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Part 2.1. Process Choice

POSITIONING STRATEGY

Fig. 2.3

Fig. 2.4

A Continuum of Strategies

Fig. 2.5

Manufacturing Strategies Based on Positioning Strategy

Make-to-Stock Strategy

Assemble-to-Order Strategy

Make-to-Order Strategy

Positioning Strategy and Competitive Priorities

TABLE 2.1. Linking Positioning Strategy with Competitive Priorities

PROCESS TRADEOFFS

WHAT IS PROCESS MANAGEMENT?

MAJOR PROCESS DECISIONS

Process Choice

Fig. 3.1

Project Process

Batch Process

Line Process

Continuous Process

Vertical Integration

Make or Buy

Own or Lease

Resource Flexibility

Work Force

Equipment

Customer Involvement

Self-Service

Product Selection

Time and Location

Capital Intensity

Fixed Automation

Flexible Automation

Relationships Between Decisions

Economies of Scope

Part 2.2. Process Design

BREAK-EVEN ANALYSIS

Evaluating Products or Services

Example A.1. Finding the Break-Even Quantity

Example A.2. Sensitivity Analysis of Sales Forecasts

Example A.3. Break-Even Analysis for Make-or-Buy Decision

DESIGNING PROCESSES

Process Reengineering

Reengineering

Critical Processes

Strong Leadership

Cross-Functional Teams

Information Technology

Clean Slate Philosophy

Process Analysis

Process Improvement

Flow Diagrams

Hot Words


Part 2.1. Process Choice

POSITIONING STRATEGY

Figure 2.3 shows how corporate strategy is translated into strategic choices, design, and operating decisions. In this section we focus on the core of operations strategy: positioning strategy.

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Based on the firm's competitive priorities for its products or services, the operations manager must select a positioning strategy, which determines how the operations system is organized. A system organized around the processes used to produce the product or service is called a process-focused strategy. A system organized around the product or service itself is called a product-focused strategy. Process-focused and product-focused strategies are the extremes; many other strategies fall between the two.

This fundamental decision sets the stage for all operations decisions that follow. Positioning strategy does not define the specific processes to use or the specific resources to organize; rather, it identifies the nature of the operations that are required to accomplish the goals of the organization. It also serves as a check on whether the firm is organized in a manner consistent with the markets it is trying to serve.

Firms using a process-focused strategy tend to produce a wide range of customized (made-to-order) low-volume products or services. Different types of machines or employees are grouped to handle all products or services requiring a specific function to be performed, and various products or services move from one process to another. For example, in a manufacturing firm, drilling and welding machines would be located together. In a bank, separate departments would handle accounts payable and credit checks. In other words, the equipment and employees are organized around the process. However, each product or customer may not need every process. This situation creates an unpredictable jumbled flow pattern of products or customers through the facility, as shown in Fig. 2.4(a). Products or customers may have to compete for resources: Note that products 1 and 3 must compete for the same resources at operation A. Note also that product 1 follows an A-B-D routing pattern, product 2 follows a D-E-C routing pattern, and product 3 follows an E-F-A routing pattern. When a company is producing customized, low-volume products or services, organizing resources around similar processes is most efficient because dedicating resources to individual products or services would lead to duplication of many operations and leave resources idle.

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A job shop is a production system with a process focus that takes on many types of small jobs and competes on the basis of resource flexibility. The flows of the product through the system are jumbled because each product can require a different sequence of resources. The more than 100,000 small job shops in the United States supply an estimated 75 percent of all machined metal parts used in products made by larger companies. Job shops employ the bulk of blue-collar workers. Other firms typically using a process-focused strategy include building contractors, law firms, architectural firms, and general medical practices.

At the other extreme is the product-focused strategy, in which the equipment and work force are organized around the product or service. A product-focused strategy fits high-volume production of a few standard products. Packaging and assembly operations often make products appear more diverse than they really are. For example, the same soft drink might be packaged in a bottle or a can, offering a degree of variety to the customer. The plant may have a line for bottles and another for cans. This type of production system is often called a flow shop because all products follow in a linear pattern. This system duplicates operations, but products and services don't have to compete for limited resources. For example, in Fig. 2.4(b), there are two operations A in the facility, one dedicated to product 1 and one to product 3. The routing pattern for each of the three products is straightforward, with several operations devoted to the same product or service. Firms typically using a product-focused strategy include fast-food restaurants, automobile assembly plants, and car washes, as well as electronic product manufacturers.

The line flows and high volumes of product-focused operations lend themselves to highly automated facilities. Such facilities can operate around the clock to offset the huge capital investment required. Borden's pasta-making plant in St. Louis is the nation's largest, making 250 million pounds annually. The 300,000 square foot plant is a marvel of simplicity. Grain is milled into flour at an adjacent mill and sped to the plant a few hundred yards away via giant pneumatic tubes. The flour is then distributed to one of eight pasta-making machines, each costing $5 million and capable of producing 6000 pounds of pasta per hour. A sophisticated touch screen computer system is used to schedule the machines. After pressing and drying, the mixture is forced through large dies, some weighing more than 200 pounds, to produce one of 65 different shapes of pasta. The product goes on to storage bins, each capable of holding 10,000 pounds of pasta until it is ready for packaging. Only 230 workers are needed to operate the plant. Production processes are automated so that the workers never touch the product. Packaging is computerized: 1200 different shapes and brands are sorted, put in the right boxes, and automatically stored. The plant operates 24 hours per day, 363 days a year.

A Continuum of Strategies

A firm's positioning strategy can vary from one facility to another, or even between areas of a single facility, depending on the product or service produced at each one. Further, numerous strategies exist between the two extremes of process focus and product focus. This continuum of choices is represented in Fig. 2.5 by the diagonal from the process focus to the product focus. The most frequently occupied positions are on this diagonal. Few firms position themselves very far outside the diagonal, and virtually none occupy positions in the white area.

