A Guide to Implementing the Theory of
A Japanese Perspective – An Explanation
This page is an attempt to resolve a conundrum over what constitutes a goal and what constitutes a necessary condition. In Theory of Constraints, “The Goal” is fairly well agreed upon for North American commercial activities. However, repeating that particular goal in Japan did not have the resonance that might have been expected. Over a period of time I came to believe that another goal, one which is equally valid, operates in parts of Japanese commerce. I want to try and describe this more fully.
Part of the problem, I am sure, is cultural. Cultural not in the selection of a goal, but rather cultural in failure to understand someone else’s selection of their goal. Frequently on the internet there are discussions about Toyota and the way it operates in North America as perceived by others living in North America but not actually working for Toyota (it would seem that many people believe that much of Toyota’s success can be ascribed to cheap non-union contract labor). I usually want to scream and shout “you are not working for Toyota so how can you understand,” followed immediately by “hey, but this isn’t even Toyota Japan this is Toyota North America.” We are not evaluating paradigms now, but rather cultures – wholly more messy situations.
Let’s try to explain matters with a couple of analogies and hope that one of them resonates. Take pumpkin pies and carrot cakes. My childhood exposure to vegetables was that they were a necessary component of a healthy diet but not a particularly enjoyable experience. How on earth could one turn vegetables into pies and cakes? After all, pies and cakes were the exact opposite – an unnecessary component of a healthy diet and a very enjoyable experience at that. Well, as with green eggs and ham, you have to try them to understand.
For a Japanese example there is a fermented Soya bean – a little like moldy cheese – called natto. About half the country thinks the other half is crazy for eating it and the other half of the country thinks that the first half is truly crazy for not eating it. And very rarely will the two halves meet. Which of course is a shame for those who don’t eat natto – they don’t know what they are missing (yes but, they will reply, we can smell it and we are not the least bit worried about missing out).
The point is, without direct experience, often we can’t appreciate the other sides view. We end up stating things like “yuk pumpkin pie and carrot cake.” Really it depends upon the cultural perspective.
So, too, with goals and necessary conditions.
Of course one of the advantages of inventing a theory such as Goldratt has is that he also gets to define the terms. And if you subscribe to a particular theory then it rather behooves you to adhere to those definitions. So let’s make sure that we know what a goal and a necessary condition is.
A goal seems to have two important features. Firstly; it must be open-ended, you can not have too much of the goal (1). Secondly; the owners have the sole right to determine what the goal is (1).
What about necessary conditions then? A necessary condition is a boundary imposed by a group external to the owners which can not be violated (1). Looking at it from a different direction this is a minimum condition that must be satisfied. A necessary condition can also be internally imposed, such as a core corporate principle or value (2).
Let’s see then how this is interpreted in North America first, and then in Japan.
The North American perspective for publicly traded companies is fairly well defined by Goldratt (1).
“If a company has even one share traded on Wall Street, the goal had been loudly and clearly stated. We invest our money, through Wall Street, in order to make more money now as well as in the future. That is the goal of any company whose shares are traded in the open market.”
What happens then if a company is privately held?
“If we are dealing with a privately held company, no outsider can predict its goal. We must directly ask the owners.”
On the measurements page we expressed the goal for a publicly traded company as small tree with two pre-requisite necessary conditions. However in contrast to the measurements page where we “dropped” the “more money” from the definition, let’s make its inclusion explicit this time.
Essentially the tree says that in order to achieve the goal and therefore to make more money now and in the future we must provide employees with a secure and satisfying workplace now and in the future and we must satisfy customers now and in the future. Failure to satisfy either necessary condition will result in less (and less) of the goal in the future. On this there is probably little to disagree with.
But why do we choose this goal? What is it about making more money now and in the future that is important to the owners of the organization? Well, it allows the company to prosper and if necessary also to grow. And let’s face it, if we develop a system that is good at producing money, won’t we want to have more of it if we are able to expand? Just ask the share market if you are unsure. So really making more money is a precursor for something else – organic growth. Organic growth as opposed to raising funds for acquisition, merger, and consolidation (aka cost cutting). Let’s draw this.
What is organic growth then? Surely it is a process of on-going improvement; the better the staff the better the product, the better the product the better the customers, and the better the customers the better the profit. Let’s then alter our diagram accordingly.
In the North American model, the investors want to secure both the present and the future of the company through a process of on-going improvement. When they see the improvement falter, they may be tempted to cash-up and find a new company to back.
What about Japan then? Let’s see.
