Operations Strategy

Session 3
Dr. Partha P. Datta Operations Management Group E-mail: ppdatta@iimcal.ac.in

Quality
High Specification, Merc S class Appropriate Specification, Fit for Purpose

What type of operations strategy will you adopt?

Level of product specification (Hard and Soft) Conformance (more headache for operations!)

Capacity: Specialist sites Supply Network: coordination, careful vendor selection, inhouse Improvement & innovation: Knowledge Management, Incremental Technology: Known and Tested

Time
Time to produce Time to clarify exact requirements Queuing Time Time to deliver, transport &/or install What type of operations strategy will you adopt?
Capacity: Surplus, Co-located sites Supply Network: Response-based Supplier Selection, Downstream Inventories Improvement & innovation: Market Focused Process Technology: Flexible and Modular

Flexibility
Product/Service Flexibility Mix Flexibility Volume Flexibility Delivery Flexibility What type of operations strategy will you adopt?
Capacity: Surplus & Multipurpose sites Supply Network: A wide network of Supplier with wide range of capability Improvement & innovation: Network based Process Technology: Flexible and Small Scale

Cost
Operating Expenditure Capital Expenditure Working Capital What type of operations strategy will you adopt?

Capacity: Balanced/deficit, Few large sites Supply Network: Cost Reduction Supply Contracts, Low Inventory, Improvement & innovation: Lean Techniques, Six-sigma Process Technology: High Automation, Large Scale Technology

The operations strategy matrix

Resource usage
Quality Performance objectives Time Operations strategy Market competitiveness Improvement & Innovation

Flexibility
Cost Capacity Supply network Process technology

Decision areas

7-Eleven Japan

Largest retailer in Japan

Sells 1.5X as much per store as nearest rival

History of cautious expansion and technical and service innovation

Field Counsellors spread operations knowledge (also do distance training)

Expansion by territory to reduce disn costs

Early use of TIS (total information system) TIS controls stock replenishment twice a day delivery (sales analysed twice a day)

New system not internet-based

New services include, Banking terminals Downloading games

Downloading music to MD
Internet ordering and collection

RESOURCE DEVELOPMENT Distribution centre grouping by temperature Distribution centres and inventory management systems give fast stock replenishment TIS allows trends tobe forecast and supply adjustments made TIS gives comprehensive and sophisticated analysis of sales & supply patterns daily Field counsellors with sales data help stores to minimise waste and increase sales Information sharing and parenting system spreads service ideas

QUALITY of products and services RESPONSE TIME to give availability

FLEXIBILITY of response to sales and customer trends

COST in terms of minimising operating cost capital cost working capital

Area dominance Common distribution centers give small reduces distribution and advertising frequent deliveries from fewer sources costs

Location of
7-11 JAPAN Pivotal Critical Secondary
CAPACITY

Number and type of The Total

distribution centres Order and stock replenishment Information System (TIS)

Franchisee
relationships New product/service development Approach to operations improvement INNOVATION & IMPROVEMENT

Size of stores

stores

SUPPLY NETWORKS

PROCESS TECHNOLOGY

Market Competitiveness

Customer Utility, trade-offs & market segmentation

Any product/service characterised by attribute bundle Each customer possesses a utility function Customer trade-offs and iso-utility/indifference curves
high

Customer Trade-offs
BJG
Private jet owner

Customization

U2 U1

low

Commuter airline

C&D Aerospace
low

high

Total Cost of Ownership

Properties of Operational Trade-offs

BJG
high
high

Customer Trade-offs

Operational Trade-offs
BJG
Custom design Job shop process

Customization

Private jet owner

Process Flexibility

low

high

Total Cost of Ownership

low

low

Commuter airline

C&D Aerospace

Standard design Flow shop process

C&D Aerospace

high

Unit Cost

low

Trade-off Principle: Operational competencies are governed by trade-offs that result from the specific operational system of resources and processes. Operational trade-offs provide competitive protection

Operations Triangle

Examples
Managing a hamburger joint in a university campus Making a decision to buy the first and only X-ray machine for a small hospital Managing an amusement park deciding on the capacity of rides

Improvement and the Efficient Frontier

100 90 80 Product Selection N 70 60 50 40 30 20 10 Last years position $1.10 $1.08 $1.06 $1.04 Unit Cost c (inverted) $1.02 $1.00

Improvement creates options to increase differentiation or cost-efficiency The frontier is the outer envelope of all competency trade-off curves Equivalent graphical representation of trade-offs Changing the value proposition: strategy effects, planning (sourcing & utilization) effects Operational Efficiency (OE)? How to estimate the frontier?
100

operational improvement
Product Selection N

90 80 70 60 50 40 30 20 10 1 $1.12 $1.10

Firm 3 Firm 4
Set of not-attainable competencies at this time

DcOE
Efficient frontier

New options for this year

Firm 2

1 $1.12

Firm 1
$1.08 $1.06 $1.04 Unit Cost c (inverted) $1.02 $1.00 $0.98 $0.96

Productivity v. Operational Efficiency

Productivity measures the efficiency of transforming inputs into outputs over a given time period (monthly, quarterly, annual) Productivity = (Units of output)/(Units of Inputs during a period)
But:
1. 2. 3. 4. Measurement is problematic Does not correct for strategic differentiation Leads to a cost-minimization focus Is a relative measure and maximizing productivity typically does not maximize value