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The intermediate strategy lies halfway between the process focus and the product focus strategies. Product or service volumes are relatively high, and the system must be capable of handling several customer orders at a time. In manufacturing, if demand is sufficiently predictable, operations can produce some standardized products or components in advance of receiving actual customer orders. The general flow pattern is still jumbled, but dominant paths emerge. For example, in some parts of the facility, the manager may dedicate resources to one product or group of similar parts. Types of businesses that utilize this strategy include heavy equipment manufacturers, garment manufacturers, caterers, automobile repair shops, and small branch offices of service facilities such as brokerage firms and advertising agencies.

Although service operations managers can identify the appropriate place to position their operations relative to service volumes, the degree of customer con- tact is another factor they should consider. When services must be tailored to each customer's needs, a process-focused strategy allows the firm to achieve customized, low-volume production involving high degrees of face-to-face contact. Such would be the case for a hair stylist, dentist, or doctor. An intermediate strategy fits better when face-to-face contact and back-room processing are balanced.

For example, in the front office of a bank customers and employees interact frequently with one another, while in the back office there is little customer contact and high use of automation and high-volume production methods to process volumes of checks and check credit references. A product-focused strategy is best in service facilities involving standardized services, high volumes, and no face-to-face contact. Such facilities include home offices, distribution centers, and power plants.

Manufacturing Strategies Based on Positioning Strategy

Three fundamental manufacturing strategies are based on positioning strategy: make-to-stock, assemble-to-order, and make-to-order.

Make-to-Stock Strategy. Product-focused manufacturing firms tend to use a make-to-stock strategy, in which the firms hold items in stock for immediate delivery, thereby minimizing customer delivery times. This strategy is feasible because most product-focused firms produce high volumes of relatively few standardized products, for which they can make reasonably accurate forecasts. Examples of products produced with a make-to-stock strategy include garden tools, electronic components, soft drinks, and chemicals.

The term mass production is often used to define firms using a make-to-stock strategy. Because their environment is stable and predictable, mass-production firms typically have a bureaucratic organization, and workers repeat narrowly defined tasks. The competitive priorities for these companies are typically consistent quality and low costs.

Assemble-to-Order Strategy. The assemble-to-order strategy is an approach to producing products with many options from relatively few major assemblies and components, after customer orders are received. The intermediate positioning strategy is appropriate for this situation because high-volume components and major assemblies can be produced with a product-focused strategy, whereas components and assemblies with lower volumes can be produced with a process-focused strategy. The assemble-to-order strategy addresses two competitive priorities: customization and fast delivery time. Operations holds assemblies and components in stock until a customer order arrives. Then, the specific product he customer wants is assembled from the appropriate assemblies and components. Stocking finished products would be economically prohibitive because the numerous possible options make forecasting relatively inaccurate. For example, a manufacturer of upscale upholstered furniture can produce hundreds of a particular style of sofa, no two alike, to meet the customer's selection of fabric and wood. Other examples include upscale farm tractors, automatic teller machines, and industrial scales.

Make-to-Order Strategy. Many process-focused firms use a make-to-order strategy, whereby operations produces products to customer specifications. This strategy provides a high degree of customization. Because most products, components, and assemblies are custom-made, the production process has to be flexible to accommodate the variety. Job shops use a make-to-order strategy. Examples of products suited to the make-to-order strategy include specialized medical equipment, castings, and expensive homes.

The ultimate use of the make-to-order strategy is mass customization, or dynamically creating the processes necessary to produce custom products. In the ideal mass-customization firm, the people, processes, and technologies are reconfigured continually to give customers exactly what they want in an ever-changing environment. Managers must create an environment where these resources can be integrated rapidly in the best combination or sequence for the custom products. The goal of mass-customized firms is low-cost, high-quality, customized products.

However appealing the concept, mass customization is relatively untested. Achieving low costs is a big hurdle, and the required organizational changes are severe. Nonetheless, as some firms are attempting to implement it, this strategy is something to watch.

Positioning Strategy and Competitive Priorities

Operations managers use positioning strategy to translate product or service plans and competitive priorities into decisions throughout the operations function. Table 2.1 shows how positioning strategies relate to competitive priorities. In process-focused operations, the emphasis is on high-performance design quality, customization, and volume flexibility. Low-cost operations and quick delivery times are less important as competitive priorities, although these features could be used to gain a market niche. Thus a process focus meshes well with product or service plans favoring customization, short life cycles, or early exit from the life cycle. A product focus is appropriate when product plans call for standard products or services and long life cycles. Low-cost operations, quick delivery times, and consistent quality are the top competitive priorities.

TABLE 2.1. Linking Positioning Strategy with Competitive Priorities

Positioning Strategy

Process Focus

Product Focus

More customized products and services, with low volumes More standardized products and services, with high volumes
Shorter life cycles Longer life cycles
Products and services in earlier stages of life cycle Products and services in later stages of life cycle
An entrance-exit strategy favoring early exit An entrance-exit strategy favoring late exit
High-performance design quality Consistent quality
More emphasis on customization More emphasis on low cost and volume flexibility
Long delivery times Short delivery times

PROCESS TRADEOFFS

One essential issue in the design of a production system is deciding what process to use in making the products or providing the services. Deciding on a process involves many different choices in selecting human resources, equipment, and materials. Processes are involved in how marketing prepares a market analysis, how accounting bills customers, how a retail store provides services on the sales floor, and how a manufacturing plant performs its assembly operations. Process decisions are strategic and can affect an organization's ability to compete over the long run.

Process decisions affect what the firm achieves with the competitive priorities of quality, flexibility, time, and cost. For example, firms can improve their ability to compete on the basis of time by examining each step of their processes and finding ways to respond more quickly to the customer. Productivity (and therefore cost) is affected by choices made when the process is designed. However, process management is an ongoing activity, with the same principles applying to both first-time and redesign choices.

We begin by defining five basic decisions about process: process choice, vertical integration, resource flexibility, customer involvement, and capital intensity. Increasing a process's capital intensity often results in the introduction of new technologies, so we turn next to managing technological change. We conclude with some basic approaches to analyzing and modifying processes: reengineering and the use of flow diagrams and process charts to improve processes. Evaluating process decisions is a first step in improving quality.

