Q&A Case Studies from Seiwajyuku

Seminars

The Amoeba Management I have thus far described will yield its real
power when employed in actual management applications. I believe that
readers who are in management may be interested in learning how these
examples actually apply to specific practical situations.

This part of the book includes questions and answers from the
Seiwajyuku, a chain of study groups that I sponsor to help young execu-
tives. All Seiwajyuku students are the heads of small to medium-sized
businesses. During Seiwajyuku sessions, they present questions on spe-
cific management problems that they are struggling with, and I offer my
own frank and serious analysis in response.

The following five examples are actual case studies to facilitate the under-
standing of Amoeba Management. These are actual, specific cases with
only minor modifications of the content for inclusion in this book.

QUESTION 1: PROACTIVE
INVESTMENT

Our company is a car dealership. Since the Japanese economic bubble col-
lapsed several years ago, we have struggled to rebuild our business.
Finally, we are at a point where both our revenues and profit are moving
in the right direction. Recently our manufacturer has become very ag-
gressive, pushing a strategy to proactively cope with environmental and
safety measures. They plan to double their unit sales in the next four
years. They are demanding that each dealer strengthen its sales force and
increase sales points.

Our company has three sales offices and fifty employees. Of these fifty, we
have fifteen salespeople who sell a total of 450 cars per year. On average,
each salesperson sells thirty cars per year, or about 2.5 cars per month.

In the past, our debt has been as high as a third of our annual revenues.
We have recently improved our service facilities and made additional fi-
nancing to meet the manufacturer’s request to hold inventory. Since we
expect sales to increase, we are planning to build a used-car center,
which will be under our direct management and will enable us to offer
higher trade-in prices to the customer. As a result of this plan, our debt is
expected to double before we can realize our anticipated sales increase.

Although profit is marginally acceptable, we really depend on the

manufacturer’s incentives. Therefore, we are, to some extent, at the
mercy of the manufacturer.

Generally speaking, every Japanese automobile manufacturer is expected

to become more selective and more demanding of its dealers in the fu-
ture. They may set a severe penalty on dealers who do not commit to
opening new sales centers or are unable to achieve sales objectives. We
believe this will lead to a market shakedown, and we are now facing the
crucial moment of whether we will be among the survivors.

We have only two ways to raise our sales: one is to increase our quota on
the number of cars each salesperson sells, and the other is to hire more
salespeople. There certainly are salespeople out there who can move five
or six cars a month. However, these kinds of exceptional salespeople are
rare because they have more than just experience and training. We think
that hiring and training new people over four years would be safer than
hiring more super-salespeople. Those new sales reps should be able to
sell 2–3 cars per month fairly quickly.
Establishing a new sales office requires a major capital investment and
we have to be careful. We thought of first doubling the number of cars
sold by increasing the number of salespeople. Every year, we intend to
hire about four new salespeople, which will double our current sales
force in four years. That should enable us to sell nine hundred cars per
year.

For our company, we consider hiring sales personnel and training them
thoroughly to raise customer satisfaction to be absolutely necessary in-
vestments that must be done even if it reduces our profit in the short
term. Especially in times of economic stagnation, like now, I think we
must have the courage to make this type of proactive investment.

On the other hand, there are also many unknowns and risks. We are very
concerned about rising competition, sacrificing our profit margins, and
putting our survival in jeopardy. I am well aware of Dr. Inamori’s advice
to “First solidify your footing by improving profitability, then make capi-
tal investments.” I would like to hear your opinion of our situation.

Comments on Question 1

Seize the best opportunity.

Reduce indirect labor costs and increase profits.

“Be alert and flatten fixed costs” is one of my accounting principles, along
with “Always maintain a frugal attitude.” Kyocera is a manufacturing
company, and our productivity depends upon how advanced our plants
and equipment are. However, since our founding, I have been saying,
“We should continue to use old plants and equipment.” We have extended
this frugal attitude toward anything that might increase our fixed costs.
In addition, we strictly control our headcount, especially in the indirect
labor force (nonsales, nonproduction employees).

