OPSM 901: Operations Management

1
OPSM 901 Operations Management
Koç University Graduate School of Business EMBA
Program

• Session 2
• Measuring Process Flows
• Littles Law

Zeynep Aksin zaksin_at_ku.edu.tr
2
Recall from last class

• Strategic position what product attributes?
• Operational effectiveness how well the process
  performs
• Process competencies cost, time, variety,
  quality
• Need internal measures that are leading
  indicators of financial performance
• Zara and article on textile industry importance
  of time based competition

3
Three Internal Process Measures

• We examine processes from the perspective of flow
• To study process flows, we first answer three
  important questions
• On average, how many flow units pass through the
  process per unit time?
• On average, how much time does a typical flow
  unit spend within process boundaries?
• On average, how many flow units are within
  process boundaries at any point in time?

4
Process Measures

• On average, how many flow units pass through the
  process per unit time?
• THROUGHPUT RATE (TH)

5
Terminology
Throughput Rate (R or TH) The average output of a
production process per unit time. At the firm
level, it is defined as the production per unit
time that is sold.
6
Process Measures

• On average, how much time does a typical flow
  unit spend within process boundaries?
• FLOW TIME (FT)

7
Terminology

• Flow Time (T or CT)
• The flow time (also called variously throughput
  time, cycle time) of a given routing is the
  average time from release of a job at the
  beginning of the routing until it reaches an
  inventory point at the end of the routing.

Flow time
1
2
3
4
8
Terminology
System Cycle Time The average interdeparture time
between two jobs leaving a routing
System cycle time
9
Process Measures

• On average, how many flow units are within
  process boundaries at any point in time?
• INVENTORY (I)

10
Terminology
Work in Process (I or WIP) The average inventory
between the start and end point of a product is
called work in process (WIP)
WIP (9 for this realization)
11
Relating operational measures (flow time T,
throughput TH inventory I) with Littles Law
Flow rate/Throughput R units/hr
Inventory I units
...
...
...
...
...
Flow Time T hrs

• Inventory Throughput x Flow Time
• I TH x T
• Turnover Throughput / Inventory
• 1/ T

12
Understanding Littles Law Consider a first
come first served Queue
13
An Intuitive Argument for Little's Law

• Consider a process with the FCFS queue discipline
• An order departs the process At this moment
  there are I (Inventory) orders within the process
• The orders that are in the process now are the
  ones that came after our departing order had
  arrived, in other words, they arrived during the
  waiting period of the departing order
• Since order arrival rate is equal to the
  throughput rate, we have the following
  relationship
• Inventory Throughput Rate x Flow Time

14
Once again...

• Inventory Throughput x Flow Time

15
Littles Law basics

• Littles Law is for a system in steady state
• input rate output rate
• Applies to most systems, even those with
  variability
• Uses average values

16
Process Flow Examples

• Material Flow A fast-food restaurant 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 flow time and the
  restaurants turnover?
• Customer Flow The above fast-food restaurant
  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 the restaurant
  and what is the average customer turnover?
• Job Flow A branch office of an 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.

17
Process Flow Examples

• Cash Flow A major manufacturer 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 flow time?
• Question A general manager at at a
  pharmaceutical company states that her inventory
  turns three times a year. She also states that
  everything that the company buys gets processed
  and leaves the docks within six weeks. Are these
  statements consistent?

18
Example Auto-Moto Financial Services

• Auto-Moto provides loans to qualified customers.
• The company receives about 1000 loan applications
  per 30-day working month
• and makes accept/reject decisions based on an
  extensive review of each application

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Auto-Moto Current Process

• Currently, Auto-Moto processes each application
  individually.
• On average, 20 of all applications received
  approval.
• An internal audit showed that, on average,
  Auto-Moto had about 500 applications in process
  at various stages of the approval procedure, but
  on which no decisions had yet been made.
• In response to customer complaints about the time
  taken to process each application, Auto-Moto
  called in OPSM Consulting Inc.