WHAT IS PROCESS MANAGEMENT?

Process management is the selection of inputs, operations, work flows, and methods for producing goods and services. Input selection includes choosing the mix of human skills, raw materials, outside services, and equipment consistent with an organization's positioning strategy and its ability to obtain these resources. Operations managers must determine which operations will be performed by workers and which by machines.

Process decisions must be made when

Not all these situations lead to changes in the current process. Process decisions must recognize costs, and sometimes the costs of change clearly outweigh the benefits. Process decisions must take into account other choices concerning quality, capacity, layout, and inventory. Process decisions also depend on where products and services are in their life cycles, on competitive priorities, and on positioning strategy. Ethics and the environment are other considerations.

MAJOR PROCESS DECISIONS

Whether dealing with processes for offices, service organizations, or manufacturing firms, operations managers must consider five common process decisions. Process choice determines whether resources are organized around the product or process in order to implement the positioning strategy. The process choice decision depends on the volumes and degree of customization. Vertical integration is the degree to which a firm's own production system handles the entire chain of processes from raw materials to sales and service. The more a firm's production system handles the raw materials, other inputs, and outputs, the greater is the degree of vertical integration. Resource flexibility is the ease with which employees and equipment can handle a wide variety of products, output levels, duties, and functions. Customer involvement reflects the ways in which the customer becomes a part of the production process and the extent of this involvement. Capital intensity is the mix of equipment and human skills in a production process; the greater the relative cost of equipment, the greater is the capital intensity.

Process Choice

Process choice is the starting point for designing well-functioning processes. Figure 3.1 shows four basic choices for implementing positioning strategy: project,, batch, line, and continuous. The best choice depends on the volume and degree of customization of the product and services produced.

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Project Process. A project process lies at the high-customization, low-volume end of the continuum. The sequence of operations - and the process at each one - is unique to each project, creating one-of-a-kind or low-volume products or services made to customer order. Typically project processes are of long duration and large scale. Products cannot be produced ahead of time because the specific needs of the next customer are unknown. Each new order is handled as a single unit, often by project teams. Firms choosing a project process (or unit process) sell themselves on the basis of their capabilities, rather than on specific products or services. Examples are firms that specialize in event planning, running a political campaign, putting together training programs, constructing a new hospital, introducing a new product, creating a new software package, providing health care, handling special-delivery mail, making customized cabinets, or shipbuilding.

Batch Process. A batch process has average volumes, but too much variety in products or services for the firm to be able to dedicate resources to each one. Instead the products and services share resources, with the firm producing a batch of one product and then switching production to the next one. Eventually the first product or service is produced again. There is no standard sequence of operations through the facility. Some of the components going into the final product or service may be produced in advance, even though the final outputs are made to order. Project and batch processes are more process focused, with resources organized around the process. Examples of batch processes are scheduling air travel for a group, making components that feed an assembly line, and manufacturing capital equipment.

Line Process. A line process is more product focused, with resources organized around the product or service. Volumes are high, and products and services are standardized. Materials and customers move linearly from one operation to the next according to a fixed sequence. Production is in small lots, often with a lot size of 1. Each operation performs the same process over and over again, with little variability. Some product variety is possible but is carefully controlled by adding standard options to the main product or service. Manufactured products are held in inventory so that they are ready when a customer places an order. Production orders are not directly linked to customer orders, as is the case with project processes or batch processes. Sometimes called mass production, a line process is what is most commonly featured in the popular press as a manufacturing process, even though it is only one of several process choices prevalent in practice. Examples of products created by line processes are automobiles, appliances, and toys. Examples of services using line processes are fast-food restaurants and cafeterias.

Continuous Process. A continuous process is the extreme end of high-volume, standardized production with rigid line flows. Usually one primary material, such as a liquid, gas, or powder, moves without stopping through the facility. The process often is very capital intensive and often is operated around the clock to maximize utilization and to avoid expensive shutdowns and startups. Continuous processes are found almost exclusively in manufacturing. Examples are petroleum refineries, chemical plants, and plants making beer, steel, and food. Firms with such facilities are also referred to as the process industry. An electric generation plant represents one of the few continuous processes found in the service sector.

Vertical Integration

All businesses buy at least some inputs to their processes, such as professional services, raw materials, or manufactured parts, from other producers. Management decides the level of vertical integration by looking at all the activities performed between acquisition of raw materials or outside services and delivery of finished products or services. The more processes in the chain the organization performs itself, the more vertically integrated it is.

Extensive vertical integration is generally attractive when input volumes are high because high volumes allow task specialization and greater efficiency. It is also attractive if the firm has the relevant skills and views the industry into which it is integrating as particularly important to its future success. It is unattractive when a supplier can provide the good or service with greater efficiency and at a lower cost. For example, most small restaurants and food-service operators buy precooked eggs for salad bars and sandwiches from suppliers, rather than process their own. Matching the efficiency of a supplier such as Atlantic Foods, where a team of six employees can peel 10,000 eggs in one shift, is difficult.

Vertical integration can be in two directions. Backward integration represents movement toward the sources of raw materials and parts. Forward integration means that the firm acquires more channels of distribution, such as its own distribution centers (warehouses) and retail stores. Village Meat , a fresh-meat supplier and the dominant source of hamburger for Wendy's International, is an example of a company that chose to decrease its forward integration. When Wendy's decided to have just one company deliver all its fresh, frozen, and dry products, Village Meats, which had been delivering its meat to Wendy's, chose to end its door-to-door deliveries. Becoming the sole distributor to Wendy's restaurants would have required the company to secure more warehouse space, handle frozen products, and purchase new trucks. The necessary investment was too much. Village Meats still supplies meat to Wendy's, but leaves the distribution to another firm.

Another example of decreasing forward integration is IBM's decision t allow versions of its minicomputer and mainframes to be marketed in Japan under the label of Mitsubishi Electric Corporation. IBM is becoming an original-equipment manufacturer (OEM) for this part of its market and leaving the sales and distribution to Japanese firms. This move allows IBM to enter otherwise closed markets, such as Japanese government agencies, because Japanese culture stresses dealing with Japanese rather than foreigners. This cultural value gives Mitsubishi Electric a distinctive competence over IBM for selling computers in Japan.

