In the early 1990s, the increasing importance of its overseas affiliates had forced SEI’s senior

management to think of SEI as a global entity and not just a Japanese firm.Adopting a global
perspective made it difficult; if not impossible, to ignore the well-being of the overseas affiliates
and simply take actions that were most beneficial to SEI in Japan. These constraints were
coupled with those imposed by SEI’s membership in the Sumitomo keiretsu. The Sumitomo
keiretsu contained 21 major companies, including Sumitomo Corporation ( The group’s trading
company), Sumitomo Bank, Sumitomo chemicals, and NEC. Unlike the major keiretsus, the
Sumitomo keiretsu did not place many restrictions on the activities of its members. For example,
member companies were free to buy products from outside the keiretsu if their price and quality
exceeded those of the equivalent products produced internally.

The Kaizen Program

SEI had developed a sophisticated keizen program to continuously reduce the cost of its
products. A cost-reduction orientation emerged at SEI around 1955 because the union leaders
believed that any salary increases they demanded should come out of their own efforts, not out of
the pockets of the firm’s other stake holders. Responding to union requests, the firm began to
invest heavily in human resource management (HRM). The objective of the new HRM system
was to create pressure on the work force to increase its productivity.

At the heart of SEI’s HRM approach was a willingness to increase the pay of the work force as it
became more efficient. This HRM policy allowed the work force to demand higher pay in
exchange for higher productivity. The success of this policy created awork force willing to
become more efficient and to change the nature of their jobs as required. This flexibility allowed
SEI to very rapidly and effectively introduce mass production despite the dislocations it caused
in the workforce.

Under the new HRM policy, salaries consisted of three elements: base salary, bonus, and
productivity enhancement bonus. Each year, the pool of funds provided to employees for their
productivity efforts was determined for each facility based upon its productivity. Each
individual’s productivity enhancement bonus was determined by multiplying the individual’s
base pay (excluding bonus) by the appropriate factory’s productivity ratio. This ratio was
determined by dividing the total funds in the productivity pool by the total salary base of the
participating employees. Thus,the pay scheme was designed to create positive pressure for
increased productivity throughout the organization.

As the pay system evolved, the three salary elements were still maintained but the productivity
enhancement bonus was not negotiated for all employees by the unions. In 1992, the productivity
enhancement was set as just over 71 % of base pay. This change in computation reflected the
system’s success in promoting a mentality of continuous improvement throughout the firm.

For the productivity incentive scheme to work, SEI had to be able to measure productivity
improvements accurately. Several systems were developed or modified to support the
productivity program, including two accounting systems- the total budget system and the direct
cost system-as well as the blue-collar and white collar cost reduction target programs.

Total Budget System

The productivity of SEI’s work force increased significantly during the 1950’s, so management
adopted the total budget system (TBS). this system was integrated into SEI’s existing
productivity systems. The TBS remained relatively unchanged until the mid-1960’s, when the
firm adopted a divisional form.

SEI’s divisional structure differed from that adopted by most Japanese firm. In SEI, the divisions
were politically weaker and lacked full autonomy. For example: both finance and personnel were
centralized functions and were managed at headquarters. The primary purpose of the divisions
was to maximize their profits based upon the limited resources at their disposal. Senior
management at SEI had decided against divisional autonomy because it believed that such an
organizational form would encourage the divisions to maximize their own economic welfare and
not that of the overall firm. By keeping certain critical functions centralized, top management
believed it was better able to optimize overall firm performance. The cost of this organizational
form was a larger head office staff than was usual for a Japanese firm of SEI’s size.

The adoption of a divisional structure created a problem for the existing cost and profit control
systems because the manufacturing divisions, reflecting their product focus, produced products
for a single product line or business segment while the sales divisions, reflecting their
geographical and customer focus, sold products that were produced by many manufacturing
divisions. For example, SEI’s divisions included electric wires and cables, special steel wires,
sintered alloy products, and brake products.

