3 Key Decisions in OM

Key Decisions in Operations Management

Learning Objectives

• Become familiar with key decisions affecting operating systems.
• Understand factors affecting 'make' or 'buy' decisions and their relation to outsourcing.
• Understand types and nature of demand forecasting decisions.
• Appreciate factors driving facility location decisions.
• Understand how capacity is planned, built, offered, and executed.
• Understand connections between key decisions, organizational aspects, and performance impacts.

Management Challenge: New Woolworths Distribution Centre

• Woolworths invested in a large distribution center near Sydney.
• The center handles over 300,000 cases per day of 20,000 items for 700 stores.
• Challenge: Supply, sort, and send goods to the right place at the right time, avoiding stockouts at the lowest cost.
• Costs include capital, operating (labor, energy), transport, store receiving, overstocking, and understocking.
• Goal: Achieve ‘swift and even flow’ in distribution operations.
• Questions:
  • Why build a new center instead of using existing ones?
  • Why not lease a facility?
  • Why choose Minchinbury for the location?
  • Should the facility be sized for present operations or future growth (10% or 20%)?

Introduction to Strategic Operations Decisions

• Organizations operate in global supply networks, requiring strategic operations decisions.
• Key Decisions:
  • Make or Buy/ Insource-Outsource Decision: How much of the supply network should the organization own?
  • Operations Facility Location: Where should each part of the network be located (e.g., Coles supermarket locations)? Strategic due to high stakes, difficulty to reverse and long-lasting impacts.
  • Long-Term Capacity Management: What physical capacity should each part of the network have? Should expansion be in large or small steps? Should capacity exceed or fall short of anticipated demand?
  • All three decisions rely on assumptions about future demand, thus the importance of good forecasting.

Make-or-Buy, Outsource, or Off-Shore?

The Make-or-Buy Decision

• Critical decision governing the supply chain's nature and management tasks.

• Managing the entire supply chain is crucial for competitive ability.

• Integrated supply chain concept changes business operations.

• Requires responsive and adaptive systems/procedures, coordination, collaboration, and relationships.

• Principal reasons for make-or-buy decisions:

  • Retaining Core Technologies: Keep core business elements in-house (e.g., customer link for service organizations, proprietary technology).
  • Strategic Considerations: Align with the business's strategic context (e.g., Dell's PC assembly vs. component suppliers' lead times).

Buy Rather Than Make

• Acquire technology as components/materials or expertise as customer/information processing.
• Example: Automotive companies buy tires due to specialized technology.
• Buying in makes it hard to gain a competitive advantage from the components or services when bought from someone else.
  • For example, automotive companies do not get competitive advantage over each other from the tyres they supply as part of their vehicles.

Service and Product Volumes

• Outsource response to demands with different volume levels if not wishing to develop in-house process.
• Example: Minor garment changes done internally, complex modifications outsourced.

Globalisation of World Trade

• Reduced trade barriers make global manufacturing feasible.

• Reduces need for local plants; markets can be supplied by imports.

• Example: Australian automotive sector with tariff reductions and increased import market share.

  • In the eighteen years to 2005, tariffs on imported cars dropped from $57.5$ to $10$ per cent. During this time, the market share of imported cars rose from $15$ to about $70$ per cent.
  • Domestic car plants (for example Nissan and Mitsubishi) have closed or reduced local production volume.

Reasons to Make vs. Buy

• Make if:

  • Core competence to preserve.
  • Lower production costs.
  • Unreliable suppliers.
  • Surplus labor/facilities available.
  • Ensure quality.
  • Remove supplier opportunism risk.
  • Protect employees/intellectual property.
  • Preserve/increase organizational size.

• Buy if:

  • Focus on primary business.
  • Lower acquisition costs.
  • Maintain supplier relationships.
  • Obtain unavailable capabilities.
  • Capacity constraints.
  • Reduce inventory costs.
  • Items protected by patents/trade secrets.

Outsourcing

• Vertically integrate or outsource key business processes/functions.
• Vertical integration: Acquiring/consolidating supply chain elements for control.
  • Provides more control, adds complexity.
• Decentralizing lessens control over cost, quality, and increases risk.
• Decisions influenced by economics, technology, and human resources.
• Outsourcing: Suppliers provide goods/services previously produced internally.
  • Opposite of vertical integration.
  • Organization doesn't own outsourced process/function.
• Examples: Banks/airlines outsource call centers and maintenance.
  • Switches fixed costs for variable costs.
  • Transfers assets, contracts, and risks.