20
Auto-Moto Assessment

• OPSM Consulting found that although most
  applications could be processed rather quickly,
  some took a disproportionate amount of time
  because of insufficient and/or unclear
  documentation.
• They suggested the following Process II

21
Auto-Moto Process II

• Because, the percentage of approved applications
  is fairly low, an Initial Review Team should be
  set up to pre-process all applications according
  to strict but fairly mechanical guidelines.
• Each application would fall into one of three
  categories type A (looks excellent), type B
  (needs more detailed evaluation), and type C
  (reject summarily). Type A and B applications
  would be forwarded to different specialist
  subgroups
• Each subgroup would then evaluate the
  applications in its domain and make accept/reject
  decisions

22
Auto-Moto Process II implementation

• Process II was implemented on an experimental
  basis.
• The company found that, on average, 25 of all
  applications were of type A, 25 were of B, and
  50 were of C.
• Typically, about 70 of type A and 10 of B were
  approved on review.
• Internal audit checks showed that, on average,
  200 applications were with the Initial Review
  Team undergoing preprocessing. Only 25 were with
  the Subgroup A Team undergoing the next stage of
  processing and approximately 150 were with the
  Subgroup B Team

23
Auto-Moto would like to determine if the
implemented changes have improved service
performance.
24
Current System
accept
20
200/month
1000/month
review
500
reject
80
800/month
T?
25
Proposed System
Subgroup A review
70
200 /month
accept
30
25
25
10
Subgroup B review
25
1000 /month
initial review
90
800 /month
reject
50
150
200
C
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Proposed System
Subgroup A review
70
200 /month
accept
30
I25
25
10
Subgroup B review
25
R1000 /month
initial review
90
800 /month
reject
50
I150
I200
C
27
New process

• Flow units applications
• Initial review R1000, I200 T0.2 months or 6
  days
• Team A R250, I25, T3 days
• Team B R250, I150, T18days
• Type A 9 days
• Type B 24 days
• Type C 6 days
• Average R1000, I375, T11.25 days

28
New process different flow unit definition

• Flow units approved/rejected applications
• Approved 70 of Type A and 10 of Type B
  0.7(250)0.1(250)17525200 applications/month
• Tapproved175/(17525)(TIRTA)
  25/(17525)(TIRTB) (175/200)9
  (25/200)2410.875 days
• Rejected 30 of Type A and 90 of Type B and all
  C
• 75225500800 applications/month
• Treject11.343 days

29
Analyzing Financial Flows through Financial
Statements

• MBPF manufactures prefabricated garages
• MBPF operations called for the purchase of both
  sheet metal (raw materials) and prefabricated
  bases (purchased parts).
• Garages were made in the fabrication area from
  sheet metal and then assembled with prefabricated
  bases in the assembly area.
• Completed garages were stored in the finished
  goods warehouse until they were shipped to
  customers
• Analyze the firms income statement, balance
  sheet, and cost of goods sold statement to
  determine in which department process
  improvements have the greatest impact on working
  capital

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Definition working capital

• Working capital requirements include the value of
  inventories in the process and the value of any
  accounts receivable. Any reduction in working
  capital reduces the firms interest expense and
  makes extra cash available for other investments.

31
Consolidated Statements of Income and Retained
Earnings

• NET SALES 250.0
• COSTS AND EXPENSES
• Cost of goods sold 175.8
• Selling, general and administrative expenses
  47.2
• Interest expense 4.0
• Depreciation 5.6
• Other (income) expenses 2.1
• TOTAL COSTS AND EXPENSES 234.7
• INCOME BEFORE INCOME TAXES 15.3
• PROVISION FOR INCOME TAXES
  7.0
• NET INCOME
  8.3
• RETAINED EARNINGS, BEG. OF YEAR
  31.0
• LESS CASH DIVVIDENDS DECLARED
  2.1
• RETAINED EARNINGS AT THE END OF YEAR
  37.2
• NET INCOME PER COMMON SHARE
  0.83
• DIVIDENDS PER COMMON SHARE
  0.21

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Consolidated Balance Sheet of Dec. 31, x

• Current Assets
• Cash 2.1
• Short-term investments at cost 3.0
• Receivables, less allowances of 0.7 mil
  27.9
• Inventories 50.6
• Other current assets 4.1
• TOTAL CURRENT ASSETS 87.7
• Property, Plant, and Equipment (at cost)
• Land 2.1
• Buildings 15.3
• Machinery and equipment 50.1
• Construction in progress 6.7
• Subtotal 74.2
• Less accumulated depreciation
  25.0
• NET PROPERTY, PLANT, AND EQUIPMENT
  49.2
• Investments 4.1
• Prepaid expenses and other deferred charges 1.9
• Other assets 4.0
• TOTAL ASSETS 146.9

