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Operations Management, 6e

O P E R A T I O N S M A N A G E M E N T

A N I N T E G R A T E D A P P R O A C H

R . D A N R E I D • N A D A R . S A N D E R S

6th EDITION

Operations Management An Integrated Approach

6th EDITION R. DAN REID • NADA R. SANDERS

VICE PRESIDENT & DIRECTOR George Hoff man

EXECUTIVE EDITOR Lisé Johnson

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v

Preface

Today, companies are competing in a very different environment than they were only a few

years ago. Rapid changes such as global competition, e-business, the Internet, and advances

in technology have required businesses to adapt their standard practices. Operations

management (OM) is the critical function through which companies can succeed in this

competitive landscape.

Operations management concepts are not confined to one department. Rather, they

are far-reaching, affecting every functional aspect of the organization. Whether studying

accounting, finance, human resources, information technology, management, marketing, or

purchasing, students need to understand the critical impact operations management has

on any business.

We each have more than 25 years of teaching experience and understand the challenges

inherent in teaching and taking the introductory OM course. The vast majority of students

taking this course are not majoring in operations management. Rather, classes are typically

composed of students from various business disciplines or students who are undecided

about their major and have little knowledge of operations management. The challenge

is not only to teach the foundation of the field, but also to help students understand the

impact operations management has on the business as a whole and the close relationship of

operations management with other business functions.

We were motivated to write this book to help students understand operations manage-

ment and to make it easier for faculty to teach the introductory operations management

course. We continue to have three major goals for this book.

Goals of the Book 1. Provide a Solid Foundation of Operations

Management Our book provides a solid foundation of OM concepts and techniques, but also covers the

latest on emerging topics such as e-business, supply chain management, enterprise resource

planning (ERP), and information technology. We give equal time to strategic and tactical

decisions and provide coverage of both service and manufacturing organizations. We look

closely at some of the unique challenges faced by service operations.

2. Provide an Integrated Approach to Operations Management

While several excellent textbooks provide appropriate foundation coverage, we believe that

few provide sufficient motivation for students. We are aware that a major teaching chal-

lenge in OM is that students aren’t motivated to study OM because they don’t understand

its relevance to their majors. We think the course textbook can greatly support the pro-

fessor in this area; therefore, a chief goal of this book is to integrate coverage of why and

vi • Preface

how OM is integral to all organizations. Interfunctional coordination and decision mak-

ing have become the norm in today’s business environment. Throughout each chapter we

discuss information flow between business functions and the role of each function in the

organization.

The text also illustrates the linkages and integration between the various OM topics. Our

end-of-chapter feature entitled “Within OM: How It All Fits Together” describes how the

chapter topic is related to other OM decisions. It addresses the issue that OM topics are

linked and interdependent, not independent of one another.

As supply chain management (SCM) has taken on an increasingly important role, the

end-of-chapter section titled “The Supply Chain Link” explains the relationships between

the specific chapter topic covered and supply chain management.

3. Help Students to Understand the Concepts This course remains challenging for students to take and professors to teach. Students

often have no prior exposure to operations concepts and little real business experience.

They have a broad spectrum of quantitative sophistication and often find the math in the

course extremely challenging. Therefore, a chief goal of the text and supplement package is

to help students with these concepts. We begin each chapter with an example from every-

day life, often a consumer or personal example, to help students intuitively understand what

the chapter will be about. Then we explain each concept clearly and carefully, with enough

depth for non-majors. Sustainability in operations is highlighted at the end of each chapter.

The new edition is focused on helping students by offering problem-solving hints and

tips as part of the solution to most examples and solved problems throughout the entire

text. Two unique supplements support student comprehension. A “Quantitative Survival

Guide,” available as an optional supplement packaged with the text, provides “help with

the math” for all chapters. WileyPLUS Learning Space (available on-line via a password in an

optional package with the book) provides plenty of homework practice, feedback for stu-

dents, an e-book, and much more. In addition, algorithmic homework problems have been

designed for each chapter in order to provide unlimited practice opportunity.

Organization and Content of the Book We have arranged the topics in the book in progressive order from strategic to tactical. Early in

the book we cover operations topics that require a strategic perspective and a cultural change

within the organization, such as supply chain management, total quality management, and

just-in-time systems. Progressively we move to more tactical issues, such as work management,

inventory management, and scheduling concerns. We recognize that most faculty will select the

chapters relevant to their needs. To make it easier for students and faculty, each chapter can

stand alone. Any specific knowledge needed for a chapter is summarized at the beginning of

each chapter, with specific topic and page references for easy review.

Balanced Coverage of Quantitative and Qualitative Topics We have tried to find a balance between the quantitative and qualitative treatment and

coverage of OM topics. To meet students’ needs, this text presents the application of OM con-

cepts through the extensive use of practical and relevant business examples. We eliminated

from the printed book coverage of topics less frequently covered at the introductory level.

Preface • vii

However, complete supplementary chapters on spreadsheet modeling, optimization, mas-

ter production scheduling, rough-cut capacity planning, and waiting line models are avail-

able on the book’s Web site (www.wiley.com/college/reid).

Integrated Technology Perspective Advances in e-commerce and the Internet are transforming the business environment, and

we integrate these concepts in every chapter. We discuss a range of topics from enterprise

resource planning (ERP) and electronic data interchange (EDI) to quality issues of buying

goods on-line.

Changes to this Edition We have made a number of changes to this edition in order to make the text as current,

user-friendly, and relevant as possible. In particular we have updated company examples,

technology, big data analytics, and added some supply chain management issues.

Company Examples: Since our last edition we have observed many changes in organi- zations that we had used as examples. Some companies have gone out of business while

others, such as Amazon.com and Dell Computer Corporation, have changed their strate-

gies. In order to offer the most current text we have made updates in company examples

across all chapters.

Technology: One of the biggest changes we are witnessing relates to changes in technology. We have updated discussions with regard to the latest technologies that impact operations man-

agement. This includes discussions of 3D Printing, new generation robotics and automation,

and advancements in radio frequency identification (RFID) in Chapter 3.

Big Data Analytics: Big data analytics is having a tremendous impact on digitizing oper- ations. We have incorporated the latest on big data analytics in Chapters 1 and 3. In Chapter

8 we have added an entire section on predictive analytics and forecasting.

Supply Chain Management Issues: Since our last edition the proposed new shipping facil- ity in Mexico has been canceled, while the Panama Canal is currently being widened. We discuss

the ramifications on materials being shipped from Asia to the United States in Chapter 4.

In addition, several chapters have been reorganized to facilitate a better flow. During the

past five editions, we have added many new topics. This sixth edition better integrates

those topics into the chapters. We continue to emphasize inter-functional coordination and

decision making, and have updated a number of features as shown below.

Before You Begin. In order to help students when solving quantitative problems, the fea- ture called “Before You Begin,” placed immediately prior to the solution of most in-chapter

example problems and end-of-chapter solved problems. Emphasizing our focus on strong

pedagogy, this feature provides problem-solving tips and hints that the student should

consider before proceeding to solve the problem.

Supply Chain Link. To emphasize the increasingly important role of supply chain man- agement, there is a section on supply chain management and expanded coverage of supply

chain and services in every chapter.

Sustainability Link. In order to address the latest challenges facing business, we have included “The Sustainability Link” feature. This feature discusses how the subject of the

chapter directly ties to today’s sustainability concerns and challenges, providing specific

business examples that illustrate the issues.

viii • Preface

Problem Solving. While our goal is to provide balanced coverage of quantitative and qualitative topics, the new edition further emphasizes and integrates problem solving to

help students experience the course more successfully. We provide algorithmic homework

problems for every chapter of the text (via WileyPLUS Learning Space) for unlimited practice

opportunities, include problem-solving help in the book (“Before You Begin”) and on-line

via WileyPLUS Learning Space, and provide step-by-step solved problems in the book and

on-line. We also provide “help with math” as needed via WileyPLUS Learning Space. We

believe that these changes to the new edition greatly enhance student learning.

Features of the Book We have developed our pedagogical features to implement and reinforce the goals discussed

previously and address the many challenges in this course.

Pedagogy that Provides an Integrated Approach Chapter Opening Vignettes and Within OM: How It All Fits Together To help students intuitively under- stand the topic, each chapter begins with a description of

a personal problem that can be solved using the concepts

discussed in the chapter. Our objective is to attract the

attention of students by starting with a personal example

to which they can relate. We demonstrate that OM is not

just about operating a plant or a business, but that it is

relevant in everything that we do. An end-of-chapter sec-

tion titled “Within OM: How It All Fits Together” describes

how the chapter topic is related to other OM decisions.

It emphasizes the point that OM decisions are not made

independently of one another, but that they are linked

together and are dependent on one another.

Links to Practice Other OM texts have many boxes and sidebars, which make it difficult for students to

understand what they need to know. Furthermore, the

many examples frequently interrupt the flow of the text

and make a chapter difficult to read and assimilate.

We recognize the importance of including “real-world”

examples, but believe they should be integrated into

the stream of the text instead of interrupting the text.

Therefore, we have developed embedded boxes titled

“Links to Practice,” which provide brief examples from actual companies in every chapter.

Embedded by both content and design into the general text discussion, each provides a

concise and relevant example without interrupting the flow of the text.

Current textbooks typically do not use business examples to which students can relate.

The typical examples provided are from large corporations such as General Motors, IBM,

or Xerox. Primarily using these types of examples creates the impression for students that

this is a field that is either beyond their reach or irrelevant to their needs. We have found

that students understand the concepts better when these concepts are also presented in a

context that is smaller in scale. The examples chosen range from large multinational organi-

zations to small local businesses.

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E veryone has had experiences of poor quality when dealing with business

organizations. These experiences might involve an airline that has lost

a passenger’s luggage, a dry cleaner that has left clothes wrinkled or

stained, poor course offerings and scheduling at your college, a purchased product

that is damaged or broken, or a pizza delivery service that is often late or delivers

the wrong order. The experience of poor quality is exacerbated when employees of

the company either are not empowered to correct quality inadequacies or do not

seem willing to do so. We have all encountered service employees who do not seem

to care. The consequences of such an attitude are lost customers and opportunities

for competitors to take advantage of the market need.

Successful companies understand the powerful impact customer-defined

quality can have on business. For this reason, many competitive firms continually

increase their quality standards. For example, Ford Motor Company’s focus on qual-

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quality problems. Open discussion is promoted, and criticism is not allowed. Although the functioning of quality circles is friendly and casual, it is serious business. Quality circles are not mere “gab sessions.” Rather, they do important work for the company and have been very successful in many firms.

The importance of excep- tional quality is demonstrated by The Walt Disney Company in the operation of its theme parks. The focus of the parks is customer satisfaction. This is accomplished through metic- ulous attention to every detail, with particular focus on the role of employees in service delivery. Employees are viewed as the most important orga- nizational resource, and great

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Preface • ix

OM across the Organization and Cross-Func- tional Icons Unique to this book is an end-of-chap- ter summary titled “OM across the Organization” that

highlights the relationship between OM and key busi-

ness functions, such as accounting, finance, human

resources, information technology, management, mar-

keting, and purchasing. This section is designed to help

students understand the close relationship of opera-

tions management with other business functions and appreciate the critical impact OM has

on other business functions. In addition, a cross-functional icon is used throughout the text

to highlight sections in the text where the relationships between OM and other key business

functions are discussed.

Cases Each chapter ends with four cases that reinforce the issues and topics discussed in the chapter. The first two cases are within the text, while the other two are on-line cases.

The cases can provide the basis for group discussion or can be assigned as individual exer-

cises for students. Many cases conclude with a list of questions for students to answer.

In addition, each chapter offers a unique interactive learning exercise titled “Internet

Challenge” where students are provided with a short case and given specific Internet assignments.

Interactive Cases There are two Web-based cases for this edition. The first case features an Internet site

for a simulated cruise company that has hired a student

intern to help solve operations problems. The second

case features an Internet site for a simulated consult-

ing company that works in the medical industry that

has hired a student to help solve operations problems.

In both cases, the students are given assignments that

require them to use information provided at the book

Web site to develop solutions. These exercises offer students hands-on experience in the

areas of supply chain management, statistical quality control, forecasting, just-in-time,

aggregate planning, inventory management, scheduling, and project management, and help

tie all the topics in the book together in a service environment.

Pedagogy to Help Students Master the Course Learning Objectives At the beginning of each chapter, students are provided with a short statement of

what they need to either know or review from previous

chapters, referring students to specific topic information.

This enables students to review previous material neces-

sary to understand the topic being covered.

Before You Go On Sections strategically placed within every chapter summarize key material the stu-

dent should know before continuing. Often the material

in chapters can be overwhelming. We felt that breaking

up the chapter with a brief summary of key material is

highly beneficial in aiding learning and comprehension.

Key Terms and Definitions Key terms and concepts are highlighted in boldface when they are first explained in the text, are defined in the margin next to their discussion in the

text, and are listed at the end of the chapter with page references.

i t th iti l i t OM h

ments of the company. A company cannot achieve high quality if its accounting is inaccu rate or the marketing department is not working closely with customers. TQM requires the close cooperation of different functions in order to be successful. In this section we look at the involvement of these other functions in TQM.

Marketing plays a critical role in the TQM process by providing key inputs that make TQM a success. Recall that the goal of TQM is to satisfy customer needs by producing the exact product that customers want. Marketing’s role is to understand the changing needs and wants of customers by working closely with them. This requires a solid identification of target markets and an understanding of whom the product is intended for. Sometimes, apparently small differences in product features can result in large differences in customer appeal. Marketing needs to accurately pass customer information along to operations, and operations needs to include marketing in any planned product changes.

Finance is another major participant in the TQM process because of the great cost con- sequences of poor quality. General definitions of quality need to be translated into specific dollar terms. This serves as a baseline for monitoring the financial impact of quality efforts and can be a great motivator. Recall the four costs of quality discussed earlier. The first two costs, prevention and appraisal, are preventive costs; they are intended to prevent inter-

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Interactive Case: Virtual Company

On-line Case: Cruise International, Inc.

Assignment: Total Quality Management (TQM) at Cruis- ing International, Inc. For this assignment, you will work again with Meghan Willoughby, Chief Purser aboard the Friendly Seas I. You know the assignment has some- thing to do with quality, but you aren’t quite sure what. You meet Meghan aboard the ship. She greets you and says, “Let me tell you a bit about what you’ll be doing for us. We’ve been working on quality measures for sev- eral years, and now must focus on quality even more as our industry becomes more competitive. We need to make sure that our guests receive quality service from

beginning to end. We need your help in bringing ideas together on how to measure quality in a service organi- zation.” This assignment will enhance your knowledge of the material in Chapter 5 of your textbook while pre- paring you for your future assignments.

To access the Web site: • Go to www.wiley.com/college/reid

• Click Student Companion Site

• Click Virtual Company/Cruise International, Inc.

• Click Consulting Assignments

• Click Service Package and Processes at CII

www.wiley.com/college/reid

Learning Objectives After studying this chapter you should be able to: 1 Explain the meaning of total

quality management (TQM).

2 Identify costs of quality

Today’s concept of quality, called total quality management (TQM), focuses on building quality into the process, as op- posed to simply inspecting for poor quality after production. TQM is customer driven and encompasses the entire compa- ny. Before you go on, you should know the four categories of quality costs. These are prevention and appraisal costs, which are costs that are incurred to prevent poor quality, and internal

and external failure costs, which are costs that the company hopes to prevent. You should understand the evolution of TQM and the notable individuals who have shaped our knowl- edge of quality. Last, you should know the seven concepts of the TQM philosophy: customer focus, continuous improve- ment, employee empowerment, use of quality tools, product design, process management, and managing supplier quality.

BEFORE YOU GO ON

x • Preface

Before You Begin Most example problems within the chapters, and end-of-chapter solved problems, have a feature called “Before You Begin.” The feature provides students

with problem-solving tips and hints they need to consider before solving the problem. The

purpose is to help students with their problem-solving ability.

Solved Problems Numerous solved problems are provided, complete with step-by-step explanations to

ensure students understand the process and why the

problem is solved in a particular way. Where appropri-

ate, we provide a series of steps for problem solving and

offer problem-solving tips.

Teaching and Learning Resources Our supporting material has been designed to make learning OM easier for students and

teaching OM easier for faculty.

Book Companion Site www.wiley.com/college/reid An extensive Web site has been developed in support of Operations Management. The site

is available at www.wiley.com/college/reid, and offers a range of information for instruc-

tors and students.

For Instructors • Instructor’s Manual: Includes a suggested course outline, teaching tips and strat-

egies, war stories, answers to all end-of-chapter material, brief description of the

additional resources referenced in the Interactive Learning box, additional in-class

exercises, and tips on integrating the theory of constraints.

• Solutions Manual: A complete set of detailed solutions is provided for all problems.

• Virtual Company Cases Instructor’s Materials: Include accompanying Instruc-

tor’s Manual with answers to exercises and Excel solutions.

· Test Bank: A comprehensive Test Bank comprised of approximately 1700 questions

that consist of multiple choice, true-false, essay questions, and open-ended problems

for each chapter. The Test Bank is also available in a computerized version that allows

instructors to customize their exams.

• PowerPoint Lecture Slides: PowerPoint Slides are available for use in class. Full-

color slides highlight key figures from the text as well as many additional lecture out-

lines, concepts, and diagrams. Together, these provide a versatile opportunity to add

high-quality visual support to lectures.

• Operations Management Video Series: The video package, including Wiley’s own

Student OM Videos, offers video selections that tie directly to the theme of operations

management and bring to life many of the examples used in the text. Videos can be

viewed within WileyPLUS Learning Space.

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PROBLEM 1

An office security system at Delco, Inc. has two compo- nent parts, both of which must work for the system to function. Part 1 has a reliability of 80 percent, and part 2 has a reliability of 98 percent. Compute the reliability of the system.

Before You Begin: Before you begin solving reliability problems, it is best to first draw a diagram of the compo-

t R b th t th t f t i d

Solution:

The reliability of the system is

Rs = R 1

X R 2

Solved Problems (See student companion site for Excel template.)

Part 1 Part 2

R 1 = 0.80 R

2 = 0.98

Preface • xi

For Students • Supplemental Chapters: The supplement chapters include Supplement A: Spread-

sheet Modeling: An Introduction; Supplement B: Introduction to Optimization; Sup-

plement C: Waiting Line Models; Supplement D: Master Scheduling and Rough-Cut

Capacity Planning.

• Excel Spreadsheets: Templates are provided so that students can model and solve

problems presented in the textbook. A spreadsheet icon appears next to those exam-

ples and problems in the textbook that have an accompanying Excel template avail-

able on the student Web site. Step-by-step directions are provided. Directions prompt

students as they work through each spreadsheet. Expected outcomes and questions

are also given.

WileyPlus Learning Space What is WileyPLUS Learning Space? It is a place where students can learn, collaborate, and

grow. Through a personalized experience, students create their own study guide while they

interact with course content and work on learning activities.

WileyPLUS Learning Space combines adaptive learning functionality with a dynamic new

e-textbook for your course—giving you tools to quickly organize learning activities, manage

student collaboration, and customize your course so that you have full control over content

as well as the amount of interactivity between students.

You can:

• Assign activities and add your own materials

• Guide students through what is important in the e-textbook by easily assigning specific

content

• Set up and monitor collaborative learning groups

• Assess student engagement

• Benefit from a sophisticated set of reporting and diagnostic tools that give greater

insight into class activity

Learn more at www.wileypluslearningspace.com. If you have questions, please con-

tact your Wiley representative.

Acknowledgments Operations Management, Sixth Edition, benefits from insights provided by a dedicated group

of operations management educators from around the globe who carefully read and cri-

tiqued draft chapters of this and previous editions. We are pleased to express our apprecia-

tion to the following colleagues for their contributions:

Charles Foley, Columbus State Community College; Nicholas C. Georgantzas, Fordham Uni-

versity Business Schools; Gregory A. Graman, Michigan Technological University; Roger Dean

lles, The University of Memphis; Tony R. Johns, Clarion University of Pennsylvania; Anita Lee-

Post, University of Kentucky; Douglas Schneiderheinze, Lewis and Clark Community College.

Yossi Aviv, Washington University in St. Louis; Kevin Caskey, SUNY New Paltz; Scott T. Crino,

United States Military Academy; Phillip C. Fry, Boise State University; Thomas F. Gattiker,

Boise State University; Christian Grandzol, Bloomsburg University; Samuel Hazen, Tar-

leton State University; James He, Fairfield University; John Jensen, University of Southern

Maine; Mark Kesh, University of Texas at El Paso; Anita Lee-Post, University of Kentucky;

xii • Preface

Winston T. Lin, SUNY Buffalo; Jaideep Motwani, Grand Valley State University; Fariborz

Y. Partovi, Drexel University; Tamara Reid, Seattle University; Dmitriy Shaltayev, Christo-

pher Newport University; Marilyn Smith, Winthrop University; Robert J. Vokurka, Texas A&M

University–Corpus Christi; Pamaela J. Zelbst, Sam Houston State University.

Dennis Agboh, Morgan State University; Karen Eboch, Bowling Green State University; Greg

Graman, Michigan Technological University; GG Hegde, University of Pittsburgh; Seung-Lae

Kim, Drexel University; John Kros, East Carolina University; Anita Lee-Post, University of

Kentucky; David Little, High Point University; Robert Vokurka, Texas A&M University; John

Wang, Montclair State University.

Ajay Aggarwal, Millsaps College; Nezih Altay, University of Richmond; Suad Alway, Chicago

State University; Robert Amundsen, New York Institute of Technology; Gordon Bagot, Califor-

nia State University, Los Angeles; Cliff Barber, California Polytechnic State University, San Luis

Obispo; Hooshang Beheshti, Radford University; Prashanth Bharadwaj, Indiana University of

Pennsylvania; Joe Biggs, California Polytechnic State University; Debra Bishop, Drake Univer-

sity; Vincent Calluzzo, Iona College; James Campbell, University of Missouri–St. Louis; Kevin

Caskey, SUNY New Paltz; Sohail Chaudhry, Villanova University; Chin-Sheng Chen, Florida

International University; Kathy Dhanda, University of Portland; Barb Downey, University of

Missouri–Columbia; Joe Felan, University of Arkansas at Little Rock; Wade Ferguson, Western

Kentucky University; Teresa Friel, Butler University; Daniel Heiser, DePaul University; Lewis

Hofmann, The College of New Jersey; Lisa Houts, California State University, Fullerton; Tony

Inman, Louisiana Tech University; Richard Insinga, SUNY Oneonta; Tim Ireland, Oklahoma

State University; Mehdi Kaighobadi, Florida Atlantic University; Hale Kaynak, The University of

Texas–Pan American; William Coty Keller, St. Josephs College; Robert Kenmore, Keller Grad-

uate School of Management; Jennifer Kohn, Montclair State University; Dennis Krumwiede,

Idaho State University; Kevin Lewis, University of Wyoming; Ardeshir Lohrasbi, University of

Illinois at Spring field; Chris McDermott, Rensselaer Polytechnic Institute; John Miller, Mer-

cer University; Ajay Mishra, SUNY Binghamton; Ken Murphy, Florida International University;

Abraham Nahm, University of Wisconsin–Eau Claire; Len Nass, New Jersey City University;

Joao Neves, The College of New Jersey; Susan Norman, Northern Arizona University; Muham-

mad Obeidat, Southern Polytechnic State University; Barbara Osyk, The University of Akron;

Taeho Park, San Jose State University; Eddy Patuwo, Kent State University; Carl Poch, North-

ern Illinois University; Leonard Presby, William Paterson University; Will Price, University of

the Pacific; Randy Rosenberger, Juniata College; George Schneller, Baruch College–CUNY;

LW Schell, Nicholls State University; Kaushik Sengupta, Hofstra University; William Sherrard,

San Diego State University; Samia Siha, Kennesaw State University; Susan Slotnick, Cleveland

State University; Ramesh Soni, Indiana University of Pennsylvania; Ted Stafford, University

of Alabama in Huntsville; Peter Sutanto, Prairie View A&M University; Fataneh Taghabon-

i-Dutta, University of Michigan–Flint; Nabil Tamimi, University of Scranton; John Visich,

Bryant College; Tom Wilder, California State University, Chico; Peter Zhang, Georgia State

University; Faye X. Zhu, Rowan University.

David Alexander, Angelo State University; Stephen L. Allen, Truman State University; Jerry

Allison, University of Central Oklahoma; Suad Alwan, Chicago State University; Tony Arre-

ola-Risa, Texas A&M University; Gordon F. Bagot, California State University–Los Angeles;

Brent Bandy, University of Wisconsin–Oshkosh; Joseph R. Biggs, California Polytechnic State

University at San Luis Obispo; Jean-Marie Bourjolly, Concordia University; Ken Boyer, DePaul

University; Karen L. Brown, Southwest Missouri State University; Linda D. Brown, Middle Ten-

nessee State University; James F. Campbell, University of Missouri–St. Louis; Cem Canel, Uni-

versity of North Carolina at Wilmington; Chin-Sheng Chen, Florida International University;

Preface • xiii

Louis Chin, Bentley College; Sidhartha R. Das, George Mason University; Greg Dobson, Uni-

versity of Rochester; Ceasar Douglas, Grand Valley State University; Shad Dowlatshahi, Univer-

sity of Missouri– Kansas City; L. Paul Dreyfus, Athens State University; Lisa Ferguson, Hofstra

University; Mark Gershon, Temple University; William Giauque, Brigham Young University;

Greg Graman, Wright State University; Jatinder N.D. Gupta, Ball State University; Peter Haug,

Western Washington University; Daniel Heiser, DePaul University; Ted Helmer, F. Theodore

Helmer and Associates, Inc.; Lew Hofmann, The College of New Jersey; Lisa Houts, California

State University–Fresno; Tim C. Ireland, Oklahoma State University; Peter T. Ittig, University of

Massachusetts–Boston; Jayanth Jayaram, University of Oregon; Robert E. Johnson, University of

Connecticut; Mehdi Kaighobadi, Florida Atlantic University; Yunus Kathawala, Eastern Illinois

University; Basheer Khumawala, University of Houston; Thomas A. Kratzer, Malone College;

Ashok Kumar, Grand Valley State University; Cynthia Lawless, Baylor University; Raymond

P. Lutz, University of Texas at Dallas; Satish Mehra, University of Memphis; Brad C. Meyer,

Drake University; Abdel-Aziz M. Mohamed, California State University–Northridge; Charles

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sity; Jay Nathan, St. Johns University; Harvey N. Nye, University of Central Oklahoma; Susan E.

Pariseau, Merrimack College; Carl J. Poch, Northern Illinois University; Claudia H. Pragman,

Minnesota State University; Willard Price, University of the Pacific; Feraidoon Raafat, San

Diego State University; William D. Raffield, University of St. Thomas; Ranga Ramasesh, Texas

Christian University; Paul H. Randolph, Texas Tech University; Robert M. Saltzman, San Fran-

cisco State University; George O. Schneller IV, Baruch College– CUNY; A. Kimbrough Sher-

man, Loyola College in Maryland; William R. Sherrard, San Diego State University; Chwen

Sheu, Kansas State University; Sue Perrott Siferd, Arizona State University; Samia M. Siha,

Kennesaw State University; Natalie Simpson, SUNY Buffalo; Barbara Smith; Niagara College;

Victor E. Sower, Sam Houston State University; Linda L. Stanley, Our Lady of the Lake Univer-

sity; Donna H. Stewart, University of Wisconsin–Stout; Manouchehr Tabatabaei, University

of Tampa; Nabil Tamimi, University of Scranton; Larry Taube, University of North Carolina–

Greensboro; Giri K. Tayi, SUNY Albany; Charles J. Teplitz, University of San Diego; Timothy L.

Urban, The University of Tulsa; Michael L. Vineyard, Memphis State University; John Visich,

University of Houston; Robert Vokurka, Texas A&M University; George Walker, Sam Houston

State University; John Wang, Montclair State University; Theresa Wells, University of Wiscon-

sin–Eau Claire; T.J. Wharton, Oakland University; Barbara Withers, University of San Diego;

Steven A. Yourstone, University of New Mexico.

Special Thanks We would also like to personally thank and acknowledge the work of our supplements

authors, who worked diligently to create a variety of support materials for both instructors

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We would also like to express our appreciation to Mark Sullivan, AIA, NCARB, of Mark

Sullivan Architects, and Susan O’Hara, RN, MPH, of O’Hara HealthCare Consultants, who

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ing on the book a pleasure. Special thanks go to Lisé Johnson, Executive Editor; Jennifer

xiv • Preface

Manias, Sponsoring Editor; and Suzie Pfi ster, Senior Production Editor, for all their efforts.

We could not have done it without you.

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Amanda Dallas, Market Solutions Assistant.

xv

About the Authors

R. Dan Reid is Associate Professor Emeritus of Operations

Management at the Whittemore School of Business and Eco-

nomics at the University of New Hampshire. He holds a Ph.D.

in Operations Management from The Ohio State University,

an M.B.A. from Angelo State University, and a B.A. in Business

Management from the University of Maryland. During the

past twenty years, he has taught at The Ohio State University,

Ohio University, Bowling Green State University, Otterbein

College, and the University of New Hampshire.

Dr. Reid’s research publications have appeared in numer-

ous journals such as the Production and Inventory Man-

agement Journal, Mid-American Journal of Business, Cornell

Hotel and Restaurant Administration Quarterly, Hospitality

Research and Education Journal, Target, and the OM Review.

His research interests include manufacturing planning and

control systems, quality in services, purchasing, and supply

chain management. He has worked for, or consulted with,

organizations in the telecommunications, consumer elec-

tronics, defense, hospitality, and capital equipment indus-

tries. Dr. Reid has served as Program Chair and President

of the Northeast Region of the Decision Sciences Institute

(NEDSI) and as Associate Program Chair and Proceedings

Editor of the First International DSI Conference, and held

numerous positions within DSI. He has been the Program

Chair and Chair of the Operations Management Division of

the Academy of Management. Dr. Reid has also served as

President of the Granite State Chapter of the American Pro-

duction and Inventory Control Society. He has been a board

member of the Operations Management Association and

the Manchester Manufacturing Management Center. Dr.

Reid is a past Editor of the OM Review.

Dr. Reid has designed and taught courses for undergrad-

uates, graduates, and executives on topics such as resource

management, manufacturing management, introduction

to operations management, purchasing management, and

manufacturing planning and control systems. In 2002 Dr.

Reid received a University of New Hampshire Excellence in

Teaching Award.

Nada R. Sanders is Distinguished Professor of Supply

Chain Management at the D’Amore-McKim School of Busi-

ness at Northeastern University. She holds a Ph.D. in Opera-

tions Management from The Ohio State University, an M.B.A.

from The Ohio State University, and a B.S. degree in Mechan-

ical Engineering from Franklin University. She has taught for

more than twenty-five years at a variety of academic insti-

tutions including The Ohio State University, Wright State

University, Texas Christian University, and Lehigh University,

in addition to lecturing to various industry groups. She has

designed and taught classes for undergraduates, graduates,

and executives on topics such as operations management,

operations strategy, forecasting, and supply chain manage-

ment. She has received a number of teaching awards and is a

Fellow of the Decision Sciences Institute.

Dr. Sanders has extensive research experience and

has published in numerous journals such as Decisions

Sciences, Journal of Operations Management, Sloan Man-

agement Review, Omega, Interfaces, Journal of Behavioral

Decision Making, Journal of Applied Business Research,

and Production & Inventory Management Journal. She has

authored chapters in books and encyclopedias such as

the Forecasting Principles Handbook (Kluwer Academic

Publishers), Encyclopedia of Production and Manufactur-

ing Management (Kluwer Academic Publishers), and the

Encyclopedia of Electrical and Electronics Engineering ( John

Wiley & Sons). Dr. Sanders has served as Vice President

of Decision Sciences Institute (DSI), President of the Mid-

west Decision Sciences Institute, and has held numerous

other positions within the Institute. In addition to DSI, Dr.

Sanders is active in the Production Operations Manage-

ment Society (POMS), APICS, INFORMS, Council of Supply

Chain Management Professions (CSCMP), and the Inter-

national Institute of Forecasters (IIF). She has served on

review boards and/or as a reviewer for numerous journals

including Decision Sciences, Journal of Business Logistics,

Production Operations Management, International Journal

of Production Research, Omega, and others. In addition, Dr.

Sanders has worked and/or consulted for companies in

the telecommunications, pharmaceutical, steel, automo-

tive, warehousing, retail, and publishing industries, and is

frequently called upon to serve as an expert witness.

Contents

Preface v

About the Authors xv

CHAPTER 1 Introduction to Operations Management 1

What is Operations Management? 2 Differences between Manufacturing and Service Organizations 5 Operations Management Decisions 6 Historical Development 10

Why OM? 10

Historical Milestones 10

The Industrial Revolution 10

Scientific Management 12

The Human Relations Movement 12

Management Science 13

The Computer Age 13

Just-in-Time 14

Total Quality Management 14

Business Process Reengineering 14

Flexibility 14

Time-Based Competition 15

Supply Chain Management 15

Global Marketplace 16

Sustainability and Green Operations 17

Electronic Commerce 17

Outsourcing and Flattening of the World 17

Big Data Analytics 18

Today’s OM Environment 18 Operations Management in Practice 19 Within OM: How It All Fits Together 20 OM Across the Organization 20

THE SUPPLY CHAIN LINK 22

THE SUSTAINABILITY LINK 22 Chapter Highlights 23

Key Terms 23

Discussion Questions 24

CASE: Hightone Electronics, Inc. 24 CASE: Creature Care Animal Clinic (A) 25

INTERACTIVE CASE: Virtual Company 26 INTERNET CHALLENGE: Demonstrating Your Knowledge of OM 26

Selected Bibliography 26

CHAPTER 2 Operations Strategy and Competitiveness 28

The Role of Operations Strategy 29 The Importance of Operations

Strategy 30

Developing a Business Strategy 30 Mission 30

Environmental Scanning 31

Core Competencies 32

Putting It Together 33

Developing an Operations Strategy 34

Competitive Priorities 35

The Need for Trade-Offs 38

Order Winners and Qualifiers 38

Translating Competitive Priorities into Production

Requirements 39

Strategic Role of Technology 40 Types of Technologies 40

Technology as a Tool for Competitive

Advantage 41

Productivity 41 Measuring Productivity 41

Interpreting Productivity Measures 44

Productivity and Competitiveness 44

Productivity and the Service Sector 45

Operations Strategy Within OM: How it All Fits Together 45 Operations Strategy Across the Organization 46

THE SUPPLY CHAIN LINK 46

THE SUSTAINABILITY LINK 47 Chapter Highlights 47

Key Terms 47

Formula Review 48

Solved Problems 48

Discussion Questions 49

Problems 49

CASE: Prime Bank of Massachusetts 50 CASE: Boseman Oil and Petroleum (BOP) 51

INTERACTIVE CASE: Virtual Company 52 INTERNET CHALLENGE: Understanding Strategic Diff erences 52

Selected Bibliography 53

Contents • xvii

CHAPTER 3 Product Design and Process Selection 54

Product Design 55 Design of Services versus Goods 55

The Product Design Process 56 Idea Development 56

Product Screening 58

Preliminary Design and Testing 59

Final Design 60

Factors Impacting Product Design 60 Design for Manufacture 60

Product Life Cycle 61

Concurrent Engineering 62

Remanufacturing 64

Process Selection 64 Types of Processes 64

Designing Processes 67 Process Performance Metrics 69 Linking Product Design and Process Selection 72

Product Design Decisions 72

Competitive Priorities 74

Facility Layout 74

Product and Service Strategy 76

Degree of Vertical Integration 76

Technology Decisions 77 Information Technology 77

Automation 78

E-manufacturing 80

Designing Services 82 How Are Services Different from

Manufacturing? 82

How Are Services Classified? 83

The Service Package 84

Differing Service Designs 84

Product Design and Process Selection Within OM: How It All Fits Together 86 Product Design and Process Selection Across the Organization 87

THE SUPPLY CHAIN LINK 88

THE SUSTAINABILITY LINK 88 Chapter Highlights 88

Key Terms 89

Formula Review 89

Solved Problems 90

Discussion Questions 91

Problems 92

CASE: Biddy’s Bakery (BB) 94 CASE: Creature Care Animal Clinic (B) 95 INTERACTIVE CASE: Virtual Company 96 INTERNET CHALLENGE: Country Comfort Furniture 96

Selected Bibliography 96

CHAPTER 4 Supply Chain Management 98

Basic Supply Chains 99 Components of a Supply Chain for a

Manufacturer 100

A Supply Chain for a Service Organization 102

The Bullwhip Effect 104

Issues Affecting Supply Chain Management 106

E-commerce and Supply Chains 106

Consumer Expectations and Competition Resulting from

E-commerce 108

Globalization 110

Infrastructure Issues 111

Government Regulation and E-commerce 113

Green Supply Chain Management 113

The Role of Purchasing 116 Traditional Purchasing and E-purchasing 116

Sourcing Decisions 120 Insourcing versus Outsourcing Decisions 121

Developing Supplier Relationships 123

How Many Suppliers? 124

Developing Partnerships 125

Supplier Management Ethics 129

The Role of Warehouses 130 Crossdocking 132

Radio Frequency Identification Technology

(RFID) 134

Third-Party Service Providers 135

Implementing Supply Chain Management 135

Strategies for Leveraging Supply Chain

Management 136

Supply Chain Performance Metrics 137

Supply Chain Management Within OM: How It All Fits Together 139 SCM Across the Organization 140

THE SUPPLY CHAIN LINK 140

THE SUSTAINABILITY LINK 140 Chapter Highlights 141

Key Terms 142

Formula Review 142

Solved Problems 142

Discussion Questions 144

Problems 144

CASE: Electronic Personal Heart Rate Monitors Supply Chain Management Game 145

CASE: Supply Chain Management At Durham International Manufacturing Company (DIMCO) 148

INTERACTIVE CASE: Virtual Company 148 INTERNET CHALLENGE: Global Shopping 149

Selected Bibliography 149

xviii • Contents

CHAPTER 5 Total Quality Management 151

Defining Quality 152 Differences between Manufacturing and Service

Organizations 153

Cost of Quality 154 The Evolution of Total Quality Management (TQM) 156

Quality Gurus 156

The Philosophy of TQM 160 Customer Focus 160

Continuous Improvement 160

Employee Empowerment 162

Use of Quality Tools 163 Product Design 166

Process Management 170

Managing Supplier Quality 171

Quality Awards and Standards 171 The Malcolm Baldrige National Quality Award

(MBNQA) 171

The Deming Prize 172

ISO 9000 Standards 173

ISO Standards for Sustainability

Reporting 174

Why TQM Efforts Fail 174 Total Quality Management (TQM) Within OM: How It All Fits Together 175 Total Quality Management (TQM) Across the Organization 175

THE SUPPLY CHAIN LINK 176

THE SUSTAINABILITY LINK 176 Chapter Highlights 177

Key Terms 177

Formula Review 178

Solved Problems 178

Discussion Questions 179

Problems 179

CASE: Gold Coast Advertising (GCA) 180

CASE: Delta Plastics, Inc. (A) 181 INTERACTIVE CASE: Virtual Company 182

INTERNET CHALLENGE: Snyder Bakeries 183

Selected Bibliography 183

CHAPTER 6 Statistical Quality Control 185

What Is Statistical Quality Control? 186 Sources of Variation: Common and Assignable Causes 187

Descriptive Statistics 187 The Mean 188

The Range and Standard Deviation 188

Distribution of Data 188

Statistical Process Control Methods 189 Developing Control Charts 189

Types of Control Charts 190

Control Charts for Variables 191 Mean (x-Bar) Charts 191

Range (R) Charts 194

Using Mean and Range Charts Together 196

Control Charts for Attributes 197 p-Charts 198

c-Charts 201

Process Capability 203 Measuring Process Capability 203

Six Sigma Quality 208 Acceptance Sampling 210

Sampling Plans 210

Operating Characteristic (OC) Curves 211

Developing OC Curves 213

Average Outgoing Quality 214

Implications for Managers 216 How Much and How Often to Inspect 216

Where to Inspect 217

Which Tools to Use 217

Statistical Quality Control in Services 217 Statistical Quality Control (SQC) Within OM: How It All Fits Together 219 Statistical Quality Control (SQC) Across the Organization 219

THE SUPPLY CHAIN LINK 220

THE SUSTAINABILITY LINK 220 Chapter Highlights 221

Key Terms 221

Formula Review 222

Solved Problems 222

Discussion Questions 227

Problems 227

CASE: Scharadin Hotels 230 CASE: Delta Plastics, Inc. (B) 231 INTERACTIVE CASE: Virtual Company 232 INTERNET CHALLENGE: Safe-Air 232 Selected Bibliography 233

CHAPTER 7 Just-in-Time and Lean Systems 234

The Philosophy of JIT 235 Eliminate Waste 235

A Broad View of Operations 236

Simplicity 236

Continuous Improvement 236

Visibility 237

Flexibility 237

Elements of JIT 237 Just-in-Time Manufacturing 237

Total Quality Management (TQM) 239

Respect for People 240

Just-in-Time Manufacturing 241 The Pull System 241

Kanban Production 241

Variations of Kanban Production 243

Small Lot Sizes and Quick Setups 245

Uniform Plant Loading 246

Flexible Resources 246

Facility Layout 247

Total Quality Management 249 Product versus Process 249

Quality at the Source 250

Preventive Maintenance 250

Work Environment 251

Respect for People 251 The Role of Production

Employees 251

Lifetime Employment 252

The Role of Management 253

Supplier Relationships 254

Benefits of JIT 255 Implementing JIT 256 JIT in Services 258

Improved Quality 258

Uniform Facility Loading 258

Use of Multifunction Workers 258

Reductions in Cycle Time 258

Minimizing Setup Times and Parallel

Processing 258

Workplace Organization 259

JIT and Lean Systems Within OM: How It All Fits Together 259 JIT and Lean Systems Across the Organization 259

THE SUPPLY CHAIN LINK 260

THE SUSTAINABILITY LINK 260 Chapter Highlights 261

Key Terms 261

Formula Review 262

Solved Problems 262

Discussion Questions 262

Problems 263

CASE: Katz Carpeting 263 CASE: Dixon Audio Systems 265 INTERACTIVE CASE: Virtual Company 265 INTERNET CHALLENGE: Truck-Fleet, Inc. 266

Selected Bibliography 266

CHAPTER 8 Forecasting 267

Principles of Forecasting 268 Steps in the Forecasting Process 268 Types of Forecasting Methods 269

Qualitative Methods 271

Quantitative Methods 272

Time Series Models 272 Forecasting Level or Horizontal

Pattern 275

Forecasting Trend 283

Forecasting Seasonality 286

Causal Models 289 Linear Regression 289

Multiple Regression 293

Measuring Forecast Accuracy 293 Forecast Accuracy Measures 293

Tracking Signal 295

Selecting the Right Forecasting Model 296

Forecasting Software 297

Predictive Analytics and Forecasting 298

Combining Forecasting 299

Collaborative Planning, Forecasting, and Replenishment (CPFR) 299 Forecasting Within OM: How It All Fits Together 300 Forecasting Across the Organization 301

THE SUPPLY CHAIN LINK 301

THE SUSTAINABILITY LINK 302 Chapter Highlights 302

Key Terms 303

Formula Review 303

Solved Problems 304

Discussion Questions 308

Problems 308

CASE: Bram-Wear 312 CASE: Th e Emergency Room (Er) At Northwest General (A) 313

INTERACTIVE CASE: Virtual Company 314 INTERNET CHALLENGE: On-line Data Access 315

Selected Bibliography 315

CHAPTER 9 Capacity Planning and Facility Location 316

Capacity Planning 317 Why Is Capacity Planning Important? 317

Measuring Capacity 318

Capacity Considerations 320

Contents • xix

xx • Contents

Making Capacity Planning Decisions 323 Identify Capacity Requirements 324

Develop Capacity Alternatives 325

Evaluate Capacity Alternatives 325

Decision Trees 325 Location Analysis 328

What Is Facility Location? 328

Factors Affecting Location Decisions 329

Globalization 331

Making Location Decisions 332 Procedure for Making Location Decisions 332

Procedures for Evaluating Location Alternatives 333

Capacity Planning and Facility Location Within OM: How It All Fits Together 343 Capacity Planning and Facility Location Across the Organization 343

THE SUPPLY CHAIN LINK 344

THE SUSTAINABILITY LINK 344 Chapter Highlights 344

Key Terms 345

Formula Review 345

Solved Problems 345

Discussion Questions 348

Problems 348

CASE: Data Tech, Inc. 351 CASE: Th e Emergency Room (ER) At Northwest General (B) 352

INTERACTIVE CASE: Virtual Company 353 INTERNET CHALLENGE: EDS Offi ce Supplies, Inc. 354 Selected Bibliography 354

CHAPTER 10 Facility Layout 355

What Is Layout Planning? 356 Types of Layouts 356

Process Layouts 356

Product Layouts 358

Hybrid Layouts 359

Fixed-Position Layouts 359

Designing Process Layouts 360 Step 1: Gather Information 360

Step 2: Develop a Block Plan 363

Step 3: Develop a Detailed Layout 366

Special Cases of Process Layout 366 Warehouse Layouts 366

Office Layouts 369

Designing Product Layouts 370 Step 1: Identify Tasks and Their Immediate Predecessors 370

Step 2: Determine Output Rate 372

Step 3: Determine Cycle Time 372

Step 4: Compute the Theoretical Minimum Number of

Stations 374

Step 5: Assign Tasks to Workstations

(Balance the Line) 374

Step 6: Compute Efficiency, Idle Time, and Balance

Delay 375

Other Considerations 376

Group Technology (Cell) Layouts 377 Facility Layout Within OM: How It All Fits Together 378 Facility Layout Across the Organization 378

THE SUPPLY CHAIN LINK 379

THE SUSTAINABILITY LINK 379 Chapter Highlights 380

Key Terms 380

Formula Review 380

Solved Problems 381

Discussion Questions 383

Problems 384

CASE: Sawhill Athletic Club (A) 388 CASE: Sawhill Athletic Club (B) 389 INTERACTIVE CASE: Virtual Company 390

INTERNET CHALLENGE: DJ and Associates, Inc. 391

Selected Bibliography 391

CHAPTER 11 Work System Design 392

Work System Design 393 Job Design 393

Job Design 393

Machines or People? 395

Level of Labor Specialization 395

Eliminating Employee Boredom 396

Team Approaches to Job Design 397

The Alternative Workplace 398

The Work Environment 400

Methods Analysis 400

Work Measurement 402 Developing Standards 404

Developing a Standard Work

Sampling 411

Learning Curve Theory 414

Compensation 415 Group Incentive Plans 417

Incentive Plan Trends 417

Work System Design Within OM: How It All Fits Together 418 Work System Design Across the Organization 418

THE SUPPLY CHAIN LINK 419

THE SUSTAINABILITY LINK 419 Chapter Highlights 420

Contents • xxi

Key Terms 421

Formula Review 421

Solved Problems 421

Discussion Questions 424

Problems 425

CASE: Th e Navigator III 428 CASE: Northeast State University 428 INTERACTIVE CASE: Virtual Company 429 INTERNET CHALLENGE: E-commerce Job Design 430 Selected Bibliography 430

CHAPTER 12 Inventory Management 432

Basic Inventory Principles 433 How Manufacturers Use Inventory 433

Inventory in Service Organizations 435

Inventory Management Objectives 436 Customer Service 436

Cost-Efficient Operations 437

Minimum Inventory Investment 438

Relevant Inventory Costs 440 ABC Inventory Classification 442 Inventory Record Accuracy 445 Determining Order Quantities 446

Non-mathematical Techniques for Determining Order

Quantity 447

Mathematical Models for Determining Order Quantity 448

The Single-Period Inventory Model 459

Why Companies Don’t Always Use the Optimal Order

Quantity 461

How a Company Justifies Smaller Order Quantities 462

Determining Safety Stock Levels 463 The Periodic Review System 466

Comparing Continuous Review Systems and Periodic Review

Systems 468

Inventory Management within OM: How It All Fits Together 468 Inventory Management across the Organization 469

THE SUPPLY CHAIN LINK 469

THE SUSTAINABILITY LINK 470 Chapter Highlights 470

Key Terms 471

Formula Review 471

Solved Problems 472

Discussion Questions 476

Problems 476

CASE: Fabqual Ltd. 480 CASE: Kayaks!Incorporated 480 INTERACTIVE CASE: Virtual Company 481 INTERNET CHALLENGE: Community Fund-Raiser (A) 482

Selected Bibliography 482

CHAPTER 13 Aggregate Planning 483

Business Planning 484 Aggregate Planning Options 486

Demand-Based Options 487 Capacity-Based Options 488

Evaluating the Current Situation 489

Aggregate Plan Strategies 490 Level Aggregate Plan 490

Chase Aggregate Plan 491

Hybrid Aggregate Plan 492

Developing the Aggregate Plan 492 Aggregate Plans for Companies with Tangible Products 494

Aggregate Plans for Companies with Nontangible

Products 497

Aggregate Planning Within OM: How It All Fits Together 502 Aggregate Planning Across the Organization 502

THE SUPPLY CHAIN LINK 503

THE SUSTAINABILITY LINK 503

Chapter Highlights 503 Key Terms 504

Solved Problems 504

Discussion Questions 510

Problems 511

CASE: Newmarket International Manufacturing Company (A) 513

CASE: JPC, Inc.: Kitchen Countertops Manufacturer 514

INTERACTIVE CASE: Virtual Company 515 INTERNET CHALLENGE: Cruising 515 Selected Bibliography 516

CHAPTER 14 Resource Planning 517

Enterprise Resource Planning 518 The Evolution of ERP Systems 520

The Benefits and Costs of ERP 522 The Benefits of ERP Systems 522

The Costs of ERP Systems 523

Material Planning Systems 524 An Overview of Material Planning Systems 524

Objectives of MRP 525

Types of Demand 525

The Operating Logic of MRP 527

How MRP Works 532 Action Notices 536

Comparing Different Lot Size Rules 536

Capacity Requirements Planning (CRP) 538 Resource Planning Within OM: How It All Fits Together 540

xxii • Contents

Resource Planning Across the Organization 540

THE SUPPLY CHAIN LINK 541

THE SUSTAINABILITY LINK 541 Chapter Highlights 542

Key Terms 542

Formula Review 543

Solved Problems 543

Discussion Questions 546

Problems 547

CASE: Newmarket International Manufacturing Company (B) 549

CASE: Desserts By J.B. 551 INTERACTIVE CASE: Virtual Company 551 INTERNET CHALLENGE: Th e Gourmet Dinner 552

Selected Bibliography 552

CHAPTER 15 Scheduling 553

Basic Scheduling Concepts 554 Scheduling High-Volume Operations 554

Scheduling Low-Volume Operations 555

Shop Loading Methods 556

Developing a Schedule of Operations 560 Scheduling Performance Measures 561

Using Different Priority Rules 564

Sequencing Jobs through Two Work Centers 567

Optimized Production Technology 569 Scheduling Bottlenecks 569

Theory of Constraints 571

Scheduling Issues for Service Organizations 572

Scheduling Techniques for Service Organizations 572

Scheduling Employees 573

Developing a Workforce Schedule 574

Scheduling Within OM: Putting It All Together 576 Scheduling Across the Organization 576

THE SUPPLY CHAIN LINK 577

THE SUSTAINABILITY LINK 577 Chapter Highlights 577

Key Terms 578

Formula Review 578

Solved Problems 578

Discussion Questions 582

Problems 583

CASE: Air Traffi c Controller School (ATCS) 586 CASE: Scheduling At Red, White, And Blue Fireworks Company 586

INTERACTIVE CASE: Virtual Company 587 INTERNET CHALLENGE: Batter Up 587 Selected Bibliography 588

CHAPTER 16 Project Management 589

The Project Life Cycle 590 Project Management Concepts 591

Step 1: Describe the Project 592

Step 2: Diagram the Network 593

Step 3: Estimate the Project’s Completion Time 595

Step 3 (a): Deterministic Time Estimates 595

Step 3 (b): Probabilistic Time Estimates 598

Step 4: Monitor the Project’s Progression 603

Estimating the Probability of Completion Dates 604 Reducing Project Completion Time 606

Crashing Projects 606

The Critical Chain Approach 609 Adding Safety Time 609

Wasting Safety Time 609

Project Management Within OM: How It All Fits Together 611 Project Management OM Across the Organization 611

THE SUPPLY CHAIN LINK 612

THE SUSTAINABILITY LINK 612

Chapter Highlights 612 Key Terms 613

Formula Review 613

Solved Problems 614

Discussion Questions 618

Problems 618

CASE: Th e Research Offi ce Moves 621 CASE: Writing A Textbook 622 INTERACTIVE CASE: Virtual Company 623 INTERNET CHALLENGE: Creating Memories 623 Selected Bibliography 624

Appendix A Solutions to Odd-Numbered Problems 625

Appendix B The Standard Normal Distribution 647

Appendix C p-Chart 648

NAME INDEX 651

SUBJECT INDEX 654

Contents • xxiii

To view Supplemental Chapters A-D, please visit www. wiley.com/college/reid or your WileyPLUS Learning Space course.

SUPPLEMENT A Spreadsheet Modeling: An Introduction A1

What Are Models? A2 The Spreadsheet Modeling Process A3

Evaluating the Spreadsheet Model A4

Constructing the Model A6

Assessing Our Model A8

Using the Model for Analysis A10

Using Data Tables A13

Graphing the Model Results A16

Multiple-Criteria Decision Making A17 Relative and Absolute Cell Referencing A19

Entering Formulas in the Model A20

Useful Spreadsheet Tips A25 Important Excel Formulas A25 Spreadsheet Modeling Within OM: How It All Fits Together A27

Supplement Highlights A27

Key Terms A28

Discussion Questions A28

Problems A28

CASE: Diet Planning A30 Selected Bibliography A31

SUPPLEMENT B Introduction to Optimization B1

Optimization B2 Algebraic Formulation B3

Examining the Formulation B6

Spreadsheet Model Development B7 Testing the Model B8

Solver Basics B8

Setting Up and Running Solver B9

Solving the Problem B12

Interpreting the Solution B13 Solver Solution Reports B14

Outcomes of Linear Programming Problems B16

Optimization Within OM: How It All Fits Together B17

Supplement Highlights B18

Key Terms B18

Solved Problems B18

Discussion Questions B23

Problems B24

CASE: Exeter Enterprises B25 Selected Bibliography B26

SUPPLEMENT C Waiting Line Models C1

Elements of Waiting Lines C2 Links to Practice: Waiting for Fast Food C2

The Customer Population C3

The Service System C3

Arrival and Service Patterns C5

Waiting Line Priority Rules C5

Waiting Line Performance Measures C6 Single-Server Waiting Line Model C6

Multiserver Waiting Line Model C9

Changing Operational Characteristics C12 Larger-Scale Waiting Line Systems C13

Waiting Line Models Within OM: How It All Fits Together C14

Supplement Highlights C14

Key Terms C15

Formula Review C15

Solved Problems C15

Discussion Questions C18

Problems C18

CASE: Th e Copy Center Holdup C19 Selected Bibliography C19

SUPPLEMENT D Master Scheduling and Rough-Cut Capacity Planning D1

Master Production Scheduling D2 MPS as a Basis of Communication D2

Objectives of Master Scheduling D3

Developing an MPS D4 Rough-Cut Capacity Planning D5

Evaluating and Accepting the MPS D8

Using the MPS D9 Stabilizing the MPS D12 Master Production Scheduling and Rough-Cut Capacity Planning within OM: How It All Fits Together D14

Supplement Highlights D14

Key Terms D15

Formula Review D15

Solved Problems D15

Discussion Questions D20

Problems D20

CASE: Newmarket International Manufacturing Company (C) D22

1 Learning Objectives After studying this chapter you should be able to 1 Defi ne operations management. 2 Describe difference between

manufacturing and service organizations.

3 Describe decisions that operations managers make.

4 Identify major historical developments in operations management.

5 Identify current trends in operations management.

6 Describe the fl ow of information between operations management and other business functions.

Introduction to Operations Management

M any of you reading this book may think that you don’t know what operations management (OM) is or that it is not something you are interested in. However, after reading this chapter you will realize

that you already know quite a bit about operations management. You may even be working in an operations management capacity and have used certain operations management techniques. You will also realize that operations management is probably the most critical business function today. If you want to be on the frontier of business competition, you want to be in operations management.

Today companies are competing in a very different environment than they were only a few years ago. To survive, they must focus on quality, time-based competi- tion, efficiency, international perspectives, and customer relationships. Global com- petition, e-business, the Internet, and advances in technology require flexibility and responsiveness. Increased financial pressures require lean and agile organizations that are free of waste. This new focus has placed operations management in the business limelight because it is the function through which companies can achieve this type of competitiveness.

Consider some of today’s most successful companies, such as Wal-Mart, South- west Airlines, General Electric, Starbucks, Apple Computer, Toyota, FedEx, and Procter & Gamble. These companies have achieved world-class status in large part

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2 CHAPTER 1 • Introduction to Operations Management

What is Operations Management? Every business is managed through three major functions: finance, marketing, and operations management. Figure 1.1 illustrates this by showing that the vice presidents of each of these functions report directly to the president or CEO of the company. Other business functions—such as accounting, purchasing, human resources, and engineering—support these three major functions. Finance is the function responsible for managing cash flow, current assets, and capital investments. Marketing is respon- sible for sales, generating customer demand, and understanding customer wants and needs. Most of us have some idea of what finance and marketing are about, but what does operations management do?

Operations management (OM) is the business function that plans, organizes, coor- dinates, and controls the resources needed to produce a company’s goods and services. Operations management is a management function. It involves managing people, equip- ment, technology, information, and many other resources. Operations management is the central core function of every company. This is true whether the company is large or small, provides a physical good or a service, is for-profit or not-for-profit. Every com- pany has an operations management function. Actually, all the other organizational func- tions are there primarily to support the operations function. Without operations, there

FINMKT

Operations management (OM) The business function responsible for planning, coordinating, and controlling the resources needed to produce a company’s goods and services.

due to a strong focus on operations management. In this book you will learn specific tools and techniques of operations management that have helped these and other companies achieve their success.

The purpose of this book is to help prepare you to be successful in this new business environ- ment. Operations management will give you an understanding of how to help your organization gain a competitive advantage in the marketplace. Regardless of whether your area of expertise is marketing, finance, MIS, or operations, the techniques and concepts in this book will help you in your business career. The material will teach you how your company can offer goods and services cheaper, better, and faster. You will also learn that operations management concepts are far-reaching, affecting every aspect of the organization and even everyday life. •

President or CEO

Operations V.P. of Operations

Manages: people, equipment, technology, materials, and information To produce: goods and/or services

Marketing V.P. of Marketing

Manages: customer demands Generates: sales for goods and services

Finance V.P. of Finance

Manages: cash flow, current assets, and capital investments

FIGURE 1.1 Organizational chart showing the three major business functions

What is Operations Management? • 3

would be no goods or services to sell. Consider a retailer such as The Gap, which sells casual apparel. The marketing function provides promotions for the merchandise, and the finance function provides the needed capital. It is the operations function, however, that plans and coordinates all the resources needed to design, produce, and deliver the merchandise to the various retail locations. Without operations, there would be no goods or services to sell to customers.

The role of operations management is to transform a company’s inputs into the finished goods or services. Inputs include human resources (such as workers and man- agers), facilities and processes (such as buildings and equipment), as well as materials, technology, and information. Outputs are the goods and services a company produces. Figure 1.2 shows this transformation process. At a factory the transformation is the phys- ical change of raw materials into products, such as transforming leather and rubber into sneakers, denim into jeans, or plastic into toys. At an airline it is the efficient movement of passengers and their luggage from one location to another. At a hospital it is organizing resources such as doctors, medical procedures, and medications to transform sick people into healthy ones.

Operations management is responsible for orchestrating all the resources needed to produce the final product. This includes designing the product; deciding what resources are needed; arranging schedules, equipment, and facilities; managing inventory; controlling quality; designing the jobs to make the product; and designing work methods. Basically, operations management is responsible for all aspects of the process of transforming inputs into outputs. Customer feedback and performance information are used to continually adjust the inputs, the transformation process, and the characteristics of the outputs. As shown in Figure 1.2, this transformation process is dynamic in order to adapt to changes in the environment.

Proper management of the operations function has led to success for many companies. For example, in 1994 Dell Computer Corporation was a second-rate computer maker that managed its operations similarly to others in the industry. Then Dell implemented a new business model that completely changed the role of its operations function. Dell developed new and innovative ways of managing the operations function that have become one of today’s best practices. These changes enabled Dell to provide rapid product delivery of customized products to customers at a lower cost. The company has since expanded this model to use an analytics driven system. This has enabled Dell to identify certain models so common they could be stocked in preconfigured inventory. Ordered today the customer can have them tomorrow. Dell’s model is one many have tried to emulate and is the key to its being an industry leader.

Role of operations management To transform organizational inputs into outputs.

FIGURE 1.2 The transformation process

Inputs

The Transformation

Process

Outputs

Performance Information

Customer Feedback

4 CHAPTER 1 • Introduction to Operations Management

Just as proper management of operations can lead to company success, improper manage- ment of operations can lead to failure. This is illustrated by Kozmo.com, a Web-based home delivery company founded in 1997. Kozmo’s mission was to deliver products to customers— everything from the latest video to ice cream—in less than an hour. Kozmo was technology enabled and rapidly became a huge success. However, the initial success gave rise to overly fast expansion. The company found it difficult to manage the operations needed in order to deliver the promises made on its Web site. The consequences were too much inventory, poor deliveries, and losses in profits. The company rapidly tried to change its operations, but it was too late. It had to cease operations in April 2001.

The Web-based age has created a highly competitive world of on-line shopping that poses special chal- lenges for operations management. The Web can be used for on-line purchasing of everything from CDs, books, and groceries to prescription medications and automobiles. The Internet has given consumers flex- ibility; it has also created one of the biggest challenges for companies: delivering exactly what the cus-

tomer ordered at the time promised. As we saw with the example of Kozmo.com, making promises on a Web site is one thing; delivering on those promises is yet another. Ensuring that orders are delivered from “mouse to house” is the job of operations and is much more complicated than it might seem. In the 1990s many dot-com companies discovered just how difficult this is. They were not able to generate a profit and went out of business. To ensure meeting promises, companies must forecast what customers want and main- tain adequate inventories of goods, manage distribution centers and warehouses, operate fleets of trucks, and schedule deliveries while keeping costs low and customers satisfied. Many companies like Amazon.com manage almost all aspects of their operation. In fact, Amazon.com has been moving toward having its own delivery service. Other companies hire outside firms for certain functions, such as outsourcing the management of invento- ries and deliveries to UPS. Competition among e-tailers has become intense as customers demand increasingly shorter delivery times and highly customized products. Same-day service has become common in metropolitan areas. For example, Barnesandnoble.com provides same-day delivery in Manhattan, Los Angeles, and San Francisco. Amazon.com has significantly expanded same-day delivery locations. Understanding and managing the operations function of an on-line business has become essential in order to remain competitive.

For operations management to be successful, it must add value during the transforma- tion process. We use the term value added to describe the net increase between the final value of a product and the value of all the inputs. The greater the value added, the more productive a business is. An obvious way to add value is to reduce the cost of activities in the transformation process. Activities that do not add value are considered a waste; these include certain jobs, equipment, and processes. In addition to value added, operations must be efficient. Efficiency means being able to perform activities well and at the lowest pos- sible cost. An important role of operations is to analyze all activities, eliminate those that do not add value, and restructure processes and jobs to achieve greater efficiency. Because today’s business environment is more competitive than ever, the role of operations manage- ment has become the focal point of efforts to increase competitiveness by improving value added and efficiency.

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Value added The net increase created during the transformation of inputs into fi nal outputs.

Effi ciency Performing activities well and at the lowest possible cost.

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THE E-TAILERS www.Amazon.com www.Barnesandnoble.com www.alibaba.com

Differences between Manufacturing and Service Organizations • 5

Differences between Manufacturing and Service Organizations

Organizations can be divided into two broad categories: manufacturing organizations and service organizations, each posing unique challenges for the operations function. There are two primary distinctions between these categories. First, manufacturing organi- zations produce physical, tangible goods that can be stored in inventory before they are needed. By contrast, service organizations produce intangible products that cannot be produced ahead of time. Second, in manufacturing organizations most customers have no direct contact with the operation. Customer contact occurs through distributors and retailers. For example, a customer buying a car at a car dealership never comes into contact with the automobile factory. However, in service organizations the customers are typically present during the creation of the service. Hospitals, colleges, theaters, and barber shops are examples of service organizations in which the customer is present during the creation of the service.

The differences between manufacturing and service organizations are not as clear- cut as they might appear, and there is much overlap between them. Most manufacturers provide services as part of their business, and many service firms manufacture physi- cal goods that they deliver to their customers or consume during service delivery. For example, a manufacturer of furniture may also provide shipment of goods and assembly of furniture. A barber shop may sell its own line of hair care products. You might not know that General Motors’ greatest return on capital does not come from selling cars, but rather from postsales parts and service. Figure 1.3 shows the differences between manufacturing

Physical product

Low customer contact

Capital intensive

Long response time

Product can be inventoried

Intangible product

High customer contact

Short response time

Labor intensive

Product cannot be inventoried

DEGREE OF CUSTOMER CONTACT Low High

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Manufacturing Organization

FIGURE 1.3 Characteristics of manufacturing and service organizations

Manufacturing organizations Organizations that primarily produce a tangible product and typically have low customer contact.

Service organizations Organizations that primarily produce an intangible product, such as ideas, assistance, or information, and typically have high customer contact.

6 CHAPTER 1 • Introduction to Operations Management

and services, focusing on the dimensions of product tangibility and the degree of cus- tomer contact. It shows the extremes of pure manufacturing and pure service, as well as the overlap between them.

Even in pure service companies some segments of the operation may have low customer contact while others have high customer contact. The former can be thought of as “back room” or “behind the scenes” segments. Think of a fast-food operation such as Wendy’s, for which customer service and customer contact are important parts of the business. How- ever, the kitchen segment of Wendy’s operation has no direct customer contact and can be managed like a manufacturing operation. Similarly, a hospital is a high-contact service operation, but the patient is not present in certain segments, such as the lab where speci- men analysis is done.

In addition to pure manufacturing and pure service, there are companies that have some characteristics of each type of organization. It is difficult to tell whether these companies are actually manufacturing or service organizations. Think of a post office, an automated warehouse, or a mail-order catalog business. They have low customer contact and are capital intensive, yet they provide a service. We call these companies quasi-manufacturing organizations.

The U.S. Postal Service is an example of a quasi-manufacturing type of company. It provides a service: speedy, reliable delivery of letters, documents, and packages. Its output is intangible and cannot be stored in inven- tory. Yet most operations management deci- sions made at the Postal Service are similar to those that occur in manufacturing. Customer contact is low, and at any one time there is a large amount of inventory. The Postal Service is capital intensive, having its own facilities and fleet of trucks and relying on scanners to

sort packages and track customer orders. Scheduling enough workers at peak processing times is a major concern, as is planning delivery schedules. Note that although the output of the U.S. Postal Service is a service, inputs include labor, technology, and equipment. The responsibility of OM is to manage the conversion of these inputs into the desired outputs. Proper management of the OM function is critical to the success of the U.S. Postal Service.

It is important to understand how to manage both service and manufacturing opera- tions. However, managing service operations is of especially high importance. The reason is that the service sector constitutes a dominant segment of our economy. Since the 1960s, the percentage of jobs in the service-producing industries of the U.S. economy has increased from less than 50 to over 80 percent of total nonfarm jobs. The remaining 20 percent are in the manufacturing and goods-producing industries. Figure 1.4 illustrates this large growth of the service sector.

Operations Management Decisions In this section we look at some of the specific decisions that operations managers have to make. The best way to do this is to think about decisions we would need to make if we started our own company—say, a company called Gourmet Wafers that produces praline–pecan cookies from an old family recipe. Think about the decisions that would have to be made to go from the initial idea to actual production of the product: that is operations management. Table 1.1 breaks these down into the generic decisions that would be appropriate for almost

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U.S. POSTAL SERVICE www.usps.com

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Operations Management Decisions • 7

any good or service, the specific decisions required for our example, and the formal terms for these decisions that are used in operations management.

Note in the Gourmet Wafers example that the first decisions made were very broad in scope (e.g., the unique features of our product). We needed to do this before we could focus on more specific decisions (e.g., worker schedules). Although our example is simple, this decision-making process is followed by every company, including IBM, General Motors, Lands’ End, and your local floral shop. Also note in our example that before we can think about specific day-to-day decisions, we need to make decisions for the whole company that are long-term in nature. Long-term decisions that set the direction for the entire organiza- tion are called strategic decisions. They are broad in scope and set the tone for other, more specific decisions. They address questions such as: What are the unique features of our product? What market do we plan to compete in? What do we believe will be the demand for our product?