Outsourcing Characteristics

• Transfers internal activities/resources to outside vendors.
• Utilizes efficiency from specialization.
• Vendor is an expert in their specialty.
• Organization focuses on critical success factors/core competencies.
• Resources transferred may include facilities, people, and equipment.
• Many organizations outsource IT, accounting, legal, and product assembly.

Off-shoring

• Migration of services to external providers located in another country.
• Success relies on lower-cost labor in another country.
• Encompasses manufacturing, IT, and back-office services.
• Processes can be handed off to third-party vendors or remain in-house.
• Involves determining which processes should move to other countries.

Off-shoring Considerations

• Economic and non-economic issues influence the decision.
• Not all multinational organizations locate across the globe (e.g., Lego).
• Lego located factories in Europe and the U.S. for expertise in injection molding and mould design.

Off-shoring Advantages

• Purely economic standpoint, off-shoring can lower unit costs.

• Countries such as China, India, and Russia have an educated workforce willing to work for low wages

  • Australian and New Zealand manufacturers have off-shored activities to China, such as basic manufacturing.
  • Reports of cost reductions of $20$ per cent and above make these arrangements worthwhile.

Alternatives to Make-or-Buy Decision

• Beyond ownership/non-ownership, alternatives exist for greater control.

  • Joint Ventures: Sharing costs and benefits with partners.
  • Co-sourcing: Bringing in competitors and specialist outsourcing organization.
  • Non-Equity-Based Collaboration: Cooperative working arrangements for long-term results.

• Joint Ventures: Sharing costs and benefits in applied technology and research.

• Co-sourcing: Organization brings in competitors with a specialist outsourcing organization.

  • Example: Banks pool cheque processing into a new company controlled by a US consultancy.

• Non-equity-based collaboration: Establishing cooperative working arrangements needing a long-term base.

  • Examples: R&D consortia, joint purchasing activities.

• Buying groups: Independent operators collaborate to improve buying power.

Forecasting Decisions

Basic Concept

• A forecast is a statement about the future, such as future customer demand.

Role of Demand Forecasting for Products and Services

• Demand forecasts inform product/service development, capacity decisions, and strategic decisions.
• Example: Qantas uses forecasts to plan airplane purchases, flight scheduling, inventory, and staffing.
• Short-term forecasts help develop seasonal routes/schedules.
• Restaurants use forecasts for food purchases.
• Forecasts drive production, capacity, and resource scheduling, and inputs to financial, marketing and HR planning.
• Shorter product/service life cycles, changing technology, price wars make accurate forecasts difficult.
• Contingency planning is crucial when forecasts are uncertain.
• Accurate forecasts are needed throughout the supply chain.

Collaborative Demand Planning

• Reduces need for traditional forecasting.
• Sharing information across the supply chain about orders, delivery schedules, backorders, and inventory improves accuracy, however it can be expensive to implement such systems.

Forecasting Development

• Level of aggregation often dictates method.
• Aggregate forecasts are easier to develop, detailed forecasts require more resources.

Forecasting Time Spans

• Short-range: Less than three months to one year (purchasing, scheduling).

  • How much shampoo will Proctor and Gamble expect to sell, in every product line, in every region, country and city of the world, by week over the next three months.

• Medium-range: Three months to three years (sales, budget planning).

• Long-range: Three years or more (new products, facility location).

  • It takes about three or four years to plan the development of a new car model and even longer to develop a new pharmaceutical product.

• Forecast accuracy diminishes as time horizon lengthens.

Forecasting Methodologies

• Qualitative: Unique/new circumstances with little reliable data.
• Quantitative: Numerical data and mathematical formulas to extrapolate past trends.

Qualitative Forecasting Methods

• Panel Approach: Focus group allowing open discussion, may be difficult to reach consensus.
• Delphi Method: Questionnaires emailed to experts, replies analyzed and summarized, process repeated until consensus.
• Scenario Planning: Panel devises range of future scenarios, discusses, and assesses risk.

Quantitative Forecasting Methods

• Time Series Analysis: Examines past sales patterns to predict future demand, and uncovers trend and cyclical movements. Techniques include moving averages and exponential smoothing.

  • The key weakness of time series analysis is that this approach simply looks at past behaviour to predict the future, ignoring causal variables that may be responsible for changes in future behaviour.

• Causal Methods: Understand relationships among variables and their impact on each other using regression analysis. For example, sales performance may be linked to demographic and economic variables such as disposable family income.

• Artificial Neural Networks: Simulate human learning in complex relationships between inputs and outputs.

