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1.

Operations Management

meeting
Z,Inc.
Z, Inc. is a multinational conglomerate wrhich is primarily a produc -

er of h earne-duty c onstruction e q u ipment, li ke ea r th m o v e rs,


graders, and haulers. Their headquarters is in Jackson, Alichigan,
and one of t h eir m a n u f actur ing f acilities at t hi s l o cation p r o d u ces

transmissians. Although transmission production is somewhat outside of their core com petency, the p lant has been successful for Z ,
Inc. in the past. This production facility divaspart of their diversifica-

tion program where they

attemp
ted

to make sure they had supporting industries outside af t h eir c ore co m p etency that ca ul d p r o t ect
their cash-flaav.

Transmission production is extremely labor intensive, resulting in


a value-added labor c on t r i b u t i on of a b o ut 2 0 p e r c ent. La bor ra tes

in the Jackson, Alichigan area were some of the highest in the nation, primarily because of the large union inAuence in the area. The
plant was about 30 years old and a )ot of the equipmentwas out of
d ate. This caused the labor intensity to be even higher than nor m al .
An updated plant w o ul d i n c rease automation and t h erefore, it divas
believed, would i n c rease quality and r e duce lead ti me. An u p d a ted
plant could b e d o n e i n se veral wais, either by i m p r o v i ng t he a u tomation in t h e existing facility, r b y c o m p l etely replacing the fa -

cility. Either way, Z, Inc. anticipated resistancefrom the union because there xvould be a reduction in t he cur rent v;ork force due ta
the automation. At a bo ard me eting of the Z co m p a n y, the falloiving conversation took place:
Baard M e m b er ZA (c o m m e n ts are being d irected at t he C E O ) :

"The transmission facility is again shavving a ha]f-million dollar lass


for the month. The PAL (P r ofit a nd L o s s) report for the plant
sllo% rs:

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Sales
Labor Expense

5 9,500,000
I 2,000,000

M a t erials Expense

I 4e000,000

Eq uipment Expense
Overhead Expense

$1,000,000
S 3,000,000.

XVe're loosing ground with t his plant."

Board %member ZB. "I agree.'5'e need a recommendation on hoav


to handle the transmission business. Are ive outside of our expertise? Or, is there a svay to turn this facility profitable again?"

The C E O

w a s l e f t w i t h t h e t a s k o f o r g anizing a re c om-

mendation.' Before we look too closely at the Z, Inc.'s problem, let' s


review some of the basics of operations

management. The purpose

of this review is to standardize on terminology, svhich can often be


quite inconsistent throughout the operations

management industry.

Some Basic Operations Management


Terminology and Concepts
There are three levels of management:
Strategic h,1anagement
Tactical Management
Op e r a tional A lanagement.

Strategic management focuseson planning and developing the business as a svhole. Typical Iob t i t l es include the B o ard of D i r e c t o rs

I. As p a rt of t he d i s cussion thr o u g h o ut t h i s chapter and t he rest of the boo k, tvc

will take further visits into the CEO's conversations and his analysis process.
At thc same time, you (thc reader) arc invited to formulate your oNn opinions and recommendations on how Z, Inc.'s transmission production should
be handled. Th>s case and many others in this book arc based on actual expcricnccs that th c a u t ho r v e n t t h r o u g h i n h i s 20 + y e ars of o p erations m an age-

ment Ide has, hnivcver, changed th names of the company and the p~~plc.
and has simplified the numbers, in order to protect the misguided. Tbc actions that are taken in these cases arc not to bc c o n s idered the " r i g ht a ns Ncr"

or "correct solution." I h csc actions arc onc of many options and thcsc options v ill be considered as altcrnativcs throughout thc book.

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SOJJLL'.B<7$lC O JiCMtlOHS a'iyJCi)h2gC]IJL')l f ..

and the CE O . Ta ctical ma nagement is t he m i d d l e m a n a gement of

an organization and focuses on the month-to-month company performance. Typical job t i t l es i n c l u de V i ce P r e sident a nd D i r e c t o r .

Operations h,management is organizationally at the bottom end of


the management heap. But this is the most critical management function since i t i s t h e p e r f o r m a nce of th e op e rations m a n agement
function t hat xvill m ak e th e o r ganization a su ccess. This book xvill
focus on the performance of the operations management func
t ion
a nd how this perform ance is effected by in t ernationalization. H o w ever, a lot of ivhat happens at the operations level is effected by decisions at the strategic and tactical levels. The process of how these

decisions interrelate ivill be included in Chapters 3 and 4.


There are three primary fun ctions of a business:

Fi nancial
Ai arketing
Op e r a tional.

