Marketing into the Game

Chapter 10 Value-Stream Structures

Chapter 11 Simple Accounting

Chapter 12 The Roadmap from Chain to Channel

Chapter 13 Scheduling the Factory

Chapter 14 Purchasing

Chapter 15 Quality Management

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Chapter 16 Sales, Operations, and Financial Planning

Chapter 17 Pricing to Win

Chapter 18 Capital Investment

Chapter 19 Performance Metrics

Chapter 20 Wrapping It Up

Index

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Preface

For over 25 years we have been working in and aroundmanufacturing. Our careers began before Jim Womack, DanJones, and Dan Roos coined the term Lean manufacturing intheir watershed book, The Machine that Changed the World,and we have seen the global manufacturing landscapetransform as companies have worked to understand and applythe principles of Lean thinking. We would like to think thatwe have even influenced the evolution of Lean a bit throughour work and our writing.

We have seen activity-based costing come into and pass outof vogue and the theory of constraints become one of thebasic principles of manufacturing. We have witnessedmanufacturing quality management evolve as a result of theideas behind statistical process control (SPC), Six Sigma, andDeming’s plan–do–check–act (PDCA) principles.Technology—especially information and communicationstechnology—has enormously impacted manufacturing overthe course of our careers. And, of course, we have observedthe effects of globalization.

Throughout this period of dramatic change and under theonslaught of new ideas, we have had a chance to observe

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some very successful companies. Unfortunately, during thistime too many great manufacturing companies have dwindledor died out all together. Most companies are somewhere inbetween, trying to figure it all out. This book is written for themanagement of those companies. Having had a chance to seeseveral very successful manufacturing companies in action,we have had the great fortune of learning some veryimportant lessons. Our purpose here is to share them.

A couple of overarching principles are woven throughout thisbook. They keep coming up because they are common amongall of the very well-managed companies we have studied andwith which we have worked, and strike us as central to theirsuccess. First among them is the degree to which the entiremanagement team is engaged and involved. While mostcompanies are relatively compartmentalized—salespeoplesell, manufacturing people manufacture, and accountingpeople account—in the best companies there’s a dramaticdifference: you need a scorecard to determine who does whateven after having spent an hour with the management team.No one’s turf is sacred. All are involved in the entire businessand work in tightly integrated teams in just about every aspectof the enterprise. This gives them a powerful synergy ofknowledge, talents, and ideas.

When we look at the evolution of Lean manufacturing, mostof the literature and most of the effort have been aimedexclusively at manufacturing operations (hence Leanmanufacturing, we suppose). On top of the Lean factoryliterature, there has been quite a bit aimed at the chiefexecutive officer (CEO) level concerning Lean philosophyand Lean leadership. In recent years accounting, productinnovation, and engineering have been slowly added into the

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mix. In most companies and in most of the literature,however, the rest of the management team (e.g., sales andmarketing, human resources, information technology) hasbeen mostly left out of the Lean transformation process. Atbest, some suggest that sales and marketing recognize thatLean manufacturing has enabled shorter lead-time deliveriesor that quality is much better as a result of the Six Sigmaeffort and that those improvements should have some value inthe marketplace. In the excellent companies, sales andmarketing are a lot more involved than that. They are thebridge that takes the factory right to the customer’s back door.

All of management is completely caught up in the process ofdriving the company to much higher levels of performance inthese great organizations, and the application of Lean and theother emerging principles is hopelessly intertwined with howthey do it.

Another common element is simplicity. The best companiesare not pursuing more sophisticated computer applicationsand more detailed financial management tools. They have thecommon sense to let their personal wisdom, judgment, andexperience trump the onslaught of management theories thatare often little more than ways to manage through and aroundcomplexity that shouldn’t be there in the first place. Quite theopposite, in fact—these companies have demonstrated a greattalent for peeling away all of the unnecessary clutter andzeroing in on the things that matter. They worry about thevalue of the products they make, how their customers feelabout things, and how well cash is flowing. Anything thatclouds their ability to keep a clear eye on those key factors iscast aside.

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These companies are as Lean as Lean can be—but they wouldprobably not pass a “Lean audit.” They are not hung up onJapanese terminology and do not seem to care very muchwhether anyone is a certified “black belt.” Rather, they havegained a keen appreciation for the principles that underlieLean manufacturing and Six Sigma and have fashioned thebest way to put those principles to work in their businesses.

The companies that have so impressed us are unique,spanning a wide range of markets, industries, and sizes. Theyare proof that there is no cookie-cutter method ofimprovement. We have learned from observing them thateach company must find its own way along the path tooperational excellence. There is no workbook everyone canuse, and there are no universal “Ten Steps.” What works forone company will not always work for another. That said,there are some common management principles.

The first objective of this book is to clearly lay out thoseprinciples. Our secondary aim is to describe how embracing,massaging, and deploying those principles require thecommitment of everyone sitting around the table at the staffmeeting. No one can stand on the sidelines and keep up“business as usual.” The journey to attain the levels ofperformance of the companies we will cite will be verysimple—but it will not be easy.

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Authors

Adam Zak is founder and chief executive officer (CEO) ofAdam Zak Executive Search and an accomplished seniorexecutive with more than 25 years of experience spanning theareas of management consulting, financial and operationsmanagement, and talent acquisition. Adam excels atidentifying and attracting business leaders who are experts inLean continuous improvement, process and operationalexcellence, and sustainability. His impact on organizationsquickly becomes apparent as these talented individuals, intheir new leadership roles, consistently go on to make theirnew companies excellent.

Adam has recruited executives for a diverse mix of Fortune1000, private-equity, and entrepreneurial companies in theUnited States and abroad. He has worked in a variety ofindustries from automotive and aerospace giantsimplementing sustainable operational excellence cultures tofast-paced consumer product distributors revolutionizing theirglobal supply chains with green management practices.

Earlier in his career Adam earned a bachelor of sciencedegree in accounting from the University of Illinois, became acertified public accountant, and worked with KPMG in both

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advisory and assurance roles. He subsequently held a varietyof financial and general management positions with venturecapital, innovative start-up, and Fortune-ranked companies inChicago, Seattle, San Francisco, and Silicon Valley.

Adam has been using his uncommon expertise to help hisclients improve their businesses operationally and financiallyfor almost 20 years. He’s been a partner with twointernational executive recruiting firms and now conductsexecutive searches in a much more creative, entrepreneurial,and results-driven (and Lean) fashion. His unique and highlypersonalized methodology for recruiting exceptional talent istrademarked as PDCAsearch•. Adam is considered by manyto be the most influential leader today in Lean recruiting andLean executive search.

Recently, Adam’s work has focused on helping to improveAmerican health care by bringing operational and processexcellence to the health-care industry. He is the innovatorbehind the recently launched recruiting initiative Crusade forLean HealthCare Talent.

Adam contributes his time to a number of professional andcommunity organizations. He often speaks and writes ontopics including the Lean enterprise, innovation, operationalexcellence, and sustainability. He is a devoted student ofexecutive leadership, change management, and, most of all,the philosophies and practices of continuous improvement.

Bill Waddell is a consultant, author, and speaker who hasspent over 30 years working in just about every facet ofmanufacturing. Beginning with his education at the

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University of Cincinnati, Bill came up through manufacturingin virtually every capacity, including accounting, industrialengineering, supply chain, production, and qualitymanagement. His resume includes working as manager ofadvanced manufacturing practices for Emerson’s CopelandDivision, as vice president of global supply chain forMcCulloch, and as vice president of global operations for theWahl Clipper Corporation. He is widely regarded as one ofthe leading authorities on Lean manufacturing and Leanenterprise management and strategies.

Bill coauthored the award-winning Rebirth of AmericanIndustry (with Norman Bodek, PCS Press, 2005) andEvolving Excellence: Thoughts on Lean EnterpriseLeadership (with Kevin Meyer, iUniverse Inc., 2007). Hisprovocative columns on manufacturing issues on EvolvingExcellence make it the most widely read manufacturing blogin the world. He is also a regular contributor toManufacturing Crunch and Pacific Excellence, and hisarticles have appeared in the Association for ManufacturingExcellence’s (AME’s) Target Magazine, APICS Journal, anda wide variety of other manufacturing publications.

As a consultant, Bill has worked with hundreds of companieson five continents in a wide variety of industries, rangingfrom multibillion dollar global organizations to his pro bonowork with local organizations hiring the handicapped to learnbasic manufacturing skills. His focus in recent years has beento work with smaller- to mid-sized companies, often insupport of the Manufacturing Extension Partnershipprograms.

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As a speaker and educator, Bill has addressed just about everysignificant manufacturing form in the world. One of theoriginal “thought leaders” behind the Lean accounting bodyof knowledge, he has become a regular fixture at the LeanAccounting Summit and at numerous events related to thefinancial management of manufacturing. He is past technicalchair for the International Six Sigma/Lean QualityConference and has spoken to dozens of groups within theAssociation for Operations Management (APICS) on topicsrelated to global supply chain optimization and leading-edgefactory scheduling. He has lectured at over a dozen topuniversities as well as at the U.S. Air Force Institute ofTechnology on manufacturing strategy, global manufacturingissues, and financial management.

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1

A Different Way ofManaging

The senior leadership team plods in for that businessritual—the weekly staff meeting. For many of the attendees,this is their only regular communication with each other. Infact, communication is the primary goal of the meeting. Theboss leads off with some general announcements: concerns,perhaps, or problems communicated from headquarters or theparent company. Then each manager, in turn, discusses theissues and events within his or her area of responsibility.Some of them may squirm under heat from departmentalmetrics, having to explain any performance since the last staffmeeting that does not meet the benchmark set for laborefficiency, sales levels, or the like.

The sales and marketing manager, always the optimist sincethat is a requisite character trait, talks about a few minorsuccesses and a few opportunities on the horizon but alsoexpresses a few tactful criticisms of the operating side of thebusiness: high prices because of high costs, customer

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complaints due to delivery or quality problems, and otherobstacles to top-line success beyond the control of the salesand marketing department.

Production follows with a beleaguered explanation of whycost reduction efforts are dragging behind plan, anexplanation of problems with the enterprise resource planning(ERP) system that wrought havoc on the factory floor (whichthe rest of the attendees have trouble following), a thinlyveiled complaint about the quality of people being hired byhuman resources (HR), and an overt plug for a capitalinvestment that is not making the hurdle rate but is neededanyway.

Purchasing goes next and offers up an explanation for latesupplier deliveries and warns of impending cost increases dueto global commodity market swings. Steel, resins, copper, orfiberboard are going up everywhere, so purchase prices willnecessarily increase; the silver lining, however, is that theywill affect competitors as well.

The supply chain manager offers little in the way ofsubstantive input. The discussion revolves around inventory,but the supply chain manager is really just the scorekeeper.Inventory is the residual of what was made and what wassold, and the ERP system simply does as it was told, so anyinventory excesses or shortages are not the supply chain’sresponsibility. Sales and marketing wants moreinventory—finance wants less, but the supply chain typicallydisavows much real ownership of the argument since thesystem drives things.

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Human resources and information technology (IT) talk aboutthings in their respective arenas—impending changes in laborlaws and a change in the backup schedule that will take theserver down at a different time on the weekends—that no oneelse in the meeting understands or cares much about.Engineering may be on the hot seat for delays and costoverruns in a new product or two, but more often than not theengineering manager talks about product or processtechnology issues that are understood or cared about only byfolks much lower in the organization than those in the staffmeeting group.

Perhaps as a leadoff, or perhaps at the conclusion, financeeventually passes out statements and launches into asoliloquy. Variances and ratios are explained and discussed.Typically HR, IT, supply chain, and engineering mentallydisengage at this point since little they do affects theshort-term fluctuations. They are all on fixed budgets, and solong as they stay within them they are below the radar ofanyone worrying about monthly profits.

The financials are usually the subject of a mildly adversarialdiscussion between sales and operations, with operationssuggesting that if sales team members would sell closer totheir forecasts all would work much better, and withsalespeople suggesting that if operations had things moreunder control the task of taking operations output to themarketplace would be a whole lot easier.

The task of the boss is often to keep things moving onschedule and, occasionally, to arbitrate any conflicts. Then itends with little or nothing in the way of solid results. Few

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action items and few problems are actually resolved and putto rest.

The goal of communications is met—after a fashion, at least.Each functional manager has a chance to let the rest of thedepartment heads know what is going on in each particulararea. The only times all staff members are fully engaged tendto be when somewhat mild topics such as the best date for thecompany picnic arise. The knottier questions of why thingsare not happening according to plan are usually left aftersome minor rock throwing back and forth between a few staffmembers. Those problems will be left for the boss to work outlater. Based on the discussion in the meeting, and perhaps theoutcome of some departmental performance metrics, it will beup to the boss to assess where the greatest fault lies and tohave hard discussions with the manager involved at a laterdate to try to get things back on track.

At an increasing number of very high-performing companies,however, staff meetings are less frequently held, and thenature of them is radically different. In those companies,rather than having functional managers, a handful ofvalue-stream managers stride in. They each discussprofitability, progress toward breaking through constraints,increases in the value proposition as perceived by customers,and advances toward strategic goals of growing market share.

Each of those managers speaks for all of the functions withinthe value stream since each leads a fully integrated team thattakes customer orders and new products from their inceptionto their final delivery. Such staff meetings are rarely calledfor because the ultimate objective of suchmeetings—communications—is the value-stream managers’

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stock in trade. They spend all day facilitating cross-functionalcommunications among the value-stream team, assuringeveryone is focused on the most critical constraints and oncontinually enhancing flow to achieve the best results.

These value-stream managers measure themselves and theirteams in terms of bottom-line results: profits and growth.They care only about total costs, and they spend little timewith detailed internal measurements. Their pricing strategiesand capital investments are driven by optimizing capacity toachieve the most economical total outcome, without regardfor how it might affect any one particular area of the plant orthe business.

The old department heads—the senior managers who onceruled their functional silos—sit off to the side in a muchdifferent role. They are advisors, mentors, teachers, andinternal consultants. They worry about the long-term and thestrategies of the organization. Their senior positions, alongwith their storehouses of knowledge that took them to thosepositions, allow them to exert a great deal of influence, butthey leave the day-to-day and week-to-week management ofthe company to the value streams. They work together withthe other senior managers as a team to collectively guide thevalue streams and the company to its long-range objectives.

The purpose of this book is to show the teams of functionalmanagers in the first staff meeting scenario how thebest-performing companies climbed out of their silos and intothe stream of continuous value creation and growth. The pathis not one of having to learn a new set of buzzwords or tomaster a new technology. It certainly is not a path thatrequires management to master a Japanese vocabulary. In

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fact, the path is one that eliminates the clutter and drasticallysimplifies the business.

Over time we have created a management scheme that callsfor too many narrowly focused experts in each of theorganization’s areas of business and technical expertise, andthen have entrenched those experts in functional silosdetached from each other. We have tried to link those silostogether with increasingly complicated systems andprocesses—ERP systems that require years of training andexperience to master, financial controls that make little senseto anyone outside of the accounting realm, and detailedmetrics of performance built on a hope that if each individualor department hits some performance goal then somehow theorganization as a whole will prosper.

Communications are indeed a difficult and serious problembecause we have created specialist managers who do not livein similar worlds or even speak the same business language.While the sales and marketing people talk about brandstrategies and the operations people talk of throughput andpull systems, the others around the table often have little ideawhat the others are really saying. More important, they oftendo not care very much since there is little linkage between thedepartments. It takes much more than an hour or two everyweek to break down these barriers.

Far from linking the business together, this entangledapproach to business has served only to drive wedgesbetween departments and managers who, as they becomemore experienced in their own areas, more and more lose anyconnection with the overall business. To run these entangledorganizations, we need people with advanced degrees in

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business—but often little real knowledge of our particularbusiness—who specialize only in trying to organize and keepthis disjointed group on track.

The fault perhaps lies more with the consultants, authors, andacademic experts and less with management. Many of theideas that have been classified as fads and buzzwords haveserved only to further confound when they should havesimplified. The very basic concept of identifying theconstraints to getting things done has become shrouded inmystique and complexity, requiring something called a“Certified Jonah” to implement. The basic idea of SixSigma—make sure your processes are capable of doing whatyou need them to do—calls for certified black belts to explainand put into play. Worst of all, the nuances of the ToyotaProduction System, renamed Lean Manufacturing, have beenwidely misrepresented and misunderstood, in no small partbecause the system seemed to require a crash course inJapanese to decipher the role of senseis, or masters. Thecommonsense idea of a Kaizen event requires an outsideexpert to show management how to get people together tosolve problems.

Finance and accounting are little different. The process ofaccounting for the simple proposition of buying material at agood price, processing it efficiently, and selling it at a profithas become enormously involved. Creating standard costs andmeasuring minute variances in three or four differentcategories, rolling the money through generally acceptedaccounting principles (GAAP) rules that wash spendingthrough inventory and spit it out in a time period other thanwhen it was spent, then cranking out reports far detachedfrom the simple proposition of spending less money this

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month than last have led to accounting departments filledwith people who generate reports few in the company reallyunderstand instead of people who spend their days helping therest of the organization improve real bottom-line results. Thechasm between real money (i.e., cash) and financial reportshas grown so great that most people cannot see the other side.

Staff departments have sprouted up to accommodate the needfor systems experts and masters of the fads. What should bestrategies and techniques for getting closer to the heart ofthings have spawned more complexity. In addition to theregular workload, people must make time for the Kaizen andSix Sigma efforts. ERP has become so pervasive that no onereally understands it all. A simple change in labor reportingon the shop floor requires meetings and extended projects ofpeople from accounting, supply chain, production, and IT towork through all of the implications of the change.

In the end, although each of these additions to the businesshas been well intended and each has merit, their accumulatedtrack record of enabling the company to enhance value forany of the shareholders has been dismal. Worse, even whenvalue is enhanced, it is difficult to sustain.

The key to long-term sustained value is to eliminate all of thenoise, waste, and clutter and to align the business on thecommonsense, fundamental issues that determine success. Wemust move people away from defining success as mastery oftheir fine-tuned specialty. All that matters is creating superiorvalue—relative to both customer expectations and tocompetitor capabilities—for the customers and to turn thatcustomer value into growing profits for the owners. Along theway we will increase the financial security for the employees

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and suppliers and make a stronger contribution to thecommunities.

While the path we will map is one of simplification, it is notnecessarily an easy one. The staff members responsible onlyfor their own area of specialization will become a team ofpeople, each responsible for a segment of the overall businessresults. There will be little room to blame other people orother departments for shortcomings. Just because problemscall for practical solutions, it is not promised that thesesolutions will be effortless. What is promised is that everyonewill be working together on the problems with the greatestbearing on the company’s results.

The job of the leadership group will be to change a team ofhorses pulling in different directions—and often againstitself—into a team where the members are all pulling togetherin the same direction. The starting point is for the leadershipgroup to begin pulling as one, and then to structure the entireorganization to do the same.

We are going to discuss the big picture: what value streamsare and how to structure the business in this powerful mannerto align everyone with the things that matter the most. Wewill also present the idea of value enhancement—what it isand how it, rather than cost reduction, should become thedriving purpose of management. We will talk about theculture and decision-making principles that can propel thebusiness to much higher levels of performance. The essenceof this section is learning to think differently. Engagingeveryone in the organization in continuously increasing therate of flow through the factory to the customer will replacetraditional thinking about how cost is optimized.

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In the remainder of this section, we will describe some basicmanagement structures we believe are necessary to put thisnew thinking into play. We will boil constraint managementdown to its practical terms and lay out a sound approach toaccounting that enables everyone to spend money where itadds value and to stop spending money where it doesn’t.Quality can be managed and Six Sigma thinking appliedwithout the need for high-cost experts, and we will show how.Performance metrics that keep everyone focused on thebottom line will be outlined. A chapter is devoted to how thesupply chain can be structured and managed in a manneraimed at continually driving improved value to yourcustomers. Last, we will talk about human resourcesmanagement practices. People are at the heart of everybusiness success or failure and how the business relates to thepeople who drive it is vitally important.

In the second section of the book we will describe how to putall of this into practice. Managing the day-to-day operationsand pricing factory capabilities in a manner that takes the bestvalue proposition the company can muster to the marketplacefor the greatest possible profits are at the heart of it. We willalso discuss an ongoing process of strategic planning that willenable you to move away from annual goal setting and toreplace it with a dynamic process of seizing opportunities andengaging the entire company in the effort to make the most ofthem.

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Section I

Thinking DifferentlyLearning new things is not particularly tough. We do thatevery day. In fact, in this age of information technology wehave to keep learning at a breakneck pace just to survive. Theadage about old dogs being unable to learn new tricks is nottrue, as demonstrated by a great number of “dogs” who aregetting gray around the temples running and driving some ofthe most amazing technology companies. What is tough isunlearning what we have long believed to be true—and thatseems to be difficult for dogs of any age.

There was a day when a Swiss watch was the paragon oftechnical precision. To own one was something of a statussymbol, and there was no questioning the accuracy of thetime it kept. There was a huge industry in Switzerland toproduce watches, and the necessary skills for preciselymachining the tiny gears and components to attaintimekeeping perfection was not only a source of pride but alsoa big contributor to the Swiss economy.

In 1962, a Swiss organization called Centre ElectroniqueHorloger came up with the first practical applications ofquartz crystal technology for timekeeping. The technologywas much more accurate, smaller, and lighterweight andcould be made at far lower costs than mechanical watches. In

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spite of all of the clear advantages, and even though thetechnology originated in their own country, the Swisswatchmaking industry as a whole rejected quartz crystal andstuck with their traditional ways.

The Japanese held no such bias, and companies like Seikoarose quickly and adopted this new and better way of buildingwatches. Since then the Swiss have staged a comeback usingelectronic technologies, but the fact remains that over 60% ofthe Swiss watch companies in existence in 1970 are nowgone—victims of their unwillingness to let go of historicallytried and true ideas even when faced with overwhelmingevidence of a better approach.

This often cited example of a paradigm shift—a change in thefundamental model of how things work—opens up all sorts ofpsychological debates. How people can cling to old ways tothe point of self-destruction when those ways have clearlybeen replaced with something better is a mystery. You needto figure out the solution to the mystery, however, at least foryourself and your company because the basic theories ofmanagement are undergoing an enormous change, and thepeople who insist on managing in the twenty-first century bywhat are basically 1960s methods are going the way of theSwiss watchmakers.

The problem with a paradigm shift is that it sets theknowledge base back to zero. The day the company switchedfrom making mechanical watches to quartz crystal, theknowledge and experience an aging Swiss craftsmanaccumulated over 30 years of watchmaking was useless. Akid fresh out of high school knew as much about makingquartz crystal watches as that old pro. No doubt the old guy

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could have learned the new methods—the old dog is verycapable of learning the new trick—but the old dog wasunwilling to let go of his old tricks. That is understandable. Itrequires a great deal of self-confidence to take the attitudethat “I learned and mastered the old methods, and now I willlearn and master the new methods just as well or better.”Many people live in fear of not being able to duplicate theirpast success. They resist change because they may findthemselves at square one again and incapable of making itback to the top.

The challenge an organization faces in transitioning to anentirely new way of thinking and operating is that a lot of olddogs are sitting around the senior management staff meeting,who have attained their positions because they have masteredthe old ideas. They have devoted a lot of years and a lot ofhard work to being very good at managing their functions theway they were taught, which was not only the best way, butthe only way. Now they are being asked to collectively writeoff the skills that have driven them to the top, and that is a lotto ask.

It is not as bad as all that, however. In fact, much of thesuccess that managers have enjoyed came as a result of theirability to work around—rather than within—the barriers putup by the old methods. People succeed because of their abilityto establish good cross-functional relationships. Dismantlingthe old functional silos and replacing them with value streamsonly formalizes the way managers have tried to work in thepast. It is more an exercise in simplicity, common sense, anddoing things the way they know deep down it should havebeen done all along. When we focus the financial equation oncreating value, rather than on rampant cost reduction, we are

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stating the obvious to most managers who have battled tomeet across-the-board cost goals with their best judgment ofwhat should and should not be cut without being unfair orunwise. The culture we are espousing is the culture managerswant to create but that has been held back by some outdatednotion that managers had to be tough and objective. Theculture we will espouse is really no more than saying, “Don’tchange when you walk through the office door on Mondaymorning.” We are saying managers should be the same personon Monday they were on weekends with their families and attheir place of worship. The same combination of knowledge,experience, compassion, and common sense that makessomeone a successful spouse, parent, and neighbor will makethem a successful manager.

So the changes may be procedural, and some of the reportingrelationships may change. However, in the end selling is stillabout communications, and manufacturing is still aboutorganizing people and machines. Engineering is still abouttransforming materials, and human resources is still all aboutthe messy endeavor of dealing with people with all of theirquirks and idiosyncrasies. The core of your experience andsuccess will still apply.

That said, there is still considerable change involved in takingthe company to a much higher level of performance. That isto be expected, of course. If it were easy, everyone wouldhave done it by now. A high degree of confidence in yourselfand in each other is necessary, as well as a commitment to theprinciples that drive such lofty performance.

In the next few chapters we will be discussing ideas. Don’tworry—this is not just another theory and philosophy book.

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We will get to the good part: the meat of the issue andspecific action items. But first we have to establish a coupleof basic principles. The action item to take from them isprimarily in the way you think. The best way to absorb themis to do so as a management team. The members of themanagement group should read a chapter and then gettogether to discuss it, to question the implications, and tocome to a consensus of what the chapter means to eachmanager individually and to the organization as a whole. Eachmanager should do his or her best to personalize the messagein the chapter and to avoid falling into the trap of thinkingabout how everyone else should change.

In later chapters we will get to how these ideas will be putinto action in a fully integrated management system, so don’tlet yourself get caught up in the problems you might see inputting the ideas into practice. The important thing at thisstage is to evaluate the ideas on their own merits. Askyourself whether this is a culture in which you would like towork and one that would improve the overall work ethic,energy level, and environment of the company. Do not get toohung up on all the obstacles you might see to maintainingprofitability when you are saddled with some of therestrictions the culture might place on you. We will get to thatpart.

Likewise with the concept of value or the idea of optimizingflow. How these things interact with your accounting systemor problems that constraint management might present withyour ERP system are not important at this juncture. We willdeal with them later. For now, what matters is whether youunderstand them and whether they make sense to you.

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Take as much time as the management team needs to read,reread, and discuss each chapter comprising the conceptualsection of this book. Each contains weighty subjects. Whenthe entire team is comfortable with them, move on to thesecond section, and we will start to build an organizationaround a powerful, inclusive, culture designed to createmaximum value for customers and to drive costs downthrough a flow focus in a manner much more effective thananything you have tried in the past.

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2

The Mom-and-Pop Theoryof Management

Whoever came up with the idea that management is littlemore than a grand game of sudoku—a couple of numbers aregiven and you win the prize if you can fill in the rest and haveit all fit—missed the boat completely. Most of themanagement thinking that drives companies to be poorperformers and lousy places to work began with thatphilosophy. The theory seems to be, like that sudoku game,that you are supposed to start with investment and profitgoals, to fill in the sales forecasts that make those numberswork, and then to set cost targets necessary to fill in the restof the blanks so that everything fits up and down. Finally, youtask the staff with making the numbers happen by any meansnecessary, and proclaim yourself to be a good leader. None ofit is based on reality: just a lot of numbers that look good onpaper, numbers that look good to Wall Street analysts andbankers. Ridiculous ideas like management by objectives andstretch goals arose from this sort of thinking.

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Those ideas along with professional management theoryfound their origins in the business schools where you cancount on one thing: no one there knows the first thing aboutyour business. Ford, Procter & Gamble, Kraft,Sherwin-Williams, Armstrong, Wahl Clipper, AndersenWindows, Boeing, Buck Knives, Westinghouse, NorthropGrumman, Weyerhauser, Broyhill, Cessna, Deere,Harley-Davidson, Parker Hannifin—these are not just thenames of big manufacturing companies. They are the namesof men who created companies—and none of them had anM.B.A. Their theory of management was to round up the bestpeople they could find, to make something that was a bettervalue for their customers than anything anyone else wasmaking, and to make it at a good price and as low a cost aspossible. Most of them would be appalled at what theirnamesake companies have become.

Management is not about numbers and computer systems. Itis about people. It is all about getting the people working foryou and your suppliers to combine their brains and brawn tocreate things that are helpful to the people who represent yourcustomers. Numbers and ratios are nothing more than a veryfeeble attempt to describe and quantify the interactions amongall of those people.