From my point of view I feel that the goal in many Japanese corporations, especially the so-called “founders companies” on the 2nd tier of the Tokyo Stock Exchange and a good few from the first tier as well, is different from that of the publicly traded companies of the United States. Sure the espoused goal might be the same, but the goal in reality is something a quite different. Let’s have a look at this.
So, we swapped the goal and a necessary condition. Now we must argue that in order to provide employees with a secure and satisfying workplace now and in the future we must make more money now and in the future and we must satisfy customers now and in the future. Failure to satisfy either necessary condition will result in less (and less) of the goal in the future.
But isn’t this goal heretical? Well it might be if your paradigm is the reductionism and efficiency, it might not be if your paradigm is systemism and subordination. Regardless of the paradigm; it is not heretical if we are after the same end result as in the United States.
But consider also the following. There is no revolving door for management in Japan, once you are in you are in and you will remain in. You make a choice for the rest of your life in your very early twenties just as you leave university for the first time. If your firm “stuffs-up,” you too are personally stuffed as well. Remember too that in a nation where women do not often hold professional positions incomes are often from a single source.
Yes, it is becoming looser more recently, some younger people actively seek to work for “American Companies,” nevertheless for most this is not an option especially outside of the main centers. Thus there is an imperative for security in Japan that is lacking in the US. Changing firms in Japan is very difficult and often quite harmful.
Employment dynamics aside; why is this goal not heretical if we are after the same results as in the United States? Well, let’s have a look.
Providing employees with a secure and satisfying workplace is a pre-requisite necessary condition for securing the present and the future of the company. We learnt previously from kaizen expert Kawase on the accounting for change page that in order for kaizen to be successful we must make sure that no jobs will be lost as a result of kaizen. The maintenance of this precondition is the key foundation for independent kaizen (3). But why is kaizen so important and so successful? Again it provides for organic growth. And again we can express this as a process of on-going improvement. Let’s add this.
In the Japanese model, the employees want to secure both the present and the future of the company through a process of on-going improvement. And as we will see the employees are the management. When employees see the improvement falter, the employees can not move on and find a new company to work for. The employees must correct the problem at hand.
What we can be certain of is that in neither system – North American nor Japanese – is the customer the goal. Schonberger states with reference to Japanese inspired World Class Manufacturing that; “The direct goal of the firm is not to produce revenue or make money. It is to serve customers (4).” Codswallop! Satisfying customers is a means to an end, in other words it is a pre-requisite necessary condition. It is not the end in itself, it is not the goal.
In Japan the customer and the guest are described by the same word. “We have guests in the factory” is how Japanese usage describes such things. And, well, if we had more guests, or if they would just pay us a little more for our product, then we could justify borrowing enough money to buy that neat new computer numerically controlled machine that we saw at the show last year!
Satisfying the customer is not the goal in either system. Its transportation to the U. S. as a goal, and its institutionalization in various national award criteria, is the result of misunderstanding.
Ah, but I can hear you say, employee security and satisfaction can’t be the goal because it’s not open ended. Oh really? Then consider the following for a moment.
A feature of Japanese corporate life is the twice annual bonus payment. One half at New Year and one half in mid-summer. Parts of the economy revolve around these periodic lump payments. Generally these range from a standard 3 months salary to about 5 months salary per year. Now suppose you were on 3 months and were offered 4, would you refuse it? I doubt it. And once you were on 4 months would you limit yourself to that if the company continued to produce more cash? Probably not. An additional month’s bonus each year would make you more satisfied and certainly more secure. Employee satisfaction and security is open-ended. You can’t have too much.
There are other non-cash incentives that add to satisfaction and security for employees-for-life. Many corporations will have limited amounts of company housing for younger families. New unmarried employees will almost certainly take advantage of company hostels because they are so much cheaper than the open market. There are usually special company deals on hotels in popular holiday areas, the company ski lodge, the company mountain house and so forth. In the context maybe we should expect nothing less. Is it open ended? It can be.
There is one other aspect. Employment-for-life or at least allegiance to the firm carries with it a need to expand. Currently, most corporations pay seniority-based pay. Year after year the total base pay of the corporation increases as the workforce ages. Expanding the firm broadens the age base with increasing numbers of younger graduates and reduces this effect. Another need to expand comes from the need to find meaningful positions for everyone. Unlike the Army for instance where it is “up or out” when there is no out, you have to keep creating “up and across.” For many Japanese firms kaizen has enabled them to grow markets in size, type, and geographic dispersion. Expanding the firm means security. Once again there is an imperative that does not exist in North America where up or out (to a better firm) operates.
