MBA Notes: Operations Management

Key Topics:
- Outsourcing
- Production methods
- Controlling operations
- Maintaining quality
- Information systems

MIT Sloane defines operations management as the subject that 'deals with the design and management of products, processes, services and supply chains. It considers the acquisition, development, and utilization of resources that firms need to deliver the goods and services their clients want'. This, the school goes on to explain, ranges from strategic issues such as where plants are located down to tactical levels such as plant layout, production scheduling, inventory management, quality control and inspection, traffic and materials handling, and equipment maintenance policies.

To stay ahead, companies need to generate innovation, organize production, collaborate with other companies and manage the performance of activities, processes, resources and control systems used to deliver goods and services. Operations management is the catch-all title used to hold all these disparate fields together. Often in business schools the subject is afforded a distinct syllabus of its own, as for example is the case at Cranfield School of Management, Warwick and Bocconi, in Milan, Italy. At Cardiff Business School, Logistics and Operations Management are bundled together with a strong emphasis on 'Lean Thinking' and in Barcelona's Esade Business School 'Innovation' is the partner subject.

However the subject is taught, the foundations if not the content started out with the work of Frederick W Taylor. Usually referred to as the 'father of scientific management', he studied and measured the way people worked, searching out ways to improve productivity. His book, The Principles of Scientific Management (1911, Harper and Row, New York), showed how science could replace apprenticeship as the way to transfer knowledge about how tasks should be done. Though much misunderstood and misapplied – the Soviet Union adopted his methods as the foundation for its five-year plans – Taylorism, as his work became known, was the spur to the many variants and extensions that are today bundled under operations management.

The next big boost to the discipline took place with the introduction of mathematical models used during the Second World War to make maximum use of scarce resources. Fairly mundane tasks, such as removing bottlenecks in tank production, led to dramatic increases in output. More esoterically, operations research, as this branch of the subject became known, was used to work out the optimum size of convoy to evade destruction by German U-boats as well as the depth at which explosives would be most effective against the submarines themselves.
MBAs, unless they have a strong background in mathematics, are unlikely to be able to apply any of the techniques and tools described below without expert help. But they do need to be aware that such methods are on hand and so can recommend their application when the opportunity or relevant problem arises.

Outsourcing and the value chain
The classic opening question in any business analysis that MBAs will find themselves addressing with increasing frequency is: what business are we in? Later in that analysis will come a more fundamental and challenging question: what business should we be in?

The answers are also key to deciding what operations a business should and should not undertake itself, and the answer will not always be the same, as business competence and market opportunities change.

The business example shown in Figure below doesn't have to do all the activities, from creative design, through manufacture, to selling out from its own retail outlets. It is highly likely that there are other businesses better at certain elements of the process. For example, most businesses don't retail the products they manufacture, and even within the same industry different approaches are taken. Dell only sells direct via the internet, Apple sells via the internet, through a small number of company-owned outlets and through other retailers. IBM, having virtually created the personal computer industry in 1981, sold its PC division to the Chinese company Lenovo on 1 May 2005 for $655 million in cash and $600 million in Lenovo stock, moving away from personal consumers to concentrate on businesses.

FIGURE: Maternity clothes value chain

Outsourcing is the activity of contracting out the elements that are not considered core or central to the business.

There are obvious advantages to outsourcing: the best people can do what they are best at. But the approach can get out of hand, if left unmanaged. In 2008, IBM completed a major overhaul of its value chain and for the first time in its century-long history created an integrated supply chain (ISC) – a centralized worldwide approach to deciding what to do itself, what to buy in and where to buy in from. Suppliers were halved from 66,000 to 33,000; support locations from 300 to 3 global centres, in Bangalore, Budapest and Shanghai. Manufacturing sites reduced from 15 to 9, all 'globally enabled' in that they can make almost any of IBM's products at each plant and deliver them anywhere in the world. In the process IBM has lowered operating costs by more than $4 billion a year.

Quality control is one strategic issue when it comes to outsourcing, and an emerging danger with the arrival of the 'socially minded customer' is that people are looking more closely at companies and their products before buying from them. Getting garments made cheaply by child labour is very much an issue on consumers' radar. So while outsourcing plays a vital role in operations, it still has to be managed and to conform with corporate ethical standards.

