MD375 Operations & Competition

Class Notes

Fall 2008

DEFINITIONS OF OPERATIONS STRATEGY

An operations strategy is a set of goals, policies, and self-imposed restrictions that together describe how the organization proposes to direct and develop all the resources invested in operations so as to best fulfill its mission.

Other definitions of operations strategy:

An operations strategy consists of a pattern of decisions that, over time, enables a business unit to achieve a desired operations structure, infrastructure, and set of specific capabilities in support of competitive priorities.

An operations strategy is a set of policies in both process choice and infrastructure design which are consistent with the existing ways that products win orders, while being able to reflect future developments in line with changing business needs.

The successful implementation of an operations strategy creates value for the customer.

1

LEVELS OF STRATEGY

2

Corporate

Divisional(business)

Fin HR MktProdDev Ops

How do we compete?

What business are we in?

Role of each function?

COMPONENTS OF THE DEFINITION

Structural decision categories:

Capacity

Facilities

Vertical integration (sourcing)

Information/process technology

Infrastructural decision categories:

Workforce

Organization

Control/quality systems

Capabilities: Unique to each firm

Competitive priorities: Cost

Quality

Delivery

Flexibility

Innovation

3

KEY OPERATIONS PRINCIPLES

Aggregation Principle: The higher the level of aggregation, the more predictable operations becomes (e.g. forecasts of total product volume tend to be more accurate than forecasts of individual products). This is a manifestation of the Central Limit Theorem.

Uncertainty Principle: The more uncertainty in operations, the greater the need to employ extra resources to cope with this uncertainty. Alternatively, the greater the stability and predictability, the more efficiently operations can function.

Efficiency Principle: All else being equal, operations should function as efficiently as possible.

4

COMPETITIVE PRIORITIESQuality

Quality consists of many dimensions that can be aggregated into: relative quality (level of attributes) and functional quality (the ability to operate as intended).

Quality Dimensions

Category Dimension DefinitionRelativequality

Performance A product's or service's primary operating characteristics

Features The "bells and whistles" of products and services, those characteristics that supplement their basic functioning

Aesthetics How a product looks, feels, sounds, tastes, or smellsFor services – physical facilities, equipment, and appearance of personnel

Perceived quality

Inferences about quality based on indirect tangible and intangible aspects of the product or service (e.g. reputation)

Functionalquality

Reliability The probability of a product malfunctioning or failing within a specified time periodFor services – ability to perform the promised service dependably and accurately

Conformance The degree to which product or service design and operating characteristics meet established standards

Durability The amount of use one gets from a product or service before it deteriorates

Service delivery

The speed, courtesy, and competence of personnelFor products – also, the ease of repair

Improvements in functional quality result from a reduction in process variation.

5

COMPETITIVE PRIORITIESDelivery

Two delivery dimensions:

Lead time – The time the customer must wait between order placement and receipt

Reliability – How reliable the company is in delivering a customer's order on or before the quoted delivery date

Both lead time and reliability can be improved by reducing uncertainty in the operations system.

6

COMPETITIVE PRIORITIESFlexibility

Primary flexibility dimensions:

Product flexibility – The ability to produce a wide variety of products or services and the ease with which the product or service mix can be changed

Volume flexibility – The ability of the production system to operate at different volumes and the ease with which the volume can be changed.

Increased flexibility is a means to deal with demand uncertainty.

Advances in technology have greatly increased operational flexibility.

7

COMPETITIVE PRIORITIESInnovation

Definition: In operations, innovation as a competitive priority involves the ability to quickly introduce and improve process technologies, which increases speed to market with often better products and services.

Main types of operations innovations:

Incremental – Minor improvements or simple adjustments in existing technology. Rapid accumulation of these innovations can convey a competitive advantage.

Radical – Fundamental changes that represent revolutionary changes in technology. They represent clear departures from existing practice (i.e., substantially new processes and process technologies)

Innovation is often the primary competitive priority in a high-velocity environment with short product life cycles.