You already know how to get people organized around acommon cause for everyone’s benefit. You do it every day inyour most important role: being a leader within your family.In just about every aspect, running the business is very muchlike leading your family and managing your home. In thatregard, perhaps the title of this book, Simple Excellence, isinaccurate because there is nothing simple about mostfamilies. However, it is something you know and execute

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based on simple principles. Make sure everyone is engaged,involved, and working to his or her potential. Make sure thecash gets managed and the finances are strong balancingshort-term and long term-needs. Do your level best to be surethat when your kids leave the nest you are sending the bestquality product you and your spouse can turn out intosociety—young people with their heads screwed on straightwho will be happy and successful and will do the familyname proud.

You succeed at this family leadership challenge by workinghard, by assuring that everyone in the family shares the samegoals and believes in the same principles, by communicatingthese well and often, by making sure everyone knows theplan, and by being smart and disciplined with the family bankaccount. Mostly you do it with compassion andlove—sometimes tough love—but always with an absolutecommitment to each other. That also pretty well describes thefounders of the great manufacturing businesses mentionedpreviously: not a lot of complicated management theory.

Management really is simple. Put all of the complex financialbooks away and focus on cash. Henry Ford said that all heneeded to know about accounting was whether there is moremoney in the bank at the end of the week than there was at thebeginning. That is pretty much the same way you gauge yourfamily’s financial condition, and it is absolutely correct. Nomatter what the rest of the financial statements say, if youkeep taking in more money than you are spending, things willwork out very well. A whole lot of managers who thoughtotherwise learned a hard lesson over the last few years whenthe credit sources went up in smoke. Those who held thenotion that cash is just another asset—no more important than

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inventory and accounts receivable—the ones who believedthe DuPont return on investment (ROI) model had anything todo with reality found out the hard way that there is a very realdifference between actual money and a “current assets”number on a financial statement.

The volumes written on human behavior and how to motivate,analyze, measure, whip into shape, and otherwise manipulatepeople into doing what you want them to do should go intothe dumpster. Managing people is no more complicated—andno easier—than the Golden Rule. Treat people with the samelevel of respect, honesty, and fairness you want, and you willbe a very good manager. Managers who think they can fool ormanipulate anyone are about as successful as husbands,wives, parents, or children who think they can fool their ownfamily: they fool only themselves.

You cannot run the purchasing function in your business anydifferent from how you would at home and expect goodresults. Sourcing the core product you sell with the lowestbidder makes about as much sense as driving your kid all theway across town to a free clinic, bypassing a better-qualifieddoctor along the way to save the copay. The same is true ofsending your core product to China. It is akin to sending youryoung children off to boarding school. A manufactureroutsourcing manufacturing and a parent outsourcing parentingso they can both focus on more important matters: what couldpossibly be more important? Selling? Managing the money?There won’t be anything worthwhile to sell or any money tomanage when the product representing the very reason for thecompany’s existence gets back to you and is somethingdifferent from—and inevitably worse than—yourexpectations. Can you name a single company that was

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successfully manufacturing in the United States whosefortunes have improved—its products are better and itsbusiness is growing—as a result of moving manufacturing toChina?

Investment decisions are the same. Pay good money, buy thevery best for the things that are important, and look on eBayfor the things that are not. The labor cost is a minorconsideration. The idea that every machine decision should bebased on an analysis of cost reductions from the new machinecompared with the old methods using some hurdle rate ordiscounted cash flow to trigger the go or no-go decision issilly. If that were the right way to make purchasing decisions,no one would ever buy a new car. It could never be costjustified. When the old one gives out you should buy thecheapest wreck you can find and drive it into the ground. Youdon’t do that because things like reliability and safety enterinto the decision as well as quality of life. Just because theoriginators of ROI theory did not know how to put a value onsuch things does not mean they are any less relevant to thebusiness decision than they are to your personal decisions.

The books on organizational theory should find their way tothe same scrap heap. All of them are based on some idea oranother of command and control, limiting communicationsand limiting the involvement of people in decision making.What form of human endeavor is bettered by restrictingcommunications and narrowing the input to decision making?None that we can think of. In fact, the more people who knowwhat is going on and provide more points of view to consider,the better the decisions that result and the stronger andhealthier manner in which problems are resolved. Ahierarchical organizational structure, intended to enable the

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person at the top to bark, “Jump!” and have that order flowlike the wave at a football game into synchronized jumpingthroughout the organization is not only wholly unnecessarybut also ineffective. The best organization is, again, like thefamily. Everyone should know what is going on up, down,across, and diagonally as much as possible. And everyonewith an idea should feel free—should be urged, in fact—tocontribute to every problem and decision. An autocratic chiefexecutive officer (CEO) or vice president is about as effectiveas an autocratic spouse or parent.

There was a placard on Albert Einstein’s wall that said, “Noteverything that can be counted counts, and not everything thatcounts can be counted.” This from the guy who went down inhistory as the most counting, mathematically oriented geniusever. Everyone knows this is true except, of course, thebusiness theorists who suggest that everything important mustbe measured and that things that cannot be measured areinherently unimportant. That makes about as much sense asmeasuring yourself as a parent on your kid’s grade pointaverage, how many times he made his bed last week, and hislittle league batting average because you know how to boilthem down to numbers while writing off his levels ofcourtesy, responsibility, and kindness to others asinsignificant because you don’t know how to put a number onthem. We would all take a courteous, responsible kid over onewho can hit a baseball thrown by another 10-year-old anyday.

Somehow we have propelled management to a level at whichcommon sense and the same basic values that serve us well inthe rest of life do not apply. We have bought into theGodfather principle that separates “business” from

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“personal.” We have come to believe that the things we putinto play with our families and strive to strengthen in placesof worship on the weekend have no place in the office fromMonday through Friday. It is high time to take a big step backand take a hard look at the whole business of management.

The early histories of Ford, Procter & Gamble, Kraft,Sherwin-Williams, Armstrong, Wahl Clipper, AndersenWindows, Boeing, Buck Knives, Westinghouse, NorthropGrumman, Weyerhauser, Broyhill, Cessna, Deere,Harley-Davidson, and Parker Hannifin are stories of hardwork, common sense, and absolute commitment to makingthe best products possible. The same is true of just aboutevery business, regardless of where it is or how much it mayhave grown over the years. The machine shop on the cornerbegan because someone had a conviction that he could makesomething better than the other sources available to somesegment of some market. It succeeded because good peopleworked very hard and proved that point. The best companieswe have had a chance to observe—especially those that havesucceeded and even grown in the face of the globalrecession—are the ones driven by those same simpleprinciples: simple excellence. They do not get tangled up infar-out management theories, and they do not spend a lot oftime reading and pondering the latest issue of the HarvardBusiness Review.

The common trait among these best companies is their abilityto concentrate on the fundamentals and to keep things simple.In no particular order, people, cash, their product, and theircustomers are the priorities. Everything else is secondary.Common sense and core values—a very keen sense of rightand wrong—trumps management theory every time. The

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more complicated a new idea is, the less likely the companiesare to adopt it. The most striking difference between theexcellent companies and the not-so-excellent ones, and thearea in which they are most like watching family decisionmaking in action, is in the time frame of their decisionmaking. The future is always more important than the present.Even though companies like Wahl Clipper are enormouslysuccessful, they operate as though the future will holdformidable challenges and they have to focus on workinghard to do the right things—the difficult things—today if theyhave any hope of meeting those challenges. It is the same asthe family in which everything is firing on all cylinders butfather, mother, son, and daughter still get up every morningand head off to work and school and then come home and dotheir chores and their homework. Today is merely preparationfor tomorrow—and tomorrow never gets here. It is the polaropposite of the firms obsessed with the current quarter andwhat Wall Street wants now.

It is ironic that most companies start out very focused andlean. It is only through success that they become bureaucraticand wasteful. Then they compound the bureaucracy and wastewith management theory to help them wade through theunnecessary complexity they have created. Companies wanttheir managers to be more entrepreneurial, but they expectthat entrepreneurial spirit to thrive within the confines ofreports, meetings, metrics, structures, and financial ratios thatno entrepreneurs would ever waste a dime or a minute of theirtime implementing.

The simplest, leanest, and best-managed a company will everbe is in its infancy when senior managers wear a lot of hats,everyone is fully engaged, and the business operates with a

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sense of camaraderie forged by a shared sense of urgency.Cash is king in the start-up, and spending is tightly controlled.The start-up hangs on every word spoken by the customer,and suppliers are chosen cautiously. It takes success todestroy all of that. The road to excellence requires undoingthe fruits of success and returning the company to itsentrepreneurial roots and focusing simply on the few thingsthat matter.

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3

It’s All about Value

Go to Google and enter the search terms “cost behaviorregression analysis,” and you will be either shocked or awedby the 373,000 results, most of them on Web sites that end in“.edu.” An enormous amount of intellectual ability is stillbeing wasted on sophisticated models of manufacturing costsand how to predict and control them. Instead of harnessingmore computer power to look at costs in more complexmanners, how about this instead: spend more money on thingsthe customers will pay for and less money on things theywon’t pay for. It really should be no more complicated thanthat. Most companies, however, have their cost managementso tangled up they have no idea what adds value and whatdoesn’t.

While the mathematics of success are quite simple, they are abit more complicated than “sales minus costs equals profit.”That equation is certainly true from an algebraic standpoint;however, it is a dangerous proposition with which to manage.It leads to thinking that prices—one of the two variables inthe sales part of the equation—have something to do with

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costs. They don’t, but, again, that is a matter of commonsense. Prices are a function of the value the product offers tothe customer. All managers know that, but most fail to makethe connection.

When you are strolling the aisles at Walmart, do you carewhat the manufacturer spent to make things in deciding whatto buy? Of course not. You care about the price comparedwith what the product can do for you. And when you see twosimilar products you are not about to pay more for one thanthe other because the manufacturer of the more expensive onehappened to waste more money on paperwork or materialhandling than the other. You go through a mental exercise inwhich you are assessing three things: what you think of thequality of the two products; how well it fits your intended useof the product; and how reliable you think the two productswill be. Somehow or another you add up those three thingsand put some sort of subconscious value on them andcompare that value to the price. You don’t always buy thecheapest product. In fact we rarely buy the cheapest product;if we did there would be only one type and brand ofeverything on the shelf—the cheapest one. No, you buy theone with the best relationship of that value you assigned tothe price charged. We commonly refer to this mental math as“getting our money’s worth.”

Your business is no different. You do not succeed by beingthe low-cost producer. You succeed by being the best-valueproducer, and value is a function of three variables: quality,utility, and reliability. If the ratio of the price you arecharging to the value you are providing is better than theother guy’s, you will more often than not get the sale. If thatvalue proposition is not as good, you lose. This should be

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intuitive, but it clearly is lost on many manufacturers, hencethe exodus to China. Driven by the destructive math of salesminus cost equals profit, they believe that if only they can getthe cost down they will be more profitable. If they were notprofitable to begin with, the problem was the valueproposition, not the cost, and the notion that they can get theirproduct made cheaply in China or anywhere else withoutaffecting the value is ludicrous.

The major brands are under siege almost across the board forthe simple reason that they have missed this point. It isestimated that by 2012 over half of the retail items purchasedin the United States will be privately labeled or storebrands—and why not? If the big brands are going to bail outof manufacturing and buy lesser-value goods from China,why shouldn’t Walmart and Kroger cut out the middle menthat add no value and buy the same-value products directlyfrom China themselves? And, as consumers, why wouldn’twe want the retailers to do this for us?

Walmart takes a beating for hammering Americanmanufacturers on price—driving them to China, so thewailing goes. All it is doing is looking out for its customers’best interests and assuring that its customers get the best valuefor their money. Consider the following two tales.

The Wahl Clipper corporation,1 makers of hair clippers forboth the professional and consumer markets, has taken overthe shelves at Walmart, with higher-cost and higher-pricedproducts, driving their 100% Made in China competitors offthe shelves. That hardly squares with the charge that Walmartcares only about price and is “driving manufacturers toChina.” When it comes to hair clippers, Walmart has been

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quite happy to do the opposite. In fact, Wahl has grownmarket share by huge bounds with products priced 30% ormore higher than other companies’ by offering hair clippersthat are perhaps twice the value. Consumers don’t wantcheap—they want their money’s worth—and they believethey get more for their money when they pay more for theWahl product.

A story in the Wall Street Journal2 recently described a younglady who had been buying a $17 bottle of Procter & Gamble(P&G) brand shampoo. Times being tough, she switched to a$5 bottle of P&G brand shampoo and learned that she couldnot discern any difference. The price gap was not based onvalue but on an image created through brand managementstrategies. Having learned that she had been duped all alongby slick advertising, she made it quite clear that, no matterhow good things are in her economic future, the odds of herever falling for the advertising con that created the falseillusion of value are slim indeed.

The companies that outsource manufacturing in pursuit of lowcost are, by and large, racing each other to the opening pricepoints in their categories. In Wahl’s case, all of their Made inChina competitors are fighting each other for the bottom shelfat Walmart where the $14.95 hair clippers are sold, whileWahl happily takes the rest of the shelf space where 80% ofthe volume is. The competitors got their costs down, to besure, but lost the business in the process. And P&G proved,once again, the wisdom in the Abe Lincoln adage about itbeing impossible to fool all the people all the time.

The problem with cost reduction is that some costs add to thevalue of the product in the eyes of the customer while others

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add nothing at all. It is ironic that the companies pursuing anoutsourcing strategy are typically looking to reduce thevalue-adding costs (i.e., direct labor and materials) and areactually adding to the costs that do not add value (i.e.,overhead and administrative costs). It is wishful thinking tobelieve that the value-creating costs can be slashed by hugeorders of magnitude without affecting the value they create.This is the folly of the sudoku school of management.Managers who see manufacturing as a grand exercise innumbers rather than as a shop-floor business where materialis transformed into something tangible fall for the idea thatanybody can make anything just as well as anyone else. Inshort, they see manufacturing as a commodity, when it isanything but that. They think that the product they can getfrom China for $5 is the same as the product that comes fromtheir own shop floor for twice that amount simply becauseboth their people and the Chinese are working to the same setof engineering specifications.

The dynamics of excellent manufacturing are invisible to theprofessional manager who runs things by theory and numbers,but they were very real to the original entrepreneur whostarted the company. In companies such as Wahl, the specsare the starting point—not the end—and engineering andproduction are continually working together to makeminiscule corrections and improvements that constantly makethe product a little better. Defects and customer input arecontinually and quickly fed to the shop floor for coursecorrections. The opposite takes place when the product ismade by a cheap labor force on the other side of the world.Chinese workers with no personal knowledge of the productbecause they couldn’t afford it if they wanted it are neitherempowered nor able to work with engineers and customers

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from the other side of the globe to fix or improve anything.Instead, it is an ongoing, losing battle to produce to thespecifications and to try to filter out all of the defects beingproduced. Wahl clippers from Illinois keep getting a little bitbetter, while the quality of the competition’s clippers stays thesame or even degrades. So Wahl laughs all the way to thebank, while the low-cost manufacturers cry all the way tobankruptcy court to file their restructuring plans.

This doesn’t mean that reducing costs is not important. It isvery important. Knowing that all costs are not the same,however, is the trick. High-value producers cut the wasteruthlessly but are very careful about cost reductions toactivities that create value. Their goal is not to be the low-costproducer; it is to be the best total-cost producer—that is, withthe greatest percentage of spending going to value-addingactivities. If 60% of your company’s total spending is goingto the quality, utility, and reliability of the product while theother company devotes only 50% of its expenses to suchactivities, yours gets to charge higher prices and grow marketshare, and it doesn’t. So the objective is to continuallyimprove the composition of total spending rather than tosimply reduce all costs. If along the way you can reduce thetotal costs in addition to improving the percentage devoted tovalue creation, so much the better.

While most accountants and most companies worry aboutrelatively meaningless breakdowns of spending by “fixedversus variable” and “direct versus overhead” or aboutspending in functional departments compared with an annualbudget, the excellent companies worry about value addingversus non-value adding. Whether a cost is contributing topremium pricing and greater customer value is a whole lot

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more important than how that cost tracks on a regressionanalysis chart. Who spent the money is not nearly soimportant as why they spent it.

The challenge most companies face in determining whichcosts add value and which don’t is that they don’t really knowhow the customers are going through that “getting theirmoney’s worth” mental exercise. They don’t know thatbecause they quite often don’t really talk to the actualcustomer who makes the decisions. Walmart places no valueon hair clippers at all. They leave that up to their customers.Walmart’s objective is to provide the products their customersbelieve have superior value. So in Wahl’s case, the definitionof value is provided by end consumers—not the Walmartbuyer. To gain that knowledge, a lot of people are walkingaround northern Illinois with bad haircuts as Wahl is eagerlyputting new clippers into people’s hands to see how they likethem—fielding complaints from irate parents from time totime when their kids signed up for a free haircut from a localamateur with a new Wahl product.

Packaging machine builder Barry-Wehmiller3 tries to get thecustomer face to face with its employees who are actuallybuilding the machine to be absolutely sure it provideseverything the customer wants and needs. It knows that noteverything can be boiled down to a specifications sheet. Thebuyers in the customer’s business are rarely the peopleactually using the product; to them it is simply a numbersexercise. Barry-Wehmiller is trying to get past the middleman and talk to the people who really assign value in all of itsterms, putting them in direct contact with its people who willcreate that value.

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At the BAE Systems plant in South Dakota,4 production folkswho took suppliers’ components out of the box and used themto build missile systems were brought face to face with thelast production people at the suppliers’ plants—flippingthings around but trying to assure that the suppliers knewexactly how BAE Systems determined value. Beyond partsspecifications the actual users of the components were able totell the actual producers about the best-parts orientationwithin the box, part-labeling issues, box sizes, the bestquantities per box, and the best size of the box—lots of thingsthat typically don’t find their way onto purchasingspecifications but that make the difference between satisfiedcustomers and indifferent ones.

It requires deep knowledge of the product and its life after itleaves your plant to truly understand how that “getting theirmoney’s worth” thinking plays out. This is the real downfallof the “professional manager” school of thought. Going backto those original names—Ford, Procter & Gamble, Kraft,Sherwin-Williams, Armstrong, Wahl Clipper, AndersenWindows, Boeing, Buck Knives, Westinghouse, NorthropGrumman, Weyerhauser, Broyhill, Cessna, Deere,Harley-Davidson, and Parker Hannifin—they were thefurthest from professional managers. Rather, they were guyswho knew their product inside and out, and they would havescoffed at the notion that anyone could run their namesakecompanies because they had an M.B.A. and, therefore, couldrun any business. On the other hand, Thomas Barry andAlfred Wehmiller—a couple of old St. Louis machinebuilders—would be very proud of the way Bob Chapman isrunning the company they created way back in 1885. AndLeo Wahl would be pleased to know that his grandson has an

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engineering degree and runs the company from the position ofknowing how clippers work as well as anyone there.

Only when management knows the products, how they aremade, and exactly how customers use them can theydetermine which expenses add value. Lou Pritchett, the sageP&G leader from before they became a brand managementcompany and were focused on products and customers, said,“The primary job of sales is to represent the customer to thecompany, not the other way around.”5 The sales andmarketing function has to be fully engaged in the critical taskof reaching through and around the buyer’s office and gettingclose to true customers—then making sure the entirecompany knows exactly what those people need and want.

The most important line on the financial statements should bea very clear and bright one that indicates the expenses abovethe line that add value and those below the line that do not.This breakdown has to be very clearly understood byeveryone in the company—if the expense adds value then theactivities behind that expense have to be executed perfectlyand continually improved. The expenses below the line haveto be continually reduced and hopefully eliminated at somepoint.

Note that just because an expense might be necessary—likepaying auditors or the cost of complying with theOccupational Safety and Health Administration(OSHA)—doesn’t mean the costs are value adding; it meansonly that they can’t be eliminated entirely. However, theycertainly can be minimized. It is also important to note thatthe segregation between value adding and non-value addingapplies to spending and activities—not people. Just because

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someone may be assigned to a task that does not add valuedoes not in any way mean that the person has no value. Amultibillion dollar manufacturer6 (that shall remain namelessto avoid embarrassing them) set off to define value addingversus non-value adding and decided to call all payrollexpenses “value adding” to avoid hurting employees’ feelingsby insinuating that they are not valuable to the company. Thisis an admirable intention, to be sure, but one that completelydefeated the purpose of the exercise.

The bottom line, however, is that understanding the value ofwhat you make is fundamental to success and that the mostimportant role of sales and marketing people is their continualenhancement of the company’s understanding of value in theeyes of the customer. There is nothing for them to sell ormarket if the company is not creating value.

1 All references to Wahl Clipper Corporation are based on thepersonal knowledge and experience of author Bill Waddellfrom 2005 through the present as a consultant to WahlClipper, and his work as VP of Global Operations, as well asinformation presented by Wahl Clipper personnel at the LeanAccounting Summits in 2007 and 2009 in Orlando, Florida,and in 2008 in Las Vegas, Nevada.

2 http://online.wsj.com/article/SB124946926161107433.html;see also Byron, E, ‘Tide Turns Basic After the Slump’, WallStreet Journal, August 6, 2009.

3 See http://www.barry-wehmiller.com. The Barry-Wehmillerhistory and philosophy are well documented throughout theWeb site; additional information on Barry-Wehmiller fromBob Chapman keynote address at 2008 Lean Accounting

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Summit in Las Vegas, Nevada, author Bill Waddellconversations with Bob Chapman in 2008 and 2009, and fromcompany literature and video provided by Barry-Wehmiller toauthor Bill Waddell of internal speeches made by BobChapman at Barry-Wehmiller on unknown dates.

4 From work author Bill Waddell did with United DefenseCorp. (subsequently sold to and now part of BAE Systems) inAberdeen, South Dakota.

5 http://www.loupritchett.com/htm/management.htm from‘Lou Pritchett on Management and People.’

6 Comment made to author Bill Waddell at 2009 LeanAccounting Summit in Orlando, Florida by the CFO of aFortune 500 company.

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4

The High Cost of Poor CostAccounting

If your company uses standard costs, the only thing that iscertain is that you don’t know what your products cost. Itwould be great if the allocated, fully burdened, standard costwere actually a reflection of the cost to make something, butit is actually nothing more than the product of some fairlysimple arithmetic with no significance whatsoever.

To understand just how little such costs have to do withreality, you have only to calculate the fully burdened cost ofreading this book. To follow the same logic as accounting youhave to include the wear and tear on the book. Let’s say youpaid $39.95 for it and someone thinks that it can be read 100times before it starts to unravel a bit—so we’ll call it 40¢ forthe book itself. Then of course we have to figure in the sixhours you spend reading it at your hourly rate plus the cost ofyour payroll associated costs, including the taxes, somethingto accrue your vacation time, and also an allocated portion ofyour medical benefits. The fact that your vacation time and

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monthly medical insurance premiums will not change one iotawhether you read the book has no bearing on thesubject—just like when the standard costs of your productsare calculated. So we are going to put you down for a fullyloaded rate of $75 an hour times the six hours for a labor costof $450—plus the 40¢ for the book. Then we have to assignthe cost of the floor space in your office, the light and heatbill, depreciation on the chair you are using—let’s say about$25 an hour times six, for another $150. So your company isout $600 plus the 40¢ for each person in the company whoreads this book.

It makes you think twice about having all of your staff—alleight of them—read it. That will result in a $5,000 hit toprofits this month, right? Wrong, of course. If you have yourstaff read the book—eight copies plus one for you is nine—at$39.95 a book, it will cost you about $360, and anyone inaccounting who wants to accrue a $5,000 expense for thebook should have his or her head examined.

It is simple, just-like-you-do-it-at-home common sense again.The food budget at your house is very unlikely to includeaccrued depreciation on the oven, the pots and pans, and thedining room table. Such numbers would be a waste of time tocalculate and as meaningless as $5,000 for book reading.Why would anyone think that applying this same logic to thecost of the products you make would result in numbers anymore meaningful?

The reason for calculating such numbers is that thegovernment says you must to comply with generally acceptedaccounting principles (GAAP) when you pay your taxes. Ifyou have to deal with commercial lending officers at the

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bank, they probably want GAAP statements, too. This,however, is hardly a reason for using such data to run thebusiness.

Consider a case in which your newly married children cometo you and say, “Mom, Dad, we are seriously thinking abouthaving a baby, but we aren’t sure we can afford it. How canwe figure out what it will cost us?” Would your answer be toadvise them to read page 44 of the IRS Form 1040Instructions where they will find the Child Tax CreditWorksheet? Or would you sit down with them and go overtheir family budget and help them determine the real changesto their monthly cash flow—up and down—that are likely toresult from having a child? That, of course, is a rhetoricalquestion. No one would use government figures to make realdecisions for anything that is not directly related to taxes. Youwould not haul out last year’s tax return to decide if you canafford a vacation this year. You would get out your bank bookand go over the family budget with a sharp pencil.

Thinking the complicated calculations resulting in standardcosts are any more relevant is silly. Those numbers are goodfor filling out forms for the tax authorities and nothing else.They certainly should not be used to make any importantbusiness decisions—like pricing or whether to outsourceanything. If you want to decide how much it will cost to havethe staff read this book, get rid of all the allocations andaccruals—those are just accounting terms for numbers thatare not real—and use the only thing that is real: the $39.95 acopy it will actually cost you. The calculated $600.40 a copyis useless, as is the standard cost for your products. After thetax returns are filed, those standard costs should never see thelight of day.

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The destructive impact of traditional cost accounting—withall its allocations, accruals, and assumptions—was firstexposed in a big way by Tom Johnson in 1991 in RelevanceLost7 Since then the issue of manufacturing accounting hasbeen at the center of hot discussions, to which accounting hasgenerally contributed very little. This is finally changing,however, with the advent of Lean accounting. JeanCunningham’s book on the subject, Real Numbers8 is veryappropriately titled.

The fact is that the traditional accounting practices actuallydiscourage good manufacturing practices. With roots in thesame ROI formulas that say cash is no more valuable thanpurely paper assets, full-absorption accounting encouragesbuilding inventory to absorb more of the fixed overhead andto keep it off the profit and loss statements—and of coursediscourages inventory reductions for the same reasons. Thatalone should be proof of the serious errors in standard costaccounting. Anyone with the least bit of manufacturingknowledge knows that building inventories and lengtheningcycle times is bad practice in every dimension. It drives upindirect costs, gobbles up floor space, undermines qualitycontrol, and creates the need for big complicated computersystems to keep track of it all. An accounting system that sayssuch an inventory build-up is good regardless of the obviousharm it does is clearly very flawed.

There is an often-repeated joke about a guy whose wife askshim to stop at the meat store and bring home a ham. He doesso, but his wife gets after him for failing to instruct thebutcher to cut off the end of the ham first.

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“Why,” the guy asks, “do you always cut off the end of theham?”

“I don’t know,” the wife answers. “It just makes the hambetter. Besides, that is the way my mother taught me, and herhams were always perfect.”

Dissatisfied, the guy calls his mother-in-law and asks her thesame question. He gets about the same answer: it just worksbetter that way, and her mother always did it that way. Nowhis curiosity is thoroughly roused, so he calls the grandmotherat the retirement home and asks her why just the end of theham has to be cut off.

“I don’t know why anyone else would want to do it,” the oldlady answers. “I cut it off because I never had a pan bigenough to hold the whole ham.”

Members of senior management should ask why as manytimes as it takes for accounting to give them an answer as towhy accounting has to be done this way and who says this isthe only way or even the best way to account formanufacturing. In all likelihood, the accounting departmentwill come up empty and have no explanation for the originsand the basis for such absurd assumptions about the financialimplications of manufacturing. The few steeped in accountinghistory will be able to explain that most of it goes back to ahopeless alcoholic by the name of Donaldson Brown whoworked for General Motors (GM) in the 1920s.9 It is donethis way because General Motors did it that way and made alot of money back in the day. Most of it codified into lawthrough an Accounting Research Bulletin formalized in 1953.So you are locked in a battle for the very survival of your

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company against the fiercest of global competitors armedwith financial thinking that has not progressed one iota sincethe Dwight Eisenhower administration. While every otherfunction of the business is pedaling as fast as it can to keep upwith the state of the art, often using technology developedafter Bill Gates retired, an accounting function stubbornlyinsisting on standing pat with practices codified the year BillGates was born is unacceptable.