Production methods and control
Manufacturing has come a long way since Adam Smith's observation in his book, An Inquiry into the Nature And Causes of the Wealth of Nations (1776), that:
The greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity, and judgment with which it is anywhere directed, or applied, seem to have been the effects of the division of labour…. I have seen a small manufactory of this kind where ten men only were employed, and where some of them consequently performed two or three distinct operations. But though they were very poor, and therefore but indifferently accommodated with the necessary machinery, they could, when they exerted themselves, make among them about twelve pounds of pins in a day. There are in a pound upwards of four thousand pins of a middling size. Those ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day. But if they had all wrought separately and independently, and without any of them having been educated to this peculiar business, they certainly could not each of them have made twenty.

By Smith's calculations, organizing production efficiently increased output by 2,400 times, leaving the market itself as the primary limiting factor. Since then the hunt has been on for ever more efficiencies in the methods of production. The main production methods employed today are:

- One-off production is when a single product is made to the individual needs of a customer, for example a designer dress. This is very much the pre-Smith way in which everything was made, often without the use of any machinery.
- Batch production involves the making of a number of identical products at the same time, then moving on to make a different product later. For example, a small food processing factory could make sausage rolls in the morning and pizzas in the afternoon. This approach requires some basic machinery and Smith would probably recognize this process were he alive today.
- Mass production is used for larger-scale production using machinery, often many different machines, for much of the work where individual tasks are carried out repetitively. This is an efficient and low-cost method of production for small and medium-sized businesses.
- Continuous-flow production produces the high volumes required by larger companies. These are highly automated and their cost usually requires them to be run 24/7. By reducing the workforce needed this eliminates one of the blockages that Smith saw: 'the improvement of the dexterity of the workman necessarily increases the quantity of the work he can perform'.
- Computer-aided manufacture (CAM) is a continuous-flow production method controlled by computers, such as used in the motor industry.
- Lean manufacturing is an approach ascribed to Toyota, where they sought to eliminate or continuously reduce waste – that is, anything that doesn't add value.

Waste in the production process taking the 'lean' approach is categorized under such headings as:

- Transport: Keep process close to each other to minimize movement.

- Inventory: Carrying high inventory levels costs money and, if too low, orders can be lost. 'Just in time' (JIT) manufacturing should be aimed for.- Motion: Improve workplace ergonomics so as to maximize labour productivity.

- Waiting: Aim for a smooth, even flow so that staff and machines are working optimally, reducing downtime to a minimum.

- Defects: Aim for zero defects as that directly reduces the amount of waste.

Production scheduling
Production scheduling is the process used to get the optimum amount of output at the lowest cost. Its success is measured by being able to meet delivery promises while hitting profit margin objectives. It achieves this by identifying possible resource conflicts; directing sufficient labour and machinery to tasks on time; accommodating downtime and preventative maintenance schedules; and minimizing stock and work in progress levels. A production schedule also gives the production team explicit targets so that supervisors and managers can measure their performance.
The techniques used to facilitate scheduling which an MBA should understand include the following.

Gantt Charts
Henry Gantt, a mechanical engineer, management consultant and associate of Frederick Taylor, showed how an entire process could be described in terms of both tasks and the time required to carry them out. He developed what became known as the Gantt chart, to help with major infrastructure projects, including the Hoover Dam and US Interstate highway system, around 1910. By laying out the information on a grid with tasks on one axis and their time sequence along the other it was possible to see at a glance an entire production plan as well as highlight potential bottlenecks.

Gantt charts can be used for any task, not just production scheduling, as in Figure below, giving an example of how a website design project could be planned, demonstrates.

FIGURE: Gantt chart showing weekly tasks for a website design project


Critical path method (CPM)
A more sophisticated way to schedule operations was developed in the late 1950s. DuPont, the US chemical company, first used CPM to help with shutting down plants for maintenance. Later, the US Navy adapted it and improved it for use on the Polaris project.

