Operations Management:

Process Analysis and Applications Module

Changing Sources of Competitive Advantage Operational Measures: Time T, Inventory I, Throughput rate R
Link through Littles Law Link to Financial Measures Levers for Improvement CRU Computer Rentals

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How can operations help a company compete? The changing sources of competitive advantage
Low Cost & Scale Economies (< 1960s) You can have any color you want as long as it is black Focused Factories (mid 1960s) Flexible Factories and Product variety (1970s) A car for every taste and purse. Quality (1980s) Quality is free. Time (late 1980s-1990s) We love your product but where is it? Dont sell what you produce. Produce what sells.
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Operational Performance Measures

Flow time Throughput Inventory Process Cost Quality

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The business imperative: creating economic value

Improvement levers Revenues Price x Quantity Material + Labor + Energy + Overhead 1. 2. Increase price Increase throughput

Profit

Costs Economic value added (EVA) -

3. 4.

Reduce costs Improve quality

Capital invested Opportunity cost x Weighted average cost of capital

PP&E + Inventory + Other

5. 6.

Reduce capital intensity Reduce inventory

Reduce time
Operational metrics 4

Financial metrics S. Chopra/Process Flows

Relating operational measures (flow time T, throughput R & inventory I) with Littles Law
Inventory I Flow rate/Throughput R

...

... ...

[units]

... ...

[units/hr]

Flow Time T [hrs]

Inventory = Throughput x Flow Time I = RxT Turnover = Throughput / Inventory = 1/ T

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Process Flow Examples

Customer Flow: Taco Bell processes on average 1,500 customers per day (15 hours). On average there are 75 customers in the restaurant (waiting to place the order, waiting for the order to arrive, eating etc.). How long does an average customer spend at Taco Bell and what is the average customer turnover? Job Flow: The Travelers Insurance Company processes 10,000 claims per year. The average processing time is 3 weeks. Assuming 50 weeks in a year, what is the average number of claims in process. Material Flow: Wendys processes an average of 5,000 lb. of hamburgers per week. The typical inventory of raw meat is 2,500 lb. What is the average hamburgers cycle time and Wendys turnover? S. Chopra/Process Flows 6

Process Flow Examples

Cash Flow: Motorola sells $300 million worth of cellular equipment per year. The average accounts receivable in the cellular group is $45 million. What is the average billing to collection process cycle time?
Question: A general manager at Baxter states that her inventory turns three times a year. She also states that everything that Baxter buys gets processed and leaves the docks within six weeks. Are these statements consistent?

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MBPF Inc.: Consolidated Statement

Net Sales Costs and expenses Cost of Goods Sold Selling, general and administrative expenses Interest expense Depreciation Other (income) expenses TOTAL COSTS AND EXPENSES INCOME BEFORE INCOME TAXES PROVISION FOR INCOME TAXES NET INCOME RETAINED EARNINGS, BEGINNING OF YEAR LESS CASH DIVIDENDS DECLARED RETAINED EARNINGS AT END OF YEAR NET INCOME PER COMMON SHARE DIVIDEND PER COMMON SHARE 250.0 175.8 47.2 4.0 5.6 2.1 234.7 15.3 7.0 8.3 31.0 2.1 37.2 0.83 0.21

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MBPF Inc.: Balance Sheet

CURRENT ASSETS Cash Short-term investments at cost (approximate mkt.) Receivables, less allowances of $0.7 mil Inventories Other current assets TOTAL CURRENT ASSETS PROPERTY, PLANT AND EQUIPMENT (at cost) Land Buildings Machinery and equipment Construction in progress Subtotal Less accumulated depreciation NET PROPERTY, PLANT AND EQUIPMENT Investments Prepaid expenses and other deferred charges Other assets TOTAL ASSETS S. Chopra/Process Flows 2.1 3.0 27.9 50.6 4.1 87.7

2.1 15.3 50.1 6.7 74.2 25.0 49.2 4.1 1.9 4.0 146.9
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MBPF Inc.: Inventory and Cost of Goods

INVENTORY Raw materials (roof) Fabrication WIP (roof) Purchased parts (base) Assembly WIP Finished goods TOTAL COST OF GOODS SOLD Raw materials Fabrication (L&OH) Purchased parts Assembly(L&OH) TOTAL 6.5 15.1 8.6 10.6 9.8 50.6

50.1 60.2 40.2 25.3 175.8

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MBPF Business Process Flows

$60.2/yr $25.3/yr

$50.1/yr

$6.5
Raw Materials (roofs)

$15.1
Fabrication (roofs)

$110.3/yr

$10.6
Assembly

$175.8/yr

$9.8

$175.8/yr

$40.2/yr

$8.6
Purchased Parts (bases)