Increasing vertical integration can reduce resource flexibility if it requires a large investment in facilities and equipment. The Kroger grocery chain, for example, had heavily invested in equipment and facilities to produce house brands. When customer preferences shifted away from house brands and generic (no- brand) products and turned toward national brands, Kroger found itself with excess manufacturing capacity, which it had to find a way to utilize. It did so by making ice cream and frozen pizza dough for its competitors, which in turn sold the products under their own labels. About 20 percent of the sales from its plants are now to companies outside Kroger. Kroger also has sold some of its plants. Extensive vertical integration limited Kroger's resource flexibility and range of acceptable business opportunities.

A converse strategy to that of Kroger is followed by hollow corporations, small firms that contract with other firms for most of their production-and for many of their other functions. Hollow corporations have little backward integration; they sometimes are called network companies because employees spend most of their time on the telephone or at the computer, coordinating suppliers. If demand for the hollow corporation's products or services changes, its employees simply pass this message along to the suppliers, who change their output levels. Hollow corporations can move in and out of markets, riding the waves of fashion and technology. They are vulnerable to new competition, however, because the investment barriers to enter their businesses are low and because they lose business if their suppliers integrate forward or their customers integrate backward. A hollow corporation's risk of losing its business to suppliers or customers increases as product volumes increase and product life cycles lengthen. For example, Conner Peripherals has been very successful since entering the hard disk drive industry in 1986. Because product life cycles are so short, often measured in months, it designs products and lets outside suppliers manufacture them. This strategy avoid the needs for Conner to invest in factories that may become obsolete as technology changes. If life cycles were longer, one of its big customers, such as Compaq Computer Corporation, might decide to make the computer drives itself and bypass Conner entirely.

Make or Buy. The decision about whether to implement backward integration is often referred to as the make-or-buy decision. In making that decision the operations manager must study all the benefits and costs of making the needed inputs and buying them from suppliers. Break-even analysis and financial analysis are good starting points in making this decision. However, equally important are qualitative factors.

The "buy" decision of farming out an operation to a supplier, outsourcing, has both advantages and disadvantages. On the negative side, a firm may farm out a process that is crucial to its mission and lose control over that area of its business. It may even lose its ability to bring the work in-house at a later date. Customers may also be less satisfied with the final output. For example, if customers at a restaurant want to make a salad to their own tastes, they will be dissatisfied with preassembled salads provided by an outside supplier. Another disadvantage is that some "make" decisions require sizable capital investments. However, doing the work in-house may mean better quality and more timely de- livery-and taking better advantage of the firm's human resources, equipment, and space. Firms are doing more outsourcing than ever before. For example, the NCNB bank in Charlotte, North Carolina, outsourced the processing of card transactions and saved $5 million per year. Merrill Lynch, Sears Roebuck, and Texaco outsource their mailroom and photocopying operations to Pitney Bowes Management Services. Many firms do the same with payroll, security, cleaning, and other types of services, rather than employ personnel to provide these services. One recent survey showed that 35 percent of more than 1000 large corporations have increased the amount of outsourcing they do. Two factors are contributing to this trend: global competition and information technology. Globalization creates more supplier options, and advances in information technology make coordination with suppliers easier. IKEA, the largest retailer of home furnishings, has 30 buying offices around the world to seek out suppliers. Its Vienna-based Business Service. Department runs a computer database that helps suppliers find raw materials and new business partners. Cash registers at its stores around the world relay sales data to the nearest warehouse and its operational headquarters in Almhult, Sweden, where information systems oversee shipping patterns worldwide. Information technology allows suppliers to come together as a virtual corporation. In a virtual corporation, competitors actually enter into short-term partnerships to respond to market opportunities. Teams in different organizations and at different locations collaborate on production, design, and marketing, with information going electronically from place to place. They disband when the project is completed. Virtual corporations allow firms to change their positions flexibly in response to quickly changing market demands.

Own or Lease. When a firm decides to increase vertical integration, it must also decide whether to own or to lease the necessary facilities and equipment. The lease option is often favored for items affected by fairly rapid changes in technology, items that require frequent servicing, or items for', which industry practices have made leasing the norm, as in the photocopier industry. Leasing is also common when a firm has a short-term need for equipment. For example, in the construction industry, where projects usually take months or years to complete, heavy equipment is often leased only as needed.

Resource Flexibility

The choices that management makes concerning competitive priorities determine degree of flexibility required of a company's resources-its employees, facilities and equipment. For example, when new products and services call for short cycles or high customization, employees need to perform a broad range of duties and equipment must be general purpose. Otherwise resource utilization will be too low for economical operation.

Work Force. Operations managers must decide whether to have a flexible work force. Members of a flexible work force are capable of doing many tasks, either their own workstations or as they move from one workstation to another. However, such flexibility often comes at a cost, requiring greater skills and thus more training and education. Nevertheless, benefits can be large: Worker flexibility can be one of the best ways to achieve reliable customer service and alleviate capacity bottlenecks. Resource flexibility is particularly crucial to process-used positioning strategy, helping to absorb the feast-or-famine workloads in individual operations that are caused by low-volume production, jumbled routings, and fluid scheduling.

Some manufacturers, such as Corning, practice resource flexibility. At its recently opened plant in Blacksburg, Virginia, Corning trains its employees to have interchangeable skills. Workers must learn three skill modules-or families of ills-within two years to keep their jobs. A multiskilled work force is one reason the Blacksburg Corning plant turned a $2 million profit in its first eight months of production, instead of losing $2.3 million as projected for the start-up period. Training has been extensive, however: In the first year of production, 25 percent of all hours worked were devoted to training, at a cost of about 50,000.

Resource flexibility is also an issue in the service sector. Administrators of large urban hospitals must make decisions about staffing and degrees of specialization. Many hospitals choose to use all registered nurses (RNs), instead of a mix of RNs, licensed vocational nurses (LVNs), and aides. Registered nurses have a higher educational level and earn more than LVNs and aides, but they are more flexible and can perform all nursing tasks.