CPM uses a chart (see Figure) showing all the tasks to be carried out to complete a scheduled activity, the sequence in which they have to be carried out and how long each event, as tasks are known, will take to be completed. The critical path is the route through the network that will take the longest amount of time. The significance of the critical path is that any delays in carrying out events on this path will delay the whole project. Tasks not on the critical path have more leeway, and may be slipped without affecting the end date of the project. This is called slack or float.

FIGURE: Critical path method applied

The steps in the critical planning method process are:
- Identify the events.
- Decide on the sequence in which they must be carried out.
- Draw the network.
- Calculate the completion time for each event.
- Identify the longest and hence critical path.
- Keep the chart updated as events unwind.

Programme evaluation and review technique (PERT) and an activity network, also known as an 'activity-on-node diagram', are more sophisticated forms of CPM that allow for a degree of randomness in activity start and completion times.

Linear programming
In 1947, George Dantzig, an American mathematician, developed an algorithm (a mathematical technique) that could help resolve problems involving operational constraints. His algorithm could, for example, help with situations where several products could be produced, but materials, labour or machine capacity is insufficient to make all that's demanded – the challenge in that last case being to decide what mix of products can be produced that will make the maximum profit and then plan accordingly. Unfortunately, the iterative nature of producing solutions using Dantzig's algorithm proved so tedious that until cheap computers arrived it remained an academic idea of interest only to mathematics students.
The Dantzig algorithm comprises an objective, the quantity to be optimized, for example profit, nutrient content, water flow or production of one particular product out of several, and any variables and constraints on them, for example a certain minimum amount of water must flow.

Excel incorporates a Solver add-in feature to solve standard linear programming problems.

It is not usually installed when Excel is first loaded so to add this facility:
- Select the menu option Tools | Add_Ins (you will need your original installation disk).
- From the dialog box check Solver Add-In.
- Access to the Solver option is now available from the new menu option Tools | Solver

These websites provide more information on using linear programming in operations:
- Economics Network (www.economicsnetwork.ac.uk/cheer/ch9_3/ch9_3p07.htm) provides a detailed explanation and Excel worked example.
- IBM (www-128.ibm.com/developerworks/linux/library/l-glpk1) has a worked example.

Queuing theory
Agner Krarup Erlang, a Danish engineer who worked for the Copenhagen Telephone Exchange, had the problem of estimating how many circuits were needed to provide an acceptable telephone service. He found out by empirical observation that the relationship between the number of circuits and the number of telephone customers who could be provided with an acceptable level of service was not as obvious as it at first seemed. For example, in his experiments where one circuit was provided on a network, adding just one more could reduce waiting time by over 90 per cent, rather than just halving it as simple logic might suggest. He published the first paper on queuing theory in 1909 and this new operation scheduling technique was born.
 

Queuing theory can help answer operational questions such as these for a service business such as a restaurant, bank or call centre: Given the present resources:
- How long will a customer have to wait before they are served?
- How long will it take for the service to be completed?
- How big a waiting area will be needed for the queue?
- What is the probability of a customer having to wait longer than a given time interval before they are served – the classic service standard problem calling for, say, 'all telephone calls to be answered within 10 rings'?
- What is the average number of people in the queue?
- What is the probability that the queue will exceed a certain length? This can cause congestion, say in a bank or supermarket.
- What time period will the server be fully occupied for and how much idle time are they likely to have, bearing in mind this is a cost to be minimized?

The technique can be used for any operational problem where efficiency is determined by calculating the optimal number of channels required to meet a level of demand. J E Beasley, formerly of the Tanaka Business School (Imperial College) and currently Professor of Operational Research at Brunel University, provides helpful notes on the subject at this web link (http://people.brunel.ac.uk/~mastjjb/jeb/or/queue.html).

Inventory management
High inventory levels are popular with marketing departments, as having them makes satisfying customers an easier task; they are less popular with production departments who have to carry inventory costs in their budgets. Finance departments insist on having the lowest possible stock levels, as high stock pushes working capital levels up and return on investment down. (Financial ratios in accounting) This tussle between departments is a strategic issue that has to be resolved by top management.