According to what you have just explained, you employ fifteen sales rep-
resentatives, which represents 30 percent of your total workforce of fifty
employees. This means that one sales representative must fund the over-
head for three employees, including him or herself. And now, you are
planning to double your sales in four years by adding four new represen-
tatives each year.

As you implement this plan, it will be important to avoid adding any indi-
rect labor. Let us suppose that you only add sales reps who are newly
graduated from college, and these new reps have to sell ten cars per year
on average in order to add value equal to their salary. You must deter-
mine how long the training should be for those employees to enable them
to sell ten cars per year. Until they become capable of selling ten cars per
year, their contribution to revenue will be lower than their salary. This
would be a significant burden. You need to analyze whether your current
profits can cover this burden. In addition, you should avoid making such
an investment based on the assumption of a future increase in sales. New
employees should be hired within your existing financial capacity.

I don’t know how long it will take, but you will see quite an improvement
in your profit ratio when those new sales representatives each become
capable of selling an average of thirty cars per year. Because your indi-
rect labor costs will not have increased, your additional trained sales reps
will not have to shoulder the salaries of three employees. If a new sales
rep could sell thirty units, the company’s profit would equal the salaries
of two sales reps. Since fifteen reps currently support a payroll of fifty, it
would be much easier if thirty sales reps supported sixty-five, in
comparison.

Your operational results indicate that your profit ratio has fallen below a
previous level of 5 percent even though sales have increased this year.
We must pay extra attention to this. If you consciously accept cost in-
creases that are proportional to sales increases, the costs usually tend to
increase more than the marginal increase of sales. Therefore, you should
be seriously concerned with the decrease in your profit ratio and set a
goal of at least 5 percent profit to sales. It would be a problem if you
added new hires at a time when your profit ratio was decreasing. Before
hiring anyone, your current expenses must be completely minimized.

Your strong sense of strategy is very good. You should be able to succeed
if you continue to have courage and remain very prudent. My suggestion
to you is to make a new investment only when you attain at least a 5 per-
cent profit ratio.

You need to watch for opportunities as you expand your business. The
business you have just described seems to have a very promising future
considering the great importance of safety and the environment. Once
your profit ratio rises above 5 percent, if you are sure of this business op-
portunity, you should go ahead. I have been saying, “Wrestle in the center
of the ring,” which means that management should always be able to af-
ford taking a good business opportunity without any concerns. You may
like to make investments while maintaining a frugal attitude, reducing
expenses company-wide. Please make all employees understand the
meaning of this investment—a big jump in business—and improve your
footing.

Again, indirect labor will also tend to increase if you hire more sales reps.
Please never let this happen. You should devote yourself to improving
sales while coming up with ideas for improving the repair services struc-
ture. Then, your profit ratio will naturally go up along with it.

As your business expands, managers must keep an eye out for details. I
would rather not go into specifics here, but store managers and all other
employees should calculate their profit ratio for each store, and be thor-
ough in following the principle of “Maximize revenues and minimize ex-
penses.” We can’t be satisfied with merely “reducing costs.” Also, there
may be a profit opportunity in the repair service sector. It could turn out
that repair services are not just an indirect division supporting sales. In
some cases, repair service and sales are divisible, and you can also have a
separate used-car center. Each division may have a different structure of
profitability, and it will be very crucial to monitor their profitability indi-
vidually as a manager.

QUESTION 2: ALLYING WITH A

LARGER BUSINESS TO INCREASE
CAPITAL

I would like to receive your advice concerning capital procurement.

We are a family-owned and family-run hotel business. While the hotel

business nationally is stagnant, our company has done well, because our
hotels are relatively new and located in good areas with increasing
tourism.

But all hotels have the problem of attracting and retaining good employ-
ees. It’s even difficult to find a good general manager. Because we require
irregular work schedules and hard work, we have difficulty even getting
qualified customer service people.

However, our hotels have recently been implementing new working ar-
rangements and we have achieved a low level of employee turnover. We
also have a successor within the family to take over our business, and our
hotels are in good standing.