The type of work force required also depends on the need for volume flexibility. When conditions allow for a smooth, steady rate of output, the likely choice is a permanent work force that expects regular full-time employment. If the process is subject to hourly, daily, or seasonal peaks and valleys in demand, the use of part-time or temporary employees to supplement a smaller core of full-time employees may be the best solution. However, this approach may not be practical if knowledge and skill requirements are too high for a temporary worker to grasp quickly.

Equipment. When a firm's product or service has a short life cycle and a high degree of customization, low production volumes mean that a firm should select flexible, general-purpose equipment. Figure 3.2 illustrates this relationship for two processes. Process 1 calls for inexpensive general-purpose equipment. It gets the job done but not at peak efficiency. Although fixed costs (Fl) are low, the variable unit cost (the slope of the total cost line) is high. Process 2 has high fixed costs (F2), but it is a more efficient process and therefore has a lower variable unit cost. Such efficiency often is possible only because the equipment is designed for a narrow range of products or tasks.

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The break-even quantity in Fig. 3.2 is the quantity at which the total costs for the two alternatives are equal. At quantities beyond this point, the cost of process 1 exceeds that of process 2. Unless the firm expects to sell more than the break-even amount (which is unlikely with high customization), the capital investment of process 2 isn't warranted. An example of a firm that made the mistake of investing too heavily in specialized equipment is General Electric, which built a $52 million highly automated plant to make T700s Jet engines-or similar-sized engines-and nothing else. Unfortunately, the Pentagon failed to order engines in the numbers anticipated, so the plant ran at only 60 percent of capacity-too low for efficient operation.

Customer Involvement

The fourth major process decision is the extent to which customers interact with the process. The amount of customer involvement may range from self-service to customization of product to deciding the time and place of service.

Self-Service. In many service industries, customer contact is crucial. At Wendy's restaurants, for instance, customers assemble their own salads. Self-service is the process decision of many retailers, particularly when price is a competitive prior- To save money, some customers prefer to do part of the process formerly performed by the manufacturer or dealer. Product-focused manufacturers of goods such as toys, bicycles, and furniture may also prefer to let the customer perform final assembly because production, shipping, and inventory costs frequently lower, as are losses from damage. The firms pass the savings on to customers lower prices.

Product Selection. A business that competes on customization frequently allows customers to come up with their own product specifications or even become involved in designing the product. A good example of customer involvement is in custom-designed and -built homes: The customer is heavily involved in the design process and inspects the work in process at various times. Customer involvement is not likely to end even when the owner occupies the house, because most builders guarantee their work for some extended time period.

Time and Location. When services cannot be provided without the customer's presence, customers may determine the time and location of the service. If the service is delivered to the customer, client, or patient by appointment, decisions involving the location of such meetings become part of process design. Will customers be served only on the supplier's premises, will the supplier's employees go the customers' premises, or will the service be provided at a third location? Operators of emergency ambulance services cannot provide service without a patient. They can't predict exactly when the next call for service will come in or ere the ambulance will have to go, so they must design their response processes accordingly. Conversely, although certified public accountants frequently work their clients' premises, both the time and the place are likely to be known well in advance.

Capital Intensity

For either the design of a new process or the redesign of an existing one, an operations manager must determine the amount of capital intensity required. Capital intensity is the mix of equipment and human skills in the process; the greater the relative cost of equipment, the greater is the capital intensity. As the capabilities of technology increase and its costs decrease, managers face an ever-widening range of choices, from operations utilizing very little automation to those requiring task-specific equipment and very little human intervention. Automation is a system, process, or piece of equipment that is self-acting and self-regulating. Although automation is often thought to be necessary to gain competitive advantage, it has both advantages and disadvantages. Thus the automation decision requires careful examination.

One advantage of computer technology is that it can significantly increase productivity and improve quality. For example, Bailey Company, an independent Arby's roast beef restaurant franchisee based in Lakewood, Colorado, has installed a computerized order-taking system. Customers punch in their own orders, increasing employee efficiency at a time when fast-food restaurants face a labor shortage. The system allows one clerk to handle two terminals for two lines of customers and has improved both service time (by about 20 seconds per order) and order accuracy. The system also encourages sales by suggesting items such as soft drinks.

One big disadvantage of capital intensity can be the prohibitive investment cost for low-volume operations. Look at Fig. 3.2 again. Process 1, which uses general-purpose equipment, isn't capital intensive and therefore has small fixed costs, Fl. Although its variable cost per unit produced is high, as indicated by the slope of the total cost line, process 1 is well below the break-even quantity if volumes are low. Generally capital-intensive operations must have high utilization to be justifiable. Also, automation doesn't always align with a company's competitive priorities. If a firm offers a unique product or high-quality service, competitive priorities may indicate the need for skilled servers, hand labor, and individual attention rather than new technology. Arby's ordering system wouldn't be appropriate for an exclusive restaurant.

Some types of equipment may be acquired a piece at a time or leased, allowing the user to try the equipment out without making a large and risky initial capital investment. Examples of such equipment are photocopy machines, personal computers, and laser printers. However, many other technological choices involve large and costly systems-and a great deal more capital and risk.

Fixed Automation. Manufacturing uses two types of automation: fixed and flexible (or programmable). Particularly appropriate for line and continuous process choices, fixed automation produces one type of part or product in a fixed sequence of simple operations. Until the mid 1980s most U.S. automobile plants were dominated by fixed automation-and some still are. Chemical processing plants and oil refineries also utilize this type of automation.

Operations managers favor fixed automation when demand volumes are high, product designs are stable, and product life cycles are long. These conditions compensate for the process's two primary drawbacks: large initial investment cost and relative inflexibility. The investment cost is particularly high when a single, complex machine (called a transfer machine) must be capable of handling many operations. Because fixed automation is designed around a particular product, changing equipment to accommodate new products is difficult and costly. However, fixed automation maximizes efficiency and yields the lowest variable cost per unit.