Short-term decisions that focus on specific departments and tasks are called tactical deci- sions. Tactical decisions focus on more specific day-to-day issues, such as the quantities and timing of specific resources. Strategic decisions are made first and determine the direction of tactical decisions, which are made more frequently and routinely. Therefore, we have to start with strategic decisions and then move on to tactical decisions. This relationship is shown in Figure 1.5. Tactical decisions must be aligned with strategic decisions because they are the key to the company’s effectiveness in the long run. Tactical decisions provide feedback to strategic decisions, which can be modified accordingly.

Goods Producing (Manufacturing Construction)

Service Producing

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Strategic decisions Decisions that set the direction for the entire company; they are broad in scope and long-term in nature.

Tactical decisions Decisions that are specifi c and short-term in nature and are bound by strategic decisions.

FIGURE 1.4 U.S. employment by economic sector

8 CHAPTER 1 • Introduction to Operations Management

TABLE 1.1 Operations Management Decisions for Gourmet Wafers

General Decisions to Be Made

Decision Specifi c for Cookie Production

Operations Management Term

What are the unique features of the business that will make it competitive?

The business offers freshly baked cookies “homemade” style, in a fast-food format.

Operations strategy

What are the unique features of the product?

The unique feature of the cookies is that they are loaded with extra-large and crunchy pecans and are fresh and moist.

Product design

What are the unique features of the process that give the product its unique characteristics?

A special convection oven is used to make the cookies in order to keep them fresh and moist. The dough is allowed to rise longer than usual to make the cookies extra light.

Process selection

What sources of supply should we use to ensure regular and timely receipt of the extract materials we need? How do we manage these sources of supply?

The key ingredients, pecans and syrup, will be purchased from only one supplier located in South Carolina because it offers the best products. A relationship is worked out in which the supplier sends the ingredients on the exact schedule that they are needed.

Supply chain management

How will managers ensure the quality of the product, measure quality, and identify quality problems?

A quality check is made at each stage of cookie production. The dough is checked for texture; the pecans are checked for size and freshness; the syrup is checked for consistency.

Quality management

What is the expected demand for the product?

Expected sales for each day of the week have been determined; for example, it is expected that more cookies will be sold on weekdays and most during the lunch hours. Expected cookie sales for each month and for the year have also been determined.

Forecasting

Where will the facility be located? After looking at locations of customers and location costs, it is decided that the facility will be located in a shopping mall.

Location analysis

How large should the facility be? The business needs to be able to produce 200 cookies per hour, or up to 2000 cookies per day.

Capacity planning

How should the facility be laid out? Where should the kitchen and ovens be located? Should there be seating for customers?

Decisions are made about where the kitchen will be located and how the working area will be arranged for maximum effi ciency. The business is competing on the basis of speed and quality; therefore, the facility should be arranged to promote these features. There will be a small seating area for customers and a large counter and display case for buying.

Facility layout

What jobs will be needed in the facility, who should do what task, and how will their performance be measured?

Two people will be needed in the kitchen during busy periods and one during slow periods. Their job duties are determined. One person will be needed for order taking at all times.

Job design and work measurement

How will the inventory of raw materials be monitored? When will orders be placed, and how much will be kept in stock?

A different policy is developed for common ingre- dients, such as fl our and sugar. These ingredients will be ordered every two weeks for a two-week supply. A special purchasing arrangement is worked out with the supplier of specialty ingredients.

Inventory management

Who will work on what schedule? Two people will work the counter in split shifts. One kitchen employee will work a full shift, with a second employee working part-time.

Scheduling

Operations Management Decisions • 9

You should understand that operations management (OM) is the business function responsible for planning, coordinating, and controlling the resources needed to produce a company’s goods and services. OM is directly responsible for managing the transformation of a company’s inputs (e.g., materials, tech- nology, and information) into fi nished products and services. OM requires a wide range of strategic and tactical decisions. Strategic decisions are long-range and very broad in scope

(e.g., unique features of the company’s product and process). They determine the direction of tactical decisions, which are more short-term and narrow in scope (e.g., policy for ordering raw materials). All organizations can be separated into manu- facturing and service operations, which differ based on prod- uct tangibility and degree of customer contact. Service and manufacturing organizations have very different operational requirements.

BEFORE YOU GO ON

You can see in the example of Gourmet Wafers how important OM decisions are. They are critical to all types of companies, large and small. In large companies these decisions are more complex because of the size and scope of the organization. Large companies typically produce a greater variety of products, have multiple location sites, and often use domestic and international suppliers. Managing OM decisions and coordinating efforts can be a com- plicated task, and the OM function is critical to the company’s success.

We can illustrate this point by looking at operations management decisions made by Texas Instruments (TI) in order to position itself for global collaboration with cus- tomers, distributors, and suppliers. TI realized its business was growing exponentially, with more than 120,000 monthly orders received and processed elec- tronically. The coordination effort encompassed 56 factories, including subcontractors, and the man- agement of over 45,000 products. To succeed, the company needed to develop a system to generate better forecasts, coordinate manufacturing of prod- ucts, manage orders, and track deliveries. Managing and coordinating global operations management functions was considered paramount to the compa- ny’s success. TI adopted a comprehensive software package called enterprise resource planning (ERP) that integrates information throughout the organization, manages forecasts, and coor- dinates factory operations. Designing and implementing the ERP system at TI required an understanding of all the strategic and tactical operations decisions; otherwise, it would not be effective. The system has proven to be a success and a major achieve- ment, enabling TI to consistently manage factory operations across the globe.

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TEXAS INSTRUMENTS INCORPORATED www.ti.com

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What are the unique features of our product that make us competitive?

TACTICAL DECISIONS

Who will work the 2 shift tomorrow?

FIGURE 1.5 The relationship between strategic and tactical decisions

10 CHAPTER 1 • Introduction to Operations Management

Historical Development Why OM? Business did not always recognize the importance of operations management. In fact, fol- lowing World War II the marketing and finance functions were predominant in American corporations. The United States had just emerged from the war as the undisputed global manufacturing leader due in large part to efficient operations. At the same time, Japan and Europe were in ruins, their businesses and factories destroyed. U.S. companies had these markets to themselves, and so the post–World War II period of the 1950s and 1960s represented the golden era for U.S. business. The primary opportunities were in the areas of marketing, to develop the large potential markets for new products, and in finance, to support the growth. Since there were no significant competitors, the operations func- tion became of secondary importance, because companies could sell what they produced. Even the distinguished economist John Kenneth Galbraith observed, “The production problem has been solved.”

Then in the 1970s and 1980s, things changed. American companies experienced large declines in productivity growth, and international competition began to be a challenge in many markets. In some markets such as the auto industry, American corporations were being pushed out. It appeared that U.S. firms had become lax due to the lack of competition in the 1950s and 1960s. They had forgotten about improving their methods and processes. In the meantime, foreign firms were rebuilding their facilities and designing new production methods. By the time foreign firms had recovered, many U.S. firms found themselves unable to compete. To regain their competitiveness, companies turned to operations management, a function they had overlooked and almost forgotten about.

The new focus on operations and competitiveness has been responsible for the recov- ery of many corporations, and U.S. businesses experienced a resurgence in the 1980s and 1990s. Operations became the core function of organizational competitiveness. Although U.S. firms have rebounded, they are fully aware of continued global competition, scarcity of resources, and increased financial pressure. Companies have learned that to achieve long- run success they must place much importance on their operations.

Historical Milestones When we think of what operations management does—namely, managing the transforma- tion of inputs into goods and services—we can see that as a function it is as old as time. Think of any great organizational effort, such as organizing the first Olympic games, build- ing the Great Wall of China, or erecting the Egyptian pyramids, and you will see operations management at work. Operations management did not emerge as a formal field of study, however, until the late 1950s and early 1960s, when scholars began to recognize that all production systems face a common set of problems and to stress the systems approach to viewing operations processes.

Many events helped shape operations management. We will describe some of the most significant of these historical milestones and explain their influence on the development of operations management. Later we will look at some current trends in operations manage- ment. These historical milestones and current trends are summarized in Table 1.2.

The Industrial Revolution The Industrial Revolution had a significant impact on the way goods are produced today. Before this time, products were made by hand by skilled craftspeople in their shops or

Industrial Revolution An industry movement that changed production by substituting machine power for labor power.

Historical Development • 11

TABLE 1.2 Historical Development of Operations Management

Concept Time Explanation

Industrial Revolution Late 1700s Brought in innovations that changed production by using machine power instead of human power.

Scientifi c management Early 1900s Brought the concepts of analysis and measurement of the technical aspects of work design and development of moving assembly lines and mass production.

Human relations movement 1930s to 1960s Focused on understanding human elements of job design, such as worker motivation and job satisfaction.

Management science 1940s to 1960s Focused on the development of quantitative techniques to solve operations problems.

Computer age 1960s Enabled processing of large amounts of data and allowed widespread use of quantitative procedures.

Environmental issues 1970s Considered waste reduction, the need for recycling, and product reuse.

Just-in-time systems (JIT) 1980s Designed to achieve high-volume production with minimal inventories.

Total quality management (TQM) 1980s Sought to eliminate causes of production defects.

Reengineering 1980s Required redesigning a company’s processes in order to provide greater effi ciency and cost reduction.

Global competition 1980s Designed operations to compete in the global market.

Flexibility 1990s Offered customization on a mass scale.

Time-based competition 1990s Based on time, such as speed of delivery.

Supply chain management 1990s Focused on reducing the overall cost of the system that manages the fl ow of materials and information from suppliers to fi nal customers.

Electronic commerce 2000s Uses the Internet and World Wide Web for conducting business activity.

Outsourcing and fl attening of the world

2000s Convergence of technology has enabled outsourcing of virtually any job imaginable from anywhere around the globe, therefore “fl attening” the world.

Big data analytics 2010s Applies math and statistics to large volumes of structured and unstructured data to gain unprecedented business insights.

homes. Each product was unique, painstakingly made by one person. The Industrial Revo- lution changed all that. It started in the 1770s with the development of a number of inven- tions that relied on machine power instead of human power. The most important of these was the steam engine, which was invented by James Watt in 1764. The steam engine pro- vided a new source of power that was used to replace human labor in textile mills, machine- making plants, and other facilities. The concept of the factory was emerging. In addition, the steam engine led to advances in transportation, such as railroads, that allowed for a wider distribution of goods.

12 CHAPTER 1 • Introduction to Operations Management

About the same time, the concept of division of labor was introduced. First described by Adam Smith in 1776 in The Wealth of Nations, this concept would become one of the impor- tant ideas behind the development of the assembly line. Division of labor means that the production of a good is broken down into a series of small, elemental tasks, each of which is performed by a different worker. The repetition of the task allows the worker to become highly specialized in that task. Division of labor allowed higher volumes to be produced, which, coupled with the advances in transportation of steam-powered boats and railroads, opened up distant markets.

A few years later, in 1790, Eli Whitney introduced the concept of interchangeable parts. Prior to that time, every part used in a production process was unique. Interchangeable parts are standardized so that every item in a batch of items fits equally. This concept meant that we could move from one-at-a-time production to volume production, for example, in the manufacture of watches, clocks, and similar items.

Scientific Management Scientific management was an approach to management promoted by Frederick W. Taylor at the turn of the twentieth century. Taylor was an engineer with an eye for effi- ciency. Through scientific management he sought to increase worker productivity and organizational output. His concept had two key features. First, it assumed that workers are motivated only by money and are limited only by their physical ability. Taylor believed that worker productivity is governed by scientific laws and that it is up to management to discover these laws through measurement, analysis, and observation. Workers are to be paid in direct proportion to how much they produce. The second feature of this approach was the separation of the planning and doing functions in a company, which meant the separation of management and labor. Management is responsible for designing produc- tive systems and determining acceptable worker output. Workers have no input into this process—they are permitted only to work.

Many people did not like the scientific management approach, especially workers, who thought that management used these methods to unfairly increase output without paying them accordingly. Still, many companies adopted the scientific management approach. Today many view scientific management as a major influence in the field of operations management. For example, piece-rate incentives, in which workers are paid in direct pro- portion to their output, came out of this movement. Also, Taylor introduced a widely used method of work measurement, stopwatch time studies. In stopwatch time studies, observa- tions are made and recorded of a worker performing a task over many cycles. This informa- tion is then used to set a time standard for performing the particular task. This method is still used today to set a time standard for short, repetitive tasks.

The scientific management approach was popularized by Henry Ford, who used the techniques in his factories. Combining technology with scientific management, Ford introduced the moving assembly line to produce Ford cars. Ford also combined scientific management with the division of labor and interchangeable parts to develop the concept of mass production. These concepts and innovations helped him increase production and efficiency at his factories.

The Human Relations Movement The scientific management movement and its philosophy dominated in the early twenti- eth century. However, this changed with the publication of the results of the Hawthorne studies. The purpose of the Hawthorne studies, conducted at a Western Electric plant in Hawthorne, Illinois, in the 1930s, was to study the effects of environmental changes, such

Scientifi c management An approach to management that focused on improving output by redesigning jobs and determining acceptable levels of worker output.

Hawthorne studies The studies responsible for creating the human relations movement, which focused on giving more consideration to workers’ needs.

Historical Development • 13

as changes in lighting and room temperature, on the productivity of assembly-line workers. The findings from the study were unexpected: the productivity of the workers continued to increase regardless of the environmental changes made. Elton Mayo, a sociologist from Harvard, concluded that the workers were actually motivated by the attention they were given. The idea of workers responding to the attention they are given came to be known as the Hawthorne effect.

The study of these findings by many sociologists and psychologists led to the human relations movement, an entirely new philosophy based on the recognition that factors other than money can contribute to worker productivity. The impact of this new philoso- phy on the development of operations management has been tremendous. Its influence can be seen in the implementation of a number of concepts that motivate workers by making their jobs more interesting and meaning ful. For example, the Hawthorne studies showed that scientific management had made jobs too repetitive and boring. Job enlargement is an approach in which workers are given a larger portion of the total task to do. Another approach to giving more meaning to jobs is job enrichment, in which workers are given a greater role in planning.

Recent studies have shown that environmental factors in the workplace, such as ade- quate lighting and ventilation, can have a major impact on productivity. However, this does not contradict the principle that attention from management is a positive factor in motivation.

Management Science While some were focusing on the technical aspects of job design and others on the human aspects of operations management, a third approach, called management science, was developing that would make its own unique contribution. Management science focused on developing quantitative techniques for solving operations prob- lems. The first mathematical model for inventory management was developed by F. W. Harris in 1913. Shortly thereafter, statistical sampling theory and quality control proce- dures were developed.

World War II created an even greater need for the ability to quantitatively solve com- plex problems of logistics control, for weapons system design and deployment of missiles. Consequently, the techniques of management science grew more robust during the war and continued to develop after the war was over. Many quantitative tools emerged to solve problems in forecasting, inventory control, project management, and other areas. A mathematically oriented field, management science provides operations manage- ment with tools to assist in decision making. A popular example of such a tool is linear programming.

The Computer Age In the 1970s the use of computers in business became widespread. With computers, many of the quantitative models developed by management science could be employed on a larger scale. Data processing became easier, with important effects in areas such as forecasting, scheduling, and inventory management. A particularly important computer- ized system, material requirements planning (MRP), was developed for inventory control and scheduling. Material requirements planning was able to process huge amounts of data in order to compute inventory requirements and develop schedules for the produc- tion of thousands of items, processing that was impossible before the age of computers. Today the exponential growth in computing capability continues to impact operations management.

Management science A fi eld of study that focuses on the development of quantitative techniques to solve operations problems.

Human relations movement A philosophy based on the recognition that factors other than money can contribute to worker productivity.

14 CHAPTER 1 • Introduction to Operations Management

Just-in-Time Just-in-time (JIT) is a major operations management philosophy, developed in Japan in the 1980s, that is designed to achieve high-volume production using minimal amounts of inventory. This is achieved through coordination of the flow of materials so that the right parts arrive at the right place in the right quantity ; hence the term just-in-time. However, JIT is much more than the coordinated movement of goods. It is an all-inclusive organiza- tional philosophy that employs teams of workers to achieve continuous improvement in processes and organizational efficiency by eliminating all organizational waste. Although JIT was first used in manufacturing, it has been implemented in the service sector, for example, in the food service industry. JIT has had a profound impact on the way compa- nies manage their operations. It is credited with helping turn many companies around and is used by companies such as Honda, Toyota, and General Motors. JIT promises to continue to transform businesses in the future.

Total Quality Management As customers demand ever higher quality in their products and services, companies have been forced to focus on improving quality in order to remain competitive. Total quality management (TQM) is a philosophy—promulgated by “quality gurus” such as W. Edwards Deming—that aggressively seeks to improve product quality by eliminat- ing causes of product defects and making quality an all-encompassing organizational philosophy. With TQM, everyone in the company is responsible for quality. Practiced by some companies in the 1980s, TQM became pervasive in the 1990s and is an area of operations management that no competitive company has been able to ignore. Its importance is demonstrated by the number of companies achieving ISO 9000 cer- tification. ISO 9000 is a set of quality standards developed for global manufacturers by the International Organization for Standardization (ISO) to control trade into the then-emerging European Economic Community (EEC). Today ISO 9000 is a global set of standards, with many companies requiring their suppliers to meet the standards as a condition for obtaining contracts.

Business Process Reengineering Business process reengineering means redesigning a company’s processes to increase effi- ciency, improve quality, and reduce costs. In many companies things are done in a certain way that has been passed down over the years. Often managers say, “Well, we’ve always done it this way.” Reengineering requires asking why things are done in a certain way, ques- tioning assumptions, and then redesigning the processes. Operations management is a key player in a company’s reengineering efforts.

Flexibility Traditionally, companies competed by either mass-producing a standardized product or offering customized products in small volumes. One of the current competitive chal- lenges for companies is the need to offer to customers a greater variety of product choices of a traditionally standardized product. This is the challenge of flexibility. For example, Procter and Gamble offers 13 different product designs in the Pampers line of diapers. Although diapers are a standardized product, the product designs are customized to the different needs of customers, such as the age, sex, and stage of development of the child using the diaper.

Just-in-time (JIT) A philosophy designed to achieve high-volume production through elimination of waste and continuous improvement.

Total quality management (TQM) Philosophy that seeks to improve quality by eliminating causes of product defects and by making quality the responsibility of everyone in the organization.

Flexibility An organizational strategy in which the company attempts to offer a greater variety of product choices to its customers.

Reengineering Redesigning a company’s processes to make them more effi cient.

Historical Development • 15

One example of flexibility is mass customization, which is the ability of a firm to pro- duce highly customized goods and services and to do it at the high volumes of mass produc- tion. Mass customization requires designing flexible operations and using delayed product differentiation, also called postponement. This means keeping the product in generic form as long as possible and postponing completion of the product until specific customer pref- erences are known.

Time-Based Competition One of the most important trends within companies today is time-based competition— developing new products and services faster than the competition, reaching the market first, and meeting customer orders most quickly. For example, two companies may produce the same product, but if one is able to deliver it to the customer in two days and the other in five days, the first company will make the sale and win over the customers. Time-based competition requires specifically designing the operations function for speed.

Supply Chain Management Supply chain management (SCM) involves managing the flow of materials and infor- mation from suppliers and buyers of raw materials all the way to the final customer. The network of entities that is involved in producing and delivering a finished product to the final customer is called a supply chain. The objective is to have everyone in the chain work together to reduce overall cost and improve quality and service delivery. Supply chain management requires a team approach, with functions such as marketing, purchasing, operations, and engineering all working together. This approach has been shown to result in more satisfied customers, meaning that everyone in the chain profits. SCM has become possible with the development of information technology (IT) tools that enable collaborative planning and scheduling. The technologies allow synchro- nized supply chain execution and design collaboration, which enables companies to respond better and faster to changing market needs. Numerous companies, including Dell Computer, Wal-Mart, and Toyota, have achieved world-class status by effectively managing their supply chains.

SCM is as important in the ser- vice industry as it is in manufactur- ing, even in pure service industries such as the creative arts. Consider the publishing industry, which is responsible for delivering the creative art of literature to read- ers. The typical publishing supply chain, shown in Figure 1.6, consists of the author, the publisher, and the bookstore retailer. In the tradi- tional publishing supply chain, the publisher is typically responsible for all the functions involved in transforming the author’s literary creation into a tangible product to be placed on a bookshelf. This includes editing, printing, distribution, inventory management, and marketing.

Many writers have seen the traditional publishing supply chain as a setback to main- taining control and innovation over their art. Large publishing houses maintain control of many critical functions of the supply chain, resulting in the commoditization of the literary arts being sold in chain-type retailers. The net effect is often a homogenization of

Mass customization The ability of a fi rm to highly customize its goods and services at high volumes.

Time-based competition An organizational strategy focusing on efforts to develop new products and deliver them to customers faster than competitors.

Supply chain management (SCM) Management of the fl ow of materials from suppliers to customers in order to reduce overall cost and increase responsiveness to customers.

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16 CHAPTER 1 • Introduction to Operations Management

titles and writers across stores, creating a best-seller list that does not necessarily reflect literary merit. This, in turn, creates a barrier for writers who have in fact created something highly personal.

Some writers have innovatively overcome the large supply chain barrier between author and bookshelf by forming their own publishing company. By doing this, they enable them- selves to maintain control of all aspects of their art, including retaining artisitic editorial prerogatives, such as choosing to print their writing in unique styles, rather than resorting to the same font and formatting dictated by a publishing house. This freedom is uniquely important to writers.

In addition to maintaining artistic freedom, this enables writers to retain full legal rights of their own work. This supply chain is shown in Figure 1.7.

Global Marketplace Today businesses must think in terms of a global marketplace in order to compete effec- tively. This includes the way they view their customers, competitors, and suppliers. Key issues are meeting customer needs and getting the right product to markets as diverse as the Far East, Europe, or Africa. Operations management is responsible for most of these decisions. OM decides whether to tailor products to different customer needs, where to locate facilities, how to manage suppliers, and how to meet local government standards. Also, global compe- tition has forced companies to reach higher levels of excellence in the products and services they offer. Regional trading agreements, such as the North American Free Trade Agreement (NAFTA), the European Union (EU), and the global World Trade Organization (WTO), guaran- tee continued competition on the international level.

Global marketplace A trend in business focusing on customers, suppliers, and competitors from a global perspective.

Publisher RetailerAuthor

Literary creation

Editing Printing Distribution Book sales

FIGURE 1.6 The traditional publishing supply chain

Author Retailer

Literary creation

Editing Printing Distribution Book sales

FIGURE 1.7 Author-controlled publishing supply chain

Historical Development • 17

Sustainability and Green Operations There is increasing emphasis on the need to reduce waste, recycle, and reuse products and parts. This is known as sustainability or green operations. Society has placed great pressure on business to focus on air and water quality, waste disposal, global warming, and other envi- ronmental issues. Operations management plays a key role in redesigning processes and prod- ucts in order to meet and exceed environmental quality standards. The importance of this issue is demonstrated by a set of standards termed ISO 14000. Developed by the International Organization for Standardization (ISO), these standards provide guidelines and a certification program documenting a company’s environmentally responsible actions.

Electronic Commerce Electronic commerce (e-commerce) is the use of the Internet for conducting business activities, such as communication, business transactions, and data transfer. The Internet, developed from a government network called ARPANET created in 1969 by the U.S. Defense Department, has become an essential business medium since the late 1990s, enabling effi- cient communication between manufacturers, suppliers, distributors, and customers. It has allowed companies to reach more customers at a speed infinitely faster than ever before. It also has significantly cut costs, as it provides direct links between entities.

The electronic commerce that occurs between businesses, known as B2B (business-to- business) commerce, makes up the highest percentage of transactions. The most common B2B exchanges occur between companies and their suppliers, such as General Electric’s Trad- ing Process Network. A more familiar type of e-commerce occurs between businesses and their customers, known as B2C (business-to-customer) exchange, as engaged in by on-line retailers such as Amazon.com. E-commerce also occurs between customers, known as C2C (customer-to-customer) exchange, as on consumer auction sites such as eBay. E-commerce is creating virtual marketplaces that continue to change the way business functions.

Outsourcing and Flattening of the World Outsourcing is obtaining goods or services from an outside provider. This can range from out- sourcing of one aspect of the operation, such as shipping, to outsourcing an entire part of the manufacturing process. The practice has rapidly grown in recent years, as you can see in Fig- ure 1.8, although it has stabilized most recently. It has helped companies be more efficient by focusing on what they do best. Outsourcing has been touted as the enabling factor that helps companies achieve the needed speed and flexibility to be competitive. Management guru Tom Peters has been quoted as saying, “Do what you do best and outsource the rest.”

The convergence of technologies at the turn of this century has taken the concept of out- sourcing to a new level. Massive investments in technology, such as worldwide broadband connectivity, the increasing availability and lower cost of computers, and the development of software such as e-mail, search engines, and other software, allow individuals to work together in real time from anywhere in the world. This has enabled countries like India, China, and many others to become part of the global supply chain for goods and services and has created a “flattening” of the world. Such “flattening,” or leveling of the playing field, has enabled workers anywhere in the world to compete globally for intellectual work. The result has been the outsourcing of virtually any job imaginable. Manufacturers have out- sourced software development and product design to engineers in India; accounting firms have outsourced tax preparation to India; even some hospitals have outsourced the reading of CAT scans to doctors in India and Australia. The “flattening” of the world has created a whole new level of global competition that is more intense than ever before.

Business-to-business (B2B) Electronic commerce between businesses.

Sustainability A trend in business to consciously reduce waste, recycle, and reuse products and parts.

Business-to-customers (B2C) Electronic commerce between businesses and their customers.

Customer-to-customer (C2C) Electronic commerce between customers.

18 CHAPTER 1 • Introduction to Operations Management

Big Data Analytics Big data analytics is applying mathematics and statistics to large volumes of structured and unstructured data to gain unprecedented business insights. Today’s world is awash in data that come in all forms. These data include point-of-sale (POS), radio frequency identifica- tion (RFID), and global positioning systems (GPS) data, or can be in the form of Twitter feeds, Facebook, call centers, or consumer blogs.

Today’s advanced analytical tools allow us to extract meaning from all types of data. Big data analytics enables converting this large amount of information into an unprece- dented amount of business intelligence. It allows companies to precisely understand what happened in the past and better predict the future. Just consider examples such as IBM’s Watson computer that uses an algorithm to predict best medical treatments and UPS that uses analytics to predict vehicle breakdowns. Big data analytics has enabled companies to gain huge business intelligence and has become a game changer for competitiveness.

Today’s OM Environment Today’s OM environment is very different from what it was just a few years ago. Customers demand better quality, greater speed, and lower costs. In order to succeed, companies have to be masters of the basics of operations management. To achieve this ability, many companies are implementing a concept called lean systems. Lean systems take a total system approach to creating an efficient operation and pull together best practice concepts, including just-in-time ( JIT), total quality management (TQM), continuous improvement, resource planning, and supply chain management (SCM). The need for efficiency has also led many

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Lean systems A concept that takes a total system approach to creating effi cient operations.

Operations Management in Practice • 19

companies to implement large information systems called enterprise resource planning (ERP). ERP systems are large, sophisticated software programs for identifying and planning the enterprise-wide resources needed to coordinate all activities involved in producing and delivering products to customers.

Applying best practices to operations management is not enough to give a company a competitive advantage. The reason is that in today’s information age best practices are quickly passed to competitors. To gain an advantage over their competitors, companies are continually looking for ways to better respond to customers. This requires them to have a deep knowledge of their customers and to be able to anticipate their demands. The development of customer relationship management (CRM) has made it possible for companies to have this detailed knowledge. CRM encompasses software solutions that enable the firm to collect customer-specific data, information that can help the firm identify profiles of its most loyal customers and provide customer-specific solutions. Also, CRM software can be integrated with ERP software to connect customer requirements to the entire resource network of the company.

Another characteristic of today’s OM environment is the increased use of cross- functional decision making, which requires coordinated interaction and decision mak- ing among the different business functions of the organization. Until recently, employees of a company made decisions in isolated departments, called “functional silos.” Today many companies bring together experts from different departments into cross-functional teams to solve company problems. Employees from each function must interact and coordinate their decisions, which require employees to understand the roles of other business func- tions and the goals of the business as a whole, in addition to their own expertise.

Operations Management in Practice

Of all the business functions, operations is the most diverse in terms of the tasks performed. If you consider all the issues involved in managing a transformation process, you can see that operations managers are never bored. Who are operations managers and what do they do?

The head of the operations function in a company usually holds the title of vice presi- dent of operations, vice president of manufacturing, V.P., or director of supply chain oper- ations and generally reports directly to the president or chief operating officer. Below the vice president level are midlevel managers: manufacturing manager, operations manager, quality control manager, plant manager, and others. Below these managers are a variety of positions, such as quality specialist, production analyst, inventory analyst, and produc- tion supervisor. These people perform a variety of functions: analyzing production prob- lems, developing forecasts, making plans for new products, measuring quality, monitoring inventory, and developing employee schedules. Thus, there are many job opportunities in operations management at all levels of the company. In addition, operations jobs tend to offer high salaries, interesting work, and excellent opportunities for advancement. Many corporate CEOs today have come through the ranks of operations. For example, the third president and CEO of Wal-Mart from January 2000 to January 2009, H. Lee Scott, came from a background in operations and logistics. The former CEO of Wal-Mart, Michael Duke, cames from a background of international operations, as does the current CEO, Doug McMillon. Also from the operations background are the former CEO of Home Depot, Bob Nardelli, and the former CEO of Lowe’s, Robert Tillman.

As you can see, all business functions need information from operations management in order to perform their tasks. At the same time, operations managers are highly dependent on input from other areas. This process of information sharing is dynamic, requiring that managers work in teams and understand each other’s roles.

Customer relationship management (CRM) Software solutions that enable the fi rm to collect customer-specifi c data.

Cross-functional decision making The coordinated interaction and decision making that occur among the different functions of the organization.

Enterprise resource planning (ERP) Large, sophisticated software systems used for identifying and planning the enterprise- wide resources needed to coordinate all activities involved in producing and delivering products.

20 CHAPTER 1 • Introduction to Operations Management

Within OM: How it all Fits Together Just as OM decisions are linked with those of other business functions, decisions within the OM function need to be linked together. We learned that OM is responsible for a wide range of strategic and tactical decisions. These decisions directly impact each other and need to be carefully linked together, following the company’s strategic direction. In the Gourmet Wafers example we observed that decisions on product design are directly tied to process selection (Chapter 3). The reason is that a company’s process needs to be capable of pro- ducing the desired product (Chapter 6). Similarly, the forecast of expected demand (Chapter 8) directly impacts functions such as capacity planning (Chapter 9), inventory management (Chapter 12), and scheduling (Chapter 15). These are just a few examples of linkages within the OM function.

Throughout this book we will study different OM functions and will learn how each impacts the other. You. will realize that OM decisions are not made in isolation. Rather, each decision is intertwined with other business functions and other OM decisions.

OM Across the Organization Now that we know the role of the operations management function and the decisions that operations managers make, let’s look at the relationship between operations and other business functions. As mentioned previously, most businesses are supported by three main functions: operations, marketing, and finance. Although these functions involve different activities, they must interact to achieve the goals of the organization. They must also follow the strategic direction developed at the top level of the organization. Figure 1.9 shows the flow of information from the top to each business function, as well as the flow between functions.

Many of the decisions made by operations managers are dependent on information from the other functions. At the same time, other functions cannot be carried out properly with- out information from operations. Figure 1.10 shows these relationships.

Sales and demand requirements

Organizational ability to meet

sales and demands

Financial status

Operations needs and financial requirements

Marketing V.P. of Marketing

Finance V.P. of Finance

President or CEO

Strategic Direction of Company

Operations V.P. of Operations

FIGURE 1.9 Organizational chart showing flow of information

Operations Management in Practice • 21

Marketing is not fully capable of meeting customer needs if marketing managers do not understand what operations can produce, what due dates it can and cannot meet, and what types of customization operations can deliver. The marketing department can develop an exciting marketing campaign, but if operations cannot produce the desired product, sales will not be made. In turn, operations managers need information about customer wants and expectations. It is up to them to design products with characteristics that customers find desirable, and they cannot do this without regular coordination with the marketing department.

Finance cannot realistically judge the need for capital investments, make-or-buy deci- sions, plant expansions, or relocation if finance managers do not understand operations concepts and needs. On the other hand, operations managers cannot make large financial expenditures without understanding financial constraints and methods of evaluating finan- cial investments. It is essential for these two functions to work together and understand each other’s constraints.

Information systems (IS) is a function that enables information to flow throughout the organization and allows OM to operate effectively. OM is highly dependent on information such as forecasts of demand, quality levels being achieved, inventory levels, supplier deliveries, and worker schedules. IS must understand the needs of OM in order to design an adequate information system. Usually, IS and OM work together to design an information network. This close relationship needs to be ongoing. IS must be capable of accommodating the needs of OM as they change in response to market demands. At the same time, it is up to IS to bring the latest capabilities in information technology to the organization to enhance the functioning of OM.

MKT

FIN

MIS

FIGURE 1.10 Information flow between operations and other business functions

Current operating capabilitiesCustomer demands

Technological capabilities

Information needs

Current performance measures

Operations capabilities

Design requirements

Product specs Labor requirements

Labor skills available

Capital investments planned Financial measures

Budgets

Stockholder requirements

Labor costsTechnological

trade-offs

Capital requirements

IS

Inventory levels

Operations Management

Finance

Accounting Engineering Human

Resources

Billing information

Process improvements

Output rates

Capacities

Customer feedback

Need for new products

Marketing

22 CHAPTER 1 • Introduction to Operations Management

Human resource managers must understand job requirements and worker skills if they are to hire the right people for available jobs. To manage employees effectively, operations managers need to understand job market trends, hiring and layoff costs, and training costs.

Accounting needs to consider inventory management, capacity information, and labor standards in order to develop accurate cost data. In turn, operations managers must com- municate billing information and process improvements to accounting, and they depend heavily on accounting data for cost management decisions.

Engineering and other disciplines that are not in the business field are also tied to operations. Operations management provides engineering with the operations capa- bilities and design requirements, and engineering, in turn, provides valuable input on technological trade-offs and product specifications. These are essential for the product design process.

The coordinated interaction and decision making between all these functions and OM are needed for success in today’s competitive environment. It is also important to extend this coordination to organizations that make up a supply chain, such as suppliers, manufac- turers, and retailers. This is discussed in the following box.

HRM

ACC

Today’s companies understand that successfully manag-ing their own OM functions is not enough to maintain leadership in a highly competitive marketplace. The reason is that every company is dependent on other members of the supply chain to successfully deliver the right product to the fi nal customer in a timely and cost-effective manner. For example, a company is dependent on its suppliers for the delivery of raw materials and components in time to meet production needs. If these materials are delivered late or are of insuffi cient quality, production will be delayed. Simi- larly, a company depends on its distributors and retailers for the delivery of the product to the fi nal customer. If these are not delivered on time, are damaged in the transportation process, or are poorly displayed at the retail location, sales

will suffer. Also, if the OM function of other members of the supply chain is not managed properly, excess costs will re- sult, which will be passed down to other members of the supply chain in the form of higher prices. Therefore, each company in the supply chain must successfully manage its OM function. Also, the companies that comprise a supply chain need to coordinate and link their OM functions so that the entire chain is operating in a seamless and effi cient manner. Just consider the fact that most of the components Dell uses are warehoused within a 15-minute radius of its assembly plant and Dell is in constant communication with its suppliers. Dell considers this essential to its ability to produce and deliver components quickly. •

THE SUPPLY CHAIN LINK

THE SUSTAINABILITY LINK

Environmental concerns, including climate change, en-ergy use, environmental contamination, and resource depletion, are all part of the contemporary business land- scape. Emerging economies, such as that of India and China, are growing at double-digit rates, and continued growth of the world population has created shortages of many resources we used to take for granted. Companies are increasingly aware that they must design their operations functions, and their entire supply chains, for sustainability. This means designing their operations processes to better and more effi ciently use their resources, to use environmen-

tally friendly inputs, and create outputs that can be recycled and that do not contaminate the environment. It also means better use of human resources, from labor to suppliers.

The operations function, with its transformation role, is uniquely poised to help companies achieve their sustain- ability goals. One of the best examples of this is illustrated through the joint efforts of the National Resources Defense Council (NRDC) and Major League Baseball (MLB) to change baseball operations to reduce the environmental impact. The “operation” of a baseball game brings together numerous industries, such as the beverage and chemical industries, as

Key Terms • 23

well as automotive, plastics, steel, and agriculture. The NRDC and MLB have worked together to make MLB opera- tions more sustainable by working with industries that serve as suppliers for baseball games, and placing “green” re- quirements on their goods and services. MLB has changed everything—from its purchasing and transportation deci- sions to the way it manages its stadiums and arenas. For example, a “red carpet” event, planned for MLB, was de- signed to use a carpet made from only recycled fi bers, in a

factory that is LEED certifi ed1 and wind and solar powered, emitting less global-warming pollutants. Simple changes such as this resulted in a more sustainable operation. This has also resulted in savings of thousands of dollars on en- ergy, waste, and water bills. •

1LEED certifi cation is the recognized standard in the United States and other countries for measuring building sustainability; we will learn about LEED certifi cation later in the text.

Chapter Highlights 1 Operations management is the business function

that is responsible for managing and coordinating the resources needed to produce a company’s products and services. Without operations management there would be no products or services to sell.

2 Organizations can be divided into manufacturing and service operations, which differ in the tangibility of the product and the degree of customer contact. Manufac- turing and service operations have very different oper- ational requirements.

3 Operations management is responsible for a wide range of decisions, ranging from strategic decisions, such as designing the unique features of a product and process, to tactical decisions, such as planning worker schedules.

4 A number of historical milestones have shaped oper- ations management into what it is today. Some of the

more significant of these are the Industrial Revolution, scientific management, the human relations move- ment, management science, and the computer age.

5 OM is a highly important function in today’s dynamic business environment. Among the trends that have had a significant impact on business are just-in-time, total quality management, reengineering, flexibility, time-based competition, supply chain management, a global marketplace, and environmental issues.

6 Operations managers need to work closely with all other business functions in a team format. Marketing needs to provide information about customer expec- tations. Finance needs to provide information about budget constraints. In turn, OM must communicate its needs and capabilities to the other functions.

Key Terms

operations management (OM) 2

role of operations management 3

value added 4

effi ciency 4

manufacturing organizations 5

service organizations 5

strategic decisions 7

tactical decisions 7

Industrial Revolution 10

scientifi c management 12

Hawthorne studies 12

human relations movement 13

management science 13

just-in-time ( JIT) 14

total quality management (TQM) 14

reengineering 14

fl exibility 14

mass customization 15

time-based competition 15

supply chain management (SCM) 15

global marketplace 16

sustainability 17

business-to-business (B2B) 17

business-to-customers (B2C) 17

customer-to-customer (C2C) 17

lean systems 18

enterprise resource planning (ERP) 19

customer relationship management (CRM) 19

cross-functional decision making 19

24 CHAPTER 1 • Introduction to Operations Management

Discussion Questions

1. Defi ne the term operations management.

2. Explain the decisions operations managers make and give three examples.

3. Describe the transformation process of a business. Give three examples. What constitutes the transformation pro- cess at an advertising agency, a bank, and a TV station?

4. What are the three major business functions, and how are they related to one another? Give specifi c examples.

5. What are the diff erences between strategic and tacti- cal decisions, and how are they related to each other?

6. Find an article that relates to operations management in either the Wall Street Journal, Fortune, or Business Week. Come to class prepared to share with others what you learned in the article.

7. Examine the list of Fortune magazine’s top 100 companies. Do most of these companies have anything in common? Are there industries that are most represented?

8. Identify the two major diff erences between service and manufacturing organizations. Find an example of

a service company and a manufacturing company and compare them.

9. What are the three historical milestones in operations management? How have they infl uenced management?

10. Identify three current trends in operations manage- ment and describe them. How do you think they will change the future of OM?

11. Defi ne the terms total quality management, just-in- time, and reengineering. What do these terms have in common?

12. Describe today’s OM environment. How diff erent is it from that of a few years ago? Identify specifi c features you think characterize today’s OM environment.

13. Describe the impact of e-commerce on operations management. Identify the challenges posed by e-commerce on operations management.

14. Find a company you are familiar with and explain how it uses its operations management function. Identify what the company is doing correctly. Do you have any suggestions for improvement?

Case: Hightone Electronics, Inc.

George Gonzales, operations director of Hightone Electronics, Inc. (HEI), sat quietly at the conference table overlooking the lobby of the corporate head- quarters offi ce in Palo Alto, California. He refl ected on the board meeting that had just adjourned and the challenge that lay ahead for him. Th e board had just announced their decision to start an Internet-based division of HEI. Web-based purchasing in the elec- tronics industry had been growing rapidly. Th e board felt that HEI needed to off er on-line purchasing to its customers in order to maintain its competitive posi- tion. Th e board looked to George to outline the key operations management decisions that needed to be addressed in creating a successful Internet-based business. Th e next board meeting was just a week away. He had his work cut out for him.

Hightone Electronics, Inc. was founded in Palo Alto, California, over 50 years ago. Originally, the company provided radio components to small repair shops. Prod- ucts were off ered for sale through a catalog that was mailed to prospective customers every four months.

Th e company built its reputation on high quality and service. As time passed, HEI began supplying more than just radio parts, adding items such as fuses, trans- formers, computers, and electrical testing equipment. Th e expansion of the product line had been coupled with an increase in the number and type of customers the company served. Although the traditional repair shops still remained a part of the company’s market, technical schools, universities, and well-known corpo- rations in the Silicon Valley were added to the list of customers.

Today HEI operates the Palo Alto facility with the same dedication to supplying quality products through catalog sales that it had when it was fi rst founded. Cus- tomer service remains the top priority. HEI stocks and sells over 22,000 diff erent items. Most customers receive their orders within 48 hours, and all components are warranted for a full year.

Expanding HEI to include Web-based purchasing seems to be a natural extension of catalog sales that the company already does successfully. George Gonzales

agrees that the company has no choice but to move in this competitive direction. However, George does not agree with the opinion of the board that this would be “business as usual.” He believes that there are many operations decisions that need to be identifi ed and addressed. As he stated in the meeting, “Having a slick Web site is one thing, but making sure the right product is delivered to the right location is another. Operations is the key to making this happen.” His challenge for the next board meeting was to identify the key operations decisions and persuade the board that these issues needed serious consideration.

Case Questions

1. Explain why operations management is critical to the success of a business. Why would developing an Internet-based business require diff erent operations considerations for HEI? Is George Gonzales correct in his assessment that this would not be “business as usual”?

2. Recall that HEI wishes to continue its reputation of high quality and service. Identify key operations man- agement decisions that need to be considered. How dif- ferent will these decisions be for the Internet business?

Case: Creature Care Animal Clinic (A)

It has been three years since Dr. Julia Barr opened Crea- ture Care Animal Clinic, a suburban veterinary clinic. Dr. Barr thought that by now she would be enjoying having her own practice. She had spent many years in college and worked to save money in order to start a business. Instead, she felt overwhelmed with business problems that were facing the clinic. She thought to herself: “I don’t produce anything. I just provide a service doing something I enjoy. How can this be so complicated?”

Company Background

Dr. Barr opened Creature Care Animal Clinic as a veteri- nary clinic specializing in the care of dogs and cats. Th e clinic was set to operate Monday through Friday during regular business hours, with half days on Saturday and extended hours on Wednesday evening. Dr. Barr hired another full-time veterinarian, Dr. Gene Yen, a staff of three nurses, an offi ce manager, and an offi ce assis- tant. Both doctors were to work during the week and rotate the shift for Wednesday evenings and Saturdays. A similar schedule was set up for the nurses. Th e offi ce manager worked during regular business hours, and the assistant worked on Wednesday evenings and Sat- urdays. Dr. Barr set up this schedule based on a clinic she had observed as a resident and thought it sounded reasonable.

Since the clinic was small, Dr. Barr did not have a formal system of inventory management. All physicians and nurses were allowed to place purchase orders based on need. Initially this system worked well, but after a few months problems started developing. Frequently,

there was excess inventory of certain items, and in many cases there were multiple brands of the same product. Sometimes medications passed their expiration dates and had to be thrown away. At the same time, the clinic often unexpectedly ran out of stock of certain supplies and rush orders had to be placed. On one occasion, the clinic ran so low on bandages that the assistant had to be sent to the local drugstore.

Dr. Barr continued to rotate with Dr. Yen for cover- age on Saturdays and Wednesday evenings. However, demand was increasing so rapidly on Saturdays that one doctor was not enough to provide needed cover- age. Also, the Friday afternoon schedule was usually so packed that the staff frequently had to stay late in the evening. At the same time, there was little demand on Wednesday evenings and Dr. Barr found herself work- ing on paperwork on those evenings, while the nurse and offi ce assistant performed menial offi ce tasks.

Case Questions

1. Identify the operations management problems that Dr. Barr is having at the clinic.

2. Th e schedule Dr. Barr set up worked well at the clinic where she was a resident. What are some of the rea- sons why it might not be working here?

3. Identify some of the reasons why the clinic is having inventory problems.

4. What should Dr. Barr have done diff erently to avoid some of the problems she is currently experiencing?

5. What suggestions would you make to Dr. Barr now?

Case: Creature Care Animal Clinic (A) • 25

26 CHAPTER 1 • Introduction to Operations Management

Internet Challenge: Demonstrating Your Knowledge of OM

Visit the Web sites of at least one service and one man- ufacturing company. For each company, identify at least fi ve characteristic OM decisions and show your results in a table. Which decisions are strategic and which are tactical? How do these decisions diff er between the two companies? Here are some Web sites to consider.

Select service company Web sites:

www.ritzcarlton.com (Ritz-Carlton Hotel)

www.sprint.com (Sprint Corporation)

www.yrcw.com (YRC Worldwide)

www.kmart.com (Kmart Corporation)

www.yahoo.com (Yahoo!)

Select manufacturing company Web sites:

www.saturn.com (Saturn Corporation)

www.alcoa.com (Alcoa Inc.)

www.milliken.com (Milliken & Company)

www.Intel.com (Intel Corporation)

www.ge.com (General Electric Company)

Selected Bibliography

Carter, P.J., R.M. Monczka, and J. Mossconi. “Looking at the Future of Supply Management,” Supply Chain Manage- ment Review, December 2005, 27–29.

Dennis, M.J., and A. Kambil. “Service Management: Build- ing Profi ts after the Sale,” Supply Chain Management Review, January–February 2003, 42–48.

Dischinger, J., D.J. Closs, E. McCulloch, C. Speier, W. Greno- ble, and D. Marshall. “Th e Emerging Supply Chain Man- agement Profession,” Supply Chain Management Review, January–February 2006, 62–68.

Friedman, T.L. Hot, Flat and crowded: Why We Need a Green Revolution—and How It Can Renew America 2.0. New

York: Picador, 2009.

Interactive Case: Virtual Company

On-line Case: Cruise International, Inc.

Assignment: Introduction to Cruise International, Inc. You will be an intern for Cruise International, Inc. (CII). Th e company competes in the cruise industry in the small-ship, medium-ship, and large-ship markets. Your internship begins in a few weeks. Bob Bristol, your immediate boss, has asked you to become famil- iar with the cruise industry and its basic markets prior to beginning any of your assignments. Th is assignment

will enhance your knowledge of the material in Chap- ter 1 of your textbook while preparing you for future assignments.

To access the Web site: • Go to www.wiley.com/college/reid

• Click Student Companion Site

• Click Virtual Company/Cruise International, Inc.

• Click Consulting Assignments

On-line Case: Valley Memorial Hospital

Assignment: Welcome to Kaizen Consulting Bob Reilly, head of Kaizen Consulting, Inc. just called to let you know that you have been accepted as an intern for his company. Kaizen handles many diff erent clients, but you will primarily be working with one of its healthcare clients, Valley Memorial Hospital. Your internship will start in a few weeks. Bob has advised you to get thor- oughly familiar with the company and its operations before you start working on the specifi c tasks that will be assigned to you. Th is assignment will enable you to

enhance your knowledge of the material in Chapter 1 while preparing you for a successful internship.

To access the Web site: • Go to www.wiley.com/college/reid

• Click Student Companion Site

• Click Virtual Company/Valley Memorial Hospital

• Click Kaizen Consulting, Inc.

• Click Consulting Assignments

• Click Welcome to Kaizen Consulting

www.wiley.com/college/reid

Friedman, T.L. Th e World Is Flat. New York: Farrar Straus and Giroux, 2005.

Fugate, B.S., and J.T. Mentzer. “Dell’s Suply Chain DNA,” Supply Chain Management Review, 2004, 20–24.

Galbraith, J.K. Th e Affl uent Society. Boston: Houghton Miffl in, 1958.

Klassen, R.D., and D.C. Whybark. “Environmental Man- agement in Operations: Th e Selection of Environmental Technologies,” Decision Sciences, 30, 3, 1999, 601–631.

Sanders, N.R. Supply Chain Management: A Global Perspective. New York: John Wiley & Sons, 2012.

Sanders, N.R., and J.D. Wood. Fundamentals of Sustainable Business. New York: John Wiley & Sons, 2014.

Skinner, W. “Manufacturing Strategy on the ‘S’ Curve,” Pro- duction and Operations Management, Spring 1996, 3–14.

Skinner, W. Manufacturing in the Corporate Strategy, New York: John Wiley & Sons, 1978.

Wu, J.C. “Anatomy of a Dot-Com,” Supply Chain Management Review, November–December 2001, 42–51.

Zacharia, Z.G., N.R. Sanders, and B. Fugate. “Th e Evolving Role of Disciplines in Supply Chain Management,” Journal of Supply Chain Management, 50, 1, 2014, 73–88.

Selected Bibliography • 27

28

Before studying this chapter you should know or, if necessary, review

1. The role of the OM function in organizations, Chapter 1.

2. Differences between strategic and tactical decisions, Chapter 1.

Learning Objectives After studying this chapter you should be able to 1 Explain the role of operations

strategy in the organization.

2 Explain how a business strategy is developed.

3 Describe how an operations strategy is developed.

4 Explain the strategic role of technology.

5 Defi ne productivity and identify productivity measures.

T o maintain a competitive position in the marketplace, a company must have a long-range plan. This plan needs to include the company’s long-term goals, an understanding of the marketplace, and a way to differentiate

the company from its competitors. All other decisions must support this long-range plan. Otherwise, each person in the company would pursue goals that he or she considered important, and the company would quickly fall apart.

The functioning of a football team on the field is similar to the function- ing of a business and pro- vides a good example of the importance of a plan or vision. Before the plays are made, the team prepares a game strategy. Each player on the team must perform a particular role to support this strategy. The strategy is a “game plan” designed so that the team can win. Imagine what would occur if individual players decided to do plays that they thought were appropriate. Cer- tainly the team’s chance of winning would not be very high. A successful football team is a unified group of players using their individual skills in support of a win- ning strategy. The same is true of a business.

The long-range plan of a business, designed to provide and sustain shareholder value, is called the business strategy. For a company to succeed, the business strategy must be supported by each of the individual business functions, such as operations, finance, and marketing. Operations strategy is a long-range plan for the operations function that specifies the design and use of resources to support the business strategy. Just as the players on a football team support the team’s strategy, the role of everyone in the company is to do his or her job in a way that supports the business strategy.

Let’s look at two companies operating in the same industry, but with very different business strategies. The first is Southwest Airlines, which has a strategy to compete on cost. Southwest offers low-cost services aimed at price-sensitive customers. To support this strategy, every aspect of Southwest’s operation is focused on cutting costs out of the system. Later in this chapter we will look at specific operations decisions that Southwest has made to achieve this. The second

2 Operations Strategy and Competitiveness

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The Role of Operations Strategy • 29

company is Singapore Airlines, which has a strategy to compete on service. To support this strategy, the airline offers free drinks, complimentary headsets, meals prepared by gourmet chefs, comfortable cabins, and even the biggest bed in business class, called the “spacebed.” Both airlines began as regional carriers, and each has grown to be a highly successful major airline. Although they are in the same industry, their operations decisions are different because of their different business strategies.

In today’s highly competitive, Internet-based, and global marketplace, it is important for compa- nies to have a clear plan for achieving their goals. In this chapter we discuss the role of operations strategy, its relationship to the business strategy, and ways in which the operations function can best support the business strategy. We conclude with a discussion of productivity, one measure of a company’s competitiveness. •

The Role of Operations Strategy The role of operations strategy is to provide a plan for the operations function so that it can make the best use of its resources. Operations strategy specifies the policies and plans for using the organization’s resources to support its long-term competitive strategy. Figure 2.1 shows this relationship.

Remember that the operations function is responsible for managing the resources needed to produce the company’s goods and services. Operations strategy is the plan that specifies the design and use of resources to support the business strategy. This includes the location, size, and type of facilities available; worker skills and talents required; use of technology, special processes needed, special equipment; and quality control methods. The operations strategy must be aligned with the company’s business strategy and enable the company to achieve its long-term plan. For example, the business strategy of FedEx, the world’s largest provider of expedited delivery services, is to compete on time and depend- ability of deliveries. The operations strategy of FedEx developed a plan for resources to support its business strategy. To provide speed of delivery, FedEx acquired its own fleet of airplanes. To provide dependability of deliveries, FedEx invested in a sophisticated bar-code technology to track all packages.

Operations strategy A long-range plan for the operations function that specifi es the design and use of resources to support the business strategy.

Business strategy A long- range plan for a business.

MISHRM

FIGURE 2.1 Relationship between the business strategy and the functional strategies

Defines long-range plan for company

Defines marketing plans to support the business

strategy

Business Strategy

Marketing Strategy

Develops financial plans to support the

business strategy

Finance Strategy

Develops a plan for the operations function to

support the business strategy

Operations Strategy

30 CHAPTER 2 • Operations Strategy and Competitiveness

The Importance of Operations Strategy Operations strategy did not come to the forefront until the 1970s. Up to that time, U.S. companies emphasized mass production of standard product designs. There were no serious international competitors, and U.S. companies could pretty much sell anything they produced. However, that changed in the 1970s and 1980s. Japanese companies began offering products of superior quality at lower cost, and U.S. companies lost market share to their Japanese counterparts. In an attempt to survive, many U.S. companies copied Japanese approaches. Unfortunately, merely copying these approaches often proved unsuccessful; it took time to really understand the Japanese approaches. It became clear that Japanese companies were more competitive because of their operations strategy ; that is, all their resources were specifically designed to directly support the company’s overall strategic plan.

Harvard Business School professor Michael Porter says that companies often do not understand the differences between operational efficiency and strategy. Operational effi- ciency is performing operations tasks well, even better than competitors. Strategy, on the other hand, is a plan for competing in the marketplace. An analogy might be that of running a race efficiently, but the wrong race. Strategy is defining in what race you will win. Operational efficiency and strategy must be aligned; otherwise, you may be very effi- ciently performing the wrong task. The role of operations strategy is to make sure that all the tasks performed by the operations function are the right tasks. Consider a software company that recently invested millions of dollars in developing software with features not provided by competitors, only to discover that these were features customers did not particularly want.

Now that we know the meaning of business strategy and operations strategy and their importance, let’s look at how a company would go about developing a business strategy. Then we will see how an operations strategy would be developed to support the company’s business strategy.

Developing a Business Strategy A company’s business strategy is developed after its managers have considered many factors and have made some strategic decisions. These include developing an under- standing of what business the company is in (the company’s mission), analyzing and developing an understanding of the market (environmental scanning), and identifying the company’s strengths (core competencies). These three factors are critical to the development of the company’s long-range plan, or business strategy. In this section we describe each of these elements in detail and show how they are combined to formulate the business strategy.

Mission Every organization, from IBM to the Boy Scouts, has a mission. The mission is a statement that answers three overriding questions:

· What business will the company be in (“selling personal computers,” “operating an Italian restaurant”)?

· Who will the customers be, and what are the expected customer attributes (“home- owners,” “college graduates”)?

· How will the company’s basic beliefs defi ne the business (“gives the highest customer service,” “stresses family values”)?

Mission A statement defi ning what business an organization is in, who its customers are, and how its core beliefs shape its business.

Developing a Business Strategy • 31

Following is a list of some well-known companies and parts of their mission statements:

Dell Computer Corporation: “to be the most successful computer company in the world” Delta Air Lines: “worldwide airlines choice” IBM: “translate advanced technologies into values for our customers as the world’s

largest information service company” Lowe’s: “helping customers build, improve and enjoy their homes” Ryder: “off ers a wide array of logistics services, such as distribution management,

domestically and globally”

The mission defines the company. In order to develop a long-term plan for a business, you must first know exactly what business you are in, what customers you are serving, and what your company’s values are. If a company does not have a well-defined mission, it may pursue business opportunities about which it has no real knowledge or that are in conflict with its current pursuits, or it may miss opportunities altogether.

For example, Dell Computer Corporation has become a leader in the computer industry in part by following its mission. If it did not follow its mission, Dell might decide to pursue other opportunities, such as producing mobile telephones similar to those manufactured by Motorola and Nokia. Although there is a huge market for mobile telephones, it is not consis- tent with Dell’s mission of focusing on computers.

Environmental Scanning A second factor to consider is the external environment of the business. This includes trends in the market, in the economic and political environment, and in society. These trends must be analyzed to determine business opportunities and threats. Environmental scanning is the process of monitoring the external environment. To remain competitive, companies have to continuously monitor their environment and be prepared to change their business strategy, or long-range plan, in light of environmental changes.

What Does Environmental Scanning Tell Us? Environmental scanning allows a company to identify opportunities and threats. For example, through environmental scan- ning we could see gaps in what customers need and what competitors are doing to meet those needs. A study of these gaps could reveal an opportunity for our company, and we could design a plan to take advantage of it. On the other hand, our company may currently be a leader in its industry, but environmental scanning could reveal competitors that are meeting customer needs better—for example, by offering a wider array of services. In this case, environmental scanning would reveal a threat and we would have to change our strat- egy so as not to be left behind. Just because a company is an industry leader today does not mean it will continue to be a leader in the future. In the 1970s Sears, Roebuck and Company was a retail leader, but it fell behind the pack in the 1990s.

What Are Trends in the Environment? The external business environment is always changing. To stay ahead of the competition, a company must constantly look out for trends or changing patterns in the environment, such as marketplace trends. These might include changes in customer wants and expectations and ways in which competitors are meeting those expectations. For example, in the computer industry customers are demanding speed of delivery, high quality, and low price. Dell has become a leader in the industry because of its speed of delivery and low price. Other computer giants, such as Compaq, have tried to redesign their business and operations strategies to compete with Dell. For Compaq, over- taking Dell was a key priority, although the company was not successful at this. Compaq was ultimately acquired by Hewlett-Packard in 2002. It is through environmental scanning that companies can see trends in the market, analyze the competition, and recognize what

Environmental scanning Monitoring the external environment for changes and trends to determine business opportunities and threats.

MKT

32 CHAPTER 2 • Operations Strategy and Competitiveness

they need to do to remain competitive. It is for this reason that Dell has changed its strategy numerous times.

There are many other types of trends in the marketplace. For example, we are seeing changes in the use of technology, such as point-of-sale scanners, automation, computer-assisted processing, electronic purchasing, and electronic order tracking. One rapidly growing trend is e-commerce. For retailers like The Gap, Eddie Bauer, Fruit of the Loom, Inc., Barnes & Noble, and others, e-commerce has become a significant part of their business. Victoria’s Secret has even used the Internet to conduct a fashion show in order to boost sales. Some companies began using e-commerce early in their development. Others, like Sears, Roebuck, and company, waited and then found themselves working hard to catch up to the competition.

In addition to market trends, environmental scanning looks at economic, political, and social trends that can affect the business. Economic trends include recession, inflation, interest rates, and general economic conditions. Suppose that a company is considering obtaining a loan in order to purchase a new facility. Environmental scanning could show that interest rates are particularly favorable and that this may be a good time to go ahead with the purchase.

Political trends include changes in the political climate—local, national, and international— that could affect a company. For example, the creation of the European Union has had a sig- nificant impact on strategic planning for such global companies as IBM, Hewlett-Packard, and PepsiCo. Similarly, changes in trade relations with China have opened opportunities that were not available earlier. There has been a change in how companies view their environment, a shift from a national to a global perspective. Companies seek customers and suppliers all over the globe. Many have changed their strategies in order to take advantage of global opportunities, such as forming partnerships with international firms, called strategic alliances. For example, companies like Motorola and Xerox want to take advantage of opportunities in China and are developing strategic alliances to help them break into that market.

Finally, social trends are changes in society that can have an impact on a business. An example is the awareness of the dangers of smoking, which has made smoking less socially acceptable. This trend has had a huge impact on the tobacco industry. In order to survive, many of these companies have changed their strategy to focus on customers overseas, where smoking is still socially acceptable, or have diversified into other product lines.

Core Competencies The third factor that helps define a business strategy is an understanding of the company’s strengths. These are called core competencies. In order to formulate a long-term plan, the company’s managers must know the competencies of their organization. Core competen- cies could include special skills of workers, such as expertise in providing customized ser- vices or knowledge of information technology. Another example might be flexible facilities that can handle the production of a wide array of products. To be successful, a company must compete in markets where its core competencies will have value. Table 2.1 shows a list of some core competencies that companies may have.

Highly successful firms develop a business strategy that takes advantage of their core competencies or strengths. To see why it is important to use core competencies, think of a student developing plans for a successful professional career. Let’s say that this student is particularly good at mathematics but not as good in verbal communication and persua- sion. Taking advantage of core competencies would mean developing a career strategy in which the student’s strengths could provide an advantage, such as engineering or computer science. On the other hand, pursuing a career in marketing would place the student at a disadvantage because of a relative lack of skills in persuasion.

Increased global competition has driven many companies to clearly identify their core competencies and outsource those activities considered noncore. Recall from Chapter 1

Core competencies The unique strengths of a business.

Developing a Business Strategy • 33

TABLE 2.1 Organizational Core Competencies

1. Workforce Highly trained Responsive in meeting customer needs Flexible in performing a variety of tasks Strong technical capability Creative in product design

2. Facilities Flexible in producing a variety of products Technologically advanced An effi cient distribution system

3. Market Understanding Skilled in understanding customer wants and predicting market trends

4. Financial Know-how Skilled in attracting and raising capital

5. Technology Use of latest production technology Use of information technology Quality control techniques

that outsourcing is obtaining goods or services from an outside provider. By outsourcing noncore activities, a company can focus on its core competencies. For example, Meijer, a grocery and general merchandise retailer, outsources the transportation of all its merchan- dise to a company called Total Logistics Control (TLC). TLC is responsible for all deliveries, route scheduling, and all activities involved in maintaining a fleet of trucks, allowing Meijer to focus on its core competencies.

Putting It Together Figure 2.2 shows how the mission, environmental scanning, and core competencies help in the formulation of the business strategy. This is an ongoing process that is constantly allowed to change. As environmental scanning reveals changes in the external environ- ment, the company may need to change its business strategy to remain competitive while taking advantage of its core competencies and staying within its mission.

Monitoring the business environment for

market trends, threats, and opportunities

Environmental Scanning

Statement that defines what is our business; who are our

clients; and how our values define our business

Mission

Defines the long-range plan for the company

Business Strategy

Unique strengths that can help us

win in the market

Core Competencies

FIGURE 2.2 Three inputs in developing a business strategy

34 CHAPTER 2 • Operations Strategy and Competitiveness

Let’s look at how Dell Computer Corporation combined its mission, environmental scanning, and core competencies to develop a highly successful business strategy. Dell’s mission is to “be the most success- ful computer company in the world at delivering the best customer experience in markets we serve. In doing so, Dell will meet customer expectations of: highest quality,

leading technology, competitive pricing, individual and company accountability, best-in- class service and support, flexible customization capability, superior corporate citizenship, and financial stability.” The mission defined what business Dell is in: highest quality, leading technology, computer company. It also defined Dell’s customers: focus on markets served. Finally, it defined how Dell would do this: through competitive pricing, best-in-class service and support, and flexible customization capability. You can see how this mission defines Dell as a company.

An environmental scan revealed that competing computer manufacturers, such as IBM, used intermediate resellers to sell computers. This led to higher inventory, higher costs, and slower responsiveness to customer wants. Michael Dell’s idea was to sell directly to the cus- tomer and be able to put together exactly the system the customer wanted within a short time. Dell defined its core competencies as flexible manufacturing and the latest technolog- ical offering. Together, the mission, environmental scan, and core competencies were used to develop a competitive business strategy that provides customized computer solutions to customers within 36 hours at a highly competitive price.

Dell’s business strategy was to take advantage of an opportunity in the market. How- ever, to implement this strategy, the company needed to develop an operations strategy that arranged all the resources in ways that would support the business strategy. Operations strategy designs a plan for resources in order to take the business strategy from concept to reality. In the next section we look at how an operations strategy is developed.

Make sure that you understand the role of the business strategy in defi ning a company’s long-term plan. Without a business strategy the company would have no overriding plan. Such a plan acts like a compass, pointing the company in the right direction. To be effective, a long-range plan must be

supported by each of the business functions. The operations strategy looks at the business strategy and develops a long- range plan specifi cally for the operations function. In the next section we will see how the operations strategy is developed.

BEFORE YOU GO ON

LINKSTO PRACTICE

DELL COMPUTER CORPORATION www.dell.com

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Developing an Operations Strategy Once a business strategy has been developed, an operations strategy must be formulated. This will provide a plan for the design and management of the operations function in ways that support the business strategy. The operations strategy relates the business strategy to the operations function. The operations strategy focuses on specific capabilities of the operation that give the company a competitive edge. These capabilities are called competitive priorities. By excelling in one of these capabilities, a company can become a winner in its

Competitive priorities Capabilities that the operations function can develop in order to give a company a competitive advantage in its market.

Developing an Operations Strategy • 35

market. These competitive priorities and their relationship to the design of the operations function are shown in Figure 2.3. Each part of this figure is discussed next.

Competitive Priorities Operations managers must work closely with marketing in order to understand the com- petitive situation in the company’s market before they can determine which competitive priorities are important. There are four broad categories of competitive priorities:

1. Cost Competing based on cost means offering a product at a low price relative to the prices of competing products. The need for this type of competition emerges from the busi- ness strategy. The role of the operations strategy is to develop a plan for the use of resources to support this type of competition. Note that a low-cost strategy can result in a higher profit margin, even at a competitive price. Also, low cost does not imply low quality. Let’s look at some specific characteristics of the operations function we might find in a company competing on cost.

To develop this competitive priority, the operations function must focus primarily on cutting costs in the system, such as costs of labor, materials, and facilities. Companies that compete based on cost study their operations system carefully to eliminate all waste. They might offer extra training to employees to maximize their productivity and minimize scrap. Also, they might invest in automation in order to increase productivity. Generally, compa- nies that compete based on cost offer a narrow range of products and product features, allow for little customization, and have an operations process that is designed to be as effi- cient as possible.

Cost A competitive priority focusing on low cost.

Defines the long-range plans for the company

BUSINESS STRATEGY

Developed to focus on the identified competitive properties

DESIGN OF THE OPERATIONS FUNCTION

Structure: Facilities, flow of goods, technology

Infrastructure: Planning & control system, workers, pay, quality

Develops a plan for the operations function focusing on specific competitive priorities

in order to meet the long-range plan

OPERATIONS STRATEGY

Competitive Priorities:

FIGURE 2.3 Operations strategy and the design of the operations function

36 CHAPTER 2 • Operations Strategy and Competitiveness

A company that successfully com- petes on cost is Southwest Airlines. Southwest’s entire operations func- tion is designed to support this strat- egy. Facilities are streamlined: only one type of aircraft is used, and flight routes are generally short. This serves to minimize costs of scheduling crew changes, maintenance, inventories of parts, and many administrative costs. Unnecessary costs are completely eliminated: there are no meals,

printed boarding passes, or seat assignments. Employees are trained to perform many functions and use a team approach to maximize customer service. Because of this strategy, Southwest has been a model for the airline industry for a number of years.

2. Quality Many companies claim that quality is their top priority, and many customers say that they look for quality in the products they buy. Yet quality has a subjective meaning; it depends on who is defining it. For example, to one person quality could mean that the product lasts a long time, such as with a Volvo, a car known for its longevity. To another person quality might mean high performance, such as a BMW. When companies focus on quality as a competitive priority, they are focusing on the dimensions of quality that are con- sidered important by their customers.

Quality as a competitive priority has two dimensions. The first is high-performance design. This means that the operations function will be designed to focus on aspects of quality such as superior features, close tolerances, high durability, and excellent customer service. The second dimension is goods and services consistency, which measures how often the goods or services meet the exact design specifications. A strong example of product consistency is McDonald’s, where we know we can get the same product every time at any location. Com- panies that compete on quality must deliver not only high-performance design but goods and services consistency as well.

A company that competes on this dimension needs to implement quality in every area of the organization. One of the first aspects that needs to be addressed is product design quality, which involves making sure the product meets the requirements of the customer. A second aspect is process quality, which deals with designing a process to produce error-free products. This includes focusing on equipment, workers, materials, and every other aspect of the operation to make sure it works the way it is supposed to. Companies that compete based on quality have to address both of these issues: the product must be designed to meet customer needs, and the process must produce the product exactly as it is designed.