Concepts such as product or customer profitability have to bekicked to the curb. There is no such thing. Only businessescan be profitable—or not. Every product and every customercontribute to your profitability to varying degrees. The onlyquestion is how much of your operating costs they cover. Ifone of your staff goes out and saves you $500 as a result ofreading this book, common sense would say that you got apretty good return on a $39.95 book. Accounting would saydon’t let anyone else read the book since you lost $100.40 onthe deal. Accounting reports that say you lose money on anyparticular product are based on precisely the same illogicallogic.

Equally pointless is worrying about whether costs are fixed orvariable. The answer is yes they are fixed, and yes they arevariable. In the short-term all costs are fixed. In the next hourthere is next to nothing you can do to change the costs in thefactory. They are past the point of no return and are prettysolidly fixed. Over the course of the next five years,everything can change, including where the factory is locatedand whether anyone in senior management still has a job.They are all variable. So everything is fixed in the short-termand variable in the long haul, and some of both anywhere inbetween. But so what? Does knowing whether they are fixed

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by some mathematical definition matter in any practicalsituation? Even if your clever teenage son provided you witha regression analysis of your electric bill demonstrating thatthe bill is statistically fixed, you would still tell him to turnoff the lights, the TV, and the stereo when he leaves the room.

Whether someone in accounting determines that something isfixed or it is variable, you still want the same thing. You wantthe organization to find ways to spend less of it—especially ifit is something that creates no value for the customers.

The central issue is that you have to get the fog andcomplexity out of your accounting processes and start tomanage the business with real numbers—real, practicalnumbers put together largely the same way you put togetheryour household budget. In some companies the answer to thequestions of what was spent last month and was it more orless than the month before cannot be discerned from thefinancial statements. They are such a compilation of accruals,allocations, and GAAP-based nonsense that such fundamentalinformation is unknown and, often, unknowable. That has tochange, and your accounting folks need to be out in frontleading the way—not coming along complaining, kicking,and fighting every step of the way.

Often, before the accounting team members can begin togenerate useful numbers their role and responsibility needs tobe redefined. In far too many companies accountingemployees have taken their audit and fiduciary controlobligations to such an extreme that they no longer feelresponsible for helping to lead the company. They areallowed to sit on the sidelines as some sort of uninvolved,impartial judges of the rest of management rather than to

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operate as fully responsible and equally committed membersof the management team. That aloof, irresponsible role iswhat the outside auditors are for. Accounting team membersshould in no way be tasked with conjuring up numbers tomake things look better than, or even different from, reality.They simply have to get out ahead of the lean-accounting,real-numbers curve and lead the company instead of fightingchange for no good reason.

The first accountant who raises Sarbanes–Oxley asjustification for providing management with uselessGAAP-based data to run the company should be told tore-read the Lean Accounting book, Sarbanes–Oxley, or both.That is a sure sign of an accountant who (1) doesn’t want tohelp, (2) doesn’t really understand Sarbanes–Oxley, or (3)both. In any event, the company needs financialleadership—not 1953 thinking and the work product of aGeneral Motors engineer from the Roaring Twenties—if itwants to join the ranks of the excellent companies. Bigcompanies like Boeing and Parker Hannifin, mid-sizedcompanies like Wahl and Barry-Wehmiller, and companies assmall as 40-employee BRAMS,10 as well as hundreds ofothers, have tossed GAAP and standard costing out thewindow and are managing the business with those realnumbers of which Jean Cunningham wrote. The rest ofmanufacturing has to do the same.

7 Johnson, H.T. and Kaplan, R. S. Relevance Lost; The Riseand Fall of Management Accounting; Harvard BusinessSchool Press, Boston, 1987.

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8 Cunningham, J. Fiume, O. and Adams, E. Real Numbers:Management Accounting In a Lean Organization. ManagingTimes Press; Durham, N.C., 2003.

9 Waddell, W.H. and Bodek, N. Rebirth of AmericanIndustry, PCS Press, Portland, Oregon, 2005. In Rebirth ofAmerican Industry the evolution of the General Motorsmanagement system and the roles played by Alfred Sloan andDonaldson Brown are described, as well as the evolution ofHenry Ford’s manufacturing and management system and itsevolution to the Toyota Production System and the rolesplayed by Taiichi Ohno, Shigeo Shingo and others at Toyota.The origins of the DuPont ROI model are also described ascentral to the GM management system. All references to thesecompanies and individuals arise from this book and the readeris advised to refer to that book for further information on anyof these people or subjects.

10 http://www.leanaccountingsummit.com/ The list ofcompanies pursuing and practicing Lean accounting iscontinually changing and being updated on this Web site. Thecompanies cited are from this list as well as author BillWaddell’s personal consulting experience.

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5

Can We Find a FewRighteous People?

We may not be living in Sodom or Gomorrah, but it sure feelsthat way to read much of the business news. The folks atGeneral Electric (GE) admit to fraudulent dealings with theU.S. Securities and Exchange Commission (SEC), Chiquitaadmits to funding terrorism in Colombia, the head of RioTinto in China sits in prison for bribery, and the boss at KIAis elated to have his embezzlement prison sentence reduced tohouse arrest—all that is before we get to Bernie Madoff,Allen Stanford, and the rest of the financial sector where theserious crimes have been committed. Most of the shadydealing that seems to have become common business practicedoes not rise to the level at which executives go to jail, butgreed sure seems to be the order of the day, even at thecompanies doing well and enjoying sterling reputations.

Smarter people than us will have to figure out how things gotto where they are, but one thing we know for sure is that thedriving principles of the excellent companies are far from this

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“every man for himself by any means possible” thinking.Perhaps the best example is Bob Chapman atBarry-Wehmiller. He is living proof that driving the businessby a strong values is not incompatible with making money butis actually the key to business success. The packagingequipment manufacturer based in St. Louis has grown its topline by a factor of four since Chapman took over a few yearsago, and the bottom line is growing correspondingly.

Chapman sounds more like a Baptist preacher than a businessguru. The Barry-Wehmiller Companies “achieve principledresults on purpose,” he says, “by continuing to develop agrowing business sustained through the power of inspiringpeople toward a fulfilling experience.” Larry Culp at theDanaher Group11 says they succeed because they “retain,attract, and develop the best talent available,” and they do soby demonstrating “high integrity” and the “utmost respect forpeople.” Contrary to the view of people as headcount to beminimized in pursuit of maximizing shareholder value—andmaximizing the personal bank accounts of seniormanagement along the way—these guys make it pretty clearthat something bigger than themselves is driving theirbusiness decisions.

We seem to have arrived at a cultural fork in the road, andmembers of senior management have to decide which paththey will take and then must demonstrate their commitment tothose principles. Platitudes don’t cut it anymore. Companieslike LEGO are all too commonplace.12 It put flowerynonsense up on the walls at corporate headquarters and in theannual reports about people being “indispensable forsustainable business success and for promoting the LEGOGroup’s corporate values and culture” and then laid off 5,300

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of those “indispensable” people so essential to their“corporate values and culture” when they outsourcedmanufacturing to just about any and every low-cost countrythey could find. Talking the talk is easy—walking it isanother matter entirely. What guys like Chapman and Culpsay is meaningful only because their actions demonstrate theirconvictions.

Greg Wahl says that his heart has to have as much weight inthe decisions at Wahl Clipper as his brain: do the right thingby all of the people who depend on the company. So Wahlhasn’t laid anyone off in some 35 years—long before thecurrent management team was in place. SC Johnson hasn’tlaid anyone off in its 126-year history,13 and it never will aslong as someone named Johnson is running the company.Google operates by the straightforward principle, “Don’t beevil,” and is willing to walk away from the huge market inChina to follow that principle.14

You don’t have to be a follower of any religious faith to be agood manager. You do, however, have to believe that youhave a heavy obligation to all of the stakeholders in thebusiness that is at least as great as the obligation you have tothe stockholders and as important as the size of your annualbonus check. The Pope stated it well in his recentEncyclical15 when he wrote, “Business management cannotconcern itself only with the interests of the proprietors, butmust also assume responsibility for all the other stakeholderswho contribute to the life of the business: the workers, theclients, the suppliers of various elements of production, thecommunity of reference.”

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Chapman agrees. He says that the great obligation and thegreat opportunity of members of senior management are theirunique position in which they can affect hundreds, thousands,maybe even millions of lives. The measure of managementsuccess is not financial but is in what they do with that chanceto make so many lives better.

Lest any of this sound like a call to social work, make nomistake about it. All of these companies make a lot of money,and their investors do very well by them. That treating peoplewell and taking good care of customers, suppliers, and thecommunity yields great results should not come as much of asurprise. It is a very straightforward, simple, andcommonsense proposition. What is complicated are theconvoluted rationalizations management theorists conjure upto explain how you can obtain profits while abusing thosestakeholders. That takes some very strained logic to explain.

Suppliers take better care of customers who demonstrateloyalty to them. It’s not rocket science. The same is true ofthe community. The local politicians and city fathers andmothers jump through hoops to take care of the big employerthat sustains and supports the community. They don’t look atthe employer that sees their husbands, wives, sons, anddaughters as “headcount” quite the same. Again, this ispatently simple and obvious, and it takes only a moment tostep back and realize it. What is complicated is convincingyourself that the opposite is true.

Old Alfred Sloan, the management “genius” who planted theseeds for what General Motors has become—a failed,government-owned dinosaur and the epitome of badmanagement from top to bottom—once wrote that workers

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simply had to “accept the hazard of the business cycle.” Inother words, getting laid off when it is convenient is just theway it is, and people working for him had to learn to live withit. They had to learn to save for the unavoidable rainy days,and to think otherwise was a “panacea” and “wishfulthinking.”

Chapman, Culp, and Wahl don’t think that the employees oftheir companies have to accept the hazards of the businesscycle. They know they are critical to the long-term success ofthe business. Fisk Johnson from SC Johnson believes that“the goodwill of the people is the only enduring thing in anybusiness. It is the sole substance. The rest is shadow.” Theseguys are endowed with enough common sense to know thatthe people they take such good care of will reciprocate and goabove and beyond the call of duty to make sure the companysucceeds. The history of the United Auto Workers(UAW)—the folks Sloan and the modern business theoristsview as headcount who should learn to live with whatevermanagement dishes out in pursuit of short-term profits—ishardly one of going above and beyond the call. That shouldcome as no big surprise to anyone.

So what does all of this mean to your business? It meanssenior management as a group has to decide what the businessis all about. You have to decide what you are trying toaccomplish and what your operating principles are: what arethe rules and limits, and how are you going to go about doingbusiness? You have to do a lot better than set the goal asmaximize shareholder value. That is about as meaninglessand uninspiring a goal as can be imagined. Try somethinglike, Provide superior value to our customers to maximizelong-term value for the shareholders and to simultaneously

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provide security and value to our employees, suppliers, andthe community in which we operate. However you choose tophrase it, defining your goals simply and with common senseand common decency is an essential launching point forjoining the excellent companies.

A good approach, once again, is to tie it back to your family.One of the authors was once chastising a young Chinesemanufacturing manager for the conditions of the workplace ina factory area. The Chinese manager, with no frame ofreference for understanding American expectations forcleanliness, lighting, and safety, asked for some specificdirection. The American knew the manager had a teenagedsister and offered that up as the standard: “Ask yourself if youwould want your sister to work here. If the answer is no, thenyou have work to do. When you get things cleaned up to thepoint that the answer is yes, then it is clean and safe enough.”At the next visit to the Chinese factory, the improvement wasextraordinary. The “little sister standard” is universal and canbe the guide for cultural transformation. Decide what youwant the stated goal to be of the company for which your littlesister—or spouse, son, or daughter—is going to work. Thatshould be the same goal you set for the people working foryou who have bet the livelihood of their families on yourintegrity and ability.

11 From author Bill Waddell’s conversations between 2005and 2008 with Mark Deluzio, former Vice President andCorporate Officer at Danaher, now President of LeanHorizons Consulting.

12 LEGO’s initial strategy to outsource manufacturing and layoff staff can be read about at http://money.cnn.com/

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magazines/fortune/fortune_archive/2006/06/12/8379252/ Their subsequentacknowledgment of the failure of that strategy can be readabout at http://ing.dk/artikel/96451-lego-her-er-opskriften-paa-succes While the secondarticle is written in Danish, it generally states that Lego nowbelieves that insourcing – bringing manufacturing back fromthe third parties in low labor cost countries, and building onintellectual capital is the key to success.

13 http://www.scjohnson.com/en/company/overview.aspx TheSC Johnson Web site contains a wealth of information on thecompany’s history, cultures and values.

14 http://www.google.com/intl/en/corporate/tenthings.html;Google; ‘Our Philosophy – Ten Things We Know to be True’Google’s dispute with and exit from China were welldocumented in the media throughout the Spring of 2010.

15 Encyclical Letter CARITAS IN VERITATE of theSupreme Pontiff Benedict XVI to the Bishops Priests andDeacons Men and Women Religious the Lay Faithful and AllPeople of Good Will on Integral Human Development inCharity and Truth; Given in Rome, at Saint Peter’s, on 29June, 2009. The document can be found athttp://www.vatican.va/holy_father/benedict_xvi/encyclicals/documents/hf_ben-xvi_enc_20090629_caritas-in-veritate_en.html

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6

People

“We believe that business enterprise has the opportunity tobecome the most powerful positive influence in our societyby providing a cultural environment in which people canrealize their gifts, apply and develop their talents, and feel agenuine sense of fulfillment for their contributions in pursuitof a common inspirational visions.” So says Bob Chapman,chief executive officer (CEO) and chair of the enormouslysuccessful Barry-Wehmiller Companies. Chapman hammerson themes like his vision of “achieving principled results onpurpose” and defining his management team as L3 —theLiving Legacy of Leadership—bringing together the tools ofLean manufacturing with Barry-Wehmiller’s uniquepeople-centric beliefs.

While some of the things Chapman says and writes soundhokey, under his leadership the Barry-Wehmiller Companieshave experienced amazing growth and financial success.According to Chapman, the real value in being a successfulmanager is that it gives you an incredible opportunity to havea positive impact on hundreds, or even thousands—perhaps

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millions—of lives. If you handle the job right, you can impactevery employee, every customer who uses your products, andthe employees of every supplier, as well as countless peoplein your communities, in a positive way. That—and notfinancial reward—is the thing of lasting value you can takeaway at the end of your career. Of course, the company has tomake money along the way for you to fulfill thisopportunity—and Chapman does it. He makes a lot of moneyfor his company, which enables him to touch all of those livesin a positive manner.

To reach the excellent Barry-Wehmiller levels ofperformance, members of senior management first need thecourage to get rid of the jerks. If 95% of the people in anyorganization show up every day, willing and often eager to dotheir job as best they can and to behave in a positive,supportive manner, then 5% of the folks have some otheragenda. Just about every company has them—often perceivedto be indispensable because of a tremendous amount of tribalknowledge in some aspect of the business or another.

Usually senior managers are blind to these folks because theyseem to be very capable: walking encyclopedias of productand part numbers or the arcane details of some system orprocedure. They thus come across to their bosses as quitevaluable to the business. More often than not, however, theyare the people who use that vast knowledge to argue whythings cannot be changed, why other people’s ideas andopinions are no good, and why they have to continue to be atthe center of everything happening within the company.

One manager described these folks as being like the alligatorsand crocodiles in the river. They win the fight by dragging

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their prey down to the bottom where they are invincible. Ondry land, they are not nearly so tough. The people in yourorganization who fit this mold are the ones who often won’tengage in ideas—instead they want to pull the discussiondown to detailed exceptions and the minutiae of the businesswhere only they have the facts.

Those unfortunate enough to have to report to these folkscannot stand them because the only behavior they support isthat of lackeys, and their peers tend to avoid them as often aspossible. The great frustration in the organization is membersof senior management’s defense of the jerks, showeringcredibility and public praise on them.

The problem is that they are indispensable to senior managersbut not to anyone else. There are usually lots of folks fullycapable of getting the jobs done that these folksdominate—often capable of doing it better—but they are notallowed inside the tent.

Senior managers must recognize that they have a unique,skewed perspective. For one, people often behave verydifferently around the big boss than they do with their peersand subordinates. Also, what is an impressive command ofdetail to senior managers is usually common knowledge atlower levels. The difference is that most people do not feelcompelled to impress senior management with thatknowledge.

It falls on Human Resources to root these people out of theorganization. Peer reviews, 360° performance appraisals, and“bottom-up” assessments are typical techniques. In one formor another, the people imbued with authority in the company

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have to be subject to formal feedback from their peers andsubordinates, and senior managers have to put more weighton these feedback processes than on their own limitedobservations of the first-line management of the company.

No matter how it is done, the few in the organization whoseagenda is a selfish preservation of power have to be rootedout. All of the platitudes about people being the mostimportant asset are quite true, as are the ones about being onlyas strong as the weakest link. Detailed knowledge of howthings are currently done is vastly overrated in mostcompanies, and the willingness to learn and work hard tend tobe equally underrated.

The most valuable person in the organization is one who canwalk through the door and perform any job in the place—andis willing to do so. Of course, that person rarely exists,especially in a good-sized company, but the principle stands.The more jobs the people in the company can do, the greaterflexibility the company has and the less is the need forspecialized support people. Not only should people be able toperform a number of production jobs, but, more importantly,they should also be self-supporting.

It is a terrible waste of talent when, as is almost always thecase, the best production people are moved out of the jobs inwhich they actually create value forcustomers—production—and are put into non-value-addingjobs inspecting parts, handling material, and supervising.Consider a young lady we know who has worked her wayfrom an entry-level, shop-floor position to a fairly importantrole in cost accounting. When asked to take over the financerole in supporting one of the major value streams, she wanted

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no part of it because the job was “back on the other side of thewall”—within the plant instead of in the office area. This wayof thinking is a very common culture and serves as a bigobstacle to excellence. People have been conditioned tobelieve that the worst job in the company is the one thatactually makes things—and the further from it they can getthe better their job and the more important their role. Usuallythere is good reason for thinking that way: in most companiesthe further people are from production the more they are paid.This must change.

One necessary solution is to get rid of production support jobsaltogether. Contrary to the gloom and doom about theeducation systems, workers in the United States, Australia,and Western Europe are far better schooled than theirlow-cost country counterparts, where the norm is asixth-grade education at best. The superior education of youremployees has to be put into play. It is hard enough tocompete with the wages of backwater places withoutcompounding your production folks’ wages with unnecessarysupport. There is no reason people cannot get and keep trackof their own parts, inspect their own work, and maintain theirmachines, and they certainly should not need a glorifiedbabysitter to make sure they show up for work on time andstay at their tasks.

In a typical manufacturing company, the ratio of direct,production employees to indirect hourly labor is close to 3:1.In the best companies it is over 4:1 and often closer to 5:1.These companies accomplish significant elimination ofnon-value-adding labor cost by relentlessly training theirpeople and setting expectations higher for people to beself-supporting.

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The BAE System plant in Aberdeen, South Dakota, is perhapsthe best example of just how effective the human resourcesfunction can be handled. There are two levels in the plant: theplant manager, and her 250 or so direct reports. Theemployees are almost entirely self-directed, working in teamsthat set their own flex-time hours and productionassignments. The only way to get a raise is to learn a newskill, so there are few people who can only machine, weld,assemble, handle materials, or anything else. It typically takesa year or two to master one of the critical skills—mastery iscertified by that person’s peers—and a pay increase isgranted. Employees need to move on and learn somethingelse, getting started on the next year or two’s efforts, to gainanother pay increase. In the meantime, however, they areworking in a production job that decreasingly needs anyoneelse to support it.

The plant, by the way, sets records for delivering missilelaunchers on time to the Navy and for continually reducingcosts. It also has one of the thinnest human resources policymanuals around. The guiding principle is not rules butfairness. Fairness in most companies has been defined astreating everyone exactly the same—largely to avoid even ahint of discrimination. When most of the decisions typicallymade by managers in accordance with a rule book are madeby an employee’s peers, however, a whole new definition offairness emerges. It has more to do with the true definition ofthe word fair. When a very good employee, whose spousealso works, has young children with the flu, in mostcompanies they are on the horns of a dilemma, trying todetermine which parent can better withstand the absenteeismpolicy violation. Members of management treat the slackerwho needs a day off to recover from a hangover the same as

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an outstanding worker with sick kids often because they don’tknow the difference, and when they do it is to avoid beingsued for mistreating the slacker. The peers know thedifference, however, because they work next to them all daylong, and that lawsuit is a lot harder to bring against aself-directed work team setting its own flexible workschedules.

The other ingredient is incentive compensation. Managementconcerns that employees left to their own devices—whetherin handling and assuring the proper accounting for materials,inspecting their own work, certifying each other’s skills, orhaving input to individual and group scheduling—will notlive up to their expectations can be allayed by giving asignificant portion of compensation in the form of bonus paybased on bottom-line results (e.g., delivery performance,value-stream profitability, quality levels). This alignsemployee goals with management and the rest of thestakeholders. They are just as concerned with getting thingsright and making sure good employees are supported whilebad ones are moved out because their paychecks largelydepend on those results.

The bottom line in managing people is this: (1) get rid of thebad eggs and move the best people as close as possible to theline of fire where production and value adding are takingplace; (2) train people relentlessly and pay generously forskills (and give that generous pay from what is saved byeliminating non-value-adding positions); (3) set highexpectations for people to be self-supporting; and (4) treateveryone fairly instead of the same and enlist the help ofevery employee to assure that fairness is properly defined.

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7

Channels and Chains

Everything that happens from the time someone digs thematerial out of the dirt, cuts down the tree, or otherwise pullsit out of its natural state until it gets to you is called the supplychain. Everything that happens after you until the finalconsumer buys the product and uses it up is called thedistribution channel. These terms are just two ways ofbasically saying the same thing—the whole series of eventsrequired to go from birth to death of a manufacturedproduct—but your suppliers think you are part of theirdistribution channel, whereas your customers see you as partof their supply chain. Whether you are a link in a chain or thecontroller of a section of channel, the important point is thatyou are not in control of much of anything. Rather, you aremerely one step in a whole series of events and organizations,and your success is a function of how that whole thingperforms. The sole judge of whether the channels and chainsare successful is the end consumer, who sets the rules; youlive or die based on how well you execute in conformance tothose rules.

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As fundamental as this might seem to be, or as much asmanagers want to write this off as some theoreticalmacroeconomic gobbledy-gook with little application to theirreal day-to-day work of making a profit, failure to understandand put into practice this basic idea is what causesmanufacturers to lose customers and sales. It is not about you:what you want or need, what you think you do best, your“core competence,” or anything else having to do with yourbusiness. Instead, it is about what the end customers wants,and you either deliver or don’t.

Every purchasing person has long experience with suppliersor would-be suppliers attempting to dictate lead times,payment terms, quality procedures, and, of course, price. Infact, those aspects of the relationship between sequentialplayers in the chains and channels are not up to either ofthem. The notion that the lead times, for instance, should beon your terms rather than the customer’s is a very commonexample of missing the basic point of supply chain economicsentirely.

Perhaps your customer is selling to Walmart, which dropsorders via electronic data interchange (EDI) with the termsthat the order must ship within 72 hours or be canceled. Ormaybe your customer is an auto assembly plant with a 10-dayrolling schedule. Maybe your customer is making missilelaunchers for the U.S. Navy with a set contract for deliveryaccording to the schedule for the construction of a new Navydestroyer. When you think you can “negotiate” lead timesgreater than the terms your customer has to live up to, you aresimply asking your customer to finance a disproportionateamount of inventory. For example, the customer ships toWalmart in three days, whereas you want two-week lead

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times. That means there are 11 days of uncertainty yourcustomer has to cover with an investment in an inventory ofyour products. To the extent that it cannot make its ownproducts in three days, it is already carrying an inventory ofits own finished goods—and now you want it to tie up cashand floor space and eat the carrying costs of your product,too? No, this is hardly some vague macro theory meaningnothing in the day-to-day rough-and-tumble of buying andselling. It is right at the heart of why companies are often toowilling to dump one supplier and move to another.

If your customer’s customer pays in 60 days but you have a“policy” of selling on two 10-net-30 terms, you are doingnothing more than asking your customer to be your bankerand to finance your investment in the supply chain.

The Navy is demanding a 5% annual cost reduction in itscontract to build destroyers; retailers are in a battle tocontinually reduce prices to consumers; car companies aredoing the same. Meanwhile, if you are sitting a mile up thechannel or eight links up the chain, telling your customersthat you need a price increase, then you are out of touch withthis basic point and are setting yourself up for failure.

The old McCulloch Corporation,16 well on its way tobankruptcy at the time and not too surprising to anyonefamiliar with it, once decided that Home Depot’s policy ofaccepting customer returns for any reason was unreasonable.It unilaterally established a return authorization policy andhad the gall to send a pad of preprinted forms describing thedefect and justification for the returns to all of itscustomers—Home Depot included—informing them that acompleted form had to accompany every returned product for

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McCulloch to issue a credit. A few weeks later, a skid ofreturned products arrived at the McCulloch warehouse inTucson. Accompanying the skid was Home Depot’s formtelling—not asking—McCulloch that it was taking a credit forthe product. Included was also one of its pads of preprintedreturn authorization forms. Across the back of the pad, on thecardboard backing, was scrawled in black marker, “This s**tdon’t work.” McCulloch got the message—it did not reallyhave the authority to decide what the return policies would befor that channel.

McCulloch personnel complained that some chain saws hadbeen purchased, used once, and then returned even thoughnothing was wrong with them. Some guy had one small treeto cut down and basically borrowed a McCulloch chain sawfrom Home Depot to do the job. Was it unfair to McCulloch?Of course. But that is just the way it works in that supplychain. Home Depot—and, more importantly, Home Depot’scustomers—had determined that a “no questions asked”return policy was an essential element of the valueproposition: the “reliability” part of the value troika ofquality–utility–reliability. It took the risk away fromcustomers who bought products they were often unfamiliarwith or were not sure were right for the job. The appropriateresponse to this rule of the supply chain would have been toput the same terms to their suppliers—not to try to push backon Home Depot.

It works both ways, of course. Just like you cannot go to yourcustomers demanding terms more lucrative than those definedby the end customer for the distribution channels in whichyou operate, you cannot tolerate suppliers coming to youtrying to do the same. Suppliers that do are merely inviting

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you to go to their competitors and find one that will play bythe rules of the chains and channels in which you operate.

By the same token, you can’t get away with expecting morefrom your suppliers than the customers are demanding of you.When you get 10-day lead times and 30-day payment terms,if you think you can dictate one-week lead times and 60-daypayment terms you are doing nothing more than urging yoursuppliers to change their focus to another distributionchannel. This is the sort of nonsense the auto companies didunder the guise of “Just In Time.” GM simply pushed all ofthe inventory investment, risk, and cost back on its suppliersto make its own books look good, oblivious to the fact thatthe supply chain wasn’t improved one iota. Doing this merelydrove its suppliers to China and many to either bankruptcy orto strategies that lessened their dependence on the automotiveindustry. Toyota and Honda, on the other hand, have notforced shorter lead times on their suppliers so much as theyhave demanded that their suppliers develop the capability ofproducing in shorter lead times. The big difference is thatToyota and Honda were intent on driving inventory out of thesupply chain all together, whereas GM didn’t care about thesupply chain so long as the inventory was not on its books.

Knowing the chains and channels in which you participateand picking the right partners is essential. There is noshortage of big companies like GM that either don’tunderstand these basic points or don’t care and freely throwtheir weight around, trashing suppliers and taking advantageof customers. When you accept purchase orders from a link inone of their supply chains—unaware of how fundamentallydysfunctional the overall chain is—you are setting yourself upfor disaster. GM’s bankruptcy and the demise of a bunch of

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big tier-one suppliers made the headlines, but they deservelittle sympathy. They are the ones who chose to trash thesupply chain for their own benefit, abusing everyone elsedown the chain and up the channel. Those who were forced tolearn hard lessons were the thousands of smallmanufacturers—tier-three suppliers and the companies thatsold to them—taking a beating or going under completelybecause they failed to look all the way down the distributionchannel and see that they were hitching their stars to an“every man for himself” supply chain.