The financial function analyzes the financial nability of the business. The m ar keting fu n c t ion a t t em pt s t o

i d e n t ify m a r k ets for t h e

goods and services produced by the business. The operational function:

Id e n t i f ies material sources


Identifies internal and external production sources
Evaluates capacities
Aianages an o r g anizations resources in o r d e r t o p r o d u c e p r o ducts that ivill s atish th e de m a n ds g enerated by th e m a r k e ting
function
J uggles the accessibility of r e sources ivithin th e l i m i t s o f t h e f i nancial constraints
Produces, packages, or adopts products using these resources

Evaluates the quality of the product and hovv favell it satisfiesthe


customer

Appanages the storage and distribution of the products produced.


Traditional m anagement th i n k in g suggests that these three organizations are in contlict svith each other and that this conilict creates a
synergistic balancing effect ivithin an o r g anization t h r o ugh the us e

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of trade-o8's.%'orld Class A?anagement wisdom suggests that there


is more positive synergy to be gained by focusing these organizations on a co m m o n g o a l. The refore, the critical part of t he p r o c ess
is to identify ivhat that goal should be. Chapter 3 will f oc us on a discussion of goat-setting and discusses hoav critical these goah are to
the over-all successful p
of the in t e rnational o r g aniza-

erformance

tion

Once again sve see that this book fo cuses on the operations management function and takes a look at how this function is effected
when globalization occurs svithin the business. Globalization can refer to:
International sourcing of products
International production of the goods and.'or services
In t e r n a tional transportation of the products
International markets for the products produced.

%'ithin the operations rnanagernent framework we see that there are


numerous types of i n d u stries. Each of th e se industries have differing requirements for successful performance. For example, we see:

%'holesaling This process includes an extensive purchasing and


inventory management function. Packaging and shipping may
also be a large piece of operations management. Examples inclu-

de the major shippersand resellers throughout the vvorld like Hyundai of Korea.
Lo g i s tics This process involves routing m a nagement and l o c a -

tion tracking of products and

or example,%'al
equipment. F

iliart
considers the l o gistics fun ction to b e t h e ir co m p e titive edge in
by always having what the customer wants available
when the customer wants it. Th e airlines industry, as in the case

performanc
e

of British A i r w ays or L u f t h a nsa, schedules not j u s t p a ssengers,


but also crew rs, meals, luggage, equipment maintenance, preven-

tive maintenance, ground support, airport schedules, etc... and is


an extremely
of the logistics process xvhich ivill
be discussed in more detail in Chapter 9.

comple
xexample

Re t a iling ll s is r e q u i r es a p u r chasing and i n v e nto ry r n a nage-

rnent function, but may also inctude a production

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management

Sor~<e Basic Opera(ios;M ange~et


process as in the example of fast food. Excellent international ex-

amples include McDonalds and Toyota.


Se r v ice The management of projects like the implementation of
computer systems or c o n sulting p r o jects requires project m an a-

gement expertise. Examples include the major international, consulting terms like AiliS (American Aianagement Systems).

Co n s t ru c t ion This r e q u i re s e x t ensive p r o j ec t m a n a gement


tools.

Process ilianufacturing Process

manufac
turing is ivhere units

produced are no t d i s crete, such as Aoure oil, paper, fabric, etc.

These processes tend to be machine intensive and require minute-by-minute scheduling.


D epartmentalized D i screte M a n u f actur ing This factory b u i l d s
a discrete product like a car or a TV set.The layout of the factory
is by departments, focusing on the specialization of labor in each
department. For example, you could have a grinding department,
a lathe department, an assembly department, etc. Ai at erials are
moved from d e p artm ent t o d e p ar tm ent in t h eir p r ocess of being

converted to a fmished good (see Chart 1.1). Automobile manufacturers l ik e

F o r d o r D a i m l e r C h r y sler or h e a r i ng a i d m a n u -

facturers like Siemens are excellent examples.

Chart 1. 1.Departn)uttara Diserc.'fei'l IslMfocf Mri]ig

Dept.

Dept D

Dept. 8

Dept. C

Dept. E

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Dept. I-

Job Shop This is a discrete manufacturing facility that produces


customized products. The layout i s similar to C h a rt l . l , b u t t h e
flow of p r o d u ct c an v a ry d r a m a t ically fr om on e p r o d u ct t o t h e

nest. Custom product shops like airplane manufacturers Airbus


or Boeing, or shipbuilders make excellent examples.
Fl ow Discrete A1anufacturing This factory focuses on the continuous movement of m a t e rials through t he f a cility. The focus is
on t he m i n i m i z ation o f m a t e r i a ls ivithin t h e o r g a nization s i nc e
materials are considered to b e t h e c r i t i cal h i gh-cost resource in

this repetitive process. The assembly line or the Japanese JIT gust-in-Time) production process are examples of this tiptoe of ma-

nufacturing environment (See Chart 1.2). Toyota manufacturing


is the master of this process and another excellent example is the
Saturn facility in the L'nited States.
E ach of t h ese different o p erations environments requires it's ow n
specific set of t o o ls, as >veil as some c o mmon t o o ls, like inventory
management. In Ch a p t er 5 ive will be d iscussing some of the alternative planning and co n t ro l m e chanisms, as well as a v ariety of i n formation systems. These often vary dramatically in an international
e nvil oll m e n t .