To see why product and process quality are both important, let’s say that your favorite fast- food restaurant has designed a new sandwich called the “Big Yuck.” The restaurant could design a process that produces a perfect “Big Yuck” every single time. But if customers find the “Big Yuck” unappealing, they will not buy it. The same would be true if the restaurant designed a sandwich called the “Super Delicious” to meet the desires of its customers. Even if the “Super Delicious” were exactly what the customers wanted, if the process did not produce the sandwich the way it was designed, often making it soggy and cold instead, customers would not buy it. Remember that the product needs to be designed to meet cus- tomer wants and needs, and the process needs to be designed to produce the exact product that was intended, consistently without error.

3. Time Time or speed is one of the most important competitive priorities today. Com- panies in all industries are competing to deliver high-quality products in as short a time as

Quality A competitive priority focusing on the quality of goods and services.

LINKSTO PRACTICE

SOUTHWEST AIRLINES COMPANY www.southwest.com

Time A competitive priority focusing on speed and on- time delivery.

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Developing an Operations Strategy • 37

possible. Companies like FedEx, LensCrafters, United Parcel Service (UPS), and Dell com- pete based on time. Today’s customers don’t want to wait, and companies that can meet their need for fast service are becoming leaders in their industries.

Making time a competitive priority means competing based on all time-related issues, such as rapid delivery and on-time delivery. Rapid delivery refers to how quickly an order is received; on-time delivery refers to how often deliveries are made on time. Another time-competitive priority is development speed, which is the time needed to take an idea to the marketplace. This is especially critical in technology and computer software fields. When time is a competitive priority, the job of the operations function is to critically analyze the system and combine or eliminate processes in order to save time. Often companies use technology to speed up processes, rely on a flexible workforce to meet peak demand peri- ods, and eliminate unnecessary steps in the production process.

FedEx is an example of a com- pany that competes based on time. The company’s claim is to “abso- lutely, positively” deliver packages on time. To support this strategy, the operation function had to be designed to promote speed. Bar- code technology is used to speed up processing and handling, and the company uses its own fleet of airplanes. FedEx relies on a very flexible part-time workforce, such as college students who are willing to work a few hours at night. FedEx can call on this part- time workforce at a moment’s notice, providing the company with a great deal of flexibility. This allows FedEx to cover workforce requirements during peak periods without having to schedule full-time workers.

4. Flexibility As a company’s environment changes rapidly, including customer needs and expectations, the ability to readily accommodate these changes can be a winning strat- egy. This is flexibility. There are two dimensions of flexibility. One is the ability to offer a wide variety of goods or services and customize them to the unique needs of clients. This is called product flexibility. A flexible system can quickly add new products that may be important to customers or easily drop a product that is not doing well. Another aspect of flexibility is the ability to rapidly increase or decrease the amount produced in order to accommodate changes in the demand. This is called volume flexibility.

You can see the meaning of flexibility when you compare ordering a suit from a custom tailor to buying it off the rack at a retailer. Another example would be going to a fine restaurant and asking to have a meal made just for you, versus going to a fast-food restaurant and being limited to items on the menu. The custom tailor and the fine restaurant are examples of companies that are flexible and will accommodate customer wishes. Another example of flexibility is Empire West Inc., a company that makes a variety of products out of plastics, depending on what cus- tomers want. Empire West makes everything from plastic trays to body guards for cars.

Companies that compete based on flexibility often cannot compete based on speed because it generally requires more time to produce a customized product. Also, flexible companies typically do not compete based on cost because it may take more resources to customize the product. However, flexible companies often offer greater customer service and can meet unique customer requirements. To carry out this strategy, flexible companies tend to have more general-purpose equipment that can be used to make many different kinds of products. Also, workers in flexible companies tend to have higher skill levels and can often perform many different tasks in order to meet customer needs.

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38 CHAPTER 2 • Operations Strategy and Competitiveness

The Need for Trade-Offs You may be wondering why the operations function needs to give special focus to some priorities but not all. Aren’t all the priorities important? As more resources are dedicated to one priority, fewer resources are left for others. The operations function must place emphasis on those priorities that directly support the business strategy. Therefore, it needs to make trade-offs between the different priorities. For example, consider a company that competes on using the highest quality component parts in its products. Due to the high quality of parts, the company may not be able to offer the final product at the lowest price. In this case, the company has made a trade-off between quality and price. Similarly, a company that competes on making each product individually based on customer specifications will likely not be able to compete on speed. Here, the trade-off has been made between flexibility and speed.

It is important to know that every business must achieve a basic level of each of the pri- orities, even though its primary focus is only on some. For example, even though a company is not competing on low price, it still cannot offer its products at such a high price that cus- tomers would not want to pay for them. Similarly, even though a company is not competing on time, it still has to produce its product within a reasonable amount of time; otherwise, customers will not be willing to wait for it.

One way that large facilities with multiple products can address the issue of trade- offs is using the concept of plant-within-a-plant (PWP), introduced by well-known Har- vard professor Wickham Skinner. The PWP concept suggests that different areas of a facility be dedicated to different products with different competitive priorities. These areas should be physically separated from one another and should even have their own separate workforce. As the term suggests, there are multiple plants within one plant, allowing a company to produce different products that compete on different priorities. For example, hospitals use PWP to achieve specialization or focus in a particular area, such as the cardiac unit, oncology, radiology, surgery, or pharmacy. Similarly, department stores use PWP to isolate departments, such as the Sears auto service department ver- sus its optometry center.

Order Winners and Qualifiers To help a company decide which competitive priorities to focus on, it is important to dis- tinguish between order winners and order qualifiers, which are concepts developed by Terry Hill, a professor at Oxford University. Order qualifiers are those competitive priorities that a company has to meet if it wants to do business in a particular market. Order winners, on the other hand, are the competitive priorities that help a company win orders in the market. Consider a simple restaurant that makes and delivers pizzas. Order qualifiers might be low price (say, less than $10.00) and quick delivery (say, under 15 minutes) because this is a stan- dard that has been set by competing pizza restaurants. The order winners may be “fresh ingredients” and “home-made taste.” These characteristics may differentiate the restaurant from all the other pizza restaurants. However, regardless of how good the pizza, the restau- rant will not succeed if it does not meet the minimum standard for order qualifiers. Know- ing the order winners and order qualifiers in a particular market is critical to focusing on the right competitive priorities.

It is important to understand that order winners and order qualifiers change over time. Often when one company in a market is successfully competing using a particular order winner, other companies follow suit over time. The result is that the order winner becomes an industry standard, or an order qualifier. To compete successfully, companies then have to change their order winners to differentiate themselves. An excellent example

Trade-off The need to focus more on one competitive priority than on others.

Order qualifi ers Competitive priorities that must be met for a company to qualify as a competitor in the marketplace.

Order winners Competitive priorities that win orders in the marketplace.

Developing an Operations Strategy • 39

of this occurred in the auto industry. Prior to the 1970s, the order-winning criterion in the American auto industry was price. Then the Japanese automobile manufacturers entered the market competing on quality at a reasonable price. The result was that quality became the new order winner and price became an order qualifier, or an expectation. Then by the 1980s American manufacturers were able to raise their level of quality to be competitive with the Japanese. Quality then became an order qualifier, as everyone had the same quality standard.

Translating Competitive Priorities into Production Requirements Operations strategy makes the needs of the business strategy specific to the operations function by focusing on the right competitive priorities. Once the competitive priorities have been identified, a plan is developed to support those priorities. The operations strategy will specify the design and use of the organization’s resources; that is, it will set forth specific operations requirements. These can be broken down into two categories.

1. Structure—Operations decisions related to the design of the production process, such as characteristics of facilities used, selection of appropriate technology, and fl ow of goods and services through the facility.

2. Infrastructure—Operations decisions related to the planning and control systems of the operation, such as organization of the operations function, skills and pay of workers, and quality control approaches.

Together, the structure and infrastructure of the production process determine the nature of the company’s operations function.

The structure and infrastructure of the production process must be aligned to enable the company to pursue its long-term plan. Suppose we determined that time or speed of deliv- ery is the order winner in the marketplace and the competitive priority we need to focus on. We would then design the production process to promote speedy product delivery. This might mean having a system that does not necessarily produce the product at the abso- lutely lowest cost, possibly because we need costlier or extra equipment to help us focus on speed. The important thing is that every aspect of production of a product or delivery of a service needs to focus on supporting the competitive priority. However, we cannot neglect the other competitive priorities. A certain level of order qualifiers must be achieved just to remain in the market. The issue is not one of focusing on one priority to the exclusion of the others. Rather, it is a matter of degree.

Let’s return to the example of Dell Computer Corporation. Earlier we explained how Dell used its mission, environmental scanning, and core competencies to develop its business strategy. But to make this business plan a reality, the company needed to develop an opera- tions strategy to create its structure and infrastructure. The focus was on customer service, cost, and speed. Dell set up a system in which customers could order computers directly from the company, without going through an intermediary, such as a retailer. An operations system was designed so that ordering of components and assembly of computers did not occur until an order was actually placed. This kept costs low because Dell did not have computers sitting in inventory. A warehousing system was designed so that when compo- nents were needed, suppliers would deliver them to the plant within 15 minutes; in con- trast, competitors like IBM and Compaq had to wait hours or even days to receive needed components. To further increase speed, Dell set up a shipping arrangement with United Parcel Service (UPS). With this structure and infrastructure, Dell was able to implement its business plan.

Structure Operations decisions related to the design of the production process, such as facilities, technology, and fl ow of goods and services through the facility.

Infrastructure Operations decisions related to the planning and control systems of the operation, such as organization of operations, skills and pay of workers, and quality measures.

40 CHAPTER 2 • Operations Strategy and Competitiveness

Strategic Role of Technology Over the last decade we have seen an unprecedented growth in technological capability. Technology has enabled companies to share real-time information across the globe, to improve the speed and quality of their processes, and to design products in innovative ways. Companies can use technology to help them gain an advantage over their competitors. For this reason technology has become a critical factor for companies in achieving a competi- tive advantage. In fact, studies have shown that companies that invest in new technologies tend to improve their financial position over those that do not. However, the technologies a company acquires should not be decided on randomly, such as following the latest fad or industry trend. Rather, the selected technology needs to support the organization’s compet- itive priorities, as we learned in the example of FedEx. Also, technology needs to be selected to enhance the company’s core competencies and add to its competitive advantage.

Types of Technologies There are three primary types of technologies. They are differentiated based on their appli- cation, but all three areas of technology are important to operations managers. The first type is product technology, which is any new technology developed by a firm. An example of this would include Teflon®, the material used in no-stick fry pans. Teflon became an emerg- ing technology in the 1970s and is currently used in numerous applications. Other examples include CDs and flat-screened monitors, water-repellent material such as GORE-TEX®, or wearable technology such as Google Glass. Product technology is important as companies can use it for a competitive advantage, but it requires that they must regularly update their processes to produce the latest types of products.

A second type of technology is process technology. It is the technology used to improve the process of creating goods and services. Examples of this would include computer-aided design (CAD) and computer-aided manufacturing (CAM). These are technologies that use computers to assist engineers in the way they design and manufacture products. Another example is 3D Printing, a technology similar to ink-jet and laser-jet printers where a solid object is created from a software design. Process technologies are important to companies, as they enable tasks to be accomplished more efficiently. We will learn more about these technologies in Chapter 3.

The last type of technology is information technology, which enables communication, processing, and storage of information. Information technology has grown rapidly over recent years and has had a profound impact on business. Just consider the changes that have occurred due to the Internet and the web. The Internet has enabled electronic commerce and the creation of the virtual marketplace and has linked customers and buyers. Another example of information technology is enterprise resource planning (ERP), which functions

By now you should have a clear understanding of how an operations strategy is developed and its role in helping the organization decide which competitive priorities to focus on. There are four categories of competitive priorities: cost, qual- ity, time, and fl exibility. A company must make trade-offs in deciding which priorities to focus on. The operations strategy and the competitive priorities dictate the design and plan for

the operations function, which includes the structure and infrastructure of the operation. This is a dynamic process, and as the environment changes, the organization must be prepared to change accordingly. Operations strategy plays a key role in an organization’s ability to compete. In the next section we discuss a way to measure a company’s competitive capability.

BEFORE YOU GO ON

Productivity • 41

via large software programs used for planning and coordinating all resources throughout the entire enterprise. ERP systems have enabled companies to reduce costs and improve responsiveness but are highly expensive to purchase and implement. Consequently, as with any technology, investment in ERP needs to be a strategic decision.

Technology as a Tool for Competitive Advantage Technology can be acquired to improve processes and maintain up-to-date standards. Technology can also be used to gain a competitive advantage. For example, by acquiring technology a company can improve quality, reduce costs, and improve product delivery. This can provide an advantage over the competition and help gain market share. However, investing in technology can be costly and entails risks, such as overestimating the benefits of the technology or incurring the risk of obsolescence due to rapid new inventions.

Technology should be acquired to support the company’s chosen competitive priorities, not just to follow the latest market fad. Also, technology may require the company to rethink its strategy. For example, when the Internet became available, it was generally assumed that it would replace traditional ways of doing business. This has not turned out to be the case. In fact, for many companies the Internet has enhanced traditional methods. Physical activities such as shipping, warehousing, transportation, and even physical contact must still be performed. For example, pharmacy chains such as Walgreens and CVS have found that although customers place orders over the Internet, they prefer to pick them up in per- son. Similarly, the airlines have discovered that an easy-to-use Web site can increase airline bookings. However, successful use of a technology such as the Internet requires companies to develop strategies that integrate the technology. As you can see, acquiring technology is an important strategic decision for companies. Operations managers must consider many factors when making a purchase decision.

Productivity Sound business strategy and supporting operations strategy make an organization more competitive in the marketplace. But how does a company measure its competitiveness? One of the most common ways is by measuring productivity. In this section we will look at how to measure the productivity of each of a company’s resources as well as the entire organization.

Measuring Productivity Recall that operations management is responsible for managing the transformation of many inputs into outputs, such as goods or services. A measure of how efficiently inputs are being converted into outputs is called productivity. Productivity measures how well resources are used. It is computed as a ratio of outputs (goods and services) to inputs (e.g., labor and materials). The more efficiently a company uses its resources, the more productive it is:

Productivity = output

input

This equation can be used to measure the productivity of one worker or many, as well as the productivity of a machine, a department, the whole firm, or even a nation. The possibilities are shown in Table 2.2.

When we compute productivity for all inputs combined, such as labor, machines, and capital, we are measuring total productivity. For example, let’s say that the weekly dollar

Productivity A measure of how effi ciently an organization converts inputs into outputs.

Total productivity Productivity computed as a ratio of output to all organizational inputs.

42 CHAPTER 2 • Operations Strategy and Competitiveness

value of a company’s output, such as finished goods and work in progress, is $10,200 and that the value of its inputs, such as labor, materials, and capital, is $8600. The company’s total weekly productivity would be computed as follows:

Total productivity = output

input =

$10,200

$8600 = 1.186

Often it is much more useful to measure the productivity of one input variable at a time in order to identify how efficiently each is being used. When we compute productivity as the ratio of output relative to a single input, we obtain a measure of partial productivity, also called single-factor productivity. Following are two examples of the calculation of partial productivity:

1. A bakery oven produces 346 pastries in 4 hours. What is its productivity?

Machine productivity = number of pastries�oven time

= 346 pastries

4 hours = 86.5 pastries�hour

2. Two workers paint tables in a furniture shop. If the workers paint 22 tables in 8 hours, what is their productivity?

Labor productivity = 22 tables

2 workers × 8 hours = 1.375 tables�hour

Examples of select partial productivity measures are shown in Table 2.3. Sometimes we need to compute productivity as the ratio of output relative to a group

of inputs, such as labor and materials. This is a measure of multifactor productivity. For example, let’s say that output is worth $382 and labor and materials costs are $168 and $98, respectively. A multifactor productivity measure of our use of labor and materials would be

Multifactor productivity = output

labor + materials

= $382

$168 + $98 = 1.436

Partial productivity Productivity computed as a ratio of output to only one input (e.g., labor, materials, machines).

Multifactor productivity Productivity computed as a ratio of output to several, but not all, inputs.

TABLE 2.2 Productivity Measures

Total Productivity Measure Output produced

All inputs used

Partial Productivity Measure Output

Labor or

Output

Machines or

Output

Materials or

Output

Capital

Multifactor Productivity Measure Output

Labor + machines or

Output

Labor + materials or

Output

Labor + capital + energy

Productivity • 43

EXAMPLE 2.1 Computing Productivity

Long Beach Bank employs three loan offi cers, each working eight hours per day. Each offi cer processes an average of fi ve loans per day. The bank’s payroll cost for the offi cers is $820 per day, and there is a daily overhead expense of $500. The bank has just purchased new computer software that should enable each offi cer to process eight loans per day, although the overhead expense will increase to $550. Evaluate the change in labor and multifactor productivity before and after implementation of the new computer software.

• Before You Begin: When solving productivity problems, make sure that the value of outputs and inputs is computed over the same time period, such as day, week, month, or year. Also, when evaluating a change in productivity, compute the productivity before and after the expected change and calculate the percentage difference.

• Solution:

Labor productivity (old) = 3 officers × 5 loans�day

24 labor-hours =

15 loans�day 24 labor-hours

= 0.625 loans per labor-hour

Labor productivity (new) = 3 officers × 8 loans�day

24 labor-hours =

24 loans�day 24 labor-hours

= 1.00 loan per labor-hour

Multifactor productivity (old) = 15 loans�day

$820�day + $500�day = 0.0113 loans�dollar

Multifactor productivity (new) = 24 loans�day

$820�day + $550�day = 0.0175 loans�dollar

The change in labor productivity is from 0.625 to 1.00 loans per labor-hour. This results in an increase of 1.00/0.625 = 1.6, or an increase of 60 percent. The change in multifactor productivity is from 0.0113 to 0.0175 loans per dollar. This results in an increase of 0.0175/0.0113 = 1.55, or an increase of 55 percent.

TABLE 2.3 Examples of Partial Productivity Measures

Business Type Productivity Measure

Restaurant Customers served Labor-hour

or Customers served

Square foot

Hospital Patients Hospital bed

or Patients

Nurse-hour

Amusement park Visitors Square foot

or Visitors

Attraction

Cattle ranch Cattle Pound of feed

or Cattle

Acre of land

Garment manufacturer Sweaters Pound of yarn

or Sweaters

Machine-hour

44 CHAPTER 2 • Operations Strategy and Competitiveness

Interpreting Productivity Measures To interpret the meaning of a productivity measure, it must be compared with a similar productivity measure. For example, if one worker at a pizza shop produces 17 pizzas in two hours, the productivity of that worker is 8.5 pizzas per hour. This number by itself does not tell us very much. However, if we compare it to the productivity of two other workers, one who produces 7.2 pizzas per hour and another 6.8 pizzas per hour, it is much more mean- ingful. We can see that the first worker is much more productive than the other two work- ers. But how do we know whether the productivity of all three workers is reasonable? What we need is a standard. In Chapter 11 we will discuss ways to set standards and how those standards can help in evaluating the performance of our workers.

It is also helpful to measure and compare productivity over time. Let’s say that we want to measure the total productivity of our three pizza makers (our “labor”) and we compute a labor productivity measure of 7.5 pizzas per hour. This number does not tell us much about the workers’ performance. However, if we compare weekly productivity measures over time, perhaps over the last four weeks, we get much more information:

Week 1 2 3 4

Productivity (pizzas/labor-hour) 5.4 6.8 7.1 7.5

Now we see that the workers’ productivity is improving over time. In fact, productivity changed from 5.4 to 7.5 pizzas per labor-hour, resulting in an increase of 7.5/5.4 = 1.39, or an increase of 39 percent. But what if we find out that our main competitor, a pizzeria down the street, has a productivity of 9.5 pizzas per labor-hour? This productivity rate is 26.7 percent (9.5/7.5 = 1.267) higher than our productivity in week 4. Suddenly we know that even though our productivity is going up, it should be higher. We may have to analyze our processes and increase our productivity in order to be competitive. By comparing our productivity over time and against similar operations, we have a much better sense of how high our productivity really is.

When evaluating productivity and setting standards for performance, we also need to consider our strategy for competing in the marketplace—namely, our competitive priorities. A company that competes based on speed would probably measure productivity in units produced over time. However, a company that competes based on cost might measure pro- ductivity in terms of costs of inputs such as labor, materials, and overhead. The important thing is that our productivity measure provides information on how we are doing relative to the competitive priority that is most important to us.

Productivity and Competitiveness Productivity is essentially a scorecard of how efficiently resources are used and a measure of competitiveness. Productivity is measured on many levels and is of interest to a wide range of people. As we showed in earlier examples, productivity can be measured for individuals, departments, or organizations. It can track performance over time and help managers identify problems. Similarly, productivity can be measured for an entire industry and even a country.

The economic success of a nation and the quality of life of its citizens are related to its competitiveness in the global marketplace. Increases in productivity are directly related to increases in a nation’s standard of living. That is why business and government leaders con- tinuously monitor the productivity at the national level and by industry sectors.

Productivity in the United States had been increasing for over 100 years. Then in the 1970s and 1980s productivity dropped, even lagging behind that of other industrial nations. Fortunately, productivity rebounded in the mid- and late 1990s. Today, companies under- stand the importance of competitiveness and productivity in the United States. Changes in U.S. productivity can be seen in Figure 2.4.

Productivity • 45

Productivity and the Service Sector Service sector companies have a unique challenge when trying to measure productivity. The reason is that traditional productivity measures tend to focus on tangible outcomes, as seen with goods-producing activities. Services primarily produce intangible products, such as ideas and information, making it difficult to evaluate quality. Consequently, accurately mea- suring productivity improvements can be difficult. A good example of the difficulty in using traditional productivity measures in the service sector is the emergency room. Here inputs are the medical staff, yet outputs may not exist if no one needed treatment on that shift. In that case, by traditional measures, productivity would be zero! The real issue in this type of environment is the level of readiness, and the challenge is to adequately measure it.

As we discussed previously, employment in the service sector of the U.S. economy has grown rapidly. Unfortunately, productivity gains in this sector have been much lower than those of manufacturing. It is hoped that advancements in information technology will help standardize services and accelerate productivity in this sector.

Operations Strategy Within OM: How it all Fits Together

We have learned that the strategic decisions of a firm drive its tactical decisions. Opera- tions strategy decisions are critical in this process because they serve as a linkage between the business strategy and all the other operations decisions. Recall that operations strategy provides a plan for the OM function that supports the business strategy. In turn, decisions regarding operations strategy directly impact decisions on organizational structure and infrastructure of the company. This includes selection of the facilities (Chapter 10), type of process (Chapter 8), choice of technology (Chapter 3), quality control decisions (Chap- ters 5 and 6), skills and pay of workers (Chapter 11), and numerous other decisions. As in the example of Southwest Airlines, an operations strategy that focuses on cost competition would translate into specific operations decisions that eliminate all frills from the system.

YEAR

5

4

3

2

1

0 2000

A N

N U

A L

P E

R C

E N

TA G

E C

H A

N G

E

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 201495 96 97 98 99

FIGURE 2.4 Percentage change in U.S. business sector productivity (output per hour)

Source: Bureau of Labor Statistics

46 CHAPTER 2 • Operations Strategy and Competitiveness

In subsequent chapters of this book, we will study specific decisions that pertain to orga- nizational structure and infrastructure. We will see that these decisions are governed by the firm’s operations strategy. We will also learn how these specific decisions impact each other.

Operations Strategy Across the Organization

The business strategy defines the long-range plan for the entire company and guides the actions of each of the company’s business functions. Those functions, in turn, develop plans to support the business strategy. However, in defining their individual strategies, it is impor- tant for the functions to work together and understand each other’s needs.

Marketing identifies target markets, studies competition, and communicates with cus- tomers. In developing its own strategy, marketing needs to fully understand the capabilities of the operations function, the types of resources being used, and the way those resources are utilized. Otherwise, marketing’s strategy could entail making promises that operations cannot deliver. In turn, marketing needs to communicate to operations all its observed and anticipated market changes.

Finance develops financial plans to support the business strategy. However, since it is the operations function that manages all the organization’s resources, the financial plans in effect support operations activities. Before it can develop its own strategy, finance needs to communicate with operations in order to understand the financial requirements of planned resources. In turn, operations managers cannot fully develop a strategy until they have a clear understanding of financial capabilities.

The strategies of all the business functions need to support each other in achieving the goals set by the business strategy and are best developed through a team approach.

MKT

FIN

The operations strategy of a fi rm directly impacts decisions on its structure and infrastructure, including its supply chain. This includes the design of the supply chain, such as its length, and the relationships the fi rm has with its supply chain partners. Together, the operations strategy and the fi rm’s supply chain must support the business strategy of the fi rm. This can be illustrated by the competitive priorities of the fi rm, which directly impact the type of supply chain a company has in place. For example, a company that competes on cost must have a highly effi cient supply chain with high integration of the OM function between supply chain partners. The reason is that the supply chain plays a critical role in keeping both production and delivery costs down. Therefore, a fi rm competing on cost might structure its supply chain so that the least expensive suppliers are used rather than those with the highest quality supplies.

In contrast, a company that competes on quality will likely have a different supply chain. Competing on quality means that a company’s products and services are known for their premium nature, such as product consistency and reliability. Many aspects

of the supply chain are altered when companies compete on quality versus another competitive priority, such as cost. The company will likely source its components from suppliers known for quality who have implemented total quality management throughout their production process. The concept of quality will also be embedded in other aspects of the supply chain, such as transportation, delivery, and packaging.

An excellent example of aligning operations strategy with the supply chain is illustrated by Wal-Mart. Sam Walton, Wal- Mart’s founder, was a strategic visionary who developed the low-cost retail strategy that is supported by its supply chain. Wal-Mart’s supply chain is designed to buy not from distribut- ors but directly from manufacturers in order to lower costs and offer a broad range of merchandise. In fact, Wal-Mart has had a legendary partnership with Procter & Gamble, where replen- ishment of inventories is done automatically. These supply chain actions were designed to help Wal-Mart meet its overall competitive strategy, which is to provide its customers with a wide product offering at a low price. This has helped Wal-Mart become the world’s largest retailer. •

THE SUPPLY CHAIN LINK

Chapter Highlights 1 The role of operations strategy is to provide a long-

range plan for the use of the company’s resources in producing the company’s primary goods and services.

· A business strategy is a long-range plan and vision for a business. Each of the individual business func- tions needs to support the business strategy.

2 An organization develops its business strategy by doing environmental scanning and considering its mission and its core competencies.

· Th e role of business strategy is to serve as an overall guide for the development of the organization’s oper- ations strategy.

3 The operations strategy focuses on developing specific capabilities called competitive priorities. In designing

its operation, an organization is governed by the oper- ations strategy and the specific competitive priorities it has chosen to develop.

· Th ere are four categories of competitive priorities: cost, quality, time, and fl exibility.

4 Technology can be used by companies to gain a com- petitive advantage and should be acquired to support the company’s chosen competitive priorities.

5 Productivity is a measure that indicates how efficiently an organization is using its resources.

· Productivity is computed as the ratio of organiza- tional outputs divided by inputs.

Key Terms

operations strategy 29

business strategy 29

mission 30

environmental scanning 31

core competencies 32

competitive priorities 34

cost 35

quality 36

time 36

trade-off 38

order qualifi ers 38

order winners 38

structure 39

infrastructure 39

productivity 41

total productivity 41

partial productivity 42

multifactor productivity 42

Key Terms • 47

Governmental decision makers can require companies to adopt practices that are deemed environmentally safe and socially responsible, using laws and government regulations. Many companies, however, engage in voluntary compliance in sustainable practices. These provide benefi ts in the form of advertising—such as logos that appeal to the preferences of a growing number of environmentally conscious consumers— and group membership in certifi cation programs, which provide directory listings and other perks. Like other operations decisions, the decision to embrace sustainability practices, above and beyond those mandated by regulatory standards, must be driven by the business strategy.

The Brazilian company Aracruz Celulose offers a good example of sustainability decisions that are driven by the company’s business strategy. The company is responsible for 24 percent of the global supply of bleached eucalyptus pulp, used in the manufacture of paper. It has developed practices of sustainable operations and supply chain management that support its goal of being a recognized sustainability leader.

For example, Aracruz ensures environmental sustainability by preserving the natural ecosystems surrounding the eucalyptus plantations. The company created a forestry management program to preserve native tree populations and prevent over- harvesting, and has put in place strict environmental control technology to protect and monitor the impact of its operations on forests and rivers. In addition to the environment, Aracruz focuses on social sustainability by contributing to the communit- ies near its operation sites. The company also gives back to the local communities. In 2004, for example, Aracruz contributed $5 million to improve the education, health, and social welfare of local populations. All these efforts were put into place to sup- port the company’s business strategy of sustainability leader- ship. This has resulted in fi nancial benefi ts for the company that have come from ensuring a consistent supply of natural material and elimination of waste. Aracruz has also received brand re- cognition for its efforts. In 2008 Aracruz was highlighted as the company with the world’s best corporate sustainability practices by the Dow Jones Sustainability Index (DJSI World). •

THE SUSTAINABILITY LINK

48 CHAPTER 2 • Operations Strategy and Competitiveness

Formula Review

Productivity = output

input

Solved Problems (See student companion site for Excel template.) PROBLEM 1

Bluegill Furniture is a small furniture shop that focuses on making kitchen chairs. Th e weekly dollar value of its output, including fi nished goods and work in progress, is $14,280. Th e value of inputs, such as labor, materials, and capital, is approximately $16,528. Compute the total productivity measure for Bluegill Furniture.

Before You Begin: In this problem you are being asked for the total productivity. Recall that it is simply the ratio of total output over input.

Solution:

Total productivity = output

input =

$14,280

$16,528 = 0.864

PROBLEM 2

Bluegill has just purchased a new sanding machine that processes 17 chairs in 8 hours. What is the productivity of the sanding machine?

Before You Begin: In this problem you are being asked for machine productivity, which is a partial productivity measure.

PROBLEM 3

Bluegill has hired two new workers to paint chairs. Th ey have painted 10 chairs in 4 hours. What is their labor productivity?

Before You Begin: Remember that you should com- pute the labor productivity of both workers combined.

PROBLEM 4

On average, Bluegill produces 35 chairs per day. Labor costs average $480, material costs are typically $200, and overhead cost is $250. If Bluegill sells the chairs to a retailer for $70 each, determine the multifactor productivity.

Before You Begin: When computing multifactor pro- ductivity, remember to compute the total value of the inputs before taking the ratio.

Solution:

Machine productivity = number of chairs

processing time

= 17 chairs

8 hours

= 2.125 chairs�hour

Solution:

Labor productivity = 10 chairs

2 workers × 4 hours

= 1.25 chairs�hour

Solution:

= value of output

labor costs + material cost + overhead

= 35 chairs × $70�chair $480 + $200 + $250

= $2450

$930

= $2.63 of sales per dollar

Multifactor productivity

PROBLEM 5

Last week employees at Bluegill produced 46 chairs after working a total of 200 hours. Of the 46 chairs pro- duced, 12 were damaged due to a problem with the new sanding machine. Th e damaged chairs can be dis- counted and sold for $25 each. Th e undamaged chairs are sold to a department store retail chain for $70 each. What was the labor productivity ratio for last week? If labor productivity was $15 in sales per hour the previ- ous week, what was the change in labor productivity?

Before You Begin: To compute productivity you must include the total value of the output. Notice that in this problem there are diff erent quantities of products that have diff erent values (damaged and good chairs). You must compute the value of each type of chair and add them together to obtain the total value before taking the ratio.

Solution:

Value to output = (12 damaged chairs × $25�damaged chair) + (34 good chairs × $70�good chair)

= $2680 Labor-hours of input = 200 hours

Labor productivity = value of output

labor-hours of input

Labor productivity = $2680

200 hours

= $13.40 in sales per hour

Th e change in labor productivity was from $15 to $13.40 in sales per hour, or a reduction of 10.67 percent.

Discussion Questions

1. Explain the importance of a business strategy.

2. Explain the role of operations strategy in a business.

3. Describe how a business strategy is developed.

4. Describe how an operations strategy is formulated from the business strategy.

5. Explain what is meant by the term competitive priority and describe the four categories of competitive priorities discussed in the chapter.

6. Find an example of a company that makes quality its competitive priority. Find another company that

makes fl exibility its competitive priority. Compare these strategies.

7. What is meant by the terms order qualifi ers and order winners? Explain why they are important.

8. Describe the three types of technologies. Explain the strategic role of technology.

9. Describe the meaning of productivity. Why is it im- portant?

10. Explain the three types of productivity measures.

Problems

1. Two workers have the job of placing plastic labels on packages before the packages are shipped out. Th e fi rst worker can place 1000 labels in 30 minutes. Th e second worker can place 850 labels in 20 minutes. Which worker is more productive?

2. Last week a painter painted three houses in fi ve days. Th is week she painted two houses in four days. In which week was the painter more productive?

3. One type of bread-making machine can make six loaves of bread in fi ve hours. A new model of the ma- chine can make four loaves in two hours. Which model is more productive?

4. A company that makes kitchen chairs wants to com- pare productivity at two of its facilities. At facility #1, six workers produced 240 chairs. At facility #2, four workers produced 210 chairs during the same time period. Which facility was more productive?

5. A painter is considering using a new high-tech paint roller. Yesterday he was able to paint three walls in 45 minutes using his old method. Today he painted two walls of the same size in 20 minutes. Is the painter more productive using the new paint roller?

6. Aztec Furnishings makes hand-crafted furniture for sale in its retail stores. Th e furniture maker has recently

Problems • 49

50 CHAPTER 2 • Operations Strategy and Competitiveness

installed a new assembly process, including a new sander and polisher. With this new system, produc- tion has increased to 90 pieces of furniture per day from the previous 60 pieces of furniture per day. Th e number of defective items produced has dropped from 10 pieces per day to 1 per day. Th e production facility operates strictly eight hours per day. Evaluate the change in productivity for Aztec using the new as- sembly process.

7. Howard Plastics produces plastic containers for use in the food packaging industry. Last year its aver- age monthly production included 20,000 containers produced using one shift fi ve days a week with an eight-hour-a-day operation. Of the items produced, 15 percent were deemed defective. Recently, Howard Plastics has implemented new production methods and a new quality improvement program. Its monthly production has increased to 25,000 containers with 9 percent defective. (a) Compute productivity ratios for the old and new

production system. (b) Compare the changes in productivity between the

two production systems. 8. Med-Tech labs is a facility that provides medical tests

and evaluations for patients, ranging from analyzing blood samples to performing magnetic resonance

imaging (MRI). Average cost to patients is $60 per pa- tient. Labor costs average $15 per patient, materials costs are $20 per patient, and overhead costs are aver- aged at $20 per patient. (a) What is the multifactor productivity ratio for Med-

Tech? What does your fi nding mean? (b) If the average lab worker spends three hours for

each patient, what is the labor productivity ratio? 9. Handy-Maid Cleaning Service operates fi ve crews with

three workers per crew. Diff erent crews clean a diff er- ent number of homes per week and spend a diff ering amount of hours. All the homes cleaned are about the same size. Th e manager of Handy-Maid is trying to evaluate the productivity of each of the crews. Th e fol- lowing data have been collected over the past week.

Work Crew Hours Homes Cleaned

Anna, Sue, and Tim 35 10

Jim, Jose, and Andy 45 15

Dan, Wendy, and Carry 56 18

Rosie, Chandra, and Seth 30 10

Sherry, Vicky, and Roger 42 18

Assuming the quality of cleaning was consistent between crews, which crew was most productive?

Case: Prime Bank of Massachusetts

Prime Bank of Massachusetts was started in 1964 with James Rogers as CEO, who is now chairman of the board. Prime Bank had been growing steadily since its beginning and has developed a loyal customer fol- lowing. Today there are 45 bank locations throughout Massachusetts, with corporate headquarters in New- bury, Massachusetts. Th e bank off ers a wide array of banking services to commercial and noncommercial customers.

Prime Bank has considered itself to be a conser- vative, yet innovative, organization. Its locations are open Monday–Friday 9–4 and Saturday 9–12. Most of the facilities are located adjacent to well-established shopping centers, with multiple ATM machines and at least three drive-through windows. However, Prime Bank’s growth has brought on certain problems. Having the right amount of tellers available in the bank as well as in the drive-through window has been a challenge. Some commercial customers had recently expressed

frustration due to long waiting time. Also, the parking lot has often become crowded during peak periods.

While Prime Bank was going through a growth period, the general banking industry had been experi- encing tougher competition. Competitors were increas- ingly off ering lower interest rates on loans and higher yields on savings accounts and certifi cates of deposit. Also, Prime Bank was experiencing growing pains, and something needed to be done soon or it would begin losing customers to competition.

Th e board, headed by James Rogers, decided to develop a more aggressive strategy for Prime Bank. While many of its competitors were competing on cost, the board decided that Prime Bank should focus on customer service in order to diff erentiate itself from the competition. Th e bank had already begun moving in that direction by off ering a 24-hour customer service department to answer customers’ banking questions. Yet, there were diffi culties with this eff ort, such as poor

staffi ng and not enough telephone lines. James Rogers wanted Prime Bank to aggressively solve all customer service issues, such as staffi ng, layout, and facilities. He also wanted greater creativity in adding improve- ments in customer service, such as on-line banking, and special services for large customers. He believed that improving most aspects of the bank’s operation would give Prime Bank a competitive advantage.

Th e board presented their new strategy to Victoria Chen, vice president of operations. Victoria had recently been promoted to the V.P. level and under- stood the importance of operations management. She was asked to identify all changes that should be made in the operation function that would support this new strategy and present them at the next board meeting. Victoria had been hoping for an opportunity to prove herself since she began with the bank. Th is was her chance.

Case Questions

1. Why is the operations function important in imple- menting the strategy of an organization? Explain why the changes put in place by Victoria Chen and her team could either hurt or help the bank.

2. Develop a list of changes for the operations func- tion that should be considered by the bank. Begin by identifying operations management decisions that would be involved in operating a bank, for example, layout of facility, staff , drive-through service. Th en identify ways that they can be improved at Prime Bank in order to support the strategy focused on customer service.

3. Th ink of the improvements identifi ed in answering question 2. How diff erent would these improve- ments be if the bank had a strategy of cutting cost rather than supporting customer service?

Case: Boseman Oil and Petroleum (BOP)

Boseman Oil and Petroleum (BOP) is one of many oil companies operating off shore petroleum platforms in the Gulf of Mexico. Th e company identifi es off shore sites for exploration drilling and constructs drilling platforms. Once exploration activities are successful, the platforms are converted to a production platform to extract crude oil and natural gas. BOP operates mul- tiple platforms and an onshore facility that serves as the primary interface between the platforms. Boats with specialized crews provide logistics services between the platforms and the onshore facility. Th e boats deliver fuel, water, equipment, and other needed supplies mul- tiple times a day to the platforms. Accurate and timely delivery of materials is absolutely necessary for suc- cessful platform operations.

BOP had traditionally focused on exploration and production activities, paying little attention to operat- ing costs. However, operating costs had been increasing rapidly. A particularly signifi cant cost was the operat- ing of boats and crews needed to provide logistics ser- vices between platforms and the onshore facility. Th e boats are highly specialized, with built-in storage tanks and unique cargo space designs. Th e boat crews are

specially trained, and operating the boats and crews is highly expensive. Although BOP is dependent on the boat deliveries, it does not use the boats at full capacity and they are often idle.

Jeff Kessinger, director of off shore operations for BOP, is now faced with the decision of how to reduce operating costs. One option is to outsource the logistics service to a company specializing in providing off shore logistics services. Logistics-Off shore Inc. is such a com- pany, owning and maintaining its own fl eet of boats and crews. Logistics-Off shore could be hired to perform this function. BOP could sell its boats and focus on oil exploration. Jeff is aware that outsourcing is an impor- tant strategic decision and there is much to consider. He is not sure where to begin.

Case Questions

1. Identify the potential strategic advantages and dis- advantages for BOP in outsourcing the boat logistics service to Logistics-Off shore. Explain the strategic implications of each.

2. Identify the type of information Jeff Kessinger needs to gather and evaluate in order to make his decision.

Case: Boseman Oil and Petroleum (BOP) • 51

52 CHAPTER 2 • Operations Strategy and Competitiveness

Interactive Case: Virtual Company

On-line Case: Cruise International, Inc.

Assignment: Getting Acquainted with Cruise Interna- tional, Inc. After a few minutes on hold, you hear Bob Bristol begin speaking on the phone. “Hello,” he begins. “I understand that you wanted to let me know about your progress and needed some additional guidelines. My assistant, Shontelle, gave me the details of your work on the fi rst assignment. I am pleased that you are begin- ning to learn about CII and the cruising industry. Since you still have some time before starting at CII, I think it would be a good idea for you to get some broad insights into the industry and its competitive environment.

“You must look at the big picture and try to under- stand the company’s vision and its mission. I want to

identify the core vales that CII emphasizes and explain how a specifi c emphasis dictates its business practices.” Th is assignment will enhance your knowledge of the material in Chapter 2 of your textbook while preparing you for future assignments.

To access the Web site: • Go to www.wiley.com/college/reid

• Click Student Companion Site

• Click Virtual Company/Cruise International, Inc.

• Click Consulting Assignments

• Click Getting Acquainted with Cruise Interna- tional, Inc.

On-line Case: Operations Strategy at Valley Memorial Hospital

Assignment: Getting Acquainted with Valley Memorial Hospital With a few more weeks before you join Kaizen and start working for its client Valley Memorial Hospi- tal, it is essential for you to get some broad insights into the company and its operations. Bob Reilly has given you a few preliminary research projects to work on in order to familiarize yourself with VMH and the healthcare industry. Th is assignment will enable you to enhance your knowledge of the material in Chapter

2 while continuing to prepare you for a successful internship.

To access the Web site: • Go to www.wiley.com/college/reid

• Click Student Companion Site

• Click Virtual Company/Valley Memorial Hospital

• Click Kaizen Consulting, Inc.

• Click Consulting Assignments

• Click Getting Acquainted with Valley Memorial Hospital

www.wiley.com/college/reid

Internet Challenge: Understanding Strategic Differences

Select two companies in the same industry, either in ser- vice or in manufacturing. You can select industries such as fast-food, banking, healthcare, computer manufactur- ing, or auto manufacturing. Use the Internet to visit the selected companies’ Web sites and collect the following information: their mission statement, target market, and specifi cs of their product and service off erings. Explain the diff erences between the companies’ business strat- egies and target markets. How do their product and

service off erings diff er relative to their target markets and their overall strategies? Finally, how does their oper- ations function support their business strategies? Try to explain how operations utilizes specifi c organizational resources to support the business strategy.

Web sites to consider:

www.lufthansa-cargo.com (Lufthansa Cargo)

www.unitedcargo.com (United Airlines, United Cargo)

Selected Bibliography

Ahlstrom, P., and R. Westbrook. “Implications of Mass Customization for OM: An Exploratory Survey,” Interna- tional Journal of Operations and Production Management, 19, 3, 1999, 262–274.

Fine, C.H. Clock Speed, Winning Industry Control in the Age of Temporary Advantage. New York: Perseus Books, 1998.

Gordon, B.H. “Th e Changing Face of Th ird Party Logistics,” Supply Chain Management Review, March–April 2003, 50–57.

Grover, V., and M.K. Malhotra. “A Framework for Examin- ing the Interface between Operations and Information Systems: Implications for Research in the New Millen- nium,” Decision Sciences, 30, 4, 1999, 901–919.

Hayes, R.H., G. Pisano, D. Upton, and S.C. Wheelwright. Operations Strategy and Technology: Pursuing the Com-

petitive Edge. New York: John Wiley & Sons, 2005.

Hayes, R.H., and S.C. Wheelwright. Restoring Our Compet- itive Edge: Competing through Manufacturing. New York: John Wiley & Sons, 1984.

Hill, T. Manufacturing Strategy Text and Cases. New York: McGraw-Hill, 2000.

Mayer-Schönberger, M., and K. Cukier. Big Data, a Revolu- tion that Will Transform How We Live, Work and Th ink. New York: Houghton Miffl in Harcourt, 2014.

Ovans, A. “Sears Has Come Back from the Brink Before,” Harvard Business Review, November 2014.

Peters, T.J. In Search of Excellence: Lessons from America’s Best Run Companies. New York: Warner Books, 1984.

Porter, M. “Th e Five Competing Forces that Shape Strate- gies,” Harvard Business Review, January 2008.

Porter, M.E. “What Is Strategy?” Harvard Business Review 74 (November–December 1996), 61–78.

Robert, M. Strategy Pure and Simple II. New York: McGraw- Hill, 1998.

Rondeau, P.J., M.S. Vonderembse, and T.S. Raghunathan. “Exploring Work System Practices for Time-Based Man- ufacturers: Th eir Impact on Competitive Capabilities,” Journal of Operations Management, 18, 2000, 509–529.

Spring, M., and J.F. Dalrymple. “Product Customization and Manufacturing Strategy,” International Journal of Operations and Production Management, 20, 4, 2000, 441–467.

Ward, P.T., and R. Duray. “Manufacturing Strategy in Con- text: Environment, Competitive Strategy, and Manufac- turing Strategy,” Journal of Operations Management, 18, 2000, 123–138.

Selected Bibliography • 53

54

Before studying this chapter you should know or, if necessary, review

1. Differences between manufacturing and service organizations, Chapter 1.

2. Differences between strategic and tactical decisions, Chapter 1.

3. Competitive priorities, Chapter 2.

Learning Objectives After studying this chapter you should be able to 1 Defi ne product design and

explain its strategic impact on the organization.

2 Describe the steps used to develop a product design.

3 Use break-even analysis as a tool in deciding between alternative products.

4 Identify different types of processes and explain their characteristics.

5 Understand how to use a process fl owchart.

6 Understand how to use process performance metrics.

7 Understand the link between product design and process selection.

8 Understand current technological advancements and how they impact process and product design.

9 Understand issues of designing service operations.

H ave you ever been with a group of friends and decided to order pizzas? One person wants pizza from Pizza Hut because he likes the taste of stuffed-crust pizza made with cheese in the crust. Someone else wants

Donatos pizza because she likes the unique crispy-thin crust. A third wants pizza from Spagio’s because of the wood-grilled oven taste. Even a simple product like a pizza can have different features unique to its producer. Different customers have different tastes, preferences, and product needs. The variety of product designs on the market appeals to the preferences of a particular customer group. Also, the different product designs have different processing requirements. This is what product design and process selection are all about.

We can all relate to the product design of a pizza just from everyday life. Now consider the complexities involved in designing more sophisti- cated products.

For example, leading manufacturers of mobile devices, including Apple, Samsung, Microsoft, and LG, produce a wide array of product designs to meet the different needs of different customers. These products range from a variety of smart phones to tablet PCs of various sizes and capabilities, such as personal information management, wireless Internet access, and gaming capabilities. Some companies, such as Apple, have even moved to wearable devices. An example is Apple’s iWatch, a customizable smartwatch designed to work with the company’s iPhone to offer a comprehen- sive health and fitness device. These leading companies, however, not only have to decide on the best product features to include. They also have to consider the best processes that are able to produce the different types of devices.

These examples illustrate that a product design that meets customer needs, although challenging, can have a large impact on a company’s success. In fact,

Product Design and Process Selection3

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Product Design • 55

product design is so important that leading-edge companies routinely invest in product design well into the future. Just consider IBM Corporation, which is rethinking computer design alto- gether. The company is pouring $3 billion into computing and chip material redesign over the next five years as it prepares for a future that may involve silicon chips. The company’s computer design initiative could pave the way for functional quantum and cognitive computers that mimic brain functionality. This type of innovative product design can give a company a significant com- petitive advantage and is precisely why IBM is investing to be on the cutting edge. •

Product Design In this chapter we will learn about product design, which is the process of deciding on the unique characteristics and features of the company’s product. We will also learn about process selection, which is the development of the process necessary to produce the designed product. Product design and process selection decisions are typically made together. A  company can have a highly innovative design for its product, but if it has not determined how to make the product in a cost-effective way, the product will stay a design forever.

Product design and process selection affect product quality, product cost, and customer satisfaction. If the product is not well designed or if the manufacturing process is not true to the product design, the quality of the product may suffer. Furthermore, the product has to be manufactured using materials, equipment, and labor skills that are efficient and affordable; otherwise, its cost will be too high for the market. We call this the product’s manufacturability—the ease with which the product can be made. Finally, if a product is to achieve customer satisfaction, it must have the combined characteristics of good design, competitive pricing, and the ability to fill a market need. This is true whether the product is pizzas or cars.

Most of us might think that the design of a product is not that interesting. After all, it probably involves materials, measurements, dimensions, and blueprints. When we think of design, we usually think of car design or computer design and envision engineers working on diagrams. However, product design is much more than that. Product design brings together marketing analysts, art directors, sales forecasters, engineers, finance experts, and other members of a company to think and plan strategically. It is exciting and creative, and it can spell success or disaster for a company.

Product design is the process of defining all the features and characteristics of just about anything you can think of, from Starbucks’ cafe latte or Jimmy Dean’s sausage to Toyota’s Prius or HP’s DeskJet printer. Product design also includes the design of services, such as those provided by Salazar’s Beauty Salon, La Petite Academy Day Care Center, or FedEx. Consumers respond to a product’s appearance, color, texture, and performance. All of its features, summed up, are the product’s design. Someone came up with the idea of what this product will look like, taste like, or feel like so that it will appeal to you. This is the purpose of product design. Product design defines a product’s characteristics, such as its appearance, the materials it is made of, its dimensions and tolerances, and its performance standards.

Design of Services versus Goods The design elements discussed are typical of industries such as manufacturing and retail in which the product is tangible. For service industries, where the product is intangible, the design elements are equally important, but they have an added dimension.

FINMKT

Manufacturability The ease with which a product can be made.

Product design The process of defi ning all of the product’s characteristics.

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56 CHAPTER 3 • Product Design and Process Selection

Service design is unique in that both the service and the entire service concept are being designed. As with a tangible product, the service concept is based on meeting customer needs. The service design, however, adds the aesthetic and psychological benefits of the product. These are the service elements of the operation, such as promptness and friendliness. They also include the ambiance, image, and “feel-good” elements of the service. Consider the differences in service design of a company like Canyon Ranch, which provides a pampering retreat for health-conscious but overworked professionals, versus Gold’s Gym, which caters to young athletes. As with a tangible product, the preference for a service is based on its product design. Service design defines the characteristics of a service, such as its physical elements, and the sensual and psychological benefits it provides.

The Product Design Process Certain steps are common to the development of most product designs: idea development, product screening, preliminary design and testing, and final design. These steps are shown in Figure 3.1. Notice that the arrows show a circular process. Product designs are never finished, but are always updated with new ideas. Let’s look at these steps in more detail.

Idea Development All product designs begin with an idea. The idea might come from a product manager who spends time with customers and has a sense of what customers want, from an engineer with a flare for inventions, or from anyone else in the company. To remain competitive, companies must be innovative and bring out new products regularly. In some industries, the cycle of new product development is predictable. We see this in the auto industry, where new car models come out every year, or the retail industry, where new fashion is designed for every season.

In other industries, new product releases are less predictable but just as important. The Body Shop, retailer of plant-based skin care products, periodically comes up with new ideas for its product lines. The timing often has to do with the market for a product and whether sales are declining or continuing to grow.

Service design The process of establishing all the characteristics of the service, including physical, sensual, and psychological benefi ts.

FIGURE 3.1 Steps in the product design process

Idea Development

Product idea developed; sources can be customers,

competitors, or suppliers

Product Screening

Product idea evaluated; need to

consider operations, marketing, and

financial requirements

Preliminary Design & Testing

Product prototypes built, tested, and

refined

Final Design

Final product specifications

completed

The Product Design Process • 57

Ideas from Customers, Competitors, and Suppliers The first source of ideas is cus- tomers, the driving force in the design of goods and services. Marketing is a vital link between customers and product design. Market researchers collect customer information by studying customer buying patterns and using tools such as customer surveys and focus groups. Man- agement may love an idea, but if market analysis shows that customers do not like it, the idea is not viable. Analyzing customer preferences is an ongoing process; customer preferences next year may be quite different from what they are today. For this reason, the related process of forecasting future consumer preferences is important, though difficult.

Competitors are another source of ideas. A company learns by observing its competitors’ products and their success rate. This includes looking at product design, pricing strategy, and other aspects of the operation. Studying the practices of companies considered “best- in-class” and comparing the performance of one’s own company against theirs is called benchmarking. We can benchmark against a company in a completely different line of business and still learn from some aspect of that company’s operation. For example, Lands’ End has historically been well known for its successful catalog business, and companies considering catalog sales often benchmark against Lands’ End. Similarly, American Express is a company known for its success at resolving complaints, and it, too, is used for benchmarking.

The importance of benchmarking can be seen by IBM’s efforts to improve its dis- tribution system. In 1997, IBM found its distribution costs increasing while cus- tomers were expecting decreasing times from factory to delivery. It appeared that IBM’s supply chain practices were not keeping up with those of its competitors. To evaluate and solve this problem, IBM hired Mercer Management Consultants, who performed a large benchmarking study. IBM’s practices were compared to those of market leaders in the personal com- puter (PC) industry, as well as to the best logistics practices outside the technology area. The objective was to evaluate IBM’s current performance, that of companies considered best-in-class, and identify the gaps. Through the study, IBM discovered which specific costs exceeded industry benchmarks and which parts of the cycle time were excessively long. It also uncovered ways to simplify and reorganize its processes to gain efficiency. Based on findings from the benchmarking effort, IBM made changes in its operations. The results were reduced costs, improved delivery, and improved relationships with sup- pliers. IBM found benchmarking so beneficial that it performs similar types of studies on an ongoing basis.

Reverse Engineering Another way of using competitors’ ideas is to buy a competitor’s new product and study its design features. Using a process called reverse engineering, a company’s engineers carefully disassemble the product and analyze its parts and features. Ford Motor Company used this approach to design its Taurus model. Ford engineers disas- sembled and studied many other car models, such as BMW and Toyota, and adapted and combined their best features. Product design ideas are also generated by a company’s R&D (research and development) department, whose role is to develop product and process innovation.

Suppliers are another source of product design ideas. To remain competitive, more com- panies are developing partnering relationships with their suppliers to jointly satisfy the end customer. Suppliers participate in a program called early supplier involvement (ESI), which involves them in the early stages of product design.

MKT

Benchmarking The process of studying the practices of companies considered “best-in-class” and comparing your company’s performance against theirs.

Reverse engineering The process of disassembling a product to analyze its design features.

Early supplier involvement (ESI) Involving suppliers in the early stages of product design.

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58 CHAPTER 3 • Product Design and Process Selection

Product Screening After a product idea has been developed, it is evaluated to determine its likelihood of success. This is called product screening. The company’s product screening team evaluates the product design idea according to the needs of the major business functions. In their evaluation, executives from each function area may explore issues such as the following:

• Operations What are the production needs of the proposed new product, and how do they match our existing resources? Will we need new facilities and equipment? Do we have the labor skills to make the product? Can the material for production be readily obtained?

• Marketing What is the potential size of the market for the proposed new product? How much eff ort will be needed to develop a market for the product, and what is the long-term product potential?

• Finance The production of a new product is a financial investment like any other. What is the proposed new product’s financial potential, cost, and return on investment?

Unfortunately, there is no magic formula for deciding whether or not to pursue a particular product idea. Managerial skill and experience, however, are key. Companies generate new product ideas all the time, whether for a new brand of cereal or a new design for a car door. Approximately 80 percent of ideas do not make it past the screening stage. Management analyzes operations, marketing, and financial factors and then makes the final decision. Fortunately, we have decision-making tools to help us evaluate new product ideas. A popular one is break-even analysis, which we look at next.

Break-Even Analysis: A Tool for Product Screening Break-even analysis is a tech- nique that can be useful when evaluating a new product. It computes the quantity of goods a company needs to sell just to cover its costs, or break even, called the “break-even” point. When evaluating an idea for a new product, it is helpful to compute its break-even quantity. An assessment can then be made as to how difficult or easy it will be to cover costs and make a profit. A product with a break-even quantity that is hard to attain may not be a good product choice to pursue. Next we look at how to compute the break-even quantity.

The total cost of producing a product or service is the sum of its fixed and variable costs. A company incurs fixed costs regardless of how much it produces. Fixed costs include overhead, taxes, and insurance. For example, a company must pay for overhead even if it produces nothing. Variable costs, on the other hand, are costs that vary directly with the amount of units produced and include items such as direct materials and labor. Together, fixed and variable costs add up to total cost:

Total cost = F + (VC)Q

where F = fi xed cost VC = variable cost per unit Q = number of units sold

Figure 3.2 shows a graphical representation of these costs as well as the break-even quantity. Fixed cost is represented by a horizontal line as this cost is the same regardless of how much is produced. Adding variable cost to fixed cost creates total cost, represented by the diagonal line above fixed cost. When Q = 0, total cost is only equal to fixed cost. As Q increases, total cost increases through the variable cost component. The blue diagonal in the figure is revenue, the amount of money brought in from sales:

Revenue = (SP)Q

where SP = selling price per unit

FINMKT

Break-even analysis A technique used to compute the amount of goods a company would need to sell to cover its costs.

Fixed costs Costs a company incurs regardless of how much it produces.

Variable costs Costs that vary directly with the amount of units produced.

The Product Design Process • 59

When Q = 0, revenue is zero. As sales increase, so does revenue. Remember, however, that to cover all costs we have to sell the break-even amount. This is the quantity Q

BE , where

revenue equals total cost. If we sell below the break-even point, we incur a loss, since costs exceed revenue. To make a profit, we have to sell above the break-even point. Since revenue equals total cost at the break-even point, we can use the previous equations to compute the value of the break-even quantity:

Total cost = total revenue F + (VC)Q = (SP)Q

Solving for Q, we get the following equation:

QBE = F

SP − VC

Note that we could also find the break-even point by drawing the graph and finding where the total cost and revenue lines cross.

Break-even analysis is useful for more than just deciding between different products. It can be used to make other decisions, such as evaluating different processes or deciding whether the company should make or buy a product.

Preliminary Design and Testing Once a product idea has passed the screening stage, it is time to begin preliminary design and testing. At this stage design engineers translate general performance specifications into technical specifications. Prototypes are built and tested. Changes are made based on test results, and the process of revising, rebuilding a prototype, and testing continues. For service companies this may entail testing the offering on a small scale and working with customers to refine the service offering. Fast-food restaurants are known for this type of testing, where a new menu item may be tested in only one particular geographic area. Product refinement

QUANTITY (IN UNITS)

D O

LL A

R S (

$ )

Fixed Costs

Break-even Quantity

Total Cost

Total Revenue

Loss

Profit

QBE

FIGURE 3.2 Graphical approach to break-even analysis

60 CHAPTER 3 • Product Design and Process Selection

can be time-consuming, and the company may want to hurry through this phase to rush the product to market. However, rushing creates the risk that all the “bugs” have not been worked out, which can prove very costly.

Final Design Following extensive design testing, the product moves to the final design stage. This is where final product specifications are drawn up. The final specifications are then trans- lated into specific processing instructions to manufacture the product, which include selecting equipment, outlining jobs that need to be performed, identifying specific materials needed and suppliers that will be used, and all the other aspects of organizing the process of product production.

Factors Impacting Product Design Here are some additional factors that need to be considered during the product design stage.

Design for Manufacture When we think of product design, we generally first think of how to please the customer. However, we also need to consider how easy or difficult it is to manufacture the prod- uct. Otherwise, we might have a great idea that is difficult or too costly to manufacture.

EXAMPLE 3.1 Computing the Break-even Quantity

Fred Boulder, owner of Sports Feet Manufacturing, is considering whether to produce a new line of footwear. Fred has considered the processing needs for the new product as well as the market potential. He has also estimated that the variable cost for each product manufactured and sold is $9 and the fi xed cost per year is $52,000.

(a) If Fred offers the footwear at a selling price of $25, how many pairs must he sell to break even?

(b) If Fred sells 4000 pairs at the $25 price, what will be the contribution to profi t?

• Solution: (a) To compute the break-even quantity:

Q = F

SP − VC

= $52,000

$25 − $9 = 3250 pairs

The break-even quantity is 3250 pairs. This is how much Fred would have to sell to cover costs.

(b) To compute the contribution to profi t with sales of 4000 pairs, we can go back to the relationship between cost and revenue:

Profit = total revenue − total cost = (SP)Q − 3F + (VC)Q4

Profit = $25(4000) − 3$52,000 + $9(4000)4 = $12,000

The contribution to profi t is $12,000 if Fred can sell 4000 pairs from his new line of footwear.

Factors Impacting Product Design • 61

Design for manufacture (DFM) is a series of guidelines that we should follow to produce a product easily and profitably. DFM guidelines focus on two issues:

1. Design simplifi cation means reducing the number of parts and features of the product whenever possible. A simpler product is easier to make, costs less, and gives higher quality.

2. Design standardization refers to the use of common and interchangeable parts. By using interchangeable parts, we can make a greater variety of products with less inventory and signifi cantly lower cost and provide greater fl exibility. Table 3.1 shows guidelines for DFM.

An example of the benefits of applying these rules is seen in Figure 3.3. We can see the progression in the design of a toolbox using the DFM approach. All of the pictures show a toolbox. However, the first design shown requires 20 parts. Through simplification and use of modular design, the number of parts required has been reduced to 2. It would certainly be much easier to make the product with 2 parts versus 20 parts. This means fewer chances for error, better quality, and lower costs due to shorter assembly time.

Product Life Cycle Another factor in product design is the stage of the life cycle of the product. Most products go through a series of stages of changing product demand called the product life cycle. There are typically four stages of the product life cycle: introduction, growth, maturity, and decline. These are shown in Figure 3.4.

Design for manufacture (DFM) A series of guidelines to follow in order to produce a product easily and profi tably.

Product life cycle A series of stages that products pass through in their lifetime, characterized by changing product demands over time.

TABLE 3.1 Guidelines for DFM

DFM Guidelines

1. Minimize parts.

2. Design parts for different products.

3. Use modular design.

4. Avoid tools.

5. Simplify operations.

48 mm

FIGURE 3.3 Progressive design of a toolbox using DFM

62 CHAPTER 3 • Product Design and Process Selection

Products in the introductory stage are not well defined, and neither is their market. Often all the “bugs” have not been worked out, and customers are uncertain about the prod- uct. In the growth stage, the product takes hold and both product and market continue to be refined. The third stage is that of maturity, where demand levels off and there are usually no design changes: the product is predictable at this stage and so is its market. Many prod- ucts, such as toothpaste, can stay in this stage for many years. Finally, there is a decline in demand because of new technology, better product design, or market saturation.

The first two stages of the life cycle can collectively be called the early stages because the product is still being improved and refined and the market is still in the process of being developed. The last two stages of the life cycle can be referred to as the later stages because here both the product and market are well defined.

Understanding the stages of the product life cycle is important for product design pur- poses, such as knowing at which stage to focus on design changes. Also, when considering a new product, the expected length of the life cycle is critical in order to estimate future profitability relative to the initial investment. The product life cycle can be quite short for certain products, as seen in the computer industry. For other products it can be extremely long, as in the aircraft industry. A few products, such as paper, pencils, nails, milk, sugar, and flour, do not go through a life cycle. However, almost all products do, and some may spend a long time in one stage.

Concurrent Engineering Concurrent engineering is an approach that brings many people together in the early phase of product design in order to simultaneously design the product and the process. This type of approach has been found to achieve a smooth transition from the design stage to actual production in a shorter amount of development time with improved quality results.

The old approach to product and process design was to first have the designers of the idea come up with the exact product characteristics. Once their design was complete they would pass it on to operations, who would then design the production process needed to produce the product. This was called the “over-the-wall” approach because the designers would throw their design “over-the-wall” to operations, who then had to decide how to pro- duce the product.

Concurrent engineering An approach that brings together multifunction teams in the early phase of product design in order to simultaneously design the product and the process.

TIME

D E

M A

N D

Introduction

Growth

Early Stages of Product Life Cycle

Later Stages of Product Life Cycle

Maturity

Decline

FIGURE 3.4 Stages of the product life cycle

Factors Impacting Product Design • 63

There are many problems with the old approach. First, it is very inefficient and costly. For example, there may be certain aspects of the product that are not critical for product suc- cess but are costly or difficult to manufacture, such as a dye color that is difficult to achieve. Since manufacturing does not understand which features are not critical, it may develop an unnecessarily costly production process with costs passed down to the customers. Because the designers do not know the cost of the added feature, they may not have the opportu- nity to change their design or may do so much later in the process, incurring additional costs. Concurrent engineering allows everyone to work together so these problems do not occur. Figure 3.5 shows the difference between the “over-the-wall” approach and concurrent engineering.

A second problem is that the “over-the-wall” approach takes a longer amount of time than when product and process design are performed concurrently. As you can see in Figure 3.5, when product and process design are done together, much of the work is done in parallel rather than in sequence. In today’s markets, new product introductions are expected to occur faster than ever. Companies do not have the luxury of enough time to follow a sequential approach and then work the “bugs” out. They may eventually get a great product, but by then the market may not be there!

The third problem is that the old approach does not create a team atmosphere, which is important in today’s work environment. Rather, it creates an atmosphere where each function views its role separately in a type of “us versus them” mentality. With the old approach, when the designers were finished with the designs, they considered their job done. If there were problems, each group blamed the other. With concurrent engineer- ing, the team is responsible for designing and getting the product to market. Team mem- bers continue working together to resolve problems with the product and improve the process.

MKT

(a) Sequential design: Walls between functional areas

(b) Concurrent design: Walls broken down

Design team

Customers Marketing personnel

Design engineer

Manufacturing engineer

Production personnel

Product concept

Performance specs

Design specs

Manufacturing specs

FIGURE 3.5 The first illustration shows sequential design with walls between functional areas. The second illustration shows concurrent design with walls broken down.

64 CHAPTER 3 • Product Design and Process Selection

Concurrent engineering has been especially enhanced through the use of computerized technologies, big data analytics, and digital manufacturing. Their use has been prevalent in aerospace and the auto industry.

Remanufacturing Remanufacturing is a concept that has been gaining increasing importance as our soci- ety becomes more environmentally conscious and focuses on recycling and eliminating waste. Remanufacturing uses components of old products in the production of new ones. It requires the disassembly, repair, or replacement of worn-out or obsolete components and modules. In addition to the environmental benefits, there are significant cost benefits because remanufactured products can be a fraction of the price of their new counterparts. Remanufacturing has been quite popular in the production of computers, televisions, and automobiles.

Process Selection So far we have discussed issues involved in product design. Though product design is important for a company, it cannot be considered separately from the selection of the process. In this section we will look at issues involved in process design. Then we will show how product design and process selection issues are linked together.

Types of Processes When you look at different types of companies, ranging from a small coffee shop to IBM, it may seem like there are hundreds of different types of processes. Some locations are small, like your local Starbucks, and some are very large, like a Ford Motor Company plant. Some produce standardized “off-the-shelf ” products, like Pepperidge Farm’s frozen chocolate cake, and some work with customers to customize their product, like cakes made to order by a gourmet bakery. Though there seem to be large differences between the processes of companies, many have certain processing characteristics in common. In this section we will divide these processes into groups with similar characteristics, allowing us to understand problems inherent with each type of process.

All processes can be grouped into two broad categories: intermittent operations and repetitive operations. These two categories differ in almost every way. Once we understand these differences, we can easily identify organizations based on the category of process they use.

Intermittent Operations Intermittent operations are used to produce a variety of products with different processing requirements in lower volumes. Examples are an auto body shop, a tool and die shop, or a healthcare facility. Because different products have dif- ferent processing needs, there is no standard route that all products take through the facil- ity. Instead, resources are grouped by function and the product is routed to each resource as needed. Think about a healthcare facility. Each patient, “the product,” is routed to different departments as needed. One patient may need to get an X-ray, go to the lab for blood work, and then go to the examining room. Another patient may need to go to the examining room and then to physical therapy.

To be able to produce products with different processing requirements, intermittent operations tend to be labor intensive rather than capital intensive. Workers need to be able to perform different tasks, depending on the processing needs of the products produced. Often we see skilled and semiskilled workers in this environment, with a fair amount of

Remanufacturing The concept of using components of old products in the production of new ones.

Intermittent operations Processes used to produce a variety of products with different processing requirements in lower volumes.

Process Selection • 65

worker discretion in performing their jobs. Workers need to be flexible and able to perform different tasks as needed for the different products. Equipment in this type of environment is more general-purpose to satisfy different processing requirements. Automation tends to be less common because automation is typically product-specific. Given that many products are being produced with different processing requirements, it is usually not cost efficient to invest in automation for only one product type. Finally, the volume of goods produced is directly tied to the number of customer orders.