The birth of Waterstone's, the bookshop business founded by Tim Waterstone, fortuitously a marketing visionary, qualified accountant and the company's managing director, provides an interesting illustration of the dimension of the stock control issue. Until the advent of Waterstone's the convention had been to store books spine out on shelves, in alphabetical order, under major subject headings – Computing, Sport, Travel. This had the added advantage of making it easy to see what books needed reordering and stock counts were a simple process. Waterstone, however, knew that 'browsers', the majority (60 per cent, according to his research) of people who go into bookshops to look around, had no idea what book they wanted, so didn't know where to start looking. His differentiating strategy was that as well as following the conventional model of having books on shelves, he scattered the books in piles around the store using a variety of methods: new books in one pile, special offers in another. Sales and profits soared, sufficient to more than compensate for the near doubling of book stock.

Inventory categories
There are three different categories of inventory that a business needs to have and keep track of:

- Finished goods: These are products ready to ship out to customers. For Apple these would be computers, iPods and so forth, for General Motors vehicles and for a baker loaves of bread.
- Work in progress (WIP): These are products in the process of being completed. They have used up some raw materials and had workers paid to start the manufacturing process, so the cost will reflect those inputs. For General Motors WIP would include vehicles awaiting paint or a pre-delivery inspection.
- Raw materials: These are the basic materials from which the end product is made. For General Motors this would include metal and paint, but it could also include a complete bought-in engine for the vehicles in which they use third-party power units.

Economic order quantity (EOQ)
Businesses have to carry a certain minimum amount of stock to ensure that the production pipeline works efficiently and likely demand is met. So the costs associated with ordering large quantities infrequently and so reducing the order cost but increasing the cost of holding stock has to be balanced with placing frequent orders, so pushing the costs in placing orders up, but reducing stock holding costs. EOQ is basically an accounting formula that calculates the point at which the combination of order costs and inventory carrying costs are the least and so arriving at the most cost-effective quantity to order.

The formula for EOQ is:

Where: R = Annual demand in units; O = Cost of placing an order; C = Cost of carrying a unit of inventory for the year.

Quality
As well as using efficient operation and control procedures an organization has to deliver a quality product or service. Quality in operations does not carry quite the same meaning as it does in, say, marketing, where it signifies something of a high standard. In operations, quality means that something meets a set of prescribed standards and performs as expected. In other words, promises are made and kept. But quality is also part of the efficiency equation too. Quality below standard can lead to high waste, disrupted schedules and lost orders.

Toyota, an early adopter of 'Lean Manufacturing' and 'Just in Time Production', both cost-reduction strategies, hit the buffers in January 2010 when they had to announce a recall of up to 1.8 million cars across Europe, including about 220,000 in the United Kingdom, following an accelerator problem. The company share price sagged by US $25 (£15.9/€18) billion when the news broke. Akio Toyoda, the company's president appeared before a US Senate hearing to apologize, where he explained that the company's quality problems had been caused by its growth outstripping the speed with which it could develop the appropriate technical expertise. He went on to say that the company's priorities, traditionally ranked as safety, quality and volume, had become confused, with the last moving to a higher position.
The ideas, concepts and techniques that drive thinking on quality come from these management ideas.

Inspection
Frederick W Taylor (see above) in his book The Principles of Scientific Management stated that one of the clearly defined tasks of management was to ensure that no faulty product left the factory or workshop. This led to a focus on the detection of problems in the product, testing every item to ensure that it complied with product specifications. The task was carried out at the end of the production process using specially trained inspectors. The 'big idea' emerging from this approach was defect prevention as the means to ensure quality control. Inspection still plays a part in modern quality practices, but less as an answer and more as one tool in the toolkit.

Philosophy
W Edwards Deming (www.deming.org), an American statistician and member of the faculty at the New York University Graduate School of Business and Columbia University, where he taught up until 10 days before his death in 1993, is considered as the founder of modern quality management. He took the inspection aspect of quality control a stage further with the introduction of statistical probability techniques. His view was that quality should be designed into products and processes and that mass inspection was redundant as statistical sampling using control charts will signal when a process is out of control.