We are now planning to renovate our hotel, which was built thirty years
ago. The layout of the guestrooms should be updated soon in order to
meet the needs of families and groups of tourists. The capacity of our gue-
strooms today is two to three people (for individuals and newlyweds),
which is not sufficient for the current trend in tourism. We are planning
to build multipurpose facilities, such as conference rooms, banquet
rooms, and spas, to accommodate larger groups. If we can double the
number of guests we serve, we can triple our revenue. We believe that
the effectiveness of this investment will be great enough to generate an
acceptable return on the invested capital.

Regarding the most important issue—financing—our financial condition

is about average compared to our competitors in the industry. We will not
be able to finance this large capital investment from our equity. In fact,
we must consider borrowing all of the funds we need for this renovation.
Frankly speaking, we cannot expect a bank loan since our debt-to-equity
ratio is already high. We have thought about finding a sponsor or estab-
lishing a membership, but these alternatives are not very realistic.
The capital investment plan I have just explained is not a simple renova-
tion plan. In commemoration of our thirtieth anniversary, we have
adopted a theme to re-establish the old-fashioned style of our business,
which is still based on the fixed-rate structure for overnight customers.
We will convert our traditional management to a more contemporary and
practical cost management system.

Therefore, we would like to implement this plan by teaming up with a

large corporation that has recently entered our area. This joint venture
would be attractive for this large corporation, too, since they are already
planning to build an amusement park in the adjacent area. We will be
able to take advantage of their funding resources and credibility now and
in the future. Specifically, we will establish a new company through
shared capital, and this new company will manage the hotels.

Since we can provide only land and employees, we may transfer part of
our managing rights to our joint venture partner. Today’s leisure and
tourism industry requires not only hearty service at local hotels, but also
various promotional activities in major cities, more modern labor man-
agement, and effective financial management. We know we cannot stay
with family management if we cannot find the appropriate leadership ca-
pabilities to expand the business in our own family.

Fortunately, our oldest son is prepared to take over our company, and we
have candidates for the general manager and other top positions. The
quality of our employees is also high, and many of them would like to
have a long career with the company. So, we would transfer only a part of
our managing rights to this larger company, if we could contribute to the
growth of the area. At the same time, we could keep those good employ-
ees in the future and our family members would continue to exercise a
role in the management of the business.

May we ask your advice on our capital investment joint-venture plan?

Comments on Question 2

Expanding before improving your profit ratio is risky.

Increase profit to wrestle in the center of the ring.

Frankly speaking, this is a very difficult issue to answer.

You have said, “We may transfer a part of our managing rights to the
large corporation if we can use their funds and sophisticated manage-
ment capabilities.” But, later you also explained that you had made a
commitment with the oldest son to let him take over management, along
with the general manager and others.

I am afraid to sound very severe, but this is not likely to happen the way
you want it to. Let us suppose that a large corporation is interested in es-
tablishing a joint venture with your company and is so committed, as you
have said. In this case, the bank would request a guaranty from the larger
corporation, of course. Because this guaranty would be the same as get-
ting a bank loan for the larger corporation, they would probably try to ac-
quire complete management rights from you. The land may be assessed,
but it would probably amount to only 10–20 percent of the total loan. You
should know that intangible assets, such as your name value and human
resources, would not be assessed. In fact, the larger company may try to
acquire 80–90 percent of managing rights.

All the employees, including your son, the general manager, and the oth-
ers, are expecting to be employed for a long time, of course. However, the
other company would probably replace your son if he was not highly ca-
pable as a manager after a couple of years of service. Even if your son is
highly capable, they might replace him once they decide that his manage-
ment does not meet the requirements of the larger company. The general
manager and the others would be in the same position. Therefore, you
must be aware that there is no guarantee of keeping the current work-
force if you proceed with the type of joint venture plan you have
outlined.

I may sound very cold, but the large corporation must act very calmly
about these matters since it is investing its money into this project, which
will eventually be its responsibility. It is a basic tenet of capitalism to pro-
tect your investments.
Of course, your situation is not rare. I feel very agonized in saying this,
but with no exceptions, small and medium-sized businesses throughout
Japan are experiencing the same problem.