Repetitive Operations Repetitive operations are used to produce one or a few stan- dardized products in high volume. Examples are a typical assembly line, cafeteria, or automatic car wash. Resources are organized in a line flow to efficiently accommodate pro- duction of the product. Note that in this environment it is possible to arrange resources in a line because there is only one type of product. This is directly the opposite of what we find with intermittent operations.

To efficiently produce a large volume of one type of product, these operations tend to be capital intensive rather than labor intensive. An example is “mass-production” operations, which usually have much invested in their facilities and equipment to provide a high degree of product consistency. Often these facilities rely on automation and technology to improve efficiency and increase output rather than on labor skill. The volume produced is usually based on a forecast of future demands rather than on direct customer orders.

The most common differences between intermittent and repetitive operations relate to two dimensions: (1) the amount of product volume produced, and (2) the degree of product standardization. Product volume can range from making a unique product one at a time to producing a large number of products at the same time. Product standardization refers to a lack of variety in a particular product. Examples of standardized products are white under- shirts, calculators, toasters, and television sets. The type of operation used, including equip- ment and labor, is quite different if a company produces one product at a time to customer specifications instead of mass production of one standardized product. Specific differences between intermittent and repetitive operations are shown in Table 3.2.

Repetitive operations Processes used to produce one or a few standardized products in high volume.

TABLE 3.2 Differences between Intermittent and Repetitive Operations

Decision Intermittent Operations Repetitive Operations

Product variety Great Small

Degree of standardization Low High

Organization of resources Grouped by function Line fl ow to accommodate processing needs

Path of products through facility

In a varied pattern, depending on product needs

Line fl ow

Factor driving production Customer orders Forecast of future demands

Critical resource Labor-intensive operation (worker skills important)

Capital-intensive operation (equipment automation, technology important)

Type of equipment General-purpose Specialized

Degree of automation Low High

Throughput time Longer Shorter

Work-in-process inventory More Less

66 CHAPTER 3 • Product Design and Process Selection

The Continuum of Process Types Dividing processes into two fundamental categories of operations is helpful in our understanding of their general characteristics. To be more detailed, we can further divide each category according to product volume and degree of product standardization, as follows. Intermittent operations can be divided into project processes and batch processes. Repetitive operations can be divided into line processes and continuous processes. Figure 3.6 shows a continuum of process types. Next we look at what makes these processes different from each other.

• Project processes are used to make one-of-a-kind products exactly to customer spec- ifi cations. Th ese processes are used when there is high customization and low prod- uct volume, because each product is diff erent. Examples can be seen in construction, shipbuilding, medical procedures, creation of artwork, custom tailoring, and interior design. With project processes the customer is usually involved in deciding on the design of the product. Th e artistic baker you hired to bake a wedding cake to your specifi cations uses a project process.

• Batch processes are used to produce small quantities of products in groups or batches based on customer orders or product specifi cations. Th ey are also known as job shops. Th e volumes of each product produced are still small, and there can still be a high degree of customization. Examples can be seen in bakeries, education, and printing shops. Th e classes you are taking at the university use a batch process.

• Line processes are designed to produce a large volume of a standardized product for mass production. Th ey are also known as fl ow shops, fl ow lines, or assembly lines. With line processes the product that is produced is made in high volume with little or no customization. Th ink of a typical assembly line that produces everything from cars, computers, television sets, shoes, candy bars, even food items.

Project process A type of process used to make a one-at-a-time product exactly to customer specifi cations.

Batch process A type of process used to produce a small quantity of products in groups or batches based on customer orders or specifi cations.

Line process A type of process used to produce a large volume of a standardized product.

Source: Adapted from Robert H. Hayes and Steven C. Wheelwright, “Link Manufacturing Process and Product Life Cycles,” Harvard Business Review, January–February 1979, 133–140.

Product Volume

1. Project Process

(Custom job shop; Customer tailoring; Construction)

2. Batch Process

(Education classes; Bakery; Printing shop)

3. Line Processes

(Assembly lines; Cafeteria)

4. Continuous Processes

(Oil refinery; Water treatment plant)

Repetitive Operations

Intermittent Operations

P ro

d u ct

S ta

n d

ar d

iz at

io n

Low

High

Low

High

FIGURE 3.6 Types of processes based on product volume and product standardization

Designing Processes • 67

• Continuous processes operate continually to produce a very high volume of a fully standardized product. Examples include oil refineries, water treatment plants, and certain paint facilities. The products produced by continuous processes are usually in continual rather than discrete units, such as liquid or gas. They usually have a single input and a limited number of outputs. Also, these facilities are usually highly capital intensive and automated.

Note that both project and batch processes have low product volumes and offer customization. The difference is in the volume and degree of customization. Project processes are more extreme cases of intermittent operations compared to batch processes. Also, note that both line and continuous processes primarily produce large volumes of standardized products. Again, the difference is in the volume and degree of standardization. Continuous processes are more extreme cases of high volume and product standardization than are line processes.

Figure 3.6 positions these four process types along the diagonal to show the best process strategies relative to product volume and product customization. Companies whose process strategies do not fall along this diagonal may not have made the best process decisions. Bear in mind, however, that not all companies fit into only one of these categories: a company may use both batch and project processing to good advantage. For example, a bakery that produces breads, cakes, and pastries in batches may also bake and decorate cakes to order.

Designing Processes Now that we know about different types of processes, let’s look at a technique that can help with process design.

Process flow analysis is a technique used for evaluating a process in terms of the sequence of steps from inputs to outputs with the goal of improving its design. One of the most important tools in process flow analysis is a process flowchart. A process flowchart is used for viewing the sequence of steps involved in producing the product and the flow of the product through the process. It is useful for seeing the totality of the operation and for identifying potential problem areas.

There is no exact format for designing a flowchart. It can be very simple or highly detailed. The typical symbols used are arrows to represent flows, triangles to represent deci- sion points, inverted triangles to represent storage of goods, and rectangles as tasks. Let’s begin by looking at some elements used in developing a flowchart, as shown in Figure 3.7. Shown first, in Figure 3.7(a), are flows between stages in a simple multistage process, which is a process with multiple activities (“stages”). You can see that the arrows indicate a simple flow of materials between the different stages.

Often, multiple stages have storage areas or “buffers” between them for placement of either partially completed (work-in-process) or fully completed ( finished goods) inventory, shown in Figure 3.7(b). This enables the two stages to operate independently of each other. Otherwise, the first stage would have to produce a product at the same exact rate as the second stage. For example, let’s say that the first stage of a multistage process produces one product in 40 seconds and the second stage in 60 seconds. That means that for every unit produced the first stage would have to stop and wait 20 seconds for the second stage to finish its work. Because the capacity of the second stage is holding up the speed of the pro- cess, it is called a bottleneck. Now let’s see what happens if the first stage takes 60 seconds to produce a product and the second stage 40 seconds. In this case the first stage becomes the bottleneck, and the second stage has to wait 20 seconds to receive a product. Obviously, the best is for both stages to produce at the same rate, though this is often not possible. Inventory is then placed between the stages to even out differences in production capacity.

Continuous process A type of process that operates continually to produce a high volume of a fully standardized product.

Process fl ow analysis A technique used for evaluating a process in terms of the sequence of steps from inputs to outputs with the goal of improving its design.

Process fl owchart A chart showing the sequence of steps in producing the product or service.

Bottleneck Longest task in the process.

68 CHAPTER 3 • Product Design and Process Selection

Often stages in the production process can be performed in parallel, as shown in Figure  3.7(c) and (d). The two stages can produce different products (c) or the same product  (d). Notice that in the latter case this would mean that the capacity of the stage performed in parallel has effectively been doubled.

Now let’s look at an illustration of a flowchart using Antonio’s Pizzeria as an example. Let’s say that Antonio produces three different styles of pizzas to satisfy different types of customers. First are cheese pizzas made with standard ingredients and a standard crust. They are the most popular items, and Antonio makes them ahead of time to ensure that they are always available upon demand. This is called a make-to-stock strategy. Second are pizzas that use a standard crust prepared ahead of time but are assembled based on specific customer requests. This is called an assemble-to-order strategy. Last are pizzas made to order based on specific customer requirements, allowing choices of different types of crusts and toppings. This is called a make-to-order strategy. We will look at these product strategies more closely later in this chapter. For now, let’s look at the flowcharts for

Make-to-stock strategy Produces standard products and services for immediate sale or delivery.

Assemble-to-order strategy Produces standard components that can be combined to customer specifi cations.

Make-to-order strategy Produces products to customer specifi cations after an order has been received.

(a) Multistage process

(b) Multistage process with buffers

(c) Parallel stages producing different products

(d) Parallel stages producing the same product

Work-in-process inventory

Finished goods

#1

Finished goods

#2

Finished goods

Stage 1

Stage 1

Stage 1

Stage 1

Stage 2

Stage 2

Stage 2

Stage 2 Stage 3

FIGURE 3.7 Elements of flowchart development

Process Performance Metrics • 69

the three processes in Figure 3.8. Notice that although the flowcharts are similar, they show customer interaction at different points in the process.

Process flowcharts can also be used to map the flow of the customer through the process and to identify potential problem areas. Figure 3.9 shows a flowchart for Antonio’s Pizzeria that includes the steps involved in placing and processing a customer order. The points in the process for potential problems are indicated. Management can then monitor these problem areas. The chart could be even more detailed, including information such as frequency of errors or approximate time to complete a task. As you can see, process flow- charts are very useful tools when designing and evaluating processes.

Process Performance Metrics An important way of ensuring that a process is functioning properly is to regularly measure its performance. Process performance metrics are measurements of different process characteristics that tell us how a process is performing. Just as accountants and finance managers use financial metrics, operations managers use process performance metrics to determine how a process is performing and how it is changing over time. There are many process performance metrics that focus on different aspects of the process. In this section we will look at some common metrics used by operations managers. These are summarized in Table 3.3.

Process performance metrics Measurements of different process characteristics that tell how a process is performing.

Make Dough

Prepare Crust

Assemble Pizza

Bake

Assemble Pizzas

Bake

Delivery

Customer Order

Finished goods

inventory “pizza”

(a) Make-to-stock strategy

Make Dough

Prepare Crust

Bake

Customer Order(b) Assemble-to-order strategy

Delivery

Delivery

Assemble Pizza

Make Dough

Prepare Crust

Customer Order

(c) Make-to-order strategy

Ingredients

Ingredients

Ingredients

Work-in-progress inventory

of “crust”

FIGURE 3.8 Flowcharts for different product strategies at Antonio’s Pizzeria

70 CHAPTER 3 • Product Design and Process Selection

A basic process performance metric is throughput time, which is the average amount of time it takes a product to move through the system. This includes the time someone is working on the product as well as the waiting time. A lower throughput time means that more products can move through the system. One goal of process improve- ment is to reduce throughput time. For example, think about the time spent at your last doctor’s appointment. The total amount of time you spent at the facility, regardless of whether you were waiting, talking with the physician, or having lab work performed, is throughput time.

Throughput time Average amount of time it takes a product to move through the system.

Begin

Customer Enters and Waits to Place Order

Customer Places Order

Waits for Order

Order Arrives

End

Lost Sale Keep Waiting?

Long Wait?

Possible Problem

Area

No Yes

Lost Sale

Lost Sale

Keep Waiting?

Wait for New Order?

Order Correct?

Long Wait?

Possible Problem

Area

Possible Problem

Area

No

No No

Yes

Yes

Yes

Yes No

No

Yes

FIGURE 3.9 Process flowchart of customer flow at Antonio’s Pizzeria

Process Performance Metrics • 71

Quite possibly much of the time at your last doctor’s appointment was spent waiting. An important metric that measures how much wasted time exists in a process is process velocity. Process velocity is computed as a ratio of throughput time to value-added time:

Process velocity = throughput time

value-added time

where value-added time is the time spent actually working on the product. Notice that the closer this ratio is to 1.00, the lower the amount of time the product spends on non-value-adding activities (e.g., waiting). Again recall your last doctor’s appointment. What was the value-added time? What was the throughput time? Can you estimate the process velocity?

Another important metric is productivity, which is the ratio of outputs over inputs. Pro- ductivity measures how well a company converts its inputs to outputs. Productivity was discussed in detail in Chapter 2, so we will not repeat its computation here. Also important is utilization, which is the ratio of the time a resource is actually used versus the time it is available for use. Unlike productivity, which tends to focus on financial measures (e.g., dollars of output), utilization measures the actual time that a resource (e.g., equipment or labor) is being used. Last, efficiency is a metric that measures actual output relative to some standard of output. It tells us whether we are performing at, above, or below standard.

Process velocity Ratio of throughput time to value- added time.

Productivity Ratio of outputs over inputs.

Utilization Ratio of time a resource is used to time it is available for use.

Effi ciency Ratio of actual output to standard output.

TABLE 3.3 Process Performance Metrics

Measure Defi nition

1. Throughput time Average amount of time product takes to move through the system

2. Process velocity = throughput time

value-added time

A measure of wasted time in the system

3. Productivity = output

input A measure of how well a company uses its resources

4. Utilization = time a resource used

time a resource available The proportion of time a resource is actually used

5. Effi ciency = actual output

standard output

Measures performance relative to a standard

EXAMPLE 3.2 Measuring Process Performance

Frantz Title Company is analyzing its operation in an effort to improve performance. The follow- ing data have been collected:

It takes an average of 4 hours to process and close a title, with value-added time estimated at 30 minutes per title.

Each title offi cer is on payroll for 8 hours per day, though working 6 hours per day on average, accounting for lunches and breaks. Industry standard for labor utilization is 80 percent.

The company closes on 8 titles per day, with an industry standard of 10 titles per day for a comparable facility.

Determine process velocity, labor utilization, and effi ciency for the company. Can you draw any conclusions?

72 CHAPTER 3 • Product Design and Process Selection

Linking Product Design and Process Selection

Decisions concerning product design and process selection are directly linked and can- not be made independently of one another. The type of product a company produces defines the type of operation needed. The type of operation needed, in turn, defines many other aspects of the organization. This includes how a company competes in the marketplace (competitive priorities), the type of equipment and its arrangement in the facility, the type of organizational structure, and future types of products that can be produced by the facility. Table 3.4 summarizes some key decisions and how they differ for intermittent and repetitive types of operations. Next we look at each of these decision areas.

Product Design Decisions Intermittent and repetitive operations typically focus on producing products in different stages of the product life cycle. Intermittent operations focus on products in the early stage of the life cycle because facilities are general-purpose and can be adapted to the needs of the product. Because products in the early stage of the life cycle are still being refined, intermit- tent operations are ideally suited to them. Also, demand volumes for these products are still

MKT

• Before You Begin: When computing process performance metrics, be careful to make sure you use consistent units in the numerator and denominator of the equation you are using.

• Solution:

Process velocity = throughput time

value-added time =

4 hours�title 1 2 hour�title

= 8

Labor utilization = 6 hours�day 8 hours�day

= 0.75 or 75%

Efficiency = 8 titles�day

10 titles�day = 0.80 or 80%

A process velocity of 8 indicates that the amount of time spent on non-value-added activities is 8 times that of value-added activities. Also, labor utilization and effi ciency are both below standard.

Make sure that you understand the key issues in product design. Be familiar with the different stages of the product life cycle. Recall that products in the early stages of the life cycle are still being refi ned based on the needs of the market. This includes product characteristics and features. At this stage the market for the product has not yet been fully developed, and product volumes have not reached their peak. By contrast, products in the later stages of their life cycle have well-developed charac- teristics, and demand volumes for them are fairly stable.

Review the different types of processes and their charac- teristics. Recall that intermittent processes are designed to produce products with different processing requirements in smaller volumes. Repetitive operations, on the other hand, are designed for one or a few types of products produced in high volumes.

Next we discuss how product design and process selection decisions are interrelated.

BEFORE YOU GO ON

Linking Product Design and Process Selection • 73

uncertain, and intermittent operations are designed to focus on producing lower volumes of products with differing characteristics.

Once a product reaches the later stages of the life cycle, both its product features and its demand volume are predictable. As volumes are typically larger at this stage, a facility that is dedicated to producing a large volume of one type of product is best from both efficiency and cost perspectives. This is what a repetitive operation provides. Recall that repetitive operations are capital intensive, with much automation dedicated to the efficient produc- tion of one type of product. It would not be a good decision to invest such a large amount of resources for a product that is uncertain relative to its features or market. However, once a product is well defined with a sizable market, repetitive types of operations are a better business alternative. This is why repetitive operations tend to focus on products in the later stages of their life cycle.

The product focus of both types of operations has significant implications for a com- pany’s future product choices. Once a company has an intermittent operation in place, designed to produce a variety of products in low volumes, it is a poor strategic decision to pursue production of a highly standardized product in the same facility. The same holds true for attempting to produce a newly introduced product in a repetitive operation.

The differences between the two types of operations are great, including the way they are managed. Not understanding their differences is a mistake often made by companies. A company may be very successful at managing a repetitive operation that produces a stan- dardized product. Management may then see an opportunity involving products in the early stage of the life cycle. Not understanding the differences in the operational requirements, management may decide to produce this new product by applying their “know-how.” The results can prove disastrous.

The problems that can arise when a company does not understand the differences between intermittent and repetitive operations are illustrated by the experience of The Babcock & Wilcox Company in the late 1960s. B & W was very successful at producing fossil-fuel boilers, a stan- dardized product made via repetitive operation. Then the company decided to pursue production of nuclear pres- sure vessels, a new product in the early stages of its life cycle that required an intermittent operation. B & W saw the nuclear pressure vessels as a wave of the future. Because it was successful at M

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TABLE 3.4 Differences in Key Organizational Decisions for Different Types of Operations

Decision Intermittent Operations Repetitive Operations

Product design Early stage of product life cycle Later stage of product life cycle

Competitive priorities Delivery, fl exibility, and quality Cost and quality

Facility layout Resources grouped by function Resources arranged in a line

Product strategy Make-to-order/assemble-to- order

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74 CHAPTER 3 • Product Design and Process Selection

producing boilers, the company believed it could apply those same skills to production of the new product. B & W began managing the production of nuclear pressure vessels—an intermittent operation—as if it were a repetitive operation. The company focused primarily on cost rather than delivery, did not give enough time for product refinement, and did not invest in labor skills necessary for a new product. Consequently, the venture failed, and the company almost went out of business. It was saved by its success in the production of boil- ers, to which it was able to return.

Competitive Priorities The decision of how a company will compete in the marketplace—its competitive priorities—is largely affected by the type of operation it has in place. Intermittent operations are typically less competitive on cost than repetitive operations. The reason is that repetitive operations mass-produce a large volume of one product. The cost of the product is spread over a large volume, allowing the company to offer that product at a comparatively lower price.

Think about the cost difference you would incur if you decided to buy a business suit “off the rack” from your local department store (produced by a repetitive operation) versus having it custom made by a tailor (an intermittent operation). Certainly a custom-made suit would cost considerably more. The same product produced by a repetitive operation typi- cally costs less than one made by an intermittent operation. However, intermittent opera- tions have their own advantages. Having a custom-made suit allows you to choose precisely what you want in style, color, texture, and fit. Also, if you were not satisfied, you could easily return it for adjustments and alterations. Intermittent operations compete more on flexibil- ity and delivery compared to continuous operations.

Today all organizations understand the importance of quality. However, the elements of quality that a company focuses on may be different depending on the type of opera- tion used. Repetitive operations provide greater consistency among products. The first and last products made in the day are almost identical. Intermittent operations, on the other hand, offer greater variety of features and workmanship not available with mass production.

It is important that companies understand the competitive priorities best suited for the type of process that they use. It would not be a good strategic decision for an intermittent operation to try to compete primarily on cost, as it would not be very successful. Similarly, the primary competitive priority for a repetitive operation should not be variety of features because this would take away from the efficiency of the process design.

Facility Layout Facility layout, covered in Chapter 10, is concerned with the arrangement of resources in a facility to enhance the production process. If resources are not arranged properly, a com- pany will have inefficiency and waste. The type of process a company uses directly affects the facility layout and the inherent problems encountered.

Intermittent operations resources are grouped based on similar processes or functions. There is no one typical product that is produced; rather, a large variety of items is produced in low volumes, each with its own unique processing needs. Since no one product justifies the dedication of an entire facility, resources are grouped based on their function. Products are then moved from resource to resource, based on their processing needs. The challenge with intermittent operations is to arrange the location of resources to maximize efficiency and minimize waste of movement. If the intermittent operation has not been designed properly, many products will be moved long distances. This type of movement adds nothing

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Linking Product Design and Process Selection • 75

to the value of the product and contributes to waste. Any two work centers that have much movement between them should be placed close to one another. However, this often means that another work center will have to be moved out of the way. This can make the problem fairly challenging.

Intermittent operations are less efficient and have longer production times due to the nature of the layout. Material handling costs tend to be high and resource schedul- ing is a challenge. Intermittent operations are common in practice. Examples include a doctor’s office or a hospital. Departments are grouped based on their function, with examining rooms in one area, lab in another, and X-rays in a third. Patients are moved from one department to another based on their needs. Another example is a bakery that makes custom cakes and pastries. The work centers are set up to perform different functions, such as making different types of dough, different types of fillings, and dif- ferent types of icing and decorations. The product is routed to different workstations depending on the product requirements. Some cakes have the filling in the center (e.g., Boston cream pie), others only on top (e.g., sheet cake), and some have no filling at all (e.g., pound cake).

Repetitive operations have resources arranged in sequence to allow for efficient produc- tion of a standardized product. Since only one product or a few highly similar products are being produced, all resources are arranged to efficiently meet production needs. Examples are seen on an assembly line, in a cafeteria, or even at a car wash. Numerous products, from breakfast cereals to computers, are made using repetitive operations.

Though repetitive operations have faster processing rates, lower material handling costs, and greater efficiency than intermittent operations, they also have their shortcomings. Resources are highly specialized and the operation is inflexible relative to the market. This type of operation cannot respond rapidly to changes in market needs for the products or to changes in demand volume. The challenge is to arrange workstations in sequence and des- ignate the jobs that will be performed by each to produce the product in the most efficient way possible. Figure 3.10 illustrates the differences in facility layout between intermittent and repetitive operations.

(a) Intermittent Operations (resources grouped by function)

(b) Repetitive Operations (resources arranged in sequence)

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76 CHAPTER 3 • Product Design and Process Selection

Product and Service Strategy The type of operation a company has in place is directly related to its product and service strategy. As we learned earlier in this chapter in the example of Antonio’s Pizzeria, product and service strategies can be classified as make-to-stock, assemble-to-order, and make-to- order. These strategies differ by the length of their delivery lead time, which is the amount of time from when the order is received to when the product is delivered. These strategies also differ by the degree of product customization. Figure 3.11 illustrates these differences.

Make-to-stock is a strategy that produces finished products for immediate sale or delivery, in anticipation of demand. Companies using this strategy produce a standardized product in larger volumes. Typically, this strategy is seen in repetitive operations. Delivery lead time is the shortest, but the customer has no involvement in product design. Examples include off-the- shelf retail apparel, soft drinks, standard automotive parts, or airline flights. A hamburger patty at a fast-food restaurant such as McDonald’s or Burger King is made-to-stock, as is a taco at Taco Bell. As a customer you gain speed of delivery but lose the ability to customize the product.

Assemble-to-order strategy, also known as build-to-order, produces standard compo- nents that can be combined to customer specifications. Delivery time is longer than in the make-to-stock strategy but allows for some customization. Examples include computer systems, prefabricated furniture with choices of fabric colors, or vacation packages with standard options.

Make-to-order is a strategy used to produce products to customer specifications after an order has been received. The delivery time is longest, and product volumes are low. Exam- ples are custom-made clothing, custom-built homes, and customized professional services. Ordering a hamburger to your liking in a sit-down restaurant is another example of this strategy. This strategy is best for an intermittent operation.

Degree of Vertical Integration The larger the number of processes performed by a company in the chain from raw materi- als to product delivery, the higher the vertical integration. Vertical integration is a stra- tegic decision that should support the future growth direction of the company. Vertical

Make-to-Stock Processing Assembly Shipping Product

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Inventory ShippingAssembly

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Processing ShippingAssembly

Assemble-to-Order

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Delivery Time

Delivery Time

Delivery Time

FIGURE 3.11 Product and service strategy options

Technology Decisions • 77

integration is a good strategic option when there are high volumes of a small variety of input materials, as is the case with repetitive operations. The reason is that the high volume and narrow variety of input material allow task specialization and cost justification. An example is Dole Food Company, which owns and controls most of its canned pineapple production from pineapple farms to the processing plant. The company has chosen to be vertically inte- grated so as to have greater control of costs and product quality.

It is typically not a good strategic decision to vertically integrate into specialized pro- cesses that provide inputs in small volumes. This would be the case for intermittent oper- ations. For example, let’s consider a bakery that makes a variety of different types of cakes and pies. Maybe the bakery purchases different fillings from different sources, such as apple pie filling from one company, chocolate filling from another, and cream filling from a third. If the company were to purchase production of the apple filling, it would not gain much strategically because it still relies on other suppliers. In this case, outsourcing may be a bet- ter choice. However, if the bakery shifted its production to making only apple pies, then the vertical integration might be a good choice.

In summary, vertical integration is typically a better strategic decision for repetitive operations. For intermittent operations it is generally a poor strategic choice.

Technology Decisions Advancements in technology have had the greatest impact on process design decisions. Technological advances have enabled companies to produce products faster, with better quality, at a lower cost. Many processes that were not imaginable only a few years ago have been made possible through technology. In this section we look at some of the greatest impacts technology has had on process design.

Information Technology Information technology (IT) is technology that enables storage, processing, and commu- nication of information within and between firms. It is also used to organize information to help managers with decision making. One type of information technology we are all familiar with is the Internet, which has had the greatest impact on the way companies conduct busi- ness. The Internet has linked trading partners—customers, buyers, and suppliers—and has created electronic commerce and the virtual marketplace.

Enterprise software is another powerful information technology, such as enterprise resource planning (ERP). These are large software programs used for planning and coordinating all resources throughout the entire enterprise. They allow data sharing and communication within and outside of the firm, enabling collaborative decision making. We will learn more about ERP in Chapter 14.

Other examples of IT include wireless communication technologies. We are all familiar with smart phones in our own lives. These technologies can also significantly improve business operations. For example, wireless homing devices and wearable computers are being used in warehouses to quickly guide workers to locations of goods. Wireless technologies enhanced by satellite transmission can rapidly transmit information from one source to another. For example, Wal-Mart uses company-owned satellites to automatically transmit point-of-sale data to computers at replenishment warehouses.

Global positioning systems (GPS) comprise another type of wireless technology that uses satellite transmission to communicate exact locations. GPS was originally developed by the Department of Defense in 1978 in order to help coordinate U.S. mil- itary operations. Today GPS has numerous business and individual applications. Large

Information technology (IT) Technology that enables storage, processing, and communication of information within and between fi rms.

Global positioning systems (GPS) A type of wireless technology that uses satellite transmission to communicate exact locations.

78 CHAPTER 3 • Product Design and Process Selection

trucking companies use GPS technology to identify the exact locations of their vehicles. Farmers use GPS while riding on tractors to identify their exact location and apply the proper mix of nutrients to the correct plot of land. GPS capability is also available for personal use in smart phones, that can identify the person’s location and plot a route to a destination.

GPS has even found its use in adver- tising. For example, Nielsen Media Research, the firm known for rating television shows, is using GPS to test billboard advertising. The company has recruited a sample of adults with known demographic characteristics and is using GPS to monitor their minute-by-minute movements. This information will then be used to deter- mine the best placement for particular billboard advertisements targeted to the particular demographic group.

Radio frequency identification (RFID) is another wireless technology that promises to dramatically change business operations. RFID uses memory chips equipped with tiny radio antennas that can be attached to objects to transmit streams of data about the object. For example, RFID can be used to identify any product movement, reveal a missing product’s location, or have a shipment of products “announce” its arrival. Empty store shelves can signal that it is time for replenishment using RFID, or low inventories can signal the vendor that it is time to ship more products. RFID can also be used in the service environment, enabling innovative applications in locating and tracking people and assets. In fact, RFID has the potential to become the backbone of an infrastructure that can identify and track billions of individual objects all over the world, in real time.

A big adopter of RFID is Wal-Mart, which is investing heavily in RFID tags for its ware- houses. Wal-Mart went live with RFID in January 2005 after pilot testing them at distri- bution centers in Dallas. The company has already seen a return on its investment. For example, out-of-stock items that are RFID tagged are replenished three times faster than before. The company is also experimenting with adding sensor tags to perishable items. This way, for example, it can track how long a crate of bananas has been in transit and how fresh it is. In 2010 Wal-Mart added removable RFID tags on individual garments from jeans to underwear in order to tightly monitor inventory. In 2013 the company used more than 1.35 billion tags.

Automation An important decision in designing processes is whether the firm should automate, to what degree, and the type of automation that should be used. Automation is the use of machinery able to perform work without human operators and can involve a single machine or an entire factory. Although there are tremendous advantages to automation, there are also disadvantages. Companies need to consider these carefully before making the final decision.

Automation has the advantage of product consistency and ability to efficiently produce large volumes of product. With automated equipment, the last part made in the day will be exactly like the first one made. Because automation brings consistency, quality tends to be higher and easier to monitor. Production can flow uninterrupted throughout the day, with- out breaks for lunch, and there is no fatigue factor.

Radio frequency identifi cation (RFID) A wireless technology that uses memory chips equipped with radio antennas attached to objects used to transmit streams of data.

Automation Using machinery to perform work without human operators.

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However, automation does have its disadvantages. First, automation is typically very costly. These costs can be justified only by a high volume of production. Second, automa- tion is typically not flexible in accommodating product and process changes. Therefore, automation would probably not be good for products in the early stages of their life cycle or for products with short life cycles. Automation needs to be viewed as another capital investment decision: financial payback is critical. For all these reasons automation is typ- ically less present in intermittent than in repetitive operations.

Automated Material Handling In the past, the primary method of moving products was the conveyor in the form of belts or chains. Today’s material handling devices can read bar codes that tell them which location to go to and which are capable of moving in many directions. One such device is an automated guided vehicle (AGV), a small bat- tery-driven truck that moves materials from one location to the other. The AGV is not operated by a human and takes its directions from either an onboard or central com- puter. Even AGVs have become more sophisticated over time. The older models followed a cable that was installed under the floor. The newer models follow optical paths and can go anywhere there is aisle space, even avoiding piles of inventory in their way. One of the biggest advantages of AGVs is that they can pretty much go anywhere, as compared to traditional conveyor belts. Managers can use them to move materials wherever they are needed.

Another type of automated material handling includes automated storage and retrieval systems (AS/RSs), which are basically automated warehouses. AS/RSs use AGVs to move material and also computer-controlled racks and storage bins. The storage bins can typ- ically rotate like a carousel, so that the desired storage bin is available for either storage or retrieval. All this is controlled by a computer that keeps track of the exact location and quantity of each item and controls how much will be stored or retrieved in a particular area. AS/RSs can have great advantages over traditional warehouses. Though they are much more costly to operate, they are also much more efficient and accurate.

Flexible Manufacturing Systems (FMS) A flexible manufacturing system (FMS) is a type of automation system that combines the flexibility of intermittent operations with the efficiency of repetitive operations. As you can see by the definition, this is a system of automated machines, not just a single machine. An FMS consists of groups of computer- controlled machines and/or robots; automated handling devices for moving, loading, and unloading; and a computer-control center.

Based on the instructions from the computer-control center, parts and materials are automatically moved to appropriate machines or robots. The machines perform their tasks and then the parts are moved to the next set of machines, where the parts automatically are loaded and unloaded. The routes taken by each product are determined with the goal of maximizing the efficiency of the operation. Also, the FMS “knows” when one machine is down due to maintenance or if there is a backlog of work on a machine, and it will automat- ically route the materials to an available machine.

Flexible manufacturing systems are still fairly limited in the variety of products that they handle. Usually they can only produce similar products from the same family. For this reason, and because of their high cost, flexible manufacturing systems are not very widespread. A decision to use an FMS needs to be long-term and strategic, requiring a sizable financial outlay.

Robotics A robot in manufacturing is usually nothing more than a mechanical arm with a power supply and a computer-control mechanism that controls the movements of the arm. The arm can be used for many tasks, such as painting, welding, assembly, and loading and unloading of machines. Robots are excellent for physically dangerous jobs such as working

Flexible manufacturing system (FMS) A type of automated system that combines the fl exibility of intermittent operations with the effi ciency of repetitive operations.

80 CHAPTER 3 • Product Design and Process Selection

with radioactive or toxic materials. Also, robots can work 24 hours a day to produce a highly consistent product.

Robots vary in their degree of sophistication. Some robots are fairly simple and follow a repetitive set of instructions. Other robots follow complex instructions, and some can be programmed to recognize objects and even make simple decisions. One type of automation similar to simple robotics is the numerically controlled (NC) machine. NC machines are controlled by a computer and can do a variety of tasks such as drilling, boring, or turning parts of different sizes and shapes. Factories of the future will most likely be composed of a number of robots and NC machines working together.

The use of robots has not been very widespread in U.S. firms. However, this is an area that can provide a competitive advantage for a company. Cost justification should consider not only reduction in labor costs but also the increased flexibility of operation and improvement in quality. The cost of robots can vary greatly and depends on the robots’ size and capabil- ities. Generally, it is best for a company to consider purchasing multiple robots or forms of automation to spread the costs of maintenance and software support. Also, the decision to purchase automation such as robotics needs to be a long-term strategic one that considers the totality of the production process. Otherwise, the company may have one robot working 24 hours a day and piling up inventory while it waits for the other processes to catch up.

One emerging technology is a new generation of intelligent assembly robots. Past robotic systems required huge, complex installations. These typically started at around $250,000 per assembly station, well above the cost of what most manufacturers could afford. The new gen- eration of robots costs a fraction of that price—at around $25,000 per robot. These robots can also be installed in less than a day. Suddenly, efficient, effective manufacturing automation is within the reach of even small companies and has the potential to change manufacturing.

Robots can be used to improve operations of almost any business— even literal “operations.” Increas- ingly, robots have been used to perform certain medical surgeries. For example, at New York Univer- sity doctors use minimally invasive robotic surgery to repair human heart valves. To perform the sur- gery, doctors use a robot arm to cut a 6-cm incision between the ribs and to place an endoscope that allows the surgeons to see what

they are doing. The robot arm is controlled through a complex robotic surgical system. The doctors, seated at a workstation, manipulate conventional surgical instruments while the robotic surgical system mirrors these movements on an ultra-fine scale. The advan- tage of robots is that they can perform delicately fine, small motor movements, have con- sistent finger dexterity, and require only tiny incisions. The prediction is that robots will become involved in performing many surgeries, such as eye surgery, neurosurgery, and cosmetic surgery.

E-manufacturing Today’s Web-based environment has created numerous opportunities for business collaboration. This includes collaboration in product and process design, where customers, buyers, and designers can share information and jointly make decisions in real time. Let’s look at some of the computer systems that can aid e-manufacturing.

Numerically controlled (NC) machine A machine controlled by a computer that can perform a variety of tasks.

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Computer-Aided Design (CAD) Computer-aided design (CAD) is a system that uses computer graphics to design new products. Gone are the days of drafting designs by hand. Today’s powerful desktop computers combined with graphics software allow the designer to create drawings on the computer screen and then manipulate them geometrically to be viewed from any angle. With CAD the designer can rotate the object, split it to view the inside, and magnify certain sections for closer view.

CAD can also perform other functions. Engineering design calculations can be per- formed to test the reactions of the design to stress and to evaluate strength of materials. This is called computer-aided engineering (CAE). For example, the designer can test how dif- ferent dimensions, tolerances, and materials respond to different conditions such as rough handling or high temperatures. The designer can use the computer to compare alterna- tive designs and determine the best design for a given set of conditions. The designer can also perform cost analysis on the design, evaluating the advantages of different types of materials.

Another advantage of CAD is that it can be linked to manufacturing. We have already discussed the importance of linking product design to process selection. Through CAD this integration is made easy. Computer-aided manufacturing (CAM) is the process of controlling manufacturing through computers. Since the product designs are stored in the computer database, the equipment and tools needed can easily be simulated to match up with the processing needs. Efficiencies of various machine choices and different process alternatives can be computed.

CAD can dramatically increase the speed and flexibility of the design process. Designs can be made on the computer screen and printed out when desired. Electronic versions can be shared by many members of the organization for their input. Also, elec- tronic versions can be archived and compared to future versions. The designer can cat- alog features based on their characteristics—a very valuable feature. As future product designs are being considered, the designer can quickly retrieve certain features from past designs and test them for inclusion in the design being currently developed. Also, by using collaborative product commerce (CPC) software, sharing designs with suppliers is possible.

Computer-Integrated Manufacturing Computer-integrated manufacturing (CIM) is a term used to describe the integration of product design, process planning, and manufac- turing using an integrated computer system. Computer-integrated manufacturing systems vary greatly in their complexity. Simple systems might integrate computer-aided design (CAD) with some numerically controlled machines (NC machines). A complex system, on the other hand, might integrate purchasing, scheduling, inventory control, and distribution, in addition to the other areas of product design.

The key element of CIM is the integration of different parts of the operation process to achieve greater responsiveness and flexibility. The purpose of CIM is to improve how quickly the company can respond to customer needs in terms of product design and avail- ability, as well as quality and productivity, and to improve overall efficiency.

3D Printing 3D Printing is three-dimensional printing technology that is similar to ink-jet and laser-jet printers. It deposits materials like plastics and metals in thick layers one atop the other. The process gradually builds up one layer at a time until the object is produced. This literally means that a solid object can be created from a software design with just a click of a button. This technology makes desktop manufacturing possible, and it requires no economies of scale. Just a few years ago, three-dimensional printers were considered useful tools in prototype studios. Today they are rapidly becoming essential machine tools on the production line and changing manufacturing. Just consider what opportunities that offers in manufacturing flexibility.

Computer-aided design (CAD) A system that uses computer graphics to design new products.

Computer-integrated manufacturing (CIM) A term used to describe the integration of product design, process planning, and manufacturing using an integrated computer system.

3D Printing 3D Printing is three-dimensional printing technology that deposits materials like plastics and metals in thick layers one atop the other with the process gradually building up one layer at a time until the object is produced.

82 CHAPTER 3 • Product Design and Process Selection

Designing Services Most of the issues discussed in this chapter are as applicable to service organizations as they are to manufacturing. However, there are issues unique to services that pose special challenges for service design.

Most of us think we know what is needed to run a good service organization. After all, we encounter services almost every day, at banks, fast-food restaurants, doctor’s offices, barber shops, grocery stores, and even the university. We have all experienced poor service quality and would gladly offer advice as to how we think it could be better. However, there are some very important features of services you may not have thought about. Let’s see what they are.

How Are Services Different from Manufacturing? In Chapter 1 we learned about two basic features that make service organizations differ- ent from manufacturing. These are the intangibility of the product produced and the high degree of customer contact. Next we briefly review these and see how they impact service design.

Intangible Product Service organizations produce an intangible product, which cannot be touched or seen. It cannot be stored in inventory for later use or traded in for another model. The service produced is experienced by the customer. The design of the service needs to specify exactly what the customer is supposed to experience. For example, it may be relaxation, comfort, and pampering, such as offered by Canyon Ranch Spa. It may be efficiency and speed, such as offered by FedEx. Defining the customer experience is part of the service design. It requires identifying precisely what the customer is going to feel and think and consequently how he or she is going to behave. This is not always as easy as it might seem.

The experience of the customer is directly related to customer expectations. For services to be successful, the customer experience needs to meet or even exceed these expectations. However, customer expectations can greatly vary depending on the type of customer and customer demographic, including customer age, gender, background, and knowledge. The expectation is developed through product marketing to a particular mar- ket segment. It is highly important in designing the service to identify the target market the service is geared to and to create the correct expectation.

High Degree of Customer Contact Service organizations typically have a high degree of customer contact. The customer is often present while the service is being delivered, such as at a theater, restaurant, or bank. Also, the contact between the cus- tomer and service provider is often the service itself, such as what you experience at a doctor’s office. For a service to be successful, this contact needs to be a positive experi- ence for the customer, and this depends greatly on the service provider.

Unfortunately, since services often have multiple service providers, there can be great variation in the type of service delivered. We have all had experiences where the service of one organization varied greatly depending on the skills of the service provider. This could be a hairdresser at a hair salon, a food server at a restaurant, or a teller at a bank. We have all heard people say something similar to “I often have dinner at Aussie Steak Grill and I insist that Jenny be my server.” Similarly, someone might say, “I go to Olentangy Family Physicians, but I won’t see Dr. Jekyl because he is rude and unfriendly.” For a service to be successful, the service experience must be consistent at all times. This requires close quality management to ensure high consistency and reliability. Many of the procedures used in manufacturing to

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Designing Services • 83

ensure high quality, such as standardization and simplification, are used in services as well. Fast-food restaurants such as McDonald’s and Wendy’s are known for their consistency. The same is true of hotel chains such as Holiday Inn and Embassy Suites.

To ensure that the service contact is a positive experience for the customer, employees of the service need to have training that encompasses a great array of skills that includes courtesy, friendliness, and overall disposition. The service company also needs to structure the proper incentive system to motivate employees.

How Are Services Classified? We can classify service organizations based on similar characteristics in order to understand them better. A common way to classify services is based on the degree of customer contact. This is illustrated in Figure 3.12.

Services with low customer contact are called “quasi-manufacturing.” These firms have a high degree of service standardization, have higher sales volumes, and are typically less labor intensive. These firms have almost no face-to-face contact with customers and are in many ways similar to manufacturing operations. Examples include warehouses, distribution centers, environmental testing laboratories, and back-office operations.

Services with high customer contact are called “pure services.” These firms have high face- to-face contact and are highly labor intensive. There is low product standardization, as each customer has unique requirements, and sales volumes tend to be low. Pure service firms have an environment of lowest system efficiency compared to other service firms. The reason is

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84 CHAPTER 3 • Product Design and Process Selection

that the service is typically customized. As each customer has unique requirements, there is less predictability in managing the operating environment. Examples include hospitals, restaurants, barber shops, and beauty salons.

Services that combine elements of both of these extremes are called “mixed services.” Some parts of their operation have face-to-face customer contact, though others do not. They include offices, banks, and insurance firms.

It is important to understand that companies with different levels of customer contact need to be managed differently. These differences also apply to high-contact and low-contact areas of firms. For example, companies should specifically hire people-oriented workers for high-contact areas, whereas technical skills are more important in low-contact areas. Also, noncontact activities should be partitioned from the customer to avoid disruptions in the flow of work. Noncontact areas can be managed borrowing tools from manufacturing, whereas high-contact areas need to focus on accommodating the customer.

The Service Package The really successful service organizations do not happen spontaneously. They are carefully thought out and planned, down to every employee action. To design a successful service, we must first start with a service concept or idea, which needs to be very comprehensive. We have learned that when purchasing a service, customers actually buy a service package or service bundle. The service package is a grouping of features that are purchased together as part of the service. There are three elements of the service package: (1) the physical goods, (2) the sensual benefits, and (3) the psychological benefits. The physical goods of the service are the tangible aspects of the service that we receive, or are in contact with, during service delivery. In a fine-dining restaurant the physical goods are the food consumed, as well as facilities such as comfortable tables and chairs, tablecloths, and fine china. The sensual benefits are the sights, smell, and sounds of the experience—all the items we experience through our senses. Finally, the psychological benefits include the status, comfort, and well- being provided by the experience.

It is highly important that the design of the service specifically identify every aspect of the service package. When designing the service, we should not focus only on the tangible aspects; it is often the sensual and psychological benefits that are the deciding factors in the success of the service. The service package needs to be designed to precisely meet the expectations of the target customer group.

Once the service package is identified, it can then be translated into a design using a process that is not too different from the one used in manufacturing. Details of the service, such as quality standards and employee training, can later be defined in keeping with the service concept. The service providers—the individuals who come in direct contact with the customers—must be trained and motivated to precisely understand and satisfy customer expectations.

Imagine going to a fast-food restaurant and having the server take his time asking you how you want your hamburger cooked and precisely what condiments you would like to accompany it, then waiting a long time to receive your food. Similarly, imagine going to an expensive hair salon and having the staff rush you through the process. In both cases, you as the customer would not be satisfied because the service delivery did not meet your expectations. Next time you might choose to go somewhere else. These examples illustrate what happens when there is a mismatch between the service concept and the service delivery.

Differing Service Designs There is no one model of successful service design. The design selected should support the company’s service concept and provide the features of the service package that the target customers want. Different service designs have proved successful in different environments.

Service package A grouping of physical, sensual, and psychological benefi ts that are purchased together as part of the service.

MKT

Designing Services • 85

In this section we look at three very different service designs that have worked well for the companies that adopted them.

Substitute Technology for People Substituting technology for people is an approach to service design that was advocated some years ago by Theodore Levitt.1 Levitt argued that one way to reduce the uncertainty of service delivery is to use technology to develop a production-line approach to services. One of the most successful companies to use this approach is McDonald’s. Technology has been substituted wherever possible to provide product consistency and take the guesswork away from employees. Some examples of the use of technology include the following:

• Buzzers and lights are used to signal cooking time for frying perfect french fries.

• Th e size of the french fryer is designed to produce the correct amount of fries.

• Th e french fry scoop is the perfect size to fi ll an order.

• “Raw materials” are received in usable form (e.g., hamburger patties are premade; pickles and tomatoes are presliced; french fries are precut).

• Th ere are 49 steps for producing perfect french fries.

• Steps for producing the perfect hamburger are detailed and specifi c.

• Products have different-colored wrappings for easy identification.

In addition to the use of technology in the production of the product, there is consistency in facilities and a painstaking focus on cleanliness. For example, the production process at McDonald’s is not left to the discretion of the workers. Rather, their job is to follow the tech- nology and preset processes.

Today we are all accustomed to the product consistency, speed of delivery, and predict- ability that are a feature of most fast-food restaurants. However, this concept was very new in the early 1970s. It is this approach to services that has enabled McDonald’s to establish its global reputation.

Substituting technology for people is an approach we have seen over the years in many service industries. For example, almost all gas stations have reduced the num- ber of cashiers and attendants with the advent of credit cards at self-serve pumps. Also, many hospitals are using technology to monitor patient heart rate and blood pressure without relying exclusively on nurses. As technologies develop in different service indus- tries, we will continue to see an ever-increasing reliance on its use and an increase in the elimination of workers.

Get the Customer Involved A different approach to service design was proposed by C. H. Lovelock and R. F. Young.2 Their idea was to take advantage of the customer’s presence during the delivery of the service and have him or her become an active participant. This is different from traditional service designs where the customer passively waits for service employees to deliver the service. Lovelock and Young proposed that since the customers are already there, “get them involved.”

We have all seen a large increase in the self-serve areas of many service firms. Traditional salad bars have led to self-serve food buffets of every type. Many fast-food restaurants no longer fill customer drink orders, but have the customers serve themselves. Grocery stores allow customers to select and package baked goods on their own. Many hotels provide in-room coffee makers and prepackaged coffee, allowing customers to make coffee at their convenience.

1Th eodore Levitt, “Production Line Approach to Services,” Harvard Business Review, 50, 5 (September–October

1972), 41–52. 2C.H. Lovelock and R.F. Young, “Look to Customers to Increase Productivity,” Harvard Business Review, 57, 2,

168–178.

86 CHAPTER 3 • Product Design and Process Selection

This type of approach has a number of advantages. First, it takes a large burden away from the service provider. The delivery of the service is made faster, and costs are reduced due to lowered staffing requirements. Second, this approach empowers customers and gives them a greater sense of control in terms of getting what they want, which provides a great deal of customer convenience and increases satisfaction. However, since different types of customers have different preferences, many facilities are finding that it is best to offer full-service and self-service options. For example, many breakfast bars still allow a request for eggs cooked and served to order, and most gas stations still offer some full- service pumps.

High Customer Attention Approach A third approach to service design is providing a high level of customer attention. This is in direct contrast to the first two approaches. The first approach discussed automates the service and makes it more like manufacturing. The second approach requires greater participation and responsibility from the customer. The third approach is different from the first two in that it does not standardize the service and does not get the customer involved. Rather, it is based on customizing the service to the needs unique to each customer and having the customer be the passive and pampered recipient of the service. This approach relies on developing a personal relationship with each customer and giving the customer precisely what he or she wants.

There are a number of examples of this type of approach. Nordstrom, Inc. department stores is recognized in the retail industry for its attention to customer service. Salespeople typically know their customers by name and keep a record of their preferences. Returns are handled without question, and the customer is always right. Another example of this is a midwestern grocer called Dorothy Lane Market. Dorothy Lane prides itself on its ability to provide unique cuts of specialty meats precisely to customer order. As at Nordstrom, a list is kept of primary customers and their preferences. Customers are notified of special pur- chases, such as unique wines, specialty chocolates, and special cuts of meat.

Whereas the first two approaches to service design result in lowered service costs, this third approach is geared toward customers who are prepared to pay a higher amount for the services they receive. As you can see, different approaches are meant to serve different types of customers. The design chosen needs to support the specific service concept of the company.

Product Design and Process Selection Within OM: How it all Fits Together

Product design decisions are strategic in nature. The features and characteristics of a prod- uct need to support the overall strategic direction of the company. In turn, product design decisions directly dictate the type of process selected. They determine the types of facilities that will be needed to produce the product, types of machines, worker skills, degree of auto- mation, and other decisions. Most companies continually design new products. The design of these new products has to take into account the type of processes the company has; oth- erwise facilities may not be available to produce the new product design. Therefore, product design and process selection decisions are directly tied to each other.

Product design and process selection decisions are further linked to all other areas of operations management. They are linked to decisions such as the level of capacity needed (Chapter 9), degree of quality (Chapters 5 and 6), layout (Chapter 10) and location of facilities (Chapter 9), types of workers (Chapter 11), and many others. As we go through this book, we will see how product design and process selection specifically impact other operations decisions.

Designing Services • 87

Product Design and Process Selection Across the Organization

The strategic and financial impact of product design and process selection mandates that operations work closely with other organizational functions to make these decisions. Oper- ations is an integral part of these decisions because it understands issues of production, ease of fabrication, productivity, and quality. Now let’s see how the other organizational functions are involved with product design and process selection.

Marketing is impacted by product design issues because they determine the types of products that will be produced and affect marketing’s ability to sell them. Marketing’s input is critical at this stage because marketing is the function that interfaces with customers and understands the types of product characteristics customers want. It is marketing that can provide operations with information on customer preferences, competition, and future trends.

Process selection decisions impact marketing as well. They typically require large capital outlays, and once made, they are typically difficult to change and are in place for a long time. Process decisions affect the types of future products that the company can produce. Because of this, marketing needs to be closely involved in ensuring that the process can meet market demands for many years to come.

Finance plays an integral role in product design and process selection issues because these decisions require large financial outlays. Finance needs to be a part of these deci- sions to evaluate the financial impact on the company. Process selection decisions should be viewed as any other financial investment, with risks and rewards. Finance must ensure that the trade-off between the risks and rewards is acceptable. Also, it is up to finance to provide the capital needed for this investment and to balance that against future capital requirements.

Information systems needs to be part of the process selection decisions. Operations deci- sions, such as forecasting, purchasing, scheduling, and inventory control, differ based on the type of operation the company has. Information systems will be quite different for intermittent versus repetitive operations. Therefore, the information system has to be developed to match the needs of the production process being planned.

Human resources provides important input to process selection decisions because it is the function directly responsible for hiring employees. If special labor skills are needed in the process of production, human resources needs to be able to provide information on the available labor pool. The two types of operations discussed, intermittent and repetitive, typi- cally require very different labor skills. Intermittent operations usually require higher-skilled labor than repetitive operations. Human resources needs to understand the specific skills that are needed.

Purchasing works closely with suppliers to get the needed parts and raw materials at a favorable price. It is aware of product and material availability, scarcity, and price. Often cer- tain materials or components can use less expensive substitutes if they are designed properly. For this reason it is important to have purchasing involved in product design issues from the very beginning.

Engineering needs to be an integral part of the product design and process selection decisions because this is the function that understands product measurement, tolerances, strength of materials, and specific equipment needs. There can be many product design ideas, but it is up to engineering to evaluate their manufacturability.

As you can see, product design and process selection issues involve many functions and affect the entire organization. For this reason, product design and process selection deci- sions need to be made using a team effort, with all these functions working closely together to come up with a product plan that is best for the company.

MKT

FIN

MIS

HRM

88 CHAPTER 3 • Product Design and Process Selection

Changes in product design can signifi cantly improve envi-ronmental and social sustainability performance. These changes can include the use of materials, sourcing, and dis- posal, as well as process modifi cations that can reduce pollu- tion. Sometimes these changes can be highly innovative. Other times they can be simple changes that the company simply overlooked. A good example is Nike Air basketball sneakers with their signature air bubble in the heel. The com- pany only recently became aware that the pocket of the sneak- ers contained a gas known as sulphur hexafl uoride, or SF6, which is actually a greenhouse gas. As part of Nike’s sustain- ability initiative, Nike replaced SF6 with nitrogen, which breaks up more readily upon release and is not a greenhouse gas. This small change did not alter consumer perception of the product, nor cost the company money, but it offered a signifi - cant environmental impact.

Companies can also work on product design changes that can be highly innovative and bring sustainability leadership to the fi rm. An excellent example is offered by PepsiCo, the world’s second largest food and beverage company. PepsiCo has worked to lower the environmental impact associated with petroleum-derived beverage bottles, which are composed of

nonrenewable fossil fuels and carry huge environmental costs. In fact, it is these plastic bottles that litter public spaces and contribute the fl oating “garbage patches” that plague the world’s oceans. First, the company lowered the amount of plastic used in its Aquafi na water bottles. It then developed a 100% recycled bottle for its Naked Juice line in 2009. Now, the company’s R&D team is working on designing and mass-producing recyclable bottles completely made from renew- able materials. The research team is working on developing bottles using wastes from its food businesses, including orange peels, potato peels, and oat hulls. They have already designed the material and have considered how it would match the cur- rent process design of PepsiCo, as changes in process design would require major capital investments. The plant-based bottles can be blown, fi lled, and labeled the same way as tradi- tional plastic ones, and would feel the same in the hands of the consumer. The company is continuing testing before mass- producing the bottles on a large scale and tracking the environ- mental impacts of the bottles to account for the environmental savings. Such a breakthrough innovation would also position PepsiCo as the leader in the entire plastic packaging industry and the premier environmentally responsible brand. •

THE SUSTAINABILITY LINK

Chapter Highlights 1 Product design is the process of deciding on the

unique characteristics and features of a company’s product. Process selection, on the other hand, is the development of the process necessary to produce the product being designed. Product design is a big strate- gic decision for a company, because the design of the product defines who the company’s customers will be, as well as the company’s image, its competition, and its overall future growth.

2 Steps in product design include idea development, product screening, preliminary design and testing, and final design. A useful tool at the product-screening stage is break-even analysis.

3 Break-even analysis is a technique used to compute the amount of goods that have to be sold just to cover costs.

4 Production processes can be divided into two broad categories: intermittent and repetitive operations. Intermittent operations are used when products with

In today’s competitive environment, companies typically have a very short window of opportunity to enter the mar- ket with a new product design. Most companies are aware that they must get to the market early with an innovative product before their competitors. This requires the support of the entire supply chain, where suppliers must be involved in the product design process. We have already learned about the time-saving advantages of concurrent engineering and early supplier involvement. These require a carefully integrated supply chain that allows collaboration and simultaneous product design between suppliers and manufacturers.

Another important supply chain link relates to the technol- ogy decisions the fi rm makes. As companies acquire new tech- nologies, they must consider how these technologies will be aligned with the technologies used by their supply chain part- ners. When an entire supply chain uses technologies that are compatible, great strides can be made in the effi ciency of pro- duction and movement of goods. Consider that Wal-Mart has mandated that its top 300 suppliers must put RFID tags on all their shipping crates and pallets. Although RFID tags are expen- sive, this move has already incurred huge savings by increasing effi ciency, better tracking of products, and reducing inventory. •

THE SUPPLY CHAIN LINK

Formula Review • 89

different characteristics are being produced in smaller volumes. These types of operations tend to organize their resources by grouping similar processes together and having the products routed through the facility based on their needs. Repetitive operations are used when one or a few similar products are produced in high volume. These operations arrange resources in sequence to allow for an efficient buildup of the product. Both intermittent and repetitive operations have their advantages and disadvantages. Intermit- tent operations provide great flexibility but have high material handling costs and challenge scheduling resources. Repetitive operations are highly efficient but inflexible.

5 A process flowchart is used for viewing the flow of the processes involved in producing the product. It is a very useful tool for seeing the totality of the operation and for identifying potential problem areas. There is no exact format for designing the chart. The flowchart can be very simple or very detailed.

6 Process performance metrics are measurements of different process characteristics that tell us how a pro- cess is performing and changing over time. There are many process performance metrics, each providing

different information about the process. Some of the most frequently used process performance metrics are throughput time, process velocity, productivity, utiliza- tion, and efficiency.

7 Product design and process selection decisions are linked. The type of operation a company has in place is defined by the product the company produces. The type of operation then affects other organizational decisions, such as competitive priorities, facility layout, and degree of vertical integration.

8 Different types of technologies can significantly enhance product and process design. These include automation, automated material handling devices, computer-aided design (CAD), numerically con- trolled (NC) equipment, flexible manufacturing sys- tems (FMS), and computer-integrated manufacturing (CIM).

9 Designing services has more complexities than manufacturing because services produce an intan- gible product and typically have a high degree of customer contact. Different service designs include substituting technology for people, getting the cus- tomer involved, and paying great attention to the customer.

Key Terms

Formula Review

manufacturability 55

product design 55

service design 56

benchmarking 57

reverse engineering 57

early supplier involvement (ESI) 57

break-even analysis 58

fi xed costs 58

variable costs 58

design for manufacture (DFM) 61

product life cycle 61

concurrent engineering 62

remanufacturing 64

intermittent operations 64

repetitive operations 65

project process 66

batch process 66

line process 66

continuous process 67

process fl ow analysis 67

process fl owchart 67

bottleneck 67

make-to-stock strategy 68

assemble-to-order strategy 68

make-to-order strategy 68

process performance metrics 69

throughput time 70

process velocity 71

productivity 71

utilization 71

effi ciency 71

information technology (IT) 77

global positioning systems (GPS) 77

radio frequency identifi cation (RFID) 78

automation 78

fl exible manufacturing system (FMS) 79

numerically controlled (NC) machine 80

computer-aided design (CAD) 81

computer-integrated manufacturing (CIM) 81

service package 84

1. Total cost = fixed cost + variable cost

2. Revenue = (SP)Q

3. F + (VC)Q = (SP)Q

4. QBE = F

SP − VC

90 CHAPTER 3 • Product Design and Process Selection

5. Process velocity = throughput time

value-added time

6. Utilization = time a resource used

time a resource available

7. Efficiency = actual output

standard output

Solved Problems (See student companion site for Excel template.) PROBLEM 1

Joe Jenkins, owner of Jenkins Manufacturing, is consid- ering whether to produce a new product. He has con- sidered the operations requirements for the product as well as the market potential. Joe estimates the fi xed costs per year to be $40,000 and variable costs for each unit produced to be $50.

(a) If Joe sells the product at a price of $70, how many units of product does he have to sell in order to break even? Use both the algebraic and graphical approaches.

(b) If Joe sells 3000 units at the product price of $70, what will be his contribution to profit?

Before You Begin: To solve this problem you must fi rst use the break-even formula. Th en to compute the contribution to profi t, recall that profi t is computed as

Profit = total revenue − total cost

Solution: (a) To compute the break-even quantity, we follow the

equation and substitute the appropriate numerical values:

Q = F

SP − VC =

$40,000

$70 − $50 = 2000 units

The break-even quantity is 2000 units. This is how much Joe would have to sell in order to cover costs.

Graphically, we can obtain the same result. Th is is shown in the fi gure.

Fixed Costs

Break-even Quantity

Total Cost

Total Revenue

Loss

2000

40,000

QBE QUANTITY (IN UNITS)

D O

LL A

R S (

$ )

(b) To compute the contribution to profit with sales of 3000 units:

Profit = total revenue − total cost = (SP)Q − 3F + (VC)Q4

Now we can substitute numerical values:

Profit = $70(3000) − 3$40,000 + $50(3000)4 = $20,000

The contribution to profit is $20,000 if Joe can sell 3000 units of product.

PROBLEM 2

Joe Jenkins, owner of Jenkins Manufacturing, has decided to produce the new product discussed in Problem 1. Th e product can be produced with the current equipment in place. However, Joe is considering the purchase of new equipment that would produce the product more effi ciently. Joe’s fi xed cost would be raised to $60,000 per year, but the variable cost would be reduced to $25 per unit. Joe still plans to sell the product at $70 per unit.

Should Joe produce the new product with the new or current equipment described in Problem 1? Specify the volume of demand for which you would choose each process.

Solution: As we mentioned in the chapter, break-even analysis can also be used to evaluate diff erent processes. Here we show how this can be done. To decide which

Discussion Questions • 91

process to use, we fi rst need to compute the point of indiff erence between the two processes. Th e point of indiff erence is where the cost of the two processes is equal. If we label the current equipment A and the new equipment B, the point of indiff erence occurs when the costs for each process are equal. Th is is shown as

Total costEquipment A = total costEquipment B

Again, total cost is the sum of fi xed and variable costs:

$40,000 + $50 Q = $60,000 + $25 Q $25 Q = 20,000

Q = 800 units produced

Q = 800 units is the point of indiff erence, that is, the point where the cost of either equipment is the same. If demand is expected to be less than 800 units, equip- ment A should be used given that it has a lower fi xed cost. If demand is expected to be greater than 800 units, equipment B should be used given that it has a lower variable cost. Th is is shown graphically.

PROBLEM 3

Zelle’s Dry Cleaners has collected the following data for its processing of dress shirts:

It takes an average of 3 1 2 hours to dry clean and press

a dress shirt, with value-added time estimated at 110 minutes per shirt.

Workers are paid for a 7-hour workday and work 5

1 2 hours per day on average, accounting for breaks

and lunch; labor utilization is 75 percent in the industry.

Th e dry cleaner completes 25 shirts per day, with an industry standard of 28 shirts per day for a comparable facility.

Determine process velocity, labor utilization, and effi - ciency for the company.

Before You Begin: When solving this problem, remem- ber to keep the units of measure consistent in the numerator and denominator of each equation.

0 500

Choose Equipment A

Choose Equipment B

Total Cost of Equipment

B

Total Cost of Equipment

A

D O

LL A

R S

1000 2000

800 units Point of indifference between

equipment A and equipment B.

30,000

40,000

50,000

60,000

70,000

80,000

90,000

1500

QUANTITY

Solution:

Process velocity = throughput time

value-added time

= 210 minutes�shirt 110 minutes�shirt

= 1.90

Labor utilization = 5

1 2 hours�day

7 hours�day = 0.786 or 78.6%

Efficiency = 25 shirts�day 28 shifts�day

= 0.89 or 89%

Process velocity shows room for process improvement, as throughput time is almost twice that of value-added time. Labor utilization is just above the industry stan- dard, though overall effi ciency is below.

Discussion Questions

1. Defi ne product design and explain its relationship to business strategy.

2. What are the diff erences between product and service design?

3. Explain the meanings of benchmarking and reverse engineering.

4. Explain the meaning of design for manufacture (DFM) and give some examples.

92 CHAPTER 3 • Product Design and Process Selection

5. Describe the stages of the product life cycle. What are demand characteristics at each stage?

6. Explain the term concurrent engineering. Why is it important?

7. Identify the two general types of operations. What are their characteristics?

8. What is meant by the term vertical integration? What types of companies are more likely to become vertic- ally integrated?

9. What is a process fl owchart, and what is it used for?

10. Give some examples of automation. How has automa- tion changed the production process?

11. Discuss the benefi ts of computer-aided design (CAD).

12. What is meant by the term service package?

13. Name three service companies and describe their service package.

14. Give examples of services that have a good match between customer expectations and service delivery. Give examples of services that do not have a good match.

Problems

1. See-Clear Optics is considering producing a new line of eyewear. After considering the costs of raw materi- als and the cost of some new equipment, the company estimates fi xed costs to be $40,000 with a variable cost of $45 per unit produced. (a) If the selling price of each new product is set at

$100, how many units need to be produced and sold to break even? Use both the graphical and algebraic approaches.

(b) If the selling price of the product is set at $80 per unit, See-Clear expects to sell 2000 units. What would be the total contribution to profi t from this product at this price?

(c) See-Clear estimates that if it off ers the product at the original target price of $100 per unit, the company will sell about 1500 units. Will the pricing strategy of $100 per unit or $80 per unit yield a higher contribution to profi t?

2. Med-First is a medical facility that off ers outpatient medical services. Th e facility is considering off er- ing an additional service, mammography screening tests, on-site. Th e facility estimates the annual fi xed cost of the equipment and skills necessary for the service to be $120,000. Variable costs for each pa- tient processed are estimated at $35 per patient. If the clinic plans to charge $55 for each screening test, how many patients must it process a year in order to break even?

3. Tasty Ice Cream is a year-round take-out ice cream restaurant that is considering off ering an additional product, hot chocolate. Considering the additional machine it would need plus cups and ingredients, it estimates fi xed costs to be $200 per year and vari- able costs to be $0.20. If it charges $1.00 for each hot chocolate, how many hot chocolates does it need to sell in order to break even?

4. Slick Pads is a company that manufactures laptop notebook computers. Th e company is considering adding its own line of computer printers as well. It has considered the implications from the marketing and fi nancial perspectives and estimates fi xed costs to be $500,000. Variable costs are estimated at $200 per unit produced and sold. (a) If the company plans to off er the new printers at

a price of $350, how many printers does it have to sell to break even?

(b) Describe the types of operations considerations that the company needs to consider before making the fi nal decision.

5. Perfect Furniture is a manufacturer of kitchen tables and chairs. Th e company is currently deciding between two new methods for making kitchen tables. Th e fi rst process is estimated to have a fi xed cost of $80,000 and a variable cost of $75 per unit. Th e second process is estimated to have a fi xed cost of $100,000 and a vari- able cost of $60 per unit. (a) Graphically plot the total costs for both methods.

Identify which ranges of product volume are best for each method.

(b) If the company produces 500 tables a year, which method provides a lower total cost?

6. Harrison Hotels is considering adding a spa to its cur- rent facility in order to improve its list of amenities. Operating the spa would require a fi xed cost of $25,000 a year. Variable cost is estimated at $35 per customer. Th e hotel wants to break even if 12,000 customers use the spa facility. What should be the price of the spa services?

7. Kaizer Plastics produces a variety of plastic items for packaging and distribution. One item, container #145, has had a low contribution to profi ts. Last year, 20,000 units of container #145 were produced and sold.

Problems • 93

Th e  selling price of the container was $20 per unit, with a variable cost of $18 per unit and a fi xed cost of $70,000 per year. (a) What is the break-even quantity for this product?

Use both graphic and algebraic methods to get your answer.

(b) Th e company is currently considering ways to improve profi tability by either stimulating sales volumes or reducing variable costs. Management believes that sales can be increased by 35 percent of their current level or that variable costs can be reduced to 90 percent of their current level. Assuming all other costs equal, identify which alternative would lead to a higher profi t contribution.

8. George Fine, owner of Fine Manufacturing, is consid- ering the introduction of a new product line. George has considered factors such as costs of raw materials, new equipment, and requirements of a new produc- tion process. He estimates that the variable costs of each unit produced would be $8 and fi xed costs would be $70,000. (a) If the selling price is set at $20 each, how many

units have to be produced and sold for Fine Manufacturing to break even? Use both graphical and algebraic approaches.

(b) If the selling price of the product is set at $18 per unit, Fine Manufacturing expects to sell 15,000 units. What would be the total contribution to profi t from this product at this price?

(c) Fine Manufacturing estimates that if it off ers the product at the original target price of $20 per unit, the company will sell about 12,000 units. Which pricing strategy—$18 per unit or $20 per unit— will yield a higher contribution to profi t?

(d) Identify additional factors that George Fine should consider in deciding whether to produce and sell the new product.

9. Handy-Maid Cleaning Service is considering off ering an additional line of services to include professional offi ce cleaning. Annual fi xed costs for this additional service are estimated to be $9000. Variable costs are es- timated at $50 per unit of service. If the price of the new service is set at $80 per unit of service, how many units of service are needed for Handy-Maid to break even?

10. Easy-Tech Software Corporation is evaluating the production of a new software product to compete with the popular word processing software cur- rently available. Annual fixed costs of producing the item are estimated at $150,000, and the variable cost is $10 per unit. The current selling price of the

item is $35 per unit, and the annual sales volume is estimated at 50,000 units. (a) Easy-Tech is considering adding new equipment

that would improve software quality. Th e negative aspect of this new equipment would be an increase in both fi xed and variable costs. Annual fi xed costs would increase by $50,000 and variable costs by $3. However, marketing expects the better-quality product to increase demand to 70,000 units. Should Easy-Tech purchase this new equipment and keep the price of its product the same? Explain your reasoning.