Chart J.2. Hotv Discrete.'lfanit facturittp

Process A

Process ('

Plocess 8

Proc e ss E

Process D

The manufacturing i operations cycle is a flow system and like all


systems, it co n t ains the basic com p onents of I n p u t , P r o cess, Output, and Feedback. In evaluating the operations cycle, as in all systems, the key point of evaluation is the output, making sure that we
satisfy the informa tion needs of the operational process. This evaluation is followed by a close look at the input elements which assures

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A Littd History
u s that the necessary data f' tools are available to create the output .
Last of all, ive look at th e p r o cess tool wh ich can take a variety of

forms (see Chart 1.3 and Chapter 5). This basic flow systemsrnodel will be followed throughout this book ~vhen planning options
are discussed. The key to selecting and developing a successful operations management system is i n m a k in g sure the r esults (outpu t )
satisg th e go a ls. That is w hy w e v i ll s p e n d t h e n e xt f eav chapters

discussing goal and systems planning options.


Chart I. 3'. The Production.'Openrlions Aoeesstng Cycle

Process

Illpllts

Change

Oulpllts

Conllot

Feedback

A Little History
As mentioned earlier, operations management goes back to the beginning of m an. H o w ever, looking into the m ore recent past, say 50
years, we find that the m ost dr amatic changes have taken place during these feiv years of history. There are several reasons for these

changes. The first seems to be wor l d %'ar II. Prior to%'O' II t h e


operations methodologies were primarily manual. Tools like EOQ
(Economic Order Quantity), LP (Linear Programming}, and the 2Bin system were considered to b e " s t a te of th e ar t " . S h o r t ly a f t e r

%'orld%''ar II the computer became available, which created computationally over-burdened systems like 6 iRP and PERT,'CP ili (Project Evaluation and Review Technique /' Critical Path AIethodology)
feasible. Also, after this war, the Japanese >vere going through a reconstruction of their i n d u s try in a co u n t ry t h at h ad no n a t u r al re -

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10
sources, min i mal c ash fl ow, and lo ts of p e o p l e. In o r d e r to g r o w
their industry, they had to b r in g m aterials into the country, convert
them to end p r o d u c ts as quickly as possible, and ship t h e m. Th e y

didn't care how many people it took because there was a plentiful
a vork force. Thi s m a t erials efficiency f o cused strategy became t h e
roots of ivhat is nosv knows' throughout t he xvorld a s Just-in-Ti m e

{JIT).
ll.eanwhile, during the same time as Japan's reconstruction and
t he introduction o f c o m p u t ers, Israel was becomin g a ne w n a t i o n
and a lso needed to d e v e lop n ew i n d u s t r ies. Rather t h an c o p y i n g
Europe or the L'SA t hey took advantage of their plentiful supply of

PhDs and decided to develop their own production methodology.


The result was the Optomizied Production Technology (OPT) (
Theory of Constraints {TOC} philosophy which p romotedthe idea
that production e K c i ency was achieved through the successful management of some operational ""bottleneck" xvithin the organization.
From Ch a rt 1 .4 we s ee the historical development of n u m e r o u s

operational methodologies. XVe end up with pre%'orld IVar II operations scheduling systems that had the following focus:
EOQ Economic Order Quantity (EOQ) is a planning system
focused on ma n a ging i n v e ntory l e vels. EOQ i s t h e m o s t c o m -

monly used production planning philosophy because of it's simplicity and minimal data
LP Linear Programming is an optimi
zation process that facilitates optimal
routings and loadings and minimizes costs. This can

requireme
nts.

b e expanded t h r o ugh t h e u s e o f I n t e ger P r o gram m in g ( I P ) o r


Geometric Programm ing (G P) in more c o m p l ez situations.