Performance of Forecasting Methods

• Forecast accuracy and frequency of updating are important.

• Understand assumptions, especially those affecting operations.

• Key factors to better understand forecast outcomes include the following:

  • Accuracy level sought and achieved and the trade-offs involved.
  • The extent to which a method assumes that past behavioural patterns and relationships will continue in the future.
  • Establishing the appropriate forecasting horizon that reflects the capacity lead time currently experienced.
  • The need to establish a match between the selected forecasting method and the data patterns that are present in a particular business. The most common patterns are described as being constant, trend, seasonal and cyclical.

Location Decisions

Strategic Importance of Location

• Major manufacturing facility construction requires long-term commitment.
• Strategic decisions include facility size, timing, location, and processes.
• Manufacturing/back-office considerations: Close existing facility? Expand? Different processes?
• Back-office: Minimize costs.
• Front-office: Driven by revenue potential, higher risks due to site characteristics, location.

Globalisation of Business

• Complicates location decision; consider local customs, tax rates/incentives, laws, infrastructure.
• India attracts service organizations for low cost and educated workforce.
• Incorrect site location reduces profits; selling facility may not recover investment.

Location Decisions in Supply Chains

• Goal: Provide quick and accurate responses at the lowest cost.
• Requires strategically located facilities.
• Example: Toyota's assembly plant location considered transport, supplier access, land cost, workforce.
• Process determines best network structure/locations to maximize service/revenue and minimize costs.
• Complex decisions for global supply chains, considering shipping costs, operating costs, revenue, labor costs, and construction costs.

Locating Service Operations

• Service facilities need to be near customers.
• Criteria differ based on customer contact.
• Facilities:
  • Direct Interface: Restaurants, banks, hospitals.
  • Indirect Contact: Call centers, virtual organizations.
  • No Customer Contact: Cheque processing, billing operations.
• Technology redefines location feasibility.

Factors to Consider When Evaluating Potential Site Locations

• Qualitative: Local infrastructure, worker education/skills, product content requirements, political/economic stability.

• Content requirements state that a minimum percentage of a product must be produced within the borders of a country in order for that product to be sold in that country.

  • Assures jobs in the local economy while reducing the amount of imports.

• Quantitative: Labor costs, distribution costs, facility costs, exchange rates, tax rates.

• Incentives: Low-cost facilities, tax exemptions in special economic zones.

• First high-level consideration is whether to expand local region capacity or supply that region from another part of the world.

Capacity Decisions

Basic Definition

• Capacity: Resources to serve customers, process information, or make products.
• Mix of people, systems, equipment, and facilities.
• Example: Bank needs staff, IT systems, ATMs.
• Manufacturing company needs staff and processes.
• Capacity decisions relate to delivery systems and process capability - to ensure that the technical specification of the service or product can be met and volume - how many services to be processed or products to be made.

Issues in Determining Levels of Capacity

• Plant/equipment capacity is usually irreversible investment.
• Staff capacity is expensive to change.
• Involves market position and competitors’ decisions.
• Consider demand and capacity issues.

Demand-Related Issues

• Meeting customer requirements by managing demand.
• Identifying nature/size of demand.
• Patterns include seasonality, variations (peaks), and one-off demands.
• Protect against ‘no shows’, airlines sometimes overbook on flights.

Capacity-Related Issues

• Demands vary based on services/products and sales levels.
• Bottlenecks occur where capacity is less than demand.
• Aspects of capacity can be less predictable (e.g., absenteeism).

Capacity Measurement

• Complexity of operations makes measurement difficult; capacity is easy to define without ambiguity.
• Output capacity (highly standardized operations): Number of tax forms printed per week (e.g., Australian taxation office) number of people the rides convey per hour (e.g., Dreamworld).
• Input capacity (complex mix of services): Number of seats in an airplane vs Number of staff hours available.
• Almost every type of operation could use a mixture of both input and output measures, but in practice most choose to use one or the other.

Impact of Capacity Planning and Control

• Costs: High unit costs due to under-utilization.
• Revenues: Capacity levels equal to or higher than demand ensure all demand is satisfied and no revenue lost.
• Working Capital: Build finished goods inventory prior to demand; requires funding.
• Quality: Large fluctuations in capacity levels can increase errors.
• Speed of Response: Build-up inventories or surplus capacity to avoid queuing.
• Dependability: Closer demand is to capacity ceiling, less able to cope with disruptions.
• Flexibility: Volume flexibility enhanced by surplus capacity.