The new organizational form made it difficult to establish meaningful profitability statements for
the manufacturing divisions because both sales prices and volumes were controlled by the sales
divisions. To help overcome this problem, two additional evaluation systems were developed:
the division profit and loss system and the sales department system. In both systems, the primary
basis for performance evaluation was contribution margin. These systems were used for internal
management purposes, not financial reporting purposes.

The research and development laboratories were evaluated as cost centers because they did not
generate revenues. However, their ability to produce output in the form of commercial products
and the willingness of the internal market (i.e., the business divisions) to commercially develop
the new products were monitored. SEI had created a three-stage procedure to bring products
developed by its R&D laboratories to market. First, new products were released to the
development room, which was part of R&D and which manufactured the new products in low
volumes so that their long-term market potential colud be evaluated. Development divisions
were created for products that were thought to have market potential. Development division were
expected to launch products and prove that they were capable of generating profits for the firm.
These divisions were expected to break even; once a development division’s revenue exceeded 5
million per month, it was either converted into a new operational division or merged with an
existing one. Finally administration departments were evaluated on their ability to reduce costs.

Blue-Collar Cost Reduction Program

Cost management, and cost reduction in particular, was considered critically important at SEI. In
1992, the overall objective of SEI’s cost reduction program was to decrease costs by
approximately 10 % of profits per annum, or about 500 million. Cost reduction was considered
so critical that it was ettendedto every day. Daily meetings were held to make everyone in the
firm aware of the importance of managing and reducing costs. These daily meetings to set cost
reduction targets did not have a name, because everyone in the firm understood their purpose.
Daily plans were developed at each facility to determine ways to reduce costs. These plans were
based upon the monthly budgets, which reflected the savings anticipated from the kaizen
programs. The objectives of the daily meetings were to discuss the savings achieved the previous
day and how they compared to the budget, and the savings expected to be achieved that day. The
rate of achieving these cost savings was measured against the monthly budgets (see figure1).
Cost reduction plans were prepared at the facility level and then consolidated at the divisional
level to see if they provided an adequatecost reduction objective for the division.

Each facility was broken into a number of distinct manufacturing processes, each run by a self-
directed work team. Usually, these groups were treated as cost centers and were responsible for
collecting cost information. However, sometimes there were several groups within a cost center,
in which case costs were collected at the group level, not at the cost-center level. The average
factory had between 20 and 30 groups. Each group would identify its own cost reduction target
for a six-month period. The only costs that were included in these targets were those that were
directly under the control of the groups. Controllable costs included supplies such as the
lubricants for the extrusion dies, machine maintenance, and the amount of labor consumed. Costs
considered outside the group’s control were excluded, including wage rates and depreciation of
equipment.

All blue-collar workers were very much aware of the cost system. charts were posted throughout
the factory that indicatedboth the cost of products and processes and the level of cost reduction
achieved (the charts consisted of graphs or tables). This sharing of cost information was
considered a critical part of the firm’s kaizen program. Only by sharing the relevant cost and
quality information could management expect the workers to be able to most effectively achieve
cost reduction by setting and committing to sensible targets.

The blue-collar workers were expected to reduce the costs of running their equipment. Given the
different abilities and working conditions of the groups, it was not unusual to find that two
identical machines cost different amounts to run in different groups. Such a discrepancy was not
ignored, however, the group with the higher cost was expected to learn from the group with the
lower cost and to bring its performance up to the same level of efficiency. The superior group
was expected to create an environment where it continued to improve its efficiency; groups were
not expected to rest on their laurels.

Two of the mechanisms used to encourage superior performing groups to keep improving were
the awards ceremonies and model zone program. The superior groups achievements were
recognized in award ceremonies that were held in front of all factory personnel. There was great
prestige associated with winning these awards more than once, thereby creating considerable
pressure on superior-performing groups to keep improving their performance. The model zone
program consisted of granting participating groups additional funds to find ways to increase their
productivity. Groups volunteered to participate and their achievements were reviewed by a panel
of judges that declared annual winners in the competition. Again, considerable prestige was
associated with winning the competition.

