Management by Financial Targets Isn't Lean
American industry must erase lean accounting before it destroys lean management
By H. Thomas Johnson
Professor of Business Administration
Portland State University
Lean accounting experts note that traditional accounting impedes efforts to adopt Toyota's style of management, commonly known as "lean" management. They point out that traditional financial systems for costing, inventory valuation, and performance assessment promote delay and discontinuity in operations, rather than flow and short lead times. Furthermore, they explain that traditional accounting does not disclose the potential financial benefits of adopting lean practices, simply because it does not show directly the cost savings and financial opportunities that might arise from disposing of or employing the resources that a successful lean initiative makes redundant.
To provide managers with better financial information that will encourage, rather than discourage, their pursuit of lean operations, these lean experts advise accountants, for example, to trace only direct costs to activities, to allocate indirect costs, if at all, in relation to the lead time consumed in activities (e.g., time-driven activity-based costing), to use value-stream map information to estimate the financial consequences of lean programs, and much more. This advice from lean accounting experts is commendable, as far as it goes. But it does nothing to challenge or revise the long-standing belief that managers must use financial information, including lean accounting information, to understand and control financial performance. In fact, this advice actually reinforces the mistaken idea that managers can rely solely on abstract financial quantities to explain and control financial results—it clearly assumes that they do not need to understand the human activities that cause those results.
It's vital to appreciate that accounting information is descriptive, not prescriptive. Obviously, accounting information can describe financial outcomes such as revenue, cost, profit, investment, and so forth. And lean accounting can improve the quality of such descriptive information, in the same way that activity-based costing improved the quality of product costs and departmental costs over two decades ago. But, like activity-based cost information, lean accounting information fails to help managers better understand how to continuously improve costs or financial performance.
The problem in using either activity-based costs or lean accounting to explain and control financial performance is that such use of abstract financial information assumes a business to be a mechanistic organization, not the social organization that systems thinkers increasingly view as a natural living system. Were a business a mechanistic organization, then a financial result—say the cost of a manufactured component—would be a linear sum of the financial costs of its parts. To change the component's cost would require managers to do no more than add or subtract parts, or change the measured cost of one or more parts. That is, in fact, how American managers today invariably view cost management.
In other words, although a financial result can be measured in a human system such as a business, the natural human system that produces the measurement cannot be understood, explained, or analyzed simply by examining the measured quantities in specific parts of the system. In the same way, a human body's temperature can be measured in degrees Fahrenheit. But information about temperature in parts of the body's system does not explain a change in body temperature. Instead, a medical diagnostician would explain a change in body temperature by scrutinizing physical conditions other than temperature, such as changes in blood flow, shivering, or perspiration—things that cause body temperature to change in ways that ensure the system's well-being.
In contrast to the medical diagnostician who views the body as a natural living system, managers view a business as a mechanism. They erroneously hold that any financial result is the linear sum of financial measures in specific parts of the business, and can be explained accordingly. Were they to view a business as a natural system, however, they would discover that financial results emerge from the system itself. They are the emergent outcome of relationships among the organization's parts. They would also realize that changes in those relationships, by affecting the consumption of resources, determine the results that accountants ultimately record in financial terms.
This is what W. Edwards Deming meant when he said many years ago that managers should not use financial targets to control long-run financial results. Instead, they should manage the system of relationships that produces those results. In other words, "the means are the ends in the making." Long-term financial results (the ends) can be no better than the system of relationships (the means) that is designed to produce them. Managers who strive to improve financial results by encouraging people to chase financial targets will invariably achieve poorer results than those who help the organization improve the system of relationships that generates the results. Deming's warning about targets remains unheeded to this day.
Lean accounting—indeed, most lean thinking and lean practice—does nothing to discourage what Deming warned against. It does not challenge the belief that financial information can be used to explain and control an organization's financial performance. Thus, managers can talk about lean accounting at one moment, and in the next encourage people to chase "lean" financial targets. As a consequence, lean accounting does nothing to end the devastating effects of "managing by results"—the use of quantitative "levers of control" to drive financial results—that has impaired the performance of American business for over 50 years.
Ideally, efforts to improve business performance will shift in the future from "managing by results" to focusing on how well organizations design their operations to follow principles observed in natural, not mechanical, systems. The principles implicit in natural systems resonate in The Toyota Way that Fujio Cho, now Chairman of the Board and Representative Director at Toyota Motor Corp., spent his career formulating. These natural system principles are also implicit in the 14 points of good management that Deming articulated many years ago. And "The Universe Story" as articulated by astrophysicist Brian Swimme and ecocosmologiest Thomas Berry, lays out the principles of nature that I apply to business in my writings, especially in my book Profit Beyond Measure.
Unfortunately, lean accounting does not focus management attention on natural system principles. On the contrary, it concentrates on cutting cost by eliminating waste. In doing so, it encourages another generation of business people to chase financial cost targets and engage in the destructive "gaming" of results that invariably follows. To promote truly lean management, as long practiced by Toyota, organizations must move away from lean accounting. Lean accounting takes traditional mechanistic thinking for granted, and simply fine-tunes the status quo by reducing waste to cut costs. Lean accounting's quantitative and deterministic assumptions of a mechanistic universe are not needed. Instead, an entirely new way of thinking is needed, one that views business operations through the lens of principles found in natural systems.