Flexible Automation. Flexible (or programmable) automation can be changed easily to handle various products. The ability to reprogram machines is useful in both process-focused and product-focused operations. A machine that makes a variety of products in small batches, in the case of a process focus, can be programmed to alternate between the products. When a machine has been dedicated to a particular product, as in the case of a product focus, and the product is at he end of its life cycle, the machine can simply be reprogrammed with a new sequence of operations for a new product. Cummins Engine Company, a manufacturer of diesel engines based in Columbus, Indiana, utilizes product-focused flexibility to handle frequent design modifications. For example, in the first 18 months after the introduction of new compression brakes for its engines, engineers made 14 design changes to the brakes. If the brakes had been made on less flexible machines, these improvements probably would have taken several years and millions of dollars to implement - and in fact might not have been made. Programmable automation gave Cummins a competitive advantage: It cut time o the market by two years, reduced annual warranty expenses by an estimated $300,000, and reduced costs to the customer by more than 30 percent.

Relationships Between Decisions

Each of the five process decisions has an underlying relationship with volume. High volume occurs when demand for a product or service is heavy, when each unit made or served requires significant work content, and when parts or tasks are standard and therefore used often. Figure 3.3 shows how process choice and the other major process decisions are tied to volume. The solid vertical lines reflect the link between volume and the process choice, and the dashed horizontal lines represent the subsequent link between process choice and the other process decisions. High volumes typically mean

  1. A line or continuous process.
  2. More vertical integration. High volumes create more opportunities vertical integration.
  3. Less resource flexibility. When volumes are high, there is no need for flexibility to utilize resources effectively, and specialization can lead to more efficient processes.
  4. Less customer involvement. At high volumes, firms cannot meet the unpredictable demands required by full-service, customized orders. Exceptions include telephone exchanges, vending machines, and automatic bank tellers, mainly because these processes require minimal personalized attention.
  5. More capital intensity. High volumes justify the large fixed costs of an efficient operation. It is automated from dough mixing to placing the product on shipping racks. Expanding this process would be very expensive.

Fig3-3.gif (39088 bytes)

Low volumes typically mean

  1. A project or batch process.
  2. Less vertical integration. Low volumes eliminate most opportunities for vertical integration.
  3. More resource flexibility. When volumes are low, as in the custom cake process, workers are trained to handle all types of customer requests.
  4. More customer involvement.
  5. Less capital intensity. The custom cake line is very labor intensive and requires little investment to equip the workers.

Of course, these are general tendencies rather than rigid prescriptions. Exceptions can be found, but these relationships provide a way of understanding how process decisions can be linked coherently.

Economies of Scope

Note that capital intensity and resource flexibility vary inversely in Fig. 3.3. If capital intensity is high, resource flexibility is low. To complete the unique customer orders, resources must be flexible, and because the process requires hand work, capital intensity is low.

In certain types of manufacturing operations, such as machining and assembly, programmable automation breaks this traditional inverse relationship between resource flexibility and capital intensity. It makes possible both high capital intensity and high resource flexibility, creating economies of scope. Economies of scope reflect the ability to produce multiple products more cheaply in combination than separately. In such situations, two conflicting competitive priorities - customization and low price-become more compatible. However, taking advantage of economies of scope requires that a family of parts or products have enough collective volume to utilize equipment fully, perhaps even making necessary the operation of machinery in multiple shifts. Adding a product to the family results in one-time programming (and sometimes fixture) costs. Fixtures are reusable devices that maintain exact tolerances by holding the product firmly in position while it is processed.

Part 2.2. Process Design

Operations managers make many choices as they deal with the various decision areas. Although the specifics of each situation vary, decision making generally involves the same basic steps: (1) recognize and clearly define the problem, (2) collect the information needed to analyze possible alternatives, and (3) choose and implement the most feasible alternative.

Sometimes hard thinking in a quiet room is sufficient. At other times reliance on more formal procedures is needed. Here we present four such formal procedures: break-even analysis, the preference matrix, decision theory, and the decision tree.

BREAK-EVEN ANALYSIS

To evaluate an idea for a new product or service or to assess the performance of an existing one, determining the volume of sales at which the product or service breaks even is useful. The break-even point is the volume at which total revenues equal total costs. Use of this technique is known as break-even analysis. Break-even analysis can also be used to compare production methods by finding the volume at which two different processes have equal total costs.

Evaluating Products or Services

We begin with the first purpose: to evaluate the profit potential of a new or existing product or service. This technique helps the manager answer questions such as the following:

Break-even analysis is based on the assumption that all costs related to the production of a specific product or service can be divided into two categories: variable costs and fixed costs.

The variable cost, c, is the portion of the total cost that varies directly with volume of output: costs per unit for materials, labor, and usually some fraction of overhead. If we let Q equal the number of units produced and sold per year, total variable cost = cQ. The fixed cost, F, is the portion of the total cost that remains constant regardless of changes in levels of output: the annual cost of renting or buying new equipment and facilities (including depreciation, interest, taxes, and insurance), salaries, utilities, and portions of the sales or advertising budget. Thus the total cost of producing a good or service equals fixed costs plus variable costs times volume, or

Total cost = F + cQ

The variable cost per unit is assumed to be the same no matter how many units Q are sold, and thus total cost is linear. If we assume that all units produced are sold, total annual revenues equal revenue per unit sold, p, times the quantity sold, or

Total revenue = pQ

If we set total revenue equal to total cost, we get the break-even point as

pQ = F + cQ

(p - c)Q = F

Q = F /(p Ц c)

We can also find this break-even quantity graphically. Because both costs and revenues are linear relationships, the break-even point is where the total revenue line crosses the total cost line.

Example A.1. Finding the Break-Even Quantity

A hospital is considering a new procedure to be offered at $200 per patient. Fixed cost per year would be $ 100,000, with total variable costs of $ 100 per patient. What is the break-even quantity for this service? Use both algebraic and graphic approaches to get the answer.

