The Ghost of Sloan

If I were a Hollywood celebrity, or the subject matter of the Superfactory blog were just politics or other unimportant social drivel, the contents of my email inbox might be called "hate mail".  Since this is just manufacturing stuff, however, the notes from people blasting me for categorizing their lean efforts as "light weight" or their management as "Wall Street lackeys" does not rise to the heady level of 'hate mail'.  It is just good, old fashioned name calling, which is OK with me.  The folks I have panned for 'looking lean' instead of actually 'being lean' seem particularly prone to using the term 'ignorant' in the salutation of their notes to me.  And having lived in Detroit for a while, I understand that "you s.o.b." can be a term of affection in some Michigan manufacturing circles. 

However, to ease some of the stress I seem to cause, perhaps an explanation of my admittedly cynical attitude toward those in the manufacturing community who view Wall Street with such fear and respect is in order.  I ought to draw the distinction between superficial lean and actual Toyota, Henry Ford style lean manufacturing. To do that, we have to get right into the belly of the management beast where the DuPont R.O.I. model reigns supreme.

Alfred Sloan and his partners in crime rolled out the DuPont model over 80 years ago.  It is a weird little flow chart that purports to calculate business performance taking into account not only whether the company had a profit, but whether that profit was good enough relative to the assets it took to generate it.  Over those 80 years, the chart has been polished, refined and so deeply embedded in business thinking that academic library shelves across the land are groaning under the weight of the adulation.  Wall Steet has been conditioned to think that it - and all of the academic derivatives of it - are the only legitimate means of measuring business performance.

The problem is that the DuPont ROI model is fundamentally, diametrically, 180 degrees opposed to lean manufacturing.  The DuPont ROI model is built on the principle that inventory and cash are completely interchangeable as far as measuring a business is concerned.  No matter what else happens, whether money is in the bank or tied up in a heap of work in process inventory has no impact on results.  Go ahead and look at it by clicking here if you want to see for yourself. 

DuPont, Sloan, Donaldson Brown and the rest of the resident wizards at General Motors in the 1920's declared inventory to be an asset.  Taichi Ohno says inventory is waste.  I wasn't anywhere near the head of my English 101 class, but I am pretty sure that "asset" and "waste" are antonyms.  Neither Henry Ford nor Toyota managed by the DuPont ROI formula.  General Motors, the modern Ford Motor Company, Delphi, General Electric, Boeing, IBM, and virtually every other publicly traded American manufacturer does. (Notice a pattern there?)  I'll give you another clue.  Smaller, privately owned manufacturers, who have a pretty good track record of becoming lean, tend to ignore DuPont ROI, also.

The problem with the DuPont ROI model in its application is that Americans are smart folks and it took no time at all to figure out the logic and realize that the ROI number would go up quite nicely if the cost of goods went down by just a little, even when the inventory went up by quite a lot.  In fact, many of those academic library shelves are near collapse under the weight of tomes written on EOQ theory, which is just that - a way of calculating just how high can the inventory mountain grow in order save a nickel of manufacturing cost.

Pull inventory out of the DuPont ROI model and the entire batch manufacturing house of cards immediately tumbles.  Looking lean happens when management and lean consultants run around the shop floor putting in kanbans and U shaped cells, but do not take on the question of DuPont ROI.  When that happens, Delphi results occur.  The telltale sign is inventory turns.  When inventory does not start turning a whole lot faster, but lean looking stuff is happening on the shop floor, you can bet the ranch that either the lean consultants were unwilling to take on management, or management was unwilling to take on Wall Street.  Nobody was willing to step up and declare that all of the accumulated overhead costs embedded in inventory needed to be written off, and that inventory would no longer be a place to park excesses in the future.  In short, everyone was willing to give lip service to Ohno and publicly state that inventory is waste, but privately they went about worshiping at the alter of Sloan et al and managing the business as if inventory were an asset.