This may be saying it too directly, but seeking a funding partnership with
a larger corporation to expand your business based upon the plans you
have just outlined seems very risky to me. It may sound harsh, but your
operating profit has not grown at all even though your sales have im-
proved a little in the past. Your ordinary income is too low because your
interest payments are a heavy burden. On the other hand, your repay-
ment schedule has increased every year. You will need a secured cash
flow in order to meet your repayment schedule, even if profit is not sig-
nificant. Conversely, your debt has increased. Therefore, you must first
find a way to improve your present profit ratio and financial condition.

An old proverb states, “God helps those who help themselves.” With this
in mind, your business has to have the capability of being independent.
Otherwise, banks will not loan to you. They will lend an umbrella only to
people who can avoid the rain. Unfortunately, your plan to team up with
a larger corporation seems to be rooted in your own financial
incapability.

The reality is that your profit has not increased at all, even though your
debt has, and despite the fact that your sales have increased little by little
in a fair volume. It is obvious that your business will face difficulties in
the future. You will not be able to resolve the problem by looking for
some new way of survival while neglecting to solve the root of the prob-
lem. In any case, you need to improve the company’s financial condition
through your own efforts.

You mentioned that current sales would triple. I think that is unrealistic.
Double may be more like it. Various issues, such as staffing and internal
management, will naturally rise to make your management more difficult
as the business triples in size. I am concerned that your plan is too opti-
mistic. Is it really that easy to achieve threefold revenue—just by rebuild-
ing your hotel?
If you cannot survive with the current thirty-year-old building, you may
face reconstruction issues. A thirty-year-old hotel should be fully depreci-
ated by the time you find it becoming decrepit. The plumbing and air-
conditioning systems you mention age faster and should be depreciated
separately from the building—for about ten years. If you used a fixed rate
for depreciation, the building should be almost fully depreciated by now.
Your profitability would have improved as a result, and you should have
enough retained earnings for future investment. The profit should have
been at least 10 percent of revenue and accumulated in your retained
earnings.

Soon after I established Kyocera Corporation, I had a chance to hear

about “dam-style management” from the late Mr. Konosuke Matsushita. I
learned the importance of managing with a strong will to accumulate re-
tained earnings for the company. I put all of my efforts into improving
profitability. I did not wait until I was pushed to the edge of the ring to
take actions, but acted while there was still distance between myself and
the edge. My resolve was strong and I knew there was no possible retreat
for me. What you must do now is increase profitability. You need to im-
plement the principle to “Maximize profits and minimize expenses.”
However, you have to be careful about the possible consequences now,
because you may lose customers due to deteriorating service or less ele-
gant food resulting from your necessary cost reductions. You should be
the cost leader in your area while upgrading food and service and main-
taining your current building. This will require unusual efforts and cre-
ative resources.

It may not be a task that anyone can do. If you can do it, you will be an ex-
cellent manager. Anyhow, you must completely improve profitability. No
matter how attractive the scheme may sound to you right now, I am
afraid it will only accelerate the danger to your company unless you in-
crease the base profit first.

Even if there were a corporation that was interested in financing or in-

vesting in your plan, you would face an ever-present danger of what to do
if the investor should withdraw its invested capital when your plans did
not materialize. Overall, it is very dangerous to expand a business by as-
suming you will have access to another company’s capital and credibility.

QUESTION 3: INCREASED DEBT DUE

TO EXPANSION

We are in the business of transporting industrial products. Since our

founding, we have been able to expand our business by steadily increas-
ing our truck fleet and by setting up a subsidiary to operate warehouse
and distribution centers. More recently, our customers have begun to
move in droves to a local industrial park, so we set up a processing plant
there to support them, since this park does not permit a warehouse with-
out some manufacturing activity. This new investment increased our
debt.

The transportation industry is typified by small businesses, and the com-

petition is fierce. To survive, we consider it essential to build up our busi-
ness and our corporate base. Thus, we have embarked upon an expan-
sion strategy.

However, the basis of a transportation company is steady, hard work.

Expanding the scope of the business does not automatically increase our
profit. As imported goods replace more and more domestic products, we
are also concerned as to whether we can continue to raise the working
conditions of our employees. I am worried that perhaps we should resist
our expansion strategy and instead reduce our debt, delaying our expan-
sion until after our company has become more firmly established.

