Updated Lean Line Question — Cost Planning


Updated: Check out the comments for a lengthy reply (link) from Jim Huntzinger of the Lean Accounting Summit.

I finally got my first two “Lean Line” calls recently. Long-time Lean Blog reader, Bryan, left a message with a question about how Toyota does annual cost planning or budgeting cycles. It is that time of year for most everybody. You can use the player, below, to listen to his question.

I don't have a good answer for that question. If you have a question, either use the “comments” feature below, or feel free to leave an audio answer by calling the Lean Line at 817-776-LEAN.

Likewise, if you have a question, feel free to call and leave a message. The line is my “Skype” number, so it is going to roll right into voice mail. My Skype ID is “mgraban.”

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Mark Graban is an internationally-recognized consultant, author, and professional speaker who has worked in healthcare, manufacturing, and startups. He is author of the Shingo Award-winning books Lean Hospitals and Healthcare Kaizen, as well as The Executive Guide to Healthcare Kaizen. His most recent book is the anthology Practicing Lean that benefits the Louise H. Batz Patient Safety Foundation, where Mark is a board member. Mark is also a Senior Advisor to the technology company KaiNexus. His latest book has been released as an "in-progress" book, titled Measures of Success.

  1. Mark Graban says

    One other comment I’ll make to get the ball rolling… Bryan says his company’s planning cycle is about “cost cutting, cost cutting, cost cutting.” Is that mindset compatible with Lean? How do you get people focused on reducing costs through quality improvement? Can you budget for that? How do you get people focused on growth in addition to cost containment?

  2. Mike T says

    I’d like to piggy-back on the accounting theme of Bryan’s question.

    Yesterday, it was noted that our standard costs for product in our first “lean” product line will be higher than expected. The reason: reduced lot sizes, without adjusting standards on the routings for reduced setup time, will drive up standard costing. Thus, even though we carry less inventory and increase turns, due to our traditional costing methods we will look worse on paper. The costing process is a directive from our parent corporation, so we do not have the power to change the method.

    How do you combat this issue? Every corporation wants to pursue Lean, but only when it affects manufacturing, not when it delves into such “golden” areas as Accounting, Design, etc. Until the financial reporting structure is changed, Lean will continue to show negative impacts to the “bean counters”, who ultimately, indirectly (and often incorrectly) guide the shareholders/potential investors. This will shut down our Lean initiative quickly if a solution isn’t achieved.

  3. Anonymous says

    From a director of finance:

    I don’t know how Toyota does annual cost planning or budgeting, but I can share an interesting experience. I previously worked in the Financial Analysis group in the corporate office of a Fortune 500 company, and was put on the budget team. Our budgeting process was ugly. We had these huge spreadsheets that went out to every division (~350 divisions) where they had to try to understand the massive spreadsheet and then forecast every single line item (over 200 in total) for every month of the following year. The process began around Labor day and ended around Thanksgiving.

    My first questions were:
    1) Who uses the budget?, and
    2) What do they use the budget for?

    Surprisingly, it was very difficult to get an answer to the first question. I spoke to the 2 people who I was told were the main corporate users of the budget and they both told me, “I would like to use the budget, but it is so far from reality that it is usually a waste of time. I generally just look at the YOY performance.” I was also told the board looks at the budget, but found that their only exposure to the budget was one page of a slide show with 2 numbers – the first number was the total year EBITDA budgeted by the field, and the second number was the dramatically lowered total year EBITDA that corporate was budgeting for.

    Believe it or not, we actually managed to put together a simple web survey before beginning the annual budgeting cycle where we asked all the area, region, district, and division controllers what their thoughts were on the budget. The overwhelming feedback was that it takes way too long to prepare, and most people felt it was of little value and governed primarily by politics.

    I did all the research I could and found that several world-class companies have adopted rolling budgets that focus primarily on budgeting/forecasting the most important numbers on an appropriate cycle. I presented the findings to my boss who was interested, but ultimately concluded that he didn’t know if the new process would be any better than the old process and in the face of this uncertainty it was easier/safer to simply continue doing what we’ve always done. Three months later, I left to take a position at my current company.

    I am not opposed to budgeting, but I do believe there is a lot of muda in today’s corporate budgeting. The annual budgeting cycle consumes a huge amount of resources while creating little if any value. I believe most companies would be better off focusing on their key line items and monitoring them on a regular basis and updating the forecast on an appropriate cycle.

  4. Matt says

    @ mike t.

    Two things.

    The first, which you know, is that reducing lot sizes uncovers the waste in your setups. So, now you can see what you need to fix, right? Keep it up. Its hard. Especially when things look bad on paper.

    The second involves going to battle with the upper management. I don’t know how your company is organized, but accounting usually reports to upper management. If upper management is on board, and understands what you’re doing, then you have an advantage. I had success with the following end-run. As long as someone in upper management was on board, in the past, we effectively ignored accounting, and repeatedly and consistently mentioned to upper management that we were saving the company money, but it doesn’t show because standard cost accounting wasn’t working. We would also non-threateningly explain the differences to a friend in accounting (over lunch, at other meetings, etc). So, I suggest that your group play the squeaky wheel about the accounting process to upper management. That way it will stay in their head.