Customer–supplier partnerships have been a widely banteredbuzzword in recent years and have generally beenmisunderstood and abused. This idea of knowing the rules ofthe supply chain as set by the end customer and becomingvery, very good at executing in conformance with them iswhat partnerships are really all about. A chain or a channel oftrue partners is one in which all of the participants understandand share in the investment, risk, and effort to meet the endcustomer’s definition of value. The more typical chains andchannels are the ones populated by a bunch of mercenariescontinually looking to get a few more pennies from bothcustomers and suppliers to make themselves more profitablein the short-term, with little regard for the impact on anyoneelse and even less regard for the impact at the end of thechannel where real customers reside.

One pretty good dictionary definition of the wordpartnership17 is “a relationship between individuals or groupsthat is characterized by mutual cooperation and responsibility,as for the achievement of a specified goal.” That gets at whata supplier partnership is really all about. Expecting a supplierto enter into a “partnership” and mutually cooperate and

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accept responsibility for the specified goal of making yourcompany more profitable regardless of the impact on itssupply chain or the supply chain in total is not any kind of apartnership. It will not work or withstand long-term stress.Only when the specified goal is maximizing value for yourcustomers can a partnership with your suppliers have validity.

A big difference between the excellent and not-so-excellentcompanies is that the good ones are selective about theircustomers, whereas the bad ones jump at every opportunity tosell anything to anybody. One contract manufacturer weknow has a 10-point assessment that all members of seniormanagement contribute to in evaluating a new customer. Thelist encompasses things like the culture and strategy of thepotential customer to make sure there is a good fit betweenthe two companies. This manufacturer is trying to get at thisdefinition of partnership: will this new customer be a fair,honest partner in the effort to continually improve? It is notlooking for easy customers; in fact, one criterion is whetherthe new customer will put pressure on the company to getbetter in areas in which it knows it should get better. Theexcellent companies can cite examples of declining salesopportunities for reasons other than the creditworthiness ofthe potential customer.

It is not easy being a supplier to SC Johnson, Wahl Clipper,Parker Hannifin, or Boeing, but it is not easy being themeither. They take care of some pretty demanding customersand operate in some high-stress supply chains and distributionchannels. They expect no less from their suppliers than theyexpect from themselves, but they expect no more either. Amanufacturer has to know the chains and channels in which itchooses to participate, and it has to know it all the way to the

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final customer. You have to be aware of the rules and make aconscious decision to play by those rules—or to find anotherchannel in which the rules are more to your liking.Attempting to do otherwise is asking the good potentialpartners—both customers and suppliers—to sooner or laterkick you out of their sandbox and find someone a lot morefarsighted to play with.

16 From author Bill Waddell’s experience as VP of SupplyChain at the McCulloch Corporation, Tucson, Arizona from1996 to 1999.

17 http://www.yourdictionary.com/partnership

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8

You Gotta Go with the Flow

While it would be helpful if the sales and marketingcommunity and the operations folks could get on the samepage and decide whether we should call this series ofactivities a chain or a channel, we have to give them credit forboth coming up with metaphors that denote continuity. Theyare all talking about the flow of materials all the way from theraw state to the final consumption of it in the form of someproduct someone will use to destruction. It seems reasonableto assume that how well that flow proceeds through yourfactory from the receiving dock to the shipping dock wouldbe a big driver of how well you do.

In fact, all of the really big leaps in manufacturing have beenbig improvements in flow. Henry Ford’s assembly line wasnothing if not the epitome of how a radical improvement inflow drives a radical improvement in profits. The assemblyline where the finished cars are put together is a big deal inthe eyes of the public and the press, which know next tonothing about manufacturing. The professionals, however,could see that putting an incredibly huge and complex

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machining operation, that makes engines and transmissions,in continuous motion, was really the heart of it. He didn’t putcars together in a matter of a few days; he took raw iron ore tosteel to machined components to engines to cars in a fewdays—and made a staggering amount of money by figuringout how to do it. When Ford uttered the often scoffed-at line,“The customer can have any color he wants, so long as it isblack,” he was not only demonstrating an appalling lack ofconcern for how his customers define value (which wouldultimately do him in), he was also talking about flow. Thecost of a Model T was ridiculously low because of theridiculously high rate of flow he achieved. Stopping the flowto change over to another color would have killed the giantcost advantage he had achieved. High flow means low cost.

Before developing into the ideas of Lean manufacturing and“Kaizen Kowboys” who want to come into your factory andlead a project laden with mysterious Japanese terms aboutsenseis and kaikaku, the folks at Toyota described theirextraordinary manufacturing approach as the continuouscompression of time and space—the time it took to flowthrough their radically smaller factories.

Before Six Sigma18 was hijacked by consultants wearingodd-colored belts, it was the driving force behind Motorola’sincredible manufacturing success in the 1980s. Itsabandonment of those principles was the energy behind itsutter failures in manufacturing in later decades. At the outsetMotorola was driven by the mantra, “The best qualityproducer is the shortest cycle time producer, and the shortestcycle time producer is the best cost producer.” It was all abouteliminating the variations in flow—the things that causedproducts to stop moving. Sitting idle, the fixed costs were

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rolling on without products moving in and out of the factoryto absorb them. The impetus behind Six Sigma was exactlythe same principle behind Ford’s assembly lines and Toyota’sJust-In-Time theory.

The idea that a factory should be broken down intodepartments—machining in one corner, molding in another,and assembly somewhere else—in the middle of the flow infrom the supply chain and then out through the distributionchannel defies logic. The justification usually has somethingto do with direct labor: either getting all of the similarlyskilled people together so they always have something towork on, or putting them all under an overseer who knows allthere is to know about his or her trade to prevent them frombuffaloing a boss into unjustified slacking off. Regardless,any justification—especially one aimed at optimizing the 5%or 6% of cost direct labor typically represents—pales incomparison with the penalty for bringing supply chain anddistribution channel flow to a halt.

Management guru Peter Drucker wrote in his omniscientarticle “The Emerging Theory of Manufacturing”19 in 1990that the factory should be “little more than a wide place in themanufacturing stream.” Warehouses and inventories may be“necessary imperfections” in the stream from the beginning tothe end, but nonetheless they are clearly imperfections. Theyare hardly something to be designed into the factory to figureout how to squeeze a few more pennies out of direct labor.

The theory of constraints, offered up by Eli Goldratt in TheGoal20 more than 20 years ago, is an enormously powerfulmanufacturing management tool, not just for factoryefficiency but also for the whole business. Goldratt and his

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various business activities have done as much harm as goodin getting that point across. Some folks call themselves“Certified Jonahs,” shrouding the straightforward idea inmystery, much like the Lean senseis and Six Sigma blackbelts who have a vested interest in making the principlesmuch more complicated than they really are to make the casethat you need to hire them and pay ridiculous fees to availyourself of their knowledge. Nonetheless, throwing the babyout with the bathwater because you rightfully don’t buy intothe expensive and over-the-top proposals these consultantsoffer would be a serious mistake. Just because you don’t needa Jonah from the Goldratt Institute doesn’t mean you shouldnot learn and keep a keen focus on the theory of constraints.

In a nutshell, the theory is that there is a bottleneck, orconstraint, in every process and that the constraint serves asthe gateway for all of the flow through the plant. Foul thingsup and lose production at the bottleneck, and you have lostthe production forever, plus the fixed costs that continued toroll on as the bottleneck remained idle. Improve things at thebottleneck, on the other hand, and you have improved thingsfor the entire factory, not just for the labor cost at thebottleneck. As Goldratt says, “An hour saved at the constraintis an hour saved for the system; an hour saved anywhere elseis a mirage.” If you have an operation that can make a part aminute, everything before that operation and after it iswasting time if it tries to produce any faster than one perminute. You can make a machine or a person look veryproductive for short periods of time producing faster than thebottleneck, but, at the end of the day, nothing is going toleave the factory any faster than the constraint. Thoseapparent efficiencies are Goldratt’s mirages.

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The big results from efficiency improvements and capitalinvestments at these nonbottleneck operations areShakespeare’s “sound and fury signifying nothing.” Most ofthe time, when manufacturers express frustration at havingsent Lean experts around running Kaizen events at greatexpense to the consulting budget or have brought in SixSigma black belts to make big changes, they have done sowithout really understanding Goldratt’s point. The tools ofLean manufacturing and Six Sigma were all designed toimprove flow, not to reduce isolated costs or to hammer ondirect labor expenses. Using them on something other thanflow or on flow without considering the bottleneck ispointless. Improving some isolated section of factory flowbrings virtually nothing to the bottom line if the improvedflow is simply going to pile up higher and faster when it hitsthe constraint.

So the overarching objective of the factory is to continuouslyaccelerate the rate at which stuff flows in the back door andout the front door, and knowing what limits, or constrains,flow is obviously a pretty important bit of information tohave. Keep in mind, however, that manufacturing operationsand machines might not be the only constraints. In more thanone factory we have seen, the constraint is in nonproductionareas. The machining business constrained by the engineerwho has to review customer drawings and turn them into shopdrawings and machine programs is fairly common. Orderentry and customer credit approvals often limit manufacturingflow.

You should keep in mind that there will always be abottleneck. Take that old operation that could only produce atone per minute and automate it down to one every 10

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seconds; although you have made a big improvement to anisolated cost, you have merely moved the bottlenecksomewhere new. Now some other machine constrains thefactory to one every 45 seconds and must be identified andoptimized just as diligently as the old constraint. This isimportant to realize before you invest in the new whiz-bangautomation. In this example, the return on the investment inautomation will not be the 83% reduction from one perminute to one every 10 seconds it appears to be. It will be a25% improvement from the old one per minute to one every45 seconds—the rate at which the new constraint will support.

This all seems quite simple and quite obvious: the wholefamily gets out the door and to grandma’s house for Sundaydinner as fast as the slowest family member gets ready andout the door. Like every point we have made when it comesto manufacturing excellence, the key is to clear away all ofthe clutter that makes simple points like this so difficult tosee. Get rid of most of the complicated mathematics having todo with discounted cash flows and internal rates of return, justgo out and find the bottlenecks, and your investments incapital improvements will pay off handsomely. Send the Leanteams and Six Sigma experts after your constraints, and theirefforts will look good in actual practice, not just on paper.

There is a very real economic significance to changingmanagement’s thinking to a flow orientation. Early on wetalked about companies like SC Johnson and Wahl Clipper,which have long track records of stable employment.Toyota’s lifetime employment philosophy is legendary. Evenwith all of its current, self-induced problems, with theexception of the folks who worked as part of its minorityownership of the New United Motor Manufacturing Inc.

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(NUMMI) joint venture with General Motors and a relativehandful of temps at its Texas truck plant, Toyota still has notlaid off any employees in the United States. Manymanufacturers—probably most manufacturers—say theywould love to do the same, but they cannot see how to avoidhaving to lay people off when their sales volumes go down.The answer is pretty straightforward: make sure salesvolumes don’t go down.

In Chapter 17, focused on strategic pricing, we will detailhow to accomplish this, but for now keep in mind a couple ofbasic principles. For one, the best way to stabilize theworkforce and sales volumes is to control the upside. Whensales team members are let loose to sell anything to anybodyany time and all of their metrics are based on the assumptionthat more is always better, you end up with a factory and acompany teetering on chaos. The behemoth of a factory andits long supply chain is expected to chase sales volumes upthe peaks and down into the valleys, continually overusingand then underusing capacity, lurching from laying off torampant hiring, from all-out expediting to inventoryreduction.

Running factories at their flat-out top speed and thenslamming on the brakes is no more economically efficientthan is the fuel efficiency resulting from driving your car inthe same manner. Just like your car operates at its best fromthe steady pace of highway driving, your factory thrives onsteady and stable levels of demand. Toyota’s oldphilosophy—one that most “Lean experts” never learned orquickly forgot about because it doesn’t fit the traditionalmodel—was, “Factory first.” It didn’t mean the factory wasmore important than anything else; rather, it meant that the

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objective is not higher sales but maximum profits. Runningthe factory at the optimum level means optimum leverage offixed costs. It means there is a sweet spot, usually in the85–90% capacity use level, at which the factory is at its bestoverall cost. The most profitable the company can be is whenit operates for sustained periods of time at that level.Continually increasing factory capacity at a steady rate andsales at the same rate means sustained, very profitablegrowth. Simply ramming more volume through the factory isnot particularly profitable.

When a company makes a commitment to stable employmentsimilar to that of SC Johnson, Wahl, and Toyota, it convertspayroll to a fixed cost. At that point, everything except formaterials is essentially fixed, so the mathematics becomesimple: get more volume across that fixed-cost base. That isall Ford did. It was no complicated theory. The factory costabout $200,000 a day to run plus the materials. Spreading thatcost over 1,000 cars a day reduced the cost per car from a950-cars-a-day rate by about $10 each. There was nothingmore complicated than that behind the thinking. The samewas true at Toyota, and it is how the other stable employmentcompanies think. It is not a vast new theory of manufacturingaccounting; instead, it is a rejection of the theories it takescost accountants years of education to derive.

Becoming a flow-driven manufacturer, rather than the sort ofmanufacturer with disjointed operations scattered around thefactory all focusing on isolated ideas of increased labor andmachine efficiency, is a huge step forward. It is also anecessary step forward if you want to adopt the basic culturalprinciples of making a commitment to your peoplecompatible with high profits. They go hand in hand. Stop all

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of the laying off and hiring, stabilize the factory employment,then focus on how you can get a steady and steadilyincreasing flow of sales and production across the plant. It’snot easy to do, but it is not complicated. The rest of this bookis directed at spelling out how you can go about making thathappen.

18 From author Bill Waddell’s experience at the MotorolaInstitute in 1990 and 1991 taking courses on Six Sigma,quality control and supply chain management; as well as BillWaddell’s conversations with former Motorola PurchasingDirector at the time of Six Sigma’s development, Kenneth J.Stork. Six Sigma is a registered trademark of Motorola, Inc.,Schaumberg, Illinois.

19 Drucker, P.F.; The Emerging Theory of Manufacturing;Harvard Business Review; Number 90303, May-June 1990.

20 Goldratt, E.M.; The Goal: A Process of OngoingImprovement; Gower; Surrey, UK, 1993; for additionalinformation on the Theory of Constraints and ThroughputAccounting see the Goldratt Institute Web sitehttp://www.goldratt.com/

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Section II

MANAGINGDIFFERENTLYWe have talked quite a bit about what is wrong with the waythings are done and have expressed some radically differentideas, such as how you approach people and focus on value.At the end of the day, we are talking about a completelydifferent approach to managing. It should come as no bigsurprise that management has to undergo some radicalchanges if the business is going to operate at radically higherlevels.

It is actually some rather outrageous wishful thinking tobelieve what most of the consultants tell you about Leanmanufacturing, Six Sigma, ERP, customer relationshipmanagement (CRM) software, and other canned fixestransforming all that ails manufacturing. They will have youbelieve that all members of management can pretty muchoperate as they have all along and that a little software or aproject or two to rearrange the furniture in the factory will fixeverything. Those might be attractive ideas, but the harshreality is that the results you are getting are the product ofhow you manage the business, and if you want radicallydifferent results it will come from radically changingmanagement.

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Look at things from the point of view of someone supervisingthe factory floor. Human resources (HR) hires the peopleworking on the floor according to some hiring criteriaestablished by management and compensated according tomanagement policy. He gets the machines justified howevermanagement decides new machines will be justified. He isgiven materials purchased from suppliers management chose,and the materials arrive (or don’t) based on the schedulingsystems and inventory schemes management put in place.Management hands him the schedule, the productspecifications, and the delivery requirements. Managementactually puts the factory in a very small box without muchlatitude over anything: the idea that management canbasically say, “We aren’t going to change any of thesethings—we are going to keep doing everything the way wehave always done them, providing the 3 M’s of men, material,and machines the same as always, but you should docartwheels and handstands inside your little box with this newsoftware and these Toyotaesque techniques and take thecompany to a whole new level of performance all byyourself.” Then, a year later, management decides thatwhichever fad they pursued must not be effective, and they gooff in pursuit of the next fad, never stopping to think that thereal problem is in how they are managing.

You get what you manage. If you want the business to getdifferent—better—results, you have to manage differently:better. If you want manufacturing to get different output, youhave to change the box you have put manufacturing into.

A big part of the problem with ideas like Lean manufacturingand the Toyota Production System is that they wereintroduced to the United States and the rest of the world by a

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bunch of nonmanufacturing people. The academics andwriters who first went to Japan to see it in action weren’treally manufacturing people, so they didn’t ask the rightquestions. They knew only what they could see—which was alot of different factory stuff: Kanbans and 5S; standard workand Kaizen events. A grizzled old manufacturing personwould have asked a lot of questions of the folks at Toyota:mostly, “How do you get your accountants to go along withall of this stuff?” That would have opened the door to a worldof things about how Toyota and others are managed.

A similar failing took place with guys like Jack Welch21 andthe others who jumped out in front of the Six Sigma parade.They never asked the questions that immediately come tomind largely because the idea thatmanagement—them—could be the real problem would nevercross their minds in a million years.

The simple fact is that the companies doing the impossiblevery successfully are doing so by managing their businessesvery differently. Most of the excellent companies areprivately held and, as a result, not the least bit concerned withwhat Wall Street or anyone else thinks of their performance inthe short-term. Because privately held companies are muchmore cash driven—like the entrepreneurial start-ups—theyalready have a very different view of accounting.

It also comes easier to companies like SC Johnson. It is nosurprise that Ford is the most successful American carcompany. Like SC Johnson, it has (1) its family name on theproduct and (2) a lot of family input in how the business isrun, even though both it and SC Johnson are publicly tradedcompanies. The ideas of value and commitment to employees,

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suppliers, customers, and communities come a lot easier whenit is the family name on the pink slips and in the newspaperswhen you decide to close plants, outsource, and devastatecommunities. So the decisions that emerge from thesecompanies are much different from those at most of the bigpublic companies.

The next several chapters describe the differences in the nutsand bolts of management—how the excellent companiesactually do the day-to-day work of running the place thatresults in better outcomes. The biggest difference centersaround accounting, however. That is the lynchpin. If youinsist on measuring yourself the way Wall Street and theInternal Revenue Service (IRS) measure you and refuse tobelieve that standard costs and numbers derived fromgenerally accepted accounting principles (GAAP) are wrong,you will never get there.

The entire integrated management infrastructure you have inplace now—whatever it is—is driven to optimize financialperformance, however you choose to define financialperformance. If you think inventory is really an asset, youhave systems and procedures in place to “optimize” inventoryrather than eliminate it. If you think that direct labor is acritical variable cost that actually drives the overheadsallocated on the basis of it, then you most likely spend a lot oftime worrying about head count and have metrics myopiaabout reducing it and squeezing more out of it. If you don’tthink cash flow is as important as book profits, then you don’thave management processes focused on product flow sincecash flow is directly related to manufacturing flow.

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The companies that do their accounting differently—the onesthat pay short shrift to book profits and care about real money(i.e., cash)—do everything differently. They care quite a bitabout production flow and see inventory as a big negative. Asa result, they approach their supply chain and the purchasingfunction in an entirely unique manner. They don’t worryabout the 5% or 6% of their costs direct labor representsnearly so much as they worry about costs that are not directlyresulting in increased selling prices. They know that directlabor is generally creating value and is more a good thingthan a bad thing—at least so long as it is making things thatget shipped. Making things to sit in inventory is bad all theway around, as these folks see it.

That radically different management infrastructure is thesubject of the rest of this book. We will touch on each of thecritical areas of management and explain the approach takenby the excellent companies. You really have to wrap yourmind around the accounting issue for it to make sense,however. If you are stuck in GAAP, none of it will click.Likewise, if you change only one thing in how you run thebusiness, change your accounting system as far as it affectsmanagement. If you do just that one thing, all the rest will fallinto place on its own.

The theme has been simplicity, and that is exactly what thisstuff is. If you change to a simple, straightforward accountingprocess, one by one all of the wasteful, complicatedmanagement systems you currently embrace will sooner orlater fall by the wayside as the power of focusing on thebasics becomes more and more evident.

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21 Welch, J and Welch, S; Winning, Harper Collins, NewYork, 2005.

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9

Getting Sales and Marketinginto the Game

In most companies that claim to have launched grandimprovement strategies (i.e., some version of Lean or SixSigma), the sales and marketing function is nowhere to befound. They are pretty much still off doing what they havealways done without much regard for what they, and the restof senior management, typically view as strictly operationalconcerns. Unfortunately for the companies that roar down thatpath, the words of English poet John Donne apply tobusinesses as well as people: “No man is an island, entire ofitself.” You can’t launch any operational strategy and havethe sales and marketing team members off doing their ownthing and expect the business as a whole to gain much by it.At best, you get organizational conflict and confusion; atworst, the whole place comes unglued.

With all we have discussed concerning the essence of value tocustomers and how you cannot possibly succeed unless youknow very clearly exactly what value is and about the supply

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chain and distribution channels being the definers of what youmust do to succeed, it should be clear that sales and marketinghave a far greater role to play than merely finding morepeople to buy more stuff.

At the outset of this book, we briefly described value streamsas cross-functional groups whose mission is to take customerorders from start to finish and whose intent is to deliver themaximum value for the customers, however they define it.Without sales and marketing tied tightly to both the customersand operations—in effect serving as the critical link betweenthe customers and the value-creation activities—there isvirtually no chance of success.

In most companies, when all of the eloquence natural to salesand marketing folks is stripped away, the objective of theseteams is to sell anything in the product line to anyone whowill buy it in the greatest quantities they can write in the salesorder. As far a target goes, that is an impossible one for thecompany to align itself toward and hit. It is true that failing toplan is planning to fail. Planning is a necessity for success,but that doesn’t mean it needs to be complicated. There islittle call to run out and hire a consultant.

Developing a sales and marketing strategy is difficult only ifyou don’t have the necessary, basic information. Thatincludes knowing what distribution channels you operate in,who the customers are, and what they want and need. Youalso need to know who your competitors are and how they goabout meeting those needs. The plan is nothing more than abasic scheme to lay out how you want to meet thosecustomers’ requirements better than the other guys do. Itseems simple enough and it is—if you have that information.

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For each channel, you lay out what you are going to sell andto whom, what the rules are for success in the channel, andhow you are going to meet or exceed the rules better than theother guys.

Even if the information is unavailable, you still have to plan,using educated guesses to fill in the blanks and thenembarking on the never-ending process of continuallylearning more about the customers, competitors, and the valueproposition needed for success. The first order of business isto identify the customers; in just about every business, onesize does not fit all, so you have to understand the differentmarkets and channels you serve.

As we laid out in the previous chapters, the center of things isvalue: creating it as best you can and eliminating the wastethat doesn’t add to it. Different customers will define valuedifferently even though they might be buying very similarproducts from you—maybe even exactly the same productfrom you.

You might be selling to consumers and to professionals inmuch the same manner as the Wahl Clipper. The consumershave a different set of requirements for your products than dothe professionals who want to use your product to help themmake a living. At the very least, they have different views ofthe utility factor. A consumer will use it occasionally,whereas a pro might use the product every day.

Like Parker Hannifin, you might be selling to the automotivesector as well as to the military. The automotive industry isvery cost driven and wants no frills and the lowest possiblecost, whereas the military is far more concerned with

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reliability: how long the product will hold up under tough use.These are matters of degree. Both markets are concerned withcost and reliability, but the shading of their relativeimportance is huge.

Even when you are selling the same product to very similarcustomers, when some of those customers are domestic andsome are overseas there is a sharp difference in how theydefine value. The domestic customer is apt to want frequent,small shipments with short lead times and all of the interfacehandled electronically by EDI or other means, whereas theexport market allows for longer lead times but requirescontainer loads, mountains of export documentation tofacilitate foreign customs, and unique financing involvingletters of credit.

The point is that you have to break your customers down intothe various, logical groupings based on how they definevalue. Generally this means that you have to break themdown by channel since the end customers in any particularchannel tend to define value alike. This is not always true,however. Sometimes there is one big player that sets its ownunique rules. Walmart, for instance, with more than 40% ofthe retail sales in North America, is quite apt to be a channelall by itself, with the rest of the big-box retailers forminganother distribution channel. In subsequent chapters we willdiscuss how to align the factory and the supply chain todeliver that value, but it all begins with getting a clear idea ofthe various definitions of value you have to fulfill.

Within each channel, the next step is to identify exactly whothe specific customers are and what products they need and todefine their value needs in every aspect. What price do you

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need to hit? What lead times? What documentation? Whatpayment terms? What quality specifications anddocumentation? What warranty and after-market support?

The objective is always to grow market share, and quite oftenthis means taking on a competitor head to head. The strategyyou come up with can be a very predatory one, aimed directlyat a single competitor with the intent of undercutting thatcompany at every turn and driving it out of the market. Thereis nothing wrong with this plan so long as you know what youare doing and are prepared for however that competitor willrespond.

At the other end of the spectrum, the strategy may be one ofsolving problems the customer doesn’t even know it has yet.Most companies that offer to put inventory in consignmentare not doing so for altruistic reasons. They do it because itgives them the inside track to your business and the chance tonose around and be the easiest solution to whatever problemsarise for your business. One such company used thistechnique to grow its percentage of its largest customers’purchasing spending from about 3% to over 10%. QualityScrew & Nut Company (QSN)22 from Chicago (acquired byand now part of Anixter) realized that eliminating the hassleof purchasing the nickel-and-dime parts it sold was asvaluable to its customers as the screws and nuts it provided.Its business model provided a consignment inventory alongwith an on-site representative, whose very part-time role wasto manage the inventory; the real objective was to take on asmuch of the “C” item sourcing and purchasing as thecustomer wanted to offload to QSN. Had it not understood thebroader definition of value, it would have been just anotheroutfit peddling hardware and butting heads with cheaper

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China sources—and most likely losing the head-buttingmatch.

Other companies do the same sorts of things (i.e., freelyprovide services above and beyond the basic requirements ofthe purchase order for not too well-disguised ulterior motives)most often to be sure their folks are hanging around andfreely available when new products are being designed. Theyrealize that their expert knowledge of the components andmaterials they provide can be of substantial value to theengineers trying to come up with new and improved products.

One structural steel company we know is privately owned andhas lots of cash but is run by financial people with little senseof the company’s customers or how it can provide value.When the global credit crunch hit, the people in charge put inever-tighter credit controls in a well-intentioned effort toprotect the company from having some of its smallercustomers go belly-up. Its chief competitor did the opposite.Knowing that these small construction guys were going to beespecially hurt by tightening bank credit, the competitoroffered all sorts of financing schemes to make it easier for thelittle guys to buy steel when the banks were unwilling to help.Of course, it tried to be smart about who it gave credit to, andof course it got burned a bit when it bet on the wrong horse,but it grew its share of the market so radically that it was asmall price to pay. And it will reap the benefits for a long,long time to come: all of the contractors came to see it as a“partner” while they viewed the tight credit company as a“supplier.”

It is all a matter of understanding the market and thecustomers and knowing what they really need in the broadest

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sense. Once you do, it is a straightforward matter of laying itout for each channel and then aligning the resources of thecompany behind the plan.

22 From author Bill Waddell’s experience with Quality Screw& Nut while working as VP of Supply Chain at McCullochCorporation from 1996 to 1999.

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10

Value-Stream Structures

Having talked about flow, the need to link the inbound supplychain with the outbound distribution channels, and the criticalnature of identifying how the customer defines value—andthen going about meeting that definition—it is time toorganize the company around making all of these lofty ideasreality. That means restructuring the whole place into valuestreams: knocking down all of the functional silo walls, withno more departments based on what kind of work people do.Everyone has to do the same kind of work—create value forcustomers. Functional departments never were a particularlygood idea, and they most certainly are not an effective way ofgetting much of anything done that a customer sees ashelpful.

A value stream is the series of activities that link eachdistribution channel you serve with its inbound supply chain.A value-stream organizational structure is one in which all ofthe folks who are needed to support the flow along the valuestream work for one boss: the value-stream manager. There isno engineering department or supply chain department, no

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purchasing department or quality department. All of thepeople who used to work in those groups of like-skilledpeople are redeployed to the value streams, and no matterwhat their technical skills they are assigned responsibility forcreating the maximum value for the customers of theirparticular value stream. They are to work cooperatively tomake sure that the value stream has all necessary skills athand to continually make things better.