Our expansions during the past five years consisted mostly of land for
garages, but we have also invested in the processing plant. In five years,
we have invested an amount close to one year’s revenue.

Our sales during the past few years have been growing smoothly. The
profit ratio has also improved with expanding revenues. But interest and
depreciation are also increasing. And the processing plant, with low start-
up sales, is a long way from becoming profitable. While I understand the
urgency of debt reduction, I also believe that it is necessary to make addi-
tional investments in our processing plant, which would increase our
debt further. However, if we were to continue in this direction, we would
never get out of the borrower mentality, even after paying off our current
loans. There will always be new investment needs.

Should we continue with this business expansion strategy? Or should I

stop the expansion, implement a program to increase organizational effi-
ciency, and build up our corporate reserves? At this critical moment in
our decision making, I would appreciate your guidance as to how we
should continue.

Comments on Question 3

Understand the figures on your P&L.

Management cannot take place without an understanding of accounting.

This is a very difficult question. First of all, your processing plant and
transportation businesses should be separated as individual divisions.
You must calculate individual P&L figures for each, including deprecia-
tion expenses and labor costs. Then consolidate the two financial state-
ments to see the entire company.

I understand that you have invested mostly in land for garages and your
processing plant. Since land does not depreciate, this purchase amount
will remain on your balance sheet for good. Therefore, you can make a
decision to purchase land from your cash flow, provided that your com-
pany has sources of cash for the purchase. If the working capital of your
business has been funded, some land can be left unused as long as the
company is able to pay the debt and interest, regardless of whether it is
funded internally or by a bank loan. However, equipment, industrial
products, and construction costs are completely different; depreciation
would add to interest expenses.
In other words, if you can obtain enough funding to purchase the land, all
you need to bear is the interest. In contrast to this, capital investment in
your plant will bring interest expense and depreciation, and continuing
profit is absolutely necessary to bear these expenses.

Through your aggressive development efforts, your revenue has steadily

grown in the past three years despite fierce competition. Your ordinary
profit ratio has grown to 10 percent from 4 percent, while interest and re-
payments have increased.

Although the business has been expanding, you are concerned about
making additional capital investments. You need to judge whether or not
the ordinary profit ratio will continue to rise above the present 10 per-
cent level. Your criterion of judgment in making this decision should be
whether it will expand not only the scope of your business, but also your
profitability.

As the scale of the business expands, all expenses increase—not just the
repayment of investment capital. While you strive to hold down costs,
you must keep the marginal growth of costs below the marginal growth
of sales.

Your current interest expense is very low, but the market trend could
change drastically. Interest rates could rise in the near future. Despite
those large capital investments, your profit is barely increasing, even
though interest rates are presently low. If rates rise, your profit could go
down to zero. You might even experience an operating loss. In any case, if
your profit starts diminishing, the bank may become reluctant to provide
a new loan and may even raise the interest rate of your current loan.
Your company could go bankrupt from capital depletion, even if you are
making profits.

Therefore, at the end of the month, managers should analyze how a 1

percent increase in interest rates would diminish your ordinary profit.
You should also calculate how much rates would have to rise in order to
bring your present profit level down to zero. You might want to slow
down the expansion after this monthly review.
The principle I am outlining here is that the amount of debt you incur for
capital investment should be limited by your repayment capacity—that is,
your after-tax profit minus the current repayment amount. In any case, it
is very important that you feel a certain uneasiness when you think about
expanding your business by increasing debt. Further, if you decide to pro-
ceed, it is very important that you have a desire to repay the debt as soon
as possible. When I entered management for the first time, one investor
supported me with 10 million Japanese yen that he had borrowed from a
bank with his house as collateral. I was desperately trying to repay him.
One day, he told me, “If you can tolerate the burden of principal repay-
ments and interest, you should borrow more and expand your business,
rather than repaying me the principal. That is what makes you an
entrepreneur.”

Even after that, I still hated the debt mentality and I made repayments as
aggressively as I could. He was amazed and he said, “You are indeed a
good engineer, but not a good manager.” Nonetheless, I wanted to wrestle
in the center of the ring without being concerned about debt. Later, I be-
came very fortunate to be able to expand my business without any debt.

