MD375 Operations & Competition Class Notes

MD375Operations & CompetitionClass Notes Fall 2009 Professor Field

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 that are consistent with the existing ways 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.

Levels of Strategy Corporate What business are we in? Divisional (business) How do we compete? Fin HR Mkt Prod Devpt Ops Role of each function?

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 Components of the Definition

Key Operations Principles • Aggregation Principle • The higher the level of aggregation of resources and information, 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.

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). The categories, dimensions, and definitions of quality are as follows: • Relative Quality • 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 smells • For 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)

Competitive PrioritiesQuality (cont.) • Functional quality: • Reliability • The probability of a product malfunctioning or failing within a specified time period • For 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 personnel • For products – also, the ease of repair Improvements in functional quality result from a reduction in process variation.

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.

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.

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 high-velocity environments with short product life cycles.

Operations Strategy FormulationContent • Mission • The 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. • Objectives • Operations 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 strategies • Structural 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. • Policies • Structural and infrastructural decisions are stated in tactical terms in support of the operational strategies. • Distinctive competence • The 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.

A Marketing-Oriented View of Operations Strategy • Development of an operations strategy: • Define corporate objectives. • Determine marketing strategies to meet these objectives. • Assess how different products or services qualify in their respective markets and win orders against competitors. • Establish the most appropriate process to produce or deliver these products or services (structural/infrastructural decisions). • Provide the operations infrastructure to support production and delivery. The last two steps constitute the operations strategy.

Order Qualifiers and Order Winners • 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.

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.

McDonald’s Example • McDonald’s operations mission: • McDonald’s operational strategies (structural): • Capacity • Growth as needed through additional stores - but capacity added carefully • Well-utilized - franchisee's well-being depends on heavily utilization • Facilities • Distributed facilities, each facility being very similar to the next, all focused around a similar menu with some local variations (especially by country) • Vertical integration (sourcing) • Partnership arrangement • Long-term relationship with suppliers to promote innovation and quality improvement • Information/process technology • High degree of process understanding, emphasis on "fool-proof" processes • A leader in the technology of fast-food delivery

McDonald’s Example(cont.) • McDonald’s operational strategies (infrastructural): • Workforce • Franchisees: well-trained, carefully selected, entrepreneurs • Operators: high-turnover, lower-paid • Organization • Guidelines provided by corporation, but franchisees push to locally optimize • Control/quality systems • Centralized buying • Bulk contracts • "Push" system for basic supplies, "pull" system day-to-day in the restaurants

Criteria for Evaluating an 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

Evolution of Operations StrategyStages • Stage 1 • Internally neutral - Minimize operation's negative potential. • Stage 2 • Externally neutral - Achieve parity with competitors. • Stage 3 • Internally supportive - Provide credible support to the business. • Stage 4 • Externally supportive - Pursue an operations-based competitive advantage.

Stages of Operations StrategyStages 1 and 2 • Stage 1 • Internally neutral • Operations not involved in strategy • Keep operations under control - detailed measurement • Fight fires, eliminate problems • Operations is kept flexible and unfocused • Short-term performance is emphasized • Top management is not involved in operations • Stage 2 • Externally neutral • Industry practice is followed • Capital investment to maintain or gain position • Keep up with competition in operations • Planning horizon is one business cycle • Use industry-wide wage rates

Stages of Operations StrategyStages 3 and 4 • Stage 3 • Internally supportive • An operations strategy is formulated and pursued • Keep operations in step with business strategy • Operations investments are screened for consistency with business strategy • Longer-term trends are addressed systematically • Consistency within operations • Translate business strategy into operations terms • Stage 4 • Externally supportive • Anticipate new operations practices and technology • Operations is an equal partner in business strategy • Operations is involved upfront in market decisions • Operations contributes to other functions • Structure and infrastructure are concerns to top management • Teamwork and involved workforce • Operations is innovative • Competitive strategy rests on operations capability • Functions of the firm are well integrated

Attacking and Defending through 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

Information-Intensive Industries and E-CommerceCharacteristics 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.

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.

Issues in Service Operations(cont.) • 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.

Customer Contact Model Potential facility efficiency • 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. • Employ contact reduction strategies where appropriate. • Employ contact enhancement strategies where appropriate. • Employ traditional efficiency improvement techniques (TQM, BPR, etc.) to improve low contact operations, especially for Cost Leader services. Most services are a combination of high and low contact and can be designed for both customer satisfaction and efficiency by following these steps:

Customer ContactBehavioral Considerations 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.

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.

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.

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

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-term • Static 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

Optimal Economic Size

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?

Developing the Supply ChainInsourcing vs. Outsourcing Considerations

Developing the Supply ChainSupplier Relations • Competitive Orientation: • The view that negotiations between buyer and seller is a zero-sum 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: Toyota

Managing Supply Chain Relationships

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. • 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.

Global Outsourcing and Offshoring • Specific considerations: • Capabilities/resources • Coordination requirements • Strategic control and risks

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

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

Supply Chain Dynamics • Horizontal networks • Vertical networks • Thebullwhip effect is a tendency towards increased fluctuations in inventory and order levels 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

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 operations • Locus of process development problem solving and learning by doing vs. learning before doing • Degree of local autonomy for developing and changing processes

Incremental Improvement, Reengineering, and Productivity - Definitions • 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. • Reengineeringinvolves 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.

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”

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.

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) Lean Systems Definition: A lean system is one which minimizes the cost of buffering (i.e., “best buffer”). Implementation 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.

Customization (Product Variety) withStandardized Operations (Mass Customization) Since customization (product variety) creates uncertainty in operations, and uncertainty requires extra resources, customization is more resource-intensive 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

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

MD375 Operations & Competition Class Notes