2-Bin This system is a simplistic volume based replenishment


v;hich requires no sophistication or automation but generally creates a lot of inventory.
These are systems that are still very much in use today, and so their
timelines continue through to the year 2000 and beyond. Ho w e ver,

afterworld'War II, sve had several events that would initiate the reinvention of PO M

m e t h.odologies. Theseivere:

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h 5'llcl]al Iet.tluirf'tasti I ' l .tttiL. (~)I(I' t


I e t .ltniquL t I'J-.R I t

(( I'x1 t

I'rolccl I;t itluatton ad Rt..i teii


( t ltlcBI I util l' I c l l l o i l o l o < yl/
Jux't-ttl- I ttll&'. (.ll I )

()ptlrnt/ /'c8 f rt.'t<Iuctll'fit )c h c i JLtfttl<y If()I


I ht.'ot''tr' ol ( o v trhlt11< ( I'(.|(

I)iit r i h utio R<..quit cn>t..nti I'I;tniL<, ( f)ICI'I

.sfattl;it'till tltL<,kc~ourcci I ' I ' r A l ta<' I ~f fC I' l l I

13ottlci.il' A IJ<x.attott Xfi.thoifoloL<v (H.'iM).


;yi.'heiJuf<.' f8'ti<.'iJ %1;tttut'a<.'turin <. (Nf&'I I

R. . i u r

. I' I a n i tt t f - I <',I' t

I- tlltlc (. Qpactl' f' .yt' llcdtl l l l\<y t I-(. J )

I t rp tt.

The advent of

t h e c o m p u ter wh i ch al l osved computationally i n -

tense systems like MRP and PERT / CPM to operate.


Th e r e c o n struction o f J a p an i v h i ch f o c u s ed on s y s tems w h e r e
materials movement di vasmore i m p o r t a nt t h a n la b or ef f iciency

generating systems like JIT.


Th e d e velopment of the nation of is rael ivhere the efficient use of
a p riority g e nerating systems like O PT a n d

machinery became

TOC.

The result divasthe creation of t h r ee major categories of new P O M

methodologies, A1RP, JIT, and TOC.


MRP Material Requirements Planning (iliRP) is a production
scheduling tool for an environment that has intermittent and,'or
irregular schedules. The ef ficiency f o cus for

il i R P is t o h a v e a

p erfectly balanced factory, ivhich m ost o f ten m e ans that all d e -

partrnents are equally balanced in their work-load of labor hours.


This system is the most data-intensive and has the toughest data
accuracy requ irements. Th e d i s t r i b u t i o n management. counter-

part to iltRP is Distribution Requirements Planning (DRP).


PERT / C P M Pr o j ect E v a luation a nd R e v iew Technique
(PERT) .' Critical Path A1ethodology I'CPh1'., are project planning
tools used in industries like construction .
JIT Just-in-Ti me @IT) f o c uses on the efficient uti lization of the

materials resource through the elimination of all inventory waste.


JIT i s ge n e rally used in hi g h l y re p e titive manufacturing p r o cesses.

O PT ! T O C Optimized Production Technology (OPT) J'Theory of C o n s t raints (T O C ) f o c u s o n t h e e f f i c ient u t i l i z ation a n d


maximization of the bottleneck svhich is generally a specific piece

of machinery svithin the facility.


As time tvent on, inflation v,ould encourage%'estern interest in some
o f the Eastern techniques like JI I. This occurred because the M R P

labor focused environments generally had high inventory levels, and


the carrying costs an these high inventories could quickly make a
company non-competitive. Shortly thereafter, western and international interest divas also sparked in th e m a chine efficient scheduling

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A Littd History
of the OP I'.' TOC systems.I t was found that the inefficient use of
the bottleneck was costing companies a small fortune.
However, the m aterials efficiency of JIT s e emed to be v ery l i t t l e

help in the Job Shop where manufacturing was non-repetitive. The


production process in the customized job shop required the sophistication of a n bi IRP scheduler,. but also needed the materials effici-

encies of JIT. This triggered the introduction of new, leading-edge


systems like Schedule Based Manufacturing (SBhi) or Bottleneck
Allocation Aiethodology (BAAi) which integrate these philosophies.
Other systems like Finite Capacity Scheduling (F C S ) at t e mp ted to

deal with the capacity scheduling inadequacies of h,iRP by integrating some of the opti mi zation of TO C . A d v a nced integrated systems
of this ts~e are often r eferred to as A d v anced Planning and S ch e-

duling (APS, 'systems.


B usiness management systems were also searching for a m e t h o d
to integrate the operations m anagement t o ols w ith ot h er i n f o r m a tion management to ols like the accounting

system,the costing sy-

s tem, and the sales and marketing systems. The first attempt at th i s

integration was Manufacturing Resources Planning (iliRP II) ( see


C hart 1.5). L ater this integration was increased to shop fl oor i n t egration and engineering integration and was labeled Enterprise Re-

sourcesAlanagement (ERP).
In Chart 1.5 we see the production and o p e rations management
functions of an e n t e rp rise detailed ou t a l on g th e r i gh t s id e of t h e
chart. Activities begin with a business plan, then they focus on planning functions like forecasting and R o ugh C u t C a p a city Pl anning.
These activities integrate into schedules like the Aggregate Production Schedule and the ili a ster Production S chedule. The execution

of the AiRP function next creates purchasing and shop floor. production requirements.
Down the left side of C h ar t l l. 5 we see all the financial activities
of an e n t erp rise in cl u d in g t h e g e neral l edger an d p r o f i t a n d l o s s
fLinctions. In th e top center of the chart we see the sales functions.
From this chart we can see how the enterprise information i nt e gration would f u n c tion u n der an ili R P I I or ER P e n v i r o n m e nt ( n o t e :
the numbers are connectors, for ex am ple the " 1" co n n e cts to t h e
other "I " i n t h e ch art these connectors are used in order to avoid
having lines crossing on the chart, but t hey have the same meaning

as woutd a connecting line).