Eli Goldratt said that the Goal of manufacturing is quite simply to make money.  If a company defines making money the way Wall Street does - as optimizing the percentage at the end of a DuPont ROI arithmetic exercise, lean isn't going to happen.  So when I deride lean efforts in one sarcastic manner or another, please don't take it personally.  I am just getting after those who want to become lean without taking on the challenge of confronting the ghost of Alfred Sloan.

Comments

[PlanMaestro]

I think you are wrong. There is alignment between the ROI formula and lean manufacturing: Reduced inventory -> increases inventory turns -> increases asset turns -> increases ROI

Regarding cash, the ROI formula substracts EXCESS cash and keeps only the one needed for operation.

[Bill Waddell]

I have noticed that the defenders of ROI do so on a theoretical basis. Reality is a bit tougher to face.

No doubt, reducing inventory improved ROI - assuming cost stays the same.

No doubt that reducing cost improves ROI - assuming inventory stays the same.

The problem stems from lowering inventory and having all of that overhead underabsorbed. Then the increase in stated cost resulting from inventory reduction sends ROI into the tank.

As far as excess cash is concerned, that is a self-defeating proposition. Cash that is surplus to operational needs means cash left over after enough of it has been plowed into inventory to bury all of the period costs on the balance sheet.

But enough theory - will one of the ROI proponents please reconcile calling inventory an asset with Toyota calling it waste? Are you folks saying that Sloan got it right and Ohno was wrong? That GM's business theory is right and Toyota's is wrong?

And while you are at it, please point me to one American manufacturer who drives their company by ROI, rather than cash, who has actually become lean.

[PlanMaestro]

As you well know lean/inventory reductions also means improvements in quality and total costs, so actually is a positive double effect in the ROI formula.

I take your point that it is difficult to implement in the shop floor, it gives the finance guy too much power that do not understand this cross effects and sometimes it can be too short-term.

However, remember that the nail in the coffin for the auto industry has been excess capacity. ALL BOOKED ASSETS CAN BECOME WASTE.

And ... Toyota has the best ROI of the industry.

[Philip Neukom]

In 15 years of implementing, advising and directing lean implementation, I would propose that the DuPont model is only one part of a significantly larger issue when implementing lean.

Firstly, the balance sheet, the place to identify the assets and liabilities, is pretty much a mortician's guide to the company.

The accounting folks, bankers etc. seem to look at the company that way. (i.e. if the company goes down the tubes, what can the receiver get for selling the assets minus the pay out of all the amounts owing.) In this case, inventory is an "asset" since in a liquidation scenario it can be sold to pay off liabilities. Unfortunately, we will never change this thinking and it actually makes sense if you use and abuse the balance sheet this way.

Also note that all operating loans for companies will have the provision to borrow against inventory. So the lean implementation has to free up more cash than is lost in margining room for senior management to get past "status quo" in a lean implementation.

You will also note that generally accepted accounting rules do even more damage to actually understanding and properly measuring the company's performance. These rules REQUIRE an overhead burden to be added to inventory. While this is totally ludicrous for a "lean" company, (ie. identification and allocation of artificial burden slows the velocity of the company), GAAP and the audit profession require it.

In itself, ROI is not a bad measure. To make sure that the cash invested in the company yields a good return is not bad either from an operational or an investment viewpoint. Why would an investor put money into building a profit making enterprise if he can get more return from putting the funds into T-Bills?

The measures are in themselves not bad. The use and abuse of those measures is the problem. I agree, inventory is "waste". But from the business mortician's view, inventory is an asset, too.

[Bill Waddell]

Couldn't agree with you more. Pierre DuPont wanted to know exactly what General Motors would command at a 'Going Out of Business Sale' and the entire financial system was structured around assuring that he would always know the answer to that question. Ford and Toyota looked at things a little different, and the results were a little different. Looks like DuPont, Sloan, Donaldson Brown and the boys are going to get their wish. We are well on the way to knowing what their company will get at that Going Out of Business Sale.

[PlanMaestro]

Very good post Philip, I completely agree