Capacity Chunks

• Step changes in capacity (e.g. planes added or removed from fleets).
• Effective management of capacity is critical to success but, often involves confronting tradeoffs

Timing of Capacity Change and Aggregate Capacity Strategies

• Decide when to bring on new capacity.

• Two extreme strategies:

  • Capacity leads demand: Sufficient capacity to meet forecast demand.
  • Capacity lags demand: Demand is always equal to or greater than capacity.

Capacity Leading Strategies

• Advantages:

  • Sufficient capacity to meet demand and extra demand if forecasts are under-estimated.
  • Capacity cushion absorbs extra demand.
  • Less affected by critical start-up problems.

• Disadvantages:

  • Under-utilization of plants.
  • High risks of over-capacity.
  • High risk if demand does not reach forecast levels and early capital spending on plant.

Capacity Lagging Strategies

• Advantages:

  • Sufficient demand to keep plants working at full capacity.
  • Over-capacity problems are minimized.
  • Capital spending on plants is delayed.

• Disadvantages:

  • Insufficient capacity to meet demand fully.
  • No ability to exploit short-term increases in demand.
  • Inability to meet demand if there are start-up problems with the new plant.

Inventories

• For materials-processing and information-processing operations, unused output can be stored via inventories and get the advantages of leading and lagging strategies.
• Storage cost, obsolescence risk are the drawbacks.

Services

• Services cannot be stored for re-use.
• Haircutting and medical services cannot be stored and must be produced and consumed at the same time and place exactly.

Balancing of Capacity and Safety Capacity

• 4-stage network: parts manufacturing -> assembly -> warehouse -> distribution.
• All stages must have the same capacity for efficient operation, capacity of the network as a whole will be limited to the capacity of its slowest link, called the bottleneck in the supply network.
• Safety capacity, defined as an amount of capacity reserved for unanticipated events to be planned into a process or facility is important for potential unanticipated events. For most service industries, safety capacity may range from $10$ to $50$ per cent, as for example in hospitals and hotels.
• In ‘lean’ operations, the facility and processes run with very little spare capacity.

Capacity Constraints

• Parts of operation operating at capacity ceiling act as constraint/bottleneck for whole operation.
• TOC: Increasing throughput by maximizing utilization of bottleneck activities.

Theory of Constraints (TOC)

• Traditional operations management definition of throughput is the average number of goods or services completed per time period by a process.
• TOC views throughput as money generated per time period through actual sales.
• Goal: Maximize throughput, thereby maximizing cash flow.
• Constraint: Anything limiting organization from achieving its goal.
• Constraints determine facility throughput by limiting production output to their own capacity.
• TOC helps managers understand relationships between demand, capacity, and resource utilization.

Service Specific Capacity Issues

• Service capacity is perishable and cannot be inventoried.
• Adjust capacity provision by influencing levels of demand in order to improve trade-offs, or balance levels of customer demand.
• Distinction between back office and front office, where distinction between parts concerns the customer interface.

Front Office

• Customers are present and the service system has to manage customers in thedelivery of the service.
• Service provision and consumption are simultaneous.
• Capacity provision needs to meet demand in terms of the services provided and level of demand.
• When demand is greater than capacity, customers either wait or go elsewhere.
• In a bank branch, demand fluctuates substantially during the day, requiring different staffing levels.

Back Office

• Customers are not present, and the pressure to respond immediately is not there.
• Tasks can be delayed to cumulate volumes and improve scheduling.
• Increases opportunity to manage demand fluctuations more efficiently.

Summary

• Strategic operations decisions for businesses competing in global supply networks.
• Key decisions configure an operation's cost, quality, flexibility, and other outcomes.
• Make-or-buy, outsource, and off-shore options.
• Forecasting customer demand to meet it effectively, but a number of forecasting approaches were discussed, along with the criteria that influence the forecasting decision.
• Location decisions for each part of the supply network.
• Medium-term to long-term capacity planning decisions (facility size/expansion).
• Demand/capacity issues, measurement, safety capacity.
• Timing of capacity changes using leading and lagging strategies.
• Capacity constrained by bottlenecks, TOC concepts.
• Service-specific capacity management (front-office/back-office).
• Building extra capacity generally adds flexibility and responsiveness and allows for higher service levels but certainly costs more!

Woolworths Example

• Location and size of distribution center is critical to future competitiveness.
• Facility is planned for possible enlargement.
• Strategic part of Woolworths business and they needed to retain full control of it.
• Transport costs and capacity from suppliers and to stores would have been a major consideration for the location decision.