LEAN MANUFACTURING MANAGEMENT: THE RELATIONSHIP BETWEEN PRACTICE AND FIRM LEVEL FINANCIAL PERFORMANCE DISSERTATION Presented in Partial Fulfillment of the Requirements for the Degree Doctor of Philosophy in the Graduate School of The Ohio State University By Eric Oscar Olsen, B.S., M.B.A., M.A. ***** The Ohio State University 2004 Dissertation Committee: Approved by Professor Peter T. Ward, Advisor Professor William L. Berry ______________________________ Professor David A. Collier Advisor Graduate Program in Business Administration Professor Anil K. Makhija ii ABSTRACT The relationship between lean manufacturing management practices and business financial performance is examined through the use of empirical surveys and archival accounting data from Compustat and stock return data from CRSP. A sample frame of small to medium sized discrete product and process manufacturing companies reporting participation in only one four-digit SIC was identified as the sample frame. The five-year (1998-2002) financial performance for these companies was analyzed at the operations and business levels using a median z-score comparing median firm performance with the median performance of a matched portfolio of firms. Operations measures included asset and employee productivity, gross margin ratio and two measures of aggregate cycle time. Business measures included return on equity (ROE), sales growth, and stock return. A web-based survey was used to collect data on seven lean practices including just-in-time production management, statistical process control, total productive maintenance, group technology, employee involvement, supplier communication, and customer involvement. Forty-two responding firms were classified as being either lean or non-lean based on a cluster analysis of factor scores. The results demonstrated that lean practices act as a synergistic, mutually supportive set rather than linearly additive individual practices iii in affecting operations financial performance. Lean classification was associated with better total and cash-to-cash cycle times, but was not related to either better or worse asset or employee productivity. Lean firms also tended to have narrower grow margins than non-lean firms. With respect to business level performance, lean firms tend to have better ROE, but no relationship was found with respect to either stock return or sales growth. Of all the lean practices tested only employee involvement demonstrated a significant relationship to business level performance. Firms with high ROE tend to have high employee involvement. A literature review topology is presented to demonstrate the need for studies combining empirical survey data and archival measures of performance. Opportunities for future research are outlined. iv Dedicated to Dawn, Kaitlin, and Skylar; whose love and support has made all the difference. v ACKNOWLEDGMENTS A debt of gratitude is owed to my committee for allowing me to take the road “less traveled by.” I especially thank Peter Ward for guiding me down the path of lean performance measurement, Bill Berry for pointing out the parallels between lean management ideals and value investing, Dave Collier for his support of cycle time as a critical measure, and Anil Makhija for guidance in financial performance measurement. This work could not have been accomplished without the support of my peer doctoral students at the Fisher College of Business. This is especially true of three individuals who put down their own work to help me with mine. I thank Stefan Hocke for putting together a web site while I was trying to determine how to collect data without one, Sebastian Garcia-Dastugue for helping my daughter Kaitlin and I create an Access database and putting up with our novice questions, and Maurice Reid for reviewing my work while studying for his own general exam. In regards to getting my survey done, I thank the Ohio State Center for Survey Research for their insights and assistance in collecting data. I thank the Center for Excellence in Manufacturing Management for their sponsorship of my survey. vi A person could not ask for a better extended family. I acknowledge the love and influence of my father, John Olsen, who knows no fear when it comes to tackling a project and my mother, Alta, whose sense of humor made those projects bearable. The Morgan Orchard represents the road less traveled for a previous generation. Addie and Marshall Ritter provided a constant source of refuge and strength as well as a rigorous review of a draft manuscript. Finally, I would like to thank the friends, friends of friends, significant others, and kids who attended the weekly happy hours over the 5 years I was in the PhD program at Ohio State. You are welcome to come over any Friday night. vii VITA February 25, 1957 Born – East Orange, New Jersey Education 1979 B.S. Forest Engineering, University of Maine at Orono 1987 M.B.A. Virginia Polytechnic Institute and State University 2002 M.A. Business Administration, The Ohio State University, Fisher College of Business 1999 – 2003 Graduate Teaching and Research Associate, The Ohio State University 2004 – Present Lecturer, California Polytechnic State University, San Luis Obispo, California Industry 1979– 1981 Engineer, Caterpillar Tractor Company, Peoria, Illinois 1982 – 1988 Engineering Manager, Litton Industries, Blacksburg, Virginia 1988 – 1999 Engineering, Production, Education Manager, Hewlett Packard/Agilent Technologies, San Jose, California viii FIELDS OF STUDY Major Field: Business Administration Concentration: Operations Management Minor Field: Management of Human Resources ix TABLE OF CONTENTS Page Abstract……………………………………………………………………………………ii Dedication……………………………………………………………………………… iii Acknowledgements……………………………………………………………………….iv Vita……………………………………………………………………………………… v List of Tables…………………………………………………………………………… vi List of Figures ………………………………………………………………………… vii Chapters: 1 Introduction ……………………………………………………… 1 1.1 Research background …………………………………………… 1 1.2 Research problem …………………………………………… … 5 1.3 Research method ………………………………………………… 7 1.4 Importance and contribution of research ………………………… 10 1.5 Organization of the dissertation ……………………………… …. 12 2 Literature review ……………………………………………….…. 13 2.0 Objectives and map of domain ……………………………… …. 13 2.1 Survey-perceptual (category 1) studies ……………………… … 21 2.1.0 Description and objectives …………………………………… …. 21 2.1.1 Lean practice measurement ……………………………………… 23 2.1.2 Lean operations performance measurement ………………… … 25 2.1.3 Summary ……………………………………………………….…. 28 2.2 Announcement-archival (category 2) studies ………………….… 28 2.2.0 Description and objectives …………………………………… …. 28 2.2.1 Lean company identification ………………………………… … 29 2.2.2 Lean financial performance measurement …………………… …. 