(b) Another option being considered by Easy-Tech is the increase in the selling price to $40 per unit to off set the additional equipment costs. However, this increase would result in a decrease in demand to 40,000 units. Should Easy-Tech increase its selling price if it purchases the new equipment? Explain your reasoning.

11. Zodiac Furniture is considering the production of a new line of metal offi ce chairs. Th e chairs can be pro- duced in-house using either process A or process B. Th e chairs can also be purchased from an outside supplier. Specify the levels of demand for each pro- cessing alternative given the costs in the table.

Fixed Cost Variable Cost

Process A $20,000 $30 Process B $30,000 $50 Outside Supplier $0 $50

12. Mop and Broom Manufacturing is evaluating whether to produce a new type of mop. Th e company is consid- ering the operations requirements for the mop as well as the market potential. Estimates of fi xed costs per year are $40,000, and the variable cost for each mop produced is $20. (a) If the company sells the product at a price of $25,

how many units of product have to be sold in order to break even? Use both the algebraic and graphical approaches.

(b) If the company sells 10,000 mops at the product price of $25, what will be the contribution to profi t?

13. Mop and Broom Manufacturing, from Problem 12, has decided to produce a new type of mop. Th e mop can be made with the current equipment in place. How- ever, the company is considering the purchase of new equipment that would produce the mop more effi - ciently. Th e fi xed cost would be raised to $50,000  per year, but the variable cost would be reduced to $15 per unit. Th e company still plans to sell the mops

94 CHAPTER 3 • Product Design and Process Selection

at $25  per unit. Should Mop and Broom produce the mop with the new or current equipment described in Problem 12? Specify the volume of demand for which you would choose each process.

14. Jacob’s Baby Food Company must go through the following steps to make mashed carrots: (1)  unload carrots from truck; (2) inspect carrots; (3) weigh carrots; (4)  move to storage; (5) wait until needed; (6) move to washer; (7) boil in water; (8) mash carrots; (9) inspect. Draw a process fl ow diagram for these steps.

15. Draw a process flow diagram of your last doctor’s offi ce visit. Identify bottlenecks. Did any activities occur in parallel?

16. Oakwood Outpatient Clinic is analyzing its opera- tion in an eff ort to improve performance. Th e clinic

estimates that a patient spends on average 3 1 2 hours

at the facility. Th e amount of time the patient is in contact with staff (i.e., physicians, nurses, offi ce staff , lab technicians) is estimated at 40 minutes. On average the facility sees 42 patients per day. Th e standard has been 40 patients per day. Determine process velocity and effi ciency for the clinic.

17. Oakwood Outpatient Clinic rents a magnetic resonance imaging (MRI) machine for 30 hours a month for use on its patients. Last month the machine was used 28 hours out of the month. What was machine utilization?

18. Mop and Broom Manufacturing estimates that it takes 4

1 2 hours for each broom to be produced, from raw ma-

terials to fi nal product. An evaluation of the process reveals that the amount of time spent working on the product is 3 hours. Determine process velocity.

Case: Biddy’s Bakery (BB)

Biddy’s Bakery was founded by Elizabeth McDoogle in 1984. Nicknamed “Biddy,” Elizabeth started the home- style bakery in Cincinnati, Ohio, as an alternative to commercially available baked goods. Th e mission of Biddy’s Bakery was to produce a variety of baked goods with old-fashioned style and taste. Th e goods produced included a variety of pies and cakes and were sold to the general public and local restaurants.

Th e operation was initially started as a hobby by Elizabeth and a group of her friends. Many of the recipes they used had been passed down for gener- ations in their families. Th e small production and sales facility was housed in a mixed commercial and residential area on the fi rst fl oor of “Biddy’s” home. Elizabeth (“Biddy”) and three of her friends worked in the facility from 6 a.m. to 2 p.m. making and selling the pies. Th e operation was arranged as a job shop with workstations set up to perform a variety of tasks as needed. Most of the customers placed advanced orders, and Biddy’s Bakery took pride in accept- ing special requests. Th e bakery’s specialty was the McDoogle pie, a rich chocolate confection in a cookie crust.

Meeting Capacity Needs

Initially sales were slow, and there were periods when the business operated at a loss. However, after a few years Biddy’s Bakery began to attract a loyal customer following. Sales continued to grow slowly but stead- ily. In 1994 a fi rst fl oor storage area was expanded to

accommodate the growing business. However, Biddy’s Bakery quickly outgrew its current capacity. In May of 2000 Elizabeth decided to purchase the adjacent build- ing and move the entire operation into the much larger facility. Th e new facility had considerably more capac- ity than needed, but the expectation was that business would continue to grow. Unfortunately, by the end of 2000 Elizabeth found that her sales expectations had not been met, and she was paying for a facility with unused space.

Getting Management Advice

Elizabeth knew that her operations methods, though traditional, were sound. A few years ago she had called upon a team of business students from a local univer- sity for advice as part of their course project. Th ey had off ered some suggestions but were most impressed with the effi cient manner with which she ran her oper- ation. Recalling this experience, she decided to contact the same university for another team of business stu- dents to help her with her predicament.

After considerable analysis the team of business students came up with their plan: Biddy’s Bakery should primarily focus on production of the McDoogle pie in large volumes, with major sales to go to a local grocery store. Th e team of business students dis- cussed this option with a local grocery store chain that was pleased with the prospect. Under the agree- ment Biddy’s Bakery would focus its production on the McDoogle pie, which would be delivered in set

Case: Creature Care Animal Clinic (B) • 95

quantities to one store location twice a week. Th e vol- ume of pies required would use up all of the current excess capacity and take away most of the capacity from production of other pies.

Elizabeth was confused. Th e alternative being off ered would solve her capacity problems, but it seemed that the business would be completely diff erent, though she did not understand how or why. For the fi rst time in managing her business she did not know what to do.

Case Questions

1. Explain the challenge Elizabeth faced in meeting her capacity needs. What should she have considered before moving into the larger facility?

2. What is wrong with the proposal made by the team of business students? Why?

3. What type of operation does Biddy’s Bakery cur- rently have in place? What type of operation is needed to meet the proposal made by the team of business students? Explain the diff erences between these two operations.

4. Elizabeth senses that the business would be dif- ferent if she were to accept the proposal but does not know how and why. Explain how it would be diff erent.

5. What would you advise Elizabeth?

Case: Creature Care Animal Clinic (B)

Company Background

Creature Care Animal Clinic is a suburban veterinary clinic specializing in the medical care of dogs and cats. Dr. Julia Barr opened the clinic three years ago, hiring another full-time veterinarian, a staff of three nurses, an offi ce manager, and an offi ce assistant. Th e clinic oper- ates Monday through Friday during regular business hours, with half days on Saturdays and extended hours on Wednesday evenings. Both doctors work during the week and take turns covering Wednesday evenings and Saturdays.

Dr. Barr opened the clinic with the intent of pro- viding outpatient animal care. Overnight services are provided for surgical patients only. No other special- ized services are off ered. Th e facility for the clinic was designed for this type of service, with a spacious waiting and reception area. Th e examining and surgical rooms are in the rear, just large enough to accommodate their initial purpose.

As time has passed, however, the number of patients requesting specialized services has increased. Initially the requests were few, so Dr. Barr tried to accommo- date them. As one of the nurses was also trained in grooming services, she began to alternate between her regular duties and pet grooming. Pet grooming was per- formed in the rear of the reception area, as it was spa- cious and there was no other room for this job. At fi rst this was not a problem. However, as the number of pets being groomed increased, the fl ow of work began to be interrupted. Customers waiting with their pets would comment to the groomer in the rear, who had diffi culty

focusing on the work. Th e receptionist was also dis- tracted, as were the animals.

Th e number of customers requesting grooming ser- vices was growing rapidly. Customers wanted to drop off their pets for a “package” of examining, grooming, and even minor surgical procedures requiring overnight stays. Th e space for grooming and overnight services was rapidly taking over room for other tasks. Also, most of the staff was not trained in providing the type of ser- vice customers were now requiring.

The Dilemma

Dr. Barr sat at her desk wondering how to handle the operations dilemma she was faced with. She started her business as a medical clinic but found that she was no longer sure what business she was in. She didn’t understand why it was so complicated given that she was only providing a service. She was not sure what to do.

Case Questions

1. Identify the operations management problems that Dr. Barr is having at the clinic.

2. How would you defi ne the “service bundle” currently being off ered? How is this diff erent from the initial purpose of the clinic?

3. Identify the high-contact and low-contact segments of the operation. How should each be managed?

4. What should Dr. Barr have done diff erently to avoid the problems she is currently experiencing? What should Dr. Barr do now?

96 CHAPTER 3 • Product Design and Process Selection

Internet Challenge: Country Comfort Furniture

You have just taken a position with Country Comfort Furniture, a furniture manufacturer known for its custom-designed country furniture. Th e primary focus of the company has been on kitchen and dining room furniture in the upper portion of the high-price range. Due to competitive pressures and changes in the mar- ket, Country Comfort is now considering production of prefabricated kitchen and dining room furniture in the medium-price range.

You have been asked to help Country Comfort eval- uate the new product design it is considering. Perform an Internet search to identify at least two major com- petitors that Country Comfort would have if it were to choose to pursue the new product line. Next, identify key product design features of each competitor’s prod- ucts, their target market, and price range. Based on your search, what are your recommendations to Country Comfort on product design and current competition?

Selected Bibliography

Boyer, K.K. “Evolutionary Patterns of Flexible Automation and Performance: A Longitudinal Study,” Management Science, 45, 6, 1999, 824–842.

Dennis, M.J., and A. Kambil. “Service Management: Building Profi ts after the Sale,” Supply Chain Management Review, January–February 2003, 42–49.

Interactive Case: Virtual Company

On-line Case: Cruise International, Inc.

Assignment: Service Package and Processes at Cruise International, Inc. Now that you have learned some- thing about the big picture at CII, you believe it is time to learn some specifi cs. You call Bob Bristol to report your progress and ask for the details of your next assignment.

“I am pleased with your progress in familiarizing yourself with CII and its operations. Now it is time for you to tackle a specific assignment under the direction of Leila Jensen, the hotel manager aboard the MS Friendly Dreams I. Specifically, you must develop a good understanding of the service pack- age currently offered by CII to its customers and the

service delivery process it uses. At the strategic level, the service package must be consistent with the company’s mission statement and the competitive priorities that it wants to emphasize.” This assign- ment will enhance your knowledge of the material in Chapter 3 of your textbook while preparing you for future assignments.

To access the Web site: • Go to www.wiley.com/college/reid

• Click Student Companion Site

• Click Virtual Company/Cruise International, Inc.

• Click Consulting Assignments

• Click Service Package and Processes at CII

On-line Case: Product Design and Process Selection at Valley Memorial Hospital

Assignment: Service Package and Processes at Valley Memorial Hospital With just a couple of weeks left before you start working at Kaizen for its client Valley Memorial Hospital, it is essential for you to get some specifi c insights into the company’s operations. Th is assignment will enable you to enhance your knowledge of the material in Chapter 3 while continuing to prepare you for a successful internship. Bob Reilly suggests you learn more about the service package at VMH.

To access the Web site: • Go to www.wiley.com/college/reid

• Click Student Companion Site

• Click Virtual Company/Valley Memorial Hospital

• Click Kaizen Consulting, Inc.

• Click Consulting Assignments

• Click Service Package and Processes at Valley Memorial Hospital

www.wiley.com/college/reid

Selected Bibliography • 97

D’Souza, D.E., and F.P. Williams. “Toward a Taxonomy of Manufacturing Flexibility Dimensions,” Journal of Operations Management, 18, 2000, 577–593.

Fitzsimmons, J.A., and M.J. Fitzsimmons. Service Management: Operations, Strategy, and Information Technology, Fifth Edition. New York: Irwin McGraw-Hill, 2005.

Hayes, R.H., G. Pisano, D. Upton, and S.C. Wheelwright. Operations Strategy and Technology: Pursuing the

Competitive Edge. New York: John Wiley & Sons, 2005.

Hayes, R.H., and S.C. Wheelwright. Restoring Our Competitive Edge: Competing through Manufacturing. New York: John Wiley & Sons Inc., 1984.

Hayes, R.H., and S.C. Wheelwright. “Link Manufacturing Process and Product Life Cycles,” Harvard Business Review, 57, January–February 1979, 133–140.

Hill, T. Manufacturing Strateg y : Text and Cases, Third Edition. New York: McGraw-Hill, 2000.

Iansiti, M., and K.R. Lakhani. “Digital Ubiquity: How Connections, Sensors, and Data Are Revolutionizing Business,” Harvard Business Review, November 2014.

Pannirselvam, G.P., L.A. Ferguso, R.C. Ash, and S.P. Sifered. “Operations Management Research: An Update for the 1990’s,” Journal of Operations Management, 18, 1999, 95–112.

Porter, M., and E. Heppelmann. “How Smart, Connected Products Are Transforming Competition,” Harvard Business Review, November 2014.

Sanders, N.R. Big Data Driven Supply Chain Management. New York. FT Pearson, 2014.

Ward, P.C., T.K. McCreery, L.P. Ritzman, and D. Sharma. “Competitive Priorities in Operations Management,” Decision Science, 29, 4, 1998, 1035–1046.

98

Before studying this chapter you should know or, if necessary, review

1. The implications of competitive priorities, Chapter 2.

2. Product design considerations, Chapter 3.

3. Process selection considerations, Chapter 3.

Learning Objectives After studying this chapter you should be able to 1 Describe basic supply chains

and supply chain management.

2 Explain issues affecting supply chain management.

3 Explain the role of purchasing.

4 Illustrate how sourcing decisions are made.

5 Describe the role of warehousing.

6 Describe how supply chain management is implemented.

B uying a product used to mean browsing through mail-order catalogs or getting dressed, leaving home, and shopping at stores or malls until you found what you wanted. Today, most of us can go on-line anytime during

the day, seven days a week, and buy just about anything over the Internet. You can shop while sitting at your computer and never need to leave home. You can order food from a supermarket or a restaurant on-line or buy clothing and household goods. You can buy books, videos, CDs, or more expensive products like diamonds and cars, or even book your vacation—the Internet has revolutionized the way we do business by allowing us access to numerous suppli- ers around the world.

The Internet also has allowed companies to change the way they find the materials and supplies that are needed for their operations. Business-to- business (B2B) transactions are conducted between companies and their suppliers, distributors, and customers. Even though direct sales to the general public are more familiar, B2B transactions make up the majority of Internet transactions.

One of the most publicized examples is Covisint, a global business-to-business automotive supplier exchange site, begun in 2000 as an initiative by the U.S. auto- makers Ford Motor Company, General Motors, DaimlerChrysler, Nissan/Renault, and PSA Peugeot Citroën. Covisint became the largest industry-sponsored net marketplace. Covisint has over 300,000 users, representing 45,000 different com- panies, located in 96 different countries.

While Covisint began as the electronic marketplace for the auto industry, in 2004 the company was bought by Compuware Company. Since that time Covisint has expanded into healthcare, oil and gas, and other industries. Covisint, a pioneer in cloud computing, developed applications that help organizations connect, com- municate, and collaborate with members of their supply chain. Using AppCloud, a secure third-party application marketplace, Covisint enables access to soft- ware-as-a-service applications. •

4

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Supply Chain Management

Basic Supply Chains • 99

Basic Supply Chains

A supply chain is the network of activities that delivers a finished product or service to the customer. These include sourcing raw materials and parts, manufacturing and assembling the products, warehousing, order entry and tracking, distribution through the channels, and delivery to the customer. An organization’s supply chain is facilitated by an information system that allows relevant information such as sales data, sales forecasts, and promotions to be shared among members of the supply chain. Figure 4.1 shows a basic supply chain structure for a manufacturer.

At the beginning of the chain are the external suppliers who supply and transport raw materials and components to the manufacturers. Manufacturers transform these materi- als into finished products that are shipped either to the manufacturer’s own distribution centers or to wholesalers. Next, the product is shipped to retailers who sell the product to the customer. Goods flow from the beginning of the chain through the manufacturing process to the customer. Relevant information flows back and forth among members of the supply chain.

Supply chain management (SCM) is the vital business function that coordinates and manages all the activities of the supply chain linking suppliers, transporters, internal

Supply chain A network of all the activities involved in delivering a fi nished product or service to the customer.

MKT

Supply chain management (SCM) Management of the fl ow of materials from suppliers to customers in order to reduce overall cost and increase responsiveness to customers.

Consumers

Suppliers

Manufacturers

Wholesalers/ Warehousers

Retailers

G o

o d

s fl

o w

In fo

rm a ti

o n fl

o w

Raw materials component parts

Shipping schedules Items and quantities

Master production schedule Shipping schedule Daily production quotas

Inventory status Custom configurations

Point-of-sale data Promotional plans Inventory status Custom product req’s.

Basic finished goods

Customized products

FIGURE 4.1 Basic supply chain

100 CHAPTER 4 • Supply Chain Management

departments, third-party companies, and information systems. Supply chain management for manufacturers entails

· Coordinating the movement of goods through the supply chain from suppliers to manufacturers to distributors to the fi nal customers

· Sharing relevant information such as sales forecasts, sales data, and promotional campaigns among members of the chain

A prime example of operations management (OM), supply chain management provides the company with a sustainable, competitive advantage, such as quick response time, low cost, state-of-the-art quality design, or operational flexibility.

Dell Computer Corporation is a good example of a company using its supply chain to achieve a sustainable competitive advantage. Quick delivery of customized computers at prices 10–15 percent lower than the industry standard is Dell’s competitive advantage. A customized Dell computer can be en route to the customer within 36 hours. This quick response allows Dell to reduce its inventory level to approximately 13 days of supply compared to the more common industry norm of 25 days of supply. Dell achieves this in part through its warehousing plan. Most of the components Dell uses are warehoused within 15 minutes travel time to an assembly plant. Dell does not order components at its Austin, Texas, facility; instead, suppliers restock warehouses as needed, and Dell is billed for items only after they are shipped. The result is better value for the customer.

Components of a Supply Chain for a Manufacturer A company’s supply chain structure has three components: external suppliers, internal functions of the company, and external distributors. Figure 4.2 shows a simplified supply chain for packaged dairy products, a manufacturing operation.

External suppliers include the dairy farmer, cardboard container manufacturer, label company, plastic container manufacturer, paper mill, chemical processing plant, lumber company, and chemical extraction plant. Internal functions include the processing of the raw milk into consumer dairy products and packaging and labeling dairy products for distribution to retail grocery outlets. The external distributors transport finished products from the manufacturer to retail grocers, where the products are sold to the customer. The supply chain includes every activity from collecting the raw milk, producing the consumer dairy products, packaging the dairy products, distributing the packaged dairy products to retail grocers, to selling the finished dairy products to the customer. Let’s look at each component of this supply chain in more detail.

External Suppliers External suppliers for a dairy products manufacturer are shown in Figure 4.2. The dairy products are packaged in either cardboard or plastic containers made by tier one suppliers. Note that any supplier that provides materials directly to the processing facility is designated as a tier one supplier (in this case, the dairy farm, the cardboard container manufacturer, the label company, and the plastic container manufacturer).

The paper mill and the chemical processing plant are tier two suppliers because they directly supply tier one suppliers but do not directly supply the packaging operation. The lumber company that provides wood to the paper mill is a tier three supplier, as is the chemical extraction plant that supplies raw materials to the chemical processing plant.

Companies put substantial effort into developing the external supplier portion of the supply chain because the cost of materials might represent 50–60 percent or even more of the cost of goods sold. A company is typically involved in a number of supply chains and often in different roles. In the supply chain for the plastic container manufacturer shown in Figure 4.2, for example, the chemical plant is now a tier one supplier and the chemical extraction facility is a tier two supplier. Even though the plastic container manufacturer was

External suppliers All suppliers providing materials or services to manufacturing or service organizations, including the suppliers’ suppliers.

Internal functions Activities performed by the fi nal product company, such as processing, purchasing, production planning and control, quality assurance, and shipping.

External distributors Transport product or service to appropriate locations for eventual sale to customers.

Tier one supplier Supplies materials or services directly to the processing facility.

Tier two supplier Directly supplies materials or services to a tier one supplier in the supply chain.

Tier three supplier Directly supplies materials or services to a tier two supplier in the supply chain.

Basic Supply Chains • 101

a tier one supplier to the milk processing facility, the plastic container manufacturer still has its own unique supply chain. Now consider the supply chain for a retail grocer: the tier one suppliers are providers of packaged consumer products, and the grocer has no external dis- tributors because the customers buy directly from the store. As you can see, supply chains come in all shapes and sizes.

Remember that tier one suppliers (the cardboard container manufacturer, dairy farm, label company, and plastic container manufacturer in Figure 4.2) directly supply the con- sumer product manufacturer (packaged dairy products), whereas tier two suppliers (paper mill and chemical processing plant) directly supply tier one suppliers. To summarize: supply chains are a series of linked suppliers and customers in which each customer is a supplier to another part of the chain until the product is delivered to the final customer.

Customers

Retail Grocers

Processing and Packaging

Facility

External distributors

External suppliers

Tier one suppliers

Tier two suppliers

Tier three suppliers

Material flow

Ra w

d ai

ry p

ro du

ct s

C ar

d b

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ta in

e rs Plastic containers

Dairy farm

Cardboard

Wood

Label company

Plastic container

manufacturer

Lab e

ls

Cardboard container

manufacturer

Paper mill

Lumber company

Chemicals

Raw materials

Chemical plant

Chemical extraction plant

Information flow

Internal functions

FIGURE 4.2 Dairy products supply chain

102 CHAPTER 4 • Supply Chain Management

Internal Functions Internal functions in, for example, a dairy products supply chain are as follows:

· Processing, which converts raw milk into dairy products and packages these products for distribution to retail grocery outlets.

· Purchasing, which selects appropriate suppliers, ensures that suppliers perform up to expectations, administers contracts, and develops and maintains good supplier relationships.

· Production planning and control, which schedules the processing of raw milk into dairy products.

· Quality assurance, which oversees the quality of the dairy products.

· Shipping, which selects external carriers and/or a private fl eet to transport the product from the manufacturing facility to its destination.

External Distributors External distributors transport finished products to the appropriate locations for eventual sale to customers. Logistics managers are responsible for managing the movement of products between locations. Logistics includes traffic management and distribution management. Traffic management is the selection and monitoring of external carriers (trucking companies, airlines, railroads, shipping companies, and couriers) or internal fleets of carriers. Distribution management is the packaging, storing, and han- dling of products at receiving docks, warehouses, and retail outlets.

A Supply Chain for a Service Organization Up till now, the discussion has focused on supply chains for manufacturing organizations rather than service organizations. However, service organizations can also benefit from supply chain management. A supply chain for a service organization is similar to that for manufacturing organizations since external suppliers, internal operations, and external distributors can be needed. In the case of an e-tailer, supply chain management can be used to integrate external suppliers (usually providing better demand forecast information to its suppliers, thus reducing uncertainty within the chain); it has internal operations with regard to order processing, order picking, and so on; and it can have external distribution done by a third-party provider (such as FedEx, UPS, or DHL).

Let’s look at an example of a supply chain for a full-service travel agency as shown in Figure 4.3. The agency arranges a wide variety of trips for its customers. The service can be as simple as making airline, train, hotel, cruise, car rental, or personal tour arrangements for the customer. A customer can require a single type of service or have a highly complicated travel request.

Internal Operations The internal operations at the travel agency are split into two parts: Travel Planning and Travel Payment.

Travel Planning begins with qualifying potential suppliers of travel services. The agency does not provide the actual travel but makes the arrangements. The agency must know the scope of services provided, as well as the quality of the services, the reliability of the provider, the safety of the service, the financial solvency, the language capability of the provider, and the like. As people travel throughout the world, it is critical to qualify any service providers used by the agency. The better the agency develops its external suppliers, the better it can match its customers with the right service providers.

The next step deals with the different forms of credit since no business transaction is completed without assuring the financing first. Providers in many developing nations don’t accept credit cards for payment, so it may be necessary to arrange bank transfers (possibly in the local currency) to finalize the service commitment. The agency must also clarify refund and cancellation policies.

MKT

Logistics Activities involved in obtaining, producing, and distributing materials and products in the proper place and in proper quantities.

Traffi c management Responsible for arranging the method of shipment for both incoming and outgoing products or materials.

Distribution management Responsible for movement of material from the manufacturer to the customer.

Basic Supply Chains • 103

Pricing deals with negotiation of terms for delivery of the service and price discounts. Group discounts may be available. Discounts may be offered for services booked during traditionally low seasons. The agency can use integrated cost data, including available discounts and other incentives, to influence customer decisions.

The last process of Travel Planning is assuring that any risk is minimized for the customer. This can be done by having integrated supplier performance files. The agency can evaluate past performance by the supplier and determine how to minimize any risk associ- ated with using the supplier (a backup provider, just in case) or travel insurance.

Travel Planning is about having a database of service providers that can be accessed instantly for use in arranging real-time travel for customers. Often the customer is sitting at the desk of a travel agent or is on the phone or Internet with the agent. The integrated database facilitates travel arrangements.

Travel Payment includes invoicing, dispute resolution, and payment to suppliers. The agency creates an integrated invoice for its customers. The agency can have both com- mercial and private accounts. Commercial clients can often receive a consolidated invoice monthly. Most private accounts are invoiced after the trip has been booked. It can include a payment required at time of booking, with the balance due prior to the actual travel. Providing a consolidated invoice reduces the number of transactions with the customer. Often systems for electronic payment are used.

The agency can be the focal point for all complaint resolution. This reduces the risk of miscommunications and provides a resolution process for both the customer and the ser- vice provider.

Payment of the invoice to the agency results in subsequent payment to the service pro- viders. Ideally, payments are processed by data transfer, thus reducing the time to cash for the service providers.

The External Distributors For the travel agency, the external distributors deliver the actual service to the customer. The external distributor is the service provider of the transportation or tour (the airline, the cruise company, the tour guides, the car rental agency, etc.). Although the agency makes all of the arrangements, the service provider is not part of the agency.

External Suppliers

Travel Planning Travel Payment Actual Providers

Internal Operations External Distributors

Airlines

Cruise lines

Trains

Tour operators

Hotels

Car rentals

Private guides

Delta, United

Celebrity Cruises

Orient Express

Shore Trips

Marriott, Hyatt

Hertz, Avis

Sourcing

Assuring

Financing

Pricing

Invoicing

Disputes

Payment

C u sto

m e rs

FIGURE 4.3 Supply chain for a travel agency

104 CHAPTER 4 • Supply Chain Management

Services deal with many of the same issues that face manufacturers. The intent is to integrate the internal operations (arranging for the travel, billing the customer, paying the service suppliers, and tracking the services provided to the customer).

The Bullwhip Effect Sharing product demand information between members of a supply chain is critical. How- ever, inaccurate or distorted information can travel through the chain like a bullwhip uncoiling. The bullwhip effect, as this is called, causes erratic replenishment orders placed on different levels in the supply chain that have no apparent link to final product demand. The results are excessive inventory investment, poor customer service levels, ineffective transportation use, misused manufacturing capacity, and lost revenues. We will discuss the causes of the bullwhip effect, and how they send inaccurate or distorted information down the supply chain. First, however, let’s look at the traditional supply chain, shown in Figure 4.4, and follow the product demand information flow from the final seller back to the manufacturer of the product:

1. Th e fi nal seller periodically places replenishment orders with the next level of the supply chain, which could be a local distributor. Th e timing and order quantity—for example, monthly orders in varying amounts—are determined by the fi nal seller. Th e timing and quantity can be fi xed or variable.

2. Th e local distributor has many customers ( fi nal sellers) placing replenishment orders. Each fi nal seller uses it own product demand estimates and quantity rules. Based on these replenishment orders, the local distributor places replenishment orders with its supplier, which could be a regional distribution center (RDC).

3. As before, the customers (the local distributors) determine the timing and quantity of orders placed with the RDC. Each RDC periodically places orders based on demand at the RDC by ordering from the manufacturer of the fi nished good.

4. In turn, the manufacturer develops plans and schedules production orders based on orders from the RDCs. Th e manufacturer does not know what the demand is for the fi nished good by the fi nal customer but knows only what the RDCs order.

The greater the number of levels in the supply chain, the further away the manufacturer is from final customer demand. Since suppliers in the chain do not know what customer demand is or when a replenishment order might arrive, suppliers stockpile inventory.

MKT

Manufacturer

Demand information

is far removed from actual

customer demand

Regional Distributor

Regional distributor’s demand information flows to manufacturer

Local Distributor

Local distributor’s demand

information only flows to regional

distributor

Retailer Customers

Retailer’s demand information only flows

to local distributor

FIGURE 4.4 Traditional supply chain information flow

Bullwhip effect Inaccurate or distorted demand information created in the supply chain.

Basic Supply Chains • 105

Causes of the Bullwhip Effect The causes of the bullwhip effect are demand forecast updating, order batching, price fluctuations, and rationing and shortage gaming. Let’s look at each of these causes.

Each member in the supply chain, beginning with the retailers, does demand forecast updating with every inventory review. Based on actual demand, the retailers update their demand forecast. The retailers review their current inventory level and, based on their inventory policies, determine whether a replenishment order is needed. The wholesalers repeat the process. Note that the demand is from the retailers’ inventory replenishments and may not reflect actual customer demand at the retail level. The wholesalers update their demand forecast and place appropriate replenishment orders with the distribution centers. The distributors repeat the process, updating their demand forecasts based on demand from the wholesalers. The distributors review their inventory levels and place the appropriate orders with the manufacturer. These orders are determined by the inventory policies at the distributors. Orders placed with the manufacturer end up replenishing each level in the supply chain rather than being directly linked to end-customer demand.

A company does order batching when, instead of placing replenishment orders right after each unit is sold, it waits some period of time, sums up the number of units sold, and then places the order. This changes constant product demand to lumpy demand—a situation where certain levels in the supply chain experience periods of no demand. Order batching policies amplify variability in order timing and size.

Price fluctuations cause companies to buy products before they need them. Price fluc- tuations follow special promotions like price discounts, quantity discounts, coupons, and rebates. Each of these price fluctuations affects the replenishment orders placed in the supply system. When prices are lower, members of the supply chain tend to buy in larger quantities. When prices increase, order quantities decrease. Price fluctuations create more demand variability within the supply chain.

Rationing and shortage gaming result when demand exceeds supply and products are rationed to members of the supply chain. Knowing that the manufacturer will ration items, customers within the supply chain often exaggerate their needs. For example, if you know the company is supplying only 50 percent of the order quantity, you double the order size. If you really need 100 pieces, you order 200 so you are sure to get what you need. Such game-playing distorts true demand information in the system.

Counteracting the Bullwhip Effect Here are four ways of counteracting the bullwhip effect:

1. Change the way suppliers forecast product demand by making this information from the fi nal-seller level available to all levels of the supply chain. Th is allows all levels to use the same product demand information when making replenishment decisions. Companies can do this by collecting point-of-sale (POS) information, a function available on most cash registers.

2. Eliminate order batching. Companies typically use large order batches because of the relatively high cost of placing an order. Supply chain partners can reduce ordering costs by using electronic data interchange (EDI) to transmit information. Lower ordering costs eliminate the need for batch orders.

3. Stabilize prices. Manufacturers can eliminate incentives for retail forward buying by creating a uniform wholesale pricing policy. In the grocery industry, for example, major manufacturers use an everyday low-price policy or a value-pricing strategy to discourage forward buying.

4. Eliminate gaming. Instead of fi lling an order based on a set percentage, manufacturers can allocate products in proportion to past sales records. Customers then have no incentive to order a larger quantity to get the quantity they need.

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Issues Affecting Supply Chain Management

Information technology enablers for supply chain management include the Internet, the Web, EDI (electronic data interchange), intranets and extranets, bar-code scanners, and point-of-sale demand information. We begin by looking at the use of the Internet and the Web as a way of doing business.

E-commerce and Supply Chains E-commerce and e-business are defined as the use of the Internet and the Web to transact business. E-business refers to transactions and processes within an organization, such as a company’s on-line inventory control system, that support supply chain management. E-commerce includes B2B (business-to-business) and B2C (business-to-consumer) transactions. Let’s take a closer look at B2B e-commerce.

In business-to-business e-commerce, companies sell and buy products to and from other businesses. B2B represents the largest segment of e-commerce sales transactions. Prior to the Internet, B2B was relatively inefficient. It took time and resources for companies to search for products, to arrange for purchase and payment, to handle shipment, and finally to receive the items. Using the Internet allowed companies to automate at least parts of the procurement process. Significant dollars are saved by organizations due to effective elec- tronic purchasing research and reduced transaction costs. Let’s look at how B2B commerce has developed.

B2B commerce began in the 1970s with automated order entry systems that used telephone modems to send digital orders to suppliers. One company, Baxter Healthcare Corporation, placed telephone modems in a customer’s purchasing department to auto- mate reordering supplies from Baxter’s computerized inventory database. This technology changed in the 1980s to personal computers and in the 1990s to Internet workstations that access on-line catalogs. Automated order entry systems are seller-side solutions. They are owned by the supplier and only offer the supplier’s product line. The primary benefits to the customers are reduced inventory replenishment costs and supplier-paid system costs.

In the late 1970s, electronic data interchange (EDI) emerged. EDI is a form of com- puter-to-computer communication standardized for sharing business documents such as invoices, purchase orders, shipping bills, and product stocking numbers. Most large firms have EDI systems, and most inventory groups have industry standards for defin- ing the documents to be communicated. EDI systems are buyer-side solutions: they are designed to reduce the procurement costs for the buyer. EDI systems generally serve a specific industry.

In the mid-1990s, electronic storefronts emerged. Electronic storefronts are on-line catalogs of products made available to the general public by a single supplier. These store- fronts evolved from the automated order entry systems. They are far less expensive than their predecessors because (1) they use the Internet as the communication medium, and (2) the storefronts tend to carry products that serve a number of different industries.

Net marketplaces emerged in the late 1990s. A net marketplace is designed to bring hundreds or thousands of suppliers (each with electronic catalogs) together with a signifi- cant number of purchasing firms in a single Internet-based environment to conduct trade. Covisint (www.covisint.com) is an example of a successful net marketplace. Covisint was started in 1999 by a consortium of the following auto manufacturers: General Motors, Ford Motor Company, DaimlerChrysler, Nissan, and Renault. Its purpose was to address escalat- ing costs and gross inefficiencies within their industry. Covisint leveraged the power and

E-commerce Using the Internet and the Web to transact business.

Automated order entry system A method using telephone modems to send digital orders to suppliers.

Electronic data interchange (EDI) A form of computer-to- computer communications that enables sharing business documents.

Electronic storefronts On- line catalogs of products made available to the general public by a single supplier.

Net marketplaces Suppliers and buyers conduct trade in a single Internet-based environment.

Issues Affecting Supply Chain Management • 107

potential of the Internet to solve industry-specific business problems in real time. Its goal was to deliver a secure marketplace, portal, and application-sharing platform for the global automotive industry. Since being bought by Compuware in 2004, Covisint has expanded into the healthcare, aerospace, public sector, and financial services industries.

A net marketplace can also facilitate on-line auctions. Two types of auctions are forward auctions (where suppliers auction excess inventory and receive the market price for their sur- plus goods) and reverse auctions (where buyers post electronic requests for quotes [eRFQs] for goods and services and suppliers bid for business on-line).

A virtual private network (VPN) is a computer network in which some of the links between nodes are carried by open connections or virtual circuits on the Internet instead of by physical wires. An organization can have a VPN for use by its own employees as well as suppliers and customers. Through this network, buyers and suppliers can work together on product design and development, manage inventory replenishments, coordinate produc- tion schedules, and work as partners. Access to the VPN is typically password controlled. More than likely, your university has a VPN for your use.

The potential benefits from Internet-based B2B commerce include.

· Lower procurement administrative costs.

· Low-cost access to global suppliers.

· Lower inventory investment due to price transparency and quicker response times.

· Better product quality because of increased cooperation between buyers and sellers, especially during product design and development.

In business-to-consumer (B2C) e-commerce, on-line businesses try to reach individ- ual consumers. Let’s examine the different models that on-line businesses use to generate revenue. In the advertising revenue model, a Web site offers its users information on ser- vices and products, and provides an opportunity for providers to advertise. The company receives fees for the advertising. Yahoo.com derives its primary revenue from selling adver- tising such as banner ads.

In the subscription revenue model, a Web site that offers content and services charges a subscription fee for access to the site. One example is Consumer Reports Online (www. consumerreports.org), which provides access to its content only to subscribers at a rate of $3.95 per month. Companies using this model must offer content perceived to be of high value that is not readily available elsewhere on the Internet for free.

In the transaction fee model, a company receives a fee for executing a transaction. For example, Orbitz (www.orbitz.com) charges a small fee to the consumer when an airline res- ervation is made. Another example, E*Trade Financial Corporation, an on-line stockbroker (www.etrade.com), receives a transaction fee each time it executes a stock transaction.

In the sales revenue model, companies sell goods, information, or services directly to customers. Amazon.com, primarily a book and music seller, Travelocity.com, an airline and hotel reservations provider, and DoubleClick Inc. (www.doubleclick.net), a company that gathers information about on-line users and sells it to other companies, all use the sales revenue model.

In the affiliate revenue model, companies receive a referral fee for directing business to an “affiliate” or receive some percentage of the revenue resulting from a referred sale. For example, MyPoints.com receives money for connecting companies with potential custom- ers by offering special deals. When members take advantage of the deal, they earn points that can later be redeemed for goods.

In addition to the Internet, companies use other technology to help manage supply chains. For example, intranets are networks internal to an organization. Intranets allow a company to network groups of internal computers together to form more effective infor- mation systems. Typically, members of the organization communicate internally on the

Electronic request for quote (eRFQ) An electronic request for a quote on goods and services.

Virtual private network (VPN) A private Internet- based communications environment that is used by the company, its suppliers, and its customers for day-to- day activities.

Business-to-consumer (B2C) e-commerce On-line businesses sell to individual consumers.

Advertising revenue model Provides users with information on services and products and provides an opportunity for suppliers to advertise.

Subscription revenue model A Web site that charges a subscription fee for access to its contents and services.

Transaction fee model A company receives a fee for executing a transaction.

Sales revenue model A means of selling goods, information, or services directly to customers.

Affi liate revenue model Companies receive a referral fee for directing business to an affi liate.

Intranets Networks that are internal to an organization.

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intranet. Organizations can link intranet systems of the Internet to form extranets. The extranet can be expanded to include both a company’s suppliers and customers. Typically, real-time inventory status is available on the extranet as well as production schedules. Extranets allow suppliers and customers to “see” within the organization. The primary dif- ference between the Internet, intranets, and extranets is who has access to the system. The Internet is wide open, the intranet is open to members of an organization, and the extranet is open to members of the organization as well as to suppliers and customers.

The past few years have seen increased use of electronic marketplaces that bring thousands of suppliers together with thousands of buyers. The objectives of these net marketplaces are to have suppliers compete on price, to encourage automated low-cost transactions, and to reduce the price of industrial supplies.

E-distributors are the most common form of net marketplace. E-distributors provide electronic catalogs representing the products of thousands of suppliers. E-distributors are independently owned intermediaries that provide a single source for customers to make spot purchases. About 40 percent of a company’s items are purchased on a spot basis. E-distributors typically have fixed prices but do offer quantity discounts to large custom- ers (see Chapter 12). The primary benefits of e-distribution to the manufacturing company are lower product search costs, lower transaction costs, a wide selection of suppliers, rapid product delivery, and low prices.

E-purchasing companies connect on-line suppliers offering maintenance, repair parts, and operating supplies (MRO) to businesses that pay fees to join the market. E-procurement companies are typically used for long-term contractual purchasing and offer value chain management services to both buyers and sellers. Value chain management (VCM) auto- mates a firm’s purchasing or selling processes. VCM automates purchase orders, requisi- tions, product sourcing, invoicing, and payment. For suppliers, VCM automates order status, order tracking, invoicing, shipping, and order corrections.

On-line exchanges connect hundreds of suppliers to unlimited buyers. Exchanges create a marketplace focusing on spot requirements of large firms in a single industry, such as the auto- motive industry or electronics industry. Examples of exchanges include ProcureSteel.com (a market for steel products), travelindustryexchange.com (an exchange bringing together travel professionals and international travel suppliers), and printindustry.com (an exchange bringing together print buyers and on-line international print suppliers).

The last type of net marketplace is an industry consortium. Industry consortia are industry-owned markets that enable buyers to purchase direct inputs from a limited set of invited participants. The objective of an industry consortium is the unification of sup- ply chains within entire industries through a common network and computing platform. Examples of industry consortia include Covisint.com (automotive industry), Avendra.com (hospitality industry), and TomballForest.com (premium forest products). It is clear that net marketplaces will be a dominant factor in effective supply chain management now and in the future. Technology continues to bring suppliers, buyers, and distributors closer together so that supply chains can be managed effectively.

Consumer Expectations and Competition Resulting from E-commerce On-line retailing, or business-to-consumer e-commerce, has shifted the power from the suppliers to the consumers. This shift in power has occurred because the Internet greatly reduced search and transaction costs for the consumer. It was estimated as early as April 2001 that some 100 million people and over 80 percent of all individuals with Internet access had purchased something (either a product or a service) on-line. In addition, millions more customers researched products on-line and subsequently bought those items off-line. The

Extranets Intranets that are linked to the Internet so that suppliers and customers can be included in the system.

E-distributors Independently owned net marketplaces having catalogs representing thousands of suppliers and designed for spot purchases.

E-purchasing Companies that connect on-line MRO suppliers to businesses that pay fees to join the market, usually for long-term contractual purchasing.

Value chain management (VCM) Automation of a fi rm’s purchasing or selling processes.

Exchanges A marketplace that focuses on spot requirements of large fi rms in a single industry.

Industry consortia Industry- owned markets that enable buyers to purchase direct inputs from a limited set of invited suppliers.

Issues Affecting Supply Chain Management • 109

capability to quickly search, evaluate, compare, and purchase products gives the consumer considerable power. Examples of successful B2C businesses are Amazon.com, eBay, BMG Music Service, Barnesandnoble.com, Columbia House, Half.com, and JCPenney. E-tailers have penetrated significantly the following markets: computer hardware and software, books, travel, music and videos, collectibles and antiques, and event tickets.

Since customers have access to so many suppliers, it is important for suppliers to differ- entiate themselves by providing customers with excellent value. Dell Computer Corpora- tion, Gateway, Inc., L.L.Bean, Inc., Lands’ End, Inc., Amazon.com, UPS, and FedEx are good examples of companies that put a premium on values such as preferred customer service, short lead times, and/or quality guarantees. Dell differentiates itself with short lead times. The company does this by warehousing most of the components used to assemble its com- puters within 15 minutes of the assembly facility and building customized computers in an assemble-to-order strategy.

Consider how Lands’ End uses technology in its business. Lands’ End went on-line in 1995. The company sold only $160 worth of gear the first month. Today, Lands’ End is one of the nation’s largest apparel retailers on-line. The com- pany has a live chat room that allows customers to ask questions about merchandise. It also offers a “shopping with a friend” service that allows a customer, his or her friend or friends, and a customer service representative to be linked together. Lands’ End’s “virtual model” highlights how far technology has advanced. A few strokes on the keyboard and the shopper is able to produce an on-screen model with his or her body measurements. Even though this virtual model is not perfect, over 1 million shoppers have built their own models at the Lands’ End site.

An additional issue here is how companies handle the return of unwanted merchan- dise and provide for product exchanges or refunds. The Boston Consulting Group (BCG) reported that the “absence of a good return mechanism” was the second-highest reason shoppers cited for not shopping on the Web. There are methods for handling returns. An on-line company often first requires authorization to return an item, then the customer must pack up the item, pay to ship it back to the company, insure the item, and then wait for a credit to be made. Once the item is returned, the original seller must unpack the item, inspect the item, check the paperwork, and try to resell the item. Typically, neither the buyer nor seller is happy with the process.

Another approach allows the customer to drop the returned items at collection stations (sometimes the physical stores of the company, for example, Staples, Inc., Sears, Roebuck and Company, OfficeMax, Inc., etc.). The returned items can then be sold from the receiving store or picked up in bulk and returned to the distribution point. Another approach is to completely outsource returns. FedEx and UPS provide such services.

In addition to buying products on-line, consumers also buy on-line services. Finance, insurance, real estate services, business services, and health services are the largest on-line service industries. Business services include consulting, advertising and marketing, and information processing.

Service organizations are categorized as either those that do transaction brokering or those that provide a “hands-on” service. An example of transaction brokering is a company providing financial services that has stockbrokers acting as intermediaries between buyers

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and sellers of stock. An example of a “hands-on” service is a legal service that interacts directly with the consumer to create a legal document. In general, most service organiza- tions are knowledge- and information-intense. To provide value to consumers, these service companies must process considerable information (legal services or medical services) and employ a highly educated and skilled workforce (lawyers and doctors).

Globalization As globalization continues to increase, supply chains cover greater geographical distances, face greater uncertainty, and can end up being less efficient. Beginning in 2004, prices for steel, oil, copper, cement, and coal began rising at double-digit rates. These increases led buyers to look globally for lower-cost alternative suppliers. After purchasing items offshore, companies were challenged with moving the commodities over longer distances. This increase in volume resulted in a transportation capacity crunch and led to higher trans- portation rates. The lack of capacity slowed down supply chains, causing inventory levels to rise. In 2008, transportation rates went even higher due to the very high fuel costs. These higher costs have prompted companies to reexamine their offshore sourcing and to con- sider returning to onshore suppliers.

Ocean carriers have predicted that the volume of goods shipped from Asia to the United States will continue to have double-digit annual increases. Most of these inbound goods are shipped through U.S. West Coast ports. The higher trade volume has caused port conges- tion in California and Washington State. In an effort to ease port congestion, ocean carriers introduced larger ships for use on the transpacific routes. While it was hoped that these larger ships would add needed capacity and reduce operating costs, only a few U.S. ports are capable of handling the larger ships. The ships take longer to unload and reload, tying up the port for five to seven days rather than the normal two days. The longer port time has reduced terminal efficiency. Previously, importers were allowed more free time (the time cargo may occupy assigned space free of storage charges) for containers at U.S. port ter- minals. Container free time basically provided a cheap form of portable warehousing for importers. Because of the terminal inefficiency, container free time has been reduced and ports have increased storage capacity in an effort to turn equipment around faster.

As a result of the congestion in the ports located on the West Coast of the United States, companies sometimes use Mexican ports located in Lazaro Cardenas, Manzanillo, Veracruz, and Altamira, as alternatives for containers shipped from Asia. A large proportion of the goods received in Mexican ports are distributed domestically in Mexico. However, major retailers (such as Wal-Mart, Home Depot, and Target) routinely use these Mexican ports to expedite delivery of Asia-sourced goods for subsequent distribution in the United States. After the economic slowdown in 2008–2009, container traffic through the Los Angeles and the Long Beach ports is once again on the rise.

In hopes of providing an alternative to congested U.S. ports, Mexican port officials pro- mote the advantages of using Mexican ports. Mexican port officials emphasize the lower labor cost (about one-fourth of the wages in Los Angeles and Long Beach), a record of labor stability (over 85 years without a strike at Mexico’s ports), and improved speed to market. Prior to the slowing economy, Mexico proposed building a new deep sea port in Punta Colo- net (Baja California) and linking it with a proposed rail line to Yuma. This port location would be closer to the U.S. border than the other major Mexican ports, thus increasing the speed to market. The proposal was to be privately funded. In 2012, the Mexican government officially announced the cancellation of the project, citing a lack of interest given the cur- rent economic conditions.

One of the additional threats to the Los Angeles and Long Beach ports is a $5.25 billion project that deepens and widens the Panama Canal. This project allows ships from Asia to

Issues Affecting Supply Chain Management • 111

bypass the West Coast ports for deep water ports located on the U.S. Gulf Coast. A second threat to the Los Angeles and Long Beach ports is a recent $900 million project undertaken by APM Terminals (a part of Danish oil and shipping group A.P. Møller-Maersk). APM Terminals is converting the port at Lazaro Cardenas into a super port.

Because of pollution and endangered whale safety, shippers to California have agreed to reduce speeds to 12 knots or less when transiting the Santa Barbara Channel. The reduced speed reduces emissions of smog-forming air pollutants and can save the lives of whales by reducing collisions between ships and whales. Ship strikes play a role in the death of one to three whales annually. In return for slowing down, the company is paid for each ship’s tran- sit through the channel.

Another issue is border security. Since September 11, 2001, the U.S. Customs and Border Protection (CBP) has implemented new requirements. Essentially, these programs result in additional processing time. The CBP has also increased inspections at ports of suspicious cargo, creating additional port delays.

In 2011, the U.S. and Mexican governments signed a memorandum of understanding on a new cross-border trucking program. With this new agreement, shippers will face fewer retaliatory tariffs on hundreds of products now being exported to Mexico. Shippers will need to be especially vigilant when they choose third-party logistics partners when engaged in cross-border trade.

As supply chains expand globally, they share some common logistical characteristics. For example, with ocean shipping, goods tend to arrive at a warehouse in very large quantities. Because of bulk arrivals, greater break-bulk activity is required. Break-bulk entails sorting the bulk shipments into smaller customer shipments. These global supply chains typically have higher inventory levels. Managing global supply chains in developing countries will be challenging in the near future.

Infrastructure Issues Global supply chains with members in developing countries can face substantial infrastruc- ture issues (such as inadequate transportation networks, limited telecommunication capa- bilities, uncertain power continuity, low worker skill, poor supply availability and quality, etc.). Each of these issues increases uncertainty in supply and demand for the supply chain, which results in higher costs and poorer service.

Inadequate transportation networks increase distribution lead times. Roads may be inadequate to transport heavy loads (necessitating the creation of smaller loads), rail travel may be unavailable or very limited in terms of frequency (once or twice a week), air service may be limited in frequency (one or two flights per day or less), and ocean shipping may be limited by the capabilities of the port. It is not unusual for an item to change hands four to eight times before reaching the final customer.

Poor telephone service can restrict the timely availability of supply and demand infor- mation. Because of this, a more extensive information system to keep track of items is often required. An unstable power supply can significantly affect the output of a supplier, in terms of both when the product can be produced and the effect on product quality caused by unstable power.

A lack of specific worker skills can limit the technology a firm uses. For example, numer- ically controlled (NC) machines use more easily trained machine setters and programmers rather than more highly skilled machinists. The increased use of NC machines in South America is a result of an inadequate number of skilled machinists.

A lack of available local materials and competent suppliers can force a firm to rede- sign its process, or even its product, to minimize or eliminate the use of scarce materials. Imported raw materials may be difficult to obtain due to import restrictions. In some cases,

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no local suppliers are available. A case in point is McDonald’s. When McDonald’s started operations in Russia, it had considerable problems developing high-quality Russian suppliers. McDonald’s used a vertically integrated strategy, developing its own plant and distribution facility for processing meat patties, producing french fries, preparing dairy products, and baking buns and apple pies. Initially, McDonald’s even grew its own potatoes.

Global competition forces firms to supply highly customized products and services to multiple national markets. Usually, a firm manufactures a basic product that is adaptable to many markets. The basic product contains most of the features and components of the finished product along with some market-specific add-on components. For example, com- puter products have country-specific power supplies to accommodate local voltage, fre- quency, and plug types. In addition, keyboards and manuals must match the local language. Such minor variations create a large number of unique finished-product configurations to be managed. Product proliferation further complicates accurate demand forecasting.

As supply chains cover greater distances, they experience greater uncertainty and gen- erally are less efficient. It is likely that supply chain velocity in these global chains will decrease. Practitioners have identified the following characteristics associated with lower- velocity supply chains: lumpy supply/demand (goods tend to arrive at the warehouse in large quantities and sometimes without notice), more break-bulk activity because of the larger quantities, slower long-distance moves as companies source offshore, and higher inventory levels in the pipeline due to longer transit times. These lower-velocity supply chains raise additional questions, such as distribution center location or a better under- standing of the economics of break-bulk and more emphasis on pipeline design.

The major trends driving innovative supply chain design are:

1. Globalization is accelerating. Supply chain volatility and uncertainty have permanently increased. Market transparency and greater price sensitivity have reduced customer loyalty. It is much harder now to diff erentiate one’s product. Future globalization will target product and technology development in addition to manufacturing and assembly.

2. Achieving growth requires truly global customer and supplier networks. Future market growth is expected to come from international customers and customized products. Reducing costs and penetrating new local markets are two key drivers of accelerated globalization. Despite average cost reductions of 17 percent per globalization initiative, many companies have not realized these savings. Th e gap between planned and actual benefi ts is caused by internal barriers that prevent full support of globalization eff orts and external network partners failing to achieve expected performance.

3. Major barriers to globalization include limited supply chain fl exibility and the lack of internal competency to manage partners.

4. Product quality and safety and supply chain delivery and security are the most critical concerns when expanding the supply chain globally.

5. China and India are major targets for globalization. Eastern Europe is catching up as a top off shoring option. Market dynamics require regional, cost-optimized supply chain confi gurations. Investments are designed to secure access to local markets.

6. Environmental sustainability is a major concern in developing future supply chain strategies. Currently, sustainability is mainly driven by regulatory compliance. It is not considered a strategic diff erentiator.

7. Existing supply chain organizations are not truly integrated and empowered. Th e supply chain must be treated as a single integrated organization.

The future of supply chain management seems focused on the development of sustainable, global supply chains.

Supply chain velocity The speed at which product moves through a pipeline from the manufacturer to the customer.

Issues Affecting Supply Chain Management • 113

Government Regulation and E-commerce The issue of government regulation of the Internet is still unresolved. Although early Inter- net users claimed the Internet could not be controlled given its decentralized design and its ability to cross borders, it is clear that the Internet can be controlled. In China, Malaysia, and Singapore, access to the Internet is controlled from government-owned centralized routers. This allows these countries to block access to U.S. or European Web sites. Search engines operating in these countries self-censor their Asian content by using only government- approved news sources. In other countries, freedom of expression has limited restrictions on the Internet. In order for leading Internet company Google to access China’s fast-growing market, it agreed to censor its search services. E-mail, chat room, and blogging services will also not be available because of concerns the government could demand users’ personal information. Google indicated that it would notify users when access had been restricted on certain search terms.

Another e-commerce issue is the collection of sales tax from customers purchasing items on the Internet. It has been described as both a states’ rights issue as well as a fairness issue. The U.S. Supreme Court has ruled that federal law prohibits states from collecting tax on Internet sales unless the company has a physical presence in the state. Because of this, billions of dollars in state sales taxes are lost. Supporters of an Internet sales tax include states that currently have no state sales tax. These states believe that it erodes their competitive advantage when consumers can go on-line and make pur- chases without paying a sales tax. These states have typically marketed the advantage of shopping in a sales-tax-free state. On-line retailers argue that collecting sales tax from consumers throughout the world will create an unreasonable burden as there are 9600 jurisdictions nationwide. Companies would have to make payments to each individual jurisdiction if a person from that jurisdiction made an on-line purchase. It is clear that this remains a major issue to be resolved.

Copyright infringement is also an issue. The U.S. copyright law protects original forms of expression such as writing (books, periodicals), art, drawings, photographs, music, motion pictures, performances, and computer programs from being copied by others for a mini- mum of 50 years. One exception to the U.S. copyright law is the doctrine of fair use. This doctrine allows teachers and writers to use materials without permission under certain circumstances. In response to copyright issues, the U.S. government enacted the Digital Millennium Copyright Act (DMCA) of 1998. The DMCA declares it illegal to make, distrib- ute, or use devices that circumvent technology-based protections of copyrighted materials and attaches stiff fines and prison sentences for violations.

Another issue concerns public safety and welfare. In the United States, e-commerce issues of safety and welfare center around the protection of children, strong antipornogra- phy sentiments, strong antigambling positions, and protection of public health by restricting sales of drugs and cigarettes. It is clear that many issues concerning government regulation of the Internet are yet to be determined.

Green Supply Chain Management Recently, green supply chain management has focused on the role of the supply chain with regard to its impact on the present natural environment as well as to the generation of any future environmental change. The intent is to be able to meet our present needs with- out compromising the ability of future generations to meet their own needs. So, how do we green supply chains?

A number of organizations have introduced “greening” requirements for both their sup- pliers and distributors. These requirements can be purchasing clauses, specified supply chain goals (carbon emission footprint reduction, reduced energy consumption, reduced

Green supply chain management Focuses on the role of the supply chain with regard to its impact on the environment.

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inventory levels, reduced transportation costs, etc.), practices (the use of sustainable farm- ing, agreeing not to use specified materials, etc.), and use or nonuse of specific technologies. Some companies develop a corporate sustainability plan, which is then translated into a code of conduct. This code can be shared with both suppliers and distributors. Members of the supply chain are monitored for compliance. If violations of the code are found, correc- tive action is taken with the intent of building a better supply chain capability. In short, the organization is telling the members of its supply chain: “This is what you must do to be part of our supply chain. If you don’t, we fix it. If it doesn’t get fixed, we find a new member for our supply chain.” The debate centers around how many organizations have that much leverage with members of their supply chain. Clearly, an organization such as Wal-Mart has consid- erable leverage. In fact, it uses a packaging scorecard to evaluate packaging compliance by members of its supply chain.

For supply chains doing business globally, it is important that they understand the packaging restrictions. For example, within the European Union cardboard boxes must be removed from consumption sites and recycled. As a result, U.S. automobile parts producers ship products in reusable containers rather than disposable containers. Reusable packaging products are used to move, store, and distribute products within a single operation or an entire supply chain. Plastic reusable packaging, a form of reusable packaging, can be used to package anything from raw materials to finished goods. It can be used within reverse logistics to return empty containers or pallets for reuse or replenishment. Products include handheld containers, pallets, bulk containers, protective interiors, and custom-designed and engineered packaging.

Companies doing business globally must also focus on the final disposition of products and packaging. The Herman Miller Company uses a design for the environment approach in new product design. To eliminate confusion as to what is a sustainable product, Herman Miller uses the McDonough Braungart Design Chemistry certification process, which is a “cradle-to-cradle” protocol for designing products in such a way that they are better for the environment. For Herman Miller, the issues centered on chemicals used and ease of dis- assembly of recyclable parts. It is clear that for global supply chains it will be important to be green, not only in terms of the environment but also in terms of eliminating waste and allowing the supply chain to be financially solvent.

Other organizations perform supply chain carbon footprint analysis. Consider the following simple supply chain example shown in Figure 4.5. When looking at the supply chain for potato chips, the chain begins with the farmer growing the potatoes, moves to the manufacturing of the chips, then their packaging, the transporting of the chips to the customer, and finally the disposal of the empty packaging. If you mapped out the carbon footprint for this supply chain, you would find that 44 percent of the carbon foot- print occured at the farm, 30 percent in the manufacturing of the chips, 15 percent in the packaging process, 9 percent in transporting the chips to market, and only 2 percent in the disposal process. In this supply chain, it turns out that the farmer was overweighting the potatoes with water, since the manufacturer bought the potatoes based on weight. Because of how the potatoes were bought, they had too much water in them; this slowed down the manufacturing process, which needed to boil out excess water before process- ing the chips. When the manufacturer changed how potatoes were bought—based now on volume rather than on weight—the manufacturer required only half as much time to process the chips. This saved considerable energy and reduced the carbon footprint. Unfortunately, attention is often fixed on the disposal process, which can be a very small contributor to the overall carbon footprint. The gain in this example lies not only in reducing the footprint, but also in becoming a more efficient and effective supply chain by eliminating a waste-causing activity.

Issues Affecting Supply Chain Management • 115

In 2007, S.C. Johnson found a “greener” way to load trucks that reduced greenhouse gases via better truckload utilization. The company created a system that combines multiple customer orders and multiple products to optimize truckload capacity usage. After the first year, S.C. Johnson reported using 2098 fewer trucks, cut fuel usage by 168,000 gallons, and saved approximately $1.6 million. It also eliminated 1882 tons of greenhouse gases. To achieve these results, the company focused on consistently hitting a trailer’s maximum weight. S.C. Johnson also maximized its use of “day cabs” (truck cabs with no sleeping compartments). Day cabs are 3000 pounds lighter than a standard truck cab. This allows the company to increase the amount of product it loads into a trailer before reaching the vehicle’s maximum weight.

In 2011, Cardinal Logistics Management was recognized by Inbound Logistics as one of the Top 75 Green Supply Chain Partners. Cardinal’s green initiatives include developing technologies that reduce fuel consumption and emissions by reducing miles and monitor- ing its fleet for efficient performance; testing renewable fuels; training employees in proper maintenance, driving habits, and mile reduction; and providing backhaul support to cus- tomers. Cardinal Logistics, headquartered in Concord, North Carolina, is a leading trans- portation solution provider, working with clients to optimize their supply chains.

Potato farmer (44%)

Processing (30%)

Packaging (15%)

Transporting (9%)

Disposal (2%)

FIGURE 4.5 Carbon footprint of potato chip supply chain

116 CHAPTER 4 • Supply Chain Management

The Role of Purchasing

A company’s purchasing department plays an important role in supply chain management decisions. Purchasing is typically responsible for selecting suppliers, negotiating and admin- istering long-term contracts, monitoring supplier performance, placing orders to suppli- ers, developing a responsive supplier base, and maintaining good supplier relations. Since material costs may represent at least 50–60 percent of the cost of goods sold, purchasing significantly affects profitability. Moreover, changes in product cost structure, with materi- als comprising the bulk of the cost of goods sold, have elevated the role of purchasing in many organizations.

Let’s look at how purchasing has been done traditionally and also look at e-purchasing.

Traditional Purchasing and E-purchasing Before companies introduced e-purchasing, purchases were made following a flow similar to that shown in Figure 4.6. Typically, the process began when a requisition request was cre- ated, often by a production planner, an inventory planner, or an administrative staff mem- ber. A requisition request is simply a form used to inform purchasing that an item or a material needs to be purchased. Before any action is taken on the request, it may need to be authorized, by either a supervisor or a manager. The level of authority needed is often based on the dollar amount of the requisition. The higher the amount, the higher the level of authority needed to okay the purchase. After the requisition has been authorized, it goes to purchasing and is given to the specific buyer responsible for making that type of purchase. The buyer contacts potential suppliers of the item to determine price and availability for the item being requested. After analyzing the information from the different suppliers, the buyer decides where to place the order. At this point it is time to release a purchase order confirming all the details of the purchase. A purchase order number is assigned to facilitate tracking the order through the system.

Then printed copies of the purchase order are distributed typically to the supplier, the initial requestor, accounts payable, the receiving dock, and the purchasing department. The purchase order is the company’s commitment to the supplier to buy the item. A copy goes to the initial requestor to let the person know the item has been ordered and to provide delivery date information. Accounts payable needs a copy to reconcile the actual bill received with the negotiated terms of the purchase order with regard to quantity and price. The receiving dock gets a copy so that it knows the item has been ordered and it is okay to accept delivery of the package. The purchasing department typically keeps a copy for its file on that specific supplier. This allows the department to rate the performance of the supplier in terms of on-time delivery performance, quality and quantity, and billing accuracy.

Requisition request Request indicating the need for an item.

Price and availability The current price of the item and whether the quantity is available when needed.

Purchase order A legal document committing the company to buy the goods and providing details of the purchase.

You need to understand the structure of a supply chain, the bullwhip effect, and the issues affecting supply chains. A supply chain structure has external suppliers, internal functions of the fi rm, and external distributors. Information technology enables supply chain management. E-commerce provides an effect- ive means for communications between an organization and its suppliers and customers. Demand data provided through

point-of-sale (POS) data help counteract the bullwhip effect and reduce distorted demand information throughout the supply chain. Service organizations also have supply chains, all of which face many major issues. Issues such as information technology, the Internet, demand uncertainty, government regulations, the need for greener supply chains, inadequate infrastructures, and product proliferation can affect all supply chains.

BEFORE YOU GO ON

The Role of Purchasing • 117

When the item arrives at the receiving dock, the copy of the purchase order is checked to confirm that the item was ordered by the company and should be accepted. The goods then might move to incoming inspection for quality verification. From incoming inspection they are taken to the storeroom and put into inventory until they are needed.

When the company receives the invoice for the goods, before authorizing payment of the invoice the accounts payable department verifies that the goods have been received and that the cost per unit matches the purchase order terms.

In the past, this process tended to be slow, was prone to errors, and clearly was in need of a better way. Many companies now do e-purchasing to reduce transaction costs and pro- vide an effective purchasing system.

E-purchasing is defined as the use of information and communications technology through electronic means to enhance external and internal purchasing and supply man- agement processes. It is not just automating the purchasing function, but requires that an organization have a well-defined purchasing and supply management strategy. It requires that an appropriate sourcing strategy be developed.

Let’s begin by looking at the e-purchasing process shown in Figure 4.7. From first glance, it is evident that the process has been streamlined and that some activities have

Incoming inspection Verifi es the quality of incoming goods.

Sourcing strategy A plan indicating suppliers to be used when making purchases.

Req. to buyer

Phone suppliers

PO number Details

Print PO & distribute

Copy to receiving

Receipt of goods

Copy to acct. pay.

Invoice match

Payment

Authorization

Paper requisition

FIGURE 4.6 Traditional purchasing process

118 CHAPTER 4 • Supply Chain Management

been eliminated. The e-purchasing process begins with the initial requestor going to the approved supplier’s Web site or the appropriate net marketplace to place the order. The company may have preauthorized spending limits set for each of its individual requestors. Any order exceeding that limit would be routed to the necessary approving authority before being processed further. Once the order is in process, all the members of the organization who need to know about the transaction learn in real time all the details associated with the order. This is the same information that they previously learned from their copy of the purchase order. When the goods are received, this fact is inputted into the system so that receipt information is provided to the interested parties. Instead of preparing an invoice for each individual shipment, the supplier consolidates invoices over a period of time and sends a single invoice to the company. This reduces supplier transaction costs. Accounts payable verifies the information on the consolidated invoice and authorizes payment. One check or funds transfer is made for all the orders placed with the supplier rather than a sep- arate check or transfer for each individual order. This reduces the accounting transaction costs for the purchasing company. Key features of typical e-purchasing systems are shown in Table 4.1.

A summary of the expected benefits to the buyers from e-purchasing is shown in Table 4.2. Basic benefits are cost savings, fewer human errors, and a more efficient purchasing process.

Supplier Web site

Receipt of goods

Consolidate invoice Manage by exception

Payment

Authorization

Requester

FIGURE 4.7 The e-purchasing process

TABLE 4.1 Key Features of E-purchasing Systems

• Web-based purchase order approval

• Automatic routing of orders requiring additional authorization to appropriate recipient

• Automatic routing of completed purchase order copies to additional recipients

• Notifi cation of receipt to appropriate recipients

• Secure e-mail sending, using standard electronic signature

• Electronic archiving to facilitate supplier evaluation and analysis of purchasing trends

The Role of Purchasing • 119

TABLE 4.2 Benefits to the Buyers from E-purchasing Systems

• Reduced purchase order processing costs

• Reduced purchase order cycle times

• Less data entry, thus reduced order processing time

• Reduced paperwork

• More effi cient distribution of information throughout the system

• Reduced buyers’ research time with electronic catalogs and net marketplaces

• Fewer order processing errors leading to incorrect shipments

• Consolidated data to facilitate analysis of purchasing patterns and supplier performance

• Share performance measurement data, which encourages improved supplier performance

• Reduced inventory because of better supplier performance

TABLE 4.3 Benefits for Suppliers Engaged in an E-purchasing Environment

• Time savings since orders do not need to be reentered

• Fewer input errors

• Reduced transaction costs and reduced purchase order cycle times

• Less inventory as a result of more effi cient communications with customers

• Better forecasting information from customers

• Better supplier performance since supplier measurement information is shared

• Faster payment

• Improved information fl ow

To successfully use e-purchasing, there must also be benefits for the suppliers. Table 4.3 shows some of the expected benefits for suppliers.

Many organizations engaged in e-purchasing establish a Web site that potential sup- pliers can visit to determine what current opportunities are available. Typically, suppliers must register to access the site, and subsequent entry is controlled by a password. Shown in Table 4.4 is an example of a Web site used by a county government to interact with its suppliers. The Web site informs a potential supplier on how to register for the site and how to certify itself as a supplier, and it shows the current opportunities available for which quotes can be submitted. An example of such opportunities is shown in Table 4.5. Access to the Web site is limited by a password. Although this example shows a govern- ment organization’s Web site, similar Web sites are used by manufacturing and service organizations.

Regardless of whether an organization engages in traditional purchasing, e-purchasing, or a combination of both, an organization must decide which sources are used. Sourcing decisions are discussed next.

120 CHAPTER 4 • Supply Chain Management

TABLE 4.4 Example of a Web Site Used by a Government Organization

Northeast County E-Purchasing E-Purchasing

Welcome to Northeast County’s E-Purchasing Web site! The Purchasing Division is responsible for the management and coordination of the acquisition of goods and services, including requisition processing, commodity code tracking, and bid specifi cations.

HOW TO DO BUSINESS WITH NORTHEAST COUNTY

Step 1 REGISTER WITH PURCHASING Persons or concerns desiring to be registered on the County’s Bidder List for

goods and/or services must complete and submit a completed Vendor Regis- tration Form.