Deming is remembered most for his 14-point 'System of Profound Knowledge'. In this he explains that becoming a quality-driven organization requires everyone, starting with top management, 'to fully embrace a new way of thinking that involves seeking the greater good for everyone involved and implementing continuous improvement'. He wanted slogans, targets and numerical targets removed and emphasized to all employees in the company that if change is to be made and processes are to be continuously improved then it's down to them to achieve it. Deming's ideas were adopted enthusiastically by the Japanese whose economy, having been crippled by the war (WW2), was ready to embrace radical change. It was not until the Japanese motor industry was cutting deep into its home market that US industry woke up to Deming's message on quality.

Total Quality Management, Quality Circles and Six Sigma have become buzzwords for variations and extensions of Deming and other pioneers' work on quality.

The latter term was in use in the 1920s where mathematicians used it as the symbol for a unit of measurement in product quality variation. But it was not until the mid-1980s that engineers in the US company Motorola used 'Six Sigma' first as an informal name – later as a brand – for their initiative aimed at reducing defects in production processes. The name Six Sigma was chosen because mathematically it represents 3.4 parts – or defects – per million, an extremely high level of quality.

Information technology
Information technology is universally seen as important by all major business schools, but taught differently and with a different level of emphasis by all. At London Business School the course is relatively short, entitled 'IT for Business Value', and has two intended outputs: to enhance students' confidence in choosing the right technology for meeting business needs; and to examine issues involved in managing the implementation of business systems. At Wharton the Management Information Systems (MIS) course on the MBA programme covers 'the practice of using computer and communication systems to solve problems in organizations and provide the essential skills and technology-based insights needed in order to manage effective problem solving with information technologies and systems (IT&S), and to extract the most value from an actual or potential information system'. The course itself is organized around several 'hands on' cases or projects, through which student teams become familiar with important information technologies, including databases and the internet. MBAs will be expected to have some appreciation of these key issues, though they will usually expect to be able to rely on professional expertise either from within the organization or outside.

Supply chain channel structures
A channel is a set of businesses that are involved in making a product or service available for use or consumption by a business or another end user. Such businesses may be independent, owned by others in the channel, they may co-exist, compete or collaborate in a wide variety of ways.

The members of a channel carry out some or all of these functions:
- Promotion and contact including advertising, creating awareness and providing contact resources.
- Information on the product or service.
- Matching the product or service to specific customer requirements.
- Risk sharing in elements of the transaction.
- Negotiation in setting the terms of trade and price.
- Financing the cost of the transaction, say by providing credit.
- Manufacturing and/or the physical distribution of the product or execution of the service.

There are four main types of channel.

Conventional
This is when each link in the chain is independent of the other and in effect competes for a slice of the value in getting the end product to the end consumer or user. There are usually four links in the chain (see Figure below), however on occasions one link will leap frog over the other.

FIGURE: Operating channels

Horizontal marketing systems (HMS)

This occurs where two or more non-competing businesses at one level in the chain combine together to market an existing product, or create a new channel to market because they lack physical or capital resources, an established brand name or to secure economies of scale. The music partnership started by Apple and Starbucks in 2007 is one such example. The aim was to allow Starbucks customers to wirelessly browse, preview, buy and download music from iTunes Music Store onto anything running iTunes. Apple's brand leadership in digital music combined with Starbuck's loyal customer base was expected to create a win–win situation for both parties. Apple hoped to sell a million songs in the first six months but passed that threshold in six days. Starbucks benefited from higher sales and even stronger customer loyalty.

Vertical marketing systems (VMS)
This strategy integrates producer, wholesalers and retailers working in one unified system. The goal of vertical marketing is to eliminate unnecessary competition between chain participants as occurs, say, when producers and retailers slug it out to get better prices from each other. VMS gives all those involved control but not necessarily ownership. Marks & Spencer, for example, provides considerable amounts of technical assistance to its suppliers, as well as providing detailed sales and stock forecast, but does not own them. VMS itself comes in three forms.

Corporate
This arises when one member of the chain owns some or all of other elements.

