Toyota in the down-turn

Bad news about the auto industry has been all over the news and Detroit executives are becoming regular visitors in Washington these days (no matter if they drive there or if they take the corporate jets…). While GM has had some time by now to get used to big losses, 2008 was a bad year even for industry darling Toyota. After years of dramatic growth in volume and in profits, Toyota now reports a multi-billion loss. Will Toyota be able to master this crisis “The Toyota Way?”. So far, all we know is that the company continues to honor its life time employment promise – the cost cutting so far has only affected temporal workers. Yet, vehicle inventory continues to grow and it is unclear how long Toyota can afford to produce more that it is able to sell.

 

See http://www.nytimes.com/2009/02/15/business/15toyota.html?pagewanted=1&_r=2&sq=toyota&st=cse&scp=3 for some updates on Toyota, including their new management team

 

http://www.nytimes.com/2009/02/15/business/15toyota.html?pagewanted=1&_r=2&sq=toyota&st=cse&scp=3

Production smoothing on a grand scale

It was just reported that the US GDP fell at an annual rate of 3.8% in the fourth quarter of 2008 but it would have fallen 5.1% had it not been for the inventory adjustment – demand “fell off the cliff” but firms kept producing, thereby causing inventories to rise.  One might interpret this as a nice demonstration of the production smoothing strategy on a grand scale – it is costly to shut down production, so keep producing and build inventory with the assumption that eventually demand will exceed your production and you can then draw down your inventory.  Production smoothing is particularly effective for coping with seasonal demand because then the firm has a good sense that demand will indeed return during the high season.  Now it is a little bit different. The drop in demand is not seasonal but systematic and it is not clear when demand will level off or at what level it will converge to. In particular, if the economy is still producing above the new long term rate of demand, then further adjustments to production will be needed.

The depth of the downturn may hinge on firms’ willingness to hold inventory. If they want to reduce their current inventories to their levels over the past five years, then they will need to really slam on the break (in effect, we have already produced for future demand and to return to equilibrium requires stopping production so that demand can catch up).  However, if firms are willing to hold on to their additional inventories, then the adjustment need not be so severe – in that case all that is necessary is that the firms align their current production with their current demand rate.

These issues are exhibited on a more “micro” scale at Chrysler. They stopped production in December 2008 because their inventories were higher than they could manage (or wanted) and continuing to produce would have only increased them further. They only just resumed production. If their current production rate equals their current demand rate, then their inventory level will remain unchanged. If they want to reduce their inventories, then they will have to produce at a rate that is lower than demand for some time.

So this raises the question of whether inventories are stabilizing or destabilizing to an economy.  You can tell a story for either one, and some additional data collection is needed to resolve the conflict.

Wall Street Journal, Jan 31, 2009, Economy Dives as Goods Pile Up

Little’s Law everywhere – even in the “body of Christ”

Little’s Law dictates the relationship between three performance metrics in a process, Inventory, Flow Rate and Flow Time:

Inventory = Flow Rate x Flow Time

If you know two of them, then you can calculate the third. It is hard to not be a Little’s Law junkie – seeing the application of Little’s Law everywhere.  Here is an application that you might not expect – the production of communion wafers. The New York Times published an article about a company in Rhode Island that makes a lot of communion wafers – about 1 billion per year. It comes with a short audio slide show which is reasonably interesting.

So what is the Little’s Law question from the article? Wafers are produced at the rate of 100 per second. They spend 15 minutes in a cooling tube. How many wafers does the cooling tube hold on average? Use Little’s Law! Inventory = 100 x 15 x 60 = 90,000, or enough for 360 Sundays at a medium sized church that serves 250 per service. (360 Sundays is almost 7 years.)

If Little’s Law isn’t your thing, then you can calculate out their process utilization. At 100 wafers per second, that is 100 x 60 x 60 x 24 x 365 = 3.2 billion wafers per year.  They only sell about 1 billion per year, so their process utilization is about 1 b / 3.2 b  = 31%

New York Times, December 24, 2008: http://www.nytimes.com/2008/12/25/business/smallbusiness/25sbiz.html?pagewanted=2&partner=rss

Is JIT dragging us down?

We all know these are tough economic times, but do we know why the economy is struggling so mightily? One theory is that JIT (and other lean manufacturing practices) are to blame. See, for example,

http://jamesfallows.theatlantic.com/archives/2008/12/pensee_dept_followup_on_the_no.php

The metaphor is simple, animals with stored fat are more likely to survive in times of scarcity than thin animals.  Alternatively, think of a group of hikers on a glacier. JIT means they all tied together with very short ropes so when one falls, they all fall in quick succession.  Are these metaphors correct? Is lean manufacturing the cause of our woes? There is reason to believe it is in fact the scapegoat.

Consider the auto industry and GM in particular.  Their demand is now much lower than their capacity.  (Actually, it has been for a long time, just now there is a very large discrepancy.) If they maintain production at their capacity, then their inventory continues to build, converting cash into inventory. This can work for a little while but eventually you run out of cash, risking bankruptcy.  This is the problem they currently have.  The alternative is to stop production, but then you pay your workers to do nothing, so you still burn through cash but then have no product to show for it. This is very costly – in theory, inventory can eventually be converted into some revenue.  

Now consider the role of lean production in this mess. If you turn back time to one year ago, had GM been less lean, then they would have had less cash and more inventory.  Consequently, they would have had less of a buffer to weather the current storm, so their problems would have hit earlier or would have been more severe.  If they had been even leaner, then they would have had less inventory at that time and more cash, thereby giving them a bigger cushion to survive the downturn.  Based on this reasoning, their current problems are as bad as they are because they weren’t lean enough, not the other way around. 

