Deming, W. E. 1993.

The New Economics For

I ndustry, Government & Education. Cambridge:
Massachusetts Institute of Technology Center for
Advanced Engineering Study.

Summary by James R. Martin
Preface Chapter 1:
How are we Doing?
Chapter 2:
The Heavy Losses
Chapter 3:
Introduction to a
System
Chapter 4:
A System of
Profound
Knowledge
Chapter 5:
Leadership
Chapter 6:
Management of
People
Chapter 7:
The Read Beads
Chapter 8:
Shewhart and
Control Charts
Chapter 9:
The Funnel
Chapter 10:
Some Lessons in
Variation

Preface
In the preface Deming states that the present style of management is a modern
invention and represents "a prison created by the way in which people interact." The
present system includes competition between people, teams, departments, divisions,
students, schools and universities. Although economists have taught that competition
will solve our problems, we now know that competition is destructive. A better
approach is for everyone to work together as a system. The solution to problems
comes from cooperation, not competition. We need a transformation to a new style of
management Deming refers to as Profound Knowledge. This includes four parts:
appreciation for a system, knowledge about variation, theory of knowledge, and
psychology. The purpose of this book is to start the reader on the road to knowledge
and to create a desire for more knowledge. This book, according to Deming, is a
textbook for engineering, economics and business students, to be used to prepare
students for the future.



Chapter 1: How are we Doing?
Will best efforts bring improvement? No, Deming argues that best efforts not guided
by knowledge will dig us deeper into the pit we are in. What is needed is new
knowledge. There is no substitute for knowledge.
In order to improve living standards, people must trade with each other and the
market is the world. Trade depends on quality. In terms of the balance of trade, the
U.S. is not doing well. We have been in economic decline for three decades. What
must be done? Our problem is education and the development of a culture that places
value on learning.
Your customer expects only what you and your competitors have led him to expect,
but he is a rapid learner. Customers do not know what they want. They may be
satisfied and switch. A customer may be loyal and switch. What is needed is
innovation. Deming provides several examples of companies that were doing well and
lost their market to an innovator. The question to ask is what business are we in and
what will it be in the future?
How do we achieve quality? Which of the following is the answer? Automation, new
machinery, more computers, gadgets, hard work, best efforts, merit system with
annual appraisal, make every body accountable, management by objectives,
management by results, rank people, rank teams, divisions, etc., reward the top
performers, punish low performers, more statistical quality control, more inspection,
establish an office of quality, appoint someone to be in charge of quality, incentive
pay, work standards, zero defects, meet specifications, and motivate people. Answer.
None of the above.
All of the ideas above for achieving quality try to shift the responsibility of
management. Quality is the responsibility of management. It cannot be delegated.
What is needed is profound knowledge. A transformation of management is required.
Chapter 2: The Heavy Losses
According to Deming, the present style of management causes huge losses that cannot
be evaluated or measured. His purpose for this chapter is to identify the most
important sources of loss (or waste) and to suggest better practices. At the beginning
of this chapter he tells us that the reason for many wrong practices is management's
failure to understand the difference between common causes of variation and special
causes of variation. He provides several tables similar to the ones I have provided
below. I have condensed his ideas and tried to capture his main points, but the reader
must consult the book for the many examples used to support his views on the present
style of management.