For example 'forward' integration, which arises where a supplier, such as Apple, owns its own retail outlets. 'Backward' integration arises when a retailer owns its own suppliers. Coca Cola, who managed to grow its profits by over 50 per cent during a period of near slump conditions thanks to sales in China and India, owns some 400 bottling plants around the world, including one launched in Malaysia in 2011. Spanish clothing chain Zara, outflanks its competitors such as Gap and Benetton by having control over almost every element of the supply chain from design and production (it makes nearly half of all the fabrics it uses itself) through to worldwide distribution and retailing. Zara can get a new line to market in just one month, some nine times faster than the industry average, which gives it a significant market edge in a fashion dominated industry.

Contractual
This is where independent firms at different levels of the distribution chain agree to co-operate in return for specific advantages. Retail co-operatives are one example of CVMS, where independent retailers band together to increase their buying power, improve their operating systems or to create distinctive brands. The International Co-operative Alliance, the trade body representing this sector, has 230 member organizations from 92 countries active in all sectors of the economy. Japan is home to the No 1 ranked co-op, Zen-Noh, a national federation of agriculture and food cooperatives with revenue of over US $60 billion.

Franchising
Franchising is the most prevalent form of CVMS operating in hundreds of business sectors, servicing both those providing service such as advertising, accounting and web design, as well as products – Ziebart in car protection and the near ubiquitous McDonalds. A PricewaterhouseCoopers study shows that in the United States alone there are more than 760,000 franchised establishments generating in excess of US $1.5 trillion in economic activity and producing one out of every seven jobs.

Administered
These occur where one or at most a few members dominate the distribution chain and use that position to co-ordinate the other members' activities. Any part of the chain can dominate. Big retailers such as Wal-Mart, Sainsbury's, Toys 'R' Us and Carrefour can leverage their strength on manufacturers to such an extent they can make them bid for shelf space. Giant consumer firms with strong brands – Procter & Gamble, Kraft, Coca-Cola, for example, can exert a similar pressure on retailers. Firms away from the fast moving consumer sector such as Sony and Samsung also exert power over the distribution chain.

Samsung achieved its strong position by ditching their dozen or so subsidiary brands – Wiseview, Tantus and Yepp, none of which meant much to consumers, to put all its resources behind the Samsung name.

Multiple channels
Major companies almost invariably use several channels to market, most noticeably clicks and bricks firms. There are significant benefits to using more than one route to market if they deliver superior benefits to a particular market segment and don't erode the brand value. Dorling Kindersley, prior to their acquisition by Pearson PLC, had a part plan operation promoting their books along the lines of Avon and other multi-level marketing companies. Pearson, however, cut out this channel immediately post acquisition as it did not correspond with the image of their high street branding.

Logistics
The goal of an operating logistics system is to manage the whole process of getting products to customers in an efficient and cost-effective manner to meet marketing goals; and to get faulty or unwanted products back. This interfaces with a host of related areas of business including physical transportation, warehousing, relationships with suppliers and inventory and stock management.

Some important considerations in logistics include:
- Just in Time (JIT) aims to reduce the need for warehousing through accurate sales forecasting. All parties in the distribution channel carry minimum stock and share information on demand levels.
- Vendor Managed Inventory (VMI) and Continuous Inventory Replenishment Systems (CIRS) requires customers to share real time data on sales demand and inventory levels with suppliers.

Information systems (IS)
If the internet is the external operations powerhouse, IS systems are the mirror image, handling all the data needed to run a 21st-century organization.

Every part of a business collects data; production monitors output efficiencies, stock levels and quality; finance gets the accounts, marketing gets figures on customer demand and competitor market share; HR keeps track of pay, training, accidents at work and sickness. But none of this data is much use unless there is an integrated system that can integrate, collate, analyse and disseminate this information in a timely manner and in a format that can be understood and used by operating management.
To be effective, IS needs an appropriate amount of hardware and software, as firms that effectively exploit the power computer information systems can deliver can outperform others. It can play a major role in opening new distribution channels, streamlining supply chains and providing efficient electronic markets.

Mainframe/legacy systems, PCs, workstations, intranets and the internet, as well as local area networks (LANs) and wide area networks (WANs), customer relationship management (CRM) and the ubiquitous Moore's Law stating that processing power doubles every 18 months while costs halve, are all vital elements in an MBA's IS vocabulary.