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The Rok o) 4'ireasirrewei]t in Operate.>ns AIanp'en)ent


The future of O p e rations 3 Tanagernent inethodolagies ~ill f i n d t h e
blending o f m or e a n d m a r e d i f f e r ent o p e r ations t e chniques and
processes. This offers the flexibility to select a production planning

process focused on any resource preference. It also offers optimization in any resource, rather than l i m i t in g us ta o nl y on e cr i t i cal resource, as the c urrent p l a n n i ng s ystems tend to d a . T h e f u t u r e o f
operations m an agement v i l l a l s o fo c us m o re a nd m o r e a n i n t e gration, particularly on internationa] integration and on supply chain integration. In t his baak, the discussion of alternative production
methodologies, and ho~v they can vary for one international setting
to another, ivill accur in m any chapters, like Chapters 5 and 10.

The Role of Measurement


in Operations Management
Referring t a C h a r t 1 . 3 , ave discussed the P Oi lt pr o c e ssing cycle.
Critical ta this processing cycle is the creation of a feedback mecha-

nism that reviewers and reports on the performance of a]l resources


in the system. There are several measures that are utilized to evalu-

ate performance, and it would be valuable ta review a few of them.


The process of measurement, and haw i t i s used for data collection

and for motivation davit) be discussed in more detail in Chapter 3.


The key areas ofperformance measurement in operations rnanagement are:

Quahty
Quality has always been a confusing term a nd is difTicult to de fine.
It is difficult to get tao p e ople to agree on a definition of qua lity, let
alone an entire industry. As a result, there are numerous d e f i n i t ions
throughout th e w o rl d f o r q u a l i ty, bu t l e t's look at a c o u p le of t h e
common d e f i n i t i ons. In t h e U n i t e d S t a t e s, q ua lity i s m o s t o f t e n

used to define "

meetingengineering standards." This is the applied

definition fo r q u a lity, not th e on es we give lip s ervice to. It m e a ns


that if a pr o du ct is built to s pecification, exactly the svay it is desig-

ned, it is considered to be a quality product. Unfortunately, this definition does little to focus on the customer.%'e have formalized this
definition of quality thr ough systems like ISO (t he European Devel-

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16
o ped Quality standard that has found i n t e r n ational application) o r

QS (the American autoniotive quality standard).


In Eu r o pe, fo r

e x a m pl e i n Ge r m a ny, the U S A d e f i n i t i on a l s o

holds. I he reason ivhy German quality is considered to be higher


than American quality is because the engineering specifications are
tighter, nat b e cause they are any m o r e " c u s t om er " o r i e n t ed. U n fortunately, the "meeting engineering standards" definition of quality is the most commo n ly applied definition thro ughout the world.
F rom Japan we get a m or e customer oriented definition of q u a l ity, which is t h at a q u a l i ty p r o d u ct i s on e th a t " t h r i l l s t he c u s to-

mer". The Japanese definition does not focus on durability or flexibility. Rather, it f o c u ses on m a r k eting appeal give the customer
whatever they get excited about. One example would be the "b o o m
box" the carry around sternum.The %'estern definition of q u a l i ty

would have the box v'ork, even if it v'as dropped from 20 feet. The
Japanese definition wo uld ha ve th bax. filled svith levers and knobs
for the user ta move around and eect the sound. For same reason,
an increased number oflevers makes the boom box seem more valuable to the customer, even if the customer never usesthem. Therefore, the perceived quality to t h e c u s tonier wo u ld m ake th e cu s tor ner feel thr illed by th e Japanese product an d th e c u stomer w o u l d
prefer to buv i t o ver the " d u r a ble" p r o d uct o p t i on. Th is could a lso

be labeled a "marketing" oriented definition af quality.


Quality can be used as a measure of p e r f o r m a nce by evaluating
d efect rates, delivery p erfo r m ance, retur n r a t es, etc. Th e i s sue o f

quality as a me asure of peiforrnance v,'ill be revisited numerous


times through t h i s b oo k s i nce i t h a s v ariations and co m p l i cations
when viewed from an int e rnational perspective (see Chapter 3). Re-

flect back on Z, Inc. Is lack of quality a reason for their lack of profitability. %'hat should their definition of qu ality be?