To illustrate the point we cite the following anonymous buttrue story:

The engineering leader of a value stream in a consumerproducts manufacturer left a meeting in which the key metricsfor the value stream were reviewed with senior management.He was pleased but still a little surprised at the changes in hisjob, his outlook, and the level of involvement he had, lessthan a year after the transition from functional departments tovalue streams. His boss was no longer the director ofengineering but now was a value-stream manager who hadcome out of the supply chain management group, apparentlywith only limited technical know-how. Where his previouspeers had been three or four engineers with qualificationssimilar to his own, he now worked alongside a manufacturingleader, a marketing leader, a supply chain leader, and avalue-stream analyst—people whose job content was asmysterious to him as were the nuances of his engineeringexpertise to them.

He couldn’t help but be pleased. Senior management had justshowered him with praise. The value-stream managementteam was a big step closer to reaching its performancebonuses because the value stream had made enormous strides

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in reducing inventory, one of five key performance indicators(KPIs) upon which value-stream success was measured. Andthe one KPI that had shown the least improvement wasinventory reduction until the team had asked him in to takethe lead. It turned out that the biggest opportunity to reduceinventory, along with corresponding costs and floor space,was to reduce component proliferation. Over the years,dozens of variations of just about each component had beencreated, many with little difference between them.

In the past, supply chain people had complained from time totime and occasionally had asked engineering departmentmembers to look at whether it was necessary to have so manydifferent part numbers; however, those requests were seldomreflected in the engineering department goals and objectives,and inventory reduction objectives were nowhere on theengineering radar screen. Supply chain was measured oninventory turns. Engineering’s goal was to get productsdesigned on time and at the right cost target. If the goal was toget the product designed at a tough-to-reach cost of $5 perunit, engineering was not about to work in an existingcomponent that cost 10¢ when a new part could be designedand procured at 8¢. And there was no time in the designschedule to go back to all of the products calling for the 10¢part and redesign them to take the new, cheaper component.That was a cost-reduction project someone else would workon someday when and if there were any pressures to costreduce those products. That is how it went on for a very longtime.

Everything changed once the value-stream structure cameinto place. There were no “engineering goals” or“supply-chain goals,” just business goals based on the KPIs

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that senior management had laid down. The value stream hadall of the cross-functional talent and authority to do just aboutwhatever it took to reach those KPI goals. Inventory was oneof those goals the value-stream team had decided to focusattention on, and the engineering leader found himselfcleaning up hundreds of part numbers with enormous impact.Profit was increasing, product costs were dropping, andinventory was dropping even faster.

Better yet, from the engineering leader’s perspective, he wasgetting support he had never imagined in his productdevelopment efforts. His value-stream peers were drivingsupplier support, making machine time available forprototyping, and giving him technicians and qualityinspectors whenever he needed them. His projects werecoming in on time for the first time in his career as he nolonger had to fight and negotiate for resources.

Breaking up all of the old functional silos and putting peopleinto cross-functional value streams, in one fell swoop,changes everything for the better. It aligns resources on thethings that really matter, gets rid of all of the departmentalsquabbling and politicking, and focuses the entireorganization on creating value for customers. It makesexcellent business performance possible and, just asimportant, sustainable, whereas simply value-stream mappingas part of some Lean Kaizen event or Six Sigma projectusually do not.

Creating a value-stream map and defining a wonderful futurestate and then sending all involved in the process back intotheir current functional (or more accurately, dysfunctional)departments rarely result in significant change for obvious

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reasons. The suboptimal current state did not just happen; itexists because people perform to their job descriptions andthe priorities given them by their supervisor. They worktoward meeting departmental metrics and the accomplishmentof strategic objectives for their functional group. Thevalue-stream engineering leader in the previous example hadbeen in a number of meetings in which part-number reductionand concerns about inventory levels had been raised. He andhis engineering peers had agreed to look at it with goodintentions. The meetings ended, however, and the higherpriority engineering projects often ran behind schedule; in theend there just wasn’t time to work on those “extra” projects,so they kept dropping down on the priority list until theydropped off all together.

The problems with converting to value streams are purelycultural and psychological. Everyone gets knocked out oftheir comfort zone. Managers who thrive on “command andcontrol” go into a panic and can foresee only gloom anddoom. No one doubts that cross-functional leadership is muchmore effective. It is a bit ironic that the traditional functionalorganizational structures were originally based on militarycommand models. Today the military has moved radically tojoint services structures because it is clearly much moreeffective to have such cross-functional integration, whilemany businesses still cling to their outdated ideas of the needto command and control everyone.

In a value-stream structure the old functional leadership staysin place; it just no longer has line control over the bulk of theemployees. Workers are transitioned to the leadership ofvalue-stream managers. The role of senior leadership switchesfrom operational control and direction to providing broad,

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strategic direction. People in leadership are detached from theday-to-day running of the business to a role that both enablesand requires them to look further down the road. Theybecome technical consultants, teachers, and mentors, lookingover the shoulders of their old functional employees and thenew value-stream managers and providing advice andguidance as they find their way. Finally, they set policies, tothe extent that policies must be set. Typically thevalue-stream teams are kept on a fairly short leash until theyhave settled in and demonstrated that they have things undercontrol.

For the senior management team to relinquish control andturn things over to the value streams requires a high degree offaith in people. More importantly, it demands that all seniormanagers have faith in each other. After years of irrational,functional bickering it can easily be cause for concern.Salespeople may well have complained long and loud aboutthe need for more inventory. This may have been an easycomplaint to make, especially when they have had noaccountability for inventory levels and finding space;counting it and paying for it have not been their problems.The supply chain manager may well lose sleep worryingabout what will come of inventory when value streams ladenwith sales and marketing people have authority overinventory levels. On the other side of the table, productionand supply chain teams may have been complaining for yearsabout poor forecasting and unreasonable lead times, urgingpolicies that customers be told no when they order somethingnot in the plan or with insufficient notice. A degree ofnervousness on the part of the sales manager would bejustified when the individuals who have suggested suchideas—again, without accountability for the results—are put

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in control. Members of senior management need to haveconfidence in the people they have hired and developed overthe years. Employees will do the right things if they are giventhe proper direction from the leadership team, and, just incase they start to stray, we will assure sufficient control overthe value streams to enable them to quickly get back on theright track.

The critical issues in creating value streams are determiningits scope and alignment and staffing. Just about everycompany initially misses the point in both areas, as it tries toapply old functional, command-and-control, cost-reductionprinciples to structuring its value streams. The drivingprinciple, as we have discussed, is optimal value to thecustomers.

Most companies make more than one product type, althoughthere are some commonalities among them. Wahl makesclippers and trimmers; Andersen makes windows and doors.Parker Hannifin makes dozens of related products that aresimilar. Most companies sell into more than one channel,perhaps into more than one market. Andersen, for example,sells both doors and windows to dealers as well as to big-boxretailers such as Home Depot and Lowe’s. Parker Hannifinsells many of its products to both commercial and defensecustomers. The first reaction by most companies is to viewvalue streams as some sort of glorified cost centers: put all ofthe windows in one value stream and all of the doors inanother to get the greatest manufacturing efficiencies andlowest costs. This misses the point.

The objective of restructuring into value streams is to alignthe company with each significant supply chain in which it

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participates—that is, by channel or customer type. Create onevalue stream to provide the maximum value to dealers andanother to focus on big-box retailers; one for commercialcustomers and one for defense contractors; one for thedomestic market and one for exports. Each supply chain hasits own critical considerations, and the objective of the valuestreams is to make sure that the manufacturer is aimeddirectly at satisfying the customer’s needs.

Each channel, and sometimes each major customer, has itsown requirements regarding normal quantities and lead times,shipment documentation and labeling, order patterns andmethods, required documentation, packaging, qualitycontrols, and dozens of other variables. Every one of thesehas an effect on the flow of products through the plant and theflow of work through the production support areas. In thecurrent credit crunch, each channel may have differentrequirements and constraints in financing purchases from you.The goal is to align the value streams to assure that all ofthose detailed elements of meeting the customers’ needs areexecuted exactly and at the lowest total cost.

Best Buy or Target may submit orders via EDI with veryshort lead times for large quantities of a narrow range ofitems. The dealers may submit small orders via fax machinewith longer lead times for small quantities of a wide range ofitems. The processes in place to optimize one set of customerrequirements are quite a bit different from the processesneeded to take care of the other. The gains in terms of totalcost and long-term value resulting from excellent customersatisfaction always outweigh any manufacturinginefficiencies resulting from having to make two similar,perhaps even identical, products in two different value-stream

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locations. It is the weakness of standard costing that hides theoverall cost–benefit stemming from value streams, which is aproblem we will overcome in the next chapter.

The scope of the value stream encompasses customerinteraction from start to finish. Every function that possiblycan be taken to the value-stream level should be taken there.The only exempt functions are the few that truly must beperformed but cannot be attributed to any one customerchannel or another—financial accounting for externalreporting purposes and supporting centralized computingservices, for instance, and the purely “blue sky” research anddevelopment (R&D) functions.

The operational, engineering, and customer-related functionsare typically easy to divide into value streams, but a numberof others may not be so easily broken down. There may betwo people handling product configurationtasks—engineering change and product change notices—andfour value streams. Some training is going to be needed toconvert two full-time jobs into four part-time jobs. Theapproach must be to keep the jobs out of the value streamsand in their functional areas until they can be adequatelydefined and the people trained. Conversion to value streams isquite often a long transition that spans weeks, months, andsometimes a year or more. The important thing is to recognizethat the transition has to happen and to have efforts in place toeventually have the value streams completely self-sufficient.

Along similar lines, it is not unusual to find that the factoryhas a shared resource or two (e.g., giant equipment“monuments” like paint lines or heat treat furnaces) thatcannot be split and would be prohibitively expensive to

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duplicate. There is no avoiding having to live with a sharedresource. One value stream or another has to “own” themonument and provide the use of it to the other valuestreams. As with splitting the jobs, it is more important torecognize the need to ultimately resolve the conflict and,when the equipment is eventually replaced, to do so withmultiple and appropriately smaller versions that can becontrolled by each value stream.

The next big challenge is to staff the value streams. Hereagain, companies often fall into the trap of thinking in atraditional manner, believing that the only person who cansupervise the engineer in the value stream is a more seniorengineer and that only a wiser and older salesperson canprovide direction to a newer sales rep. The worry is that therewill be no one to fill the value-stream manager positions ifthey have to be more qualified in every area than thefunctional leaders in the value stream who will report to them.Value-stream managers are not mini chief executive officers(CEOs), however. The leaders of each functional area withinthe value stream are assumed to be fully capable of lookingout for their area of expertise without the need for someone todirect their every move. Technical support or guidance will beprovided by the senior manager who used to manage thatfunction. The task of the value-stream manager is to be thebuilder and leader of a team of people with a wide range skillsand knowledge but with little familiarity with the knowledgeof the others on the team. Leadership and communicationsskills are the most important attributes of an effectivevalue-stream manager. Certainly the persons in charge of thevalue stream has to be senior enough in the company tocommand the respect of the team, and they have to be wellversed enough in the broader aspects of the business to

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appreciate the importance of each function. They do not haveto possess superpowers, however. They are team builders, notbosses.

To ensure a successful transition to value streams, each seniormanager must make the single most important contribution ofproviding full, unqualified support to both the idea and to thevalue-stream managers. The greatest obstacle to value-streamsuccess—and therefore to achieving the level of excellencecompanies such as Andersen and Parker Hannifin enjoy—isone or more senior managers who refuse to give up their turf.The vice presidenet or director of sales and marketing whoargues eloquently and passionately why sales and marketingshould not be included in the value streams but shouldcontinue to work for him while the rest of the companyrestructures can easily kill the entire transition to excellence.The vice president or director of operations who will supportthe value-stream idea only if the value-stream managers allcome from her silo and refuses to allow operations people towork for anyone other than operations people stopsexcellence in its tracks. Those attitudes are all too common,and they doom the company to mediocrity.

Human resources clearly has an enormous role to play in thetransition. Literally every job in the company will change,which presents an administrative challenge. The biggerchallenge will be that of communicating what and why. Thebest approach is to inundate all employees withcommunications before, during, and after the transition,soliciting their input and support each step of the way.Converting a good-sized, traditionally functional-basedcompany to value streams is akin to turning a battleshiparound in a river, and human resources has to be integrally

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involved, as well as supportive, at every turn to be surenothing and no one fall through the cracks.

The task of actually breaking up the departments andassigning people to the value streams looks and feels a lot likechoosing sides to play baseball in the sandlot. It is importantto get the right balance, however, and to avoid having itbecome a personality contest. If one value-stream managercame from a supply chain background, for instance, then thatsupply chain can afford to have a less senior supply chainleader as the value-stream manager can pick up any slack.Another value stream whose leader came from engineering,for example, would require that a more capable supply chainleader join the team. The objective must be to assure thatstrength in every key area exists somewhere in thevalue-stream leadership team.

Product engineering can have a somewhat tricky role to playin determining what level of work to assign to value streamsand what to keep out in a general R&D function. Productengineering runs the gamut from fairly straightforwardproduct maintenance (i.e., minor tweaking for quality issuesand to accommodate changes in the manufacturing process)all the way up to theoretical research. Somewhere in betweenis the appropriate cutoff, and, since the move up the scalefrom product maintenance to research parallels the scale fromtactical to strategic, it is often prudent to start at the low endand move more product engineering into the value streams asit becomes the standard operating mode for the company.

Accounting and information technology (IT) are going tohave an enormous amount of work to do in transitioning thecompany to value streams as a result of having to change how

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just about all of the company information is collected andsummarized. How much depends on the nature of thecompany’s information systems? Companies that rely heavilyon database and spreadsheet applications tend to have a mucheasier time than those that are extensively committed to acomplex ERP system. The changes in accounting andperformance metrics will be substantial, however, and a majoreffort is inevitable.

Finally, this is perhaps the most significant change a companywill make under the direction of a CEO. On one hand, anenormous number of details will have to be addressed beforeit is finished. It is not possible for the CEO to micromanagethe transition to value streams. On the other hand, this is notime to stand on the sidelines and delegate. CEOs must beactively involved in the process and must make their presenceknown at every level of the organization—not to tell anyonethe details of how to split up those two product configurationjobs into four part-time jobs but to assure that the people whoare doing it know the importance of getting it done. The CEOhas to be the philosophical leader and the force to keep theorganization moving through myriad small obstacles—somereal and some emotional. The employees in everyorganization that goes through the transition conclude aboutthree months into it that value streams are the most senselessthing senior management ever did. A year after the transition,the people in the company think value streams are the bestthing that ever happened, and they wonder why it took seniormanagement so long to do it.

If this doesn’t sound simple, consider the inverse case.Suppose the company were already aligned this way. Itprobably was back in its infancy when everyone wore

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multiple hats; then it morphed into the current complicated,functional mess. Then suppose a consultant came in andadvised you to break everything up into disjointed, functional,physically separated groups. What questions and concernsyou would have! How much time is wasted trying tocoordinate and communicate among all of the disparatedepartments working to different agendas? How manymeetings and e-mails does it take to get the people from onedepartment to get something as simple as scheduling ameeting accomplished? How much time is wasted on officepolitics as people in different departments jockey for power,control, and prestige?

The big problem is that nobody in the whole company isresponsible for profits and customer satisfaction. Only theCEO has that burden. Everyone else is working toward somedepartmental goal that may or may not result in overallsuccess. How often does the company come up short in itsprofit goals yet have to reward individual employees withbonuses and raises because, even though the company didn’tfare so well, some employees were “outstanding performers”because they hit all their objectives out of the park? Thisalone should be proof that things aren’t hooked together sowell in functional organizations.

No, at the end of the day value streams are very, very logical:a team of people with mutual clear-cut objectives that are thesame as the CEO’s. Functional organizations are thecomplicated ones; they are also inefficient and messy. It willcertainly take some doing to convert to value streams, but,once in place, they represent the cleanest and easiest way torun any business.

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11

Simple Accounting

Let’s begin by making a few points very clear: generallyaccepted accounting principles (GAAP) may well be legallyrequired, but they have no place in providing managementwith the information needed to succeed in a manufacturingenvironment. Period. End of that discussion.

Previously we cited the example of the expenses like thelights in the factory. Accountants use many differentapproaches to allocate the light bill to products—on the basisof payroll or labor hours, based on machine hours or floorspace, by some complicated activity-based accountingscheme—but at the end of the day it really doesn’t matter.Every method results in incorrect and misleading information.The root of the difficulty is that the lights have no relationshipto any particular products, so however accounting goes aboutassigning some minute fraction of the light cost to any item itis wrong. Assigning a penny of lighting cost to a product maywell be required by the IRS and others for the purpose ofplacing a value on inventory for the statements the companymust provide to the IRS, but management should not for a

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second believe that the product actually incurred a penny inlighting costs. To take that penny and build customer priceson top of it, expecting the customer to pay for an allocatedpenny for this product, but not that one, is silly. To includethat penny in the cost of the product when making amake-versus-buy decision is sillier. That penny has nothing todo with that product or any other product. It is simply a smallpart of the real cost of lighting part of the factory. Beyondthat it is no more than the output of someone’s clever, butmeaningless, arithmetic.

If the allocated costs were only a matter of a few pennies, thiswhole chapter would be moot, but it is a lot more than a fewpennies. In most companies allocated or assigned costs are 5to 10 times greater than labor costs. It is not unusual to see adollar of product costs that is made up of 60¢ in directmaterial, 6¢ in direct labor, and 34¢ in allocated mush. Athird or more of the “cost” of the product is not real; it isaccounting math driven by GAAP rules. With this menagerieof all sorts of costs driven by all sorts of things built into thecost of any individual product, the futility of calculatingproduct profitability becomes apparent.

Of course, the cost of the lighting and the rest of the allocatedexpenses has to be covered somewhere, by some products, orthe business will not make money. That does not mean,however, that every product on every transaction has to covera proportionate amount of the allocated mush. Walking awayfrom a sale if a customer is unwilling to pay for some amountthat was arbitrarily allocated to a specific product is senseless.

The problem lies in the failure to look at the business, theproduct offerings, and customers holistically. We want to

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break every cost down to its smallest increment and assignevery penny to something—the same idea as breaking thebusiness down into silos and individual machines. We wouldlike to think that we can calculate a whole cost for eachproduct for each sale and can compare it with the price paid.If we can be profitable on each transaction, then the sum ofall transactions will result in a profitable business. It soundsgood in theory but fails miserably in practice.

Since there are no rules or laws dictating what managementcan or cannot do when it comes to internal, managerialaccounting, it is up to the senior management team to makesome decisions about how it wants to run the company.Ignoring the question or simply accepting the old standardcosts because everyone is comfortable with them is a decisionto knowingly allow yourself to be led down a path todestruction. Obviously, that is not an acceptable course ofaction for a team with a sincere interest in taking the companyto higher levels of performance.

The starting point is to decide what it is the company wantsthe accounting system to do. The most important objectivehas to be clearly communicated, understandable information.Jerry Solomon,23 vice president of operations atMarquipWardUnited, led the transformation of the accountingsystem there. He said:

Traditional accounting is a foreign language to the folks in theshop who have to use the information to improve. How canthey improve something if they don’t understand it? We haveto make accounting information easy to understand,actionable, and timely. If you go to a football game, youalways know the score, how much time is left in the game,

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and what yard line you’re on. Imagine if you went to a gameand you didn’t know any of those things. It would be prettyfrustrating. In comparison, that’s what traditional accountingprovides the folks who have to use the information. Theydon’t know the score; they don’t know where they are; andthey don’t clearly understand the goals. Yet we give themnumbers at the end of the month and tell them to make thembetter.

He was referring to the accounting gyrations of amortizing,allocating, and assigning—all of which are other names fortaking an expense and putting it somewhere or in some timeperiod other than the one in which it really happened. Atypical monthly profits and losses (P&L) statement containsvery little information regarding the month in question,thanks to those GAAP-driven numbers games and somethingcalled the “matching principle” that drives the company totake this month’s spending and bury it in inventory until theday comes that the products are sold. This month’s cost ofgoods sold is composed of money spent this month, lastmonth, the month before that—maybe even some spent lastyear. The first step, if management shares Solomon’sobjective of making accounting information “easy tounderstand, actionable, and timely,” is to put as much of theaccounting on a cash basis as possible. Let the purchasedmaterial portion of spending wash through inventory, but calleverything else a “period cost”—one that is charged in themonth, or period, in which it was actually spent. Whenmanagers, or more importantly the operations peopleresponsible, see a $10,000 expense for machine maintenancelast month, that has to reflect the real money spent to maintainmachines last month.

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Next, both revenues and expenses should be accumulated byvalue streams, not the old functional departments. Theobjective is not to run the lowest cost-machining departmentor the lowest cost-assembly operation. The goal is to operateat the lowest total cost. When expenses are broken down intochunks called “cost centers” or, worse, “profit centers” theability to see and optimize the whole diminishes. It getsharder to see and implement an idea that spends an extradollar in one part of the process to save two dollars in anotherpart.

Next, the goal is not only to give people a clearer visibility ofcosts but also to have them take that clear vision and reducethe costs, especially the non-value-adding costs. In addition,most of that allocated mush is non-value adding, which makesit all the more important to provide visibility to the folkstasked with eliminating it. The best way to accomplish this isto assume that all costs, except for direct material, are fixed. Itis often this step that creates the most discomfort foraccounting and senior management, but it really is the mostlogical assumption to make.

All costs are fixed in the very short-term. As you read thisthere is not much of anything you can do to change thespending in the factory. For the next few hours or days thecosts are fixed. At the other extreme, over the course of thenext three years, everything can be changed, includingreplacing the entire senior management team and moving theentire business across the country or to China. So for theshort-term everything is fixed, and in the long-termeverything is variable; in addition, most decisions are madesomewhere in between the two extremes where there are apt

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to be elements of both fixed and variable cost behavior andcontrol.

What makes it more complicated is that just about everythingin any given account is actually a combination of things. Thecharges to the machine maintenance account may includecosts for repairs as well as costs for preventive work. Theymay also include the paycheck for the maintenance personwho does both scheduled and unscheduled work. Thebreakdowns may be somewhat variable, whereas thescheduled maintenance and the person’s labor are more fixed.Most accounts include these combinations. For years themanagement accounting experts have tinkered with more andmore arcane variations of statistical tools such as regressionanalysis to try to figure out how to determine fixed versusvariable costs with greater precision, all for naught. Theanswer to the question is unknown and unknowable, and it alldepends on the time frame anyway; however, the question isnot only unsolvable but also irrelevant.

Again, it boils down to what management wants toaccomplish with the accounting system. If the goal is tocontinually reduce costs—or at least to keep them fromincreasing—then how does that play out if you make an errorin calling costs fixed or variable?

SCENARIO #1

You use a standard cost system that basically assumes that allcosts are variable; after all, once someone has gone throughthe exercise of allocating that penny for lighting costs to the

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product, then one penny is allowed to be spent for each one ofthose products made or sold.

As the business grows the accounting system allowsadditional spending proportionate to the increase in salesvolume. So if a cost is really fixed but management has erredand called it variable, if the spending rate is $10,000 permonth, and if volume goes up by 5%, the accounting systemhas allowed a fixed cost to be overspent by $500 per monthwithout being flagged or highlighted as a spending problem.

In a steadily growing business, making the mistake of erringon the variable side takes away insight and pressure to keepfixed costs under control. They are allowed to creep up andessentially become variable even when they shouldn’t.

SCENARIO #2

The accounting system assumes everything is fixed, eventhough some costs very probably have some degree ofvariability in their behavior. Now volume increases by 5%,but no increase in spending is allowed anywhere except forthe direct materials that went into the products. Any andevery account that went up by any amount jumps out as aspending problem, requiring investigation and explanation.

Clearly this approach puts a much greater degree of costcontrol pressure on the entire organization. This does notmean that some costs will not increase with volumes. Afterall, some costs really are variable at least to some degree, butthey will go up only with management knowledge and clearvisibility.

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In reality, most businesses do not have wild swings inshort-term volume. The variations from month to month tendto be small—less than 10% and often only in the 2–3% range.As a result, the operating mantra becomes to spend as muchas last month or less in every cost category. This putstremendous pressure on the entire organization to keepconstantly engaged in costs and to be continually looking foropportunities to reduce them.

In the companies that manage with this approach toaccounting (e.g., Buck Knives, Boeing, Parker Hannifin andhundreds of other companies implementing Lean accounting)they almost always have a volume “trigger” to cause them togo back and recalculate things if volume does change by asubstantial amount. Normally the trigger is in the 10–15%range. If volume changes in the short-term by an amountgreater than the trigger, these companies sit down andreestablish the monthly fixed-budget amounts.

So the key elements of the internal accounting systems mustinclude (1) accounting for everything (except for directmaterials and capital investments) as period costs; (2)accumulate, track, and manage revenues and expenses byvalue stream rather than any functional areas; and (3) calleverything fixed except for the direct materials. What you endup with is something that looks a lot like a manager’s homebudget. More importantly, you have a set of accountingreports that say what they mean and mean what they say.They will be very easily understandable by everyone in theorganization. They will meet the MarquipWardUnited aims ofbeing easy to understand, actionable, and timely.

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Standard costs are by the wayside, as the only specificproduct costs are the direct materials. This typically creates agreat deal of consternation because, as inaccurate as they mayhave been, the old standard costs were the universal tool andthe universal security blanket. Unfortunately, they also servedas the buffer between the sales and marketing group and theoperations people. In most companies the sales and marketingpeople have little knowledge of the operating costs becausethey do not need to. The standard cost tells them all they needto know. It is up to them to take those products at thatstandard cost and go sell them at a price that covers theselling, general, and administration (SG&A) expenses of thecompany and leaves a profit. If they cannot do so, they are offthe hook because the standard costs are too high and that isnot within their control.

On the other side of the standard cost buffer, operationspeople know very little about the pricing side of the businessor the financial interactions with the customers. Their job is tomake things at standard, and what happens from there is nottheir concern. When the standard costs go away, sales andmarketing come face to face with operations, and they have tocollectively figure out what to do. How deeply they have beenisolated from the other side and how little the managers reallyknow about the overall business often become painfullyapparent.

Typically when presented with the idea of getting rid of theold GAAP-based standard costs, the people in accountinghave little intellectual objection to the idea; after all, they arethe ones who did all of the amortizing, assigning, andallocating, and they know better than anyone how far fromreality the numbers are. Their concern is more often a very

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valid one, and that is the financial ignorance of the rest ofmanagement. Managers in standard cost-driven companiestend to be masters of the system (and often masters at gamingthe system to hide problems and make things look better thanthey really are). Accounting is apt to have a legitimateconcern with the ability of people in sales and marketing andoperations to manage without the safety net of standardcosting.

The biggest concern is usually in the area of pricing—an areaso important it will merit its own chapter later in the book.Beyond pricing lies any number of decisions, ranging fromnew product costing that drove design decisions,make-versus-buy decisions, and capital investments that allhad standard costing as a key input. The decisions made withthe costs were not good ones because the standard cost datawere not good, but the decisions tended to be safe ones.Standard costs may have kept the company from making salesthat would have been helpful to profits, but they also assuredthat nothing was ever dangerously underpriced. The answer isthat accounting must change from a number-crunching,report-generating role to a teaching, coaching, and supportingrole. The organization will be given more information in theform of rawer data—accurate but unprocessed—in fact,accurate because it is unprocessed. Accounting will have tobe a major player in the discussions and decisions that takethat data and do something with them, at least until the overallfinancial skills of the company rise.

The final major area of concern is direct labor, which hastraditionally been viewed as a classically direct cost. Theassumption underlying calling direct labor a variable cost isthe notion that people can be laid off and recalled with the

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changing winds of sales volume and that new people canalways be hired to support growth. In Chapters 5 and 6concerning culture, when the company embraced thecommitment to provide security and value to employees, allof that came to an end. Once the excellent companies makesuch a commitment to their employees—that there will be nolayoffs unless it is the last resort before insolvency—directlabor most certainly became a fixed cost. The expectation isthat, in return for the company’s commitment to itsemployees’ long-term security and the value the companywill strive to bring to their lives, they will actively engage incontinuous productivity efforts. Fear of working themselvesout of a job will be gone, and again within some reasonableupper limit, the employees will find ways to meet demandincreases without the need to hire many additional people. Asa result, direct labor should be largely fixed on the upper endas well.