So, you are quite right in worrying now. I believe that if you continue to
be careful as you are now, your company will continue to grow.

QUESTION 4: SETTING
MANAGEMENT GOALS

When I am making our annual or five-year plan, I am often at a loss in

trying to set annual sales growth targets and other numerical goals.

For example, in discussing whether our growth should be 20, 25, or 30

percent, I would obviously prefer to set our goal at 30 percent. However,
my subordinates have their own ideas, and I need to take into considera-
tion various factors relating to the market and the economy in general. I
am finding it quite difficult to pick the correct target.
If I set a goal that is too high, it may be pretty but unrealistic—as we say
in Japan, “painted rice cakes in a picture.” Yet if I make it too low, I think
it will lead to a diminished sense of challenge and vitality in our work-
place. Ideally, I want to provide an adequate level of challenge to our em-
ployees without making the goal seem unattainable.

When we set a goal, should it be top-down or bottom-up? If it is top-down,

employees may consider it just a corporate-mandated “wish.” If it is bot-
tom-up, it tends to be only a slight increase over current results.

Please enlighten us on what you consider to be the key in setting the ap-
propriate target.

Comments on Question 4

The plan reflects the top manager’s will.

The fact that you are concerned about such a thing is already an ad-
mirable trait for a manager. Since setting a goal is the most important fac-
tor in management, any executive who takes his or her job seriously will
sooner or later encounter this dilemma. You may say it is a dilemma that
every successful company is destined to encounter.

Management means doing something with a group of human beings, so

we shouldn’t talk about management without referring to human minds
and hearts, and we shouldn’t manage by disregarding the human
element.

Therefore, setting a goal for the company is a matter of deciding how to

deal with human hearts. It is not easy to do this correctly. If you were to
set a target that could not be achieved in spite of your utmost efforts, peo-
ple would say, “We can just ignore this unrealistic goal.” In this scenario,
if you were to respond by shifting the goal downward, your employees
would think that goals are easily abandoned or revised, and you may find
yourself having to further make downward corrections. Once your em-
ployees adopt this attitude, you have lost regardless of whether or not
you actually lower your goal.
I believe that the role of a manager is to breathe life into a corporation. If
we were to think of a company as a human body, a manager is like a
brain cell that commands the body to work. When the manager is at the
helm actively leading all employees, the company is alive and well. If the
leaders start putting priority on their own well-being, they sap the life
right out of the company.

Therefore, a management goal must be the willful decision of a person

who is seriously concerned about the company without any selfish
interest.

In reality, as long as you are worried about how to judge whether the
goals are too high or too low, and whether they should be set top-down or
bottom-up, you cannot truly excel in your management. If there were one
best way to set management goals, anybody could become a good
manager.

The problem is not whether the target value is high or low. What is im-
portant is that you, the manager, must have a targeted number that you
wish to achieve. Then, it becomes a matter of inspiring all employees to
act in unison and with vigor toward achieving the target.

If you set a figure that seems too high, your insistence on employees’
willpower to achieve it will be met with resignation: “Mr. President, no
matter how you say it, what you are demanding is impossible for us to
achieve,” they will say, or, “Last year’s result was negative. You can’t ask
us to double our output all of a sudden!” Your pep talk will be useless, no
matter how strong your own willpower is.

How to appeal to the hearts of human beings is the most important thing
in management. This is not just a problem for managers. Whether you
are a school teacher, a baseball coach, or any other leader of a group, it is
important to understand the psychology of the people involved, and
know how you can inspire them to do what you think is the right thing.

To transform the manager’s will into the employees’ will, there is no

other way but to go top-down. Otherwise, you will not be able to set a
high goal that everyone will work hard to achieve. It has to be the person
on top who says, “Let’s double our result next year!” Then, he must ex-
plain, “If our company merely continues as it is now, we will eventually
lose out. We know of other companies that are growing successfully, such
as the XYZ Company.” The manager can then motivate the employees by
saying, “If they can do it, our company should also be able to do it. We
were stagnant until now, but I know we have what it takes to double our
sales.” Employees who see the confidence imbued by the person on top
may naturally begin to have a greater belief in their own potential. So,
when you finally say, “Let’s set our goal to be twice as high as last year’s
result,” the atmosphere should encourage all to respond, “Let’s do it!”