Solution. The formula for the break-even quantity yields

Q = F/(p - c) = 100,000/(200- 100) = 1000 patients

To solve graphically we plot two lines - one for costs and one for revenues. Two points determine a line, so we begin by calculating costs and revenues for two different output levels. The following table shows the results for Q = 0 and Q = 2000. We selected zero as the first point because of the ease of plotting total revenue (0) and total cost (F). However, we could have used any two reasonably spaced output levels.

Quantity(patients) (Q)

Total Annual Cost ($)(100,000 + 100Q)

Total Annual Revenue($)(200Q)

0

100,000

0

2000

300,000

400,000

We can now draw the cost line through points (0, 100,000) and (2000, 300,000). The revenue line goes between (0, 0) and (2000, 400,000). As Fig.A.1 indicates, these two lines intersect at 1000 patients, the break-even quantity.

FigA-1.gif (11482 bytes)

Break-even analysis cannot tell a manager whether to pursue a new product or service idea or drop an existing line. The technique can only show what is likely to happen for various forecasts of costs and sales volumes. To evaluate a variety of "what if" questions, we use an approach called sensitivity analysis, a technique for systematically changing parameters in a model to determine the effects of such changes. The concept can be applied later to other techniques, such as linear programming. Here we assess the sensitivity of total profit to different pricing strategies, sales volumes forecasts, or cost estimates.

Example A.2. Sensitivity Analysis of Sales Forecasts

If the most pessimistic sales forecast for the proposed service in Fig.A.1 were 1500 patients, what would be the procedure's total contribution to profit and overhead per year?

Solution. The graph shows that even the pessimistic forecast lies above the break-even volume, which is encouraging. The product's total contribution, found by subtracting total costs from total revenues, is

pQ - (F + cQ) = 200(1500) - [100,000 + 100(1500)] = $50,000

Evaluating Processes

Often choices must be made between two processes or between an internal process and buying the service or material on the outside. In such cases we assume that the decision does not affect revenues. The operations manager must study all the costs and advantages of each approach. Rather than find the quantity where total costs equal total revenues, the analyst finds the quantity for which the total costs for two alternatives are equal. For the make-or-buy decision, it is the quantity for which the total "buy" cost equals the total "make" cost. Let Fb equal the fixed cost (per year) of the buy option, Fm equal the fixed cost of the make option, cb equal the variable cost (per unit) of the buy option, and cm the variable cost of the make option. Thus the total cost to buy is Fb + cbQ, and the total cost to make is Fm + cmQ. To find the break-even quantity, we set the two cost functions equal and solve for Q:

Fb + cbQ = Fm + cmQ

Q = (Fm Ц Fb)/(cb Ц cm)

The make option should be considered, ignoring qualitative factors, only if its variable costs are lower than those of the buy option. The reason is that the fixed costs for making the product or service are typically higher than the fixed costs for buying. Under these circumstances, the buy option is best if production volumes are less than the break-even quantity. Beyond that quantity, the make option becomes best.

Example A.3. Break-Even Analysis for Make-or-Buy Decision

The manager of a fast-food restaurant featuring hamburgers is adding salads to the menu. There are two options, and the price to the customer will be the same for each. The make option is to install a salad bar stocked with vegetables, fruits, and toppings and let the customer assemble the salad. The salad bar would have to be leased and a part-time employee hired. The manager estimates the fixed costs at $12,000 and variable costs totaling $1.50 per salad. The buy option is to have preassembled salads available for sale. They would be purchased from a local supplier at $2.00 per salad. Offering preassembled salads would require installation and operation of additional refrigeration, with an annual fixed cost of $2400. The manager expects to sell 25,000 salads per year.

What is the break-even quantity?

Solution. The formula for the break-even quantity yields

Q = (Fm Ц Fb)/(cb Ц cm) =

= (12,000 Ц 2400)/(2.0-1.5) =

= 19,200 salads

The break-even quantity is 19,200 salads. As the 25,000-salad sales forecast exceeds this amount, the make option is preferred. Only if the restaurant expected to sell fewer than 19,200 salads would the buy option be better.

DESIGNING PROCESSES

The five major process decisions represent broad, strategic issues. The next issue in process management is determining exactly how each process will be performed. Two different but complementary approaches exist for designing' processes: process reengineering and process improvement. We begin with process reengineering, which is getting considerable attention today in management circles.

Process Reengineering

Reengineering is the fundamental rethinking and radical redesign of business processes to dramatically improve performance in areas such as cost, quality, service, and speed. Process reengineering is about reinvention, rather than incremental improvement. It is strong medicine and not always needed or successful. Pain, in the form of layoffs and large cash outflows for investments in information technology, almost always accompanies massive change. However, reengineering processes can have big payoffs. For example, Bell Atlantic reengineered its telephone business. After five years of effort, it cut the time to hook up new customers from 16 days to just hours. The changes caused Bell Atlantic to lay off 20,000 employees, but the company is decidedly more competitive.

A process selected for reengineering should be a core process, such as a firm's order fulfillment activities. Reengineering then requires focusing on that process, often using cross-functional teams, information technology, leadership, and process analysis.

Critical Processes. The emphasis of reengineering should be on core business processes, rather than functional departments such as purchasing or marketing. y focusing on processes, managers may spot opportunities to eliminate unnecessary work and supervisory activities, rather than worry about defending turf. Reengineering should be reserved for essential processes, such as new-product development or customer service, because of the time and energy involved. Normal process improvement activities can be continued with the other processes. The processes selected should be broadly defined in terms of cost and customer value so that overall performance improves.

Strong Leadership. Senior executives must provide strong leadership for reengineering to be successful. Otherwise, cynicism, resistance ("we tried that before"), and boundaries between functional areas can block radical changes. Managers can help overcome resistance to the new and different. They provide the clout to push the project through to completion. They also ensure that the project proceeds within a strategic context, with direct ties to corporate strategy and competitive priorities. Executives should set and monitor key performance objectives for the process, such as cost, quality, or speed of service. When Union Carbide decided to emphasize commodity chemicals rather than specialty products, its reengineering goal was low manufacturing cost and quick delivery. Top management also creates a sense of urgency, making a case for change that is compelling and constantly refreshed.