8

OPERATIONS STRATEGY FORMULATIONContent

MissionThe operations mission specifies what operations must accomplish for the business to succeed. It states the purpose of the operations function and competitive priorities as they relate to the customer and competition.

ObjectivesOperations objectives should be defined in concise, measurable terms, as part of the operations strategy. They should be specific statements of expected results – a refinement of the mission.

Operational strategiesStructural and infrastructural decisions are stated in strategic terms. They must be formulated to support the operations mission and objectives and should be consistent with each other and with what is intended to be accomplished by operations.

PoliciesStructural and infrastructural decisions are stated in tactical terms in support of the operational strategies.

Distinctive competenceThe competitive priorities provide a framework for developing a distinctive competence, which is realized through the implementation of the operations strategy and the use of the firm’s resources. It is what sets operations apart from the competition and, thus, can be defined in terms of uniqueness.

9

A MARKETING-ORIENTED VIEW OFOPERATIONS STRATEGY

Development of an operations strategy:

1. Define corporate objectives.

2. Determine marketing strategies to meet these objectives

3. Assess how different products or services qualify in their respective markets and win orders against competitors.

4. Establish the most appropriate process to produce or deliver these products or services (process choice/structural decisions).

5. Provide the operations infrastructure to support production and delivery.

Steps 4 and 5 constitute the operations strategy.

10

ORDER-WINNERS AND QUALIFIERS

Order-qualifiers are those criteria that a company must meet for a customer to even consider it as a possible supplier. Companies need only be as good as competitors.

Order-winners are those criteria that win the order. Companies need to be better than their competitors.

From an operations perspective, determining order-winners and order qualifiers helps to define competitive priorities.

This view of operations strategy is especially time- and market-specific.

11

IMPORTANT CONSIDERATIONS IN OPERATIONS STRATEGY FORMULATION

Operations are part of a system that includes the other functional areas, the business, and the corporation.

As such, the strategies must be linked, integrated, and mutually supportive.

The operations strategy process is iterative, both within a planning cycle and between cycles.

Between planning cycles, the operations strategy process should reflect the changing environment.

While strategic planning precedes implementation, a plan that is not implemented is not a strategy and is often worse for the organization than no stated plan at all.

12

McDonald’s Operations Mission

McDonald’s Operational Strategies

Dimension StrategyCapacity Growth as needed through additional stores -

but capacity added carefully Well-utilized - franchisee's well-being

depends on it being heavily utilizedFacilities Distributed facilities, each facility being very

similar to the next, all focused around a similar menu with some local variations (especially by country)

ProcessTechnology

High degree of process understanding, emphasis on "fool-proof" processes

A leader in the technology of fast-food delivery

VerticalIntegration

Partnership arrangement Long-term relationship with suppliers to

promote innovation and quality improvementWorkforce Franchisees: well-trained, carefully selected,

entrepreneurs Operators: high-turnover, lower-paid

Organization Guidelines provided by corporation, but franchisees push to locally optimize

ControlSystems

Centralized buying Bulk contracts "Push" system for basic supplies, "pull"

system day-to-day in the restaurants

13

CRITERIA FOR EVALUATINGAN OPERATIONS STRATEGY

Consistency (internal and external)Between the operations strategy and the overall business strategy

Among the decision categories that make up the operations strategy

Between the operations strategy and the other functions’ strategies

Between the operations strategy and the business environment (resources available, competitive behavior, governmental restraints, etc.)

Contribution (to competitive advantage)Making trade-offs explicit, enabling operations to set priorities that enhance the competitive advantage

Directing attention to opportunities that complement the business strategy

Promoting clarity regarding the operations strategy throughout the firm

Providing the operational capabilities that will be required by the business now and in the future

14

EVOLUTION OF OPERATIONS STRATEGYStages

Stage Operation's strategic role

1 Internally neutral - Minimize operation's negative potential

2 Externally neutral - Achieve parity with competitors

3 Internally supportive - Provide credible support to the business

4 Externally supportive - Pursue an operations-based competitive advantage

15

STAGES OF OPERATIONS STRATEGYStages 1 and 2

Stage 1 Internally neutralOperations not involved in strategyKeep operations under control - detailed

measurementFight fires, eliminate problemsOperations is kept flexible and unfocusedShort-term performance is emphasizedTop management is not involved in operations

