Thanksgiving Day Blog: Systems Thinking P. I

This thanksgiving – like so many others over the past 10 years while I have been and expatriate in central Europe - was more or less like any Thursday. E-mails, phone calls, some attempts to do real work, punctuated with a comment from wife; “oh my gosh, Happy Thanksgiving! Are you sad you are not home? Do you miss Thanks giving? Are you sad that you have to be here working instead of eating, relaxing and watching football games and eating apple pie?” Well what could I say? Nothing. So I put my face in my hands and waited for her to leave the room. She didn’t. Finally she asked me if I wanted her to leave. “Yes”, I replied.

OK enough of my pity party – for now, at least. What I wanted to talk about among other things is Toyota. For those of you who have or will take my Ops. Mgmt. class you will know I’m a big fan. So what does it have to do with BSE, CSR and sustainability?

Well there is one concept we covered in class very briefly called Systems Thinking – an off-shoot of an earlier field known as Systems Dynamics. For all the academic literature on the subject there is probably no better real life example than Toyota Motor Corp.

What Toyota has so successfully done over 50 years is employ what Amory Lovins calls “optimizing whole systems” rather than isolated parts of the system. By doing this Toyota will not only become the largest car maker in the world next year, they will also have annual profits and a market capitalization bigger than their next five competitors combined. And they are also the leading automaker in terms of environmental performance.

How did Toyota become a “systems thinking” organization? Early on in the ‘50s, lead engineer Taichi Ohno realized that Japan could never build cars the way the Americans do. In the 1950s car manufacturing was characterized by long production runs, long set-up times for model change-overs, and a small selection of models (think: “ . . . in any color – so long as its black . . . ). This successfully achieved excellent economies of scale in labor and machines – two subsystems – but also required high inventories and lots of mistakes which nobody was willing to stop and fix, thus ensuring people and machines were always busy. General Motors and Ford made up for these suboptimal aspects of the system very simply - by passing the cost on to the customer. This worked when they had no competition but that hasn’t been the case since the 1970s - which is why GM and Ford are facing bankruptcy while Toyota is achieving record breaking growth and profitability every year.

Ohno’s insights are partly due to his realization that Japan could never afford the American way of car manufacturing. Besides, the Japanese markets would never except so few models – it was a smaller more fragmented market. But luckily Ohno had an idea. If Toyota could just reduce the changeover time on a model from the typical one or two days to say a few minutes, than they wouldn’t need so many machines. If they could economically switch over several times a day, they wouldn’t need so much inventory because they could react to demand instantly – on a daily basis. Finally - and perhaps most important – with such small batch sizes, quality would have to be almost perfect to keep the line going. At the same time, because there were no buffer stocks to hide or to cover mistakes, quality, or lack of it, would be instantly visible.

This phenomenon is what’s called a feedback loop. Without feedback a system cannot respond. In the Toyota system there is a feedback on quality and a feedback on demand and this enables the system to respond by fixing mistakes and giving the customers cars they want. In the case of GM and Ford, long runs and piles of inventory between work stations means there is no feedback on what customers are buying and whether mistakes are being made.

To achieve this optimized whole system – one that is so clearly dominant over its competitors - there is a price to pay. The workers need to be flexible, to become more generalists rather than specialists, to accept more responsibility and above all be good at team–work. None of this is easy as I’m sure all of you know from your own experiences – including MBA group work. Also, quite often workers and machines are allowed – and in fact encouraged - to be idle. This may not be good for unit labor and machine costs, but is more than made up for in reduced inventory, less scrap and rework costs, and fewer and smaller discounts needed to “move the metal”.

The punch line of this well documented example, however, is the power of a positive feedback loop. Toyota’s financial success, which is based on a completely new approach to business, enables Toyota two significant advantages that their American (and to a lesser degree) European competitors are so far unable to develop. One is the freedom to engage in long term thinking. Two is the cash to invest in the great ideas that came out of this process. Today the rest of the industry is carrying out a series of short-term restructurings which increasingly rely on very short sighted decisions. These include slashing R& D budgets and engaging in heavy discounting rather than killing off stagnant brands and models.

While possibly over-hyped and deserving of more critical scrutiny the Toyota Prius nonetheless stands as a wonderful example of how a reinforcing feedback loop can bring unexpected advantages. Development of the Prius came about in the 90s – when oil was very cheap – based on the notion that sooner or later the car industry would have to confront environmental issues. Toyota’s goal became nothing less than to own this space. Realizing the promising technology of Hydrogen fuel was decades away, Toyota invested heavily in Hybrids.

The initial plan for Hybrids was never forecasted to be nearly as successful as it has turned out to be, but then nobody new oil would be approaching $80 a barrel a time when oil was trading near $10. So while Detroit was dumping all of their limited cash into successful but gas guzzling SUVs Toyota was dumping its cash – a lot more of it - into new technologies for hybrids. At the same time they were also investing into SUVs, and in fact successfully spotted a subtle transition to a more economic version of SUVs – the cross over.

So when gas prices went through the roof Toyota just happened to be ready with a solution. At the same time Detroit was caught with its proverbial pants down. All of a sudden Toyota’s solid competitive advantage became a huge competitive advantage. Is Toyota just lucky, benefiting from a one-off instance of good timing or is there something more identifiable behind Toyota’s good fortune? Systems thinking may very well hold some clues.