Present wrong practice. (What is
wrong?)
Recommended Practice
Short term thinking. (Short term
solutions have long term effects,
frequently undesirable effects.)
Adopt constancy of purpose. Develop
long term objectives and importantly,
methods for achievement.
Ranking people. (Ranking is a farce and
indicates the abdication of management. If
x is the contribution of an individual and
yx is the effect of the system on his or her
performance, then x + (yx) =
performance. Ranking people ignores the
predominant (yx) term. Ranking does not
help anyone improve or help improve the
system.)
Abolish ranking. Manage the whole
company as a system. Study and
understand how every component
contributes towards optimization of the
system.
Merit systems, incentive pay and
annual appraisal of people. (These are
forms of ranking that create competition
between people and are demoralizing.
They do not help anyone improve or
improve the system.)*
Abolish these methods. Study the
capability of the system (chapter 3),
leadership (chapter 5) and the
management of people (chapter 6) and
use this knowledge to manage.
Manage the individual components
(individuals, teams, departments, etc.)
as profit centers. (This ignores the
interdependences between the
components, causes sub-optimization and
everybody loses.)
Manage the company as a system
focused on the future. Encourage
communication and continual learning.
Draw a flow diagram to show how each
component depends on others in the
system so that people can see the process
and improve it.
Management by objectives, numerical
goals and quotas. (These methods ignore
the interdependences and provide no
method for achievement. As a result they
may cause behavior that destroys the
system.)
Manage the system. Develop methods for
improving the process. Develop a
horizontal self directed work force.
Management by results. (Action based
on outcome is not action on the causes of
the outcome. Emphasis on cost reduction
is an example. Costs are not causes.)
Use the concepts and tools related to
variation to understand and improve
the system. Deming estimates that around
94% of the possible improvements belong
to the system - the responsibility of
management.
Buying based on the lowest bid. (Ignores
the related costs and effects on quality.)
Buy based on estimates of all related
costs and effects on quality.
Delegate quality to an individual or
group. (The responsibility for quality
cannot be delegated.)
Recognize that quality is management's
responsibility.
Although the losses from faulty management practices cannot be measured, Deming
argues that it is a myth to assume that if you can't measure it, you can't manage it. We
must learn to manage these losses and the transformation requires a system of
profound knowledge (Chapter 4).
* See the Herzberg, Kohn, and Pfeffer summaries for some related arguments about
money as a motivator.
Chapter 3: Introduction to a System
Deming begins this chapter by saying that the prevailing style of management is a
modern invention and a trap that has led us into decline. He defines a system as "a
network of interdependent components that work together to try to accomplish the
aim of the system." A man made system must have an aim and this purpose, or aim
must be clear to everyone in the system. Deming continues by stating that "A system
must be managed. It will not manage itself." Left to themselves the components of a
system become selfish and competitive and this behavior has a destructive effect on
the system.
An organization is a system if it has an aim or purpose. This purpose, or aim precedes
the organizational system and the people working in it. The system must be defined in
terms of the aim, not in terms of methods. When the whole system is optimized,
everybody wins. Any less than optimization of the whole system means eventual loss
to everyone.
A system includes the future and part of management's job is to govern the
organization's future. A system cannot manage itself. It needs guidance from outside.
Managers must learn that in order to compete, they must learn to cooperate. A system
includes competitors who working together to provide better service and to expand
the market, contribute towards optimization for the entire industry. Deming argues
that rather than worry about market share, companies would be better off to work
together to expand the market.
Deming includes a diagram (used in Japan starting in 1950) that illustrates how
production is viewed as a system. The flow of information and materials from any
part of the system (from suppliers to customers) must match the input requirements of
subsequent stages. It is used for planning from the idea stage through design,
production, distribution and customer service. It also helps in making predictions of
how changes in one component will affect the other components and shows the
people in the system where their jobs are and how their work is related to the work of
others in the system. This knowledge helps people take joy in their work.
The flow diagram is a more meaningful organization chart than the usual pyramid
showing who reports to whom. The diagram shows the value chain concept described
by Porter, although Deming does not use that term. The pyramid type organization
chart ignores customers (internal and external) and contributes to the fragmentation of
the organization into individual profit centers. The terms silos and stovepipes have
been used by others who have described this problem. (See the Mintzberg & Van der
Heyden summary on developing Organigraphs).
Two important jobs of management include: Recognizing and managing