We will use OE and NPV instead of productivity

How improve operational efficiency? The concept of focus in operations

Focus is a joint property of the process and of how we choose to utilize it. Focus principle: A focused operation is more likely to have a competitive advantage by being near the frontier.
Non-cost competency X Non-cost competency X

A focused process has a consistent operating point on its trade-off curve

The operating points of an unfocused process are scattered over a large region on its trade-off curve

High

Unit Cost c

Low

High

Unit Cost c

Low

How to focus an operation: Tailored divide and conquer

Competency Space

1.

Partition products and services into groups with homogeneous competency needs. (The example to the right has 3 groups.) Consider product-line rationalization.

Quality

Cost efficiency

2.

For each group, separate those resources and processes that critically support its value proposition while sharing the others. (e.g., EPSON, Michelin) Create a charter for each operation to retain focus over time.

Degree of focus of operational system

3.

One single system shared by three groups

tailored degree of focus

Three separate systems, each one focused on one group

Analyzing a competitive threat: Differentiation strategy v. Low cost position

High

us Non-cost competency X

DX

DC

rival
Low

Low High

Unit Cost c

Q: What is the efficient frontier, and how derive it?

 Consider two hypothetical examples:

Differentiation X vs. Low Cost C Strategy: Measuring operational efficiency OE

Break-up DC into a strategy component DCS and an inefficient component DCOE
Differentiation X

Differentiation X

us

us

frontier
DX DX

DC

rival

DC

rival

Hi

Price/Cost

Lo

Hi

Price/Cost

Lo

Valuing X vs. C Strategy: Given processes and practices (@ designed volume) yield trade-off curves
Differentiation X

us
DCv, us DX DC Hi DCv,rival

rival
Lo

Cost

Valuing X vs. C Strategy: Breaking up DC into volume, strategic and OE component using trade-off curves
Differentiation X

DCOE

DCS
rivals position if it were to enter our core market

us
DCv, us DX DC
Hi

DCv,rival
Cost

rival
Lo

DC = DCOE + DCS + DCv,us - DCv, rival

Q: What happens if DCOE is positive?

Three definitions
DCV is the volume-(or utilization) driven cost differential
These are the extra costs incurred by operating at less than the strategicallytargeted utilization level because of spreading a fixed cost over fewer units Why have this?

DCS is the competitive strategy-driven cost differential

This is the cost difference inherent in the way each company chooses to compete. We would expect that a strategy emphasizing product innovation and customer responsiveness is more costly than a pure low cost strategy

DCOE is the operational efficiency-driven cost differential

This is the remainder of the cost differential after controlling for volume and strategy. It measures how one company is just more efficient in their operations and management than another, even if both were to run at their desired utilizations and to provide identical value proposition.

Competitive intelligence gathering

Manufacturing leaders claim they focus on being cost competitive more than they focus on any other priority
Tasks for Manufacturing Leaders Percentage of Survey Respondents stating High, Medium, Low Priority or N/A

How to be cost competitive

91%

5% 4%

How to deal proactively with safety/quality issues What type of measurement system to use to track performance

84%

12%

2%2%

67%

26%

2% 5%

How to motivate the work force

63%

19%

14%

4%

How to implement TPS, Six Sigma, TQM, etc.

42%

44%

14%

The geographical network of plants

40%

28%

30%

2%

Vertical integration (in-house manufacture vs. outsource)

0%

16%

49%

30%

5%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Note: 40 percent of the interviewees proposed additional tasks Source: Booz Allen Hamilton/IPSOS-MORI survey of manufacturing leaders

but they actually know little about competitors costs

You understand very well your own detailed cost structure and those of your competitors You know your own manufacturing cost structure well, but are unclear about those of key competitors You understand some aspects of your manufacturing cost structure, and little of those of your key competitors You arent concerned by your cost structure or those of competitors; others follow that within your company
0%
Source: Booz Allen Hamilton/IPSOS-MORI survey of manufacturing leaders

33%

56%

8%

3%

Percentage Who Responded Yes to each statement

60%

and when making decisions, they typically dont leverage competitive information as much as they could.
Company financial targets translated into expected contributions Detailed studies of the operations
70%

67%

Comparisons of plants internally Comparisons with competitors or players in other industries

0%
Source: Booz Allen Hamilton/IPSOS-MORI survey of manufacturing leaders

51%

33%

Percentage Who Responded Yes to each statement

80%

Operations Strategy to improve CA

Study your own as well as your rivals trade-off curve Strengthen own competitive position Anticipate customer dynamics and strategic inflection points
FIGHT ADAPT/ADOPT RETREAT Opportunity to rise or beginning of the end

Be careful with cost and productivity numbers

Sugar & Spice

Cupcake Wars

Introduction to competitive benchmarking

Key questions: What is the competitive threat/opportunity for Sugar & Spice compared to Sprinkles?
Should Sugar & Spice continue to focus on custom cupcakes?
custom madeto-order
(wedding , celebrities, events)

Or should Sugar & Spice try to sell more standard cupcakes?

standard

Introduction to competitive benchmarking

In order to analyze this, we will look at operational competitive benchmarking
What are the strategic differences between Sugar & Spice and Sprinkles?

