It is about to become painfully, crystal clear: The essential innovation Toyota made was SMED – Single Minute Exchange of Dies. Nothing else about the Toyota Production System comes close in significance. The rest is all just cost reduction and quality improvement, but SMED is changing the global economy. Those who cannot see the forest for the trees can quibble all they want over what Ohno did and what Shingo did, and exactly what Shingo’s relationship with the Toyota Production System was. They all agree that Shingo fathered SMED, however, which puts him in a league entirely of his own. It will also make fools out of the Nobel Prize people who said his work was not worthy of consideration.
SMED is so important because it killed economy of scale. You can check the math:
Let’s say the factory has $4 million in fixed overhead costs. To keep the math simple, let’s say the plant’s maximum capacity is 4,000 hours per year. That means it costs $1,000 an hour to run the plant, regardless of volume. If it takes two hours to set up the machines in the plant, the capacity cost of changing over from one product to another is $2,000. The total cost to the company is:
(Number of products) X (Number of set ups each) X $2,000
Economy of scale is based on this arithmetic. The lowest total cost depends on spreading the fixed capacity cost over the greatest number of products. One way to do this is to control the "number of set ups" variable: fewer setups means bigger production lot sizes, or batches, which means carrying more inventory. The other way is to minimize the "number of products" variable – make fewer product variations: One size fits all.
Henry Ford drove costs down by making the "number of products" variable = 1, which made the "number of sets ups" = 0. That is where, "The customer can have any color he wants so long as it is black" came from. Model T’s actually came in five versions the year he said that – all black, all with the same machined components. That is because machining and paint required setups. The other components that went into the five variations did not require set ups and Ford had no objection to offering them.
Alfred Sloan knew next to nothing about manufacturing, but he was smarter than Henry Ford when it came to marketing. He knew that the customers would not sit still for the "number of products" to equal 1, so the "number of setups" variable had to be minimized. As I pointed out, that meant that a good deal of inventory would result. So the principle that inventory was a good thing – an asset – was formalized on the rationalization that it would theoretically minimize long term, overall costs.
If you are a regular reader, you have often read my assertions that lean manufacturing is based on a different economic model than traditional manufacturing. The different economic model is the result of Toyota recognizing that Ford’s economy from continuous flow was the lowest cost way of producing, but his one model principle was all wrong.
They realized that Sloan’s multiple model principle was correct, but his assumption that the resulting inventory kept cost down was wrong. The brilliance of the Toyoda family, Ohno and Shingo was in realizing that the only way to get the manufacturing benefit of Ford’s flow efficiency and the marketing benefit of Sloan’s model variation was to make set up time = 0.
(No matter how many different products) X (no matter how many setups) X 0 = $0 fixed capacity cost lost. When set up time = 0, it does not matter whether the company makes 10,000 of 1 product; or 1 each of 10,000 products. The cost per product is the same, and it is the minimum amount it can be. In the words of the great philosopher, Foghorn Leghorn, "That’s mathematics, son. You can argue with me but you can’t argue with figures."
Economy of Scale is based on the assumption that making more than one of something is always cheaper than making only one. Shingo and SMED invalidated the theory.
What drives me to jump up on my soapbox and lecture on this particular point at this particular time is a press release from LEI about Tesco. Tesco is a big UK based retailer who (1) is beating Walmart in head to head competition, (2) is moving into the US, and (3) is doing so on the strength of their understanding that economy of scale is dead and that lean is a more effective economic model.
To the dinosaurs who insist their is still breath in economy of scale’s lungs: Tesco has lower costs, lower prices and better margins in convenience stores than Walmart has in superstores.
Last Fall, the Japanese owners of 7-Eleven took them private because they did not want to mess around with Wall Street and the American financial community’s ignorance of the death of economy of scale. As a private company they can strategically reconfigure 7-Eleven without having to cope with outdated drivel from financiers and economists.
In JIT Is Flow, Hiroyuki Hirano said, "The net effect of this new era of a consumer driven, linear economy has on business – especially manufacturing – is increased pressure to make small quantities fast. It is the direct opposite of the old economy of scale model. Where manufacturers once looked for profits through scale, or volume, they must now look for profits from flexibility, or their ability to respond to changing customer requirements." As an example, he pointed out that, in Japan, small convenience stores with multiple locations have replaced big grocery stores in few locations. This is what the strategic reconfiguration of 7-Eleven is all about.
The 7-Eleven model will be the same as the Tesco model described in the LEI press release: "Tesco’s lean provision system combines point-of-sale data, cross-dock distribution centers, and frequent deliveries to many stores along "milk-runs" to stock the right items in a range of retail formats." It takes a supply chain of producers with setup times near zero to feed this retail model.
Unless they figure it out soon, you are seeing in Walmart today what you saw in General Motors thirty years ago: A great commercial empire at its peak; and what is coming is the same long, inevitable, downhill slide. Just as the Japanese decimated Western manufacturing by their ability to see that economy of scale is dead long before the West (in fact, most still don’t understand), a new generation of retailers is emerging that will finish the job.
Too many American and European manufacturers have avoided facing up to the fundamental economic change represented by lean by selling to retailers and OEM’s that still hung on to the old paradigms. Those ‘mass merchandisers’ are doomed and they will take their ‘mass production’ supply chains down with them. The pace of this change is starting to pick up.
Bob Lutz at GM and Mark Fields at Ford are searching for the economy of scale Holy Grail – the superstar product they can make in staggering quantities. The only practical scale issue left to remotely justify this is tooling, which is becoming cheaper and more flexible all the time. Walmart has driven the invention of Super Pan’s – container ships so big they have to slather ’em with K-Y Jelly to get through the Panama Canal bringing Walmart quantities to market. They are monuments to last century thinking. In the very near future, manufacturers and retailers alike, along with economists and investors, will reach the watershed. The lean will prosper while the economy of scalers will die.