Stage 2 Externally neutralIndustry practice is followedCapital investment to maintain or gain positionKeep up with competition in operationsPlanning horizon is one business cycleUse industry-wide wage rates

16

STAGES OF OPERATIONS STRATEGYStages 3 and 4

Stage 3 Internally supportiveAn operations strategy is formulated and pursuedKeep operations in step with business strategyOperations investments are screened for

consistency with business strategyLonger-term trends are addressed systematicallyConsistency within operationsTranslate business strategy into operations terms

Stage 4 Externally supportiveAnticipate new operations practices and

technologyOperations is an equal partner in business

strategyOperations is involved up front in market

decisionsOperations contributes to other functionsStructure and infrastructure are concerns to top

managementTeamwork and involved workforceOperations is innovativeCompetitive strategy rests on operations

capabilityFunctions of the firm are well integrated

17

ATTACKING AND DEFENDINGTHROUGH OPERATIONS

Attacking:

Positioning – Appealing to a different customer need

Capabilities – being better at the same game

Process-based capabilities

Systems (coordination)-based capabilities

Organization-based capabilities

Defending:

Exploiting its own strengths

Attacking its attacker’s operations-based weaknesses

Recognizing the seriousness of the attack quickly and emulating the attacker’s strategy

18

INFORMATION-INTENSIVE INDUSTRIES,E-COMMERCE

Characteristics and Implications for Operations

Characteristics: The cost structure for most information-intensive products is

dominated by the “up-front” costs associated with developing a new product and creating its associated production/delivery facilities.

Rapid changes in technology and markets. Network effects (i.e. the increasing attractiveness to users of

certain networks as they increase in size). Network effects are a function of the number of users of a particular technology and the system of complementary products associated with the network.

Quality and time have an interaction effect. Information technology enables direct, real-time

communication with users. Compatibility is as important as differentiation.

Implications: Increased importance of project (vs. process) management. Cumulative output and speed to market are key for low-cost

strategies. Installing a less-than-perfect but improvable system is

sometimes better than waiting to introduce a more refined system later.

High flexibility (customization) is at least an order qualifier. Operations must be able to introduce new products and

services rapidly. Operations organized for collaboration and communication.

19

ISSUES IN SERVICE OPERATIONS

Simultaneous production and consumption

Inability to inventory the customer-facing portion of services increases the importance of capacity and facilities management

Services tend to be high on experience and credence attributes, and

Much of the service delivery process is transparent to the customer, therefore …

Evaluation of the service is based to a large extent on the process and not just the outcome

Because both the provider and customer are involved in service delivery process (i.e., co-production), effective service delivery requires that service delivery “models” or “scripts” are consistent between the customer and service provider.

20

ISSUES IN SERVICE OPERATIONS

Customer contact

The interaction between the front-line employee and customer is an important determinant of customer satisfaction, therefore …

A high degree of customer contact requires that the interface between the service provider and customer be carefully managed.

Greater variability (both complexity and divergence) in outcomes exists due to customer participation in service delivery, therefore …

As the customer becomes more actively involved in the service process, it becomes increasingly difficult to deliver the service efficiently.

Even a service that can be characterized as “high customer contact” overall, is usually a mix of high and low contact.

High and low contact segments of the service can be decoupled for greater efficiency, but should not always be decoupled.

21

CUSTOMER CONTACT MODEL

Potential facility efficiency 1

customer contact

Most services are a combination of high and low contact, and can be designed for both customer satisfaction and efficiency by following these steps:

1. Identify those points in the service system where decoupling between high and low contact is possible and desirable.

For “Cost Leader” type services, back-office activities are decoupled from the front office for the purpose of lowering costs.

For “Personal Service” type services, back-office tasks are retained in the front office to pursue non-cost-oriented objectives.

For “Kiosk” type services, all tasks remain in the front-office to save costs.