interdependence. Defining jobs to include what the work will be used for and how it
contributes to the aim of the system.
Deming provides several examples of how lack of cooperation is destructive to an
organization. In one company example, an increase in the cost of an engine of $30
would decrease the cost of the transmission by $80. The responsibility center in
charge of the engine would not accept the idea because of the effect of the change on
that segment's profits.
If the components of an organization are all optimized, the organization will not be
optimized. If the whole is optimized, the components will not be optimized. "If
economists understood the theory of a system, and the role of cooperation in
optimization, they would no longer teach and preach salvation through adversarial
competition. They would instead lead us into optimization of a system, in which
everybody would come out ahead."
In a 1990 statement of the Interstate Commerce Commission (ICC), Deming states
that forcing motor freight carriers to compete on the basis of price in a zero sum game
will destroy a healthy transportation system. Deming points out that cheaper is not
always better. It is more important to increase reliability and dependability by
reducing variation in time of transit and time of delivery. He urges the ICC to take a
leadership role in promoting cooperation between the components of the industry.
At the end of this chapter, Deming describes fifteen examples of cooperation that
provide benefits to everyone. Some of these include common international
measurements of time and date, red and green traffic signals, the metric system, and
standardized parts such as batteries. Another example involves two service stations on
opposite corners of an intersection that share each others tow trucks and stay open late
on alternate nights. These companies compete with each other, rather than against
each other and everybody wins.
Chapter 4: A System of Profound Knowledge
Deming states that the prevailing style of management must undergo transformation
and this requires a new map of theory he refers to as profound knowledge. His
purpose in Chapter 4 is to describe the components of the system of profound
knowledge.
The first step, according to Deming, is the transformation (more appropriately
conveyed by the Greek word metanoia or spiritual conversion) of the individual. He
describes this change as a reorientation of one's way of life to apply the principles of
profound knowledge in every kind of relationship with other people.
The system of profound knowledge includes four components as indicated in the
preface, each described briefly below.
Appreciation for a System
An appreciation for a system includes knowledge of what a system is (defined in
Chapter 3) and how interdependence between the components of the system creates a
need for communication and cooperation. The greater the interdependence, the greater
the need for the parts to work together. A bowling team, orchestra and business are
used in a graphic illustration to show how interdependence ranges from low for the
bowling team, to high for the orchestra and is very high in a business organization.
Knowledge of Variation
A knowledge of variation includes knowledge that life is variation, knowledge of the
difference between a stable state and an unstable state, knowledge of the difference
between common and special causes of variation and knowledge of the effect of the
system on the performance of people. It also includes a knowledge of the implications
of all this for management.
The Theory of Knowledge
The theory of knowledge includes an understanding that management in any form is
prediction. A statement, if it conveys knowledge, predicts a future outcome including
the risk of being wrong. Prediction requires theory. Without theory, experience has no
meaning and there is no learning. Copying examples without understanding the
underlying theory may lead to disaster. Any number of examples cannot establish a
theory.
Deming states that "There is no true value of any characteristic, state, or condition
that is defined in terms of measurement or observation." "There is no such thing as a
fact concerning an empirical observation." An operational definition is needed. He
defines this as a procedure agreed upon for translation of a concept into a
measurement. But this produces information and information is not knowledge.
Knowledge comes only from theory.
Psychology
A Knowledge of Psychology includes a knowledge that people are different from one
another and knowledge of how to use these differences to optimize everybody's
abilities and inclinations. It includes the concepts of intrinsic and extrinsic motivation
and the phenomenon of over justification.
People are born with intrinsic motivation that is often destroyed by various practices
at school and work. Grades cause students to work for grades, or a reward from
parents for grades, rather than to work for the purpose of learning. Rewards at work
such a merit pay cause people to work for rewards rather than for job satisfaction and
to find meaning in their work and lives. Some extrinsic motivation helps develop an
individual's self-esteem, but over emphasis on extrinsic motivation eventually
destroys an individual's intrinsic motivation and leads to detrimental effects on self
esteem. Work and life eventually have no meaning. Ranking people, even if it could
be done accurately (as opposed to ranking the effects of the system on the workers)
would not improve the performance of the people, or the system.