Well, if the goal in this case is indeed open-ended, then surely it is not what the owners of the system have declared as the goal. Well let’s see. We need to look at the corporate structure in Japan and the role of the banks.
"At an average U.S. publicly traded company, the board of directors has about 13 members, only two or three of whom are from inside the company. The remaining are appointed from outside."
"But at an average company in Japan, there are no outside board members. The board often has more that 20 members and usually they all are executives engaged in daily operations of the company (5).”
Thus we can see that the governance structure of Japanese corporations is somewhat different from what we would expect in North American or European models. Let’s continue.
“The board rarely dismisses the president because members have long been subordinate to the president, who effectively has the final say in appointing board members, subject to the approval at a shareholders' meeting.
Cross-shareholdings also still account for much of the total outstanding shares of the Japanese companies, and there are fewer institutional investors on the market than in the U.S.
Management teams thus feel relatively little pressure from the stock market and shareholders, a situation that allows them to operate at low return-on-equity ratios (5).”
Thus active institutional investment in publicly traded companies is much less than in North America and representation by such shareholders is non-existent.
We can see some of the institutionalized disenfranchisement in the fact that about 70% of publicly traded companies which close their books in March have their annual shareholders meeting in June – June the 27th to be exact! Racketeers might be the stated reason for this coincidence (6) but I invite you to consider this more fully.
Tightly held ownership of shares is not unique to Japan. For a North-American example we can turn to Cummins Engine Company. By developing tightly held ownership rather than cross-ownership Cummins Diesel was able, in the early 1990’s, to fend-off the “efficiency” of the markets through selling shareholdings to Ford, Tenneco, and Kubota; all of whom had mutual interests in Cummins’ success. It was a strategy to secure “patient capital” and achieve the position of a “private company with public ownership.” It is acknowledged that making the interests of the company and several key customers congruent actually made the company paradoxically more “Japanese” in its mode of operation (7).
It was suggested in the quote that management feels relatively little pressure to increased return-on-equity. Let’s examine this further.
“According to U.S. ‑based consulting firm McKinsey & Co., the average ROE of listed Japanese companies, excluding financial institutions, has fallen from a peak of 16.6 percent in 1969 to 2 percent in 1999. The ROE of U.S. firms, on the other hand, has gradually increased over the same period, hitting 23 percent in 1999 (5)."
If debt finance is important, then what is the role of the banks in Japan? Here is one view (8).
"We have entered the realm of the absurd, when it comes to credit and risk," said Takehiro Sato, economist and executive director at Morgan Stanley. "Banks continue to be nonprofit organizations whose sole purpose is to provide a safety net against unemployment (by carrying ailing companies)."
So who are the owners? The owners of debt financing, the banks, are essentially ensuring that the goal of employee satisfaction and security through continued employment is met. The owners of equity finance are most often cross-shareholdings – which amounts to owning yourself.
So we could answer the question in two ways. Firstly to use Goldratt’s criterion that the goal is set by the owners, we must agree then that the owners are the employees – through cross-shareholding in each others’ firms and via government sanctioned debt financing. At least we are consistent with our definitions here.
Secondly, we could consider that the portion of shares freely traded on the stock exchange represent the real owners, but if that is the case then those shareholders have abrogated their right to determine the goal, and have instead assigned that right to the management.
Regardless of the way we substantiate the matter it seems fairly clear that for many companies in Japan the effective goal is the satisfaction and security of their employees. Moreover this goal is largely supported by society.
Which goal is correct then? The North American one or the Japanese one? Well, surely both are correct. Correct within their respective social contexts and correct within our prior definition. Moreover, they both create value; and they both create a process of on-going improvement.
One is maybe more capitalistic and the other more socialistic – but then, this more like two end-points of a continuum rather than two mutually exclusive positions. During the 1920’s and 1930’s Japan tried a more purely capitalist approach, but as in other countries at that time, industrial unrest was rife. Maybe the more collective model developed in the 1950’s harks back to an earlier and more stable pre-industrial social order. One that we see replicated to some extent in several of the industrialized countries of Europe.
Deming certainly saw past this apparent dichotomy of employee versus investor; he considered that management must signal their intent to “stay in business and aim to protect investors and jobs (9).” The accent is on investors and jobs; not either or. He addressed those comments to a North American constituency.
If neither then is incorrect as a goal within the culture that it operates; what then is the problem? Let’s see.
There is nothing wrong with the American perspective – except that sometimes one of the necessary conditions is not met.