For operations and human resources, this will have aprofound impact on scheduling and overtime policies, andmost importantly it will put a very high premium oncross-training. When pressed to continually improveproductivity, the most effective tool will be having peoplewho are capable of performing a broad number of jobs. Thistoo will be addressed in a later chapter.

As a final cautionary note, there has been considerable changeand evolution in management accounting thinking in the yearssince Tom Johnson and Robert Kaplan wrote theirgroundbreaking book, Relevance Lost: The Rise and Fall ofManagement Accounting (1991), which first outlined themore harmful effects of traditional accounting onmanufacturing. The first solution was activity-based costing

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(ABC), which has since been largely discredited. It is reallyjust an attempt to make allocations more accurate, which is aneffort that could possibly succeed. Don’t waste your time onABC as a compromise solution. The work currently beingdone under the auspices of Lean accounting, as well as someof the work referred to as throughput accounting, is the onlyeffective approach to bringing accounting to bear as amanagement tool for continuous improvement rather than anobstacle. That is largely because it is the simplestapproach—and simple means useful and accurate.

23 http://www.isosupport.com/newsletters/articles/2006_Feb_MarquipWardUnited_Pkg_Lean%20Accounting.pdf;Solomon, J. Keeping Score With Lean Cost AccountingManagement, SME; February, 2006.

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12

The Roadmap from Chain toChannel

The value-stream map is a flowchart describing how value iscreated for the customer from start to finish—from theinbound supply chain to the outbound distribution channel. Itdescribes the core of the business and is the single mostimportant document management has. Every piece ofinformation managers have been using to run things isnothing more than a bit of data along a value-stream map.Knowing labor efficiency or the cost of something is neithergood nor bad unless you can see how it fits into the bigpicture.

While most of the Lean consultants and Six Sigma wizardswill have you use value-stream mapping on a project basis, inthe excellent companies it is a living document, visually andvividly displayed and continually updated with informationthat enables everyone in the value stream to see how thingsare going, where any problems exist.

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The core of a value-stream map is a sequential series of boxesidentifying each step in the overall process. Of course, anynumber of “feeder processes” flow into the main line,indicating everything from subassemblies to businessprocesses to schedule events, or to provide specifications ormachine programs needed to execute customer orders. Ateach box, data are recorded concerning cost, number ofpeople, the identification of constraints, quality results, andbuffer inventories. There are no rules or limits to the typesand quantities of data required to manage by the value-streammap. Contrary to many “Lean manufacturing experts,” nospecial forms are required, and no specific data aremandatory. There are no rules mandating that inventory beplaced in one particular-shaped identifier while computeroperations are marked in another. All that matters is that thevalue-stream map provides a comprehensive visual picture ofthe entire process and that the information needed to optimizethe process is clearly available.

While there are no rules when it comes to value-streammapping, there are a few critical underlying principles, themost important of which is to link it from end to end. Just aswhen taking a trip, information about a specific location isuseful only if your map shows your route from start to finishso you can see where you are along the way, a value-streammap is useful only if it encompasses the entire process—whatTaiichi Ohno, the original Toyota manufacturing leader,defined as “the timeline from the moment the customer givesus an order to the point when we collect the cash.” Avalue-stream map that does not link end to end withcustomers is only marginally better than no map at all.

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It is also necessary that the map be a manual, visualdocument. The power of the value-stream map is that itprovides a clear image of the entire process. Putting thevalue-stream map into a computer defeats the purpose. TheBible says, “Nor do men light a candle and put it under abushel”; in the same way, it is foolishness to take the visualrepresentation of the core business process and then to bury itin a computer so that only certain people can see it. Most ofthe excellent companies use an entire wall of the war room inwhich the value-stream management team works for thevalue-stream map. Most effective is the use of afloor-to-ceiling, wall-to-wall whiteboard, with the operationsidentified by pieces of paper taped to the board and plenty ofspace around each operation for whiteboard notes andcontinually updated information. In one Wahl Clipper valuestream, the value-stream map is on an 8-foot whiteboardmounted on rollers so it can be moved around the factory toprovide the necessary perspective when issues are addressedin one work area or another.

The value-stream map is the vehicle that pulls all of theconcepts previously discussed together, including quality,accounting, supply chain, metrics, and people.

When we discuss quality management in Chapter 15 we willgo back to the value-stream map and will introduce the ideaof defect mapping on the same simple visual control. Thedefect map is a step-by-step identification of each opportunityto create a defect. For instance, at a machining operation, eachcritical tolerance that must be met represents a defectopportunity. The steel itself also represents one or moredefect opportunities—the dimensions, grade, and hardness ofthe steel being machined, for instance. The value-stream map

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should identify each such opportunity to do something wrong(i.e., to miss a spec) and the measures to preclude it fromturning into a defect that reaches a downstream operation orworse—one that finds its way into the hands of the customer.Finally, the value-stream map is the place to track the resultsof the defect map, indicating how well the defectopportunities are avoided and handled.

The value-stream map is also used to indicate where along theprocess expenses are incurred, including support labor andother overhead costs. By providing visual representation it iseasier to see where non-value-adding costs are being added.The notation of such costs highlights where value-streammanagement attention can pay the biggest dividends inoptimizing their Value Added Ratio (VAR) calculated bydividing value adding cost by total costs. Typically, thelocation of material handling, maintenance, and qualityinspection personnel are noted in a unique color providing avisual image of waste. Also, the span of responsibility ofsupervisory people is marked, making it readily apparentwhere the value-adding people require too much oversight.

Value-stream mapping is not something to be used as anadjunct to whatever complicated computer system you mightbe using, replete with dashboards and all sorts of bells andwhistles aimed at setting senior management up at thebusiness equivalent of NASA’s flight control center. Itreplaces most of that approach. It is the antithesis of thatapproach. It is a basic picture of how work gets done, and youuse it to plan, manage, and improve the core of the business ina manner everyone in the company can see and understand.

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13

Scheduling the Factory

Nowhere is the difference between wasteful, ineffectivecomplexity and cheap, effective simplicity more evident thanin how companies schedule production.

Excellent companies use whiteboards, spreadsheets, andkanban cards to continually schedule the factory. Mediocreones spend absurd sums of money on ERP/manufacturingresource planning (MRP) systems and deploy an army ofplanners and schedulers.

Excellent companies put enormous energy into continuallyreducing cycle times to get their lead times down andresponsiveness up. In the mediocre companies supply chainpeople gripe nonstop about the lack of accurate forecasting,and salespeople complain day and night about needing moreinventory.

In the excellent companies most of the material is orderedfrom the suppliers directly from the shop floor with aproduction person firing off an e-mail or making a phone call

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to the supplier. In the mediocre ones a designated buyermakes a bunch of computer transactions and analyzes partrequirements and on-hand quantities before killing a few treesto create a purchase order.

In the excellent companies scheduling problems are assumedto be the result of unnecessary complexity, and solutions areaimed at cutting to the core of the shop floor decision-makingneeds and empowering the production folks to beself-scheduling. In the mediocre ones, scheduling problemsare assumed to be the product of bad attitudes or a lack ofintelligence on the shop floor for their failure to appreciateand comply with the beauty and grandeur of the mainframecomputer-generated scheduling results—so the solution ismore computer-centered complexity.

While scheduling does not have to be nearly so difficult as wemake it out to be, it does require some knowledge and a solidgrasp of some core principles. It is more important thatmembers of senior management understand those principlesthan having the people actually doing the scheduling knowthem. The first of them is the basic water-and-rocks analogy.

Consider production to be like the on-time delivery canoecruising down the value-stream river through the factory. Theriver (factory) has all sorts of problems—bad layout, poorquality, unreliable machines, poor scheduling resulting fromlong lead times, unmanaged constraints, and who knows whatelse—but all of them are non-value adding and are drivingyou to have to charge higher prices for stuff customersperceive to be creating no value. Those problems are likerocks in the river. Inventory is the water in the river. If you

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put in enough water, the canoe can coast easily over all of therocks and reach its destination, the customer.

Now managers have two choices. They can keep all of thoserocks covered up with inventory all the time so they seem tobe invisible. Just because they are covered, however, doesn’tmean they aren’t there, eroding profits and undermining thefinished quality. The inventory just makes sure the rocksaren’t causing any problems today. Or managers cancontinually lower the water level in the river, bringing morerocks to the surface and forcing the plant to address theproblem: eliminate the cause, and enable the canoe to coast tothe customers. The first choice—drown the factory withinventory—is the easy one. It is also the more expensive one.Not only do the costly problems stay hidden, but all of thatinventory costs money too. It gobbles up floor space, requiressomeone to move it around and cycle count it, often incursproperty tax, and so forth. Coupled with accounting systemsthat allocate and bury all of these overhead costs, thecompany has little chance of success. The secondoption—drain the swamp and bring the problems into thespotlight so they have to be addressed and solved—is whatthe Lean manufacturing folks are talking about when theyadvocate continuous improvement.

While the accounting folks call inventory an “asset,” in amanufacturing organization inventory is only an asset in thesame manner as sand is an asset to an ostrich. That is, it isvery helpful if your objective is to delude yourself intothinking everything is fine. However, that is about as far fromthe dictionary definition of an asset—“a useful or valuablething; an advantage or resource”24 —as you can get if yourobjective is to reduce costs and improve cash flow.

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Principle number two is that inventory and time are two sidesof the same coin. Time is inventory, and inventory is time. Ifyou have 1,000 widgets in inventory and you sell 50 a day,then you have 20 days’ worth of widgets. Straightforwardenough. It can also be said that assuming you do a pretty goodjob at rotating the stock and practicing first in–first out if youbuy another widget today and add it to the pile, it will be 21days until that widget gets shipped out.

In the flow from the supply chain through your business andout through the distribution channel to the final customer, thelength of time material will spend in your place, consumingfixed costs and covering up your rocks depends on how muchmaterial you have. More inventory means longer cycle times.When the folks at Motorola said, “The best quality produceris the shortest cycle time producer, and the shortest cycle timeproducer is the best cost producer,” it was saying thecompany that lowers the water level and exposes the mostrocks will have the best overall cost structure because it didthe best job of rooting out all of the hidden cost in the factory.

When Taiichi Ohno at Toyota said, “All we are doing islooking at the timeline, from the moment the customer givesus an order to the point when we collect the cash. And we arereducing that timeline by removing the non-value-addedwastes,” he was talking about the same thing.

When Henry Ford put everything in motion and figured outhow to build cars in a week or so from start to finish, he didso by getting rid of even the smallest pebble in the Fordfactory river. He rooted out just about every possible penny ofnon-value-adding cost and was able to sell Model Ts atabsurdly low prices and still make a lot of money. Put another

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way, he created a fantastic value proposition for his customersand himself. With minuscule non-value-adding costs he wasnot in the position of having to convince customers to paymore for cars than they were worth, and he did not have to seehis profits diminished by a lot of money spent for no usefulpurpose.

The strategies of Lean manufacturing and Six Sigma havebeen convoluted to mean a lot of things other thancompressing cycle times to expose the rocks and force theelimination of costs that do not add value for the simplereason that accounting is built around the idea that inventoryis an asset—just as valuable as cash. When senior managersdon’t understand that inventory may be an accounting asset,but a manufacturing crutch and the device that covers upwaste, they see little value in compressing cycle times. Salesfolks who advocate more inventory—“You can’t sell from anempty wagon” and other clever criticisms ofmanufacturing—are really advocating more water to cover upthe waste that is causing them to have to convince thecustomers to pay higher prices.

Cycle-time compression, Just In Time, and running withLeaner inventories are not about inventory, per se. Nobodycares about inventory for inventory’s sake. It is aboutcontinually bringing problems to the surface and forcingresolution, which continually pushes the factory to lessnon-value-adding waste.

Senior management needs to clearly understand theseprinciples to give direction and support to the schedulingfunction. Make no mistake: scheduling is very, very easy. It ismanaging all of the excess inventory that makes it hard. If it

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weren’t for all of the underlying problems that drive thefactory to carry so much inventory, all a scheduler wouldhave to do is write the order down on a piece of paper when itcomes in and hand it to the factory, telling them to “make thisnext.”

Inventory has another big driver: supplier lead times. Whenyour customers want you to ship in one week but yoursuppliers can’t ship parts to you for four weeks, you have aproblem: a three-week gap. You have to be ordering partsfour weeks ahead of time, but you know what you actuallyneed only one week ahead. So schedulers try to solve thisproblem by (1) pounding on salespeople to predict the futureout to the lead time with perfect accuracy (in effect, askingthem to predict orders with such accuracy that to theschedulers they are getting four-week customer lead times);and (2) bringing in an excessive amount of purchasedinventory to try to cover any eventuality. Neither approachworks too well, so the scheduling job becomes a grandexercise in managing parts availability and shortages. There isnothing simple about scheduling in an environment in whichsupplier lead times are way out of line with customer deliveryterms.

Of course, the problem in many manufacturers is a whole lotworse than figuring out how to cover a three-week gap. Thatwould be a walk in the park for most production schedulers.The reality is that, because accountants and senior managersare oblivious to most of this, getting parts from some cheapsource 9,000 miles away looks like good economics, and leadtimes from China are measured in months rather than weeks.When the gap between supplier lead times and customer leadtimes is stretched out to 10 or 12 weeks, things really get

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interesting. The problem is so great that the two solutions(i.e., forecasting and carrying big inventories) become epic insize. Companies spend tens of thousands of dollars onforecasting software with ever more sophisticated predictionalgorithms and create jobs like forecast analyst and demandplanner and hold forecast meetings to try to sort through it allto predict the unpredictable. The investment in forecasting istrivial compared with the investment in ERP software, thebasic purpose of which is to sort through all of theinventory—a veritable tsunami in the factory river—to keepproduction going. All of this is necessary to achieve thesavings from buying parts in China or some other farawayplace. Those savings become very expensive indeed. The vastinventory needed to cover the long lead-time gaps, added tothe big work-in-process inventories to cover up all of thefactory rocks, results in big scheduling departments andenormous factory complexity.

The key to excellence is merely stepping back from the wholemess and realizing that, rather than throwing lots and lots ofgood money after bad to try to manage through all of thecomplexity, and simply reducing supplier lead times;voilá—problem solved. That is why Just In Time came topass. How to go about accomplishing this will be addressed inthe next chapter. The next order of business is driving thework-in-process inventory out of the factory—lowering thewater level to force the waste out of manufacturing. This iswhat the rest of the Lean manufacturing and Six Sigmatoolkits are intended to do.

Tools like set-up reductions, kanbans, and mistake proofingwere designed to help the factory drive down the cycle times.Using them as tools to reduce direct labor, for instance, is like

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using a hammer to drive a screw; it’s the wrong tool for thejob and not likely to get the desired results.

There are two other key principles senior management needsto master to lead the factory scheduling function: push versuspull and some basic statistics.

The supply chain management people talk in terms of pushand pull, which means nothing more than working to aforecast versus working to reality. We have described theprocess and the ensuing problems from trying to manage to aforecast. That is a “push system.” It means pushing materialand production into the factory and into inventory ahead ofreal demand. Pull, on the other hand, or kanban, meanscarrying a set level of inventory and continually replenishingit based on actual demand. It works a whole lot better.Kanbans can be set up anywhere there is repeat demand—infinished-goods inventories, works-in-process, or purchasedparts. The process is to simply analyze how much inventory isrequired to protect the gap in the lead time and any variabilityin the flow and to put that quantity in place. Then whencustomer orders come along and consume some of theinventory, the scheduler issues the orders to replace it in kind.It is simple and assures that inventory is at least capped andwill not increase based on forecast errors. The idea, then, is toidentify why the kanban inventory is the size it is—long leadtime and variation in factory flow—to improve thosevariables, and to reduce the size of the kanban. That isactually how the water-level reduction takes place. Puteverything you can into a calculated kanban, do all thescheduling on a simple replenishment pull (which can bedone on the back of a bar napkin; no big complicated

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computer systems needed), and focus your attention onreducing the size of the kanban.

The statistical principle at play in directing the schedulingfunction is pretty basic. The amount of inventory you need isa function of both the lead time and the potential variation inthe rate of demand. That means the calculation has to be alittle more complicated than having someone gaze into acrystal ball and say, “Let’s keep four weeks of inventory onhand.” That usually means four weeks of average demand,and averages are horrible numbers to use. As the old sayinggoes, “If you stick your head in the freezer and your feet inthe oven, on average you should feel pretty good.” You haveto use any one of a number of formulas available that takesinto consideration both the number of weeks of lead time youhave to protect and how much variation there is apt to be inthe customer orders during that time.25

Most importantly, senior management has to engage in thescheduling process. In far too many companies, rather thanviewing the factory scheduling process as a critical driver ofthe strategy to drive out waste, it is seen as some sort ofclerical exercise requiring relatively unskilled people toprocess paperwork in accordance with the dictates of someanonymous computer system.

24 http://www.yourdictionary.com/asset

25 There are a number of different statistical formulas forcalculating kanban quantities. The formula used by authorBill Waddell in his consulting practice is kanban quantity =(Average weekly demand + (2Σ * 1.1)) * ((Cumulative LeadTime – Customer Lead Time)/2)).

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14

Purchasing

Unless you are very vertically integrated, the purchasedcontent of your product represents: most of its cost, is theoverwhelming driver of its quality, consumes the greatestamount of your cash in inventories, and pretty much controlswhether you make a profit. In fact, it is the single biggestdriver of whether you will grow and prosper or go under. Sothe logical thing is to do your buying via an online auctionand turn it over sight unseen to the lowest bidder, or sourcethe key components with some factory in China you havenever seen via some agent you found on the Internet, right?Or maybe just give it to the sales rep who drops in and takesyour buyers to lunch and springs for a bottle of scotch atChristmas. Put that way, the approach most manufacturerstake to the sourcing and purchasing function soundsoutrageous.

Engineering, in particular, has to be fully engaged in viewingthe sourcing function as a very strategic endeavor. Yourproduct cost is as much as 90% fixed when it leaves design.All the buyers and shop-floor manufacturing people can do

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after that is tweak it up or down a little, but the cost structureis a done deal before they even see it. Engineers who designaround parts from a catalog without considering the supplier’slead times and quality controls, are a manufacturingnightmare. Adding suppliers who sell only one or two parts toyou expand your non-value-adding cost exponentially.Engineers who assume they know all there is to know aboutthe materials and components available usually leave a lot ofpotential value on the table. The right relationship with theright suppliers means you can avail yourself of a lot of freetechnical input and a mutually, economically beneficial setupfor both parties. Engineering team members have to be afundamental part of the sourcing process, but they have tofully understand the profit objectives of the business andknow how to optimize the whole. They cannot view productdesign as something akin to the junior high school science fairwhere the only thing that matters is technical elegance.Design engineering is, when you boil it all down, thetechnical link between the supply chain and the finalcustomers out at the very end of the distribution channels.

Accounting, of course, has to either get involved in assistingwith a broad, strategic understanding of sourcing or get out ofthe way. In the value-stream section we described theinventory out of control with a root cause of design engineerswho had been driven to explode the variations on a prettycommon part because all they knew to consider was thepurchase price of the parts. A hundred variations on the samepart from a dozen different suppliers makes sense only if youapply typical accounting logic rather than basic commonsense. The least educated shopper knows that you can spendall day running around to six different grocery stores to doyour weekly shopping to get the lowest prices in town on

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each item you buy, but the $5 you will save will be more thangobbled up by the $8 you will spend on gas, let alone thewaste of an entire day. So you go to the one or two thatenable you to optimize the whole. The purchasing function inyour business has to be executed with the same simpleapproach. Like the shopper who settles in on the one grocerystore that, all things considered, represents the best overallselection and value, you have to look over the landscape andpick a couple of suppliers that are the best situated to supporta broad range of your needs.

That broad range of needs includes technical, economic, andstrategic considerations. Technically, you have to developrelationships with suppliers that can share your vision ofgrowing in the distribution channels you serve and are willingto provide input to your product development efforts to makesure you are always offering the best value. Economically,your suppliers have to share your understanding of value. Wepreviously described supplier partnerships as “characterizedby mutual cooperation and responsibility, as for theachievement of a specified goal.” That goal is continuallyincreasing the value you jointly provide to customers.Haggling with suppliers over pennies that will either comeout of their profits or yours, depending on who has thesuperior negotiating skills, is an utter waste of time.

You have some value content in your overall coststructure—say, 60% of the money you spend goes to creatingvalue, and the other 40% goes to non-value-adding wastes.Your supplier also has some percentage of value to waste.The pricing and sales you realize from manufacturing are afunction of the 60% you spend on things customers will payfor. There you have the “specified goal” you and your

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supplier should mutually cooperate upon: improving yourvalue ratio. To the extent the supplier can help you spendmore money on value and less on waste—from defects,inventory costs, paperwork, and the like—you should bewilling to pay more for the things you buy from that supplier.At the same time, the supplier should be working with you toenable you to improve its value proposition—eliminate itswaste. The mutual economic gains cannot come from arm’slength negotiations in which each of you is keeping yourcards close, looking to play a zero-sum gain; your gain mustbe the supplier’s loss and vice versa. In the end, you both losethat game. Its only possible outcome is an eventual end whenone of you says enough and you both go off and find anotherentity to begin the process all over again.

The final consideration is strategic. We discussed values,supply chain strategies, and the importance of setting yourfactory up as Peter Drucker’s “wide spot” in the stream. Youhave to make senior management-level decisions aboutpotential suppliers to evaluate all of the nonfinancialintangibles and whether the supplier shares your values andlong-term goals. This does not mean that the leadership teamnecessarily needs to be involved in every supplier selection. Itdoes mean, however, that a well-thought-out policy should beestablished by the senior team identifying the broad criteria tobe used in selecting suppliers. The selection of suppliers ofcritical technologies and high-cost components should havedirect involvement of the senior team.

The role of purchasing should be primarily one of facilitatinglong-term, broad relationships and not to serve as a constraint.Once the relationship is in place, purchasing’s role should beto act as the matchmaker. Bring your accounts payable people

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into direct contact with the supplier’s accounts receivablefolks; introduce your receiving dock personnel to its shippingpeople; get your engineers and suppliers into directcommunication; and then get out of the way and let therelationship work at every level. Demanding that allcommunications go through some buyer is a wasteful formulafor failure.

More important than the price for each item are the termsbetween you and the supplier for overall supply chainmanagement. Once you have come to understand thatreducing supplier lead times is the key to enabling you to rootout all of the destructive waste in your factory, the need to dosomething better than to throw purchase orders at yoursupplier one at a time as you need parts becomes moreobvious. The simplest way to reduce supplier lead times isjust to ask the supplier to carry finished-goods inventory.This, however, is often no more than shoving the inventoryrisk and carrying costs back on the supplier and doesn’t reallyhelp the overall supply chain. And it serves to cover over thewaste in the supplier factory, which will eventually be passedon to you.

The use of blanket orders is almost always more effective. Atypical example would be to estimate your use of the item forthe next year, then give the supplier a blanket order for about60–70% of that quantity, and then ask it to carry inventory tosupport that volume. You tell the supplier what you actuallyexpect to use and guarantee about two thirds of that amount.That way the supplier knows its investment in the inventory isnot at risk. If all goes well, seven or eight months into theyear you have bought all the blanket-order quantity, and youdo the same thing all over again. In the meantime, the

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supplier carries inventory sufficient to meet your needs, whilereducing its internal lead times.

Often the best way to start is to sit down with the supplier andfind out why its lead times are so long. More often than not, ithas to do with its lead times for raw materials. If that’s thecase, you might be buying a dozen different products from thesupplier that use the hard-to-get material, and the problem isthat you don’t know which of the final configurations youwill need. You do know that you are going to use something,however. So you either guarantee some amount of volume intotal without specifying the particular part numbers, or youeven buy the raw material yourself and keep it at thesupplier’s site. The point is that by investing in $1 of rawmaterial for the supplier—or guaranteeing the supplier’sinvestment in it—you can save $5 worth of inventory in yourfactory, and achieve a substantial reduction in lead times.

It usually takes nothing more than a little creativity and hardwork to reduce supplier lead times by big amounts, but it willnever happen if you don’t try. And it certainly won’t happenif you never ask the simple questions of your suppliers andthen recognize that the risk of inventory should be equitablyshared, as should the return from that risk when you turnshorter lead times into better value for your customers.

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15

Quality Management

Any husband who has ever felt the pressure of moving a largepiece of nice furniture through a narrow doorway under thewatchful eye of a wife admonishing him to be sure not toscratch either the furniture or the door frame understands thebasic concept of Six Sigma only too well. The originators ofthe concept at Motorola back in their heady, BaldrigeAward-winning days when Six Sigma burst onto themanufacturing scene used a similar analogy—that of a carand a garage door. Either way, the wider the door, the lesslikely you are to fail. If you try to drive a 7-foot-wide carthrough an 8-foot-wide garage door or you try to move a30-inch-wide armoire through a 32-inch-wide door, there isnot much room to stray from the centerline before you hitsomething and find yourself in a lot of trouble.

In work terms, the width of the door represents the capabilityof the process. The question is how much room is there forsomething to stray from perfection before it becomes a realproblem? Obviously the wider the garage door, the less likelyyou are to hit something. Basically, Six Sigma theory says

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you need to have a 14-foot-wide garage door to operate withconfidence that your 7-foot-wide car will never hit anything(at least as close to never as never can be in the real world).

Motorola’s big idea was that processes tend to drift out ofcontrol—away from perfection—and that perfect quality ispossible only when you plan for this and assure that everyprocess is robust enough to tolerate a great deal of driftingwithout causing a defect. As we mentioned previously, thebroader intent was to assure flow. Variation in the rate of flowthrough the factory gums up everything. Only when each stepin the process receives a steady input from the previous stepcan things happen at their lowest cost. When production is fedto the next operation in fits and starts, machine and peopletime are wasted, inventories build, and non-value-addingcosts start to add up. So by making each step capable ofhandling a wide margin of error—especially humanerror—the flow will be able to continue, and the factory willoperate at its best. Put another way, the factory is a series ofdozens, perhaps hundreds, of garage doors. The presence ofjust one or two doors without enough room for steering errorwill stop the flow of cars driving through the factory, creatingbackups, logjams, inventory, and excess cost.

That is Six Sigma in a nutshell—at least Six Sigma as it wasoriginally conceived. Since then it has strayed quite a bit andhas become shrouded in special terminology, procedures, andforms, and it requires people certified to hold belts of varyingcolors. It is often applied as some sort of grand cost-cuttingtechnique rather than as the steady-flow driver it wassupposed to be. You will notice, however, that a very smallpercentage of Six Sigma cost savings finds its way to thebottom line, and General Electric under Jack Welch, the

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grandest of Six Sigma users, generally used it to identifyoutsourcing opportunities. This is not the sort of Six Sigmaany of the truly sustaining excellent manufacturing companiesdeploy. Theirs is truer to the original concept, and they rarelyrequire Six Sigma black belts to put the principles to work. Itreally just comes down to management integrity: whethermanagement can be honest with itself. If you want Six Sigmato be a self-fulfilling prophecy and have it tell you what youwant to hear—that outsourcing is the answer toeverything—you can manipulate it that way. If you want touse it as a tool to get to the truth of things, however, it is avery good tool.

The ideas about process capability, process design, andprocess control are really the power of Six Sigma thinking.They have a lot in common with the tried and true statisticalprocess control (SPC) applications. SPC essentially says thatevery process has its center point—perfection—and atolerance limit. The tolerance limit is the point at which theprocess has strayed so far from perfection that it no longerworks. SPC charts track the straying and enable someone totake action before defects are produced.

The idea of process is central to achieving outstanding,near-perfect quality. In poorly run companies, a defect iscause for management to ask, “Who screwed up?” In well-runcompanies, the question is, “What process is not undercontrol?” And what do we need to do to make the processrobust enough, or capable enough, so as not to allow defectsto be created? Anytime quality is dependent on people nevermaking mistakes, quality is going to be pretty shabby. Theidea behind the design of a good quality system is to expect

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human errors and have the processes capable of absorbingthem without creating poor products.

In designing the quality system, the senior management teamhas to be composed of process thinkers. That should besounding like a broken record by now. Organizing into valuestreams is nothing more than formally organizing peoplearound processes rather than functions. In managingconstraints we are simply identifying the greatest obstacles toprocess flows and paying very close attention to them. Inoverhauling the accounting systems we are primarily trying toorganize financial information and decision making aroundprocess performance. That recurring theme—process,process, process—applies to quality as well. Effective qualitymanagement requires creating and controlling processescapable of (1) preventing quality problems from occurring inthe first place, and (2) quickly catching them when they dooccur.