Chapter 5: Leadership
This is a very short chapter. Deming explains that the job of a leader is to accomplish
the transformation of his organization. A leader needs theory, obligation, a plan and
persuasive power.
Chapter 6: Management of People
Deming begins this chapter by saying that "We are living in prison, under the tyranny
of the prevailing style of interaction between people, between teams, between
divisions." We must replace the idea that we need competition between people with
cooperation. He provides a graphic illustration similar to the one below to show how
present practices squeeze intrinsic motivation, self esteem and dignity out of people
over their life time. Across the top of his illustration he lists the forces of destruction
such as forced distribution of grades, merit systems, competition between people and
groups, incentive pay, numerical goals, explanation of variances, and treating every
group as a profit center. Along the vertical axis he shows the characteristics that
people are born with such as intrinsic motivation, self esteem, dignity, cooperation,
and joy in learning.

All of the forces of destruction must be replaced with new ways to manage people.
The purpose of this chapter is to examine how to do this under the new philosophy or
theory of profound knowledge.
The role of a manager of people
After the transformation, a manager will:
1. Understand the meaning of a system and convey this to the people in the system.
2. Help people see how they must cooperate with the preceding and following
stages
as a component of the system to optimize the system.
3. Understand that people are different and use this knowledge to develop their
abilities
to optimize the system.
4. Be a continuous learner and encourage continuous learning for others in the
system.
5. Be a coach and counsel, not a judge.
6. Understand a stable system and that anyone's performance will reach a stable
state.
7. Develop and mainly use knowledge, personality and persuasive power in the
management
of people, and not rely on authority of office except to change the system for
improvement.
8. Study results to improve as a manager of people.
9. Try to discover if anyone is outside the system in need of special help. This is an
extension
of item 6 above.
10. Create an environment of trust to encourage freedom and innovation.
11. Not expect perfection.
12. Listen and learn without passing judgment.
13. Have an unplanned and unhurried conversation with each worker at least once a
year
to understand their aims, hopes and fears.
14. Understand the benefits of cooperation and the losses created by competition
between people and groups.
The Shewhart PDSA Cycle
Deming discusses the Plan, Do, Study, Act continuous improvement cycle developed
around 1950 he refers to as the Shewhart cycle. He provides an illustration showing a
circle where a plan for a change or test of a change in the process or system is
developed in the first step, the change or test of change is made below clockwise in
the do step, the results are examined in the study step, and the change is either
adopted or abandoned in the act step. This leads to the start step, i.e., next plan for
change or test of a change in the process or system, the foundation for the whole
cycle.