Ironically it is the necessary condition that the Japanese address as their goal. North America companies often don’t provide employees with a secure and satisfying workplace either now or for the future. If seems that there is no lack of recognition of the importance of financial capital in this system, but there is a failure to sufficiently recognize the providers of the enterprise capital of the system – the people. It is failure to satisfy this pre-requisite necessary condition that is the real problem.
Goldratt has an important cloud that describes the conflict that give rise to this problem. The cloud is well known but hard to find. I know, I searched for a published copy. Fortunately, Cox and Spencer include it in the last chapter of their constraints management handbook (10). Here is the cloud as Goldratt originally verbalized it.
We need to break this cloud. We need to satisfy the two needs; induce people to improve and also convert any local improvements into bottom line results – all without laying people off. Note that the language of this cloud is predominately that of the reductionist/local optima approach. The solution however is firmly within the systemic/global optimum approach. Let’s have a look.
And let’s be really clear about what improved productivity means;
Productivity = Throughput / Operating Expense
Under the systemic approach this means the following;
Improve Productivity = Increase Throughput / Maintain Operating Expense
Improved productivity means increased throughput at constant operating expense during the exploitation phase and if we have to increase expenditure during the elevation phase then the increase in expenditure must be significantly less than the increase in resultant throughput. We must constantly strive to decouple throughput from costs. Constraints accounting shows us how to convert the investment sums needed for the elevation phase into operating expense for management accounting purposes so that we can evaluate the improvement using the relationship above (11).
Let’s be very clear, improved productivity does not mean this;
Improve Productivity = Maintain Throughput / Decrease Operating Expense
This is the reductionist approach. This thinking is the cause of the cloud before we broke it. This thinking is a legacy of our pre-industrial past – leave it there, don’t bring it into the present with us. I didn’t even want to write it. Let’s erase it from our minds.
Improved productivity means increased throughput at constant operating expense – because we don’t want to layoff anyone at all. We must make more money for the system from the system as it exists now in order to satisfy both of the needs. This may eventually mean new markets or strategy. Initially it may simply mean better exploitation of existing circumstances. Whatever the intent, it really means establishing an holistic approach at the very outset of the journey towards a process of on-going improvement.
Caspari and Caspari have a specific solution for this problem which they outline in constraints accounting using a POOGI bonus scheme (11). It is not far removed from similar solutions in Japan. We shouldn’t be surprised, after all the objective is the same.
There is nothing wrong with the Japanese perspective – except that sometimes one of the necessary conditions is not met.
Ironically it is the necessary condition that the North Americans address as their goal. Japanese companies often don’t make enough profit either now or for the future. If seems that there is no lack of recognition of the importance of enterprise capital in this system, but there is a failure to sufficiently recognize the providers of the financial capital to the system – the share markets. It is the failure to satisfy this pre-requisite necessary condition that is the real problem.
We can build a cloud that describes the conflict that gives rise to the problem that we observe. Let’s have a look.
We saw that meeting current satisfaction and security requires a lot of cash (bonuses, benefits) and investment (employee accommodation and related facilities). Thus we must maintain or better still increase this. On the other hand reducing this expenditure would immediately increase the return-on-equity from the firm. Clearly we have a dilemma here. The solution is however the same as for the North American case. Let’s have a look.
And, once again, let’s be really clear about what improved productivity means;
Productivity = Throughput / Operating Expense
Under the systemic approach this means the following;
Improve Productivity = Increase Throughput / Maintain Operating Expense
Improved productivity means increased throughput at constant operating expense during the exploitation phase and if we have to increase expenditure during the elevation phase then the increase in expenditure must be significantly less than the increase in resultant throughput. We must constantly strive to decouple throughput from costs. Constraints accounting shows us how to convert the investment sums needed for the elevation phase into operating expense for management accounting purposes so that we can evaluate the improvement using the relationship above.
We must improve productivity because we don’t want to reduce current operating expenditure such as bonuses or benefits or divest any of our “extra” facilities. We must make more money for the system from the system as it exists now in order to satisfy both of the needs. This may eventually mean new markets or strategy. Initially it may simply mean better exploitation of existing circumstances. Whatever the intent, it really it means establishing an holistic approach at the very outset of the journey towards a process of on-going improvement.
Taiichi Ohno understood the need to satisfy making money and how to do it by increasing productivity (12). “What is the difference between traditional IE [industrial engineering] and the Toyota system? In brief, Toyota-style IE is mokeru or profit-making IE.” Thus we can see that it is indeed possible for companies in Japan to satisfy both necessary conditions in the cloud as shown above. Toyota has been doing it for years. Toyota is the largest corporate tax payer in Japan. You have to be quite profitable to do that. It is imperative to make a profit for the long-term success of the firm.