Manufacturers in a constant struggle with quality are thosethat are siloed and compartmentalized. They think that qualityis something the quality control department and operationshandles with maybe a little engineering support and that poorquality is a failure on the part of those departments. Sales andmarketing, supply chain, accounting people, the CEO, and ITfolks set themselves up as critics or take kibitzing to highlevels to demonstrate their support but do not see it as theirresponsibility in any way. In fact, excellent quality is theproduct of an integrated management system, and the peoplein those functional roles have a very direct impact on quality.

In many companies, the toughest quality problems are thoserevolving around vague standards for cosmetic features

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initiated by sales and marketing people. Hitting a tenthousandths of an inch spec on a machined component is easycompared with coming up with exactly the right shade ofpurple, the right feel on a gel grip, or perfect clarity on ablister pack. Setting measurable standards and then devisingprocesses that can meet them are the fundamental buildingblocks of quality and require the active participation ofeveryone to see that this happens.

More importantly, sales and marketing reps must assure thatcustomer quality requirements really reflect the customer’strue perception of value. The sad fact is that very often thedifficult cosmetic quality requirements the factory strugglesto maintain are not about customer value at all but are drivenby an attempt to create the illusion of value. The customerreally wants a device that works well and holds up over timein hard use. Because the company has so gutted the core ofthe product in cost-cutting efforts, marketing has had to resortto wrapping the product in a purple gel grip in a crystal-clearblister pack to create an impression of quality that does notreally exist. Quality is all about knowing what is trulyimportant in the eyes of the customer and then getting thosethings absolutely right.

The technical quality battle driving every aspect of theproduct that make it work right and stand up to use is largelywon or lost in the engineering effort to design products.Whether a high-quality product will be made and shipped isdecided before it ever hits the factory floor. We do not wantto turn this into a technical–statistical dissertation, but it isimportant to know that the ability to make quality products islargely driven by the standards, or specifications, establishedby the design engineers relative to the capabilities of the

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people and machines that will make them. Part of the SixSigma body of knowledge and techniques is an analysiscalled Cpk, or a capability analysis. This is where that widthof the car compared with the width of the garage doorarithmetic has to be done. If the product specifications call fora tolerance of plus or minus eight thousandths of an inch andthe machine that will make the part is capable of holdingtolerances of only ten thousandths of an inch, it istheoretically possible to make the part, but there is not muchroom for things to stray from perfection on the machinebefore there is a problem. Before any new product is releasedfor production, sales and marketing, operations, andengineering should review a detailed Cpk analysis of theproduct and have a high degree of confidence that the productis really manufacturable.

The design of the quality system is important to the entiremanagement team for a couple of reasons. For one, it must begood. If the company is going to be focused on value to thecustomer and pricing is going to be value driven, then assuredquality has to be a given. Value in the eyes of the customersdoes not end with very high quality, but it most certainlybegins there. No company is ever going to reach excellentstatus if its quality levels are unreliable.

For another reason, there are a lot of bad ideas out there onhow to create and control quality, and it is very possible tospend a lot of money and effort on quality without gettingmuch in return. Just as many companies get caught up in thetrappings of Six Sigma and fail to grasp the basic, underlyingprinciples that make it worthwhile; it is very easy to substituteInternational Standards Organization (ISO) procedures forISO intent. Creating and filling out forms and putting together

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and maintaining the policy manuals needed for ISOregistration is a waste of money. For some companies it maybe a necessary waste of money as certain customers havemade ISO registration mandatory, but it is nonetheless waste.The principles underlying the ISO process are what createvalue. It is so important to keep focused on that. Far too often,the senior management team is disengaged from the truequality system, assuming all is well because people aremaintaining the ISO documentation and because some outsideentity comes in every now and then and audits things. That isnot the same thing as having an effective quality system. Itmeans only that people are complying with a set ofprocedures that may, or may not, be getting the job done. Andeven if they are getting the job done, they may be drowningquality control with unnecessary paperwork and procedures.

Most important is the relationship between quality and flow.When one of the authors learned Six Sigma soon after itsorigins, one of his most influential teachers was Motorola’sdirector of materials management. While continuous,defect-free flow across the factory results in the best cost,continuous flow also enables the best quality. They feed oneach other. A Motorola Six Sigma mantra was, “The bestquality producer is the shortest cycle time producer, and theshortest cycle time producer is the best cost producer.” Thisrelationship among quality, cost, and cycle time (how fastsomething goes from the beginning of the manufacturingprocess to completion) is a core principle that has been lost asthe certified black belts try to apply Six Sigma to traditionalcost cutting. It boils down to understanding that inventoryundermines quality.

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We cannot stress enough the importance of a keenappreciation of time to achieve manufacturing excellence.Whoever first coined the phrase, “Time is money,” was agenius. Inventory is a lot of things, but most importantly itreflects time. The excellent companies continually drive downinventories to save time—not to free up cash or to shove all ofthe inventory risk and handling costs back on suppliers butbecause inventory consumes precious time.

If assembly needs to consume 10 widgets per day to meetcustomer demand and the factory keeps a buffer inventory of100 widgets in front of assembly to be sure it always hasplenty to work with, then the widgets being made today inmachining to go into that buffer inventory will not be used inassembly for 10 days. If the widgets being machined aredefective, no one will know for 10 days until assembly goesto use them and finds that they don’t fit. The more inventorythere is, the longer the time gap between creating a defect andfinding it. Of course, the longer the time gap, the less likely itis that anyone will ever find out what went wrong. Often it isimpossible to learn who made the defective parts or on whatmachine since the problem occurred weeks ago.

It gets even worse because the usual reason for having theinventory is to enable the machines making the parts to savelabor costs by building big batches without having to losetime setting up the machine so often to make something else.As a result, if the machine making the defective widgetsmakes them in batches of 50 at a time, when the defect isfound 10 days later, it is not one bad widget—it is 50.

Excessive time between creating quality problems and findingthem makes it more difficult, if not impossible, to ever have

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excellent quality. Time between something going wrong andfinding out about it increases the magnitude of the problem.Inventory is the manifestation of time. The more inventorythere is, the worse quality is, and the more expensive poorquality is.

How the supply chain is constructed has a huge bearing onquality. These basic principles do not apply just to internalinventories and defects between operations in the factory;they apply everywhere. Purchasing in big quantities to save afew cents on the purchase price increases the likelihood andconsequences of supplier quality problems. When salespeoplecomplain that they “can’t sell from an empty wagon” and thatthe company should carry more inventory, they are upping theprobability of shipping poor quality products to customers.

Everyone on the senior management team has a stake inminimizing inventories and, as a result, shortening the cycletime between events in the process. This time–qualityrelationship is not just a manufacturing issue either. Whenpeople process paperwork or enter data into computers inbatches, the same risks increase. The longer the time gapbetween when something is done and the person using that“something” gets it, the greater the chances and impact ofmistakes.

Companies try to deal with this by having inspectors lookingat the widgets to make sure no bad ones go over to thestockpile in front of assembly. Inspection is an utternon-value-adding waste of money and is the least effectiveway to catch problems and defects.

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The basic architecture for a world-class quality system is adefect map, which is a flowchart of each product or productfamily showing each step in the process and identifying eachdefect opportunity—that is, each place where a defect can becreated that would harm end quality. For all practicalpurposes, that means each critical specification. At eachdefect opportunity, the quality control in place is identifiedthat assures the defect is caught before it passes on to the nextstep in the process.

The best quality controls are the simple ones that prevent thedefect in the first place. That is where the Cpk studies andensuring robust processes come in. Quality is almostguaranteeed if a very wide range of errors will not result in anunusable product. Better yet is the Japanese concept ofpoka-yoke, or mistake proofing. It is the idea of making itimpossible to do anything other than the correct way.Engineering can make sure the wrong screw is never used bydesigning the product such that only one screw size is usedanywhere. Everyone uses the right screw all the time becausethe right screw is the only one anywhere in the factory—or atleast in an area of the factory. IT can eliminate data entryerrors by building in edits making certain that only data in theright format can be entered in any particular field. You can’tput the customer name in the address field because theaddress requires a combination of letters and numbers and thefield will not accept anything with letters only, like a name.

The bottom line is that quality is the cornerstone of providingvalue to customers, and it is essential for cost-effectivemanufacturing. Excellent quality is a function ofwell-designed processes and practical quality controls. Itrequires a concerted effort on the part of everyone to drive

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cycle times down and to focus on process performance ratherthan inspectors wasting money checking other people’s work.There is a great deal of substance underlying Six Sigma andISO, but these concepts are also misused and can create theillusion of quality and consume a lot of money unlessmanagers keep their eyes on those core principles. No pointsare awarded for passing ISO audits or for having more blackbelts on the payroll than the competition. The points areawarded only for excellent quality.

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16

Sales, Operations, andFinancial Planning

Of all of the tried and true management practices of the past,annual budgeting might be the most useless and perhaps themost destructive. In many companies the budgeting process isso complicated and fraught with manipulation that a salesforecast from as early as October for the following year isneeded to have time for all of the number crunching back andforth required to lock in on a plan. Quite often the revenueplan is outdated before the budget year even begins.Undeterred, management marches through the yearcomparing everything that occurs to the fairy tale year theoutdated budget describes. Accounting compensates with ablizzard of variance analyses—calculating everything fromvolume and mix variances to spending variances—all gaugingthe difference between reality and what has evolved into anutterly meaningless set of numbers.

Money may or may not be spent in September because it is oris not in a budget that departed from reality long before.

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People are promoted and given raises as a result of theirability to control spending against a pointless set of numbersrather than making decisions about how dollars are best spentto optimize the current realities of the business. Yet, in spiteof the patent silliness of it all, every fourth quarter accountingmoves to the front and center, and managers everywhere areconsumed with budgeting work.

Of course, even in the unlikely event that management wasable to accurately predict the market for an entire year, thatknowledge was rarely built into the budget. In mostcompanies budgeting is more a grand exercise in gaming theperformance metrics than anything else. Sales understatesexpected demand to make it easier to hit the targets, whileoperations overstates needed spending to lighten the load forthe coming year. Senior management usually knows that noneof the budgeting input is credible and arbitrarily adjusts all ofthe numbers to compensate for the game playing as well as tocreate a fairy tale of its own—a plan for a successful yearwhether it is practical.

A static plan for the year is an exercise in futility mostlybecause there is nothing static about manufacturing and notmuch that naturally occurs in annual buckets. The onlyconvenience is for accounting, which has to file tax returnsand other financial and legal documents annually. As far asthe business is concerned, there is no practical reason toexpect January 1 to be anything other than the tick on thesecond hand following 11:59:59 on December 31.Manufacturing is a continuum, defined only by product lifecycles that are not slaves to a calendar unless managementforces them to be.

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The alternative, and the much more powerful process forplanning and executing, is a shorter-term approach calledsales, operations, and financial planning (SOFP). Usually arolling three-month outlook, SOFP is a process forcontinually ensuring that sales and operations are linkedtogether in a cohesive manner to deliver on time in the mostprofitable manner possible. That three-month horizon may belonger in companies that manufacture longer lead-timeproducts (e.g., capital equipment) but is rarely shorter.

Because the planning horizon is much shorter than an annualplan and because SOFP is a rolling, monthly process, thesales projections are more a plan than a forecast. Typicallythe sales leadership in the value stream brings acustomer-by-customer, product-by-product plan forshipments over the upcoming 90 days based on the currentrealities with each customer. The sensitivities of the sales planare introduced to the entire value-stream team and arediscussed: what customers might order more or less of andwhy. The particulars in each customer’s business arediscussed, including what is happening that could causeunusual changes in the normal pattern of demand.

On the operations side of the discussion, because all of theexpenses are assumed to be fixed, the starting assumption isthat the actual levels of spending over the last few monthswill continue or be reduced over the upcoming few months.Reasons the fixed-spending plan was violated in the lastmonth are discussed, and plans for cost reduction in theupcoming months are cross-functionally covered.Constraints—both real and potential—are identified and plansare set to manage them.

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By linking production and sales together, taking into accountthe potential variations in customer orders, an inventory plancomes out of the SOFP meeting that assures customerdeliveries will be made and that value-stream inventoryobjectives will be met.

In a broad sense, SOFP is a method of assuring that allparticipants in the value stream are linked together in ashort-term plan that continually improves execution to theirkey performance metrics. The meeting ends with a consensusacross every function within the value stream concerning theactions everyone will take in the coming few weeks to keepon track. The firefighting that occurs in most organizations asthe functional departments are continually surprised by theactivities in other functions—operations being hit byunexpected variations in demand, sales being surprised byproduction capacity shortages, months ending with widevariations in ending inventories from the beginning of themonth—is largely eliminated. Who has to spend an extradollar to save two elsewhere is well known and planned for.The drivers of variances are commonly understood, and thepotential problems are known by everyone before theyhappen so that contingencies can be planned.

The SOFP process is also senior management’s opportunity tomonitor value-stream execution and performance. The seniorfolks typically sit in on the SOFP meetings and have a chanceto see how things are going, such as how well teams aremeeting their key performance indicators (KPIs), and togauge whether things are under control. Because the role ofthe value stream is primarily to focus on continuousshort-term planning and execution while senior managementfocuses on the longer-term, SOFP is senior management’s

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chance to communicate longer-range issues and to ensure thatthe value stream is constantly positioning itself to be preparedfor what it will encounter down the road.

A high-priority function of the SOFP process is capacityplanning. Whether the horizon is 90 days or longer, thevalue-stream team is constantly looking at the workload onconstraint resources—which bottleneck machines or peopleare beginning to reach levels of maximum use. The valuestream gains a clear understanding of when and where pinchpoints will occur that could impact flow and customer servicein ample time to head them off at the pass.

The importance of this ongoing planning, execution, andreplanning process cannot be overstated. Although SOFP isstructured around a financial review of sales and operations, itis much more than a traditional budget review session. Forone thing, the nonfinancial KPIs are tracked and discussed. Inaddition, the process serves as primarily a communicationsvehicle that assures no one is retreating into silos within thevalue streams. It gives structure to make certain salespeopleare closely attuned to operational issues, and that operationspeople know very well the challenges and opportunities theongoing chatter between salespeople and customers hasidentified. An effective value-stream manager uses SOFP asthe forum for making sure the entire value-stream team isfocused on the fundamental mission of providing superiorvalue for customers and that employees are not straying offon a path of their own. SOFP rallies the troops and reenforcesthe sharp focus on customers, processes, and profits.

Figure 16.1 shows a sample SOFP report format, indicatingthe last three months’ actual results and the upcoming three

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months’ plan. Previously we discussed the implications ofcalling just about all costs fixed, and it is here that thebenefits of that approach come to the forefront. The objectiveis to assure that all indirect costs come in at the same level orbelow last month’s levels. To the extent that there may be avariable element of any given cost, this will be difficult toaccomplish as volumes increase. However, the rising costs arequite visible in the SOFP format and are the focus ofdiscussion and attention. The value-stream team can focus onwhy indirect, usually non-value-adding costs have increasedand can decide on a course of action to stop it. In traditionalbudgeting and cost reviews, those costs would be buried withallowable variable costs and would be far less visible tomanagement.

By taking overhead costs out of the product costs andmanaging them as they really are—precise dollar amountsspent on specific activities—and by seeing them in the properperiod, they can be managed and reduced. In the previousexample, direct labor and materials comprise over 60% of theproduct, whereas costs such as depreciation and buildingmaintenance each make up less than 2%. Looking at productcosts in a typical standard cost format, they are trivial. Even ifthey were to be eliminated entirely they would not appear tohave more than a negligible impact on the product, so noone focuses on them. In the SOFP format, they are seen forwhat they are—non-value-adding expenses that detract fromprofits—and any reduction that can be made in them resultsdirectly in an improvement in profits.

Kaizen events and Six Sigma projects are targeted efforts todirect resources at making rapid, cross-functionimprovements. An outcome of the SOFP process is the

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priority list for such efforts. Non-value-adding costs that arenot on a steady reduction track are high-priority targets forsuch improvements. SOFP is the ongoing tool to identifycost-improvement opportunities and to gain consensus forbringing all of the right people together to turn thoseopportunities into reality.

Figure 16.1SOFP format.

While the need for constant communication is always thereand the work of managing the value streams is continuous,SOFP is the vital core of excellent management: bringingsenior management and value-stream management togetheron a routine basis to continually focus on planning, execution,and improvement and to assure that everyone stays focusedon the goals and values of the business.

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17

Pricing to Win

The typical approach to sales and marketing has been to sellas much as possible of anything the company can make towhoever will buy them. More is better, so it is believed, andany increase in the top line is perceived to be good. Growth insales year after year and quarter after quarter has becomeingrained in business thinking as a critical measure ofbusiness performance, and the company with the greatestincrease is the best.

In support of this, manufacturing and the often long tails ofthe supply chain are expected to follow sales up the peaks anddown into the valleys as best as they possibly can. Companiesare hiring as many folks as they can find and workingovertime one quarter and are laying off and idling machinesand entire shifts in another quarter. The result is a coststructure that is never optimized.

If we consider the companies rapidly emerging as best able tosucceed in these dynamic times and attempt to boil down theirapproach to management into one overarching principle—and

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the one unifying principle behind every chapter in thisbook—it is all about managing the whole. Whether it isthrough functional organizations, standard costs, detailedperformance metrics, or sophisticated enterprise resourceplanning (ERP) systems, the great failing of manufacturingmanagement in the past has been to try to break the businessdown into small pieces and then to seek to optimize eachpiece separately. In doing so most companies have lost theability to focus the entire business on the most importantcentral objectives; they have lost the need for each person andeach department to be mutually supportive in pursuit of thosegoals. Nowhere is this more destructive than in the gapbetween the sales and marketing efforts and the productionefforts. It is also true that no greater improvement can bemade to most companies than to bring these efforts together.

Figure 17.1 shows two potential sales curves over a 10-yearperiod. While both companies enjoy the same overall salesrevenue, the sales represented by the dotted line drive aconstant state of capacity overuse, which drives overtimecosts, delays in preventive maintenance, productivity lost dueto hiring and training, expediting charges for parts andmaterials, then capacity underuse resulting in the costs oflaying people off and leaving the benefit of their fixed-costbase on the table. What is happening is that the rate of flowthrough the factory is being continually changed, shovingmore through it than it can handle and then starving it.

Conversely, the sales represented by the solid line with afairly steady slope keep the factory at a constant state ofcapacity use, gradually but steadily increasing it as the plantbreaks through constraints and finds productivity

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improvements. The cost structure of the factory—and theentire business—is always near its optimum state.

Figure 17.1Sales curve comparisons.

During Toyota’s boom years, while most of the world focusedon its manufacturing techniques—Lean manufacturing, theToyota Production System—what flew under most radars wasthat its sales curve looked a lot like that steady solid linewhile its unprofitable American competitors had salespatterns much like the wildly varying dotted line. Toyota’srecent problems stem largely from its failure to maintain thisstrategy: pushing the slope of the sales curve up too hard andworrying too much about being the biggest instead of beingthe best. For 50 years they demonstrated that the tortoise’s

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strategy was far superior to that of the hare in the race forlong-term business success.

The big culprit in this, making it all possible and seeminglylogical, is standard costing and the widespread approach topricing that boils down to marking up the standardcosts—looking to get a planned margin over standard costs oneach sale. What makes this problematic is that standard costsinclude all of the overhead expenses, which as we havediscussed are far more fixed than variable. The sales forcesets prices based on a terribly flawed assumption that thefixed cost per widget can be determined and that the resultingcost holds true whether it is the first widget being sold or themillionth.

First, the fixed cost per widget can never be calculated simplybecause the fixed costs likely had nothing to do with anyparticular widget. Just as critical, the amount of fixed cost theselling price of the widget has to cover is completelydependent on whether it is the first widget or the millionth.

Pricing is not a simple mathematical exercise, easilydelegated to someone with basic clerical skills or the productof math left to a pricing module in the computer. Pricing is avery strategic endeavor, involving the highestcross-functional leaders in the organization. Toyota achievedthat steady slope by using pricing as the valve to be turned upor down as needed to assure a steady slope. Most of theexcellent companies cited in this book do the same. They seeka planned volume level and view significant variation fromthat rate of sales—either up or down—as failure.

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The gulf between selling and producing has to be crossedwith a solid bridge. In fragmented organizations, decisions tooutsource production—move it all to China—make sensedirectly as a result of the separation of the two functions.Since selling and making are organizationally and financiallydistinct, it doesn’t seem to matter much where either one isdone relative to the other. The gaping hole between sales andmanufacturing in many companies is an opening companiessuch as Buck Knives and Wahl Clipper exploit when theycharge in with a unified business and a strategy to providesuperior value through their manufacturing capability, but ittakes a tightly connected selling and manufacturing effort anda sound business strategy to make it happen.

Previously we discussed restructuring the business into valuestreams, each including all of the functionalresources—including both sales andmanufacturing—necessary to provide maximum value tocustomers. Each value stream is aimed at a distinct market, orchannel within a market. In some cases a value stream caneven exist to support one customer when that customer is bigenough or important enough to warrant such singular focus.Each value stream, then, needs to be operating toward aspecific strategy.

The critical inputs to forming the strategy include both marketand capacity inputs. From the market side, you have to knowthe size of the market and your share of it, who thecompetition is, and how you stack up in the core value areas(i.e., quality, functionality, and reliability) as well as price.Most importantly, you must have a keen sense of how thecustomers define value, what their needs are, and the valuestream’s capacity.

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The important discussion must be around the volume youneed to attain to optimize the business. This comes fromlooking at the volume needed to prudently optimize the coststructure—typically at about 85–90% of capacity (not 100%because even Toyota needed to have some “wiggle room” tomeet unexpected spikes in demand or to be able to recoverfrom a disruption in production or the supply chain). It alsorequires knowing how much volume growth is available inthe channel or market: do you currently enjoy a 90% marketshare or a 10% share?

In the event the company is near its maximum capacity buthas a fairly small market share, how to install additionalcapacity is the obvious first step, and then the strategy has torevolve around determining the volume level to optimize thenew capacity levels.

This exercise must take place uniquely within each valuestream and for each market or channel the company serves. Itis typical within the excellent companies for one value streamto seek significant volume growth and going to market withvery aggressive pricing to do so, and another value stream totake a more conservative pricing and growth approach. Thismerely reflects the fact that one value stream has quite a bit ofunderused capacity, whereas the other one doesn’t. For mostcompanies, however, the objective is to grow sales and takeadvantage of idle capacity—especially during the currenteconomic downturn. The task, then, is to learn how to usestrategic pricing, rather than standard cost plus a markup, asthe control valve to drive flow through the factory at the leveleveryone agrees will optimize capacity use (and therefore bestleverage fixed costs) and will result in the market positiondesired.

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The widely used approach to pricing begins with unit costing.While companies may use different allocation logic (e.g.,assigning overheads on the basis of direct labor dollars orhours, machine hours, or multiple drivers as suggested by theactivity-based costing school of thought), one way or anotherthey all arrive at the same place; overhead costs are assignedto the various products. In Figure 17.2, a planned volume ofsales is multiplied by the standard direct labor cost perproduct to arrive at a total planned labor expense. This total isthen compared with the total planned overhead expenses,including both fixed and somewhat variable expenses toarrive at an overhead rate—400% in this simple example.

The total standard cost, then, is the sum of the direct materialcost for each product, the standard direct labor, and overheadat 400% of the labor cost. While most companies take a moreanalytical approach, the result is the same: overhead costs arebuilt into a “total cost” for each product. The pricing effort isthen supposed to assure that each item is sold at a pricesignificantly higher than the total cost to cover the sales,general, and administrative (SG&A) costs and leaves anacceptable profit.

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Figure 17.2Sample overhead allocation method.

If you follow the logic, you can see in Figure 17.3 that the“Total Standard Cost” is built on an assumption of volumes.Since it includes costs that are clearly fixed (e.g., machinedepreciation and management salaries), using differentvolume levels would have yielded different total costs. Thetotal costs are also blind to capacity use. The less capacity isemployed, the lower the volumes used to calculate the costwill result in higher unit costs. If a machine has a $1,000depreciation expense, for instance, and is capable ofproducing 10,000 units per year, the depreciation rate wouldideally be 10¢ per unit produced. However, if the factory isonly utilized at a 60% rate—6,000 units to be made by themachine; then a depreciation cost of 17¢ will be built into thestandard cost. The point is that the lower the volumes, thehigher the costs. This is just a matter of common sense, somemight say, but many companies go into a “death spiral” as aresult of this phenomenon. Volumes are down for whateverreason, causing costs to increase, leading to higher prices and

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then fewer sales and then further cost increase and so on, untiloutsourcing production to a country with low labor costsseems to be the only solution to their high costs.

Figure 17.3Sample standard costs.

At the heart of the problem is that fixed overheads are not thecost to produce any particular unit or even any particularvolume. They are the costs of capacity. It is also true thatmost companies have overhead rates far higher than the 400%in our simple example. Due to automation, mechanization,and a long focus on basic productivity improvement, mostcompanies have very low direct labor costs (often 5–6% ofsales) but increasing overhead costs. The more costs shift tocapacity costs and away from true unit costs, the moredestructive standard costing and the pricing decisions thatflow from it become.

Using the standard costs from our previous example, thetypical analysis yields something like the summary inFigure 17.4. Without really understanding the implications ofthe numbers, one would look at Products E and F and come tothe conclusion that a serious problem exists with thecost–price relationship. E contributes only 2% to SG&A and

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profits, whereas F is “losing money,” or is underwater, witheach sale.

Figure 17.4Typical unit “profitability” calculation.

The logical next steps would be to try to raise the price, tooutsource production to some lower cost source, or todiscontinue selling the item all together. None of thesesolutions are likely to be very effective, and since they arebased on flawed logic they are likely to be whollyunnecessary to begin with.

If the price could be raised without losing sales, in alllikelihood, the sales and marketing folks would have done itlong ago. More often, the product is repackaged or given asuperficial facelift, or advertising money is thrown at it in anattempt to drive a price that is truthfully out of line with thebasic value of the product. Although sometimes it can makesense, raising prices is rarely a viable option. In fact, moreoften the company is facing pressure from customers and

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competitors to reduce prices. Any marketing or brandmanagement solutions aimed at increasing prices relative tothe real value of the product are bound to fail eventually, ifnot right from the start.

Outsourcing production and discontinuing production areeven more destructive. Products E and F have a combined$54,200 of overhead assigned to them, most of it fixed. Whenyou farm them out or simply walk away from their volume,most of that $54,200 stays with you. It will end up beingallocated to the remaining products, driving their “total cost”up and detracting from your profits and inevitably causingyou to think you have to get higher prices or come up withother solutions for the rest of the products. This is anotherpath to the “death spiral” that only can end up in disaster.

The much more effective way—strategic pricing and strategiccost management—begins with rolling the numbers up a bitdifferently. As the following example indicates, the numbersare the same as the previous charts with one major exception.We have pulled the allocated overheads out of the unit costs.Note that the companies committed to the principles oflifetime employment—those that have truly built the culturalideals of the first section of this book into their businessmodel—also exclude labor from the product cost math. Bycommitting to employees, they become a fixed cost too. Theyare another capacity cost. It is precisely through this logic andthought process that Toyota has avoided layoffs for more than50 years and that Wahl Clipper has gone 35 years without alayoff. While most companies, as much as they would like tocommit to their employees, struggle with the idea because itjust doesn’t make sense to them financially. The chart inFigure 17.5 reveals the beginning of the different set of

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numbers the successful companies use. Looking at things thisway, committing to employees makes perfect financial sense.This view of the numbers demonstrates that every productmakes a contribution to the combined need to cover SG&A,profits, and the overheads truly related to capacity, rather thanvarying volumes and mixes of production.

The next step is really quite simple: Play “what if” gameswith pricing and volumes. This entails applying the volumestargeted in the strategic session and the prices necessary toachieve those volumes. In Figure 17.6, some prices actuallywent up, with a corresponding decrease in volume, whereasmost went down but generated a disproportionate increase involume.

Figure 17.5Margin analysis using direct costs only.

The important ingredient is the knowledge of where the valuestream stands from a capacity use standpoint: how muchadditional volume can the value stream produce without a

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significant increase in the fixed cost base needed to supportthe capacity? The goal is to find the point that drives the“right” volume through the value stream that hits theoptimum total cost structure and fulfills strategic salesobjectives.