Produc
tivity
Productivity is another measure that permits an unlimited number
of variations and is therefore difficult to define. Specifically, productivity is output d i v ided by in p ut . O u t pu t i s generally accepted to be
Net Sales. Output can b e th e v alue of p r o d u c t ion o r t r a n sfer cost
rate if we are interested in f a c t a ry pr o ductivity wxhere product is
transferred bet fveen factories of the same o rgaization. Input c an b e

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The Ro( of 2'l'Ir2sur&'>nntin O~~'rations Africannk'i](

any number of th ings. Input can be varied so much so t hat any


company or country can claim exceHent productivity, depending on
how it's measured. This international inconsistency in the definition

of what should be included as input also complicates comparisons


of productivity b etween coun tr ies and c o m p a nies. It has g otten to
the point wh e re th o nly effective compa risons that can be d r a w n

for productivity is to compare a company or country xvith itself over


time to see if it is improving.

P)'DEAL.' ll \'i fi P'

iu(
arity.

lripttr
In the W'estern countries, productivity almost al ways means labor

productivity. The Input in the productivity formula is either direct


labor hours or d i r ect l abor cost. Because of its focus on la bor, the
United States leads the world in p r o d u ct ivity. But there are also disadvantages associated ivith labor productivity as a measure of national productivity. f h e p r i m ar y d isadvantage is that labor is less than
ten percent of the value-added content of m o st m a n u factured products. Therefore, being labor effilcient doesn't necessarily mean that
the Un i ted S t ates is pr o d u cing p r o d uc t e f ficiently. Recently it h a s
been discovered that i n c reasing labor p r o d u c tivity, in s om e cases,
can actual)y result in a l oss of p r o f i tability, rather than an i n c rease
of profitability. For a mo r e d e t a i led d i s c ussion of t h i s , issue, see
Chapter 3.
Ac'.if Sa jes
Pmchrr. li vi (l~- Dir ec(LoEmi Oortrso~ DijeeI Labor DoElors

Internationally, we find a mul t i t u de of measures of productivity perforrnance. For examples in Japan we find s everal productivity m e a -

sures, one of which is value-added productivity. Value-addd productivity focuses on getting as much increased value out of t he production process as possible. For example, as a Japanese producer
we are building a TV , a nd th e TV h a s a t u n e r a nd p o w er s u p p l y,
each of ivhich costs 85 to produce.% 7e can sell the tuner for $10 on

the open market. The 510 includes $5 of production costs and 55


of increased value added.%'e can sell the popoversupply for on]y $7
on the open market (only 52 of increased value added). W,'ewould

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18
get more value-added content out of p r o d u c i ng the tuner, and have
the USA subcontractor produ ce the power supplies. Both count r ie s
wou]d input 55 of p r o d u c tive effort, but for t h at effort t h e Japanese

wou]d gain $5 of increased value added and the US would only


gain 52 of increased value added. It's easy to see svhy the balance of
trade has tended to favor Japan using a value-added productivity
calculation.

Prod)(c'.Ii <irl ?

A'et Sales

.VetSales Co>I of Goo' Sold

Another popular pr o d u ctivity m easure is Total Factor Produ c tivity.


%Pith Total Factor P r o d u ctivity, the in p ut i n c l u d es all the resource
elements that went into the produ ction process. For example, materials costs, machine costs, and even overhead costs would be included along v,ith the labor costs. Total Factor Produ ctivity is considere d to be a m o r e accurate measure of th e o v erall p r o d u ct ivity o f a
particular production environm ent.
P!'udt! C I !1! tl

Set Sales

Lcll?or+ .'1 faIc'.rial'+ E I Ier y

+ A f a c htn!.'1'1'+t.'h.'.

Aiore recently, a measure of productivity known as Cr i tical Resource Productivity has become popular because it is easy to me as ure and focuses an organization on i t ' s most e ff ect ive area of i rn p rovement. For example, in th e a u t o m o b ile i n d u stry, 7 t o 1 0 p e r cent of the va]ue added cost content of the vehicle is labor while 5t)
to 60 percent of the va]ue added cost content is in m a t e rials. Hen-

ce, materials is the critical resource (the dominant v a lue added


component) and ,materials productivity is a lot m o re meaningful
than labor p r o d u ct ivity as a me a sure of o p e r ational p e rforma nce.
The input used in t his productivity equation is the critical resource
in the production pro cess. A more d e tailed discussion of critical resources is found in Chapters 3 and 4.

I-'roclitct! v! tl'

5'eI Sale>
-

CA'I!ca( Rc?Sot!!'c. c?osts


(.