We need to focus less on the goal, or the difference between the goals and instead focus more on the insufficient fulfillment of the complementary pre-requisite necessary conditions.
Both countries; either directly or indirectly, fail to understand the tremendous commercial advantage of increasing productivity within their existing operations and instead look to cheaper labor rates and develop “we can’t compete” attitudes towards other countries. This doesn’t have to be the case.
It is an absolute shame that plants in the US industrial belts can get a new die manufactured in China sooner and for a much lower price compared to the established shop down the road. It is not the high cost of labor down the road that is causing this disparity. It is something else. “In 1986, the Japanese industrialist Konosuke Matsushita predicted that America would lose in the race for international markets because it was infected with a disease, the disease of Taylorism (13).” The disease of least cost. In a business the quickest way to realize cost savings is to lay-off staff. To lay-off staff destroys one of the necessary conditions for on-going improvement. Maybe this is why North American die makers can’t compete.
Japanese companies are not dissimilar. Many Japanese corporations have in recent years invested heavily in new plants in low labor cost countries in South-east Asia and mainland China. Sometimes this is to support other Japanese firms which have set up assembly lines in the same area, often times, however, it seems to be motivated by a fear that domestic labor will become too expensive. However, often substantial production exists within current domestic facilities, where the investment has already been made in plant and personnel. The potential for increased profitability from these facilities is immense.
In many ways current Japanese business practice appears to have strong parallels with North-American businesses in the late 1970’s. Donaldson characterized the management during this period in North-America as conservative, operating with low debt and high retained earnings (14). Debt excepted; conditions are similar. In North America the low debt and high earnings retention became a target of the changing nature of the markets which began to demand better “efficiency” – if not voluntarily, then involuntarily through hostile take-over. Donaldson argues that voluntary internal restructuring in response to these market changes was often much more effective and considerably less painful than eventual externally enforced restructuring. We could draw from this that maybe voluntary improvements now in Japanese businesses will be much more effective than waiting until it is externally imposed. For that matter; why restructure? Why not simply reframe.
We can use the wisdom of senior management and the enthusiasm of younger management.
There is a recent excellent account of the rise and fall of the Long Term Credit Bank in Japan by Gillian Tett. The first third of the book mirrors the development of Japanese economic and social norms since the 1950’s and provides an excellent context for understanding the situation in Japan as it is today. The remaining two thirds of the book are an insightful description of the differences in current cultural and economic approaches between Japan and North America and the interaction that occurs when they meet head-on.
Tett, G., (2003) Saving the sun; a Wall Street gamble to rescue Japan from its trillion-dollar meltdown. Harper Business, 337 pp.
(1) Goldratt, E. M., (1990) The haystack syndrome: sifting information out of the data ocean. North River Press, pp 8-13.
(2) Dettmer, H. W., (2003) Strategic navigation: a systems approach to business strategy. ASQ Quality Press, pg 62.
(3) Kawase, T., (2001) Human-centered problem-solving: the management of improvements. Asian Productivity Organization, pp 118-119.
(4) Schonberger, R. J., (1996) World class manufacturing: the next decade: building power, strength, and value. The Free Press, pg 231.
(5) Yoshida, R., (2002) Japan gropes for ideal corporate governance model. Japan Times, Friday August 23rd edition.
(6) Japan Times (2003) Some firms hold early stock meetings. Japan Times, Friday June 20th edition.
(7) Cruikshank, J. L., and Sicilia, D. B., (1997) The engine that could: 75 years of values-driven change at Cummins Engine Company. Harvard Business School Press, pp 413-442.
(8) Negishi, M., (2003) Foreign banks excel in lending with measure of risk, realism. Japan Times, Friday July 18th edition.
(9) Deming, W. E., (1982) Out of the crisis. Massachusetts Institute of Technology, Centre for Advanced Education, pg 23.
(10) Cox, J. F., and Spencer, M. S., (1997) The constraints management handbook. St Lucie Press, pg 298.
(11) Caspari, J. A. and Caspari, P., (2004) Constraint management: using constraints accounting measurement to lock in a process of ongoing improvement. John Wiley & Sons Inc., (draft).
(12) Ohno, T., (1978) The Toyota production system: beyond large-scale production. English Translation 1988, Productivity Press, pg 71.
(13) Kanigel, R., (1997) The one best way: Frederick Winslow Taylor and the enigma of efficiency. Viking, pg 486.
(14) Donaldson, G., (1994) Corporate restructuring: managing the change process from within. Harvard Business School Press, 227 pp.
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