The development of a new engine is used as an example. The secret to shorter
development times is to put more effort into the early stages and understanding the
interaction between stages. The manager's job is to manage the whole process, not to
optimize any stage. Everyone involved including marketing people, suppliers,
toolmakers, etc. should be included in the planning stage.
Problems with Accounting
Current accounting practices reinforce the incorrect perception that decisions made
during the development stage are independent of the future costs related to capital
expenditures, maintenance, operations and the losses suffered by customers.
What should business schools teach?
Business schools should teach the theory of a system and the theory of profound
knowledge for transformation, some economics, statistical theory, language and
science. They should teach that un-measurable damage is created by short term
thinking, ranking people, merit systems, incentive pay, management by results, and
tampering.
How should the education system change?
To achieve notable improvement, the education system should abolish grades, merit
ratings for teachers, comparison of schools on the basis of scores, and gold stars for
athletics. Joy in learning comes more from learning than from what is learned. A
grade is a permanent label for opening doors or closing doors, a way to achieve
quality by inspection, rather than building in quality, a way to produce competition
between people, rather than cooperation, a way to label people as winners or losers, a
way to humiliate those at the bottom, rather than to promote their desire to learn and
future achievement.
In this chapter, Deming says that he does not grade students, but gives them a "P" for
pass.
Some thoughts on grades.
Chapter 7: The Read Beads
I summarized the Red Bead experiment earlier and refer the reader to that Summary.
Chapter 8. Shewhart and Control Charts
In this chapter, Deming discusses Shewhart's concepts of variation, common causes -
variation caused by the system and special causes - variation caused by something
that is not part of the system of common causes.
He mentions the two mistakes, i.e., reacting to an outcome as if it came from a special
cause when it came from a common cause, or reacting to an outcome as if it came
from a common cause when it came from a special cause.
One of Shewhart's contributions was to develop control charts to minimize the loss
from the combination of both mistakes. When the chart indicates no special causes,
the process is in statistical control, or stable. In a stable system the performance of the
system can be predicted within a range of variation. The performance of an unstable
process cannot be predicted. After statistical control is achieved, the process may be
improved. An improvement is either a reduction in variation or a movement in the
average, up or down, closer to the optimum level. "The control chart is the process
talking to us."
There are many potential applications of the control chart concepts, or techniques in
industry, education and government. The most important application is in the
management of people.
Some managers set specification limits where they think the limits should be.
However, there is no logical connection between control limits and specification
limits. Using specification limits based on intuition causes loss either from mistake 1
or mistake 2, but no one could know which or the extent of the losses.
Deming discusses some examples where common causes are often confused with or
interpreted as special causes. These include accidents on the highway, fires,
absenteeism, and malpractice suits. Highway accidents arise mostly from common
causes such as drunk driving and unintelligible road signs. These, he says, are not
special causes. Malpractice suits in medicine, engineering and accounting all treat the
event as a special cause - somebody is at fault. Study and knowledge of variation
leads to the conclusion that the event could have come from the process itself. The
system may be at fault.
Chapter 9: The Funnel
The purpose of this chapter is to illustrate the losses that are caused by tampering with
a system or process. At the beginning of this chapter, Deming defines tampering as
management by results. Other ways to define tampering include trying to improve the
performance of a process or system based on an individual observation or result, or
trying to improve the process or system without theory.
The funnel demonstration includes a funnel, a marble and a table, preferably with a
cloth on it to record the results. A dot is drawn on the table cloth to represent the
target. Then four rules or procedures are used and the results are recorded on the
cloth.
Rule 1: Hold the funnel over the target and drop the marble through the funnel 50
times marking each spot where the marble stops. A distribution of spots or plots will
occur.
Rule 2: After each drop, move the funnel from the previous position to compensate
for the last error. The last error is the basis or reference point for each new drop.
Record the spots with a different symbol. A wider distribution will occur. Deming
calculates the diameter of this rough circle will be 41% wider than the circle based on
rule one. This is tampering, i.e., trying to improve the performance of process each
time based on an individual result.
Rule 3: After each drop, adjust the funnel using the target as the reference point. The
results will be worse than before.
Rule 4. After each drop, set the funnel over the spot where the marble stops. The
results continue to spread out and are even worse than in rule 3.
Tampering with the process (Rules 2, 3 and 4) only makes things worse. Deming says
that possible improvements in this process include lowering the funnel, using a
thicker table cloth, and using a steel ball rather than a marble. A magnetic target and
marble will also improve performance of the process.
Deming provides seventeen examples of tampering based on rule 2. Some of these
include reactions to a complaint of a customer, adjustments in interest rates made by
the Federal Reserve Board, a reaction to stock market news, changing company policy
based on the latest attitude survey, continuous tax law changes that try to correct a
previous mistake, and price wars.
Examples of rule 3 include nuclear proliferation, barriers to trade, illicit drug
enforcement, and a gambler increasing their bet to cover losses.
Examples of rule 4 include workers training other workers in succession, a group of
players in an orchestra tuning their instruments sequentially not against the same
source, hanging wallpaper, and copying examples with no theory.
A process may be stable and produce defects and errors. To adjust the process based
on a single defect or error is tampering with the process and will make performance
worse. Improvement in a process requires studying the process to understand the
capability of the process, including the mean outcome and range of variation. If the
process is stable, then a planned change can be developed based on theory, then
tested, studied, then implemented or rejected.
Chapter 10: Some Lessons in Variation
The purpose of this chapter is to provide: 1) some easy lessons in variation including
examples of situations where common cause variations are confused with special
cause variations, and 2) some illustrations based on the concept of a loss function.
Deming explains that variation is life. Life is variation, but those who have no
knowledge of statistical theory tend to attribute every event to a special cause. One
qualification useful to anyone, and definitely needed by anyone in management, is to
understand the concept of variation. This understanding of variation will help them
understand the system and to stop asking people to explain the day to day, month to
month, and year to year ups and downs that come from the variation that is built into
the system.
Loss Functions
Deming explains that a loss function shows the losses that a system suffers from
different values of some adjustable parameter. A loss function is useful to help one
change from the idea of meeting specifications to continual reduction in variation and
improvement in the mean outcome through improvement of the process or system.
Each individual has a loss function and a combination of people have a loss function.
Loss functions are usually not symmetrical but may look something like the
illustration below.