Differences related to strategic choices and competitive position Example question: making larger size cupcakes than your competitor?

What are the operational differences?

Differences directly related to the operational assets and strategy Example question: leasing an industrial kitchen vs. a store in Beverly Hills?

How to compare operations?

Our operational benchmarking will compare:
Variable Costs: What is the difference in the variable costs for an order of 4 dozen cupcakes? 1. Ingredients 2. Decorations 3. Labor 4. Packaging Fixed Costs: What is the difference in the variable costs for an order of 4 dozen cupcakes? 1. Rent & Utilities 2. Fixed Salaries

Calculate the $cost differences between Sprinkles and Sugar & Spice Determine whether they are strategic or operational Our unit of comparison is one order of 4 dozen cupcakes Custom vs. standard

The analysis is only as good as the research and assumptions

Our analysis is based on research and assumptions

Both Sugar & Spice and Sprinkles are private companies

This is like real lifethe information is not always clean

Sugar and Spice is a small company operating out of home Have to dig for information on competitors

Have to use judgment and intuition Your competitors wont put together nice case exhibits for you

Analysis will focus on the key areas where there are differences

Sugar & Spice is not at scale today

Sugar & Spice Financial Performance
Gross Margin
$8,000

Fixed Costs

$6,000

$4,000

Rent and Utilities $3000 / month

$2,000

$0
Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10

Sugar & Spice is not at scale today

Our first adjustment is on volume: assume that Sugar & Spice will operate at planned scale
Today Sugar & Spice is not at scale
Current production:138 dozen / month Sugar & Spice is inside the operational frontier Fixed cost allocation is very high

For this analysis, we assume that Sugar & Spice can hit scale
Efficient scale is
~400 dozen/month for high customized cupcakes This information was owners best assumption of her capacity

highly customized
pictures, flavors, display made to order

$175 $280
cost at scale current cost not at scale

Customization
standard flavors
not made to order

Sugar & Spice is not at scale and is inside the operations frontier -High fixed cost allocation -Not even covering rent

Sugar & Spice needs to increase to ~400 dozen / month to operate at scale 3x her current sales For the rest of the analysis, we will assume she is at scale

Hi

Cost

Lo

Summary of Competitive Cost Analysis

Sugar & Spice (at scale) Sprinkles (standard) Sprinkles (custom) Total Difference Strategic Difference Operational Difference

4 dozen custom cupcakes Variable Costs 1. Ingredients 2. Decorations 3. Hourly Labor 4. Packaging Fixed Costs 1. Rent & Utilities 2. Fixed salaries Total cost
$30.00 $50.00 $174.69 $33.33 $19.44 $93.88 $71.43 $41.67 $212.33 ($3.33) $30.56 $80.81 $38.10 $22.23 $118.45 ($41.43) $8.33 ($37.64) $27.60 $28.80 $35.53 $2.76 $31.81 $0 $7.3 $2.00 $39.33 $28.80 $29.10 $2.00 ($4.21) $28.80 $28.23 $0.76 $7.52 $28.80 $21.80 $0.00 ($11.73) $0.00 $6.43 $0.76

Highly customized made-to-order

highly customized
pictures, flavors, display made to order

(wedding , celebrities, events)

$212

$175

Customization

operational difference:

$37.63

$94

Variety of flavors
(purchased in store)

If Sprinkles tried to compete in Sugar & Spice space, it might face higher operational costs due to its high fixed costs
- Cant produce enough cupcakes to offset fixed costs - Store front in Beverly Hills with salaried managers

standard flavors
not made to order

Hi

Cost

Lo

Sprinkles compared to Sugar & Spice for highly customized cupcakes

$38

$60

$22 $29 $8

$212 $175

$94

Sparkles standard custom ingredients

decorations

additional labor

delevering of fixed Sparkles custom costs (due to lower volume)

Operational differences

S&S Custom

What does this mean?

1. 2.

Sugar & Spice has an operational advantage in making custom cupcakes Sprinkles fixed costs are too high to play in a low volume game
Need high production volume to leverage fixed costs Capacity constrained because it takes so much longer to make custom cupcakes

3.

Sugar & Spice should likely continue to focus on custom cupcakesbut they will need to drive enough demand to operate at scale