The kaizen program created strong pressures to innovate. All groups were expected to imitiate
the innovations of other firms. Several mechanism exixted to help groups identify innovations
that might be beneficial; these mechanisms included a special group at SEI head offices, the
ready availability of publications that reported on innovations, membership in industrial groups,
and attendance at seminars given by SEI’s major customers, especially the automobile industry.

When investments in production process improvements were made, the blue-collar targets had to
be changed to reflect the new conditions. To ensure that the new blue-collar target costs were
appropriately set, the monitoring period was reduced from six months to three months. Once
management was convinced that the new targets were appropriately set, the monitoring period
returned to six months. The objective of this more frequent monitoring was to ensure that the
targets were adjusted to reflect the new conditions and that the maximum target cost reductions
were achieved. When the new conditions led to increased cost reduction targets, there was little
problem; however, when the new conditions resulted in a decrease in the blue-collar target
reductions, then the plant manager was expected to find ways to still achieve the overall cost
reduction target for the plant.

The cost reduction targets were set at achievable levels (see figure 2). The majority of groups
achieved their cost reduction targets to within 2 %. Typically, between 10 % and 20 % of the
groups failed to achieve their targets, with a similar percentage achieving higher savings. No
statistics were kept on group performance because management considered it more important to
monitor how each group performed rather than how close it came to its target.

The level of expected cost reduction dependedupon the product. Some products had the potential
for high kaizen savings, while the costs of other, more mature products were difficult to reduce.
For this reason, not attempt was made to compare cost reduction performance across groups.
Such comparisons were not made because management felt that they ignored the relative ease of
achieving cost reductions.
For Kaizen cost reductions, the trend was to delegate cost reduction to the factory level. In
particular, management tried to use accounting data at that level.previously, cost data had been
collected at the factory level and then sent to the accounting department, where it was compiled
into accounting information. This information was not subsequently used at the factory level, but
rather at the division level to help report on divisional performance. The accounting department
collected only the information it required to produce the financial reports: it did not collect
information specifically for managerial purposes. To transfer ownership of accounting
information from the accounting department to the shop floor, factory personnel began to prepare
shop floor cost management information, and subsequently some of it was used by accounting
department to produce financial reports.

Negotiation of cost reduction targets

Group leaders were expected to negotiate their group’s cost reduction targets.these negotiations
were part of a hierarchical negotiations process, which was a mixture of informal and formal
communications. Given the informality of some of the process, it is difficult to describe its exact
sequence. The division managers were responsible for setting the cost reduction targets at both
the division and group levels. The critical player in setting these targets was the plant manager,
who had access to detailed information about what was happening on the factory floor and at the
conduit between the factory floor and the divisional manager, helping him or her identify
realistic stretch targets for each group. Once the informal targets were established, the groups
entered formal negotiations to fine-tune the targets and commit to them.

SEI’s budgeting procedure was used to formalize these negotiations. Budgets were prepared
every six months, and were based upon sales forecasts provided by the marketing division and
cost estimates provided by the plant managers. These cost estimates included allowances for the
cost reduction targets negotiated by the divisional general manager, plant manager, and group
managers. Reflecting its central objective-profit management-the basic budget plan was known
as the profit plan.

The six-month profit plan was prepared in two stages. In the first stage. The first three months of
the plan were enumerated individually and the second three months were averaged together. In
the second stage, at the end of the third month, the remaining three months were estimated
individually. Thus, although the profit plan covered a six-month period, it was reviewed
quarterly.

Delegation of cost management to workers

The plan to delegate cost management to the workers contained five major elements:

1. Workers were provided with cost information and were expected to manage with it.
2. Accounting was performed in the plants as well as at headquarters.
3. Some investment decisions were made by the blue-collars workers
 4. There were separate financial and management accounting systems.
5. Monthly meetings were held with blue-collar workers to evaluate plant and divisional
performance

The accounting system was used to determine when the division was not achieving its cost
reduction targets. It was plant accounting’s responsibility to draw attention to any cost reduction
shortfalls and obtain an explanation from the division general managers as to why the planned
cost reductions were not achieved. Every six months, a more thorough review was undertaken
that included analyzing the cost reductions due to investments. Investment-related cost reduction
analyses were only performed every six months because, unlike the blue-collar cost reductions,
they required off-line calculations.