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The Rol of 2'l'Ir2sur&'>nntin O~~'ratioirs AfricanIlk'i]t

19

Productivity vill b e a continuing discussion throughout this book.


For example, in Z, Inc. productivity became a critical issue. Loss of
prot
ectabilitycould have been blamed on a lack of Total Factor Productivity. How ~vould you focus Z, In c . 's resources to turn i t ' s P8;L
statement from red to black?

Eff iciency
Efficiency is a minor measure of performance which is primarily
used to evaluate internal effectiveness. For example, in the Un i t e d
States, labor efficiency is used to c o m p a re labor p erforma nce to a
standard. This comparison to standard ivould then be used to m easure if and hov mu c h of a performa nce bonus svould be paid out to
a particular employee. Anything over 100 '.4 svould constitute good

performance, and anything less than 100'ro would justify a reprimand.

Ef ficieitc.v -

Stet))clat'cPTitr)e

Actual Ti iree

x 1 {!0

Is efficiency a tool th at Z, I n c . could u se to i m p r o ve their loss of


profitability? %'ouM efficiency be something that you xvould suspect

is already being used by Z, Inc.?

Financial ~Measures
Financial measures of performance include protit and loss numbers
from the P8'L statement as favell as performance and liquidity ratios
from th e B a l ance Sheet. Appendix A (a t th e e nd o f t h e b o o k) i n cludes several of the most common p
r atios that a r e

erformance

used for measuring international performance. The applicability


and use of many of these numbers is questioned internationally. For
example, the Cu r r ent Ra tio is considered to be good the larger the
value it has.

(C~n t ertt Ratioj -

t Total Ctirrent .Assets j


( T o t a l Ct tn ent D

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ebts j

20
However, Inventory reduction is also considered to be good.
That rnea/ns, as inventory g oes do wn , th e i n v entory asset ratio
would imp rove but the current ratio ~vould get worse. W'hich ratio is
the better measure of over-all corporate goal achievement?

(Ir1 vc'.)1(oui,O'ser Rc>fto J

(Toit(I br ' ' HINDI'I')

(To(a( Cue c'o( Assets)

There are n u m erous stories of co m p a nies v here the president r educed inventories only ta get repr im anded by the B o ard of D i r e c t-

ors for a poor Current Ratio performance. The result, in most of


t hese cases, divas that the p r esident ended u p

b u )ing b ack the in-

ventory, even th ough i t w a s o p erationally i n efficient t o d o s o . R e viesv the discussion of conflicting goals in Chapter 3.
Are conflicting financial and operational goals a factor in Z, I n c.'s
performance>

BencIr ma rII r'n g


Benchrnarking is a modern buzzword ivhich refers to comparative
measures o f p e r f o r m ance. T h ere are tw o t y p e s o f B e n c h m arking;

Internal and

E x t ernal Benchmarking. Internal Benchmarking is

where you use several measures of yourself and r e t ake those same
measures over time to see if you are improving. Internal Benchmarking can also me asure different f acilities svithin t he s ame c o m p a ny

against each other. E>'ternal Benchmarking is where you measure


your performance against that of someone else, like a competitor or
like the industry averages that are available for your specific industry,

to seeho~v your performance measures up.2 External Benchrnarking


can also be used to refer to a comparison of your use of

2. (inc of thc most popular tables of industrial ratios is thc Industry Norms and
Key B u siness Ratios put

ou t b y D u n a n d B r a d s t r e et I n f o r m a t i on S e rr ic c s .

This report will give all the average ratios, thc average profit and loss statement, and the average balance sheet for one year f or each Standard I n d u s t r i a l

Classification (SIC) code. It is available in most business libraries but not on


t he wcb .

C o n t a c t t h c B u s i n ess Soluti on s I ) c p a r t m c n t a t v wvN'd n b .corn f o r

information about asailabi]ity.

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The Ro( of 2'l'Ir2sur&'>nntin O~~'rations Afarsapnk'J](


m ethodologies o r

t o o l s an d t e c h n i q ues w he n c o m p a red t o y o u r

competitors. Appendix A includes a collection of measures of performance and discusses their applicability.

'fX'ould Benchmarking be useful for Z, Inc.?

Other Op e ra ti onal iUeasures


'.hlumerous other measures of operational performance exist, many
of v, hich measure the same thing. For example:

Inventory Level

erformance

Inventory level has become a measure of p


in many organizations, primarily because it is i mportan
t in Japanese JIT production. H oavever, it is n at a l w ays a valuable measure of p e rform ance if it i s no t a c r i t i cal resource, as it is in th e t y pes of p r o d u cts
that the Japanese produce. The discussion. of critical resources will

be expanded on in Chapter 4.