Registration can be completed online or in person.

Step 2 CERTIFY WITH HUMAN RELATIONS FEP compliance is required for all contracts greater than $50,000 (supply/service)

and $100,000 (construction). Northeast County Certifi cation Categories:

• Fair Employment Practice (FEP) • Northeast County Based Enterprise (CBE) • Small Business Enterprise (SBE) • Targeted Growth Community Enterprise (TGCE) • Expanding Business Enterprise (EBE) • MBE/WBE (Declaration) • Disadvantaged Business Enterprise (DBE)

Step 3 QUOTES OPPORTUNITIES Quotes are published daily on this Web site.

Sourcing Decisions

Which products or services are provided in-house by the manufacturer, and which are pro- vided to the manufacturer by other members of the supply chain? Vertical integration is a measure of how much of the supply chain is owned or operated by the manufacturer. Products or services provided by the manufacturer are insourced. Products or services not provided by the manufacturer are outsourced. Outsourcing means that the manufacturer pays suppliers or third-party companies for their products or services, a practice that is on the rise. A recent survey reported that 35 percent of more than 1000 large companies have increased their outsourcing. Another survey of large companies reported that 86 percent outsourced at least some materials or services. The activity most frequently outsourced was manufacturing.

Backward integration is a company’s acquisition or control of sources of raw materials and component parts: the company acquires, controls, or owns the sources that were pre- viously external suppliers in the supply chain. Forward integration is a company’s acqui- sition or control of its channels of distribution—what used to be the external distributors in the supply chain.

Vertical integration A measure of how much of the supply chain is actually owned or operated by the manufacturing company.

Insource Processes or activities that are completed in-house.

Outsource Processes or activities that are completed by suppliers.

Backward integration Owning or controlling sources of raw materials and components.

Forward integration Owning or controlling the channels of distribution.

MKT

Sourcing Decisions • 121

TABLE 4.5 Example of a Web Site Showing Current Opportunities for Suppliers

INVITATION FOR BIDS

DUE DATE BID # COMMODITY/SERVICE ADDENDA BUYER

6/29/16 11-705 Fifth Street Utility Replacement and Streetscape Improvements: Phase II and IIA Drawings: Phase II: Set A Set B Phase IIA

Addendum No. 1

Bid Schedule (EXCEL)

RDR

DATE EXTENDED 7/28/16

12-711 2016 MUNICIPAL PAVING CONTRACT (SUMMER BID)

PAVING SUMMER 2016 ADDENDUM Addenda #2 Addenda #3

LMM

8/18/2016 12-715 Parkview Waterline Relocation Drawings

LMM

8/09/2016 12-716 (14) Light Duty Vehicles— Replacement

Addendum 1—7/29/16 Addendum 2—8/1/16

FRH

INVITATION FOR PROPOSALS

DUE DATE RFP # COMMODITY/SERVICE ADDENDA BUYER

7/16/16 11-707 Airport Engineering Svcs for Airfi eld Pavement and Apron Rehabilitation Work at Regional Airport

LMM

7/28/16 11-709 Juvenile Services Group Home Addendum No. 1 SRT

8/09/2016 12-713 Zoning Ordinance Diagnostic Consultant

Addendum No. 1 SRT

8/12/2016 10-587 Riverside Park Renovation, Phase 1 Addendum No. 1 SRT

A company bases its level of vertical integration on its objectives. The greater the ver- tical integration, the lower is the level of outsourcing. Conversely, the higher the level of outsourcing, the lower is the level of vertical integration. Some factors favor vertical integra- tion. For example, companies needing a high volume of a product or service can sometimes achieve economies of scale by providing the product or service in-house. Companies with special skills may find that it is cheaper to provide certain products or services in-house. Other factors encourage outsourcing. For example, companies with low volumes generally find it cheaper to outsource a product or service rather than provide it in-house. Sometimes a company can get a better-quality product or service from a supplier than it can provide itself.

Now let’s look at the financial calculations behind insourcing and outsourcing decisions.

Insourcing versus Outsourcing Decisions It may be easy to calculate the costs of insourcing versus outsourcing and make the right financial decision. But such decisions involve more than financial calculations. Is a partic- ular product or service critical to your company’s success? Is the product or service one of your company’s core competencies? Is it something your company must do to survive?

122 CHAPTER 4 • Supply Chain Management

If the answer is yes to any of these questions, your company will provide the product or service in-house. If the product or service is not one of its core competencies, the company needs to decide whether it should make or buy the product or service. Other considerations are, for example, whether the products or services provided in-house are identical to those outsourced. Is product quality in-house comparable to product quality in the marketplace? Is product functionality comparable, or does one product have an advantage in terms of quality or functionality? Finally, does the company have the capital needed for any up-front costs to provide the product or service in-house?

Now let’s look at how a company might make the financial calculations. To make a finan- cial calculation, we look at the total costs involved in either producing the entire quantity in-house or buying the entire quantity from a supplier. The total cost of buying the item is any fixed annual cost associated with buying the product plus a variable cost for each item bought during the year, or

TCBuy = FCBuy + (VCBuy × Q)

where TC Buy

= total annual costs of buying the item from a supplier FC

Buy = fi xed annual costs associated with buying the item from the supplier

VC Buy

= variable costs per unit associated with buying the item from the supplier

Q = quantity of units bought

Similarly, we calculate the total cost of making the item in-house as

TCMake = FCMake + (VCMake × Q)

where TC Make

= total annual costs of making the item in-house FC

Make = fi xed annual costs associated with making the item in-house

VC Make

= variable costs per unit associated with making the item in-house Q = quantity of units made in-house

The first step in solving the make-or-buy decision is to determine at what quantity the total costs of the two alternatives are equal. To do this, we set the total annual cost of buying equal to the total annual cost of making:

FCBuy + (VCBuy × Q) = FCMake + (VCMake × Q)

Solving this tells us the indifference point—that is, how many units we must buy or produce when the total costs are equal. If we need this exact amount, we would be indifferent to whether we bought the item or produced it in-house. If we need less than this quantity, we choose the alternative with the lower fixed cost and the higher variable cost. If we need more than this quantity, we choose the alternative with the lower variable cost.

Let’s look at a numerical example. Remember that when the quantity needed exceeds the indifference point, use the alternative with the lower variable cost. If the usage quantity is below the indifference point, then choose the alternative with the lower fixed cost.

EXAMPLE 4.1 MS Bagel Shop: A Make-or-Buy Decision

Two recent college graduates, Mary and Sue, have decided to open a bagel shop. Their fi rst decision is whether they should make the bagels on-site or buy the bagels from a local bakery. They do some checking and learn the following:

• If they buy from the local bakery, they will need new airtight containers in which to store the bagels delivered from the bakery. The fi xed cost for buying and maintaining these containers is $1000 annually.

• The bakery has agreed to sell the bagels to Mary and Sue for $0.40 each.

Sourcing Decisions • 123

• If they make the bagels in-house, they will need a small kitchen with a fi xed cost of $15,000 annually and a variable cost per bagel of $0.15.

• They believe they will sell 60,000 bagels in the fi rst year of operation. (a) Should Mary and Sue make or buy the bagels? (b) If Mary and Sue are uncertain as to the demand for bagels next year, what is the indiffer-

ence point between making or buying the bagels?

• Before You Begin:  To make their decision when demand is known, Mary and Sue need to calculate the total cost of making or buying 60,000 bagels. Determine the relevant data for these calculations. To fi nd the total annual cost of buying 60,000 bagels, you need both the annual fi xed costs ($1000) and the variable cost per bagel ($0.40). To calculate the total annual cost of making the 60,000 bagels, you need the annual fi xed costs ($15,000) and the variable cost per bagel ($0.15).

• Solution: (a) The total cost for buying 60,000 bagels is $25,000. That is $1000 in annual fi xed cost plus

60,000 bagels multiplied by the $0.40 unit variable cost. The total cost for making 60,000 bagels is $24,000. That is $15,000 in annual fi xed costs plus the 60,000 bagels multiplied by the $0.15 unit variable cost.

(b) If Mary and Sue don’t know the demand for bagels, they can fi nd the indifference point by setting the total annual costs of each option equal to the other, as shown below. Although in this problem we are comparing the options of making or buying, we could just as easily compare two different suppliers or two different internal processes.

Set the total annual costs equal to each other using the formula.

FCBuy + (VCBuy × Q) = FCMake + (VCMake × Q)

or

$1000 + ($0.40 × Q) = $15,000 + ($0.15 × Q)

Solving for Q, we have ($0.25Q) = $14,000, or Q = 56,000 bagels. Since the costs are equal at 56,000 bagels and Mary and Sue expect to use 60,000 bagels, they should make the bagels in-house rather than buy them from the local bakery. By making the bagels, the cost for each additional bagel above 56,000 is $0.15 instead of the $0.40 they would pay the local bakery for each bagel.

Outsourcing requires decisions about which supplier to contract with for products or services. These decisions in turn depend on the criticality and frequency of the product or service, and they determine the relationship the company forms with the supplier. For example, if the purchase is one-time only, the company does not need to develop a rela- tionship with the supplier. However, if the company wants a reliable supplier for a critical product or service, it needs to develop a long-term relationship with the supplier.

Developing Supplier Relationships A strong supplier base is essential to the success of many organizations. Choosing a supplier is like choosing where to shop for something you want to buy. The first thing you decide is which merchants have the product or service you want. Adequate quality for the product or service is usually a prerequisite for even considering a merchant. What else is important to you when choosing a merchant? Availability, perhaps size and color for clothing, freshness and appearance for produce, and physical proximity so you can see the product or try it on. Quick response time, such as overnight shipping or rapid alterations; price, of course; ease of doing business; reputation; and warranty or service agreements are all considerations.

What is important to you as an individual when choosing a merchant is also important for your company when choosing a supplier. In general, we want merchants or suppliers

124 CHAPTER 4 • Supply Chain Management

who give us good value. Several studies report that the top three criteria for selecting sup- pliers are price, quality, and on-time delivery. Even more important, however, is that the choice of suppliers be consistent with a company’s mission. For example, if your company is competing on the basis of quick response time, your suppliers must offer minimal lead times and be able to respond quickly.

How Many Suppliers? Once your company has chosen its suppliers, the next question is: Should you give a single supplier all your business for a particular product or service? Or should you use multiple suppliers? Table 4.6 lists arguments in favor of a single supplier and multiple suppliers.

For some operations, like make-to-order products, it is easier to deal with a single sup- plier. This is especially true for scheduling deliveries, resolving problems, minimizing the cost of dies or tools, developing computer links, and so forth. In addition, using a single supplier can improve the quality of your finished product by ensuring the consistency of the input materials.

On the other hand, multiple suppliers reduce the risk of a disrupted supply—that is, if one supplier suffers a disaster, other suppliers can pick up the slack. Further, multiple sup- pliers can more easily support changing quantity requirements. For example, if you need a larger quantity than a single supplier can supply, the order can be split among multiple

TABLE 4.6 Arguments in Favor of One Supplier and of Multiple Suppliers

Pros of One Supplier Pros of Multiple Suppliers

• The supplier may be the exclusive owner of essential patents and/or processes and thus be the only possible source.

• Competition among suppliers may provide better service and price.

• By using one supplier, quantity discounts may be achieved.

• Probability of assured supply is better. Multiple suppliers spread the risks.

• The supplier will be more responsive if it has all of your business for the item.

• Eliminates a supplier’s dependence on the purchaser.

• Contractual agreements may prohibit the splitting of an order.

• Provides a greater fl exibility of volume.

• The supplier is so outstanding that no other supplier is a serious contender.

• No single supplier may have suffi cient capacity.

• Single sourcing is a prerequisite for partnering. • Allows for testing of new suppliers without jeopardizing the fl ow of materials.

• The order is too small to split between suppliers. • Government regulations may require multiple sources.

• When the purchase involves a die, tool, mold, or expensive setup, the cost of duplicating may be prohibitive.

• Deliveries can be scheduled more easily.

• Supports just-in-time manufacturing and EDI.

• Allows for better supplier relations.

• The just-in-time philosophy can be better utilized.

Sourcing Decisions • 125

suppliers. This is referred to as flexibility of volume. Finally, government regulations may require the use of multiple suppliers for some projects.

The answer to how many suppliers depends on your supply chain structure. If your company wants to integrate its supply chain, then partnering or using a single supplier makes sense.

Developing Partnerships One compelling argument in support of using single suppliers is that it is often a pre- requisite for developing a partnering relationship. Partnering with a supplier requires a commitment from both the company and the supplier. The goal is to establish an ongoing relationship in which both parties benefit from the arrangement—what is called a “win-win situation.”

The two kinds of partnerships are basic and expanded. A basic partnership is built on mutual respect, honesty, trust, open and frequent communications, and a shared under- standing of each partner’s role in helping the supply chain achieve its objectives. Expanded partnerships are reserved for a few key suppliers. These are long-term relationships built on mutual strategic goals. Expanded partners must be committed to helping each other succeed. They must place a high priority on maintaining the relationship and on sharing information, risks, opportunities, and technologies.

The Bama Companies is an innova- tor of wholesome bakery products and caters to the needs of many well-known restaurant chains. The company’s core product lines are hand held pies, biscuits, buns, pie shells, and pizza crust. Bama supplies innovative culinary and product development services and custom-made oven-ready products to customers in more than 20 countries. Bama is a past Malcolm Baldrige National Quality Award (discussed in Chapter 5) winner. The key to Bama’s success has been focusing on quality relationships and products.

The old adage, treat others how you want to be treated, is the basis for the relationships Bama builds with its suppliers. Bama reduced the number of suppliers used and focused on developing long-term relationships. Now the company only deals with 50–60 key suppliers and most of these have been partners with Bama for at least 15 years. The company prefers to deal with a single supplier for an ingredient rather than multiple sources, thereby giving as much business as possible to that single supplier. This creates supplier loyalty and a com- mitment to the success of Bama.

The company’s founder, Peter Marshall, built the bakery business on handshake deals. While today’s suppliers go through a more formal process, the company still maintains the handshake mentality to strengthen supplier relationships. Ingredient suppliers undergo fre- quent audits from Bama to ensure ingredient integrity and manufacturing practices. While the company expects a lot from its supplier partnerships, it also rewards its suppliers for exceptional performance. Bama determines award winners on 10 factors: innovation, con- tinuous improvement, quality of products, service, fair pricing, cost containment, technical support, customer service support, shared philosophies and values, and the ability to bring new business to The Bama Companies. In 2005, Bama implemented its Six Sigma quality program (discussed in Chapter 5) into its supply chain. As a result, one of its flour suppliers, in a joint project with Bama, addressed suboptimal truck weights. As a result, the supplier

Partnering A process of developing a long-term relationship with a supplier based on mutual trust, shared vision, shared information, and shared risks.

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126 CHAPTER 4 • Supply Chain Management

increased average weight per truckload by about 2,000 pounds and decreased truckload weight variation by 50 percent.

In recent years when sugar availability was limited because of bad hurricane seasons, Bama’s relationship with its sugar supplier has proven quite beneficial. Bama’s supplier maintained a consistent sugar supply during that period as well as honoring the original contract price.

A company evaluating potential partners looks at the following aspects of the potential partner’s business:

· History, sales volume, product lines, market share, number of employees, major customers, and major suppliers.

· Current management team in terms of past performance, stability, and strategic vision.

· Labor force in terms of skill, experience, commitment to quality, and relations with the supplier.

· Internal cost structure, process and technology capabilities, fi nancial stability, infor- mation system compatibility, supplier sourcing strategies, and long-term relationship potential.

The company reduces the selection pool to a few potential partners, identifies a single partner, and commits to the partnership. At this point, both parties agree on how to mea- sure the performance of the partnership. The partners set time frames for the frequency and methods of performance assessment and decide how problems will be resolved. When they reach agreement on these issues, the partners develop supply chain operating procedures and put the partnership into motion. Table 4.7 shows possible benefits from partnering.

Critical Factors in Successful Partnering Impact, intimacy, and vision are critical factors in successful partnering. Impact means attaining levels of productivity and com- petitiveness that are not possible through normal supplier relationships. Intimacy means the working relationship between partners. Vision means the mission or objectives of the partnership. Let’s look at each of these factors.

Impact comes through mutual change. The supplier and the customer must be willing to make changes. Studies suggest that the three sources of impact are reduction of duplication and waste, leveraging core competence, and creating new opportunities.

Duplication can involve any activity done by both the supplier and the customer. For example, suppliers count items before shipping, and customers count the same items after receipt. What value is added by having both parties count the same items?

TABLE 4.7 Possible Benefits from Partnering

Manufacturer’s Benefi ts Supplier’s Benefi ts

• Reduce costs • Increase sales volume

• Reduce duplication of effort • Increase customer loyalty

• Improve quality • Reduce costs

• Reduce lead time • Improve demand data

• Implement cost reduction program • Improve profi tability

• Involve suppliers earlier • Reduce inventory

• Reduce time to market

• Reduce inventory

Sourcing Decisions • 127

Waste reduction means eliminating any activity that does not add value. For example, moving items into and out of storage adds no value. It makes sense to have items delivered to and stored where they are used.

Duplication can also be eliminated in paperwork and administration. Solo Cup Company, formerly known as the Sweet- heart Cup Company, manufactures paper drinking cups. Sweetheart faced serious price-cutting demands from one of its major customers or another supplier would be used. To meet this challenge, Sweet- heart partnered with paperboard producer Georgia-Pacific. A shared electronic data interface reduced paperwork and adminis- tration and cut expensive inventory. Joint planning optimized production plans, giving Sweetheart a more consistent product from Georgia-Pacific at a better price. Sweet- heart can satisfy its high-volume customers, and Georgia-Pacific benefits through more business.

Leveraging core competence is about sharing knowledge. Different companies have differ- ent strengths or competencies. Instead of making the supplier or the customer reinvent the wheel, all partners can benefit from shared expertise. Following is an example.

Hillenbrand Industries, a manufacturer of hospital room equipment products, has six geographically dispersed manufacturing facilities. The company uses its own 400-truck fleet and both domestic and international carriers. Hillenbrand decided to partner with UPS to improve the cost, quality, and responsiveness of Hillenbrand’s overall logistics. For UPS, fleet management is a core competence; for Hillenbrand, fleet management is an expensive, non- core requirement. Hillenbrand does not want to incur the expense of building a world-class core competence in fleet management. By partnering with UPS, Hillenbrand can leverage and benefit from its partner’s expertise. Hillenbrand was able to create $1.5 million in cost improvements during the first year of the partnership. UPS revenues with Hillenbrand have grown by almost $2 million. Both the supplier and the customer have benefited.

Creating new opportunities means partners working together to produce something that neither could have achieved alone. Let’s look at an example involving a tier one supplier to an automobile manufacturer.

This supplier used to make daily truckload deliveries of a major subassembly to the auto assembly plant approximately 1200 miles away. Every day, four trucks left the supplier filled with subassemblies, and every day four of the supplier’s empty trucks left the auto assembly plant. The supplier was wasting significant transport capacity, with empty trucks returning to its facility. To remedy the problem, the supplier worked with the automobile manufacturer to develop a new truck trailer that carried subassemblies to the automaker and also hauled new autos back to a major metropolitan area. Thus, the auto manufacturer could send new cars to market and eliminate wasted transport capacity. Because the supplier transported the cars to market in an enclosed truck, protected from weather and road hazards, the cars arrived customer-ready. By using the empty trucks to haul the new autos to this market, the supplier eliminated the wasted transport capacity, provided a valuable service to the auto manufacturer, and generated cost savings for both partners. The partnership created a win- win situation that neither could have created alone.

Intimacy comes from the working relationship between partners. Because partners share confidential information, trust between them is critical. Intimacy means eliminating surprises: sharing daily information with partners prevents surprises. For example, a tier one supplier to the automotive industry needs to know how many autos are produced daily,

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any planned changes in production rates, and the current number of days of finished goods inventory. This information shows the supplier near-term demand and facilitates better customer service to the auto producer.

Intimacy is a result of sharing information. This information includes sales data col- lected at the point of sale; order change notices such as additional orders or cancellations; global inventory management, both quantity and location; and global sourcing opportu- nities so that supply chain members can improve purchase leveraging and component standardization.

The benefits of information sharing can be significant. When OSRAM GmbH bought GTE’s Sylvania lighting division, it initiated a supply chain integration program. Within six months, fill rates were at 95 percent and climbing; individual stock keeping unit (SKU) fore- cast accuracy had improved by 16 percent; obsolete inventory was down 10 percent; and the company had saved more than $300,000 on transportation costs.

Vision is the mission or objective of the partnership. The partners must articulate and share their vision. This shared vision provides the structure for the partnership and the role each partner plays in achieving success for the supply chain.

Successful partnering needs a substantial commitment by both partners. Many companies try to reduce the number of their suppliers and develop a smaller, highly focused supplier base. The emphasis is on finding viable suppliers and developing long-term partner relationships. Table 4.8 summarizes the different aspects of partner relationships.

Benefits of Partnering Early supplier involvement (ESI) is a natural result of part- nering relationships and is one way to create impact. Critical suppliers become part of a cross-functional, new-product design team. These suppliers provide technical exper- tise in the initial phases of product design. Early involvement by suppliers often short- ens new-product development time, improves competitiveness, and reduces costs. One example of early supplier involvement is Whirlpool Corporation’s partnership with Eaton, a supplier of gas valves and regulators. Whirlpool used Eaton’s design expertise to bring a new gas range to market several months sooner than it could have using Whirlpool’s in-house design skills.

Selecting the right mix of sourcing strategy (global sourcing, outsourcing, single sourcing, and partnering) eliminates supply redundancies and allows companies to low- ers costs, achieve higher margins, and bring improvements in quality and performance. Often there is a strong correlation between an increase in supply chain efficiency and an increase in supply interruption risk. Global sourcing can increase exposure to a new set of risks. Terrorist attacks, natural disasters, tariffs and trade agreements, political instability,

TABLE 4.8 Characteristics of Partnership Relations

• Have a long-term orientation

• Are strategic in nature

• Share information

• Share risks and opportunities

• Share a common vision

• Share short- and long-term plans

• Are driven by end-customer expectations

Sourcing Decisions • 129

and customs delays can impact the continuity of supply and affect supply lead time. Many products, processes, and/or services can be outsourced. The company must put processes, people, and controls in place to manage the risks of outsourcing and ensure successful results. Single sourcing can improve product or service quality and typically leads to a partnership with the company’s source. However, the greater the buying com- pany’s dependence on a single source, the greater the risk of supply interruption. It is very important the company understand and manage the risks inherent with its sourcing strategy.

Supplier Management Ethics A constant concern within purchasing departments is the issue of ethics in managing sup- pliers. Sales representatives from suppliers often offer buyers free lunches, free tickets to sporting or entertainment events, free weekend getaways, or valuable gifts. While suppliers may view these merely as promotional activities, at some point buyers need to consider how much is too much. Because buyers are in a position to influence or determine which supplier is awarded business, buyers must make certain that they avoid any appearance of unethical behavior or a conflict of interest.

Many companies have specific policies outlining what constitutes an acceptable gift or promotion. In some companies, buyers are not allowed to accept anything from a supplier, not even a pen. In other companies, there are dollar limits on what may be accepted. To guide purchasing employees, the Institute for Supply Management (ISM) has approved a set of principles and standards, which are shown in Table 4.9.

A report by business ethicist Professor Kirk O. Hanson identifies the best ethical stan- dards for the group purchasing organizations (GPOs) that serve most of the nation’s hospi- tals. New best practices recommended in the report are:

· Require a standard administrative fee (a percentage of total purchases under the con- tract) for each category of product or service;

· Limit equity investments in contracting companies by GPO employees;

· Prohibit more strictly gifts and perks from seller companies;

· Adopt as standard for fi nancial disclosure the one used by not-for-profi t organizations.

At the center of the recommendations is concern for the ethical conflict of interest. These conflicts include the quality and the cost of goods used in medical care; unit price and cost-in-use; the benefits of standardization; the need to adopt superior technologies; multiyear contracting; and spot-market purchasing. The GPO’s first obligation is to serve its members, including the goals of good medical outcomes and cost containment. All types of organizations (manufacturing, healthcare, education, government, etc.) have a code of ethics concerning the fair treatment of suppliers. Most of these are available on the organi- zation’s Web site.

Given these many codes of ethics, purchasing is still questioned by its internal employ- ees about the ethics of the purchasing department. Consider the following circumstances that might suggest that members of the purchasing department behaved unethically. First, a purchasing member accepts a gift (even a small gift such as a pen) from a supplier. Second, a purchasing member has a personal or financial relationship with a supplier or an employee of a supplier (think of favoritism). Third, a purchasing team member owns its supplier’s stock. Fourth, a purchasing member mixes business and entertainment with a supplier (think about doing business on the golf course). Fifth, in a competitive bid- ding situation, information is provided to one supplier that was not supplied to other suppliers. Sixth, it is not transparent as to why a particular supplier was chosen. And seventh, selection criteria used were not consistent with criteria noted in the request for proposal. Any of the above situations can be done ethically ; however, it is important for

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the purchasing department to understand how each of these activities could suggest a potential conflict of interest.

The Role of Warehouses

Warehouses include plant, regional, and local warehouses. They can be owned or operated by the supplier or wholesaler, or they can be public warehouses. A further classification is general warehouse or distribution warehouse.

A general warehouse is used for storing goods for long periods with minimal handling. A distribution warehouse is used for moving and mixing goods. Within the supply chain, warehouses have three roles: transportation consolidation, product mixing or blending, and service. The business of a general warehouse is storage. The business of a distribution ware- house is movement and handling; therefore, the size of the facility is less important than its throughput. At a distribution warehouse, goods are received in large-volume lots and broken down into small individual orders.

General warehouse Used for long-term storage.

Distribution warehouse Used for short-term storage, consolidation, and product mixing.

TABLE 4.9 ISM Principles and Standards of Ethical Supply Management Conduct

Principles and Standards of Ethical Supply Management Conduct Integrity in Your Decisions and Actions

Value for Your Employer Loyalty to Your Profession

From these principles are derived the ISM (Institute for Supply Management) global standards of supply management conduct.

1. Impropriety. Prevent the intent and appearance of unethical or compromising conduct in relationships, actions, and communications.

2. Confl icts of Interest. Ensure that any personal, business, or other activity does not confl ict with the lawful interests of your employer.

3. Infl uence. Avoid behaviors or actions that may negatively infl uence, or appear to infl uence, supply management decisions.

4. Responsibilities to Your Employer. Uphold fi duciary and other responsibilities using reasonable care and granted authority to deliver value to your employer.

5. Promote positive supplier and customer relationships.

6. Sustainability and Social Responsibility. Champion social responsibility and sustainability practices in supply management.

7. Confi dential and Proprietary Information. Protect confi dential and proprietary information.

8. Reciprocity. Avoid improper reciprocal agreements.

9. Applicable Laws, Regulations, and Trade Agreements. Know and obey the letter and spirit of laws, regulations, and trade agreements applicable to supply management.

10. Professional Competence. Develop skills, expand knowledge, and conduct business that demonstrates competence and promotes the supply management profession.

Reprinted with permission from the publisher, the Institute for Supply Management™, Principles and Standards of Ethical Supply Management Conduct, adopted January 2012.

The Role of Warehouses • 131

A good example of the impor- tance of distribution warehous- ing in support of e-commerce is Fingerhut’s warehouse in St. Cloud, Minnesota. Employees rush through the warehouse on forklifts and cargo haulers filling orders for on-line retailers. Every item is encoded to speed packing. Red lasers scan each package as it rushes down the conveyor, ver- ifying the actual package weight against expected package weight. Packages that do not match are pushed aside for further inspection. The crew at this warehouse can process as many as 30,000 items per hour.

Transportation Consolidation occurs when warehouses consolidate less-than-truckload (LTL) quantities into truckload (TL) quantities. This consolidation can be both in supplier shipments to the manufacturer and in finished goods shipped to distant warehouses. The goal is to use TL shipments for as much of the distance as possible because TL shipments are cheaper than LTL shipments.

For inbound supplier shipments, a manufacturer can have small LTL deliveries from several suppliers consolidated at a convenient warehouse and then shipped to the man- ufacturer in TL shipments. For outbound shipments, the manufacturer can send TL deliveries to distant warehouses that break down the shipment for LTL delivery to local markets. Transportation consolidation is usually done to reduce transportation costs.

Product Mixing is a value-added service for customers. With product mixing, the cus- tomer places an order to the warehouse for a variety of products. The warehouse groups the items together and ships the mixture of items directly to the customer. Without product mixing, the customer would have to place individual orders for each item and pay shipping for each item. Instead, product mixing enables quicker customer service and reduces trans- portation costs.

Services offered by the warehouses can improve customer service by moving goods closer to the customer and thus reducing replenishment time. For example, a tier one automotive supplier can use a warehouse located near an automotive assembly plant to store instrument panels. The producer requires the supplier to provide these instrument panels in VIN (vehicle identification number) order sequence within an hour. That means the warehouse must load and deliver the parts in the correct sequence to match the pro- duction as it occurs on the line, that is, right color, right style, right identification number, and so on.

Warehouses can also be used to finish custom products. For example, when manufacturers use postponement in their product design process, almost-finished products are delivered to the warehouse. When actual customer orders are received, the warehouse finishes the product according to the specifications of the customer. For example, in the furniture indus- try products can be left unstained until the customer order is received. The stain is then applied and the customer receives a custom product in minimal time. In the electronics industry, a unit may need to have the appropriate power supply and cord attached based on the location of the customer. Using the warehouse in this manner allows a manufacturer to maintain flexibility with almost-finished products and also to quickly provide a custom product for the customer.

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Postponement A strategy that shifts production differentiation closer to the consumer by postponing fi nal confi guration.

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Crossdocking Crossdocking eliminates the storage and order-picking functions of a distribution warehouse while still performing its receiving and shipping functions. Trucks arrive at a crossdock with goods to be sorted, consolidated with other products, and loaded onto outbound trucks. Those trucks may be headed to a manufacturer, a retailer, or another crossdock. Shipments are transferred directly from inbound trailers to outbound trail- ers without any storage in between. Shipments should spend less than 24 hours in a crossdock.

What is the big difference between crossdocking and traditional distribution warehous- ing? In a traditional setting, the warehouse holds stock until a customer places an order; then the item is picked, packed, and shipped. The customer typically is not known before the items arrive at the warehouse. With crossdocking, the customer is known before the items arrive at the warehouse and there is no reason to move the items into storage.

Crossdocking has two major advantages. First, the retailer reduces inventory holding costs by replacing inventory with information and coordination. Second, crossdocking can consolidate shipments to achieve truckload quantities and significantly reduce a company’s inbound transportation costs.

Types of Crossdocking Manufacturing crossdocking is the receiving and con- solidating of inbound supplies to support just-in-time manufacturing. In this case, the warehouse might be near the manufacturing facility and used to prep subassemblies or consolidate kits of parts. Distributor crossdocking is the receiving and consolidating of inbound products from different vendors into a multistock-keeping unit pallet that is delivered once the last product is received. Transportation crossdocking is the consol- idating of shipments from LTL and small-package industries to gain economies of scale. Retail crossdocking is sorting product from multiple vendors onto outbound trucks headed for specific retail stores.

Home Depot, Inc., Wal-Mart, Costco Wholesale Corporation, and FedEx Freight are examples of companies using crossdocking. At FedEx Freight, pickup and delivery drivers are busy during the day picking up freight that must be delivered that night and making deliveries. Each evening, drivers return to the crossdock. Freight is unloaded, sorted, and placed onto outbound trucks. The trucks travel through the night to their destina-

tions, where the freight is unloaded and sorted onto local delivery trucks. FedEx Freight has achieved economies of scale that allow cost-effective transportation to areas with relatively little freight traffic.

Crossdocking Innovations Recent developments in information systems and software solutions have created more opportunities for crossdocking. Better supply chain visibil- ity and improved data sharing between members of the supply chain have resulted. Older crossdocking systems were able to do pure crossdocking. The software worked only if it was a perfect match going directly to an outbound truck. Now software allows orders and order lines to be split. The ability to split orders and ship partial orders immediately can avoid shortages on store shelves.

Crossdocking Eliminates the storage and order-picking functions of a distribution warehouse.

Manufacturing crossdocking The receiving and consolidating of inbound supplies and materials to support just-in-time manufacturing.

Distributor crossdocking The receiving and consolidating of inbound products from different vendors into a multi-SKU pallet.

Transportation crossdocking Consolidation of LTL shipments to gain economies of scale.

Retail crossdocking Sorting product from multiple vendors onto outbound trucks headed for specifi c stores.

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The Role of Warehouses • 133

By using Web-based portals, suppliers can create and transmit Advance Shipment Noti- fication (ASN) information to their retail customers. ASN is an electronic file transmitted from suppliers to retail customers providing advance notice of what products are being shipped to the retailer’s distribution center and their estimated time of arrival. Advance notice allows the retailer to allocate the product while it is still in transit. Basically, ASNs provide better visibility into the supply chain. In recent years, software providers also have been developing their products onto a single supply chain process platform. This reduces the problem of software compatibility.

In recent history equipment innovations have centered on conveyor sorting systems, print and apply mechanisms, and automatic identification technologies. The sliding shoe sorter pushes cartons off the conveyor to the appropriate conveyor lane. Parallel sorting enables smaller gaps between cartons. More densely packed conveyors allow the crossdock operators to reduce the speed of the conveyor and still maintain the same throughput as before. Slower conveyor speeds cause less wear and tear, less energy usage, and less maintenance.

Another issue is printing and applying labels to cartons. Print and apply systems allow crossdock operators the ability to deal with inadequately labeled cartons so that proper labels can be printed and applied on the cartons as they move along conveyors. This allows the item to be crossdocked. By attaching an RFID (discussed in more detail in the next sec- tion) tag on a pallet, the simple act of moving the pallet from a tractor trailer through a receiving portal acknowledges receipt of the item and downloads critical information so that automatic crossdock allocations can be made.

Crossdocking Implementation In concept, crossdocking looks simple. The inbound product arrives on one side of the dock and is transferred to waiting trucks on the other side of the dock. Crossdocking systems can include a number of distribution activities. One approach is simply in one door and directly out the other. However, crossdockers can also add value in the interval between receiving and shipping (printing and applying labels, releasing ASNs, etc.). An organization can expect the following from a successful crossdock- ing implementation:

· Reduction in capital investment in facilities and equipment (less space required)

· Reduction in inventory

· Reduction in personnel requirements

· Reduction in order cycle time

· Reduction in product damage (reduced touches)

· Reduction in freight costs

The primary reasons why implementations fail are:

· Poor facility layout

· Internal information systems are not integrated

· Low level of supply chain integration and collaboration

· Noncompliance by all supply chain members

· Th e wrong products are selected for crossdocking

· Unreliable suppliers in terms of accuracy and on-time deliveries

· Insuffi cient volume of activity

· Not understanding peak workload variations

Successful crossdock implementation requires visibility into what you will be receiving before receiving it. ASNs are the source of that information. Let’s look at how RFID technology is improving the collection of data needed to support successful crossdocking.

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Radio Frequency Identification Technology (RFID) Radio frequency identification (RFID) is an automated data collection technology. It uses radio frequency waves to transfer data between a reader and an RFID tag. The infor- mation is transmitted automatically so no one needs to unpack or scan individual bar code labels, yet it provides accurate data transmittal.

The RFID tags contain encoded information that identifies items at the case, pallet, or container level. Rolls-Royce now uses RFID technology to track components used in mili- tary transport and combat aircraft and helicopters. In states with toll highways, RFID tech- nology is used to collect tolls automatically. As a car with an RFID tag slowly passes through a collection lane, the RFID reader records the relevant vehicle data, and the appropriate toll charge is processed.

In a survey concerning RFID implementation, nearly half of consumer goods makers, a third of food and beverage makers, and a quarter of textile and apparel manufacturers indicated that they were implementing RFID technology because of a mandate from Wal- Mart. The survey further indicated that 59 percent of companies in the automotive industry would deploy RFID technology during the coming year. Worldwide, RFID is forecasted to surpass $2.5 billion by 2010. There is some potential controversy regarding personal privacy in some possible future uses of RFID technology.

New RFID applications have been developed for several industries. For example, in the hospitality industry, some hotels are now using RFID electronic locks. Instead of sliding a key through a card reader on the door, the guest merely holds the key card near the door lock and the RFID signal unlocks the door. The RFID electronic locks are more secure and not prone to cloning. Hotels also use RFID technology to track towels and linens. A wash- able RFID chip sewn into towels, robes, and bed sheets, allows hotels to track their linens. A hotel in Honolulu, using these RFID chips, reduced theft of its pool towels from 4000 a month to just 750, a savings of more than $16,000 a month.

A jewelry retailer in Texas uses passive RFID tags in its stores. As an item is received into inventory, an employee attaches a tag encoded with the product’s item number. Each morning after stocking the display cases, a clerk moves a handheld RFID reader over each tray. The RFID reader transmits the captured data into the company’s information system providing a master inventory list.

Hospitals spend nearly 30 percent of their total operational budgets on securing and managing consumable medical supplies. Since these items play a crucial role in patient care, medical facilities tend to overstock nursing stations. Combining the kanban philos- ophy (covered in Chapter 7) and passive RFID tags, a kanban-based resupply system was implemented. The RFID tag was embedded in each of the two baskets containing a specific item. For example, sutures may be contained in two baskets, each with 25 sets of sutures. The first container is placed in front of the second container. When a nurse removes the last set of sutures from the first container, it is removed from the shelf along with its RFID tag. The RFID tag is then clipped to a board designed for collecting the tags. At that point an RFID reader mounted behind the board collects the unique ID number encoded to the product’s tag and transports the data into the supply database. The software then automat- ically generates a resupply request. In 2011, the cardiovascular laboratory at a hospital in Kansas City deployed passive RFID tags and readers that have enabled the hospital to better manage its stock of pacemakers, coronary stents, and defibrillators. Doing this, the hospital was able to reduce its coronary device inventory by $500,000.

Many manufacturers also use RFID technology to manage the replenishment of items used during the manufacturing process. The John Deere Planter factory reported a 40 percent increase in efficiency in welding due to improvements in material replenishment and fewer material-related delays.

Radio frequency identifi cation (RFID) A wireless technology that uses memory chips equipped with radio antennas attached to objects used to transmit streams of data.

Implementing Supply Chain Management • 135

RFID technology for tracking individual participants is being used at the New York City marathon. RFID data combined with GPS data allow runners to view their own progress dur- ing the race and also enable friends, family members, and others to determine a particular runner’s location at any given time as well as where that participant is relative to spectators.

As you can see, RFID applications are numerous and expected to increase in the future as more companies understand how RFID technology can help better manage inventory and resupply processes.

Third-Party Service Providers The ease of developing an electronic storefront has allowed the discovery of suppliers from around the world. A good example is the success of artisans in Kenya, who by marketing over the Internet increased annual export earnings to $2 million from only $10,000. While smaller companies have benefited from these electronic storefronts, they often are not pre- pared to handle the logistics aspect. Many of these B2C companies outsource the delivery and return of products to companies such as FedEx and UPS. This works especially well when the consumer is paying for delivery.

A good example is Bike World, a company known for its high-quality bicycles, expert advice, and personalized service. After beginning Internet operations in 1996, Bike World found itself overwhelmed processing orders, manually shipping packages, and responding to customer inquiries regarding order status. Because of this, Bike World outsourced its order fulfillment to FedEx. FedEx offered reasonably priced delivery that exceeded customers’ expectations.

Even larger companies often outsource their logistics. Consider when over 5400 CVS stores unveiled Gillette’s Fusion, a new shaving product, all on the same day. Eight to ten weeks of planning was needed for this one-day event. The product was shipped to five of the CVS dis- tribution centers. At the distribution centers, CVS coordinated pick-and-pack activities and readied the product for shipping to the stores. CVS used expedited shipping through a third- party logistics provider, delivering razors to all stores by noon that day. It was the first chain to have the new product available, providing it with increased market share.

Implementing Supply Chain Management

Implementing a strategic, integrated supply chain requires considerable effort on the part of the initiating company. This change often is a result of external pressures faced by the com- pany, such as increased global competitors, an industry consolidation reducing the number of surviving companies in the industry, a switch to e-commerce (including e-purchasing and e-sourcing), or major technological changes within the industry.

Typically, a company begins by analyzing its current supply chain. A small cross-functional team leads the effort, examining all facets of the system to determine where improve- ments are possible and necessary. Most companies begin by looking at the parts of the supply chain, the internal dimension, in which they have the most control: manufacturing or service processes, distribution processes, and/or retail capacity and the time and costs of sourcing, producing, and distributing products or services. Improving performance in these areas has been the priority of many supply chain management initiatives. For a typical manufacturer, this means investing in automation and sales and operations planning tech- nologies. For distributors and retailers, the priority has focused on supplier relationships, warehouse management, and transportation management solutions.

Some companies also include product design and supply chain design in the internal dimension. Supply chain design includes determining the best locations for manufacturing and warehousing facilities, as well as for retail outlets, and how to design the store itself. In

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global supply chains, companies also must decide whether or not to adopt offshore pro- duction. This decision now considers the traditional cost factors, such as production costs, distribution, and inventory, but also takes into account the greater risk of product dam- age and delay resulting from offshore production. Product design includes quality function deployment (QFD), ease of manufacturing, design for the environment (DFE), and ease of distribution throughout the supply chain.

The external dimension is that part of the supply chain that the company does not con- trol. Predictable external factors include government regulations, mandates from trading partners, and environmental requirements. Often there is some advance notice of changes resulting from these factors. For example, a manufacturer can prepare itself to meet health, safety, or regulatory requirements such as the U.S. Food and Drug Administration (FDA) might apply to supply chains for food, drugs, and cosmetics. An example of a common trad- ing partner mandate in the auto industry is the use of electronic data interchange (EDI) and membership in the net marketplace Covisint. If you want to be a supplier to an auto indus- try manufacturer, you must comply with these mandates. When integrating the external supplier base, many companies develop supplier relationships.

The requirement to use radio frequency identification (RFID) technology is occurring in consumer goods and retail supply chains. Environmental considerations include restric- tions on the discharge of solid, liquid, and gaseous waste. The supply chain can accommo- date these predictable or expected external factors.

The external dimension also includes actions that are very difficult to predict and can devastate an organization. A sudden spike in fuel prices, worker strikes, delays in shipping due to customs noncompliance, port congestion, and major weather-related disasters can put considerable stress on the supply chain. Any problems that occur inside the supplier’s or the distributor’s supply chain also can lead to delays in sourcing, production, and move- ment of finished products, which threaten supply continuity and the quality of service to the final customer. To meet such challenges, companies need to improve their supply chain visibility so that real-time responses can be made to minimize the chance of disruption.

The customer dimension is where your company may have some influence but does not have total control. Ways to influence the customer include offering customers the features and functions they want, when they want them, and at an attractive price. Companies also can use promotional strategies to shape demand to better meet their business goals. Supply chains can typically provide better customer service when better product demand infor- mation is available to all members of the chain. This can be done using point-of-sale (POS) technology. Let’s look at some strategies to leverage your supply chain.

Strategies for Leveraging Supply Chain Management Although implementing supply chain management requires a set of actions that are unique to every company, the end goal is the same. Companies want a supply chain that makes it possi- ble to manage and adapt to all of the business dynamics affecting the company. This includes improving insight and control over your own internal operations; catering to, influencing, and responding faster to events beyond your control; and focusing on the customer and demand signals that affect your supply chain. You should consider each of the following actions.

1. You should regularly assess your supply chain network to make sure it is still suited for your business. Make sure that you are not making adjustments to a supply chain that is no longer suitable for meeting your current and future business needs. Many supply chains merely evolve over time or through acquisitions. Th ey are not designed but rather worked around. Take time to make sure your network fi ts your needs. Long- term profi tability depends on having the right capacity and the right location of your physical assets.

Implementing Supply Chain Management • 137

2. You should have a global view of demand. You need to anticipate demand and take opportunities to infl uence it to reach your fi nancial objectives. Using a collaborative demand planning solution (discussed in Chapter 8) is a good way to develop a global view of demand. You need visibility into customer buying patterns so that you can determine appropriate inventory, production, sourcing, and distribution plans.

3. You should decide how to get products to your customers. You decide what to make or buy; whether to build products in America, Europe, or elsewhere; which distribution center to provide the product to the customer; and how much inventory to hold and where.

4. You should improve asset productivity. For manufacturers, better demand visibility allows for eff ective planning and scheduling to maximize returns on critical assets, such as equipment, materials, and people. For logistics providers and retailers, the reduced uncertainty allows more eff ective use of warehousing and transportation assets.

5. You should expand your visibility. In global supply chains, product travels more miles, passes through more hands, and crosses more systems on its way to the fi nal customer. Th ere are numerous points where a disruption can occur. Th e use of RFID technology can provide real-time visibility into inventory status regardless of where it is and improve your ability to predict and plan for its arrival.

6. You need to know what happens, when it happens. For you to minimize the eff ect of an external event or to maximize the opportunity of new customer demand, you need to know about it as early as possible so that you can take the appropriate action. For example, if you learn immediately when a manufacturer has a major production problem, you can possibly allocate some production to another factory within the supply chain. If you learn immediately of increased customer demand in a specifi c region, you may be able to meet this demand by rerouting product as it moves through the supply chain.

7. You need to design to deliver. A holistic view of the supply chain must include the design of the product itself. Focus on ways to reduce development time and time to market. Consider whether it makes sense to use a third-party logistics provider for last-minute product customization. Th e postponement approach provides fl exibility, as well as removing costs from manufacturing. It often allows for delivery of the fi nal confi gured product within 24 hours to the customer. If a company wants to use a postponement approach, it must be considered during the product design.

8. You must track performance to allow for continuous improvement.

Implementing these strategies should result in benefits for members of the supply chain. You should reduce operations expenses. Having a clearer picture of end-customer demand allows companies to better plan for the appropriate mix of inventory, production, and transportation strategies. The companies should expect improved profitability as internal operations become more efficient and cost effective. Customer service should be improved since the companies have better visibility into final customer demand. Competitiveness and faster growth should improve as the company gains better insight into the internal, exter- nal, and customer dimension of its business.

Supply Chain Performance Metrics A company can use traditional financial measures such as return on investment (ROI), prof- itability, market share, and revenue growth, as well as traditional inventory performance measures such as customer service levels, inventory turns, weeks of supply, and inventory obsolescence (all discussed in Chapter 12).

138 CHAPTER 4 • Supply Chain Management

Let’s look at how a large state university used several metrics to analyze how well its supply chain achieved the following initiatives. The first initiative was a spend analysis. This was a strategic review of spend data across all purchase and payment methods to increase compliance and identify new organization-specific contracting and cost containment opportunities. The university also evaluated its level of progress in strategic sourcing. The purpose of the supply base management initiatives was to leverage the university’s buying power and maximize the value of its strategic supplier business relationships. A third ini- tiative concerned contract management. This initiative concerned the development and implementation of a university-wide best-in-class contract pricing agreement that would assure the university the “least total cost” for products and services required from external suppliers. The fourth initiative evaluated the use of collaborative buying. This examined how well the university had used local, regional, and national collaborative buying business part- ners to further leverage buying power. The last initiative was concerned with compliance. It was designed to promote faculty and staff compliance with procurement and disbursement financial policies and to determine the level of compliance to university-authorized buy- ing methods and use of contract suppliers. To summarize, the university analyzed the fre- quency with which members of its supply chain were used, while simultaneously checking to see whether new suppliers should be added to its supply chain.

The university also used a number of key purchasing performance metrics. The financial metric measured ROI, the total cost containment versus the operating budget, the combi- nation of cost savings and supply chain revenue, the negotiated product and service cost savings, and purchasing revenue. The contracting metric looked at the number of new pre- ferred discount contracts, the level of spending done with contract suppliers, the amount of collaborative buying, the number of electronic competitive bidding events, and the number of strategic sources deactivated. The compliance metric also considered the level of pur- chase order buys and the level of buys through managed supplier relationships, the level of purchase activity at the university’s net marketplace and the use of marketplace suppliers, and the amount of green product and service purchases.

An analysis of the e-marketing summarized the number of unique visitors to the pur- chasing services Web site and to the supplier showcase. Operations were analyzed based on the percentage of customers very satisfied in a biannual survey. Economic inclusion mea- sured the amount of buys placed with local community-based suppliers. It also analyzed the amount of purchases made with all diversity-owned suppliers, as well as all African American–owned suppliers. The number of diversity suppliers in the university marketplace was also monitored. The university used purchasing cards (p-cards) for staff to place small purchases without the need for a purchase order. The level of use of p-cards was tracked to determine the level of noncompliance with commodity or supplier restrictions. Travel expenses were also monitored to determine compliance with negotiated travel service providers. And finally, the university measured accounts payable activities, such as the per- centage of electronic purchase order invoices, the effectiveness of the electronic invoice business process (EDI), the number of data errors causing rejections, the percentage of sup- plier invoices paid within terms, and the use of electronic fund transfers (EFT). Clearly, the number of specific metrics used by the university is quite significant. Other activities to analyze can include quality and on-time delivery of products and services.

Organizations also often measure the quality of their products or services. An organiza- tion can measure product or service quality by looking at warranty costs, products returned, and markdowns given to the customer due to poor quality or service. In Chapters 5 and 6, you will learn about different aspects of quality and methods for measuring quality levels. These techniques can easily track supply chain quality.

In Chapter 15, you will learn about scheduling performance measures that could be used to evaluate the company’s response time as well as to evaluate how well the company is

Implementing Supply Chain Management • 139

using its capacity. Excess capacity may enable much quicker response times, but the com- pany must assess the cost of low capacity utilization.

The company needs to determine what customer satisfaction means to its customers. Does it mean filling the entire order? Does it mean how quickly it can respond to customer requests? Or is it more important to have the product always arrive on time? Answering these questions identifies the activities that support the supply chain’s objectives. These are the activities that must be measured.

An example of manufacturing performance metrics was reported in a study of U.S.– Mexican maquiladora operations. Performance measurements included cycle-time reduction (response time), routing and scheduling performance (on-time delivery, response time, and capacity utilization), and outbound cross-border transportation. The bottom line is that companies must measure performance of the supply chain and the measurements must support behavior that is consistent with the supply chain objectives.

The Supply Chain Operations Reference (SCOR) model is an effort to standardize mea- surement of supply chain performance. The SCOR model examines four different opera- tional perspectives: reliability, flexibility, expenses, and assets/utilization. From a reliability perspective, the supply chain is measured on on-time delivery, order fulfillment lead time, and fill rate (the fraction of demand met from stock). In terms of flexibility, supply chain response time and production flexibility are measured. For expenses, supply chain man- agement cost, warranty cost as a percentage of revenue, and value added per employee are examined. In terms of assets/utilization, total inventory days of supply, cash-to-cash cycle time, and net asset turns can be measured.

Supply Chain Management Within OM: How it all Fits Together

Supply chain management (SCM) is directly linked to many OM activities. The degree of supply chain management is a strategic decision for the organization (Chapter 2) and deter- mines the level of vertical integration in the organization. SCM is concerned with external suppliers, internal operations, and external distributors.

Effective SCM requires supplier partnerships. Using the ISM Principles and Standards of Ethical Supply Management Conduct, purchasing develops partnerships with suppliers to assure a continuous supply of materials at a reasonable cost. Purchasing also works with suppliers to improve communications, to develop flexibility in meeting changes of demand, to improve quality of materials, and to assure on-time delivery. This assured, continuous supply of materials allows the production planners to effectively schedule jobs (Chapter 14) and to use equipment and personnel efficiently.

SCM also provides for streamlined communications between suppliers and the com- pany, thus reducing purchasing lead time. As we will learn when studying inventory man- agement in Chapter 12, reduced lead time results in lower inventory levels. The improved communications within the supply chain improve demand forecasting accuracy. This reduces demand uncertainty, allowing lower safety stock investment while still maintaining customer service levels. Improved demand forecast accuracy also contributes to the devel- opment of better staffing plans (Chapter 13), which can lead to lower personnel costs, lower inventory costs, and improved customer service.

SCM affects product and process design (Chapter 3) by specifying which items are done in-house and which items are outsourced. Good supply chain management provides timely, accurate information that is critical to successful operations management.

140 CHAPTER 4 • Supply Chain Management

SCM Across the Organization Supply chain management changes the way companies do business. Consider how supply chain management affects different functional areas within the organization.

Accounting shares some of the benefits and responsibilities of supply chain manage- ment. As inventory levels decrease, customer service levels increase. Accounting is exposed to the risks of information sharing and involved in developing long-term partnerships. With information sharing comes the need for increased confidentiality and trust.

Marketing benefits by improved customer service levels achieved by POS data collec- tion. A shared database provides marketing with current demand trends and eliminates demand filtering between levels of the supply chain. POS data also facilitate quicker cus- tomer response time. Global supply chains facilitate access into local markets.

Information systems are critical for supply chain management. Information systems provide the means for collecting relevant demand data, developing a common database, and providing a means for transmitting order information. Information systems enable information sharing through POS data, EDI, RFID, the Internet, intranets, and extranets.

Purchasing has an important role in supply chain management. Purchasing is responsi- ble for sourcing materials and developing a strong global supplier base through long-term partnering agreements, using e-sourcing and e-purchasing concepts.

Operations uses timely demand information to more effectively plan production sched- ules and use manufacturing capacity. Operations responds more quickly to changing cus- tomer demand data, thus providing improved customer service levels.

Who is responsible for supply chain management within an organization? In a manu- facturing company, it is often the materials manager, since he or she is more familiar with external suppliers, internal functions, and external distributors. The person who does sup- ply chain management must see the “big picture” so that local priorities do not overshadow global priorities. In a service organization, the operations or office manager may be respon- sible for supply chain management.

ACC

MKT

MIS

OM

This chapter provides the framework for understanding sup-ply chain management. Supply chains consist of external suppliers, internal processes, and external distributors. Internal processes (purchasing, processing, production planning and control, quality assurance, and shipping) are integrated fi rst since the manufacturer has direct control over these activities. Integrating external suppliers into the supply chain begins with sourcing decisions and subsequent strategic partnership devel- opment by the purchasing function. Electronic net marketplaces

facilitate sourcing by bringing together thousands of suppliers and buyers to a common site. Distributors are usually the last segment of the chain to be integrated. Warehouses can be used for consolidation, product mixing, or fi nalizing products. Cross- docking can reduce transit time as well as reduce handling of goods. RFID helps track materials as they fl ow through the sup- ply chain. POS demand data are provided to all members of the supply chain to reduce uncertainty and to assure that all mem- bers of the supply chain work with common data. •

THE SUPPLY CHAIN LINK

Supply chain management has tremendous opportunity to impact sustainability as it cuts across all enterprises in- volved in product creation and delivery. A sustainability change in the operations function of one member of the supply chain does not solve the problem if the other members of the supply chain continue to violate sustainability goals. A company, for

example, can develop production processes at its manufactur- ing facility with reduced emissions. However, not much has been accomplished if the materials it sources are produced or delivered in ways that pollute the environment. For changes to have impact, they must be made across the entire supply chain.

THE SUSTAINABILITY LINK

Companies must ensure that sustainable changes are not made to just one operation in the supply chain, but to the en- tire system of sourcing, production, transportation, delivery, and all “operations” involved. For example, one important as- pect of supply chain sustainability is the movement and stor- age activities of the supply chain. These activities are among the most energy intensive. Carbon dioxide emissions from the transportation sector alone account for 33 percent of the

United States’ total CO 2 emissions. Judicious consideration of

modes of transportation and sourcing can dramatically impact sustainability. Think about the difference between energy con- sumed to ship a New Zealand lamb chop to a restaurant in New York City, versus procuring a lamb chop from a farm in upstate New York. The savings in product price or the benefi ts of product quality may be outweighed by the environmental costs of logistics across large distances. •

Chapter Highlights 1 Every organization is part of a supply chain, either

as a customer or as a supplier. All supply chains have external suppliers, internal functions, and external dis- tributors. An external supplier’s position in the supply chain is designated by its tier status. A tier one sup- plier directly supplies the manufacturer of the finished good. A tier two supplier directly supplies a tier one supplier, thus indirectly supplying the manufacturer. Internal functions include activities performed by the final product company, such as processing, purchasing, production planning and control, quality assurance, and shipping. External distributors transport the prod- uct or service to appropriate locations for eventual sale to customers. The bullwhip effect distorts product or service demand information passed between different levels of the supply chain. The more different levels that exist, the greater the distortion can be. Variabil- ity results from updating demand estimates at each level, order batching, price fluctuations, and ration- ing. Shared demand data help eliminate the bullwhip effect.

2 A number of issues affect supply chain management. E-commerce is the use of the Internet and the Web to transact business. E-commerce began with auto- mated order entry systems, evolved to electronic data interchange (EDI), to electronic store fronts, to net marketplaces, and to the development of intranets and extranets. All are designed to facilitate informa- tion sharing among members of the supply chain. Consumer expectations are high as they demand bet- ter service, better product quality, quicker response times, and reasonable prices. Global supply chains face greater uncertainty because of the shipping distances involved. Port congestion on the U.S. West Coast has generated considerable port activity in Mexico. Proj- ects to upgrade ports and the project to widen and deepen the Panama Canal offer alternative shipping routes from Asia to the United States Government regulations currently focus on the issue of sales tax on

Internet purchases. It is likely that a bill will be passed in the near future settling the issue. Green supply chain management focuses on the environment and how anything done in the supply chain affects the environ- ment. Supply chains try to reduce their carbon foot- print and become more environmentally friendly.

3 Purchasing has a major role in supply chain manage- ment. Purchasing makes sourcing decisions, develops strategic long-term partnerships, and maintains a sup- plier base capable of supporting the supply chain.

4 Sourcing decisions are critical in establishing a respon- sive supplier base. The use of net marketplaces allows companies to reduce supplier search costs and facil- itate the use of e-sourcing. Companies also make insourcing and outsourcing decisions. These make-or- buy decisions are based on financial and strategic cri- teria. Companies do not outsource activities that are part of their core competencies. Developing partner- ships requires sharing information, risks, technologies, and opportunities. Impact, intimacy, and vision are critical to successful partnering. Ethics in supply man- agement is an ongoing concern. Buyers are in a posi- tion to influence or award business, so it is imperative that they avoid any appearance of unethical behavior or conflict of interest. The Institute for Supply Manage- ment has established a set of principles and standards to guide buyers.

5 Supply chain distribution requires effective warehous- ing operations. Warehouses allow transportation con- solidation, product mixing, and service. Warehouses consolidate less-than-truckload (LTL) quantities into truckload (TL) quantities. Product mixing adds value by grouping items and shipping those items directly to the customer. Warehouses improve customer ser- vice by placing goods closer to the customer to reduce response times. Crossdocking takes goods from inbound trucks and quickly loads the material onto outbound trucks. This action eliminates the need to enter goods into warehouse inventory. Typically the

Chapter Highlights • 141

142 CHAPTER 4 • Supply Chain Management

goods are on the crossdock for less than 24 hours. RFID accurately tracks shipments. As more new small com- panies establish an e-commerce presence, the need for third-party logistics providers increases.

6 Implementing supply chain management usually begins with a manufacturer or service provider inte- grating its internal functions. Then the company works on integrating the external suppliers. Net marketplaces simplify developing a company’s supplier base and

facilitate the integration process. The final step is inte- grating the external distributors. A company needs metrics to evaluate supply chain performance. Regular performance metrics (ROI, profitability, market share, customer services levels, etc.) and other measures that reflect the objectives of the supply chain are used. The company can use the Supply Chain Operations Ref- erence (SCOR) model to standardize its supply chain performance.

Key Terms

supply chain 99

supply chain management (SCM) 99

external suppliers 100

internal functions 100

external distributors 100

tier one supplier 100

tier two supplier 100

tier three supplier 100

logistics 102

traffi c management 102

distribution management 102

bullwhip eff ect 104

e-commerce 106

automated order entry system 106

electronic data interchange (EDI) 106

electronic storefronts 106

net marketplaces 106

electronic request for quote (eRFQ) 107

virtual private network (VPN) 107

business-to-consumer (B2C) e-commerce 107

advertising revenue model 107

subscription revenue model 107

transaction fee model 107

sales revenue model 107

affi liate revenue model 107

intranets 107

extranets 108

e-distributors 108

e-purchasing 108

value chain management (VCM) 108

exchanges 108

industry consortia 108

supply chain velocity 112

green supply chain management 113

requisition request 116

price and availability 116

purchase order 116

incoming inspection 117

sourcing strategy 117

vertical integration 120

insource 120

outsource 120

backward integration 120

forward integration 120

partnering 125

general warehouse 130

distribution warehouse 130

postponement 131

crossdocking 132

manufacturing crossdocking 132

distributor crossdocking 132

transportation crossdocking 132

retail crossdocking 132

radio frequency identifi cation (RFID) 134

Formula Review For insourcing or outsourcing:

FCBuy + (VCBuy × Q) = FCMake + (VCMake × Q)

Solved Problems (See student companion site for Excel template.) PROBLEM 1

Jack Smith, owner of Jack’s Auto Sales, is deciding whether his company should process its own auto loan applications or outsource the process to Loans Etc. If Jack processes the auto loan applications internally, he

faces an annual fi xed cost of $2500 for membership fees, allowing him access to the TopNotch credit company, and a variable cost of $25 each time he processes a loan application. Loans Etc. will process the loans for $35 per

application, but Jack must lease equipment from Loans Etc. at a fi xed annual cost of $1000. Jack estimates processing 125 loan applications per year. What do you think Jack should do?

(a) Should Jack process the loans internally or outsource the loans if demand is expected to be 125 loan applications?

(b) Is Jack indifferent to internal processing and out- sourcing at one level of loan applications?

Before You Begin: To make his decision when demand is known, Jack needs to calculate the total cost of processing the auto loans in-house and compare it to the total cost of outsourcing the loan processing. You need to identify the relevant costs. If Jack processes the loans internally, he has an annual fi xed cost of $2500 plus a per loan variable cost of $25. If the loan processing is outsourced, Jack has a fi xed annual cost of $1000 and a per loan variable cost of $35.

PROBLEM 2

Big State University (BSU) is considering whether or not it should outsource its housekeeping service. Currently, BSU employs 400 housekeepers at an average annual wage of $23,000 plus another 39 percent for fringe benefi ts. Annual fi xed costs associated with housekeeping are $1,278,800.

Eric’s Effi cient Cleaners (EEC) will provide similar housekeeping for a fi xed annual cost of $7,500,000 plus a variable cost of $20,000 per housekeeper required. Because Eric uses state-of-the-art equipment and well-trained employees, his company would need only 80 percent of the current BSU housekeeper staff (or 320 housekeepers).

(a) Calculate the annual cost of BSU using its current housekeeping staff.

(b) Calculate the annual cost if BSU lets EEC do the housekeeping.

(c) Find the indifference point for the two alternatives.

Before You Begin: Identify the relevant costs. You need to know the cost to BSU for using its own house- keeping staff . Th e average annual salary per house- keeper is $23,000 plus fringe benefi ts (39 percent of the average annual salary). Th e annual fi xed cost associ- ated with housekeeping is $1,278,800. If housekeeping is outsourced, BSU doesn’t need to pay fringe benefi ts. EEC will provide similar service for a fi xed annual cost of $7,500,000 plus a variable cost of $20,000 per house- keeper. Remember that EEC only needs 320 house- keepers for the job.

Solution:

(a) The total cost for processing 125 loan applications internally is $5625. That is $2500 in annual fixed costs plus 125 loan applications multiplied by the $25 per application variable cost. The total cost for outsourcing the applications is $5375. That is $1000 in annual fixed costs plus 125 loan applica- tions multiplied by the $35 per application variable cost. At 125 loan applications, it is cheaper for Jack to outsource the loan application processing.

(b) When demand is not known, set the total costs of each alternative equal to each other, or $1000 + ($35 * Q) = $2500 + ($25 * Q). Solving for Q, we have 10Q = $1500, or Q = 150 loan applications. Since the costs are equal at 150 loan applications and Jack expects to need 125 applications pro- cessed, he is better off outsourcing the loan appli- cations to Loans Etc.

Solution:

(a) If BSU does its housekeeping with its current staff, the cost is $14,066,800.

Cost per housekeeper ($23,000 + 39% fringe benefits) = $31,970

Cost for 400 housekeepers (400 × $31,970) = $12,788,800

Annual fixed costs = ˚1,278,000

Total annual costs $14,066,800

(b) If BSU has EEC do the housekeeping, the cost is $13,900,000.

Cost for 320 housekeepers (320 × 20,000) = 6,400,000

Annual fixed costs = ˚7,500,000

Total annual costs $13,900,000

(c) The indifference point is found by setting the two cost functions equal to each other. Since EEC only needs 80% as many employees as BSU, we need to adjust the cost functions.

$1,278,800 + $31,970(Q) = $7,500,000 + (0.8Q)($20,000) Q = 389.55, or 390 employees. Th erefore, if the school needs fewer than 390 in-house housekeepers, it should do the housekeeping rather than outsource it. If BSU needs more than 390 housekeepers, it should outsource with EEC.

Solved Problems • 143

144 CHAPTER 4 • Supply Chain Management

Discussion Questions

1. Discuss the diff erent types of e-commerce.

2. Explain the diff erent revenue models used in e-commerce.

3. Give two examples from the Internet for each of the diff erent revenue models used in e-commerce.

4. Describe the evolution of business-to-business (B2B) e-commerce.

5. For the next item you buy, determine its supply chain.

6. How do supply chains for service organizations diff er from supply chains for manufacturing organizations?

7. How can companies satisfy increasing customer ex- pectations?

8. Describe the additional factors that aff ect global supply chains.

9. Th ink of your last major purchase. What criteria did you use to select the supplier?

10. Explain the concept of partnering, including advantages and disadvantages.

11. Explain the benefi ts of using a single supplier as opposed to multiple suppliers.

12. Describe the kinds of information that are necessary in a supply chain.

13. Describe the role of warehouses in a supply chain.

14. Describe radio frequency identifi cation (RFID) and how it could be used by an organization.

15. Describe the current trends in e-commerce and how they aff ect supply chain management.

Problems

1. Gabriela Manufacturing must decide whether to in- source or outsource a new toxic-free miracle carpet cleaner that works with its Miracle Carpet Cleaning Machine. If it decides to insource the product, the process would incur $300,000 of annual fi xed costs and $1.50 per unit of variable costs. If it is outsourced, a supplier has off ered to make it for an annual fi xed cost of $120,000 and a variable cost of $2.25 per unit in variable costs. (a) Given these two alternatives, determine the

indiff erence point (where total costs are equal). (b) If the expected demand for the new miracle cleaner

is 300,000 units, what would you recommend that Gabriela Manufacturing do?

2. Gabriela Manufacturing was able to fi nd a new sup- plier that would provide the item for $1.80 per unit with an annual fi xed cost of $200,000. Should Gabriela Manufacturing insource or outsource the item?

3. Downhill Boards (DB), a producer of snow boards, is evaluating a new process for applying the fi nish to its snow boards. Durable Finish Company (DFC) has off ered to apply the fi nish for $170,000 in fi xed costs and a unit variable cost of $0.65. Downhill Boards cur- rently incurs a fi xed annual cost of $125,000 and has a variable cost of $0.90 per unit. Annual demand for the snow boards is 160,000. (a) Calculate the annual cost of the current process

used at Downhill Boards. (b) Calculate the annual cost if Durable Finish

Company applies the fi nish.

(c) Find the indifference point for these two alternatives.

(d) How much of a change in demand is needed to justify outsourcing the process?

4. Fast Finish, Inc. (FFI) has made a technological break- through in snow board fi nish application. FFI will ap- ply the fi nish for $0.23 per unit in variable costs plus a fi xed annual cost of $230,000. Use the cost and demand information given in Problem 3 for Downhill Boards to evaluate this proposal. (a) What will it cost Downhill Boards to outsource

the fi nishing process? (b) At what demand level does it make sense

economically to outsource the fi nishing process? (c) What additional factors should be considered

when making this outsourcing decision? 5. Henri of Henri’s French Cuisine (HFC), a chain of 12 res-

taurants, is trying to decide whether it makes sense to outsource the purchasing function. Currently, Henri em- ploys two buyers at an annual fi xed cost of $85,000. Henri estimates that the variable cost of each purchase order placed is $15. Value-Buy (VB), a group of purchasing spe- cialists, will perform the purchasing function for a fi xed annual fee of $100,000 plus $5 for each purchase order placed. Last year, HFC placed 1450 purchase orders. (a) What was the cost last year to HFC when doing

the purchasing in-house? (b) What would the cost have been last year had HFC

used Value-Buy?

(c) What is the indiff erence point for the two alternatives?

(d) If HFC estimates it will place 1600 purchase orders next year, should it use VB?

(e) What additional factors should be considered by HFC?