Every human being, somewhere in his or her heart, has a desire to take
on new challenges and break away from the status quo. This heart says
there should be more than what there is now. But, everyone also has an
opposite thought that it is safer to resist change, to just keep things as
they are. If we do something new, it may backfire. And the bigger the
group, the less likely they are to want to take on new challenges. If you
just leave your employees alone, they will all end up becoming increas-
ingly more conservative.

So, the task of a manager is to draw out that natural tendency that human
beings have to challenge something new. You want them to say, “It’s
worth a try.” But for that, the goal has to be daring and worthy of their
challenge.

Of course, to set up a truly challenging goal, there has to be a correspond-

ing business opportunity. And, this business opportunity is not something
that you can just wait for. You set the goal, decide when and what you
want to achieve, and then run many simulations in your head as to how it
can be achieved. As you continue to reflect, you start to notice business
opportunities. That’s where you want to lead your employees. Which of
these opportunities should we select? That is the goal you want to set for
your company.

In Chinese literature, there is a saying, “Time comes from Heaven, wealth

comes from the Earth, and harmony comes through people.” Even if you
were to gain time from Heaven and wealth from the Earth, things are ul-
timately decided by the hearts of people. As more people seek to elevate
themselves and head toward the corporate goal, even those who were
originally unreceptive to the idea start aligning themselves toward the
goal. It is a matter of psychology.

QUESTION 5: THE SHORTFALLS OF

COST ACCOUNTING

Our company manufactures industrial machinery components and was

established only a few years ago. Our market has expanded recently, our
production is rapidly expanding, and we now produce a wide variety of
products. However, I am concerned that if we continue in this manner, it
will eventually become impossible for me to comprehend our true oper-
ating results. We want to accelerate the introduction of an accounting
control system that will enable us to accurately view and understand
management information relating to our own performance.

In the case of manufacturers, I understand that most companies use cost

accounting to manage their business. Kyocera, on the other hand, has
never used cost accounting. Instead, you developed your own manage-
ment method based on Amoeba Management.

Would you kindly tell us what you see as the problems of traditional cost
accounting?

Comments on Question 5

A manufacturer’s profit must come from production.

As you have correctly stated, many manufacturers control finances using

cost accounting, especially through what is commonly known as the stan-
dard cost accounting method. Kyocera does not do this. Our reason for
shying away from the cost accounting approach can be clearly illustrated
by an anecdote I once heard about a major electrical equipment
manufacturer.
This story came from an executive from that company, which was strug-
gling with a low profit margin. His division manufactured consumer ap-
pliances and used a cost accounting system for management control. This
system would first project the current retail price for the appliance, in-
cluding the discounted sales prices, in Tokyo’s Akihabara district (known
as Electronics Town due to its high concentration of consumer electronics
retailers, which sell everything from computers to toasters).

Then, using this final retail price, the system computes margins for retail-
ers and wholesalers, and subtracts Sales, General, and Administrative
(SG&A) expenses. Based on this calculation, it produces the “target price”
for the manufacturing plant.

If the plant employees work hard to produce the desired products at the
target price, they are considered to have met their goal. It does not mean
that the plant is profitable, only that it was able to lower its production
costs to the target price and that it met the volume requirement. Then
sales will purchase the products at this target price, add its own markup,
and send them to their distributors for wholesale.

Unfortunately, the market is always full of surprises. When a competing

product appears with a slightly different feature, consumers consider all
current products obsolete and won’t buy them unless they are heavily
discounted. When retailers lower their prices, wholesalers naturally ask
the manufacturer to lower its price. They say, “Your products are obso-
lete. Unless you lower your price drastically, we will end up with a huge
inventory.” This process eventually leads to a price war with deep
discounts.

Originally the manufacturer may have planned a 20 percent margin, but

this margin decreases rapidly as the retail price drops. They may end up
lucky to have a profit of just a few points. In the worst case, as often hap-
pens with semiconductor products, a drop in the market creates an
avalanche of price erosion, rendering everyone on the supply chain
awash in red ink in both manufacturing and distribution.