Inventory Turns
Inventory tu rns measures ho~v often inventory is used up and repla-

ced in one year. A high level of inventory turns is good since it suggests t hat you d o n 't h a ve a l ot o f i n v e ntory s it ting a ro un d. S it t i n g
inventory is a resource svaste.

Throughput
Throughput is a measure of quality units shipped ta the customer.
It incorporates a focus on q u a l i ty a nd on d e l i v ered sales.It leaves
aut a m easure o f p r o d u c t i on s i n ce p r o d u c ed g o o ds t h at a r e n o t

shipped is operationally inefficient and expensive.

Operating Expense
Operating Expense measures the cost of runn ing the factory floor in

aggregate. Often this measure is more meaningful when analyzed


a long side of T h r o ughput. I f O p e rating Expense goes up a n d
Throughput

d o e sn't, t h en i t ' s c o s t i ng u s m o r e t o d o th e sa m e

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22
amount of business as before. A ratio of the two, called Thr oughput

Performance, gives us a measure of comparative performance. The


more the number grows, the better.

(Iltvef1tot'\ 3 AS''.t Ratto)

(Total ls)velttopl')

(Total Crrn ent Assets)

Integration
Integration is. a measure of internal perform ance. It is a measure of
hoav effective the comm u n i cation channels svork within an organizat ion. There are nu m erous ways of m easuring in tegration w h ich i n -

clude:
Number of Cress-Functional Teams
Le vel of Integration %within Teams

Number of Team I mplemented


Innovations.

Cycle Time
Cycle Time is a me asure of t he a mo u nt of t i m e i t t a k es to pr o cess
an order, fron> start to f i n i s h. Reduced cycle time m e ans increased

requireme
nts

responsiveness to customer
and reduced in-process
inventory levels. This ivould increase inventory turns. The Japanese
use Cycle Time as a measure of p
because responsive-

erformance

ness and reduced inventory are both goals of the JIT pr o c ess and a
cycle tim e iTteasurement i m p r o vement is e a sily c o m m u n i c able t o
employees. Cycle Time readily demonstrates an accomplishment of
all goals. Fo r e x a m p le, Toyota has a Cy c le T i m e f o r a u t o m o b i l e

3 . Cust omer r e sponsiveness can b c

i n c r c ascd b y i n c r easing tLnished go od s i n -

ventory. Howcwxrs by reducing th e cy cle t im e sufficiently, cvcn carrying


finished goods inventory can bc a liability because of it's increased carrying
cost U l t i m ately, if wc only had to keep raiv materials inventory, and all other
levels of inventory are committed to specific customer orders, ave would minimize inventory costs.

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production of th r ee hours. They pro d u ce a car fr om start to f i n i s h

in three hours. The Cycle Time for American and European auto
manufacturers is me a sured in we e ks a nd i n s o m e p l a n ts e ven i n
months. Inventory t u r n s every f ou r h o u r s a t T o y ot a so th a t, over
t wo shifts, th e i n v entory t u r n s n u m b er s ar e o ver 1 M O t u r n s p e r

year. A good inventory turns number for American or European auto manufacturers svould be 10 turns per year.
Another form of c yc le time t hat is "P r o d u ct D e v elopment Cy c le

Time". Here we focus on the time it takes from the conceptualization of a ne w p r o d u ct i d e a, to i t 's being available to the customer.
Responsiveness in this area is critical for th e p r o d u cts that re quire

fast responsiveness, for example, the fad fashions in the apparel industry.
A thir d f o r m o f c y c l e t i m e ha s gained extensive popularity b e cause of the eCo m m e rce push. This is the cash-to-cash cycle time .
This forin of cycle time tracks the time from u hen an order is received, until the pr o d uct is paid for.%'hen considering internet speed
and responsiveness, we also need to take a close look at the financial
responsiveness of the internet transaction. For example, in the cornputer industry, the average cash-to-cash cycle time is 106 days and
the best of class cycle time is 21 da>s. That means that on the average, the cash for salesis tied up for about 3 'A m o n t h s. The carrying
cost of f i n ancing t hi s i n ventory can be d e v astating to a c o m p u t e r
e quipment supplier. That is why the D el l C o m p u ter m o del for p u r chasing equipment on - line h as become so a ttractive. De ll c o m p u ters has managed to re duce the cash-to-cash cycle time to a ne gative S days. They have turned the ti de to iv here they are operating
on the customers' money. It then comes as no surprise that Dell can

se'll equipment for significantly lessthan other computer equipment


vendors.

Back to Z, Inc.
Do t hey n e ed o p e rational m e asures of p e r f o r m a nce? %'hich m e a sures do they need.' Should Z 's C EO a n a l yze these measures prior

to making a recommendation for Z's future? Or should the Z, Inc.


decision be primarily a fj.nancial one.'
This section discussing measurement systems raises more q u e s-

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