32 2.2.2.1 Operations measures ………………………………………….… 32 2.2.2.2 Business measures …………………………………………… … 35 2.2.3 Methods of financial performance analysis ………………………. 38 2.2.3.1 Comparison formation …………………………………………… 38 x 2.2.3.2 Measures of central tendency ………………………………….… 40 2.2.3.3 Comparison time span …………………………………………… 41 2.2.3.4 Methods of analysis ……………………………………………… 42 2.2.4 Summary ………………………………………………………… 43 2.3 Survey-archival (category 3) studies ………………………… … 44 2.3.0 Description and objectives …………………………………… …. 44 2.3.1 Performance measurement …………………………………….… 45 2.3.2 Practice measurement ………………………………………….… 46 2.3.3 Methods of analysis ……………………………………………… 47 2.4 Summary and literature-based justification for study …………… 49 3 Research Propositions……………………………………………… 51 3.0 Research propositions – objectives …………………………….…. 51 3.1 Lean archetype versus operations financial performance (P1) … 53 3.1.1 Theoretical support …………………………………………….… 53 3.1.2 Empirical support …………………………………………… … 55 3.2 Individual lean practice versus operations financial performance (P2) ………………………………………………… 58 3.2.1 Relationship to Simple Linear Combinations of Practices …….… 58 3.2.1.1 Theoretical Support ……………………………………………… 58 3.2.1.2 Empirical Support …………………………………………… …. 59 3.2.2 Relationship between individual practice and performance measures ……………………………………………………….… 60 3.3 Lean archetype versus business financial performance (P3) … …. 62 3.3.1 Theoretical support …………………………………………….… 62 3.3.2 Empirical support …………………………………………… … 66 3.4 Individual lean practices versus business financial performance (P4) …………………………………………………………….… 68 3.4.1 Relationship to simple linear combinations of practices ………… 68 3.4.1.1 Theoretical support …………………………………………….… 68 3.4.1.2 Empirical support …………………………………………… … 69 3.4.2 Relationship between individual practice and performance measures ……………………………………………………….… 70 3.5 Lean operations versus business financial performance (P5) ….…. 71 3.6 Summary ……………………………………………………….…. 72 4 Methods …………………………………………………………… 73 4.0 Methods – objectives ……………………………………………… 73 [...]... ………………………………………………………… Relationship between lean archetypes and operations financial performance …………………………………………… Relationship between individual lean practices and operations financial performance …………………………………………… Relationship between lean archetypes and business financial Performance ……………………………………………………… Relationship between individual lean practices and business financial performance …………………………………………… Relationship. .. the relationship between lean practice and either operations financial performance (L-O) or business financial performance (L-B) Lean practice is tested in two ways for each practice- performance relationship: both as a mutually supportive set of practices and as individual practices Next, the relationship between operations and business financial performance is tested (O-B) This scheme results in the. .. in the sample frame and calculating the difference between the median 5-year performance for the sample firm and that of its matched comparison portfolio The relationships between lean and non -lean firms were compared with respect to operations financial and business financial performance using nonparametric statistics and logistic regression As accounting and financial data is prone to 8 skewness and. .. validity and generalizability Chapter 6 presents conclusions and offers directions for future research into the relationship between lean manufacturing management practices and financial performance 12 CHAPTER 2 LITERATURE REVIEW 2.0 Objectives and Map of Domain This study aims to capture and quantify the relationship between lean manufacturing management practices and financial performance at both the. .. data The study tests several research propositions to systematically analyze the question of whether lean practices affect financial performance These propositions are structured by 5 articulating the problem as a need to understand the dyadic relationships between three ideas: lean practice, operations financial performance, and business financial performance (Figure 1.1) The first to be examined is the. .. positive relationship between lean practices and perceived financial performance Managers who are responsible for, or involved in, implementing lean practices may tend to notice only those performance indicators that affirm their belief An independent source of performance data is required to enhance the validity of these research studies The second problem occurs in accounting and finance studies of the practice- performance. .. study views lean as a synergistic set of mutually supportive and integrated management practices The research confirms and measures the relative composition of the lean practice set by identifying lean and non -lean archetypes within a well-defined sample frame of manufacturing companies Specifically, this research examines whether lean practices as a set, or as individual, specific lean practices as... as subsets of practices often fall short of accounting for significant changes in financial performance 3 The major contribution of this research is to more definitively assess the practiceperformance relationship by using both well-validated practice survey questions (for assessing the actual level of lean implementation) and archival performance data Standard and Poor’s Compustat1 and the Chicago Graduate... Categorization as a lean archetype based on operations financial performance is positively associated with business financial performance Research Frame Business Financial ($) Performance “O-B” Manufacturing Companies Operations Financial ($) Performance “L-B” “L-O” Lean Practices Figure 1.1: Research frame and relationship diagram 1.3 Research Method The approach taken to study the practice- performance problem... related to two levels of sustained financial performance (the operations and the business level) At the operations level, Compustat data is used to assess performance by measuring five-year median asset and employee productivity, gross profit margin, and total cycle time At the business level, return on equity (ROE) and sales growth are measured using Compustat data and stock return performance is . LEAN MANUFACTURING MANAGEMENT: THE RELATIONSHIP BETWEEN PRACTICE AND FIRM LEVEL FINANCIAL PERFORMANCE DISSERTATION Presented in Partial Fulfillment of the Requirements for the Degree. 128 4.4.2 Relationship between individual lean practices and operations financial performance …………………………………………… 128 4.4.3 Relationship between lean archetypes and business financial Performance. 129 4.4.4 Relationship between individual lean practices and business financial performance …………………………………………… 129 4.4.5 Relationship between lean operations and business financial Performance