For “Focused Professional” type services, front- and back-office activities are decoupled to enable front-office workers to provide higher service, rather than to reduce costs.

2. Employ contact reduction strategies where appropriate.

3. Employ contact enhancement strategies where appropriate.

4. Employ traditional efficiency improvement techniques (TQM, BPR, etc.) to improve low contact operations, especially for Cost Leader services.

CUSTOMER CONTACTBehavioral Considerations

22

Sequence effects:Customers carry away an overall assessment of an experience based on:

The trend in the sequence of pain or pleasure

The high and low points

The ending

Duration effects:People who are engaged in a task don’t notice how long it takes

People will overestimate the time an activity takes

Increasing the number of segments in an encounter lengthens its perceived duration

Rationalization effects:People want things to make sense. If there’s no handy explanation for an unexpected event, they’ll concoct one.

23

IMPLICATIONS FOR SERVICE DESIGN

Finish strong.

Get the bad experiences out of the way early.

Segment the pleasure, combine the pain.

Build commitment through choice.

Give people rituals, and stick to them.

24

WORK TEAMS

The following types of work teams are found within operations:

Team Autonomy Continuum

Traditional work groups. Workers perform the core production activities and have no management responsibility or control.

Quality circles. Workers participate in group problem identification and solving meetings. Day-to-day operating organization remains intact.

Semi-autonomous work groups. Workers manage and execute major production activities, but not support activities.

Self-managing teams. Groups of individuals self-regulate on their interdependent tasks, with the scope of tasks more comprehensive than that of semi-autonomous work groups.

Self-designing teams. These groups have all the characteristics of self-managing teams. In addition, they have control over the design of the team itself and decide such issues as what tasks should be done and who should belong to the team.

25

WORK TEAMS

Issues to consider:

Participatory decision making approaches are not necessarily best for all situations.

However, current operations environments are often characterized by functional and process interdependencies, requiring team, rather than individual, approaches to decision making.

Work teams will be successful in the long-term if they are organized as institutionalized forms of substantive participation. Substantive participation is the ability of teams to make and implement decisions.

Work teams and hierarchies are not mutually exclusive. Each serves its own role.

26

STRUCTURAL DECISIONSCapacity Strategy

Eight important factors to consider:

Capacity is technologically based.

Capacity depends on the interaction of multiple resource constraints.

Capacity is mix dependent.

Capacity can sometimes be stored.

Capacity depends on management policies.

Capacity is dynamic.

Capacity is location specific.

Capacity is affected by the degree of variability of demand and processing time.

With demand and processing variability, lines may form even with excess capacity.

As the average rate of arrivals approaches the average processing rate, system performance deteriorates rapidly and a capacity squeeze occurs.

27

CAPACITY STRATEGYTiming of Capacity Changes

Policies:

Lead demand with capacity

Build to the forecast

Add capacity only after demand exceeds it

Mixed and/or nonstructural policies

Determining the appropriate capacity cushion:

Unit costs of excess/insufficient capacity

28

CAPACITY STRATEGYSizing of Capacity Increments

Economies of scale:

Short-term – cost per unit output decreases as total output increases (i.e., spreading the overhead costs)

Intermediate-term – increasing batch sizes (decreasing changeovers); dedicating resources to specific products, services, or tasks; using equipment that is specifically designed for the needs of a given product or service

Long-termStatic economies of scale – using one large facility or piece of equipment instead of a number of smaller ones to create a product or service

Dynamic economies of scale – improvements in the total operating cost per unit that results from the skills, systems, and experience that accumulates over time

Diseconomies of scale:

Distribution, bureaucratization, confusion, vulnerability

Increasing economies of scale:

Network effects

29

OPTIMAL ECONOMIC SIZE

Plant size

Av

era

ge

co

st/

un

it

30

CAPACITY STRATEGYApproaches to Capacity Expansion

Don't build additional capacity until the need for it develops

Try to outguess the market by following a counter-cyclical strategy

Build for the long haul

Follow the leader(s)

Question:

How can a capacity expansion strategy be used proactively?