Direct Costing system. The primary system for the determination of contribution margin at SEI
was the direct costing system (DCS). Within the divisional performance reporting system, the
DCS played two critical roles : it formed the basis of the divisional profit and loss system, and it
acted as the bridge between the financial and managerial accounting systems.

The DCS was first introduced in1953 and had remained the basis for the firm’s cost system ever
since. Over the years, the system had been improved by increasing the level of detail it could
report; these improvements were achieved primarily through automation. The DCS contained
three major elements: a standard costing system, a direct costing system, and an annual standards
revision procedure. The primary use of the standard cost reported by the DCS was to compute
the split between cost-of-good-sold and inventory valuation for financial accounting purposes. At
year end, the actual results were use to calculate an conversion ratiothat was use to convert cost
of goods and inventory valuations from syandard to actualfor the year. This conversion ratio was
computed by dividing total actual cost by total standard costs. Conversion ratios were
determinedfor each of the firm’s six product groups: electric wires and cables, special steel
wires, sintered alloy pruducts, brake products, hybrid products, and other products. Product
groups identified SEI’s major business areas.

The design of SEI’s cost system reftected the underlying production process. There were four
major steps in the production process for insulated electical wire: drawing the purchased wire to
the appropriate gauge, standing, insulation with PVC, and marking the wire. To determine the
final cost of the wire required calculating the cost of the copper purchased from SEI’s bare wire
division, adjusting it for scrap levels and time to manufacture was the time taken to produce one
kilometer of wire, plus set-up time. The cost per hours was determined by dividing the group’s
direct costs, including labor, energy, maintenance, and lubricans costs, by the group’s hours of
production.

One of the major purposes of the cost system was to determine the price of products. Price were
set in three steps. First, the annual price for copper was set by the purchasing department,
located at the firm’s Tokyo head office. (An annual price, not a current price, was established
because copper prices fluctuated daily, and since there was no merchanism for SEI to track
actual material costs, a standard was required. An annual standard was chosen because it allowed
the firm to monitor price changes across the year via the calculation of monthly price variances).
The purchasing department also set the annual price of all of the other metals used in SEI
products. Second, The cost of the bare wire was set by the bare wire division, located in the
Osaka works. It was determined by adding the direct and indirect production costs to the scrap-
adjusted cost of the copper. And third, the cost of the assembled products was determined by
adjusting the material costs by the standard loss ratio to allow for material losses.

The standard loss ratio consisted of three factors: the loss ratio of surplus, the loss ratio of
giveaway, and the loss ratio for scrap. The loss ratio of surplus captured the extra length of
product that was unavoidably produced in the production process or consumed by inspection.
The majority of the surplus loss ratio was caused by the production department running “a little
extra” for each customer to ensure that the customer received at least the length of usable wire
that was dered. Obviously, if the customer received less than ordered, it would return the wire,
which usually would have to be scrapped. Running a little extra avoided this problem. The loss
ratio of giveaway was the difference between the panned and actual diameter of the product.
Finnaly, the loss ratio for scrap captured the amount of PVC and other materials that were
wasted at the beginning of a production run. This head loss was unavoidable because of the
length of the machine and the way the wire was produced. For example, when polyethylene-
coated wires were produced, the first few meters were scrapped because it took a while for the
coating process to stabilize.

Standard loss ratios were determined by multiplying the loss ratio of surplus by the loss ratio of
giveaway plus the loss ratio for scrap. Standard loss ratios were generated every year for each
group of products, not for each product; product group consisted of products that different
primarily by the gauge of the wire. For such product groups, the loss ratios were essentially
identical among products. Any minor variations between products in a group were not
considered worth tracking.