Finished Goods

$40.2/yr

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MBPF Inc.: Flow Times

Raw Materials Throughput R $/Year $/Week Inventory I ($) Flow Time T = I/R (weeks) 50.1 0.96 6.5 6.75

Fabrication

Purchased Parts 40.2 0.77 8.6 11.12

Assembly

Finished Goods 175.8 3.38 9.8 2.90

110.3 2.12 15.1 7.12

175.8 3.38 10.6 3.14

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Flow rate R ($/week)

5.0

3.38

Accounts Receivable
Assembly

2.12 0.96 0.77 Purchased Parts 11.12

Raw Materials Fabrication

Finished Goods

6.75

7.12

3.14

2.90

5.80
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Flow Time T (weeks)

Why the Difference in Performance?

Inventory Over Last 8 Quarters (Ending Q3 2001)
6000

5000

4000

Inventory

3000

Nokia Ericsson Motorola

2000

1000

0 0 1 2 3 4 5 6 7 8 9

Quarter

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CRU Computer Rentals

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Case: CRU Computer Rentals Flow Chart

Status 40

Ship

Receiving
70% Status 24

30%

Repairs
15%

Customer

Pre-Config

Status 41

Parts places order Receives from Supplier

Status 32

Ship

Config
Status Flows S. Chopra/Process20

Repairs
Status 42
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CRU Situation in Previous Year:

Customer term = 8 wks, Demand = 1000 units/wk
Customer Receiving Status 24 Status Parts Suppliers 40 Status 41 Status 42 Status 20

Throughput 1,000 (units/week)

1,000

700

300 + 105 = 405 1,000

405

405

405

405

1,000

Inventory (units)

8,000

500

1,500

500

405

500+405 = 905

500

2,000

Flow Time (weeks)

8.0

0.5

2.14

2.47

1.23

2.23

1.23

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Number of units on rent = 8,000 Total number of units = 14,405 Utilization = 0.56 (56%) Revenue rate = 8,000 x 30 = $240,000/wk Variable Cost rate = 25 x 1,000 (R) + 25 x 1,000 (S) + 4x700x.85 + 150 x 405 = $113,130/wk Contribution Margin = $126,870/wk Depreciation = 14,405 x ($1000/156wks) = $92,340/wk
bottomline = $126,870-$92,340 = $34,530

CRU Situation in Previous Year: Financial Performance

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CRU Situation in Current Year:

flow times unchanged, Demand = 1400 units/wk
Customer Receiving Status 24 Status Parts Suppliers 40 Status 41 Status 42 Status 20

Throughput 1,400 (units/week)

1,400

980

567

567

567

567

567

1,400

Inventory (units)

8,000

700

2,100

1,400

700

567

1,267

700

2,800

Flow Time (weeks)

5.7

0.5

2.14

2.47

1.23

2.23

1.23

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CRU Situation in Current Year:

flow times unchanged, Demand = 1400 units/wk
Number of units on rent = 8,000 Total number of units = 16,967 Utilization = 0.47 (47%) Revenue = 4,800 x 30 + 3,200 x 35 = $256,000/wk Cost = 25 x 1,400 (R) + 25 x 1,400 (S) + 4 x 980x .85 + 150 x 567 = $158,382/wk Contribution Margin = $97,618/wk Depreciation = 16,967 x (1000/156) = $108,763/wk
bottomline = $97,618 - $108,763 = -$11,145

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CRU Potential situation in Current Year:

without sales drive, Demand = 600 units/wk
Customer Receiving Status 24 Status 40 Parts Suppliers Status 41 Status 42 Status 20

Throughput (units/week)

600

600

420

243

243

243

243

243

600

Inventory (units)

4,800

300

900

600

300

243

543

300

1,200

Flow Time (weeks)

0.5

2.14

2.47

1.23

2.23

1.23

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CRU Potential situation in Current Year:

Number of units on rent = 4,800 Total number of units = 8,643 Utilization = 0.56 (56%) Revenue = 4,800 x 30 = $144,000/wk Cost = 25 x 600 (R) + 25 x 600 (S) + 4x420x .85 + 150 x 243 = $67,878/wk Contribution Margin = $76,122/wk Depreciation = 8,643 x (1000/156) = $55,404/wk
bottomline = $76,122 - $55,404 = $20,718

without sales drive, Demand = 600 units/wk

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Learning Objectives Basic Process Analysis

Process Measures: time, inventory, and throughput What is an improvement?
Link financial measures to operational ones Good operational measures are leading indicators of financial performance

Using Littles law for process flow analysis Targeting areas and performance measures for improvement; link financial and operational flows

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