6. Cal’s Carpentry is considering outsourcing its accounts receivable function. Currently, Cal employs two full-time clerks and one part-time clerk to manage accounts receivable. Each full-time clerk has an annual salary of $36,000 plus fringe benefi ts costing 30 percent of the salary. Th e part-time clerk makes $18,000 per year but has no fringe benefi ts. Total salary plus fringe cost is $111,600. Cal estimates that each account receiv- able incurs a $10 variable cost. Th e Small Business Accounts Receivables Group (SBARG) specializes in handling accounts receivable for small- to medium-size

companies. Doris Roberts from SBARG has off ered to do the accounts receivable for Cal’s Carpentry at a fi xed cost of $75,000 per year plus $30 per account re- ceivable. Next year, Cal expects to have 2000 accounts receivable. (a) Calculate the cost for Cal’s Carpentry to continue

doing accounts receivable in-house. (b) Calculate the cost for Cal’s Carpentry to use

SBARG to handle the accounts receivable. (c) If the fi xed annual cost off ered by SBARG is non-

negotiable but it is willing to negotiate the variable cost, what variable cost from SBARG would make Cal indiff erent to the two options?

(d) What other alternatives might Cal consider in terms of his current staffi ng for accounts receivable?

(e) What additional criteria should Cal consider before outsourcing the accounts receivable?

Case: Electronic Personal Heart Rate Monitors Supply Chain Management Game

In this supply chain game, retailers sell electronic heart rate monitors to their customers and place replenish- ment orders to their wholesaler. Th e wholesaler sells the heart rate monitors to the retailers and orders the monitors from a distributor. Th e distributor sells the heart rate monitors to the wholesalers and orders mon- itors directly from the factory. Th e distribution system is shown in the fi gure. For each period the game is played, participants must follow the same sequence: 1. Receive any shipments into inventory.

2. Ship monitors to satisfy both new customer demand and any back orders, as long as suffi cient product is available.

3. Determine the ending inventory (a negative value indicates back orders exist).

4. Determine the inventory position (ending inventory plus any quantity already ordered).

5. Place replenishment orders.

For this game, inventory holding costs will be $10 per case per week and back order costs will be $15 per case per week.

Each person must keep track of his or her own costs. Th e weekly demand at the retailers will be provided by your professor. Once the demand is known by the retailers, the retailers place the appropriate replen- ishment orders with the wholesalers. Th e wholesalers update their inventory records and place the necessary

orders with the distributor. At this point, the distribu- tor updates its inventory records and places the appro- priate replenishment order with the factory. Lead time throughout the supply chain is two weeks. For example, once the factory releases an order to be manufactured, it is two weeks before it is available; when the distribu- tor orders heart rate monitors from the factory, it is two weeks before they arrive.

Factory (1)

Distributors (3)

Wholesalers (6)

Retailers (12)

Customers

Electronic heart rate monitor supply chain

Case: Electronic Personal Heart Rate Monitors Supply Chain Management Game • 145

146 CHAPTER 4 • Supply Chain Management

A number of participants are needed in this game (see the fi gure). One person manages the factory (1). Th ere are three distribution centers, each needing a manager (3). Each distribution center supplies two dif- ferent wholesalers (6), and each wholesaler supplies two unique retailers (12). In some cases, a location may have co-managers to speed up the transactions. Th e accompanying table provides information regarding each location in the supply chain.

For each period of the game, retailers follow these procedures:

1. Th e retailer accepts into stock any orders due to arrive during the current period. Th e beginning inventory plus the arriving order determine how much inventory the location has available to satisfy demand during that period.

2. Next, your professor provides each retailer with actual demand data for that period. Th e demand is given to the retailer on a paper order form. Th e data are not shown to other members of the supply chain but are treated as confi dential information.

3. Retailers fi ll orders as long as suffi cient inventory (calculated in Step 1) is available.

4. Retailers calculate their ending inventory level. If suffi cient inventory is available, ending inventory is beginning inventory minus that period’s actual demand. If there is not suffi cient inventory, then back orders occur. When a back order occurs, your ending inventory value is negative. For example, if you only have 30 units available and demand is 32 units, your inventory balance is −2 units.

Individual Location Information

Replenishment Order Quantity

(cases) Recorder point

(cases) Beginning

Inventory (cases) Average Weekly Demand (cases)

Factory 350 190 277 175

Distributor A 120 125 185 60

Distributor B 180 190 280 90

Distributor C 100 52 77 25

Wholesaler A1 90 95 140 45

Wholesaler A2 60 31 46 15

Wholesaler B1 105 110 163 52.5

Wholesaler B2 75 80 118 37.5

Wholesaler C1 60 31 46 15

Wholesaler C2 40 21 31 10

Retailer A11 60 62 92 30

Retailer A12 30 31 46 15

Retailer A21 45 24 35 11.25

Retailer A22 15 8 13 3.75

Retailer B11 75 78 116 37.5

Retailer B12 60 31 46 15

Retailer B21 40 42 62 20

Retailer B22 35 37 55 17.5

Retailer C11 40 21 31 10

Retailer C12 20 11 16 5

Retailer C21 20 12 18 5.5

Retailer C22 20 10 15 4.5

5. Retailers calculate their inventory position. Inven- tory position is the ending inventory plus any quan- tity already ordered that has not yet arrived. For example, if your ending inventory is −2 but you have placed an order for 90 additional cases, your inven- tory position is 88 cases (−2 + 90).

6. If the retailer’s inventory position is at or below its reorder point, the retailer places an order with its wholesaler. Retailers A11 and A12 order from wholesaler A1, retailers A21 and A22 order from wholesaler A2, and so on. Th ese orders are made in writing and delivered to the appropriate wholesaler. No other communication is permitted.

For the wholesalers, the procedure each period is the following:

1. Th e wholesaler accepts into stock any orders due to arrive during the current period. Th e beginning inventory plus the arriving order determine how much inventory the location has available to satisfy demand during that period.

2. Next, the wholesalers look at the replenishment orders from the retailers for that period. Th ese data are not shown to other members of the supply chain but are treated as confi dential information.

3. Wholesalers fi ll orders as long as suffi cient inven- tory (calculated in Step 1) is available.

4. Wholesalers calculate their ending inventory level. If suffi cient inventory is available, ending inventory is beginning inventory minus that period’s actual demand. If there is not suffi cient inventory, then back orders occur. When a back order occurs, your ending inventory value is negative.

5. Wholesalers calculate their inventory position. Inventory position is the ending inventory plus any quantity already ordered that has not yet arrived.

6. If the wholesaler’s inventory position is at or below its reorder point, the wholesaler places an order with its distributor. Wholesalers A1 and A2 order from distributor A, wholesalers B1 and B2 order from dis- tributor B, and so on. Th ese orders are in writing and delivered to the appropriate distributor. No other communication is permitted.

For the distributors, the procedure followed each period is the following:

1. Th e distributor accepts into stock any orders due to arrive during the current period. Th e beginning inventory plus the arriving order determine how

much inventory the location has available to satisfy demand during that period.

2. Next, the distributor looks at the replenishment orders from its wholesalers for that period. Th ese data are not shown to other members of the supply chain but are treated as confi dential information.

3. Distributors fi ll orders as long as suffi cient inventory (calculated in Step 1) is available.

4. Distributors calculate their ending inventory level. If suf- fi cient inventory is available, ending inventory is begin- ning inventory minus that period’s actual demand. If there is not suffi cient inventory then back orders occur.

5. Distributors calculate their inventory position. Inventory position is the ending inventory plus any quantity already ordered that has not yet arrived.

6. If the distributor’s inventory position is at or below its reorder point, the distributor places an order with the factory. Th ese orders are in writing and delivered to the appropriate distributor. No other communica- tion is permitted.

Th e factory follows these procedures each period:

1. Th e factory accepts into stock any manufacturing orders completed for the current period. Th e begin- ning inventory plus the arriving order determine how much inventory the location has available to satisfy demand during that period.

2. Next, the factory looks at the replenishment orders from the distributors for that period.

3. Th e factory fi lls orders as long as suffi cient inventory (calculated in Step 1) is available.

4. Th e factory calculates its ending inventory level. If suffi cient inventory is available, ending inventory is beginning inventory minus that period’s actual demand. If there is not suffi cient inventory, then back orders occur. When a back order occurs, your ending inventory value is negative.

5. Th e factory calculates its inventory position. Inven- tory position is the ending inventory plus any quan- tity already ordered that has not yet arrived.

6. If the factory’s inventory position is at or below its reorder point, the factory releases an order to manufacturing.

Procedures for all locations include the following:

1. At the end of each period, record the amount of actual inventory you have left, the actual number of back orders, the cost of holding the inventory, the cost of the back orders, and the total cost.

Case: Electronic Personal Heart Rate Monitors Supply Chain Management Game • 147

148 CHAPTER 4 • Supply Chain Management

2. Update your total statistics, that is, keep a running total of the cases of inventory, the number of back orders, and the cumulative holding costs, cumulative back order costs, and total costs.

End of Game Discussion Questions

1. How well does the distribution system seem to work? Talk about it in terms of customer service, costs, eff ec- tive use of inventory, and information fl ows.

2. Given the amount of inventory in the system, why did back orders occur?

3. In this distribution chain, what happened to customer demand data?

4. How should customer demand data be communi- cated through the system?

5. What would you recommend be done diff erently?

Case: Supply Chain Management at Durham International Manufacturing Company (DIMCO)

Lucille Jenkins, the CEO for the Durham International Manufacturing Company (DIMCO), believes that the company can signifi cantly increase its operating profi t by implementing supply chain management. DIMCO manufactures a variety of consumer electronic prod- ucts, from hair dryers to humidifi ers to massagers, for the world market.

Lucille believes that DIMCO has already integrated its internal processes and is ready to proceed with exter- nal integration. However, she is uncertain as to which direction to take. Should the company work on inte- grating the suppliers or the distributors fi rst? Currently, DIMCO uses approximately 1350 diff erent components and/or raw materials in manufacturing its product line. Th ose components and raw materials are purchased from approximately 375 diff erent suppliers around the world. In terms of distribution, DIMCO currently sends its fi nished products to a central warehouse that

supplies 10 regional distribution centers (RDC); 6 are domestic and 4 are located outside of the United States. Each RDC supplies an average of 12 local distributors that each supply an average of 35 retailers.

Lucille is looking for some advice.

1. Briefl y describe DIMCO’s supply chain.

2. What are the advantages that DIMCO can gain by implementing supply chain management?

3. What would you recommend DIMCO attempt next? Should it work on integrating the suppliers or the distributors fi rst? Or should it work on both simultaneously?

4. What are your recommendations with regard to the external suppliers?

5. What are your recommendations with regard to the external distributors?

Interactive Case: Virtual Company

On-line Case: Cruise International, Inc.

Assignment: Supply Chain Management at Cruise Inter- national, Inc. Bob Bristol, your boss at CII, just called to tell you that he was impressed with your progress thus far in familiarizing yourself with operations at CII—both the strategic details pertaining to its mission, competi- tive priorities, and so on, and the specifi c details con- cerning its services and processes. He tells you that with all the buzz about supply chain management (SCM) that you hear these days, CII is actively interested in explor- ing how diff erent SCM concepts and techniques could

be used in its operations. Providing an adequate, assured supply of a variety of mechanical equipment, entertain- ment equipment, retail merchandise, food products, and supplies for maintaining the ship is critical to CII. Meghan Willoughby, Chief Purser aboard the Friendly Seas I, has a couple of specifi c assignments that you will work on later. But for now, Meghan would like a concise research report for the top management team addressing SCM issues relevant to CII. Th is assignment will enhance your knowledge of the material in Chapter 4 of your text- book while preparing you for future assignments.

www.wiley.com/college/reid

To access the Web site: • Go to www.wiley.com/college/reid

• Click Student Companion Site

• Click Virtual Company/Cruise International, Inc.

• Click Consulting Assignments

• Click Supply Chain Management at CII

On-line Case: Supply Chain Management at Valley Memorial Hospital

Bob Reilly, head of Kaizen, just called you to say that he was impressed with your progress in familiarizing yourself with the operations at VMH—both the stra- tegic details pertaining to its mission and competitive priorities and the specifi c details concerning its prod- ucts and processes. He tells you that with all the buzz about supply chain management (SCM) that you hear these days, VMH is actively interested in exploring how SCM concepts and techniques could be adopted in its operations. Maintaining an adequate and timely supply of a variety of laboratory equipment, surgical instru- ments, and supplies is critical to VMH. Meg Willoughby, the head of materials management at VMH, has a cou- ple of specifi c assignments that you will work on later.

For now, Meg has suggested that you prepare a concise research report for top management addressing SCM issues relevant to VMH. She has also put together a few specifi c questions for you to address. Th is assign- ment will enable you to enhance your knowledge of the material covered in Chapter 4.

To access the Web site: • Go to www.wiley.com/college/reid

• Click Student Companion Site.

• Click Virtual Company/Valley Memorial Hospital

• Click Kaizen Consulting, Inc.

• Click Consulting Assignments

• Click Supply Chain Management at Valley Memorial Hospital

Internet Challenge: Global Shopping

Since the Internet provides access to products around the world, your challenge involves some global shop- ping. Th is year you have been given a budget of $10,000 to furnish and decorate your off -campus apartment. You have chosen a global theme. Your job is to fi nd items from as many diff erent parts of the world as you can to use in your apartment. You can spend up to $10,000 but you cannot exceed your budget. Do not for- get that shipping must be included in your budget. You can choose more than a single item from any country.

(a) Visit the Internet to fi nd products for your apart- ment. You need to furnish a one-bedroom apartment.

You do not need to worry about major appliances (computer, television, stereo, oven, refrigerator, dish- washer, etc.), but you do need everything else. Since you plan to host a major party in your new apart- ment, everything you buy must be delivered within six weeks.

(b) Provide a list of all of the items you would buy, the cost of each item, and the total money spent. Orga- nize your list by the room the item is intended for. Be sure to identify the country of origin for each item. Have fun shopping!

Selected Bibliography

Atkinson, W. “Th e Big Trends in Sourcing and Procure- ment,” Supply Chain Management Review, May 1, 2008.

“Champion of Green: An Interview with Drew Schramm.” Supply Chain Management Review, July 1, 2008.

“City of Lynchburg: Current Solicitations.” http://www/ lynchburgva.gov/current-solicitations.

“City of Lynchburg: Purchasing Code and Ethics.” http:// www.lynchburgva.gov/procurement.

Frei, W. “Online Sales Tax Bill Sees New Life in the Senate.” http://www.avalara.com/blog/2014/07/17/online-sales- tax-bill-sees-new-life-senate/. July 17, 2014.

Selected Bibliography • 149

150 CHAPTER 4 • Supply Chain Management

“Governors Want Action on Internet Sales Tax Bill.” http:// www.theleafchronicle.com/story/opinion/editorials/2014/ 07/25/governors-want-action-internet-sales-tax-bill/ 13118465/. July 25, 2014.

Howton, J. “Crossdocking: A New Vision for an Old Idea.” http://inboundlogistics.com/cms/article/crossdocking- a-new-vision-for-an-old-idea/. April 2010.

LaLonde, B. “As the World Goes Global, Supply Chain Velocity Will Actually Decrease in Many Instances. Th e Key Is How You Respond,” Supply Chain Management Review, January 1, 2006.

LaLonde, B. “Crunch Time in the Supply Chain—Huge Domestic and Global Developments Could Radically Change the Way We Th ink about Supply Chain Man- agement,” Supply Chain Management Review, March 1, 2005.

“Mexico’s New $900 Million Mega-Container Port.” http:// gcaptain.com/mexicos-900-million-mega-container/. September 5, 2012.

Murfee, A. “Cross Docking.” http://ezinearticles.com/? Cross-Docking&id=7219340. August 8, 2012.

Napolitano, M. “Crossdocking: Th e Latest and Greatest.” http://www.mmh.com/article/crossdocking_the_latest_ and_greatest/. April 1, 2010.

“New Dimensions in Supply Chain Management: Eight Strategies for Improving Performance from Concept to Customer.” Infor SCM Whitepater. Infor Corporate Headquarters, Alpharetta, Ga. Copyright 2007.

“Pollution, Whales Prompt Shipping Slow-down in California.” http://news.msn.com/us/pollution-whales-prompt- shipping-slow-down-in-California. August 12, 1014.

“Punta Colonet Project on Hold by Mexico.” http://www. longshoreshippingnews.com/tag/punta-colonet/.

Sills, J. “Applying Green Principles to Supply Chain Man- agement.” http://ezinearticles.com/?AppIying-Green- Principles-to-Supply-Chain-Management. Copyright 2011.

Simpson, D., and D. Samson. “Developing Strategies for Green Supply Chain Management,” Decision Line, July 2008.

“Supply Chain Business Strategies.” http://www.purchasing. upenn.edu/supply-chain/core.php.

Sutherland, J., and B. Bennett. “Th e Seven Deadly Supply Chain Wastes,” Supply Chain Management Review, July 1, 2008.

151

Before studying this chapter you should know or, if necessary, review

1. Trends in total quality management (TQM), Chapter 1.

2. Quality as a competitive priority, Chapter 2.

Learning Objectives After studying this chapter you should be able to 1 Explain the meaning of total

quality management (TQM). 2 Identify costs of quality. 3 Describe the evolution of TQM. 4 Identify features of the TQM

philosophy. 5 Describe quality awards and

quality certifi cations. 6 Understand why and how TQM

efforts fail.

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E veryone has had experiences of poor quality when dealing with busi- ness organizations. These experiences might involve an airline that has lost a passenger’s luggage, a dry cleaner that has left clothes wrinkled or

stained, poor course offerings and scheduling at your college, a purchased product that is damaged or broken, or a pizza delivery service that is often late or delivers the wrong order. The experience of poor quality is exacerbated when employees of the company either are not empowered to correct quality inadequacies or do not seem willing to do so. We have all encountered service employees who do not seem to care. The consequences of such an attitude are lost customers and oppor- tunities for competitors to take advantage of the market need.

Successful companies understand the powerful impact customer-defined quality can have on business. For this reason, many competitive firms continually

increase their quality stan- dards. For example, Ford Motor Company’s focus on quality improvements has led to new levels of customer sat- isfaction with vehicle quality. Ford focused on tightening already strict standards in its production process and implementing a quality pro- gram called Six Sigma. This enabled Ford to be tied with Toyota as the industry leader

in 2009. By 2014 Ford had been the recipient of multiple quality awards as noted by J.D. Power.

In this chapter you will learn that making quality a priority means putting cus- tomer needs first. It means meeting and exceeding customer expectations by involving everyone in the organization through an integrated effort. Total quality management (TQM) is an integrated organizational effort designed to improve quality at every level. In this chapter you will learn about the philosophy of TQM, its impact on organizations, and its impact on your life. You will learn that TQM is about meeting quality expectations as defined by the customer; this is called customer-defined quality. However, defining quality is not as easy as it may seem, because different people have different ideas of what constitutes high quality. Let’s begin by looking at different ways in which quality can be defined. •

152 CHAPTER 5 • Total Quality Management

Defining Quality The definition of quality depends on the point of view of the people defining it. Most consumers have a difficult time defining quality, but they know it when they see it. For example, although you probably have an opinion as to which manufacturer of athletic shoes provides the highest quality, it would probably be difficult for you to define your quality standard in precise terms. Also, your friends may have different opinions regarding which athletic shoes are of highest quality. The difficulty in defining quality exists regardless of product, and this is true for both manufacturing and service organizations. Think about how difficult it may be to define quality for products such as airline services, child day-care facilities, college classes, or even OM text- books. Further complicating the issue is that the meaning of quality has changed over time.

Today, there is no single, universal definition of quality. Some people view quality as “per- formance to standards.” Others view it as “meeting the customer’s needs” or “satisfying the customer.” Let’s look at some of the more common definitions of quality.

· Conformance to specifi cations measures how well the product or service meets the targets and tolerances determined by its designers. For example, the dimensions of a machine part may be specifi ed by its design engineers as 3 ± 0.05 inches. Th is would mean that the target dimension is 3 inches, but the dimensions can vary between 2.95 and 3.05 inches. Similarly, the wait for hotel room service may be specifi ed as 20 minutes, but there may be an acceptable delay of an additional 10 minutes. Also, consider the amount of light delivered by a 60-watt light bulb. If the bulb delivers 50 watts, it does not conform to specifi cations. As these examples illustrate, conformance to specifi ca- tions is directly measurable, though it may not be directly related to the consumer’s idea of quality.

· Fitness for use focuses on how well the product performs its intended function or use. For example, a Mercedes-Benz and a Jeep Cherokee both meet a fi tness for use defi nition if one considers transportation as the intended function. However, if the defi nition becomes more specifi c and assumes that the intended use is for transpor- tation on mountain roads and carrying fi shing gear, the Jeep Cherokee has a greater fi tness for use. You can also see that fi tness for use is a user-based defi nition in that it is intended to meet the needs of a specifi c user group.

· Value for price paid is a defi nition of quality that consumers often use for product or service usefulness. Th is is the only defi nition that combines economics with con- sumer criteria; it assumes that the defi nition of quality is price sensitive. For example, suppose that you wish to sign up for a personal fi nance seminar and discover that the same class is being taught at two diff erent colleges at signifi cantly diff erent tuition rates. If you take the less expensive seminar, you will feel that you have received greater value for the price.

· Support services provided are often how the quality of a product or service is judged. Quality does not apply only to the product or service itself; it also applies to the people, processes, and organizational environment associated with it. For example, the quality of a university is judged not only by the quality of staff and course off erings but also by the effi ciency and accuracy of processing paperwork.

· Psychological criteria is a subjective defi nition that focuses on the judgmental eval- uation of what constitutes product or service quality. Diff erent factors contribute to the evaluation, such as the atmosphere of the environment or the perceived prestige of the product. For example, a hospital patient may receive average healthcare, but a very friendly staff may leave the impression of high quality. Similarly, we commonly associate certain products with excellence because of their reputation; Rolex watches and Mercedes-Benz automobiles are examples.

Conformance to specifi cations How well a product or service meets the targets and tolerances determined by its designers.

Fitness for use A defi nition of quality that evaluates how well the product performs for its intended use.

Value for price paid Quality defi ned in terms of product or service usefulness for the price paid.

Support services Quality defi ned in terms of the support provided after the product or service is purchased.

Psychological criteria A way of defi ning quality that focuses on judgmental evaluations of what constitutes product or service excellence.

Defi ning Quality • 153

Differences between Manufacturing and Service Organizations Defining quality in manufacturing organizations is often different than it is for service organi- zations. Manufacturing organizations produce a tangible product that can be seen, touched, and directly measured. Examples include cars, CD players, clothes, computers, and food items. Therefore, quality definitions in manufacturing usually focus on tangible product features.

The most common quality definition in manufacturing is conformance, which is the degree to which a product characteristic meets preset standards. Other common definitions of quality in manufacturing include performance, such as acceleration of a vehicle; reliability, meaning that the product will function as expected without failure; features, the extras that are included beyond the basic characteristics; durability, the expected operational life of the product; and serviceability, how readily a product can be repaired. The relative importance of these defini- tions is based on the preferences of each individual customer. It is easy to see how different customers can have different definitions in mind when they speak of high product quality.

In contrast to manufacturing, service organizations produce a product that is intangible. Usually, the complete product cannot be seen or touched. Rather, it is experienced. Examples include delivery of healthcare, the experience of staying at a vacation resort, and learning at a university. The intangible nature of the product makes defining quality difficult. Also, since a service is experienced, perceptions can be highly subjective. In addition to tangible factors, quality of services is often defined by perceptual factors. These include responsive- ness to customer needs, courtesy and friendliness of staff, promptness in resolving complaints, and atmosphere. Other definitions of quality in services include time, the amount of time a customer has to wait for the service; and consistency, the degree to which the service is the same each time. For these rea- sons, defining quality in services can be especially challenging. Dimensions of quality for man- ufacturing versus service orga- nizations are shown in Table 5.1.

Today’s customers demand and expect high quality. Com- panies that do not make quality a priority risk long-run survival. World-class organizations such as General Electric and Moto- rola attribute their success to

LINKSTO PRACTICE

GENERAL ELECTRIC COMPANY www.ge.com

MOTOROLA, INC. www.motorola.com

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TABLE 5.1 Dimensions of Quality for Manufacturing versus Service Organizations

Manufacturing Organizations Service Organizations

Conformance to specifi cations Intangible factors

Performance Consistency

Reliability Responsiveness to customer needs

Features Courtesy/friendliness

Durability Timeliness/promptness

Serviceability Atmosphere

154 CHAPTER 5 • Total Quality Management

having one of the best quality management programs in the world. These companies were some of the first to implement a quality program called Six Sigma, where the level of defects is reduced to approximately 3.4 parts per million. To achieve this level, everyone in the com- pany is trained in quality. For example, individuals highly trained in quality improvement principles and techniques receive a designation called “Black Belt.” The full-time job of Black Belts is to identify and solve quality problems. In fact, Motorola was one of the first compa- nies to win the prestigious Malcolm Baldrige National Quality Award in 1988 due to its high focus on quality. Both GE and Motorola have had a primary goal of achieving total customer satisfaction. To this end, the efforts of these organizations have included eliminating almost all defects from products, processes, and transactions. Both companies consider quality to be the critical factor that has resulted in significant increases in sales and market share, as well as cost savings in the range of millions of dollars.

Cost of Quality The reason quality has gained such prominence is that organizations have gained an understanding of the high cost of poor quality. Quality affects all aspects of the organi- zation and has dramatic cost implications. The most obvious consequence occurs when poor quality creates dissatisfied customers and eventually leads to loss of business. How- ever, quality has many other costs, which can be divided into two categories. The first category consists of costs necessary for achieving high quality, which are called quality control costs. These are of two types: prevention costs and appraisal costs. The second cat- egory consists of the cost consequences of poor quality, which are called quality failure costs. These include external failure costs and internal failure costs. These costs of quality are shown in Figure 5.1. The first two costs are incurred in the hope of preventing the second two.

Prevention costs are all costs incurred in the process of preventing poor quality from occurring. They include quality planning costs, such as the costs of developing and implementing a quality plan. Also included are the costs of product and process design, from collecting customer information to designing processes that achieve con- formance to specifications. Employee training in quality measurement is included as part of this cost, as well as the costs of maintaining records of information and data related to quality.

Appraisal costs are incurred in the process of uncovering defects. They include the cost of quality inspections, product testing, and performing audits to make sure that quality

Prevention costs Costs incurred in the process of preventing poor quality from occurring.

Appraisal costs Costs incurred in the process of uncovering defects.

FIGURE 5.1 Cost of quality

Prevention costs. Costs of preparing and implementing a quality plan.

Appraisal costs. Costs of testing, evaluating, and inspecting quality.

Internal failure costs. Costs of scrap, rework, and material losses.

External failure costs. Costs of failure at customer site, including returns, repairs, and recalls.

Cost of Quality • 155

standards are being met. Also included in this category are the costs of worker time spent measuring quality and the cost of equipment used for quality appraisal.

Internal failure costs are associated with discovering poor product quality before the product reaches the customer site. One type of internal failure cost is rework, which is the cost of correcting the defective item. Sometimes the item is so defective that it cannot be corrected and must be thrown away. This is called scrap, and its costs include all the material, labor, and machine cost spent in producing the defective product. Other types of internal failure costs include the cost of machine downtime due to failures in the process and the costs of discounting defective items for salvage value.

External failure costs are associated with quality problems that occur at the cus- tomer site. These costs can be particularly damaging because customer faith and loyalty can be difficult to regain. They include everything from customer complaints, product returns, and repairs to warranty claims, recalls, and even litigation costs resulting from product liability issues. A final component of this cost is lost sales and lost customers. For example, manufacturers of lunch meats and hot dogs whose products have been recalled due to bacterial contamination have had to struggle to regain consumer confidence. Other examples include auto manufacturers whose products have been recalled due to major malfunctions such as problematic braking systems and airlines that have experi- enced a crash with many fatalities. External failure can sometimes put a company out of business almost overnight.

Companies that consider quality important invest heavily in prevention and appraisal costs in order to prevent internal and external failure costs. The earlier defects are found, the less costly they are to correct. For example, detecting and correcting defects during product design and product production is considerably less expensive than when the defects are found at the customer site. This is shown in Figure 5.2.

External failure costs tend to be particularly high for service organizations. The reason is that with a service the customer spends much time in the service delivery system, and there are fewer opportunities to correct defects than there are in manufacturing. Examples of external failure in services include overbooking airline flights, long delays in airline service, and lost luggage.

Internal failure costs Costs associated with discovering poor product quality before the product reaches the customer.

External failure costs Costs associated with quality problems that occur at the customer site.

FIGURE 5.2 Cost of defects

LOCATION OF DEFECT

C O

S T O

F D

E F E

C T

Product Design

Product Production

Customer Site

156 CHAPTER 5 • Total Quality Management

The Evolution of Total Quality Management (TQM)

The concept of quality has existed for many years, though its meaning has changed and evolved over time. In the early twentieth century, quality management meant inspecting products to ensure that they met specifications. In the 1940s, during World War II, quality became more statistical in nature. Statistical sampling techniques were used to evaluate quality, and quality control charts were used to monitor the production process. In the 1960s, with the help of so-called quality gurus, the concept took on a broader meaning. Quality began to be viewed as something that encompassed the entire organization, not only the production process. Since all functions were responsible for product quality and all shared the costs of poor quality, quality was seen as a concept that affected the entire organization.

The meaning of quality for businesses changed dramatically in the late 1970s. Before then quality was still viewed as something that needed to be inspected and corrected. How- ever, in the 1970s and 1980s, many U.S. industries lost market share to foreign competition. In the auto industry, manufacturers such as Toyota and Honda became major players. In the consumer goods market, companies such as Toshiba and Sony led the way. These foreign competitors were producing lower-priced products with considerably higher quality.

To survive, companies had to make major changes in their quality programs. Many hired consultants and instituted quality training programs for their employees. A new concept of quality was emerging. One result was that quality began to have a strategic meaning. Today, successful companies understand that quality provides a competitive advantage. They put the customer first and define quality as meeting or exceeding customer expectations.

Since the 1970s, competition based on quality has grown in importance and has generated tremendous interest, concern, and enthusiasm. Companies in every line of business are focus- ing on improving quality in order to be more competitive. In many industries quality excel- lence has become a standard for doing business. Companies that do not meet this standard simply will not survive. As you will see later in the chapter, the importance of quality is demon- strated by national quality awards and quality certifications that are coveted by businesses.

The term used for today’s new concept of quality is total quality management or TQM. Figure 5.3 presents a time line of the old and new concepts of quality. You can see that the old concept is reactive, designed to correct quality problems after they occur. The new con- cept is proactive, designed to build quality into the product and process design. Next, we look at the individuals who have shaped our understanding of quality.

Quality Gurus To fully understand the TQM movement, we need to look at the philosophies of notable individuals who have shaped the evolution of TQM. Their philosophies and teachings have

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Total quality management (TQM) Philosophy that seeks to improve quality by eliminating causes of product defects and by making quality the responsibility of everyone in the organization.

TIME: Early 1900s 1940s 1960s 1980s and Beyond

FOCUS: Inspection Statistical sampling

Organizational quality focus

Customer-driven quality

Old Concept of Quality: Inspect for quality after production.

New Concept of Quality: Build quality into the process. Identify and correct causes of

quality problems.

FIGURE 5.3 Time line showing the differences between old and new concepts of quality

The Evolution of Total Quality Management (TQM) • 157

contributed to our knowledge and understanding of quality today. Table 5.2 summarizes their individual contributions.

Walter A. Shewhart Walter A. Shewhart was a statistician at Bell Labs during the 1920s and 1930s. Shewhart studied randomness and recognized that variability existed in all man- ufacturing processes. He developed quality control charts that are used to identify whether the variability in the process is random or due to an assignable cause, such as poor workers or miscalibrated machinery. He stressed that eliminating variability improves quality. His work created the foundation for today’s statistical process control, and he is often referred to as the “grandfather of quality control.”

W. Edwards Deming W. Edwards Deming is often referred to as the “father of quality control.” He was a statistics professor at New York University in the 1940s. After World War II, he assisted many Japanese companies in improving quality. The Japanese regarded him so highly that in 1951 they established the Deming Prize, an annual award given to firms that demonstrate outstanding quality. It was almost 30 years before American businesses began adopting Deming’s philosophy.

A number of elements of Deming’s philosophy depart from traditional notions of quality. The first is the role management should play in a company’s quality improvement effort. Historically, poor quality was blamed on workers—on their lack of productivity, laziness, or carelessness. However, Deming pointed out that only 15 percent of quality problems are actually due to worker error. The remaining 85 percent are caused by processes and sys- tems, including poor management. Deming said that it is up to management to correct system problems and create an environment that promotes quality and enables workers to achieve their full potential. He believed that managers should drive out any fear employees have of identifying quality problems and that numerical quotas should be eliminated. Proper methods should be taught, and detecting and eliminating poor quality should be everyone’s responsibility.

Deming outlined his philosophy on quality in his famous “14 Points.” These points are principles that help guide companies in achieving quality improvement. The principles are founded on the idea that upper management must develop a commitment to quality and provide a system to support this commitment that involves all employees and suppliers.

TABLE 5.2 Quality Gurus and Their Contributions

Quality Guru Main Contribution

Walter A. Shewhart –Contributed to understanding of process variability. –Developed concept of statistical control charts.

W. Edwards Deming –Stressed management’s responsibility for quality. – Developed “14 Points” to guide companies in quality improvement.

Joseph M. Juran –Defi ned quality as “fi tness for use.” –Developed concept of cost of quality.

Armand V. Feigenbaum –Introduced concept of total quality control.

Philip B. Crosby –Coined phrase “quality is free.” –Introduced concept of zero defects.

Kaoru Ishikawa –Developed cause-and-effect diagrams. –Identifi ed concept of “internal customer.”

Genichi Taguchi –Focused on product design quality. –Developed Taguchi loss function.

158 CHAPTER 5 • Total Quality Management

Deming stressed that quality improvements cannot happen without the organizational change that comes from upper management.

Joseph M. Juran After W. Edwards Deming, Dr. Joseph M. Juran is considered to have had the greatest impact on quality management. Juran originally worked in the quality pro- gram at Western Electric, a former equipment division of AT&T. He became better known in 1951 after the publication of his book Quality Control Handbook. In 1954, he went to Japan to work with manufacturers and teach classes on quality. Though his philosophy is similar to Deming’s, there are some differences. Whereas Deming stressed the need for an organizational “transformation,” Juran believed that implementing quality initiatives should not require such a dramatic change and that quality management should be embedded in the organization.

One of Juran’s significant contributions was his focus on the definition of quality and the cost of quality. Juran is credited with defining quality as fitness for use rather than simply con- formance to specifications. As we have learned in this chapter, defining quality as fitness for use takes into account customer intentions for use of the product, instead of focusing only on tech- nical specifications. Juran is also credited with developing the concept of cost of quality, which allows us to measure quality in dollar terms rather than on the basis of subjective evaluations.

Juran is well known for originating the idea of the quality trilogy: quality planning, quality control, and quality improvement. The first part of the trilogy, quality planning, is necessary so that companies identify their customers, product requirements, and overriding business goals. Processes should be set up to ensure that the quality standards can be met. The sec- ond part of the trilogy, quality control, stresses the regular use of statistical control methods to ensure that quality standards are met and to identify variations from the standards. The third part of the quality trilogy is quality improvement. According to Juran, quality improve- ments should not be just breakthroughs, but continuous as well. Together with Deming, Juran stressed that to implement continuous improvement, workers need to have training in proper methods on a regular basis.

Armand V. Feigenbaum Another quality leader is Armand V. Feigenbaum, who intro- duced the concept of total quality control. In his 1961 book Total Quality Control, he out- lined his quality principles in 40 steps. Feigenbaum took a total system approach to quality. He promoted the idea of a work environment where quality developments are integrated throughout the entire organization, where management and employees have a total com- mitment to improve quality, and where people learn from each other’s successes. This phi- losophy was adapted by the Japanese and termed “company-wide quality control.”

Philip B. Crosby Philip B. Crosby is another recognized guru of TQM. He worked in the area of quality for many years, first at Martin Marietta and then, in the 1970s, as the vice president for quality at ITT. He developed the phrase “Do it right the first time” and the notion of zero defects, arguing that no amount of defects should be considered acceptable. He scorned the idea that a small number of defects is a normal part of the operating process because systems and workers are imperfect. Instead, he stressed the idea of prevention.

To promote his concepts, Crosby wrote a book titled Quality Is Free, which was published in 1979. He became famous for coining the phrase “quality is free” and for pointing out the many costs of quality, which include not only the costs of wasted labor, equipment time, scrap, rework, and lost sales but also organizational costs that are hard to quantify. Crosby stressed that efforts to improve quality more than pay for themselves because these costs are prevented. Therefore, quality is free. Like Deming and Juran, Crosby stressed the role of management in the quality improvement effort and the use of statistical control tools in measuring and monitoring quality.

Kaoru Ishikawa Kaoru Ishikawa is best known for the development of quality tools called cause-and-effect diagrams, also called fishbone or Ishikawa diagrams. These diagrams are used for quality problem solving, and we will look at them in detail later in the chapter.

The Evolution of Total Quality Management (TQM) • 159

He was the first quality guru to emphasize the importance of the “internal customer,” the next person in the production process. He was also one of the first to stress the importance of total company quality control, rather than just focusing on products and services.

Dr. Ishikawa believed that everyone in the company needed to be united with a shared vision and a common goal. He stressed that quality initiatives should be pursued at every level of the organization and that all employees should be involved. Dr. Ishikawa was a pro- ponent of implementation of quality circles, which are small teams of employees who volun- teer to solve quality problems.

Genichi Taguchi Dr. Genichi Taguchi is a Japanese quality expert known for his work in the area of product design. He estimates that as much as 80 percent of all defective items are caused by poor product design. Taguchi stresses that companies should focus their quality efforts on the design stage, as it is much cheaper and easier to make changes during the product design stage than later during the production process.

Taguchi is known for applying a concept called design of experiment to product design. This method is an engineering approach based on developing robust design, a design that results in products that can perform over a wide range of conditions. The idea is that it is easier to design a product that can perform over a wide range of environmental conditions than it is to control the environmental conditions.

Taguchi has also had a large impact on today’s view of the costs of quality. He pointed out that the traditional view of costs of conformance to specifications is incorrect and proposed a different way to look at these costs. Let’s briefly look at Dr. Taguchi’s view of quality costs.

Recall that conformance to specification specifies a target value for the product with specified tolerances, say 5.00 ± 0.20. According to the traditional view of conformance to specifications, losses in terms of cost occur if the product dimensions fall outside of the specified limits. This is shown in Figure 5.4. However, Dr. Taguchi noted that from the cus- tomer’s view there is little difference whether a product falls just outside or just inside the control limits. He pointed out that there is a much greater difference in the quality of the product between making the target and being near the control limit. He also stated that the smaller the variation around the target, the better the quality. Based on this, he pro- posed the following: as conformance values move away from the target, loss increases as a quadratic function. The Taguchi loss function is shown in Figure 5.5. According to the

Robust design A design that results in a product that can perform over a wide range of conditions.

Taguchi loss function Costs of quality increase as a quadratic function as conformance values move away from the target.

Target 5.00

tolerances

Cost

0.480 0.520

Loss LossNo Loss

FIGURE 5.4 Traditional view of the cost of nonconformance

Target 5.00

tolerances

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Loss Loss

FIGURE 5.5 Taguchi view of the cost of non- conformance—the Taguchi loss function

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function, smaller differences from the target result in smaller costs: the larger the differ- ences, the larger the cost. The Taguchi loss function has had a significant impact on chang- ing views of quality cost.

The Philosophy of TQM What characterizes TQM is the focus on identifying root causes of quality problems and correcting them at the source, as opposed to inspecting the product after it has been made. Not only does TQM encompass the entire organization but it stresses that quality is cus- tomer driven. TQM attempts to embed quality in every aspect of the organization. It is con- cerned with the technical aspects of quality as well as the involvement of people in quality, such as customers, company employees, and suppliers. Here we look at the specific con- cepts that make up the philosophy of TQM. These concepts and their main ideas are sum- marized in Table 5.3.

Customer Focus The first, and overriding, feature of TQM is the company’s focus on its customers. Quality is defined as meeting or exceeding customer expectations. The goal is to first identify and then meet customer needs. TQM recognizes that a perfectly produced product has little value if it is not what the customer wants. Therefore, we can say that quality is customer driven. However, it is not always easy to determine what the customer wants because tastes and preferences change. Also, customer expectations often vary from one customer to the next. For example, in the auto industry trends change relatively quickly, from small cars to sports utility vehicles and back to small cars. The same is true in the retail industry, where styles and fashion are short-lived. Companies need to continually gather information by means of focus groups, market surveys, and customer interviews in order to stay in tune with what customers want. They must always remember that they would not be in business if it were not for their customers.

Continuous Improvement Another concept of the TQM philosophy is the focus on continuous improvement. Tradi- tional systems operated on the assumption that once a company achieved a certain level of

HRMMKT

Continuous improvement A philosophy of never- ending improvement.

TABLE 5.3 Concepts of the TQM Philosophy

Concept Main Idea

Customer focus Goal is to identify and meet customer needs.

Continuous improvement A philosophy of never-ending improvement.

Employee empowerment Employees are expected to seek out, identify, and correct quality problems.

Use of quality tools Ongoing employee training in the use of quality tools.

Product design Products need to be designed to meet customer expectations.

Process management Quality should be built into the process; sources of quality problems should be identifi ed and corrected.

Managing supplier quality Quality concepts must extend to a company’s suppliers.

The Philosophy of TQM • 161

quality, it was successful and needed to make no further improvements. We tend to think of improvement in terms of plateaus that are to be achieved, such as passing a certifica- tion test or reducing the number of defects to a certain level. Traditionally, for American managers change involves large magnitudes, such as major organizational restructuring. The Japanese, on the other hand, believe that the best and most lasting changes come from gradual improvements. To use an analogy, they believe that it is better to take frequent small doses of medicine than to take one large dose. Continuous improvement, called kaizen by the Japanese, requires that the company continually strive to be better through learning and problem solving. Because we can never achieve perfection, we must always evaluate our performance and take measures to improve it.

Now let’s look at two approaches that can help companies with continuous improve- ment: the plan–do–study–act (PDSA) cycle and benchmarking.

The Plan–Do–Study–Act Cycle The plan–do–study–act (PDSA) cycle describes the activities a company needs to perform in order to incorporate continuous improvement in its operation. This cycle, shown in Figure 5.6, is also referred to as the Shewhart cycle or the Deming wheel. The circular nature of this cycle shows that continuous improvement is a never-ending process. Let’s look at the specific steps in the cycle.

· Plan Th e fi rst step in the PDSA cycle is to plan. Managers must evaluate the current process and make plans based on any problems they fi nd. Th ey need to document all current procedures, collect data, and identify problems. Th is information should then be studied and used to develop a plan for improvement as well as specifi c measures to evaluate performance.

· Do Th e next step in the cycle is implementing the plan (do). During the implemen- tation process managers should document all changes made and collect data for evaluation.

· Study Th e third step is to study the data collected in the previous phase. Th e data are evaluated to see whether the plan is achieving the goals established in the plan phase.

· Act The last phase of the cycle is to act on the basis of the results of the first three phases. The best way to accomplish this is to communicate the results to other mem- bers of the company and then implement the new procedure if it has been successful. Note that this is a cycle; the next step is to plan again. After we have acted, we need to continue evaluating the process, planning, and repeating the cycle again.

Benchmarking Another way companies implement continuous improvement is by study- ing business practices of companies considered “best in class.” This is called benchmarking. The ability to learn and study how others do things is an important part of continuous improvement. The benchmark company does not have to be in the same business as long as it excels at something that the company doing the study wishes to emulate. For example, many companies have used Lands’ End to benchmark catalog distribution and order filling

Kaizen A Japanese term that describes the notion of a company continually striving to be better through learning and problem solving.

Plan–do–study–act (PDSA) cycle A diagram that describes the activities that need to be performed to incorporate continuous improvement into the operation.

Benchmarking The process of studying the practices of companies considered “best-in-class” and comparing your company’s performance against theirs.

Plan

Study

Act Do

FIGURE 5.6 The plan–do–study–act cycle

162 CHAPTER 5 • Total Quality Management

because Lands’ End is considered a leader in this area. Similarly, many companies have used American Express to benchmark conflict resolution.

Employee Empowerment Part of the TQM philosophy is to empower all employees to seek out quality problems and correct them. Under the old concept of quality, employees were afraid to identify problems for fear that they would be reprimanded. Often, poor quality was passed on to someone else in order to make it “someone else’s problem.” The new concept of quality, TQM, provides incentives for employees to identify quality problems. Employees are rewarded for uncover- ing quality problems, not punished.

In TQM, the role of employees is very different from what it was in traditional systems. Workers are empowered to make decisions relative to quality in the production process. They are considered a vital element of the effort to achieve high quality. Their contributions are highly valued, and their suggestions are implemented. In order to perform this function, employees are given continual and extensive training in quality measurement tools.

To further stress the role of employees in quality, TQM differentiates between external and internal customers. External customers are those that purchase the company’s goods and services. Internal customers are employees of the organization who receive goods or services from others in the company. For example, the packaging department of an organization is an internal customer of the assembly department. Just as a defective item would not be passed to an external customer, a defective item should not be passed to an internal customer.

Team Approach TQM stresses that quality is an organizational effort. To facilitate the solving of quality problems, it places great emphasis on teamwork. The use of teams is based on the old adage that “two heads are better than one.” Using techniques such as brain- storming, discussion, and quality control tools, teams work regularly to correct problems. The contributions of teams are considered vital to the success of the company. For this rea- son, companies set aside time in the workday for team meetings.

Teams vary in their degree of structure and formality, and different types of teams solve different types of problems. One of the most common types of teams is the quality circle, a team of volunteer production employees and their supervisors whose purpose is to solve quality problems. The circle is usually composed of eight to ten members, and decisions are made through group consensus. The teams usually meet weekly during work hours in a place designated for this purpose. They follow a preset process for analyzing and solving quality problems. Open discussion is promoted, and criticism is not allowed. Although the functioning of quality circles is friendly and casual, it is serious business. Quality circles are not mere “gab sessions.” Rather, they do important work for the company and have been very successful in many firms.

The importance of excep- tional quality is demonstrated by The Walt Disney Company in the operation of its theme parks. The focus of the parks is customer satisfaction. This is accomplished through metic- ulous attention to every detail, with particular focus on the role of employees in service delivery. Employees are viewed as the most important orga- nizational resource, and great

Quality circle A team of volunteer production employees and their supervisors who meet regularly to solve quality problems.

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care is taken in employee hiring and training. All employees are called “cast members,” regard- less of whether they are janitors or performers. They are extensively trained in customer ser- vice, communication, and quality awareness. Continual monitoring of quality is considered important, and employees meet regularly in teams to evaluate their effectiveness. All employ- ees are shown how the quality of their individual jobs contributes to the success of the park.

Use of Quality Tools You can see that TQM places a great deal of responsibility on all workers. If employees are to identify and correct quality problems, they need proper training. They need to under- stand how to assess quality by using a variety of quality control tools, how to interpret find- ings, and how to correct problems. In this section we look at seven different quality tools, often called the seven tools of quality control (Figure 5.7). They are easy to understand, yet

Suppliers

Environment

Workers

Processes

Machines

Materials

Quality Problems

1. Cause-and-Effect Diagram 4. Control Chart 

5. Scatter Diagram

6. Pareto Chart

2. Flowchart

3. Checklist

Defect Type

Broken zipper Ripped material Missing buttons Faded color

3 7 3 2

No. of Defects Total

UCL

LCL

Y

X

A B C D E

%

7. Histogram

A B C D E

Frequency

F re

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FIGURE 5.7 The seven tools of quality control

164 CHAPTER 5 • Total Quality Management

extremely useful in identifying and analyzing quality problems. Sometimes workers use only one tool at a time, but often a combination of tools is most helpful.

Cause-and-Effect Diagrams Cause-and-effect diagrams identify potential causes of particular quality problems. They are often called fishbone diagrams because they look like the bones of a fish (Figure 5.8). The “head” of the fish is the quality problem, such as damaged zippers on a garment or broken valves on a tire. The diagram is drawn so that the “spine” of the fish connects the “head” to the possible cause of the problem. These causes could be related to the machines, workers, measurement, suppliers, materials, and many other aspects of the production process. Each of these possible causes can then have smaller “bones” addressing specific issues that relate to each cause. For example, a problem with machines could be due to a need for adjustment, old equipment, or tooling problems. Similarly, a problem with workers could be related to lack of training, poor supervision, or fatigue.

Cause-and-effect diagrams are problem-solving tools commonly used by quality con- trol teams. Specific causes of problems can be explored through brainstorming. The devel- opment of a cause-and-effect diagram requires the team to think through all the possible causes of poor quality.

Flowcharts A flowchart is a schematic diagram of the sequence of steps involved in an operation or process. It provides a visual tool that is easy to use and understand. By seeing the steps involved in an operation or process, everyone develops a clear picture of how the operation works and where problems could arise.

Checklists A checklist is a list of common defects and the number of observed occur- rences of these defects. It is a simple yet effective fact-finding tool that allows the worker to collect specific information regarding the defects observed. The checklist in Figure 5.7 shows four defects and the number of times they have been observed. It is clear that the biggest problem is ripped material. This means that the plant needs to focus on this spe- cific problem—for example, by going to the source of supply or seeing whether the material rips during a particular production process. A checklist can also be used to focus on other

Cause-and-effect diagram A chart that identifi es potential causes of particular quality problems.

Flowchart A schematic of the sequence of steps involved in an operation or process.

Checklist A list of common defects and the number of observed occurrences of these defects.

Environment Processes Materials

Suppliers

late deliveries

Quality Problem

training

ability

supervision

experience

maintenance

calibration

type

age

temperature process design

material grade

type

poor quality management

out of specification

poor product design dust

lighting

ventilation

out of spec material

defects

Workers Machines

FIGURE 5.8 A general cause-and-effect (fishbone) diagram

The Philosophy of TQM • 165

dimensions, such as location or time. For example, if a defect is being observed frequently, a checklist can be developed that measures the number of occurrences per shift, per machine, or per operator. In this fashion we can isolate the location of the particular defect and then focus on correcting the problem.

Control Charts Control charts are a very important quality control tool. We will study the use of control charts at great length in the next chapter. These charts are used to eval- uate whether a process is operating within expectations relative to some measured value such as weight, width, or volume. For example, we could measure the weight of a sack of flour, the width of a tire, or the volume of a bottle of soft drink. When the production process is operating within expectations, we say that it is “in control.”

To evaluate whether or not a process is in control, we regularly measure the variable of interest and plot it on a control chart. The chart has a line across the center representing the average value of the variable we are measuring. Above and below the center line are two lines, called the upper control limit (UCL) and the lower control limit (LCL). As long as the observed values fall within the upper and lower control limits, the process is in control and there is no problem with quality. When a measured observation falls outside of these limits, there is a problem.

Scatter Diagrams Scatter diagrams are graphs that show how two variables are related to one another. They are particularly useful in detecting the amount of correlation, or the degree of linear relationship, between two variables. For example, increased production speed and number of defects could be correlated positively; as production speed increases, so does the number of defects. Two variables could also be correlated negatively, so that an increase in one of the variables is associated with a decrease in the other. For example, increased worker training might be associated with a decrease in the number of defects observed.

The greater the degree of correlation, the more linear are the observations in the scatter diagram. On the other hand, the more scattered the observations in the diagram, the less correlation exists between the variables. Of course, other types of relationships can also be observed on a scatter diagram, such as an inverted ∪. This may be the case when one is observing the relationship between two variables such as oven temperature and number of defects, since temperatures below and above the ideal could lead to defects.

Pareto Analysis Pareto analysis is a technique used to identify quality problems based on their degree of importance. The logic behind Pareto analysis is that only a few quality problems are important, whereas many others are not critical. The technique was named after Vilfredo Pareto, a nineteenth-century Italian economist who determined that only a small percentage of people controlled most of the wealth. This concept has often been called the 80–20 rule and has been extended to many areas. In quality management the logic behind Pareto’s principle is that most quality problems are a result of only a few causes. The trick is to identify these causes.

One way to use Pareto analysis is to develop a chart that ranks the causes of poor quality in decreasing order based on the percentage of defects each has caused. For example, a tally can be made of the number of defects that result from different causes, such as opera- tor error, defective parts, or inaccurate machine calibrations. Percentages of defects can be computed from the tally and placed in a chart like the one shown in Figure 5.7. We generally tend to find that a few causes account for most of the defects.

Histograms A histogram is a chart that shows the frequency distribution of observed values of a variable. We can see from the plot what type of distribution a particular vari- able displays, such as whether it has a normal distribution and whether the distribution is symmetrical.

Control charts Charts used to evaluate whether a process is operating within set expectations.

Scatter diagrams Graphs that show how two variables are related to each other.

Pareto analysis A technique used to identify quality problems based on their degree of importance.

Histogram A chart that shows the frequency distribution of observed values of a variable.

166 CHAPTER 5 • Total Quality Management

In the food service industry the use of quality control tools is important in identifying quality problems. Grocery store chains, such as Kroger and Meijer, must record and monitor the quality of incoming produce, such as tomatoes and lettuce. Quality tools can be used to eval- uate the acceptability of product qual- ity and to monitor product quality from individual suppliers. They can also be used to evaluate causes of quality prob-

lems, such as long transit time or poor refrigeration. Similarly, restaurants use quality con- trol tools to evaluate and monitor the quality of delivered goods, such as meats, produce, or baked goods.

Product Design Quality Function Deployment A critical aspect of building quality into a product is to ensure that the product design meets customer expectations. This typically is not as easy as it seems. Customers often speak in everyday language. For example, a product can be described as “attractive,” “strong,” or “safe.” However, these terms can have very different meaning to dif- ferent customers. What one person considers to be strong, another may not. To produce a product that customers want, we need to translate customers’ everyday language into specific technical requirements. However, this can often be difficult. A useful tool for translating the voice of the customer into specific technical requirements is quality function deployment (QFD). Quality function deployment is also useful in enhancing communication between dif- ferent functions, such as marketing, operations, and engineering.

QFD enables us to view the relationships among the variables involved in the design of a product, such as technical versus customer requirements. This can help us analyze the big picture—for example, by running tests to see how changes in certain technical require- ments of the product affect customer requirements. An example is an automobile manufac- turer evaluating how changes in materials affect customer safety requirements. This type of analysis can be very beneficial in developing a product design that meets customer needs, yet does not create unnecessary technical requirements for production.

QFD begins by identifying important customer requirements, which typically come from the marketing department. These requirements are numerically scored based on their importance, and scores are translated into specific product characteristics. Evaluations are then made of how the product compares with its main competitors relative to the identified characteristics. Finally, specific goals are set to address the identified problems. The result- ing matrix looks like a picture of a house and is often called the house of quality.

We will consider the example of manufacturing a backpack to show how we would use QFD. We will start with a relationship matrix that ties customer requirements to product characteristics, shown in Figure 5.9.

· Customer Requirements Remember that our goal is to make a product that the cus- tomer wants. Th erefore, the fi rst thing we need to do is survey our customers to fi nd out specifi cally what they would be looking for in a product—in this case, a backpack for students. To fi nd out precisely what features students would like in a backpack, the marketing department might send representatives to talk to students on campus, con- duct telephone interviews, and maybe conduct focus groups. Let’s say that students have identifi ed fi ve desirable features: the backpack should be durable, lightweight, and roomy; look nice; and not cost very much (Figure 5.10). Th e importance customers

Quality function deployment (QFD) A tool used to translate the preferences of the customer into specifi c technical requirements.

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The Philosophy of TQM • 167

attach to each of these requirements is also determined and shown in Figure 5.10. Th is part of the fi gure looks like the chimney of the “house.” You can see that durability and roominess are given the greatest importance.

· Competitive Evaluation On the far right of our relationship matrix is an evaluation of how our product compares to those of competitors. In this example there are two competitors, A and B. Th e evaluation scale is from 1 to 5—the higher the rating, the better. Th e important thing here is to identify which customer requirements we should pursue and how we fare relative to our competitors. For example, you can see that our product excels in durability relative to competitors, yet it does not look as nice. Th is means that we could gain a competitive advantage by focusing our design eff orts on a more appealing product.

· Product Characteristics Specifi c product characteristics are on top of the relation- ship matrix. Th ese are technical measures. In our example they include the number of zippers and compartments, the weight of the backpack, the strength of the backpack, the grade of the dye color, and the cost of materials.

· Th e Relationship Matrix Th e strength of the relationship between customer require- ments and product characteristics is shown in the relationship matrix. For example, you can see that the number of zippers and compartments is negatively related to the weight of the backpack. A negative relationship means that as we increase the desirability of one variable, we decrease the desirability of the other. At the same time, roominess is positively related to the number of zippers and compartments, as is appearance. A positive relationship means that an increase in desirability of one

Customer Requirements

Durable

Lightweight

Roomy

Looks Nice

Low Cost

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Competitive Evaluation

B A

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Relationship

Strong Positive

Positive

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Strong NegativeX

US = Our Backpack A = Competitor A B = Competitor B

TOTAL 100

FIGURE 5.9 Relationship matrix

168 CHAPTER 5 • Total Quality Management

variable is related to an increase in the desirability of another. Th is type of information is very important in coordinating the product design.

· Th e Trade-off Matrix You can see how the relationship matrix is beginning to look like a house. Figure 5.10 shows the complete house of quality. Th e next step in our building process is to put the “roof ” on the house. Th is is done through a trade-off matrix, which shows how each product characteristic is related to the others and thus allows us to see what trade-off s we need to make. For example, the number of zippers is negatively related to the weight of the backpack.

· Setting Targets Th e last step in constructing the house of quality is to evaluate com- petitors’ products relative to the specifi c product characteristics and to set targets for our own product. Th e bottom row of the house is the output of quality function

Customer Requirements

Durable

Lightweight

Roomy

Looks Nice

Low Cost

TOTAL

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Relationship

Strong Positive

Positive

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Strong Negative

Competitive Evaluation

B A

B

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B AUS

US/A

A US/B

1 2 3 4 5

1 2 3 4 5

1 2 3 4 5

1 2 3 4 5

B AUS 1 2 3 4 5

25

20

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10

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X

X

X

US = Our Backpack A = Competitor A B = Competitor B

A GradeB

B

Competitive Evaluation

OUR TARGETS

2

3

4

$8

$10

$8

1.2 lbs.

14 lbs.

Grade A

0.8 lbs.

10 lbs.

Grade A

0.5 lbs.

16 lbs.

Product Characteristics

X

FIGURE 5.10 House of quality

The Philosophy of TQM • 169

deployment. Th ese are specifi c, measurable product characteristics that have been formulated from general customer requirements.

The house of quality has been very useful. You can see how it translates everyday terms like “lightweight,” “roominess,” and “nice looking” into specific product characteristics that can be used in manufacturing the product. Note also how the house of quality can help in the communication between marketing, operations, and design engineering.

Reliability An important dimension of product design is that the product functions as expected. This is called reliability, the probability that a product, service, or part will perform as intended for a specified period of time under normal conditions. We are all familiar with product reliability in the form of product warranties. We also know that no product is guaranteed with 100 percent certainty to function properly. However, companies know that high reliability is an important part of customer-oriented quality and try to build this into their product design.

Reliability is a probability, a likelihood, or a chance. For example, a product with a 90 percent reliability has a 90 percent chance of functioning as intended. Another way to look at it is that the probability the product will fail is 1 − 0.90 = 0.10, or 10 percent. This also means that 1 out of 10 products will not function as expected.

The reliability of a product is a direct function of the reliability of its component parts. If all the parts in a product must work for the product to function, then the reliability of the system is computed as the product of the reliabilities of the individual components:

Rs = (R1)(R2)(R3) . . . (Rn)

where Rs = reliability of the product or system R1...n = reliability of components 1 through n

Reliability The probability that a product, service, or part will perform as intended.

EXAMPLE 5.1 Computing Product Reliability

Assume that a product has two parts, both of which must work for the product to function. Part 1 has a reliability of 80 percent and part 2 has a reliability of 90 percent. Compute the reliability of the product.

• Before You Begin: Remember that the reliability of the system is simply the product of the individual reliabilities.

• Solution: The reliability of the product is

R = (0.80) (0.90) = 0.72

Part 1 Part 2

0.80 0.90

Notice in the example that the reliability of the “system” is lower than that of individual components. The reason is that all the components in a series, as in the example, must function for the product to work. If only one component doesn’t work, the entire product doesn’t work. The more components a product has, the lower its reliability. For example, a system with five components in series, each with a reliability of 0.90, has a reliability of only (0.90)(0.90)(0.90)(0.90)(0.90) = (0.90)5 = 0.59.

The failure of certain products can be very critical. One way to increase product reli- ability is to build redundancy into the product design in the form of backup parts. Consider the blackout during the summer of 2003, when most of the northeastern part of the United States was out of power for days. Critical facilities, such as hospitals, immediately switched

170 CHAPTER 5 • Total Quality Management

to backup power generators that are available when the main systems fail. Consider other critical systems, such as the navigation system of an aircraft, systems that operate nuclear power plants, the space shuttle, or even the braking system of your car. What gives these systems such high reliability is the redundancy built into the product design that serves to increase reliability.

Redundancy is built into the system by placing components in parallel so that when one component fails the other component takes over. In this case, the reliability of the system is computed by adding the reliability of the first component to the reliability of the second (backup) component, multiplied by the probability of needing the backup. The equation is as follows:

R s

= 3Reliabilit yof 1stcomponent4 + 53Reliabilit yof 2ndcomponent4 × 3Probabilityof needing2nd component46 Notice that if the reliability of the first component is 0.90, the probability of needing a sec- ond component is equal to the first component failing, which is (1 − 0.90) = 0.10. Now let’s look at an example.

Process Management According to TQM, a quality product comes from a quality process. This means that quality should be built into the process. Quality at the source is the belief that it is far better to uncover the source of quality problems and correct it than to discard defective items after production. If the source of the problem is not corrected, the problem will continue. For example, if you are baking cookies you might find that some of the cookies are burned. Simply throwing away the burned cookies will not correct the problem. You will continue to have burned cookies and will lose money when you throw them away. It will be far more effective to see where the problem is and correct it. For example, the temperature setting

Quality at the source The belief that it is best to uncover the source of quality problems and eliminate it.

EXAMPLE 5.2 Computing Product Reliability with Redundancy

Two power generators, the main and backup, provide electricity to a facility. The main generator has a reliability of 0.95 and the backup a reliability of 0.90. What is the reliability of the system?

• Before You Begin: Notice in this problem that redundancy has been added to the system in the form of a backup component. Remember to draw the backup in parallel to the original component and compute the total reliability accordingly.

• Solution: The system can be represented in the following way

Original

Backup

0.95

0.90

The reliability of the system is

Rs = 0.95 + [(0.90) × (1 − 0.95)] = 0.995

Quality Awards and Standards • 171

Today’s concept of quality, called total quality management (TQM), focuses on building quality into the process, as opposed to simply inspecting for poor quality after production. TQM is customer driven and encompasses the entire company. Before you go on, you should know the four categories of quality costs. These are prevention and appraisal costs, which are costs that are incurred to prevent poor quality, and internal and external

failure costs, which are costs that the company hopes to pre- vent. You should understand the evolution of TQM and the notable individuals who have shaped our knowledge of quality. Last, you should know the seven concepts of the TQM philo- sophy: customer focus, continuous improvement, employee empowerment, use of quality tools, product design, process management, and managing supplier quality.

BEFORE YOU GO ON

may be too high; the pan may be curved, placing some cookies closer to the heating ele- ment; or the oven may not be distributing heat evenly.

Quality at the source exemplifies the difference between the old and new concepts of quality. The old concept focused on inspecting goods after they were produced or after a particular stage of production. If an inspection revealed defects, the defective products were either discarded or sent back for reworking. All this cost the company money, and these costs were passed on to the customer. The new concept of quality focuses on identifying quality problems at the source and correcting them.

In Chapter 6 we will learn how to monitor process quality using quality tools, such as control charts.

Managing Supplier Quality TQM extends the concept of quality to a company’s suppliers. Traditionally, companies tended to have numerous suppliers who engaged in competitive price bidding. When materials arrived, they were inspected for quality. TQM views this practice as contributing to poor quality and wasted time and cost. The philosophy of TQM extends the concept of quality to suppliers and ensures that they engage in the same quality practices. If suppliers meet preset quality standards, materials do not have to be inspected upon arrival. Today, many companies have a representative residing at their supplier’s location, thereby involv- ing the supplier in every stage from product design to final production.

Quality Awards and Standards The Malcolm Baldrige National Quality Award (MBNQA) The Malcolm Baldrige National Quality Award was established in 1987 when Congress passed the Malcolm Baldrige National Quality Improvement Act. The award is named after the former Secretary of Commerce Malcolm Baldrige, and is intended to reward and stim- ulate quality initiatives. It is designed to recognize companies that establish and demon- strate high-quality standards and is given to no more than two companies in each of three categories: manufacturing, service, and small business. Past winners include Motorola Cor- poration, Xerox, FedEx, 3M, IBM, and the Ritz-Carlton.

To compete for the Baldrige Award, companies must submit a lengthy application, which is followed by an initial screening. Companies that pass this screening move to the next step, in which they undergo a rigorous evaluation process conducted by certified Baldrige examiners. The examiners conduct site visits and examine numerous company documents. They base their evaluation on seven categories, which are shown in Figure 5.11. Let’s look at each category in more detail.

Malcolm Baldrige National Quality Award An award given annually to companies that demonstrate quality excellence and establish best practice standards in industry.

172 CHAPTER 5 • Total Quality Management

1 Leadership

2 Strategic Planning

3 Customer and Market Focus

4 Information and Analysis

5 Human Resource Focus

6 Process Management

7 Business Results

TOTAL POINTS

Categories

120

85

85

90

85

85

450

1000

Points

FIGURE 5.11 Malcolm Baldrige National Quality Award criteria

The first category is leadership. Examiners consider commitment by top management, their effort to create an organizational climate devoted to quality, and their active involve- ment in promoting quality. They also consider the firm’s orientation toward meeting cus- tomer needs and desires, as well as those of the community and society as a whole.

The second category is strategic planning. The examiners look for a strategic plan that has high-quality goals and specific methods for implementation. The next category, customer and market focus, addresses how the company collects market and customer information. Successful companies should use a variety of tools toward this end, such as market surveys and focus groups. The company then needs to demonstrate how it acts on this information.

The fourth category is information and analysis. Examiners evaluate how the company obtains data and how it acts on the information. The company needs to demonstrate how the information is shared within the company as well as with other parties, such as suppli- ers and customers.

The fifth and sixth categories deal with management of human resources and manage- ment of processes, respectively. These two categories together address the issues of peo- ple and process. Human resource focus addresses issues of employee involvement. This entails continuous improvement programs, employee training, and functioning of teams. Employee involvement is considered a critical element of quality. Similarly, process man- agement involves documentation of processes; use of tools for quality improvement, such as statistical process control; and the degree of process integration within the organization.

The last Baldrige category receives the highest points and deals with business results. Numerous measures of performance are considered, from percentage of defective items to financial and marketing measures. Companies need to demonstrate progressive improve- ment in these measures over time, not just a one-time improvement.

The Baldrige criteria have evolved from simple award criteria to a general framework for quality evaluation. Many companies use these criteria to evaluate their own performance and set quality targets even if they are not planning to formally compete for the award.

The Deming Prize The Deming Prize is a Japanese award given to companies to recognize their efforts in quality improvement. The award is named after W. Edwards Deming, who visited Japan after World War II upon the request of Japanese industrial leaders and engineers. While

HRM

Deming Prize A Japanese award given to companies to recognize efforts in quality improvement.

Quality Awards and Standards • 173

there, he gave a series of lectures on quality. The Japanese considered him such an impor- tant quality guru that they named the quality award after him.

The award has been given by the Union of Japanese Scientists and Engineers ( JUSE) since 1951. Competition for the Deming Prize was opened to foreign companies in 1984. In 1989, Florida Power & Light was the first U.S. company to receive the award.

ISO 9000 Standards Increases in international trade during the 1980s led to the development of universal stan- dards of quality. Universal standards were seen as necessary in order for companies to be able to objectively document their quality practices around the world. Then in 1987 the International Organization for Standardization published its first set of standards for qual- ity management, called ISO 9000. The purpose of the International Organization for Stan- dardization (ISO) is to establish agreement on international quality standards. It currently has members from 164 countries, including the United States. It created ISO 9000 to develop and promote international quality standards. ISO 9000 consists of a set of standards and a certification process for companies. ISO 9000 certification demonstrates that companies have met the standards. The standards are applicable to all types of companies and have gained global acceptance. In many industries ISO certification has become a requirement for doing business. Also, ISO 9000 standards have been adopted by the European Commu- nity as a standard for companies doing business in Europe.

In December 2000 the first major changes to ISO 9000 were made, and then clarified in 2008, introducing the following three new standards:

· ISO 9000:2008, Quality Management Systems—Fundamentals and Standards: Provides the terminology and defi nitions used in the standards. It is the starting point for understanding the system of standards.

