In her recent editorial, Pat Panchak cites several ways in which financial performance metrics can undermine any manufacturing operation. Michael Sekora elaborates in Forbes, "The disease killing America's economic health is financial-based planning, and one of the symptoms of this ongoing disease is the loss of the U.S. manufacturing base." Industry is the foundation of military as well as economic power, so the resulting transfer of American manufacturing capability to China is extremely dangerous.

Panchak's article underscores the very ancient principle, "Be careful what you wish, because you are likely to get it," such as purchase price reductions at the expense of quality and lead time. The rest of this article will focus on why financial metrics that are mandatory for financial reports and tax returns have no place in operational decision making. In My Life and Work, Henry Ford and Samuel Crowther warned more than 90 years ago, "That finance is given a place ahead of work and therefore tends to kill the work and destroy the fundamental of service." The reference is probably the best business book ever written, and it is also in the public domain.

Henry Ford's creation of what we now call lean manufacturing is an excellent reason to listen to him today, and so is his company's role in making the United States the wealthiest and most powerful nation on earth. Why, then, do we call his methods the Toyota production system instead of the Ford production system? When the so-called "Whiz Kids" applied financial metrics to the Ford Motor Co. after World War II, it declined to the point where it forgot the methods to which it owed its phenomenal success. In a 2001 Wall Street Journal article, Norihiko Shirouzu reported that a Ford vice president was "trying to entice assembly workers and engineers to abandon nearly all they know about the mass manufacturing system that Henry Ford brought to life about 90 years ago." The rest of the article showed that the vice president was actually trying to teach the workforce exactly how Henry Ford made cars, but he apparently believed the methods to be Japanese.

Finance can be far more dangerous than poor quality because scrap, rework and customer returns all make themselves known very quickly. Financial performance metrics that drive dysfunctional operational behavior are, on the other hand, the elephant on the shop floor that simply does not go away.

When Inventory Is Not an Asset

Everybody knows, at least in the accounting world, that inventory is a current asset: one that can be converted into cash within a year. This means there is nothing wrong with purchasing extra materials to get a good deal or a price discount, as cited by Panchak. Benjamin Franklin, however, warned of the unintended consequences in The Way to Wealth:

"You call them goods; but, if you do not take care, they will prove evils to some of you. You expect they will be sold cheap, and, perhaps, they may for less than they cost; but, if you have no occasion for them, they must be dear to you. Remember what poor Richard says, "Buy what thou hast no need of, and ere long thou shalt sell thy necessaries." And again, "At a great pennyworth pause a while:" he means, that perhaps the cheapness is apparent only, and not real; or the bargain, by straitening thee in thy business, may do thee more harm than good. For, in another place, he says, "Many have been ruined by buying good pennyworths."

Ford cited Franklin as a major influence on his own practices, and his books paraphrase The Way to Wealth extensively. This makes Franklin not only one of the country's Founding Fathers, but also the true originator of what we now call lean manufacturing.

Straiten means to constrain, limit or restrict, and idle cash in the form of inventory does exactly that. Idle cash is furthermore not the least of our problems, as illustrated by Little's Law:

Cycle time (days) = Inventory (units) divided by Throughput (units per day)

High inventories therefore mean longer cycle times, longer lead times and less responsiveness to customer needs. This can require production to meet unreliable market forecasts (which, in turn, require the business to carry more inventory) as opposed to actual customer orders. Ford and Crowther in My Life and Work elaborate with an explicit description of what we now call just in time (JIT) production.

We have found in buying materials that it is not worth while to buy for other than immediate needs. We buy only enough to fit into the plan of production, taking into consideration the state of transportation at the time. If transportation were perfect and an even flow of materials could be assured, it would not be necessary to carry any stock whatsoever. The carloads of raw materials would arrive on schedule and in the planned order and amounts, and go from the railway cars into production. That would save a great deal of money, for it would give a very rapid turnover and thus decrease the amount of money tied up in materials. With bad transportation one has to carry larger stocks.

…We have carefully figured, over the years, that buying ahead of requirements does not pay—that the gains on one purchase will be offset by the losses on another, and in the end we have gone to a great deal of trouble without any corresponding benefit. Therefore in our buying we simply get the best price we can for the quantity that we require. We do not buy less if the price be high and we do not buy more if the price be low. We carefully avoid bargain lots in excess of requirements. … The only way to keep out of trouble is to buy what one needs—no more and no less. That course removes one hazard from business.

Note particularly the sentence, "If transportation were perfect and an even flow of materials could be assured, it would not be necessary to carry any stock whatsoever." Ford recognized explicitly the effect of variation in processing and material transfer times on cycle time, and therefore inventory, more than 60 years before Eliyahu Goldratt illustrated this in the first edition (1984) of The Goal.

If this is not enough to convince the reader that inventory is anything but an asset (except on paper), Ford and Crowther add the following. This underscores again the relationship between cycle time and the amount of money that is tied up in inventory.

"We discovered, after a little experimenting, that freight service could be improved sufficiently to reduce the cycle of manufacture from twenty-two to fourteen days. That is, raw material could be bought, manufactured, and the finished product put into the hands of the distributor in (roughly) 33 per cent. less time than before. We had been carrying an inventory of around $60,000,000 to insure uninterrupted production. Cutting down the time one third released $20,000,000, or $1,200,000 a year in interest. Counting the finished inventory, we saved approximately $8,000,000 more—that is, we were able to release $28,000,000 in capital and save the interest on that sum."

This statement also applies to container ships full of "cheap" offshore goods that can take weeks to reach our West Coast ports. A container ship is nothing more than an inventory-laden floating warehouse that ties up cash, adds to cycle time, and gives defects a place to hide.