Tuesday, April 16, 2002

Lean Contracts

Tool and Die Contracts
The cost of developing dies which stamp out body panels for a new model car can account for half of the model’s capital investment. Consequently, a great deal of time is spent in all automotive companies working to minimize the cost of these dies. The approach in Japan is distinctly different from that in the U.S., and dramatically more effective. The best Japanese companies develop these dies for half the cost and in half the time as their counterparts in the West. The resulting Japanese dies average five shots per panel, while U.S. dies average seven shots per panel, significantly reducing manufacturing costs as well.

From the classic book Product Development Performance by Clark and Fujimoto, Harvard Business School Press, 1991:
Japan firms use an ‘early design, early cut’ approach, while U.S. practice is essentially ‘wait to design, wait to cut.’

Because it entails making resource commitments while the body design is still subject to frequent changes, the Japanese early design, early cut approach entails significant risks of waste and duplication of resources…. Many engineering changes occur after final release of blueprints. At peak, hundreds of changes are ordered per month.

Behind the wait to design, wait to cut approach in U.S. projects is a desire to avoid expensive die rework and scrappage, which we would expect to be an inevitable consequence of the bold overlapping that characterizes the Japanese projects. However, our study revealed a quite different reality. U.S. firms, despite their conservative approach to overlapping, were spending more on engineering changes than Japanese firms. U.S. car makers reported spending as much as 30-50 percent of original die cost on rework due to engineering changes, compared to a 10-20 percent margin allowed for engineering changes by Japanese products.

The Japanese cost advantage comes not from lower wages or lower material prices, but from fundamental differences in the attitudes of designers and tool and die makers toward changes and the way changes are implemented…. In Japan, when a die is expected to exceed its cost target, die engineers and tool makers work to find ways to compensate in other areas…. Die shops in high-performing companies develop know-how techniques for absorbing engineering changes at minimum cost…. In the United States, by contrast, engineering changes have been viewed as profit opportunities by tool makers….

Suppose a body engineer decides to change the design of a panel to strengthen body-shell rigidity. The high performers tend to move quickly. The body designer immediately instructs the die shop to stop cutting the die on the milling machine. Without paperwork or formal approval, the body designer goes directly to the die shop, discusses modifications with the die engineers, checks production feasibility, and makes the agree-upon changes on the spot. Unless the changes are major, decisions are made at the working level. Traditionally, the die shop simply resumes working on the same die. Paperwork is completed after the change has been made and submitted to supervisors for approval. The cost incurred by the change is also negotiated after the fact. The attitude is “change now, negotiate later.”

In companies in which die development takes a long time and changes are expensive, the engineering change process is quite different. Consider the context in which changes occur. In extreme versions of the traditional U.S. system, tool and die makers are selected in a competitive bidding process that treats “outside” tool shops as providers of a commodity service. The relationship with the die maker is managed by the purchasing department, with communication taking place through intermediaries and drawings. The individuals who design the dies and body panels never interact directly whit the people who make the dies.
You would think that tool and die makers in Japan must be a department inside the automotive company. How else could it be possible for a designer to walk into a tool and die shop, stop the milling, make changes, and start up the milling again, leaving approvals and cost negotiations for later? But this is not the case. Tool and die makers are supplier companies in Japan, just as they are in the U.S. The difference lies in the attitudes of the different countries toward supplier contracts.

For Toyota in particular, a supplier is a partner. The basis of this partnership is a target cost for each area of the car. This translates into target costs for all development activities, including dies. Of course, U.S. companies have target costs for each component also, but they tend to impose the cost on the supplier without regard to feasibility. This has a tendency to create a win-loose relationship, leaving the supplier no option but to recoup costs through the change process.

In contrast, Toyota does not impose cost targets on suppliers that it does not know how to meet, and it works with suppliers to help them meet their targets. If something goes wrong and the targets cannot be met, Toyota shares the problem in an equitable manner. In this win-win environment, arms-length exchange of information through written documentation and an extensive change approval processes is unnecessary.

Software Contracts
It can be argued that the emphasis on written requirements coupled with an extensive change approval process comes from a win-loose atmosphere in contracting for software development. Even when development is done inside a company, the influence of traditional requirements management and change approval processes is difficult to avoid.

Let’s face it, traditional project management practices are an outgrowth of the military contracting environment of the 1980’s. In software development today, everyone knows that the waterfall approach is ineffective, but no one seems to know how to escape it. Management tends to value written requirements that do not need human interpretation and rigorous change approval procedures. After all, these seem to be necessary if a contract is to be enforceable. Even for development done without a contract, the same approach is frequently used, despite the fact that it is a sub-optimizing outgrowth of a win-loose contracting environment.

There is a better way, and the results of Toyota’s partnership relationship with their tool and die suppliers indicates that the better way can dramatically improve operating results. Efficient information flow between development teams and users is far too important to be committed exclusively to writing or passed through a third party. A ‘wait to design, wait to code’ approach may seem to offer significant risk reduction, but the truth is quite the opposite. In a environment where change is the norm, it is far more effective to develop techniques and practices which allow changes to be rapidly implemented.

Lean Contracts
There are two ways of looking at a contracting relationship. One view is that a contract is a way for a company to shed responsibility. The other way is for a company to share responsibility. If a company wants to achieve a certain result in a set timeframe for a fixed amount of money, it might consider a contract with a vendor as an method to shed the responsibility for achieving this goal. In theory, the company no longer has to worry about achieving the goal, responsibility has been transferred through a contract.

In practice, if a contract sets up a win-loose situation, the long term result cannot be good for either company. There is rarely a winning party to such deal. A vendor that loses money will not be around to support the system, and often cannot even complete the contract satisfactorily. In fact, a company that makes a practice of negotiating contracts without regard for the vendor’s ability to deliver and make a profit has no one to blame but themselves when the results do not match the agreements.

I used to be responsible for negotiating contracts with suppliers for a division which then re-sold these products at a good profit. I quickly learned that if the contract was not win-win, it was not worth the paper it was written on. We depended on our suppliers over the long run, and they depended on us. The contract was a method to share, not shed responsibility. These contracts were partnership contracts, the kind that Toyota has with its tool and die makers.

Requiring a software vendor – or even an internal organization – to deliver a pre-defined set of functionality over a set timeframe for a fixed price in an environment where stakeholders and technologies change is almost never a win-win situation. It is an attempt to shed responsibility, and the only way the vendor can win is to significantly overcharge or make their profit in the change orders.

Why do we impose such an inefficient contracting system on our companies and our vendors? It doesn’t have to be that way. Look to the way your business deals with other suppliers in its supply chain and you will probably find good models for win-win contracts.

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