31

DEVELOPING THE SUPPLY CHAINInsourcing vs. Outsourcing Considerations

Pros Cons

Insourcing

Increased control over price, quality, etc.

Economies of combined operations

Proprietary products protected

Capital costs Capability limits Time limits Opportunity costs Reduced flexibility to

change partners Reduced volume flexibility

Outsourcing

Low capital costs Specialization Competition Increased flexibility

Unfavorable allocation of product

Lack of control over price, quality, etc.

Lock-in from specialized contracts and assets

Transaction (coordination) costs

32

DEVELOPING THE SUPPLY CHAINSupplier Relations

Competitive Orientation:The view that negotiations between buyer and seller is a zero-sum (i.e., win/lose) game. Often used when a firm represents a significant share of the supplier’s sales or many substitutes are available. Example: WalMart

Cooperative Orientation:The view that the buyer and seller are partners. Includes sole sourcing. Often used with strategically important and/or high value-added components. Example: McDonald’s

Mixed strategy:Seeks to combine the advantages of the competitive orientation (e.g. low prices) with the cooperative orientation (e.g. few suppliers). Example: Dell Computer

33

SUPPLY CHAIN MANAGEMENTManaging Supply Chain Relationships

Long term relationships Arm’s-length Non-strategic Strategic

Characteristics Short-term contracts Price sensitivity Minimal interface

between firms Contractual

safeguards are sufficient to enforce agreements

Longer-term contracts Price sensitivity more broadly

defined Minimal to moderate interface

between firms Contractual safeguards are

sufficient to enforce agreements

Long-term contracts Relation-specific

investments Supplier performance more

broadly defined Self-enforcing agreements

are necessary for optimal performance

When to use Product is necessary but non-strategic

Commodity product Purchases account for

a small percentage of supplier’s production

Switching costs are low

Low value-added

Product is necessary but non-strategic

Dividing purchases across multiple suppliers reduces the ability of suppliers to achieve significant economies of scale

Vigorous competition can be achieved with few suppliers

Switching costs are relatively high Low value-added

Components help to differentiate the customer’s product

Customized, non-standard products

Multiple interaction effects with other inputs

High degree of supplier/ buyer interdependence

High value inputs

34

STRATEGIC MANAGEMENT OF THE SUPPLY CHAIN

Efficient Supply Chains:

The purpose of efficient supply chains is to coordinate the flow of materials and services so as to minimize inventories and maximize the efficiency of the manufacturers and service providers in the chain. Efficient supply chains work best when demand is predictable and products/services are stable. Example of competitive priority: low cost.

Responsive Supply Chains:

The purpose of responsive supply chains is to react quickly to market demands by positioning inventories and capacities in order to hedge against uncertainties in demand. Responsive supply chains work best when demand is unpredictable, new product introduction is frequent, and product variety is high. Examples of competitive priorities: development speed, fast delivery, customization, volume flexibility, high-performance design quality.

In addition: Innovations in information technology and other practices are facilitating the integration of the supply chain for greater efficiency and responsiveness and enabling “orchestrated” networks.

35

GLOBAL OUTSOURCING AND OFFSHORING

Specific considerations:

Capabilities/resources

Coordination requirements

Strategic control and risks

36

DESIGNING THE MULTIFACILITY NETWORKFacilities Decisions

Number

Size

Location

Specialization (focus)

By product line

By production volumes

By process stage

By geographic region

Layout – some key issues are efficiency, communication, and ergonomics

37

MANAGING THE MULTIFACILITY NETWORK

Infrastructural issues

Choosing and managing a network type

Horizontal network

Vertical network

Degree of (de)centralization

Centralized networks are more appropriate when different facilities:

Produce similar products

Serve similar customers who value uniformity

Operate in similar environments with similar constraints and/or resources, especially in the presence of significant economies

Decentralized networks are more appropriate when facilities:

Produce different products

Serve customers with different needs

Operate in very different local environments

38

SUPPLY CHAIN DYNAMICS

Horizontal networks

Vertical networks

The bullwhip effect – in which fluctuations in inventory and order levels tend to increase as one moves back up the channel from the final customer

Some causes of the bullwhip effect include lack of visibility/communication throughout the supply chain, delays in information flows, ordering and shipping lags.