This executive said that experiencing this cycle over and over created the
“conventional wisdom” that no one can make much money in electronic
appliances, short of inventing a new “hit” product.

What, then, is the problem? A manufacturer should be making profit in

manufacturing. The problem is that they created a system where produc-
tion no longer has a profit motive, but must merely meet the price and
volume targets. Therein lies the problem.

In the current case, a sales executive sets the manufacturing cost target
and decides what the price of the product should be. Cost accounting is a
way for the manufacturer to determine the selling price, so it uses the
cost of production as a way to move the market.

But unfortunately, markets do not move at the will of the manufacturers.

Rather, the market ends up deciding the market price regardless of the
cost. The suppliers’ logic fails, and the manufacturers feel as if the market
has betrayed them. The story our executive told us is a clear illustration
of this mechanism.

The market economy is becoming a global competition where companies

from all over the world compete freely. We must base our thinking on the
fact that the market price is something that is determined by the market.
A manufacturer must accept the fact that “neither the price nor the cost is
fixed,” and continuously apply innovative efforts to lower production
costs.

Since a manufacturer’s profit should be generated at the production level,

it is a fundamental mistake to manage production as a cost center, as in
the case of this electronic appliance company. In other words, giving a
target price to production is tantamount to cutting it off from the reality
of the marketplace, and ruins any eagerness to meet the market price.
Production will strive to meet the target price, but will have a hard time
finding the motivation to lower its costs any further.

Of course, there is a cost accounting method of making profit centers out

of production. While this is a far superior system to the previously men-
tioned method of treating production as purely a cost center, it still has
the tendency to isolate production from the marketplace and focus only
on attaining the target cost. Therefore, I doubt that it can really meet the
true spirit of the premise that “profit must be generated by production.”

For example, the standard cost accounting that is widely used as the way
to control manufacturing costs would have standard costs assigned to
each product. They would be computed for each unit of production or
sales. First, a standard cost is given as a target for production to achieve.
Production is evaluated by its variance from the target. If the production
cost is below the standard cost, we have a positive variance and produc-
tion is praised for its efforts. If the variance is negative, there is a short-
fall. It then analyzes where the discrepancy came from and how it can be
improved: raising the material yield, lowering the cost of purchased ma-
terials, shortening the process cycle time, and so on. It is seemingly a very
sophisticated system. This system produces a nice analytical report that
shows how much the actual sales were, what operating profit production
would have generated had it met the standard cost exactly, what the vari-
ance was, and what the actual operating profit ended up being.

This system appears to consider production as a true profit center.

Indeed, many large corporations are using this method. But the method
also has shortcomings. First of all, it requires a tremendous amount of la-
bor and expense to compute the standard cost for each product and for
each process of production. Then, the task of comparing the actual cost
against the standard cost usually falls, not on production, but on an ad-
ministrative unit, such as a cost accounting department or a cost control
department. Since an administrative department does not directly have
production responsibilities, it can only set the new standard cost target as
a slight improvement over actual past performance.

In other words, this method does not allow production to be a truly au-
tonomous management unit, but places its profit-making task under an
administrative unit. The emphasis is on control rather than on manage-
ment. In the case of a large corporation, this renders the organization
highly bureaucratic.

Then, what is one to do? I believe that the answer is to make production a
true profit center, as in Amoeba Management. In Amoeba Management,
production is directly linked to the market and bears responsibility for
pricing its products to meet the ever-changing market price. As it deals
with the marketplace, it is enticed to lower its expenses and raise its prof-
itability. Further, production is free to set ambitious targets for sales and
profits. The result is a drastically lower cost structure, and all the credit
for the effort goes to production, making it the veritable “star” of the
manufacturing company.

So, my advice to you is that, even if you are determined to introduce a

cost accounting system, you should adapt it to overcome the problems I
have mentioned, including the problem of standard cost computation. In
any case, you should accept as your premise the concept that “the profit
of a manufacturing company should be generated by production.” Thus, it
is important that you design a system that can be easily understood by
production and utilized for their management.