  5. Ralf says

    It seems to me that the time frame of changes is most difficult for managers to grasp (see Mike’s comment).

    So the change over time is the most important fact that has to put down to see the effects of policy changes in the future (Manager, “I don’t see whether the new way of budgeting is better than the old one!”).

    Who of you has any experience with system dynamics and modeling such problems in appropriate programs such as VENSIM?

    Best regards


  6. Mike T says

    This thread has generated a discussion with our Director of Finance. His comments to me are below:

    “Reducing lot sizes will drive up unit costs. The standard will go up, but so will the actual cost. If there is a setup, the cost of that setup is divided by how many pieces you can spread the cost of the setup over. This is not a problem with the standards system, it is real. We have had setup reduction projects for eons trying to reduce the time spent setting up. You can see the success we have had to date.

    I think that for us to go forward we have to do something that will reduce setup to the status of an insignificant ‘cost of doing business’ item. Year’s ago I was advocating getting setup out of the standards altogether and calling it an expense item that we reported indirect labor too. (In those days we reported all labor).”

    The first paragraph falls in line with the ‘Inventory is an Asset’ mindset…even though the company is really driving the initiative to reduce inventory.

    What I’m most interested in is: feedback on the second paragraph. Not being an accountant, this idea sounds interesting to me. What are people’s opinions on this forum?

    This thread has been very valuable to me. Thanks for generating this discussion Bryan/Mark!

  7. Mark Graban says

    I think your finance guy inadvertently hit on a salient point, Mike T.

    The key with Lean isn’t to just cut batch sizes. The key is to actually reduce changeover time dramatically. That’s the power of the SMED system.

    It doesn’t CHANGE the economics of “optimal lot size.” SMED lowers the time (and the cost) which allows you to run smaller lot sizes economically.

    Now, if you reduce the setup time and people don’t update the ERP system, then you will have troubles.

    But, am I right in inferring that you ARE having trouble getting your setup times down? If so, why?

    I’ll throw a few other “why’s” in there, in advance :-)


  8. Mike T says

    That’s where things get interesting. We have reduced setups in some areas. Nothing is even close to SMED, but we have reduced times (in some instances) up to 50%.

    Here’s the issue: manufacturing management does not want the routings changed (which is where setup time is recorded) for two reasons that they have voiced (we won’t get into the unvoiced issues). The first being that they don’t want the employees to fall back into standards-based work (mostly because our standards are wrong and the Union shop floor fights anything relating to standards heavily). You can see the unvoiced issues there, I imagine. The second reason is that changing the information would heavily change the variance, possibly into a negative result. On the surface, this shouldn’t be an issue. If they don’t change, the per unit cost will drive a variance also. Politics are playing havoc with the Lean implementation at this point.

  9. Jim Huntzinger says

    Commenting on the original caller and the first posting – yes, lean is about cutting costs! BUT, the difference in HOW you approach cutting costs is critical. Toyota is as focused as any company on reducing costs – reducing costs and leadtime were key issues Ohno was facing during the period when he worked on developing the system because Toyota was cash starved. And for any company to be competitive in a free market they must first, make a product that the market wants/needs; then once that is met, a firm must compete by price, leadtime (delivery) and quality. And, if a firm would like to remain in business it must (assuming reasonable quality and delivery) sell at a price the market will bear – while retaining its cost to receive a reasonable margin. So cost reduction is a key feature to any successful firm.

    Back to the “how”. A lean firm approaches the cost function from what Ohno called a limited production system. That is; design the “system” to achieve customer satisfaction (price, delivery, and quality) using the absolute minimum of resources in the shortest amount of time. Their systems of product/process development, hoshin kanri, target costing, flow development, kaizen costing, etc., etc. are all MEANS to meet that end. And it evolved out of Ohno’s (and other’s) work to develop a limited production system. If you read Ohno’s books and also Fujio Cho has commented on this, a limited production system is a system, according to Ohno, which avoids any work in excess of what it took to produce what could be sold. Cho actually contrasted the difference between limited production and economies of scale by saying that the difference between the two is the use of all resources as “anything other than the of equipment, materials, parts, space, and worker’s time, which are absolutely essential to add value to the product.” This lines up exactly with the definition of JIT; what is needed, when it is needed, in the amount needed using the minimum materials, equipment, labor and space. Coincidence – I don’t think so!

    Although, Toyota uses shopfloor kaizen to incorporate improvements in operations, their MAJOR cost advantage (approx. 85%) comes from designing the system (product/process) for limited production WITH the customers needs/wants intimately at the forefront.

    To get into the details of all of the “hows” which Toyota or an excellent lean firms applies (and integrates together) to be successful is too long and complex of a discussion for a single book, let alone a blog. BUT the best source to understand this function and the mindset which it requires is illustrated brilliantly in Tom Johnson’s book, Profit Beyond Measure. In it Tom describes the difference between Management by Results (MBR) verses Management by Means (MBM) – where the means are the key functions or “hows” that Toyota goes about to “reduce costs”.

    Obviously, this posts skates around the question about budgeting, but until you can understand this aspect – or as Tom Johnson puts it, MBM – the meaning of the budgeting process is only dancing around the periphery.

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