The bullwhip effect can be alleviated by:

Reducing the number of stages in the supply chain

Communicating consumer demand directly up the supply chain

Reducing ordering and shipping delays

Reducing demand destabilizing practices

Counter consumer “gaming” during shortages

39

STRUCTURAL DECISIONSProcess Technology

Strategic implications of superior process technology implementation:

Accelerated time to market

Rapid ramp-up

Enhanced customer acceptance

Stronger proprietary position

Key process development decisions:

Approaches to integrating process and product development (e.g. design for manufacturability, prototyping)

Timing of technology transfer to operationsLocus of process development problem solving and learning by doing vs. learning before doing

Degree of local autonomy for developing and changing processes

40

INCREMENTAL IMPROVEMENT, REENGINEERING, AND PRODUCTIVITYDefinitions

The purpose of incremental process improvement and reengineering is to move operations toward the performance frontier by: 1) eliminating non-value added activities and steps in the process and/or, 2) moving to a new performance frontier.

Non-value added activities or steps can be characterized as waste (i.e., no potential to add value) or slack (i.e., resources in excess of what are required to get the job done, including buffers). The concept of “value added” can be thought of in the context of whether a customer would be willing to pay for that activity or step to be performed and/or whether a product or service’s value can be increased through that activity.

Incremental process improvement involves eliminating non-value added activities or steps while leaving the current process essentially intact.

Reengineering involves a fundamental rethinking and radical redesign of processes to improve performance dramatically in terms of cost, quality, service, and speed.

Elimination of non-value added activities or steps increases productivity, by definition.

41

SOURCES OF NON-VALUE ADDED ACTIVITIES

Why do non-value added activities or steps occur in processes?

Poor process and/or organizational design (dysfunctional uncertainty)

Historical artifact

Barriers to learning

Individual

Within group

Across groups

From outside the organization

To find and correct errors elsewhere in the process

Unclear understanding of “value” and “risks”

42

PROCESS IMPROVEMENT PROCEDURE

Discover where non-value added activities are in the process and prioritize improvement efforts

Flow charts (value stream mapping)

Brainstorming

Data collection

Take action based on the source of the non-value added activity

Process reviews

Remove barriers to learning

Continuous improvement

Reducing dysfunctional uncertainty

Implementing a systematic approach to process improvement

Increasing process knowledge

Reengineering projects often take more of a “clean-slate” approach than incremental process improvement and are typically higher risk and higher return.

43

LEAN SYSTEMS

DefinitionA lean system is one which minimizes the cost of buffering (i.e., “best buffer”).

Implementation

Reduce the need for buffers (uncertainty principle): Address dysfunctional uncertainty (e.g.

poor quality, poor planning processes)

Reduce excess buffers (efficiency principle): More efficient responses to strategic

uncertainty (e.g. cross-training, mass customization)

Lower-buffer practices in stable and predictable environments (e.g. JIT)

If buffers are needed, it is often possible to “swap” buffers (inventory, capacity, time) to minimize the disruption to the process/customer and provide the slack to address and eliminate problems.

44

Customization (Product Variety) withStandardized Operations (Mass Customization)

Since customization (product variety) creates uncertainty in operations, and uncertainty requires extra resources, customization is inherently less efficient than standardization.

However, it is sometimes possible to increase operational efficiency even with customization using standardization strategies (i.e., mass customization). Standardization strategies include:

Part standardization – Maximize component commonality across products

Process standardization – Delay customization as late as possible

Product standardization – Carry a limited number of products in inventory

45

CREATING AN IMPROVEMENT STRATEGY

What are the pros and cons of the following improvement strategies?

Tightly focused, top management-driven improvement programs

Single performance measure, dominant quadrant

Single performance measure, multiple quadrants

Broadly based, diffused improvement programs

Top management directed, staged improvement programs

46