The corrosive impact of mechanistic thinking that has dominated American business for a century or more is evident in a story that is currently popular among lean writers. It is now well known that key features of the Toyota Production System (but not the principles that underlie TPS) were visible many years ago in at least two American business institutions. In particular, they were visible in the continuous-flow operations at Henry Ford's early Highland Park and River Rouge plants around the time of World War I. They also appeared in the sophisticated approach to standardization and problem solving that was taught to manufacturers during World War II in the Training Within Industry (TWI) program. Recent writings show that Toyota executives and managers learned much of what would later be known as TPS in visits to Ford's plants before World War II, and in the TWI training they received in Japan just after World War II. Possibly Toyota would not have developed TPS as well or as early as it did had its people not learned from the early Ford operations and TWI.
This is an interesting observation, and may in fact be true, but it does not address the question of why American companies, including Ford Motor Company, did not reach identical conclusions and put them to work in their own plants immediately after World War II. Had they done so they might have surpassed Toyota even before Toyota left the starting block.
Perhaps Americans failed to adopt "lean" in the 1940s and 1950s because their obsession with traditional financial controls kept them from seeing what Toyota's observers noted. Not obsessed with management accounting "levers of control," but working from an entirely different set of assumptions, Toyota's people put what they saw in prewar Ford and postwar TWI to work in a new and unique way that led them, eventually, to produce variety in small volumes at mass-production costs. Americans, on the other hand, believing they could manage by numbers, remained mired in massproduction thinking and rising overhead costs for decades after World War II.
Indeed, that belief in "managing by results" persists to the present day in the form of lean accounting. It is the continuing belief in the power of financial numbers to explain and control financial results that prevents American business from seriously replicating the Toyota system. Lean accounting does nothing to alter that belief. It threatens to perpetuate the insidious influence accounting has had on American business operations since at least the 1920s. Thus, to be on the same playing field as Toyota, American business should erase lean accounting and begin seriously to nurture the natural system principles that support true lean management.
True lean management, as observed for many years in Toyota, equates performance improvement with improving how well a company's system follows the right principles, not improving the system's financial results. As long as American companies associate improvement with terms such as savings, cost, or bottom-line impact, they will not be on the pathway to true lean management. They will simply be improving short-run financial results in systems that remain mired in the wrong thinking. Improvement in a truly lean context must be seen, instead, in nonquantitative terms such as increased possibilities, simpler pathways, more-fulfilling relationships, or more-direct connections. Instead of chasing target results (including reduction of waste), lean managers must focus on target conditions that reflect these non-quantitative terms, e.g., continuous flow, balanced pace, real-time problem identification and counter-measuring, and standardized activity.
In the end, truly lean management, guided by the principles of natural living systems, will dispense with any need for quantitative results data. When an organization's system conforms to nature's principles, pattern and order emerge spontaneously and "right results" will follow. Believing that "the means are the ends in the making," management will see its task as "managing by means," not "managing by results."
This is, of course, a giant leap from where companies stand today. But it will be a leap companies must take to reach Toyota's level of "lean" management and then go beyond that to the level known as "sustainability." At the level of true sustainability, the human economy does nothing to diminish the flourishing of all life on Earth, human and nonhuman.
The most likely path to this level is to emulate the patterns and principles of Earth's natural systems in all human economic activity. Toyota's operations reflect only imperfectly what it means to emulate natural systems, and they are far from achieving sustainability. Indeed, no growth-oriented publicly traded corporation is ever likely to achieve true sustainability. However, that is an issue to discuss at a later time. The more modest task now is to help all economic organizations understand true lean management, as quickly as possible, and then move toward sustainability. But before any of that can happen, organizations must first erase lean accounting.
H. Thomas Johnson
H. Thomas Johnson was named one of the 200 leading management thinkers living today in a survey published by Harvard Business School Press in 2003. Winner of the Shingo Prize for Excellence in Manufacturing Research in 2001 and 2007, Johnson received the American Accounting Association's highest award for research in 2007, The Seminal Contribution to Accounting Literature Award, for his co-authored book Relevance Lost: The Rise and Fall of Management Accounting (Harvard Business School Press, 1987). Johnson's full biography is available at: www.sba.pdx.edu/faculty/tomj/tomj.htm.
For More Information
H. Thomas Johnson lists the following reading as directly related to the subjects addressed in this article.
William Waddell and Norman Bodek, Rebirth of American Industry: A Study of Lean Management (Vancouver, WA: PCS Press, 2005), esp. ch. 21;
James R. Huntzinger, Lean Cost Management: Accounting for Lean by Establishing Flow (Fort Lauderdale, FL: J. Ross Publishing, Inc., 2007).
Brian Maskell, How to Calculate the Financial Benefits of Lean Manufacturing, Presentation at Seventh Annual Lean Manufacturing Conference (Ann Arbor, MI: University of Michigan and the Lean Enterprise Institute, May 1, 2001).
H. Thomas Johnson, Confronting the Tyranny of Management by Numbers, Reflections: The SoL Journal, Vol. 5, No. 4 (2004), pp. 51-61.
H. Thomas Johnson, Lean Accounting: To Become Lean, Shed Accounting, Cost Management, January/February, 2006, pp. 6-17.
Brian Swimme and Thomas Berry, The Universe Story (New York; Harper Collins Publishers, 1992).
H. Thomas Johnson and Anders Broms, Profit Beyond Measure: Extraordinary Results through Attention to Work and People (New York: The Free Press, 2000).
John R. Ehrenfeld, Searching for Sustainability: No Quick Fix, Reflections: The SoL Journal, Vol. 5, No. 8 (2004), pp. 137-149.
Peter M. Senge, The Fifth Discipline: The Art & Practice of the Learning Organization (New York: Currencyi/Doubleday, 2006, revised and updated edition), pp. 363-367.
This article was first published in the December 2007 edition of Manufacturing Engineering magazine.