Two distributions are shown in the extended graphic illustration below to convey my
interpretation of the concept Deming explains in Chapter 10. The distributions are
identical except for their means, i.e., the range of variation is the same in both
distributions. However, the one on the left creates more loss than the one on the right.
The mean of the process described by the distribution on the left is further away from
the optimum or minimum loss. The mean of the process on the right is very close to
the optimum value. Improvements in both mean and range of variation are possible
for the process on the left. Improvement in the range of variation, i.e., reduction of the
amount of variation, is possible for the process on the right.

Why was Deming critical of the zero defect philosophy?
Deming was critical of the zero defect philosophy because it is associated with the
idea of meeting specifications as opposed to continual reduction in variation and
improvement in the mean outcome through improvement of the process or system.
This point was not entirely clear to me when I read the last chapter of The New
Economics. Several articles by Albright and Roth helped to clear up my confusion
(See references below). According to these authors, there are two philosophies
associated with quality. One concept is the zero defects philosophy and the other
concept is the robust quality philosophy based on the Taguchi loss function.
According to Roth and Albright, the zero defects philosophy is associated with
defining quality as conforming to specifications where the only costs attributed to
variation are those that fall outside the specification limits. They refer to this as the
goalpost view. However, the robust quality philosophy views any variation from a
target value as undesirable because it causes unnecessary costs to be incurred by the
manufacturer, the customer or society. The lost function provides a way to estimate
these costs. Deming subscribed to the robust quality philosophy as indicated by his
discussion of the loss function in Chapter 10. See the summaries below for more on
this issue.
_________________________________________
Albright, T. L. and H. Roth. 1992. The measurement of quality costs: An alternative
paradigm. Accounting Horizons (June): 15-27. (Summary).
Albright, T. L. and H. P. Roth. 1994. Managing quality through the quality loss
function. Journal of Cost Management (Winter): 20-37. (Summary).
Anderson, S. W. and K. Sedatole. 1998. Designing quality into products: The use of
accounting data in new product development. Accounting Horizons (September): 213-
233. (Summary).
Kim, M. W. and W. M. Liao. 1994. Estimating hidden quality costs with quality loss
functions. Accounting Horizons (March): 8-18. (Summary).
Roth, H. P. and T. L. Albright. 1994. What are the costs of variability? Management
Accounting (June): 51- 55. (Summary).
Sedatole, K. L. 2003. The effect of measurement alternatives on a nonfinancial quality
measure's forward-looking properties. The Accounting Review (April): 555-580.
(Summary).
Taguchi, G. and D. Clausing. 1990. Robust quality. Harvard Business Review
(January-February): 67-75. (Summary).