33
Inventories and Cost of Goods Details

• Cost of Goods Sold
• Raw Materials 50.1
• Fabrications (Labor and Overhead) 60.2
• Purchased Parts (Labor and Overhead) 40.2
• Assembly (Labor and Overhead) 25.3
• TOTAL 175.8
• Inventory
• Raw Materials (roof) 6.5
• Fabrications WIP (roof) 15.1
• Purchased Parts (base) 8.6
• Assembly WIP 10.6
• Finished goods 9.8
• TOTAL 50.6

34
Questions

• How long does it take for a cost dollar to yield
  revenue?
• How long does it take on average between the time
  at which a dollar enters the accounts receivable
  department and the time at which it is received
  as payment from the customer?
• In which department does a reduction of flow time
  have the greatest impact on working capital?

35
How long does it take for a cost dollar to yield
revenue?
60.2/yr
25.3/yr
LOH fab
LOH ass
RM
50.1/yr
COGS
50.6
175.8/yr
Parts
40.2/yr
Flow unit cost dollars TI/R50.6/175.80.288
years14.97 weeks
36
Process Flows Accounts receivable

• How long does it take on average between the time
  at which a dollar enters the accounts receivable
  department and the time at which it is received
  as payment from the customer?
• Flow unit dollar of accounts receivable (sales
  )
• R 250 million/year (net sales)
• I27.9 million (receivables)
• TI/R27.9/2500.112 years5.8 weeks

37
In which department does a reduction of flow time
have the greatest impact on working capital?
60.2/yr
25.3/yr
Raw materials
Fabrication
50.1/yr
6.5
15.1
110.3/yr
Assembly
Finished goods
175.8/yr
Purchased Parts
10.6
9.8
40.2/yr
8.6
40.2/yr
38
Detailed Financial Flow Analysis
60.2/yr
25.3/yr
Raw materials
Fabrication
50.1/yr
6.5
15.1
110.3/yr
Assembly
Finished goods
175.8/yr
Purchased Parts
10.6
9.8
40.2/yr
8.6
40.2/yr
Flow unit cost dollars TI/R50.6/175.80.288
years14.97 weeks
39
Flow Times through MBPF
Raw materials Fabrication Purchased parts Assembly Finished goods
Throughput/year R 50.1 110.3 40.2 175.8 175.8
Throughput/week R 0.96 2.12 0.77 3.38 3.38
Inventory I 6.5 15.1 8.6 10.6 9.8
Flow time T 6.75 7.12 11.12 3.14 2.90
40
Inventory Value Representation
TH (mil/week)
5.0
3.38
Accounts Receivable
2.12
Fabrication
Assembly
Finished goods
0.96
Raw materials
Purchased Parts
0.77
T (week)
11.12
6.75
7.12
3.14
2.90
5.80
41
Example Emergency Room
Flow units?
42
Littles Law
T I/R 34/55 hr 0.62 hrs 37.1 min
T I/R 7/55 hr 0.127 hrs 7.6 min
I RT 552/60 1.83 patients.
43
On average how long does a patient spend in the
ER?

• Two types of flow units
• Potential admits
• Simple prescriptions
• Potential admits flow time7.6 2 37.1 30
  76.7 minutes
• Simple prescriptions flow time 7.6 2 37.1
  5 51.7 minutes.
• Average
• T 10 76.7 9051.7 54.2 minutes.

44
On average how many patients are being examined
by doctors?

• Potential admits
• R 5.5 patients/hr,
• T 30 min 0.5 hr
• I RT 5.5/hr0.5 hr 2.75 patients
• Simple prescription
• R 49.5 patients/hr,
• T 5 min (5/60) hr
• I RT 49.5(5/60) 4.125 patients

45
On average how many patients are there in the ER?

• total inventory in ER
• inventory in buffer 1 inventory in
  registration inventory in buffer 2 inventory
  with doctors
• 7 1.83 34 6.865 49.695 patients.

46
For next time

• Read the Kristens Cookie case (3 pages)
• Will have Quiz 1
• Closed books and notes
• Problems similar to what we have seen in class
• Study business model product attributes-process
  capabilities product-process matrix process
  flows Littles Law