Cross-Functional Teams. A team, consisting of members from each functional area affected by the process change, is charged with carrying out a reengineering project. For instance, in reengineering the process of handling an insurance claim, three departments should be represented: customer service, adjusting, and accounting. Team-building concepts, including team rewards based on the outcomes achieved, should be applied. Reengineering works best at high-involvement workplaces, where self-managing teams and employee empowerment are the rule rather than the exception. Top-down and bot- tom-up initiatives can be combined-the top-down for performance targets and the bottom-up for deciding how to achieve the targets.

Information Technology. Information technology is a major enabler of process engineering. Most reengineering projects design processes around information flows such as customer order fulfillment. The "process owners" who will actually be responding to marketplace happenings need information networks and computer technology to do their jobs better. The reengineering team must think through who needs the information, when they need it, and where. Restructuring an organization around information flows can eliminate many levels of management and work activity. For example, Wal-Mart reengineered its process so as to use information technology to eliminate wholesalers and drastically cut costs. Now, when a customer buys something, the information goes back instantly to the supplier's plant and is reflected in the manufacturing and shipping schedule.

Clean Slate Philosophy. Reengineering requires a "clean slate" philosophy - that is, starting with the way the customer wants to deal with the company. To ensure a customer orientation, teams begin with internal and external customer objectives for the process. Often this means first establishing a price target for the product or service and deducting profits desired and then finding a process that provides what the customer wants at the price the customer will pay. Reengineers start from the future and work backward, unconstrained by current approaches.

Process Analysis. Despite the clean slate philosophy, a reengineering team must understand things about the current process: what it does, how well it performs, and what factors affect it. Such understanding can reveal areas where new thinking will provide the biggest payoff. However, the emphasis is on understanding rather than analyzing the process in agonizing detail. Otherwise, the team will be blind to radically different approaches. At the same time, the team must look at every procedure involved in the process throughout the organization, mapping out each step and then questioning why it is done and eliminating steps that are not really necessary. Information on standing relative to the competition, process by process, is also valuable.

Process Improvement

Process improvement is the systematic study of the activities and flows of each process to improve it. The relentless pressure to provide better quality at a lower price means that companies must continually review all aspects of their businesses. As the chief executive of Dana Corporation, a $4.9 billion producer of auto motive parts, put it, "You have to get productivity improvements forever." Process improvement goes on, whether or not a process is reengineered. Further reengineering uses process improvement tools and is followed after completion by process improvement efforts. For example, Wal-Mart keeps improving it reengineered process.

In this section we present two basic mapping techniques for analyzing processes: flow diagrams and process charts. These techniques systematically map the details of a process to allow better understanding of it. The analyst then can highlight tasks that can be simplified or indicate where productivity can otherwise be improved. Improvements can be made in quality, throughput time, cost, errors, safety, or on-time delivery. These techniques can be employed to design new processes and redesign existing one and should be used periodically to study all operations. However, the greatest payoff is likely to come from applying them to operations having one or more of the following characteristics.

Х The process is slow in responding to the customer.

Х The process introduces too many quality problems or errors.

Х The process is costly.

Х The process is a bottleneck, with work piling up waiting to go through it.

Х The process involves disagreeable work, pollution, or little value added.

Both analytic techniques involve breaking a process into detailed components. To do this, the manager should ask six questions:

1. What is being done?

2. When is it being done?

3. Who is doing it?

4. Where is it being done?

5. How long does it take?

6. How is it being done?

Answers to these questions are challenged by asking still another series of questions. Why? Why is the process even being done? Why is it being done where it is being done? Why is it being done when it is being done? Such questioning often can lead to creative answers that cause a breakthrough in process design. The analyst should brainstorm different aspects of the process, listing as many solutions as possible. Work elements can be streamlined, entire processes: eliminated entirely, purchased materials usage cut, or jobs made safer. Most facilities can trim labor costs by eliminating unnecessary functions, such as parts inspection, warehousing, materials handling, and redundant supervision, among others - and reorganizing the process. For example, Eaton Corporation rearranged its plant in Marshall, Michigan, to use a conveyor to transport a rough forging automatically from machine to machine until it emerges as a polished gear for a truck differential. Computerized measuring machines, instead of human inspectors, ensure that automated turning centers cut gears to a precise size. Such changes come from a critical analysis of each process.

Flow Diagrams. A flow diagram traces the flow of information, customers, employees, equipment, or materials through a process. There is no precise format, and the diagram can be drawn simply with boxes, lines, and arrows. Figure 3.4 is a diagram of an automobile repair process, beginning with the customer's call for an appointment and ending with the customer's pickup of the car and departure. In this figure, the dotted line of visibility divides activities that are directly visible to the customers from those that are invisible. Such information is particularly valuable for service operations involving considerable customer contact. Operations that are essential to success and where failure occurs most often are identified. Other formats are just as acceptable, and it is often helpful to show beside each box such process measurements as

  1. total elapsed time,
  2. quality losses,
  3. error frequency,
  4. capacity, or
  5. cost.

Fig3-4.gif (44374 bytes)

Figure 3.4. Flow Diagram for Automobile Repair

Sometimes flow diagrams are, overlaid on a facility's layout. To make this special kind of flow diagram, the analyst first does a rough sketch of the area in which the process is performed. On a grid the analyst plots the path followed by the person, material, or equipment, using arrows to indicate the direction of movement or flow. Figure 3.5 shows such a flow diagram for a car-wash facility illustrating the flows of cars and customers. The facility used to have only one waiting line, but during peak periods the line of cars would extend back into the street, blocking traffic. The owner used a flow diagram to determine that a second waiting line could be added without changing the flow of the other operations. Now cars enter one of two lines from the street and alternate in forming a single line that rounds a sharp corner into the washing bay. Just before a car enters the bay, the customer leaves the car, walking through a separate door and hallway to the office to pay for the service. The car proceeds through the washing bay, and the customer exits through the hallway and a second door to rejoin the car after it is rolled to an open area and wiped down. The customer then gets back into the car and drives away.

Fig3-5.gif (45863 bytes)

Figure 3.5. Flow Diagram for a Car Wash Faculty


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