Note in Figure 17.6 that the prices identified by most of thetruly outstanding companies we have cited are the pricesneeded to undercut their standard cost-driven competitors. Itis easy to see how a company deploying this approach topricing will have an overwhelming advantage over anothertrying to recover allocated fixed costs on each unit witheach sale.

Of course there is always the possibility that this approach topricing will yield prices necessary to meet volumerequirements but will not generate a contribution to profit forthe value stream. It is important to note that this is the truth,which is usually hidden in standard costing’s generalallocations and broad-brush approach. The truth has to beconfronted, and that is where the SOFP process has suchpotential.

The costs that have to be reduced are not necessarily relatedto any particular product. Rather, the overall cost of the valuestream has to be minimized. The direct link between reducingthe non-value-adding overhead costs (e.g., salaries andfactory support labor) and profit objectives can be clearlyidentified, and cost-reduction efforts can be launched to meetthe strategic objectives.

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Figure 17.6Margin analysis using different pricing scenario.

The point to take away from this chapter is that pricing shouldbe an ongoing effort, continually tying total operating costswith sales realities and customer requirements to ensureongoing bottom-line success. This way of thinking is a radicaldeparture from unit costing, unit pricing, and unit marginsand dispels the notion that some products are profitablewhereas others are not. In fact, only businesses can beprofitable, and just about every product can make acontribution to profits in the right volumes.

This strategic approach to pricing and cost management is thefinancial engine that turns the focus on flow and capacity intoextraordinary success. The keys to success are a unified,broad approach to the business by all of the seniormanagement team, especially sales and marketing,manufacturing and supply chain, and the financial staff. Allsenior management and value-stream team members have to

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be continually engaged in broad planning and decisionmaking and must look at the business as a whole.

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18

Capital Investment

Everyone knows that you cannot buy happiness, but lessbroadly understood is that you cannot buy profitability either.By some estimates, General Motors under Roger Smith spentclose to $30 billion on robots and factory automation as itscompetitive response to Toyota. It did not succeed, as couldhave been easily predicted, and served only to hasten GeneralMotors’ demise. Nothing for sale can give you a leg up on theother guy. If robots were the key to success, Toyota couldhave bought just as many of the same ones. Any machine youcan buy, your competitors can buy too. Any factory you canbuild, so can they. In the end, success or failure is a functionof management. The winner is always the company thatmanages best, not the company that spent the most. Thedownward spiral of American manufacturing is littered withpoorly managed companies that thought they could solve theirproblems through the acquisition of successful smallcompanies; this only destroyed them and the companies theybought.

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Capital spending should be very judicious and operate as anextension of good management, not a replacement for it. Oneof the authors was profoundly struck several years ago by thesight of a state-of-the-art electrical discharge machine in aChinese factory nearly adjacent to a 1950s vintage stampingpress. It was a vivid illustration of using the most appropriatetechnology for the job, not the highest level of technology butnot the cheapest either. That principle of investing in the mostappropriate technology—neither the latest or thecheapest—for the work you are trying to do should be theguiding principle behind capital spending.

The major failing in most capital spending decisions is the useof some variation on ROI logic as the basis for the decision.Such analyses are based on largely unknown and unknowablefinancial considerations and are inevitably tilted toward laborcost reductions simply because labor cost is the only inputmost companies find easy to quantify. Capital spending oftenbecomes little more than a hunt to find machines to replacepeople. One of the more obvious insights from Japanesecompanies is that the labor savings from investments inmachines rarely happens and that most often you end upreplacing lower-paid production people with more highly paidspecialists to take care of and set up the expensive machinesand to deal with the quality problems machines oftencompound. As the Motorola originators of Six Sigma werefond of saying, with automation you can create defects at arate you never before thought possible.

The most profound application of the head, heart, and gutapproach to decisions is in the area of capital spending. Ofcourse the cost of the machines should be considered, andwhether it is going to reduce or increase costs should be

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determined as best it can. But investments primarily aimed ateliminating people fail the heart test, and many investmentsutterly fail the commonsense gut test.

In considering the numbers, as with metrics, the numbers thatmatter are the bottom-line outputs. As best you can, acurrent-state and future-state statement of value-streamcontribution to cash flow, inventories, and profits shoulddrive the numerical analysis. This requires a keenunderstanding of the constraints in the overall process and anappreciation for whether the investment is an improvement atthe bottleneck or one of Eli Goldratt’s “mirages” ofimprovement somewhere else.26 The primary impact capitalinvestment has on the economics of a value stream is theimpact on flow. If the new equipment will facilitate fasterend-to-end flow it is likely to be a very good idea; if not, aneyebrow should be raised at just why the equipment is beingpurchased. Eliminating labor cost through the use of amachine that will crank out parts faster than the upstream ordownstream operations can process them or faster thancustomers want them is almost always a false economy, nomatter what the ROI numbers say. The two most powerfuljustifications for investing in new machines are (1) to breakthrough a constraint in factory flow and thereby leverage thefixed costs of the factory, and (2) to increase the capability ofa process, or to widen the narrowest garage door, so to speak.The next best basis for investment tends to be to improvechangeovers by reducing machine setup times. Way down atthe bottom of the list of investments that truly pay off is onethat reduces labor cost.

The best investments almost always improve quality andflexibility. They can turn on a dime and start to produce a

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different part in a very reliable manner. These things aretough to quantify in a traditional accounting system, however,and cause too many companies managed by the numbers tomiss the boat of opportunity. It is important to point out that,while success cannot be bought and management is the driverof success, management is typically manifested in itsdecisions concerning what and what not to buy. Poorlymanaged companies spend a lot of money on machines to cutlabor costs. Well-managed companies spend their money onmachines to blow production from one end of the factory tothe other faster and with higher precision. It is the differencebetween night and day, but because traditional accountingsystems support the former approach, the companies that holdonto old financial ideas suffer.

Common sense and a keen understanding of the valueproposition the company provides must be big drivers ofcapital spending. In the excellent companies there is a verylow threshold for investing in technology that improves thecore of the product; for example, machines that will result in abetter clipper blade at Wahl or a better-sealed window atAndersen find a pretty easy path through the approvalprocess. Machines that improve peripheral products orfeatures find it tougher going. Investments innon-value-adding tasks, such as computer software formanagement, often find approval virtually impossibleregardless of the ROI. Investments that expand the capacity toproduce core products similarly get an almost free pass.

26 Goldratt, E.M.; The Goal: A Process of OngoingImprovement; Gower; Surrey, UK, 1993; for additionalinformation on the Theory of Constraints and Throughput

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Accounting see the Goldratt Institute Web sitehttp://www.goldratt.com/

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19

Performance Metrics

In the wildly successful movie Rain Man, Dustin Hoffmanplayed a character who was an autistic savant. He had anamazing ability to calculate, memorize, and spit out detailedinformation but absolutely had no idea how to put it intoperspective. Living in the information age for the last30 years or so has made managerial savants of many when itcomes to metrics. We have access to prodigious amounts ofdata, and the fact that like the “Rain Man,” we often have noconcept of perspective does not stop us from trying to act onit.

Rain Man committed the phone book to memory but had noidea how to make a phone call. He memorized every statisticon the backs of thousands of baseball cards but had neverbeen to a baseball game. In like fashion, managers track andrecite statistics on headcount, labor efficiency, and points ofproduct sales margins and can often provide financial ratios totwo decimal points; all the while, the company is losingmoney.

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The first half of Albert Einstein’s quote, “Not everything thatcan be counted counts,” applies directly to this obsession withmetrics. Just because someone can gather the data and put iton a chart or can compare it with some other number andcalculate a ratio does not mean it is important or that it hasany meaning at all. It certainly does not mean thatmanagement team members should form any conclusions ortake action simply because they have data.

Perhaps the worst abuse of information simply because wecan get it is to attempt to boil our assessment of people’sperformance down to some number we have rather arbitrarilychosen to call a metric. This applies to the second half ofEinstein’s quote: “Not everything that counts can becounted.” No one’s contribution—or lack thereof—to thecompany can be summed up mathematically, no matter howmuch we would like it to be so or no matter how much easierthat would make the job of managing people.

The problem is that we confuse measures of performance(i.e., bottom-line outputs and results) with subordinate bits ofdata that may or may not have an impact on those results. Wealso suffer from a limited view and a limited understanding ofall of the different variables that interact along the way toachieving the results. Labor efficiency, for instance, isimportant only to the extent that it provides one small bit ofinformation concerning total costs. By itself, it is neither goodor bad; it is meaningless. The stockholders could care lessabout labor efficiency, although they hope members ofmanagement are on top of it and are using it as one input ofmany into the process of achieving overall profits.

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Manufacturing is a lot like baseball when it comes to metricsversus data. Baseball fans can become obsessed withstatistics, but all that really matters is winning games. Earnedrun averages and on-base percentages mean nothing if theteam is in last place. They also mean nothing when the teamis in first place. They are simply data points a good coachuses—along with a lot of other data points, judgment, andexperience—when making the decisions.

Many of the subordinate measures of how processes areperforming—and that is what they are—can be traded againsteach other, which is why management must be very carefulwith them. High labor efficiency is a good thing to have, butnot if it comes at the cost of higher inventories or poorerquality. Inventory reduction is generally good too, but not ifcustomer delivery suffers as a result. Therein lies the problemwith using these data points as the basis for making decisionsor thinking they are valid measures of performance. Unlessmanagement team members know all of the possible sideeffects of emphasizing a particular aspect of the performanceof a process, they are opening themselves up to disastrousunintended consequences when they push one metric too hardto save a dollar, and end up spending two dollars in someother area.

The only real measures of performance of a process is theabsolute output. View the factory—or at least a value streamwithin the factory—as a “black box.” All you know for sure iswhat went in and what comes out. Those absolute inputs andoutputs are the only basis for valid performance metrics.While each company has to decide for itself what to measure,the inputs are basically the money that went in, and theoutputs are profits, cash flow, customer delivery, and quality.

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These bottom-line results compared with resources that wentinto the black box are what really matter. Everything insidethe box is simply data that enable management to betterunderstand and affect the real outputs.

Headcount, labor efficiency and productivity, overallequipment effectiveness, quality inspections at some interimstep in production, floor space used, and machine use are allbits of data helpful only if they provide insight into improvingprofit and cash flow.

When the company was compartmentalized by function,using these internal bits of data as substitutes for performancemetrics may have been a necessary evil. However, when thecompany is aligned into value streams, everyone should havea clear line of sight to the bottom line. The measurement of avalue stream and the metrics for the performance of themanagement teams are the bottom-line results of the valuestream: its contribution to profit, its inventory levels, cashflow from the value stream, and its customer outputs, such asquality and delivery. In devising schemes to pay bonuses orcreate an incentive for the value-stream management, thesebottom-line output metrics should be the only ones used. Whocares what overall equipment effectiveness (OEE) or thedirect to indirect labor ratio was within the value stream if itis increasing profit contribution and cash flow, customerdeliveries, and quality? Conversely, why would we want topay someone to improve those internal metrics if the valuestream is not performing well in its outputs?

It is very important to segregate the few things that reallymatter and measure them diligently. It is also important tomeasure them as often as practical and measure graphically.

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Fixed-point measurements are dangerous, such as quarterlyprofit contribution compared with last quarter or to the samequarter last year. Such measures create a powerful incentiveto take harmful short-term actions, as everyone who hasworked in a factory belonging to a publicly traded companyknows. The activities in such plants to make this quarter’snumbers look good, regardless of the impact on next quarter,are often ridiculous. Plants irritate customers by shippingearly and suppliers by refusing to take delivery of incomingmaterials just to hit a quarterly inventory target. Vitalpreventive maintenance and employee training are deferredfor a few weeks simply to beat this quarter’s cost targets.

If cash flow, for instance, can be measured weekly, all thebetter; if not, then monthly. The point is to capture the data inthe most frequent intervals practical and measure them on agraph. Trends are much more informative than widely spaceddata points.

It is important to keep in mind that, once data are used formeasurement and once people are impacted by the results ofthose measurements, the data will cease to be objective. Theywill be influenced as much as possible by the people whoselives are affected by the results of the measurements. That isnot necessarily a bad thing, but managers have to be verycareful what they ask for, lest they get it. It is far better to askfor steadily increasing cash flow and profits over thelong-term than to ask for a very specific “stretch goal” by aset point.

None of this means those subordinate bits of data areunimportant or should be ignored. By all means, seniormanagement members should insist that value-stream

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management identify, track, and properly use all of therelevant indicators of how well their processes areperforming. The point is that these data should not drivedecision making unless they can be shown through a clear anddirect line that the decisions will have a positive impact onthose bottom-line, output metrics without trading one foranother.

There is only one exception to this arm’s length approach tosubordinate data within the value-stream “black box”: the useof OEE at the bottleneck operations. This should not beoptional. We discussed at great length the importance of flowand the huge impact the performance the bottleneck operationhas on overall flow: an hour saved at the bottleneck is an hoursaved for the entire process and so forth. We also pointed outthat there is always a constraint, though it may change. Thatmeans one operation is always the primary driver of overallflow through the processes and the controller of the overallcosts. Applying OEE at the constraint should not be optional.This is no casual, technical, detailed shop-floor metric. It isright at the heart of manufacturing management because itembodies everything important: managing the constraint,optimizing flow, understanding that direct labor and machineuse all by itself is destructive. When people ask why seniormanagement should be involved in the details of a metric likethis, the answer is because it is the acid test of whethermanagement really understands manufacturing excellence. IfOEE is perceived to be just another shop-floor detail best leftto people a few rungs down the ladder while the senior folksfocus on the important, heady issues of management, it is aclear sign that the senior folks have missed the boat.

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OEE is simply a combination of machine availability, its use,and its yield. It is calculated as

A × U × Y = OEE

where

A = the amount of time a machine is actually available as apercentage of time it was planned to be available. In otherwords, if you plan to work two shifts and have the machineavailable for 80 hours minus 2 hours per week for plannedmaintenance, availability (A) would be the number of hoursthe machine was actually in working order and available to beused divided by 78. So if the machine is actually available torun only for 70 hours, then A = 70 ÷ 78 = 90%.

U = the production of the machine compared with the actualrequirements on the machine. Note that this is not necessarilythe same thing as the maximum the machine can produce.Rather, if the true customer demand from the machine is 100pieces per hour during the 78 hours the machine is expectedto be available and the actual output is only 95 pieces perhour, then U = 95 ÷ 100 = 95%. (The maximum valueallowed is 100%; no credit is given for overproducing to theschedule.)

Y = the yield from the machine in terms of good pieces. If themachine produced 6,650 pieces and 133 of them were bad,then Y = 6,517 ÷ 6650 = 98%.

So if OEE = A × U × Y, then OEE = 90% × 95% × 98%, or84%.

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This is a very important composite measure of the effectivemanagement of a constraint resource and should always beemployed rather than simple machine utilization. Wheresimple machine use measurements can encourageoverproduction and poor quality, OEE is a balanced measureof all of the essential elements of bottleneck optimization. Asgood as it is for measuring the use of a critical resource, it isnot a particularly helpful measure in nonconstraint resources.As with all of the subordinate data within the “black box,” itis important to know which of the measurement tools to usewhen and how to use it.

Earlier we mentioned two very fundamental metrics of thevalue-driven, excellent companies: sales to value-adding costs(SV) and value adding ratio (VAR). These help boil downHenry Ford’s adage that “profit is the inevitable result ofwork well done” to its core.

Taken in reverse order, VAR is a measure of how muchmoney is being “wasted” on things that do not increase salesvalue. The objective of the company is not to reduce costs,contrary to conventional but uninformed wisdom. It is tospend as much of the money going out the door on things thatwill result in revenues. This pure entrepreneurial approach isthe hallmark of an excellent company. The startup businesswastes as little as possible on overheads, churning everythinginto products that can be sold. The mature company loses thissense of urgency and priority, becoming laden withadministrative and bureaucratic expenses the entrepreneurwould never dream of incurring.

How a company chooses to determine which expenses addvalue and which do not is purely a matter of understanding

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the products and the customers. Most direct materials arevalue adding, as is most direct labor. There are plenty of grayareas, however. Packaging is one. To the extent that thepackaging protects and organizes the various elements of theproduct it is a value-adding cost. To the extent that it isadvertising, it does not. Of course the packaging must clearlyidentify the product and assure the customer of exactly whatis inside the package. For the most part it is safe to include allpackaging costs in the value-adding cost calculation, but thereare many cases in which marketing has gone over the top,spending as much or more on multicolored packaging toinduce the customer to buy the product than was spent on theactual product. While this may add value to the salesperson’scommission, it does not add value in the eyes of the customer.

Many machine-related costs are also in a gray area. Machinedepreciation and preventive maintenance may well bevalue-adding costs, whereas breakdown expenses are not.Most of product engineering can be classified as addingvalue, except for the time product engineers spend correctingquality problems stemming from design flaws and their pure“blue sky” research and development (R&D) time.

Members of each management team must decide forthemselves what adds value, but team members should spendconsiderable time exploring the decision. If nothing else, itmakes for a very interesting and lively discussion as theyform a consensus around what really matters. Moreimportantly, the discussion will lead to a clarity of focus onwhat is important to the customers and, hence, to thecompany.

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The other key measure, SV, keeps the first measure honest. Itevaluatees the degree to which costs assumed to add value tothe customer are being translated into sales dollars. While itcan be seen as a measure of pricing effectiveness—is the salesand marketing effort commanding prices commensurate withthe value being provided?—it is more often a measure of howwell the company understands value-adding versusnon-value-adding costs.

One company we know included all labor costs in thevalue-adding category because it did not want to offend anyemployees by implying that they were not valuable to thecompany. While its intentions are admirable, value adding isnot a measure of people’s worth. It is a measure of whatcustomers are willing to pay for, and the company wouldhave been better served correctly identifying its truevalue-adding work and finding another way to reassure itsemployees of their inherent worth to the company.

The value of SV is that, in the case of that misguidedcompany just cited, adding more employees would have madeits VAR look good, those mistakenly classified “value-addingcosts” would not have translated into higher sales dollars, andthe SV would have suffered.

In this manner the SV metric is a powerful tool for filteringcost increases in the value-adding area. If someone wants todo something in one of those gray areas (e.g., spend more onpackaging), the criteria for the decision should largely revolvearound whether that addition to packaging costs will directlytranslate into increased sales revenues.

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Taken together, keeping a close eye on how the SV and VARnumbers improve is the best way to keep a value-drivencompany on track, profitable, and growing.

Concerning the SV and VAR metrics, most importantly thesefigures should be the subject of an ongoing discussion amongall members of the senior management team. These numbersdefine the core of the business’ value proposition and its basisfor existence. A consensus understanding of exactly whatcreates value for customers—and what does not—is vital toensuring that the entire organization is working in unisontoward the same goal. There can be no major disagreementsamong the senior managers on this score.

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20

Wrapping It Up

We have created a pretty lengthy to-do list formanagement—nothing short of a complete overhaul of howyou think and how you run every aspect of the business. Thegood news is that it doesn’t have to be all done at once. Thetransition from where you are to where you have to be to jointhe elite ranks of the companies defying conventional wisdomand succeed in countries where manufacturing cannotcompete, in industries that can be served only by countrieswith low labor costs, is one that never ends. You simply haveto change the way you think and then start to change the wayyou run the business.

The bad news is that this is not a cafeteria deal. You don’t getto pick the elements of managing differently that are easiest todo and leave the rest alone. It is an all-or-none proposition.Either you believe that it is all about creating value forcustomers, or you don’t, in which case you will continue tochase cost reduction for its own sake.

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Either you believe that cash is real and is the only aspect offinancial management that really matters in the end, or youdon’t, in which case you will continue chasing paper profitsand optimizing financial ratios.

Either you are committed to a responsibility for all of thestakeholders and believe that a commitment to them willresult in a commitment from them to you that will pay off in abig way, or you don’t, in which case you see them all as“headcount” and “inputs” to the profit chase. You buy intothat old Alfred Sloan theory that basically says thestakeholders buy their tickets and take their chances.

Either you have the courage to step up to the idea that theproblems on the factory floor are a result of management andthat management has to undergo radical change, or you don’t,in which case you choose to believe in the infallibility of oldmanagement theories and opt to put all of the onus onmanufacturing to perform better or die.

You really don’t have much choice. The economic fiasco ofthe past few years has already created the watershed. Thecompanies stuck in old management thinking are the ones inthe most trouble and the ones at the head of the line atbankruptcy court, by and large. If you weren’t already startingto question some of the management thinking—especially thethinking that said cash is just another commodity andinventory is just another liquid asset—then you are probablydoing so now.

If nothing else we hope we demonstrated that simplicity andfocus on commonsense fundamentals has power. Questioneverything, especially the complicated and expensive

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solutions. You have to get out of the spiral of pursuingcomplex solutions and then, when they don’t work,compounding them with greater complexity. The enterpriseresource planning (ERP) system isn’t helping much, but youneed to quit adding to it by implementing complicatedforecasting systems when the root of it all is long lead times.Shorten the lead times, then get rid of the forecasting system,and then gut the ERP system down to its basic core: simple,uncomplicated.

Purge the accounting reports and financial analyses thatnobody really understands, and just spend less cash. Startrunning the business more like you run your life, where yourbasic values, the wisdom from hard-earned experience, playsa bigger role than spreadsheets.

The best your company ever operated was in its infancy whenthere was no bureaucracy, few meetings, no wasted effort andmoney, when people did a lot of different jobs, and no onewas a dispassionate professional thinking what you did couldbe boiled down to numbers and charts. People had energy andfocused on customers and cash. Inventories were lean. Thepeople who knew the most about the products were the peoplein charge. Implementing management processes was whatdrove it away from those high-energy, sharp-focus days.Simple excellence is simply a return to those days and thatapproach to managing.

Perhaps the best outcome from joining the companiesachieving excellent results from simplicity is that the peopleworking for those companies have more fun and a sense offulfillment their bureaucratic competitors never know. Peopleare more empowered: everyone knows what the core

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objectives are and believes he or she plays a part in meetingthem. Value-stream structures put people from differentbackgrounds together for a common, important purpose, and asense of teamwork emerges that people hunkered down infunctional silos—all believing they are underappreciated andmisunderstood—never feel.

Knowing they are working for a company that shares theirpersonal values gives people that sense of purpose andfulfillment Bob Chapman at Barry-Wehmiller sees as themost important aspect of leadership. It is simply an approachto business that puts the common sense and integrity ofeveryone, from the executive suite to the shop floor, at theforefront. Most importantly, it works and results in successmany believe to be impossible.

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Index

A

Aberdeen, South Dakota, 42

Accounting Research Bulletins, 30

Activity Based Costing (ABC), vii, 77, 84, 117

Andersen Windows, 13, 17, 24, 71, 73

Anixter, 64

Armstrong World Industries (Armstrong Flooring), 13, 17,24, 125

Australia, 41, 59

B

BAE Systems, 24, 42

Barry, Thomas, 24; See also Barry-Wehmiller

204

Barry-Wehmiller, 23, 32, 33, 39, 137

Best Buy, 72

Bible, 86

Boeing, 13, 17, 24, 32, 49, 81

BRAMS, 32

Brown, Donaldson, 30, 32

Broyhill, 13, 17, 24

Buck Knives, 13, 17, 24, 81, 115

C

Centre Electronique Horloger, 9

Certified Jonah 5, 53; See also Goldratt Institute

Cessna, 13, 17, 24

Chapman, Bob, 24, 33–36, 39, 137; See alsoBarry-Wehmiller

Chiquita, 33

Colombia (country), 33

Culp, Larry, 33–34, 36

205

Cunningham, Jean, 29, 32

Customer Relationship Management (CRM), 57

D

Danaher Group, 34

Deere, 13, 17, 24

Deming, William Edwards, vii

Donne, John, 61

Drucker, Peter, 52, 97

Dupont Return On Investment model (ROI), 15–16, 29,123–124, 125

E

Einstein, Albert, 16, 127

Electronic Data Interchange (EDI), 46, 63, 72

Enterprise Resource Planning (ERP), viii, 1, 2, 4, 5, 12, 57,74, 89, 93, 113, 136

Europe, Western, 41, 59

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F

Ford Model T, 51, 91

Ford Motor Company, 13, 17, 24, 56, 59, 91; See also HenryFord

Ford, Henry, 14, 51, 52, 91, 131,

G

Gates, Bill, 30

General Electric (GE), 33, 100

General Motors (GM), 30, 32, 35, 55, 123

Generally Accepted Accounting Principles (GAAP) 5, 28,31–32, 59, 60, 77–79, 82

Goldratt Institute, 53; See also Eliyahu Goldratt

Goldratt, Eliyahu, 53–54

Google, 19, 34

H

Harley-Davidson, 13, 17, 24

Harvard Business Review, 17

Hoffman, Dustin, 127

207

Home Depot, 46–47, 71

Honda, 48

I

Internal Revenue Service (IRS), 28, 59, 77

International Standards Organization (ISO), 103

J

Johnson, H. Thomas, 29, 84

Johnson, Fisk, 36; See also SC Johnson

Jones, Dan, vii

K

Kaizen event, 5, 52, 54, 58, 69, 110

Kaplan, Robert, 84

KIA Motors, 33

Kraft, 13, 17, 24

Kroger, 20

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L

LEGO, 34

Lincoln, Abraham, 21

Lowe’s, 71

M

Madoff, Bernie, 33

Manufacturing Resource Planning (MRP), 89

MarquipWardUnited, 78, 82

McCulloch Corporation, 46–47

Motorola, 52, 91, 99, 103, 124; See also Six Sigma

N

National Aeronautics and Space Administration (NASA), 87

New United Motors Manufacturing, Inc (NUMMI), 55

Northrop Grumman, 13, 17, 24

O

Occupational Health and Safety Administration (OSHA), 25

209

Ohno, Taiichi, 86, 91; See also Toyota Production System

Overall Equipment Effectiveness (OEE), 129, 130–131

P

Parker-Hannifin, 13, 17, 24, 32, 49, 62, 71, 73, 81

Plan-Do-Check-Act (PDCA), vii

Pope Benedict, XVI 35

Pritchett, Lou, 24

Procter & Gamble, 21, 24

Q

Quality Screw and Nut Company (QSN), 64

R

Rain Man, 127

Real Numbers, 29, 32

Relevance Lost, 29, 84

Rio Tinto, 33

Roos, Dan, vii

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S

Sales to Value Adding Ratio (SV), 131, 132, 133

Sarbanes–Oxley, 32

SC Johnson, 34, 36, 49, 55, 56, 59

Securities and Exchange Commission (SEC), 33

Shakespeare, William, 53

Sherwin-Williams, 13, 17, 24

Six Sigma, vii, viii, 5, 6, 53, 54, 55, 57, 58, 61, 69, 85, 91, 93,99–100, 102, 105, 110

origins of 52, 99–100, 103, 124

Sloan, Alfred, 35, 36, 135

Smith, Roger, 123; See also General Motors

Sodom and Gomorrah, 33

Solomon, Jerry, 78–79

St. Louis, Missouri, 24, 33

Stanford, Allen, 33

Statistical Process Control (SPC), vii, 100

211

Sudoku, 13, 21

Swiss watch makers, 9–10

T

Target Corporation, 72

The Emerging Theory of Manufacturing, 52

The Goal, 53

The Godfather, 17

The Machine That Changed the World, vii; See also JimWomack

Toyota Motor Company, 48, 52, 55, 56, 58, 86, 91, 114, 115,116, 120, 123; See also

Toyota Production System (TPS), 5, 52, 58, 114

U

United Auto Workers (UAW), 36

U.S. Navy, 42, 46

V

Value Added Ratio (VAR), 87, 131–133

212

W

Wahl Clipper Corporation, 13, 17, 20, 21, 22, 23, 24, 32, 49,55, 56, 62, 71, 86, 115, 120, 125

Wahl, Greg, 34, 36; See also Wahl Clipper Corporation

Wall Street, 13, 18, 59

Wall Street Journal, 21

Walmart, 19, 20, 21, 23, 46, 63,

Wehmiller, Alfred, 24; See also Barry-Wehmiller

Welch, Jack, 58, 100

Westinghouse, 13, 17, 24

Weyerhauser, 13, 17, 24

Womack, Jim, vii

213