It is possible to defend JIT in another way – if JIT were the problem, then we would expect the leanest of the auto manufacturers to be suffering the most.  Toyota and Honda are among the leanest, and they are suffering, but not by as much, which is again consistent with the notion that during this crisis, being lean is a help and not a hindrance. Maybe the better metaphor is the following.  Two people are thrown overboard a cruise ship and nobody notices, so they need to fend for themselves. They see an island in the distance and start to swim for safety.  Who is more likely to make it, the fit and lean person or the “master of the buffet” person?

Out of stock for Christmas

Believe it or not, there is actually a product out of stock this Holiday season – Amazon’s Kindle. Oprah announced that she loves her Kindle and sales have exceeded Amazon’s expectations. The forecast is that they will not be in stock until February.  The key question is how many unit sales will they lose because they are not available in the peak month of the year? Probably more than they want. Even if those sales are deferred to the next holiday season, it is a costly situation for the company.  Of course, there is no way to know if they are just the victim of bad luck (or too much good luck) or bad planning, but it does illustrate that challenges of meeting highly uncertain demand.

Wall Street Journal Dec 4, 2008 – Better Scratch That Kindle Off Your List

Lean manufacturing gone too far?

“5S” in the world of lean manufacturing stands for “sort”, “straighten”, “shine”, “standardize”, and “sustain”. While it is hard to argue with the success of lean manufacturing on the assembly line, how far should the concept be taken? For example, can an employee add a hook on a door to hang a sweater? According to some 5S proponents, the answer is “no” – it doesn’t contribute to “aesthetic uniformity”.  Put a box of papers on top of a file cabinet – another “no no”.  This raises the question of how far a employer should go to dictate how employees do their job. One might argue that the employer should care only about output and not about process. Another may argue that employees will not maximize output because they will not choose the right process.  It would be nice to see some data on whether application of 5S to office environments indeed yields improvement.

Wall Street Journal, October 27, 2008 – Neatness Counts at Kyocera and at others in the 5S Club

Aldi’s operational simplicity

Aldi, the German founded grocery chain,  is a fascinating retail concept.  Like the wholesale club stores (e.g., Costcos) they sell a limited number of different items within each category.  Unlike the wholesale club store, and like a convenience store, they sell through a small physical layout.  Consequently, not only do they have limited variety within each category, they have limited overall variety – a typical grocery store carries 45,000 different items whereas an Aldi carries about 1,300 different items.  And unlike grocery stores, Aldi prides itself on its no-frills approach to service - you have to bag your own groceries, you can’t pay with a credit card or check, items are displayed in the boxes they were shipped in, most items are private label and you have to rent a grocery cart.  So why are people shopping at Aldi – in a word, “price”. Aldi claims “its private-label products were 16 percent to 24 percent below those at discounters and big-box stores, and 40 percent less than those at traditional supermarkets.”  This strategy is very much akin to Southwest’s initial approach in the airline industry – offer a very specific service to customers, with absolutely no additional service, and charge them a noticeably lower price.  It can be argued that Southwest has drifted away from that strategy.  In the current economic climate, Aldi may have extra reason to stick to its approach.

Wall Street Journal, Sep 7, 2008 – The Allure of Plain Vanilla

When the chips are down, do not hold too many of them

Micron Technology reported a $344m loss for the fourth quater, in large part due to a $205m write-down of memory chip inventory.  They report that DRAM chips fell 5% in price from the third quarter and NAND chips fell 15% over the same period.  Those price-decline rates translate to about 19% and 48% on an annual basis.  Holding even an extra week of inventory in such a climate is very expensive!

Wall Street Journal, October 1, 2008 – Micron Post $344 Million Loss

Quality, Incentives and Healthcare

The opportunities for improved quality in healthcare are enormous.  Now, there is more incentive for the industry to take quality seriously – Medicare will stop paying for 10 conditions that it deems to be “reasonably preventable”.  For example, Medicare will no longer pay for the treatment of patients who received incompatible blood transfusions. No doubt, some of the techniques that have been used to improve quality on the factory floor will also be useful in the hospital – reporting defects so that attention can be focused on them, changing labels on sensitive medications so that additional care is given to them, asking all attending a surgery to count sponges and instruments to confirm that no unwanted objects have been left in the patient, etc. And, additional quality improvement techniques may be developed that are tailored just for healthcare.

New York Times, Sep 30, 2008: http://www.nytimes.com/2008/10/01/us/01mistakes.htm

Honda’s Flexible Plants Provide Edge

This has been a tough year for most auto makes :  so far this year sales are down 24% at Chrysler, 18% at GM, 15% at Ford and 7.8% at Toyota.  But U.S. sales at Honda are up 1.7%.  There are two reasons for Honda’s success. (1) Honda’s product mix depends less on SUVs and pickups than the others (i.e., fuel efficient models make up a larger portion of their portfolio). (2) Honda has some of the most flexible plants in the U.S. To illustrate that flexibility, Honda is able to switch from producing  Civics to CR-Vs with only 5 minutes of downtime!  Honda has achieved this flexibility through many different decisions.  For example, the Civic and CR-Vs were designed to be manufacturered in the same sequence of steps, so the same step (such as a door installation) can occur at the same location on the assembly line.  Honda did have to invest $400m several years ago to improve its flexibility.  That looks like a good investment in the current climate.  

Wall Street Journal, Sep 23, 2008 – Honda’s Flexible Plants Provide Edge