· ISO 9001:2008, Quality Management Systems—Requirements: Th is is the standard for the certifi cation of a fi rm’s quality management system. It is used to demonstrate the conformity of quality management systems to meet customer requirements.

· ISO 9004:2008, Quality Management Systems—Guidelines for Performance: Provides guidelines for establishing a quality management system. It focuses not only on meet- ing customer requirements but also on improving performance.

These three standards are the most widely used and apply to the majority of companies. However, many more published standards and guidelines exist as part of the ISO 9000 family of standards.

To receive ISO certification, a company must provide extensive documentation of its quality processes. This includes methods used to monitor quality, methods and frequency of worker training, job descriptions, inspection programs, and statistical process control tools used. High-quality documentation of all processes is critical. The company is then audited by an ISO 9000 registrar, who visits the facility to make sure the company has a well- documented quality management system and that the process meets the standards. If the registrar finds that all is in order, certification is received. Once a company is certified, it is registered in an ISO directory that lists certified companies. The entire process can take 18 to 24 months and can cost anywhere from $10,000 to $50,000. Companies have to be recer- tified by ISO every three years.

One of the shortcomings of ISO certification is that it focuses only on the process used and conformance to specifications. In contrast to the Baldrige criteria, ISO certification does not address questions about the product itself and whether it meets customer and market requirements. Today there are over 40,000 companies that are ISO certified. In fact, certification has become a requirement for conducting business in many industries.

ISO 9000 A set of international quality standards and a certifi cation demonstrating that companies have met all the standards specifi ed.

174 CHAPTER 5 • Total Quality Management

ISO Standards for Sustainability Reporting The International Organization for Standardization (ISO) now offers managerial and organizational guidance in the form of frameworks that organizations of any size and industry can use to promote social responsibility and continuously improve environmen- tal management.

The ISO 26000 series, Guidance on Social Responsibility, emphasizes a process to ensure business decisions affecting society or the environment are made ethi- cally and transparently. The ISO 26000 addresses issues ranging from human rights and labor practices, to environmental issues of pollution prevention and sustainable resource use.

The ISO 14000 series provides tools to identify and report on the adverse impacts of business, including environmental management systems that track energy use and water consumption at specific facilities; life cycle impact analysis of products in development; methods of communicating about sustainability; and auditing protocols. Businesses use these standards to reduce waste management costs, reduce material and resource con- sumption, reduce the costs of distribution, and improve reputation among government offi- cials and their clients.

ISO even publishes sustainability checklists for small and mid-size enterprises. These standards can guide the selection of new technology; identify opportunities to reduce cost, waste, and pollution; and ensure operations are socially responsible through trans- parency. ISO standards can be introduced voluntarily or a company’s supplier may request compliance.

Why TQM Efforts Fail In this chapter we have discussed the meaning of TQM and the great benefits that can be attained through its implementation. Yet there are still many companies that attempt a variety of quality improvement efforts and find that they have not achieved any or most of the expected outcomes. The most important factor in the success or failure of TQM efforts is the genuineness of the organization’s commitment. Often, companies look at TQM as another business change that must be implemented due to market pressure without really changing the values of their organization. Recall that TQM is a complete philosophy that has to be embraced with true belief, not mere lip service. Looking at TQM as a short-term financial investment is a sure recipe for failure.

Another mistake is the view that the responsibility for quality and elimination of waste lies with employees other than top management. It is a “let the workers do it” mentality. A third common mistake is over- or underreliance on statistical process control (SPC) meth- ods. SPC is not a substitute for continuous improvement, teamwork, and a change in the organization’s belief system. However, SPC is a necessary tool for identifying quality prob- lems. Some common causes for TQM failure are

· Lack of a genuine quality culture

· Lack of top management support and commitment

· Over- and underreliance on statistical process control (SPC) methods

Companies that have attained the benefits of TQM have created a quality culture. These companies have developed processes for identifying customer-defined quality. In addi- tion, they have a systematic method for listening to their customers, collecting and ana- lyzing data pertaining to customer problems, and making changes based on customer feedback. You can see that in these companies there is a systematic process for prioritizing customer needs that encompasses the entire organization.

ISO 26000 A set of international standards developed to help organizations evaluate and address their social responsibility.

ISO 14000 A set of international standards and a certifi cation focusing on a company’s environmental responsibility.

Customer-defi ned quality The meaning of quality as defi ned by the customer.

Why TQM Efforts Fail • 175

Total Quality Management (TQM) Within OM: How it all Fits Together

Implementing total quality management requires broad and sweeping changes throughout a company. It also affects all other decisions within operations management. The decision to implement total quality management concepts throughout the company is strategic in nature. It sets the direction for the firm and the level of commitment. For example, some companies may choose to directly compete on quality, whereas others may just want to be as good as the competition. It is operations strategy that then dictates how all other areas of operations management will support this commitment.

The decision to implement TQM affects areas such as product design (Chapter 3), which needs to incorporate customer-defined quality. Processes are then redesigned in order to produce products with higher quality standards. Job design (Chapter 11) is affected, as workers need to be trained in quality tools and become responsible for rooting out quality problems. Also, supply chain management (Chapter 4) is affected as the commitment to quality translates into partnering with suppliers. As you can see, virtually every aspect of the operations function must change to support the commitment to total quality management.

Total Quality Management (TQM) Across the Organization

As we have seen, total quality management impacts every aspect of the organization. Every person and every function is responsible for quality and is affected by poor quality. For example, recall that Motorola implemented its Six Sigma concept not only in the production process but also in the accounting, finance, and administrative areas. Similarly, ISO stan- dards do not apply only to the production process—they apply equally to all departments of the company. A company cannot achieve high quality if its accounting is inaccurate or the marketing department is not working closely with customers. TQM requires the close cooperation of different functions in order to be successful. In this section we look at the involvement of these other functions in TQM.

Marketing plays a critical role in the TQM process by providing key inputs that make TQM a success. Recall that the goal of TQM is to satisfy customer needs by producing the exact product that customers want. Marketing’s role is to understand the changing needs and wants of customers by working closely with them. This requires a solid identification of target markets and an understanding of whom the product is intended for. Sometimes, apparently small differences in product features can result in large differences in customer appeal. Marketing needs to accurately pass customer information along to operations, and operations needs to include marketing in any planned product changes.

Finance is another major participant in the TQM process because of the great cost con- sequences of poor quality. General definitions of quality need to be translated into specific dollar terms. This serves as a baseline for monitoring the financial impact of quality efforts and can be a great motivator. Recall the four costs of quality discussed earlier. The first two costs, prevention and appraisal, are preventive costs; they are intended to prevent inter- nal and external failure costs. Not investing enough in preventive costs can result in failure costs, which can hurt the company. On the other hand, investing too much in preventive costs may not yield added benefits. Financial analysis of these costs is critical. You can see that finance plays a large role in evaluating and monitoring the financial impact of manag- ing the quality process. This includes costs related to preventing and eliminating defects, training employees, reviewing new products, and all other quality efforts.

MKT

FIN

176 CHAPTER 5 • Total Quality Management

Accounting is important in the TQM process because of the need for exact costing. TQM efforts cannot be accurately monitored and their financial contribution assessed if the company does not have accurate costing methods.

Engineering efforts are critical in TQM because of the need to properly translate cus- tomer requirements into specific engineering terms. Recall the process we followed in developing quality function deployment (QFD). It was not easy to translate a customer requirement such as “a good-looking backpack” into specific terms such as materials, weight, color grade, size, and number of zippers. We depend on engineering to use general customer requirements in developing technical specifications, identifying specific parts and materials needed, and identifying equipment that should be used.

Purchasing is another important part of the TQM process. Whereas marketing is busy identifying what the customers want and engineering is busy translating that information into technical specifications, purchasing is responsible for acquiring the materials needed to make the product. Purchasing must locate sources of supply, ensure that the parts and materials needed are of sufficiently high quality, and negotiate a purchase price that meets the company’s budget as identified by finance.

Human resources is critical to the effort to hire employees with the skills necessary to work in a TQM environment. That environment includes a high degree of teamwork, cooperation, dedication, and customer commitment. Human resources is also faced with challenges relating to reward and incentive systems. In TQM, rewards and incentives are different from those found in traditional environments that focus on rewarding individuals rather than teams.

Information systems (IS) is highly important in TQM because of the increased need for information accessible to teams throughout the organization. IS should work closely with a company’s TQM development program in order to understand exactly the type of informa- tion system best suited for the firm, including the form of the data, the summary statistics available, and the frequency of updating.

ACC

HRM

MIS

The ultimate goal of TQM is to produce and deliver a good or service that provides value to the fi nal customer. This can only be achieved if the concepts of TQM are adopted by all members of the supply chain. The reason is that the supply chain is a system of organizations that are linked together and that are dependent on each other’s performance. If just one member of the chain produces poor quality, the entire chain will suffer, as the defective product will be passed down the chain until the defect is fi nally discovered. This will result in higher cost

for all chain members and possibly the loss of customers. That is why one of the main ideas of TQM is to extend quality concepts to a company’s suppliers. In the chapter we discussed the differ- ences between the external and internal customer, stressing that no one in the company should pass a defective item on to the internal customer. Just as all the internal functions of an or- ganization are dependent on one another, so are the members of a supply chain. For this reason, the concepts of TQM must be extended to everyone in the chain. •

THE SUPPLY CHAIN LINK

THE SUSTAINABILITY LINK

J ust as TQM must be extended to everyone in the supply chain, so must sustainability standards for them to have a meaningful impact. Today companies are under increasing pressure from consumers and governmental agencies to be sustainable. As a result they are making numerous claims about their performance. So, how can we as consumers know that these claims are true? Being able to objectively

verify these claims is critical. For example ISO Standards for Sustainability Reporting help with this verifi cation. Recall from the chapter that ISO 14000 is a set of international standards and a certifi cation focusing on a company’s envir- onmental responsibility. As with other quality measures, set- ting measurable standards for sustainability is critical. ISO 14000 is designed to provide customers with reasonable

assurance that the environmental performance claims of a company are correct. It is important to note, however, that the ISO 14000 standards do not themselves specify environ- mental performance goals. ISO 14000 is similar to ISO 9000 and ISO 26000 as they all pertain to the process of how the product is produced, rather than the characteristics of the product itself.

When it comes to standards for product characteristics, it is up to the customers and other stakeholders to hold compan- ies accountable. For that reason, there have been numerous other standards that have been developed by the government and various nonprofi t agencies. For example, in the area of materials three sustainability standards have been developed. The fi rst is Global Organic Textile Standards (GOTS), the lead- ing process standard for organic fi ber textiles that provides textile processors and manufacturers with one organic textile

certifi cation. Another is the Green Seal certifi cation that certi- fi es offi ce paper, paper towels, cleaning products, food pack- aging, and household products. There is also Cradle to Cradle, which certifi es paper and packaging, personal care products, textiles and fabrics, and many other products. Certifi cations have also been developed in the areas of building, construc- tion, and energy. The U.S. Green Building Council’s LEED cer- tifi cation is the most widely recognized green building stand- ard in the United States, providing certifi cation for multiple building types. Similarly, Energy Star is the EPA’s certifi cation for new and upgraded energy-effi cient homes and offi ce buildings. These certifi cations are important as they provide measurement, a baseline of performance, and validation of company claims. As sustainability continues to evolve we will continue to see more standards emerge that will help guide consumers and corporations. •

Chapter Highlights 1 Total quality management (TQM) is different from

the old concept of quality because its focus is on serving customers, identifying the causes of quality problems, and building quality into the production process.

2 There are four categories of quality costs. The first two are prevention and appraisal costs, which are incurred by a company in attempting to improve quality. The last two costs are internal and external failure costs, which are the costs of quality failures that the com- pany wishes to prevent.

3 The concept of quality has been around for decades but has changed over the years. Today’s concept means building quality into the process rather than the old concept of checking for defects after production.

4 Seven features of TQM combine to create the TQM philosophy: customer focus, continuous improvement, employee empowerment, use of quality tools, product design, process management, and managing supplier quality.

· Quality function deployment (QFD) is a tool used to translate customer needs into specifi c engineering requirements. Seven problem-solving tools are used in managing quality. Often called the seven tools of quality control, they are cause-and-eff ect diagrams, fl owcharts, checklists, scatter diagrams, Pareto analy- sis, control charts, and histograms.

5 The Malcolm Baldrige Award is given to companies to recognize excellence in quality management. Com- panies are evaluated in seven areas, including quality leadership and performance results. These criteria have become a standard for many companies that seek to improve quality. ISO 9000 is a certification based on a set of quality standards established by the International Organization for Standardization. Its goal is to ensure that quality is built into produc- tion processes. ISO 9000 focuses mainly on quality of conformance.

6 The most important factor in the success of TQM is the genuineness of the organization’s commitment.

Key Terms

conformance to specifi cations 152

fi tness for use 152

value for price paid 152

support services 152

psychological criteria 152

prevention costs 154

appraisal costs 154

internal failure costs 155

external failure costs 155

total quality management (TQM) 156

Walter A. Shewhart 157

W. Edwards Deming 157

Joseph M. Juran 158

Armand V. Feigenbaum 158

Philip B. Crosby 158

Key Terms • 177

178 CHAPTER 5 • Total Quality Management

Kaoru Ishikawa 158

Genichi Taguchi 159

robust design 159

Taguchi loss function 159

continuous improvement 160

kaizen 161

plan–do–study–act (PDSA) cycle 161

benchmarking 161

quality circle 162

cause-and-eff ect diagram 164

fl owchart 164

checklist 164

control charts 165

scatter diagrams 165

Pareto analysis 165

histogram 165

quality function deployment (QFD) 166

reliability 169

quality at the source 170

Malcolm Baldrige National Quality Award 171

Deming Prize 172

ISO 9000 173

ISO 26000 174

ISO 14000 174

customer-defi ned quality 174

Formula Review 1. Reliability of parts in series:

Rs = (R1) (R2) . . . . (Rn)

2. Reliability of parts with redundancy (in parallel):

Solved Problems (See student companion site for Excel template.) PROBLEM 1

An offi ce security system at Delco, Inc. has two compo- nent parts, both of which must work for the system to function. Part 1 has a reliability of 80 percent, and part 2 has a reliability of 98 percent. Compute the reliability of the system.

Before You Begin: Before you begin solving reliability problems, it is best to fi rst draw a diagram of the com- ponents. Remember that the system of components is drawn in series, except when there is redundancy built into the system through a backup component. In that case, the backup component is drawn in par- allel. Always read the problem carefully to determine whether redundancy is built into the system.

Solution:

Part 1 Part 2

R1 = 0.80 R2 = 0.98

Th e reliability of the system is

Rs = R1 × R2

Rs = (0.80)(0.98) = 0.784

PROBLEM 2

Delco, Inc., from Problem 1, is not happy with the reli- ability of its security system and has decided to improve it. Th e company will add a backup component to part 1 of its security system. Th e backup component will also have a reliability of 0.80. What is the reliability of the improved security system?

Before You Begin: Notice that in this problem there is redundancy in the form of a backup component for part 1. Th is means that when drawing the diagram you should place the two components for part 1 in paral- lel. Proceed by computing the reliability for part 1 and then the entire system.

R s

= 3Reliabilit yof 1stcomponent4 + 53Reliabilit yof 2ndcomponent4 × 3Probabilityof needing2nd component46

Solution: Th e system for Delco, Inc. now looks like this:

Part 1 Part 2

0.80 0.98

0.80

Th is system can then be reduced to the following two components:

Part 1 Part 2

R1 = 0.80 R2 = 0.98

R1 = 0.80 + 0.80(1 − 0.80) = 0.96 R2 = 0.98 (from Solved Problem 1) Rs = R1 × R2

Th e reliability of the improved system is:

Rs = 0.96 × 0.98 = 0.94

Discussion Questions

1. Defi ne quality for the following products: a university, an exercise facility, spaghetti sauce, and toothpaste. Compare your defi nitions with those of others in your class.

2. Describe the TQM philosophy and identify its major characteristics.

3. Explain how TQM is diff erent from the traditional no- tions of quality. Also, explain the diff erences between traditional organizations and those that have imple- mented TQM.

4. Find three local companies that you believe exhibit high quality. Next, fi nd three national or interna- tional companies that are recognized for their quality achievements.

5. Describe the four dimensions of quality. Which do you think is most important?

6. Describe each of the four costs of quality: prevention, appraisal, internal failure, and external failure. Next, describe how each type of cost would change (in- crease, decrease, or remain the same) if we designed a higher-quality product that was easier to manufacture.

7. Th ink again about the four costs of quality. Describe how each would change if we hired more inspectors without changing any other aspects of quality.

8. Explain the meaning of the plan–do–study–act cycle. Why is it described as a cycle?

9. Describe the use of quality function deployment (QFD). Can you fi nd examples in which the voice of the customer was not translated properly into tech- nical requirements?

10. Describe the seven tools of quality control. Are some more important than others? Would you use these tools separately or together? Give some examples of tools that could be used together.

11. What is the Malcolm Baldrige National Quality Award? Why is this award important, and what companies have received it in the past?

12. What are ISO 9000 standards? Who were they set by and why? Can you describe other certifi cations based on the ISO 9000 certifi cation?

13. Who are the seven “gurus” of quality? Name at least one contribution made by at least three of them.

Problems

1. A CD player has fi ve components that all must func- tion for the player to work. Th e average reliability of each component is 0.90. What is the reliability of the CD player?

2. A jet engine has 10 components in series. Th e average reliability of each component is 0.998. What is the reli- ability of the engine?

3. An offi ce copier has four main components in a series with the following reliabilities: 0.89, 0.95, 0.90, and 0.90. Determine the reliability of the copier.

4. An engine system consists of three main components in a series, all having the same reliability. Determine the level of reliability required for each of the compon- ents if the engine is to have a reliability of 0.998.

Problems • 179

180 CHAPTER 5 • Total Quality Management

5. A bank loan processing system has three components with individual reliabilities as shown:

R1 = 0.90 R2 = 0.89 R3 = 0.95

What is the reliability of the bank loan processing system?

6. What would be the reliability of the bank system above if each of the three components had a backup with a reliability of 0.80? How would the total reliability be diff erent?

7. An LCD projector in an offi ce has a main light bulb with a reliability of 0.90 and a backup bulb, the reliabil- ity of which is 0.80. Th e system looks as follows:

0.80

0.90

What is the reliability of the system?

8. A university Web server has fi ve main components, each with the same reliability. All fi ve components must work for the server to function as intended. If the university wants to have a 95 percent reliability, what must be the reliability of each of the components?

9. BioTech Research Center is working to develop a new vaccine for the West Nile Virus. Th e project is so im- portant that the fi rm has created three teams of ex- perts to work on the project from diff erent perspect- ives. Team 1 has a 90 percent chance of success, team 2 an 85 percent chance of success, and team 3 a 70 percent chance. What is the probability that BioTech will develop the vaccine?

10. Th e following system of components has been pro- posed for a new product. Determine the reliability of the system.

R = 0.90 R = 0.85 R = 0.90 R = 0.95

R = 0.85 R = 0.90

Case: Gold Coast Advertising (GCA)

George Stein sat in his large offi ce overlooking Chicago’s Michigan Avenue. As CEO of Gold Coast Advertising, he seemed to always be confronted with one problem or another. Today was no exception. George had just come out of a long meeting with Jim Gerard, head of the board for the small advertising agency. Jim was concerned about a growing problem with lowered sales expectations and a decreasing customer base. Jim warned George that something had to be done quickly or Jim would have to go to the board for action. George acknowledged that sales were down but attributed this to general economic conditions. He assured Jim that the problems would be addressed immediately.

As George pondered his next course of action, he admitted to himself that the customer base of GCA was slowly decreasing. Th e agency did not quite understand the reason for this decrease. Many regular customers were not coming back, and the rate of new custom- ers seemed to be slowly declining. GCA’s competitors seemed to be doing well. George did not understand the problem.

What Do Customers Want?

GCA was a Chicago-based advertising agency that developed campaigns and promotions for small and medium-sized fi rms. Its expertise was in the retail area, but it worked with a wide range of fi rms from the food service industry to the medical fi eld. GCA competed on price and speed of product development. Advertising in the retail area was competitive, and price had always been important. Also, since retail fashions change rap- idly, speed in advertising development was thought to be critical.

George reminded himself that price and speed had always been what customers wanted. Now he felt con- fused that he really didn’t know his customers. Th is was just another crisis that would pass, he told himself. But he needed to deal with it immediately.

Case Questions

1. What is wrong with how Gold Coast Advertising measures its quality? Explain why Gold Coast should ask its customers about how they defi ne quality.

2. Off er suggestions to George Stein on ways of identi- fying quality dimensions GCA’s customers consider important.

3. Develop a short questionnaire to be fi lled out by GCA’s customers that evaluates how customers defi ne quality.

Case: Delta Plastics, Inc. (A)

Company Background

Delta Plastics, Inc. specialized in the design and manu- facture of plastic containers, primarily for kitchen and household use. Its products were sold through mer- chandise retailers and were recognized for high quality. Delta also had an active R&D group that was contin- uously working to develop new plastic materials and new product designs. Delta was a recognized industry leader and was aggressively looking to increase brand recognition and market share.

Delta’s R&D group had recently developed a new plastic material that tolerates rapid changes in tem- perature, from heating to deep cooling. Th is material could be used to make containers for kitchen use that could immediately be moved from the oven to the refrigerator. Unlike glass containers with this capa- bility, the plastic containers would not break or chip. Delta’s marketing group was eager to promote sales of containers made with the new material. Market- ing believed the new material could revolutionize the industry, so it pushed for rapid production, arguing that the sooner the new products were available to

customers, the sooner the company could corner the market.

The Decision

Th e decision whether to initiate production or con- tinue with material testing was made during a heated meeting on April 28. Isabelle Harrison, director of R&D, stated that more product testing was needed in order to fi ne-tune the characteristics of the new material. Although there was no question regarding product safety, she wanted to refi ne the material to make sure that no unexpected defects occurred during production. Jose De Costa, director of manufacturing, supported this posi- tion, stating that the new material might be suscepti- ble to cracking. However, George Chadwick, director of marketing, countered that millions of dollars had already been spent on design and testing. He argued that produc- tion needed to be as rapid as possible before a competi- tor came out with a similar design. At one point George looked at Isabelle and asked: “Are you certain that the product is safe?” She replied that it was. “Th en,” he said, “conducting more testing is unnecessary.”

QUALITY REPORT I STANDARD MATERIAL

Week 1 Week 2

Defect Type M T W Th F M T W Th F

1. Uneven edges 1 2 2 3 2 3 1 1 2 0 2. Cracks 2 3 2 3 0 3 2 2 1 3 3. Scratches 3 1 2 3 4 2 1 0 2 3 4. Air bubbles 4 2 2 3 4 4 3 2 4 3 5. Thickness variation 1 0 4 0 2 0 1 1 2 0

Week 3 Week 4

Defect Type M T W Th F M T W Th F

1. Uneven edges 2 2 1 3 2 3 1 1 2 2 2. Cracks 3 2 2 0 2 1 2 2 3 3 3. Scratches 3 1 0 1 3 3 1 0 1 3 4. Air bubbles 3 1 2 2 4 2 3 2 4 1 5. Thickness variation 1 1 3 0 2 2 1 1 2 0

Case: Delta Plastics, Inc. (A) • 181

182 CHAPTER 5 • Total Quality Management

Th e fi nal decision came from Jonathan Fine, Delta’s CEO. He agreed with George. “If product safety is guar- anteed, small problems in production should not be a big deal. Let’s initiate production as soon as possible.”

The Problem

On June 15, exactly one month after production began, Jose De Costa sat at his desk looking at the latest production quality report. The report showed weekly defects for products made with the new material (dubbed by marketing as “super plastic”) versus the standard material. Jose knew he needed to conduct a better analysis of the data to see whether there were indeed differences in defects between the two materials. Jose was nervous. Even if there were

differences in quality, he was not sure what actions to take.

Case Questions

1. Identify the diff erent costs of quality described in the case. Explain the trade-off s between the costs of quality that Delta made in its decision. Was George Chadwick correct that conducting more tests was unnecessary?

2. Use one of the quality tools described in the chapter to analyze the defects in the case. How do the qual- ity dimensions diff er between the two materials? Are there more defects associated with the super plastic versus the standard material?

3. Given your fi ndings, what should Jose do?

II SUPER PLASTIC (NEW MATERIAL) Week 1 Week 2

Defect Type M T W Th F M T W Th F

1. Uneven edges 2 2 3 2 0 3 1 1 2 3 2. Cracks 6 6 4 3 7 4 4 4 3 3 3. Scratches 0 1 0 1 0 0 1 0 2 2 4. Air bubbles 2 0 2 1 3 4 3 2 4 3 5. Thickness variation 1 0 2 1 2 0 1 2 2 0

Week 3 Week 4

Defect Type M T W Th F M T W Th F

1. Uneven edges 1 2 2 2 3 3 2 1 2 0 2. Cracks 4 6 4 4 3 5 7 6 3 7 3. Scratches 0 1 2 1 0 1 1 0 2 3 4. Air bubbles 4 5 5 5 3 6 5 4 6 5 5. Thickness variation 1 0 4 0 1 0 1 1 2 0

Interactive Case: Virtual Company

On-line Case: Cruise International, Inc.

Assignment: Total Quality Management (TQM) at Cruise International, Inc. For this assignment, you will work again with Meghan Willoughby, Chief Purser aboard the Friendly Seas I. You know the assignment has some- thing to do with quality, but you aren’t quite sure what. You meet Meghan aboard the ship. She greets you and says, “Let me tell you a bit about what you’ll be doing for us. We’ve been working on quality measures for

several years, and now must focus on quality even more as our industry becomes more competitive. We need to make sure that our guests receive quality service from beginning to end. We need your help in bringing ideas together on how to measure quality in a service organi- zation.” Th is assignment will enhance your knowledge of the material in Chapter 5 of your textbook while pre- paring you for your future assignments.

www.wiley.com/college/reid

To access the Web site: • Go to www.wiley.com/college/reid

• Click Student Companion Site

• Click Virtual Company/Cruise International, Inc.

• Click Consulting Assignments

• Click Service Package and Processes at CII

On-line Case: Product Design and Process Selection at Valley Memorial Hospital

Assignment: Total Quality Management. For this assign- ment, you’ll be working with Jane Starr of Valley Memo- rial Hospital’s Risk Management Department. You know the assignment has something to do with quality, but you’re wondering how quality applies to health care. At the hospital, you fi nd Jane Starr’s offi ce. She greets you and says, “Let me tell you a bit about what you’ll be doing for us. We’ve been working on quality measures for several years, and now we have to focus on quality even more. Th e Joint Commission for Accreditation of Healthcare Organizations is currently looking hard at

quality when it visits hospitals and-decides whether to accredit them. We need your help in bringing ideas together on how to measure quality in a service organization.”

To access the Website: • Go to www.wiley.com/college/reid

• Click Student Companion Site

• Click Virtual Company/Valley Memorial Hospital

• Click Kaizen Consulting, Inc.

• Click Consulting Assignments

• Click Total Quality Management at Valley Memorial Hospital

Internet Challenge: Snyder Bakeries

You have recently taken a position with Snyder Bakeries, a producer of a variety of diff erent types of baked goods that are packaged and sold directly to grocery chains. Snyder Bakeries has been in business since 1978. It is a small company with 95 employees, earning roughly $2.5 million annually. Competition in the baked goods market has been increasing steadily, and Snyder Baker- ies is being forced to look at its operations. In addition, turnover and dissatisfaction among Snyder employees have been high. Mr. Lowell Snyder, President of Snyder Bakeries, is looking to you for help in redesigning the company’s quality program. He would like you to focus on helping Snyder Bakeries develop a team approach

among its employees as part of the implementing prin- ciples of total quality management.

To help Mr. Snyder, use the Internet as a source of information. Perform an Internet search to iden- tify at least two companies that Snyder Bakeries can use as a benchmark for developing a team approach among employees. Explain how each of these compet- itors uses teams, how the teams are developed, how incentives are provided, and how employees are moti- vated. Also identify the benefi ts these companies have gained from using the team approach. Finally, outline a plan for Mr. Snyder based on the information you have gathered.

Selected Bibliography

Crosby, P. Quality without Tears: Th e Art of Hassle-Free Man- agement. New York: McGraw-Hill, 1984.

Crosby, P.B. Quality Is Free. New York: New American Library, 1979.

Deming, W.E. Out of Crisis. Cambridge, Mass.: MIT Center for Advanced Engineering Study, 1986.

“Discovering ISO 26000: Social Responsibility.” http://www. iso.org/iso/discovering_iso_26000.pdf

Evans, J.R., and W.M. Lindsay. Th e Management and Control of Quality, Fourth Edition. Cincinnati: South-Western, 1999.

Garvin, D.A. Managing Quality. New York: Free Press, 1988.

Garvin, D.A. “Competing on the Eight Dimensions of Qual- ity,” Harvard Business Review, November–December 1987, 101–110.

Goetsch, D.L., and S. Davis. Implementing Total Quality. Upper Saddle River, N.J.: Prentice-Hall, 1995.

Selected Bibliography • 183

184 CHAPTER 5 • Total Quality Management

Hall, R. Attaining Manufacturing Excellence. Burr Ridge, Ill.: Dow-Jones Irwin, 1987.

“ISO 14000: Environmental Management.” http://www. iso.org/iso/home/standards/management-standards/ iso14000.htm.

Juran, J.M. Juran on Planning for Quality. New York: Free Press, 1988.

Juran, J.M. Quality Control Handbook, Fourth Edition. New York: McGraw-Hill, 1988.

Juran, J.M. “Th e Quality Trilogy,” Quality Progress, 10, 8, 1986, 19–24.

Kitazawa, S., and J. Sarkis. “Th e Relationship between ISO 14001 and Continuous Source Reduction Programs,”

International Journal of Operations and Production Man-

agement, 20, 2, 2000, 225–248.

Medori, D., and D. Steeple. “A Framework for Auditing and Enhancing Performance Measurement Systems,” Interna- tional Journal of Operations and Production Management, 20, 5, 2000, 520–533.

Oakland, J.S. Total Quality Management and Operations Excellence: Text and Cases. New York: Routledge, 2014.

Orsini, J.N. The Essential Deming: Leadership Principles from the Father of Quality. New York: McGraw-Hill, 2013.

6 Before studying this chapter you should know or, if necessary, review

1. Quality as a competitive priority, Chapter 2.

2. Total quality management (TQM) concepts, Chapter 5.

Learning Objectives After studying this chapter you should be able to 1 Describe categories of

statistical quality control (SQC). 2 Identify and describe causes of

variation. 3 Explain the use of descriptive

statistics in measuring quality characteristics.

4 Describe the use of control charts.

5 Identify the differences between x-bar and R-charts.

6 Identify the differences between p- and c-charts.

7 Explain the meaning of process capability and the process capability index.

8 Explain the concept Six Sigma. 9 Explain the process of

acceptance sampling and describe the use of operating characteristic (OC) curves.

10 Identify decisions that managers must make when implementing SPC.

11 Describe the challenges inherent in measuring quality in service organizations.

Statistical Quality Control

W e have all had the experience of purchasing a product only to discover that it is defective in some way or does not function the way it was designed to. This could be a new backpack with a broken zipper or

an “out of the box” malfunctioning computer printer. Many of us have struggled to assemble a product the manufacturer has indicated would need only “minor” assembly, only to find that a piece of the product is missing or defective. As con- sumers, we expect the products we purchase to function as intended. However, producers of products know that it is not always possible to inspect every product and every aspect of the production process at all times. The challenge is to design ways to maximize the ability to monitor the quality of products being produced and eliminate defects.

One way to ensure a quality product is to build quality into the process. Con- sider Steinway & Sons, the maker of premier pianos used in concert halls all over

the world. Steinway has been making pianos since the 1880s. Since that time, the company’s manufacturing process has not changed significantly. It takes the company nine months to a year to produce a piano by fashioning some 12,000 hand- crafted parts, carefully mea- suring and monitoring every part of the process. Although many of Steinway’s competi-

tors have moved to mass production, where pianos can be assembled in 20 days, Steinway has maintained a strategy of quality defined by skill and craftsman- ship. Steinway’s production process is focused on meticulous process precision and extremely high product consistency. This has contributed to making its name synonymous with top quality. •

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186 CHAPTER 6 • Statistical Quality Control

What Is Statistical Quality Control? In Chapter 5 we learned that total quality management (TQM) addresses organizational qual- ity from managerial and philosophical viewpoints. TQM focuses on customer-driven quality standards, managerial leadership, continuous improvement, quality built into product and process design, identifying quality problems at the source, and making quality everyone’s responsibility. However, talking about solving quality problems is not enough. We need spe- cific tools that can help us make the right quality decisions. These tools come from the field of statistics and are used to help identify quality problems in the production process as well as in the product itself. Statistical quality control is the subject of this chapter.

Statistical quality control (SQC) is the term used to describe the set of statistical tools used by quality professionals. Statistical quality control can be divided into three broad categories:

1. Descriptive statistics are used to describe quality characteristics and relationships. Included are statistics such as the mean, the standard deviation, the range, and a measure of the distribution of data.

2. Statistical process control (SPC) involves inspecting a random sample of the output from a process and deciding whether the process is producing products with characteristics that fall within a predetermined range. SPC answers the question of whether or not the process is functioning properly.

3. Acceptance sampling is the process of randomly inspecting a sample of goods and deciding whether to accept the entire lot based on the results. Acceptance sampling determines whether a batch of goods should be accepted or rejected.

The tools in each of these categories provide different types of information for use in analyzing quality. Descriptive statistics are used to describe certain quality characteristics, such as the central tendency and variability of observed data. Although descriptions of certain characteristics are helpful, they are not enough to help us evaluate whether there is a problem with quality. Acceptance sampling can help us do this. It helps us decide whether desirable quality has been achieved for a batch of products and whether to accept or reject the items produced. Although this information is helpful in making the quality acceptance decision after the product has been produced, it does not help us identify and catch a qual- ity problem during the production process. For this we need tools in the statistical process control (SPC) category.

All three of these statistical quality control categories are helpful in measuring and eval- uating the quality of products or services. However, statistical process control (SPC) tools are used most frequently because they identify quality problems during the production

process. For this reason, we will devote most of the chapter to this category of tools. The quality con- trol tools we will be learning about do not only measure the value of a quality characteristic; they also help us identify a change or varia- tion in some quality characteristic of the product or process. We will first see what types of variation we can observe when measuring quality. Then we will be able to identify the specific tools to use for measuring this variation.

Statistical quality control (SQC) The general category of statistical tools used to evaluate organizational quality.

Descriptive statistics Statistics used to describe quality characteristics and relationships.

Statistical process control (SPC) A statistical tool that involves inspecting a random sample of the output from a process and deciding whether the process is producing products with characteristics that fall within a predetermined range.

Acceptance sampling The process of randomly inspecting a sample of goods and deciding whether to accept the entire lot based on the results.

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Descriptive Statistics • 187

Variation in the production process leads to quality defects and lack of product consistency. The Intel Corporation, the world’s largest and most profitable manufacturer of microproces- sors, understands this. Therefore, Intel has implemented a program it calls “copy-exactly” at all its manufacturing facilities. The idea is that regardless of whether the chips are made in Arizona, New Mexico, Ireland, or any of its other plants, they are made in exactly the same way. This means using the same equipment, the same exact materials, and performing the same tasks in the exact same order. The level of detail to which the “copy-exactly” concept goes is meticulous. For example, when a chipmaking machine was found to be a few feet longer at one facility than another, Intel made them match. When water quality was found to be different at one facility, Intel instituted a purification system to eliminate any differences. Even when a worker was found polishing equipment in one direction, he was asked to do it in the approved circular pattern. Why such attention to exactness of detail? The reason is to minimize all variation. Now let’s look at the different types of variation that exist.

Sources of Variation: Common and Assignable Causes

If you look at bottles of a soft drink in a grocery store, you will notice that no two bottles are filled to exactly the same level. Some are filled slightly higher and some slightly lower. Similarly, if you look at blueberry muffins in a bakery, you will notice that some are slightly larger than others and some have more blueberries than others. These types of differences are completely normal. No two products are exactly alike because of slight differences in materials, workers, machines, tools, and other factors. These are called common, or random, causes of varia- tion. Common causes of variation are based on random causes that we cannot identify. These types of variation are unavoidable and are due to slight differences in processing.

An important task in quality control is to find out the range of natural random variation in a process. For example, if the average bottle of a soft drink called Cocoa Fizz contains 16 ounces of liquid, we may determine that the amount of natural variation is between 15.8 and 16.2 ounces. If this were the case, we would monitor the production process to make sure that the amount stays within this range. If production goes out of this range—bottles are found to contain on average 15.6 ounces—this would lead us to believe that there is a prob- lem with the process because the variation is greater than the natural random variation.

The second type of variation that can be observed involves those where the causes can be precisely identified and eliminated. These are called assignable causes of variation. Exam- ples of this type of variation are poor quality in raw materials, an employee who needs more training, or a machine in need of repair. In each of these examples, the problem can be iden- tified and corrected. If the variation is allowed to persist, it will continue to create a problem in the quality of the product. In the example of the soft-drink bottling operation, bottles filled with 15.6 ounces of liquid would signal a problem. The machine may need to be readjusted, an assignable cause of variation. We can assign the variation to a particular cause (machine needs to be readjusted) and we can correct the problem (readjust the machine).

Descriptive Statistics Descriptive statistics can be helpful in describing certain characteristics of a product and a process. The most important descriptive statistics are measures of central tendency such as the mean, measures of variability such as the standard deviation and range, and measures of the distribution of data. We first review these descriptive statistics and then see how we use them to measure changes in product and process characteristics.

Common causes of variation Random causes that cannot be identifi ed.

Assignable causes of variation Causes that can be identifi ed and eliminated.

188 CHAPTER 6 • Statistical Quality Control

The Mean In the soft-drink bottling example, we stated that the average bottle is filled with 16 ounces of liquid. The arithmetic average, or the mean, is a statistic that measures the central ten- dency of a set of data. Knowing the central point of a set of data is highly important. Just think how important that number is when you receive test scores!

To compute the mean, we simply sum all the observations and divide by the total number of observations. The equation for computing the mean is

x = a

n

i = 1 xi

n

where x = the mean xi = observation i, i = 1, . . . , n n = number of observations

The Range and Standard Deviation In the bottling example, we also stated that the amount of natural variation in the bottling process is between 15.8 and 16.2 ounces. This information provides us with the amount of variability of the data. It tells us how spread out the data are around the mean. There are two measures that can be used to determine the amount of variation in the data. The first measure is the range, which is the difference between the largest and smallest observations. In our example, the range for natural variation is 0.4 ounce.

Another measure of variation is the standard deviation. The equation for computing the standard deviation is

σ = R a

n

i = 1 (xi − x)

2

n − 1

where σ = standard deviation of a sample x = the mean xi = observation i, i = 1, . . . , n n = the number of observations in the sample

Small values of the range and standard deviation mean that the observations are closely clustered around the mean. Large values of the range and standard deviation mean that the observations are spread out around the mean. Figure 6.1 illustrates the differences between a small and a large standard deviation for our bottling operation. You can see that the figure shows two distributions, both with a mean of 16 ounces. However, in the first distribution the standard deviation is large and the data are spread out far around the mean. In the second distribution the standard deviation is small and the data are clustered close to the mean.

Distribution of Data A third descriptive statistic used to measure quality characteristics is the shape of the distribution of the observed data. When a distribution is symmetric, there are the same number of observations below and above the mean. This is what we commonly find when only normal variation is present in the data. When a disproportionate number of observa- tions are either above or below the mean, we say that the data have a skewed distribution. Figure 6.2 shows symmetric and skewed distributions for the bottling operation.

Mean (average) A statistic that measures the central tendency of a set of data.

Range The difference between the largest and smallest observations in a set of data.

Standard deviation A statistic that measures the amount of data dispersion around the mean.

Statistical Process Control Methods • 189

Statistical Process Control Methods Statistical process control methods employ descriptive statistics to monitor the quality of the product and process. As we have learned so far, there are common and assignable causes of variation in the production of every product. Using statistical process control, we want to determine the amount of variation that is common or normal. Then we monitor the production process to make sure production stays within this normal range. That is, we want to make sure the process is in a state of control. The most commonly used tool for monitoring the production process is a control chart. Different types of control charts are used to monitor different aspects of the production process. In this section we will learn how to develop and use control charts.

Developing Control Charts A control chart (also called process chart or quality control chart) is a graph that shows whether a sample of data falls within the common or normal range of variation. A control chart has upper and lower control limits that separate common from assignable causes of variation. The common range of variation is defined by the use of control chart limits. We say that a process is out of control when a plot of data reveals that one or more samples fall outside the control limits.

Figure 6.3 shows a control chart for the Cocoa Fizz bottling operation. The x axis rep- resents samples (#1, #2, #3, etc.) taken from the process over time. The y axis represents the quality characteristic that is being monitored (ounces of liquid). The center line (CL) of the control chart is the mean, or average, of the quality characteristic that is being mea- sured. In Figure 6.3 the mean is 16 ounces. The upper control limit (UCL) is the maximum acceptable variation from the mean for a process that is in a state of control. Similarly, the lower control limit (LCL) is the minimum acceptable variation from the mean for a process that is in a state of control. In our example, the upper and lower control limits are 16.2 and 15.8 ounces, respectively. You can see that if a sample of observations falls outside the control limits, we need to look for assignable causes.

The upper and lower control limits on a control chart are usually set at 63 standard deviations from the mean. If we assume that the data exhibit a normal distribution, these control limits will capture 99.74 percent of the normal variation. Control limits can be set at ±2 standard deviations from the mean. In that case, control limits would capture 95.44

Out of control The situation in which a plot of data falls outside preset control limits.

15.7

Small standard deviation Large standard deviation

15.8 15.9 16.0 16.1 16.2 16.3

MEAN

FIGURE 6.1 Normal distributions with varying standard deviations

15.7 15.8 15.9 16.0 16.1 16.2 16.3

MEAN

Symmetric distribution Skewed distribution

FIGURE 6.2 Differences between symmetric and skewed distributions

190 CHAPTER 6 • Statistical Quality Control

percent of the values. Figure 6.4 shows the percentage of values that fall within a particular range of standard deviation.

Looking at Figure 6.4, we can conclude that observations falling outside the set range represent assignable causes of variation. However, there is a small probability that a value that falls outside the limits is still due to normal variation. This is called Type I error, with the error being the chance of concluding that there are assignable causes of variation when only normal variation exists. Another name for this is alpha (a) risk, where alpha refers to the sum of the probabilities in both tails of the distribution that fall outside the confidence limits. The chance of this happening is given by the percentage or probability represented by the shaded areas of Figure 6.5. For limits of ±3 standard deviations from the mean, the probability of a Type I error is 0.26 percent (100% − 99.74%), whereas for limits of ±2 standard deviations it is 4.56 percent (100% − 95.44%).

Types of Control Charts Control charts are one of the most commonly used tools in statistical process control. They can be used to measure any characteristic of a product, such as the weight of a cereal box, the number of chocolates in a box, or the volume of bottled water. The different charac- teristics that can be measured by control charts can be divided into two groups: variables and attributes. A control chart for variables is used to monitor characteristics that can be

Variable A product characteristic that can be measured and has a continuum of values (e.g., height, weight, or volume).

Attribute A product characteristic that has a discrete value and can be counted.

FIGURE 6.3 Quality control chart for Cocoa Fizz

Variation due to assignable causes

Observation out of control

Variation due to assignable causes

Variation due to normal causes

#1 #2

UCL = (16.2)

LCL = (15.8)

CL = (16.0)

#3 #4 #5 #6

SAMPLE NUMBERV O

LU M

E I N

O U

N C

E S

23𝜎 22𝜎 12𝜎 13𝜎MEAN 95.44%

99.74%

FIGURE 6.4 Chance of Type I error for ±3σ (sigma-standard deviations)

23𝜎 22𝜎 12𝜎 13𝜎MEAN

99.74%

Type 1 error is .26%

FIGURE 6.5 Percentage of values captured by different ranges of standard deviation

Control Charts for Variables • 191

measured and have a continuum of values, such as height, weight, or volume. A soft-drink bottling operation is an example of a variable measure, since the amount of liquid in the bot- tles can be measured and can take on a number of different values. Other examples are the weight of a bag of sugar, the temperature of a baking oven, or the diameter of plastic tubing.

A control chart for attributes, on the other hand, is used to monitor characteristics that have discrete values and can be counted. Often they can be evaluated with a simple yes- or-no decision. Examples include color, taste, or smell. The monitoring of attributes usually takes less time than for variables because a variable needs to be measured (e.g., the bottle of soft drink contains 15.9 ounces of liquid). An attribute requires only a single decision, such as yes or no, good or bad, acceptable or unacceptable (e.g., the apple is good or rotten, the meat is good or stale, the shoes have a defect or do not have a defect, the light bulb works or it does not work), or counting the number of defects (e.g., the number of broken cookies in the box, the number of dents in the car, the number of barnacles on the bottom of a boat).

Statistical process control is used to monitor many different types of variables and attributes. In the next two sections we look at how to develop control charts for variables and control charts for attributes.

Control Charts for Variables Control charts for variables monitor characteristics that can be measured and have a con- tinuous scale, such as height, weight, volume, or width. When an item is inspected, the vari- able being monitored is measured and recorded. For example, if we were producing candles, height might be an important variable, so we could take samples of candles and measure their heights. Two of the most commonly used control charts for variables monitor both the central tendency of the data (the mean) and the variability of the data (either the standard deviation or the range). Note that each chart monitors a different type of information. When observed values go outside the control limits, the process is assumed not to be in control. Production is stopped, and employees attempt to identify the cause of the problem and correct it. Next we look at how these charts are developed.

Mean (x-Bar) Charts A mean control chart is often referred to as an x-bar chart. It is used to monitor changes in the mean of a process. To construct a mean chart, we first need to construct the center line of the chart. To do this we take multiple samples and compute their means. Usually these samples are small, with about four or five observations. Each sample has its own mean, x. The center line of the chart is then computed as the mean of all k sample means, where k is the number of samples:

x = x1 + x 2 + p + xk

k

To construct the upper and lower control limits of the chart, we use the following formulas:

Upper control limit (UCL) = x + zσ x

Lower control limit (LCL) = x − zσ x

where x = the average of the sample means z = standard normal variable (2 for 95.44% confi dence, 3 for 99.74% confi dence) σ

x = standard deviation of the distribution of sample means, computed as σ�1n

σ = population (process) standard deviation n = sample size (number of observations per sample)

Example 6.1 shows the construction of a mean (x-bar) chart.

x-bar chart A control chart used to monitor changes in the mean value of a process.

192 CHAPTER 6 • Statistical Quality Control

EXAMPLE 6.1 Constructing a Mean (x-Bar) Chart

A quality control inspector at the Cocoa Fizz soft-drink company has taken 25 samples with 4 observations each of the volume of bottles fi lled. The data and the computed means are shown in the table. If the standard deviation of the bottling operation is 0.14 ounce, use this information to develop control limits of 3 standard deviations for the bottling operation.

Sample Number

Observations (bottle volume in ounces)

1 2 3 4

Average

X

Range

R

1 15.85 16.02 15.83 15.93 15.91 0.19

2 16.12 16.00 15.85 16.01 15.99 0.27

3 16.00 15.91 15.94 15.83 15.92 0.17

4 16.20 15.85 15.74 15.93 15.93 0.46

5 15.74 15.86 16.21 16.10 15.98 0.47

6 15.94 16.01 16.14 16.03 16.03 0.20

7 15.75 16.21 16.01 15.86 15.96 0.46

8 15.82 15.94 16.02 15.94 15.93 0.20

9 16.04 15.98 15.83 15.98 15.96 0.21

10 15.64 15.86 15.94 15.89 15.83 0.30

11 16.11 16.00 16.01 15.82 15.99 0.29

12 15.72 15.85 16.12 16.15 15.96 0.43

13 15.85 15.76 15.74 15.98 15.83 0.24

14 15.73 15.84 15.96 16.10 15.91 0.37

15 16.20 16.01 16.10 15.89 16.05 0.31

16 16.12 16.08 15.83 15.94 15.99 0.29

17 16.01 15.93 15.81 15.68 15.86 0.33

18 15.78 16.04 16.11 16.12 16.01 0.34

19 15.84 15.92 16.05 16.12 15.98 0.28

20 15.92 16.09 16.12 15.93 16.02 0.20

21 16.11 16.02 16.00 15.88 16.00 0.23

22 15.98 15.82 15.89 15.89 15.90 0.16

23 16.05 15.73 15.73 15.93 15.86 0.32

24 16.01 16.01 15.89 15.86 15.94 0.15

25 16.08 15.78 15.92 15.98 15.94 0.30

Total 398.75 7.17

• Before You Begin: Before developing control limits and constructing the chart, calculate the mean of all 25 samples. This will be the center line of the control data. Then compute the upper and lower control limits. To complete the control chart, notice that you actually plot sample means, not individual samples.

• Solution: The center line of the control data is the average of the samples:

x = 398.75

25

x = 15.95

Control Charts for Variables • 193

The control limits are

UCL = x + zσ x = 15.95 + 3 a0.1414 b = 16.16

LCL = x − zσ x = 15.95 − 3 a0.1414 b = 15.74

The resulting control chart is

O U

N C

E S

15.60 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

15.70

15.80

15.90

16.00

16.10

16.20

LCL CL UCL Sample Mean

This can also be computed using a spreadsheet, as shown here.

1

2 3 4 5 6 7 8 9

10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36

1 2 3 4 5 6 7 8 9

10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

A

Sample Num 15.85 16.12 16.00 16.20 15.74 15.94 15.75 15.82 16.04 15.64 16.11 15.72 15.85 15.73 16.20 16.12 16.01 15.78 15.84 15.92 16.11 15.98 16.05 16.01 16.08

Obs 1

F7: =AVERAGE(B7:E7)

F32: =AVERAGE(F7:F31)

Number of Samples Number of Observations per Sample

G32: =AVERAGE(G7:G31)

G7: =MAX(B7:E7)-MIN(B7:E7)

Bottle Volume in Ounces

0.19 0.27 0.17 0.46 0.47 0.20 0.46 0.20 0.21 0.30 0.29 0.43 0.24 0.37 0.31 0.29 0.33 0.34 0.28 0.20 0.23 0.16 0.32 0.15 0.30 0.29

R-bar

Range 15.91 16.00 15.92 15.93 15.98 16.03 15.96 15.93 15.96 15.83 15.99 15.96 15.83 15.91 16.05 15.99 15.86 16.01 15.98 16.02 16.00 15.90 15.86 15.94 15.94 15.95

Xbar-bar

Average 15.93 16.01 15.83 15.93 16.10 16.03 15.86 15.94 15.98 15.89 15.82 16.15 15.98 16.10 15.89 15.94 15.68 16.12 16.12 15.93 15.88 15.89 15.93 15.86 15.98

Obs 4 15.83 15.85 15.94 15.74 16.21 16.14 16.01 16.02 15.83 15.94 16.01 16.12 15.74 15.96 16.10 15.83 15.81 16.11 16.05 16.12 16.00 15.89 15.73 15.89 15.92

Obs 3 16.02 16.00 15.91 15.85 15.86 16.01 16.21 15.94 15.98 15.86 16.00 15.85 15.76 15.84 16.01 16.08 15.93 16.04 15.92 16.09 16.02 15.82 15.73 16.01 15.78

Obs 2

B C D E F G

x-Bar Chart: Cocoa Fizz

25 4

194 CHAPTER 6 • Statistical Quality Control

Another way to construct the control limits is to use the sample range as an estimate of the variability of the process. Remember that the range is simply the difference between the largest and smallest values in the sample. The spread of the range can tell us about the variability of the data. In this case, control limits would be constructed as follows:

Upper control limit (UCL) = x + A2R

Lower control limit (LCL) = x − A2R

where x = average of the sample means R = average range of the samples A2 = factor obtained from Table 6.1

Notice that A2 is a factor that includes 3 standard deviations of ranges and is dependent on the sample size being considered.

Range (R) Charts Range (R) charts are another type of control chart for variables. Whereas x-bar charts mea- sure a shift in the central tendency of the process, range charts monitor the dispersion or variability of the process. The method for developing and using R-charts is the same as that

Range (R) chart A control chart that monitors changes in the dispersion or variability of a process.

EXAMPLE 6.2 Constructing a Mean (x-Bar) Chart from the Sample Range

A quality control inspector at Cocoa Fizz is using the data from Example 6.1 to develop control limits. If the average range (R) for the 25 samples is 0.29 ounce (computed as 7.1725 ) and the average mean (x) of the observations is 15.95 ounces, develop 3-sigma control limits for the bottling operation.

• Before You Begin:  To compute control limits from the sample range, remember that you need to look up the value of factor A2 from Table 6.1.

• Solution: x = 15.95 ounces  R = 0.29

The value of A2 is obtained from Table 6.1. For n = 4, A2 = 0.73. This leads to the following limits:

The center of the control chart = CL = 15.95 ounces

UCL = x + A2R = 15.95 + (0.73) (0.29) = 16.16

LCL = x − A2R = 15.95 − (0.73) (0.29) = 15.74

39 40 41 42 43 44 45 46 47

Overall Mean (Xbar-bar) = Sigma for Process =

Standard Error of the Mean = Z-value for control charts =

CL: Center Line = LCL: Lower Control Limit =

UCL: Upper Control Limit =

A B C D E F G Computations for X-Bar Chart

15.95 0.14 0.07

3

15.95 15.74 16.16

ounces

D40: =F32

D45: =D40

D46: =D40-D43*D42 D47: =D40+D43*D42

D42: =D41/SQRT(D34)

Control Charts for Variables • 195

TABLE 6.1 Factors for 3-sigma control limits of x- and R-charts

Sample Size n

Factor for x -Chart

A2

Factor for R-Chart

D3 D4

2 1.88 0 3.27

3 1.02 0 2.57

4 0.73 0 2.28

5 0.58 0 2.11

6 0.48 0 2.00

7 0.42 0.08 1.92

8 0.37 0.14 1.86

9 0.34 0.18 1.82

10 0.31 0.22 1.78

11 0.29 0.26 1.74

12 0.27 0.28 1.72

13 0.25 0.31 1.69

14 0.24 0.33 1.67

15 0.22 0.35 1.65

16 0.21 0.36 1.64

17 0.20 0.38 1.62

18 0.19 0.39 1.61

19 0.19 0.40 1.60

20 0.18 0.41 1.59

21 0.17 0.43 1.58

22 0.17 0.43 1.57

23 0.16 0.44 1.56

24 0.16 0.45 1.55

25 0.15 0.46 1.54

for x-bar charts. The center line of the control chart is the average range, and the upper and lower control limits are computed as follows:

CL = R

UCL = D4 R

LCL = D3 R

where values for D4 and D3 are obtained from Table 6.1.

Source: Factors adapted from the ASTM Manual on Quality Control of Materials.

196 CHAPTER 6 • Statistical Quality Control

Using Mean and Range Charts Together You can see that mean and range charts are used to monitor different variables. The mean or x-bar chart measures the central tendency of the process, whereas the range chart mea- sures the dispersion or variance of the process. Since both variables are important, it makes sense to monitor a process using both mean and range charts. It is possible to have a shift in the mean of the product but not a change in the dispersion. For example, at the Cocoa Fizz

EXAMPLE 6.3 Constructing a Range (R) Chart

The quality control inspector at Cocoa Fizz would like to develop a range (R) chart in order to monitor volume dispersion in the bottling process. Use the data from Example 6.1 to develop control limits for the sample range.

• Before You Begin: To develop control limits for the sample range, fi rst compute the average range of all 25 samples. Then use Table 6.1 to develop upper and lower control limits. To complete the control chart, you plot the sample ranges.

• Solution:

From the data in Example 6.1 you can see that the average sample range is

R = 7.17 25

R = 0.29 n = 4

From Table 6.1 for n = 4: D4 = 2.28

D3 = 0

UCL = D4R = 2.28(0.29) = 0.6612

LCL = D3R = 0(0.29) = 0

The resulting control chart is

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

LCL Sample MeanCL UCL

16 17 18 19 20 21 22 23 24 25

O U

N C

E S

Control Charts for Attributes • 197

bottling plant the machine setting can shift so that the average bottle filled contains not 16.0 ounces but 15.9 ounces of liquid. The dispersion could be the same, and this shift would be detected by an x-bar chart but not by a range chart. This is shown in part (a) of Figure 6.6. On the other hand, there could be a shift in the dispersion of the product without a change in the mean. Cocoa Fizz may still be producing bottles with an average fill of 16.0 ounces. However, the dispersion of the product may have increased, as shown in part (b) of Figure 6.6. This condition would be detected by a range chart but not by an x-bar chart. Because a shift in either the mean or the range means that the process is out of control, it is important to use both charts to monitor the process.

Control Charts for Attributes Control charts for attributes are used for quality characteristics that are counted rather than measured. Attributes are discrete in nature and entail simple yes-or-no decisions, for example, the number of nonfunctioning light bulbs, the proportion of broken eggs in a car- ton, the number of rotten apples, the number of scratches on a tile, or the number of com- plaints received. Two of the most common types of control charts for attributes are p-charts and c-charts.

P-charts are used to measure the proportion of items in a sample that are defective. Examples are the proportion of broken cookies in a batch and the proportion of cars produced with a misaligned fender. P-charts are appropriate when both the number of

FIGURE 6.6 Process shifts captured by x-charts and R-charts

15.8 15.9 16.0 16.1 16.2

MEAN 15.8 15.9 16.0 16.1 16.2

MEAN UCL

LCL x-chart

UCL

LCL R-chart

15.8 15.9

UCL

LCL

UCL

LCL

16.0 16.1 16.2 15.8 15.9 16.0 16.1 16.2

MEAN MEAN

x-chart R-chart

(a) Shift in mean detected by x-chart but not by R-chart

(b) Shift in dispersion detected by R-chart but not by x-chart

198 CHAPTER 6 • Statistical Quality Control

defectives measured and the size of the total sample can be counted. A proportion can then be computed and used as the statistic of measurement.

C-charts count the actual number of defects. For example, we can count the number of complaints from customers in a month, the number of bacteria in a petri dish, or the num- ber of barnacles on the bottom of a boat. However, we cannot compute the proportion of complaints from customers, the proportion of bacteria in a petri dish, or the proportion of barnacles on the bottom of a boat. To summarize:

P-charts: Used when observations are placed in either of two groups.

Examples:

· Defective or not defective

· Good or bad

· Broken or not broken

C-charts: Used when defects can be counted per unit of measure.

Examples:

· Number of dents per item

· Number of complaints per unit of time (e.g., hour, month, year)

· Number of tears per unit of area (e.g., square foot, square meter)

Problem-Solving Tip The primary difference between using a p-chart and a c-chart is as follows. A p-chart is

used when both the total sample size and the number of defects can be computed. A c-chart is used when we can

compute only the number of defects but cannot compute the proportion that is defective.

p-Charts P-charts are used to measure the proportion that is defective in a sample. The compu- tation of the center line as well as the upper and lower control limits is similar to the computation for the other kinds of control charts. The center line is computed as the average proportion defective in the population, p. This is obtained by taking a num- ber of sample observations at random and computing the average value of p across all samples.

To construct the upper and lower control limits for a p-chart, we use the following formulas:

UCL = p + zσ p LCL = p − zσ p

where z = standard normal variable p = the sample proportion defective σ p = the standard deviation of the average proportion defective

As with the other charts, z is selected to be either 2 or 3 standard deviations, depending on the amount of data we wish to capture in our control limits. Usually, however, the deviations are set at 3.

The sample standard deviation is computed as follows:

σ p = Bp(1 − p)n where n is the sample size.

p-chart A control chart that monitors the proportion of defects in a sample.

Control Charts for Attributes • 199

EXAMPLE 6.4 Constructing a p-Chart

A production manager at a tire manufacturing plant has inspected the number of defective tires in 20 random samples with 20 observations each. Following are the number of defective tires found in each sample:

Sample Number

Number of Defective

Tires

Number of Observations

Sampled Fraction

Defective

1 3 20 0.15

2 2 20 0.10

3 1 20 0.05

4 2 20 0.10

5 1 20 0.05

6 3 20 0.15

7 3 20 0.15

8 2 20 0.10

9 1 20 0.05

10 2 20 0.10

11 3 20 0.15

12 2 20 0.10

13 2 20 0.10

14 1 20 0.05

15 1 20 0.05

16 2 20 0.10

17 4 20 0.20

18 3 20 0.15

19 1 20 0.05

20 1 20 0.05

Total 40 400

Construct a 3-sigma control chart (z = 3) with this information.

• Before You Begin: To solve this problem, you should use a p-chart because both the total sample size and the number of defects are provided.

• Solution:

The center line of the chart is

CL = p = total number of defective tires total number of observations

= 40

400 = 0.10

σ p = Bp(1 − p)n = B (0.10) (0.90)20 = 0.067 UCL = p + z(σ p) = 0.10 + 3(0.067) = 0.301

LCL = p − z(σ p) = 0.10 − 3(0.067) = −0.101 S 0

In this example the lower control limit is negative, which sometimes occurs because the computation is an approximation of the binomial distribution. When this occurs, the LCL is rounded up to zero because we cannot have a negative control limit.

200 CHAPTER 6 • Statistical Quality Control

The resulting control chart is as follows:

This can also be computed using a spreadsheet, as shown here.

1

2

3

A B C D

C8: =B8/C$4

4

5

20

20

Size of Each Sample

Number Samples

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

Sample #

Constructing a p-Chart

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

# Defective Tires

3

2

1

2

1

3

3

2

1

2

3

2

2

1

1

2

4

3

1

1

Fraction Defective

0.15

0.10

0.05

0.10

0.05

0.15

0.15

0.10

0.05

0.10

0.15

0.10

0.10

0.05

0.05

0.10

0.20

0.15

0.05

0.05

0.35

0

0.05

0.1

0.15

0.2

0.25

0.3

LCL pCL UCL

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

F R

A C

T IO

N D

E F E

C T IV

E (

p )

SAMPLE NUMBER

Control Charts for Attributes • 201

A B C D E F

Computations for p-Chart p bar =

Sigma_p =

Z-value for control charts =

CL: Center Line =

LCL: Lower Control Limit =

UCL: Upper Control Limit =

0.100

0.067

3

0.100

0.000

0.301

29

30

31

32

33

34

35

36

C30: =SUM(B8:B27)/(C4*C5)

C34 = C30

C35 = MAX(C$30-C$32*C$31,0)

C36 = C$30+C$32*C$31

C31: =SQRT((C29*(1-C29))/C4)

c -Charts C-charts are used to monitor the number of defects per unit. Examples are the number of returned meals in a restaurant, the number of trucks that exceed their weight limit in a month, the number of discolorations on a square foot of carpet, and the number of bacteria in a milliliter of water. Note that the types of units of measurement we are considering are a period of time, a surface area, or a volume of liquid.

The average number of defects, c, is the center line of the control chart. The upper and lower control limits are computed as follows:

UCL = c + z3c LCL = c − z3c

c-chart A control chart used to monitor the number of defects per unit.

EXAMPLE 6.5 Computing a c-Chart

The number of weekly customer complaints are monitored at a large hotel using a c-chart. Complaints have been recorded over the past 20 weeks. Develop 3-sigma control limits using the following data:

Total

Week No. of Complaints

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

3 2 3 1 3 3 2 1 3 1 3 4 2 1 1 1 3 2 2 3 44

• Before You Begin: To solve this problem, you should use a c-chart because only the number of defects (complaints) is provided and you cannot compute the proportion defective.

• Solution:

The average number of complaints per week is 44 20

= 2.2. Therefore, c = 2.2.

UCL = c + z3c = 2.2 + 332.2 = 6.65 LCL = c − z3c = 2.2 − 332.2 = −2.25 S 0

As in the previous example, the LCL is negative and should be rounded up to zero. Following is the control chart for this example:

202 CHAPTER 6 • Statistical Quality Control

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

WEEK

C O

M P

LA IN

T S P

E R

W E

E K

LCL pCL UCL

This can also be computed using a spreadsheet, as shown here.

1

2

A B

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

Week

Computing a c-Chart

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

Number of Complaints

3

2

3

1

3

3

2

1

3

1

3

4

2

1

1

1

3

2

2

3

A B C D E F G

Computations for a c-Chart c bar =

Z-value for control charts =

Sigma_c = 1.4832397

CL: Center Line =

LCL: Lower Control Limit =

2.2

3

2.20 0.00

26

27

28

29

30

31

32

33

UCL: Upper Control Limit = 6.6534

C27: =AVERAGE(B5:B24)

C32: =C27

C33: =MAX(C$27-C$28*C$30,0)

C34: =C$27+C$28*C$30

C30: =SQRT(C27)

Process Capability • 203

We have discussed several types of statistical quality control (SQC) techniques. One category of SQC techniques consists of descriptive statistics such as the mean, range, and standard deviation. These tools are used to describe quality character- istics and relationships. Another category of SQC techniques consists of statistical process control (SPC) methods that are used to monitor changes in the production process. To understand SPC methods you must understand the differ- ences between common and assignable causes of variation. Common causes of variation are random causes that cannot be identifi ed. A certain amount of common or normal variation

occurs in every process due to differences in materials, work- ers, machines, and other factors. Assignable causes of vari- ation, on the other hand, are variations that can be identifi ed and eliminated. An important part of statistical process control (SPC) is monitoring the production process to make sure that the only variations in the process are those due to common or normal causes. Under these conditions, we say that a produc- tion process is in a state of control.

You should also understand the different types of quality control charts that are used to monitor the production process: x-bar charts, R (range) charts, p-charts, and c-charts.

BEFORE YOU GO ON

Process Capability So far, we have discussed ways of monitoring the production process to ensure that it is in a state of control and that there are no assignable causes of variation. A critical aspect of statistical quality control is evaluating the ability of a production process to meet or exceed preset specifications. This is called process capability. To understand exactly what this means, let’s look more closely at the term specification. Product specifications, often called tolerances, are preset ranges of acceptable quality characteristics, such as product dimen- sions. For a product to be considered acceptable, its characteristics must fall within this preset range. Otherwise, the product is not acceptable. Product specifications, or tolerance limits, are usually established by design engineers or product design specialists.

For example, the specifications for the width of a machine part may be specified as 15 inches ±0.3. This means that the width of the part should be 15 inches, though it is acceptable if it falls within the limits of 14.7 inches and 15.3 inches. Similarly, for Cocoa Fizz, the average bottle fill may be 16 ounces with tolerances of ±0.2 ounce. Although the bottles should be filled with 16 ounces of liquid, the amount can be as low as 15.8 or as high as 16.2 ounces.

Specifications for a product are preset on the basis of how the product is going to be used or what customer expectations are. As we have learned, any production process has a certain amount of natural variation associated with it. To be capable of producing an acceptable product, the process variation cannot exceed the preset specifications. Process capability thus involves evaluating process variability relative to preset product specifi- cations in order to determine whether the process is capable of producing an acceptable product. In this section we will learn how to measure process capability.

Measuring Process Capability Simply setting up control charts to monitor whether a process is in control does not guar- antee process capability. To produce an acceptable product, the process must be capable and in control before production begins. Let’s look at three examples of process variation relative to design specifications for the Cocoa Fizz soft-drink company. Let’s say that the specification for the acceptable volume of liquid is preset at 16 ounces ±0.2 ounce, which is 15.8 and 16.2 ounces. In part (a) of Figure 6.7 the process produces 99.74 percent (3 sigma) of the product with volumes between 15.8 and 16.2 ounces. You can see that the process variability closely matches the preset specifications. Almost all the output falls within the preset specification range.

Process capability The ability of a production process to meet or exceed preset specifi cations.

Product specifi cations Preset ranges of acceptable quality characteristics.

204 CHAPTER 6 • Statistical Quality Control

In part (b) of Figure 6.7, however, the process produces 99.74 percent (3 sigma) of the product with volumes between 15.7 and 16.3 ounces. The process variability is outside the preset specifications, and a large percentage of the product will fall outside the specified limits. This means that the process is not capable of producing the product within the preset specifications.

Part (c) of Figure 6.7 shows that the production process produces 99.74 percent (3 sigma) of the product with volumes between 15.9 and 16.1 ounces. In this case, the process variability is within specifications and the process exceeds the minimum capability.

Process capability is measured by the process capability index, Cp, which is computed as the ratio of the specification width to the width of the process variability:

Cp = specification width

process width =

USL − LSL 6s

where the specification width is the difference between the upper specification limit (USL) and the lower specification limit (LSL) of the process. The process width is computed as 6 standard deviations (6σ) of the process being monitored. The reason we use 6σ is that most

Process capability index An index used to measure process capability.

FIGURE 6.7 Relationship between process variability and specification width

Specification Width Specification Width LSL

15.7

(a) Process variability meets specification width (b) Process variability outside specification width

15.8 15.9 16.0

MEAN 16.1 16.2 16.3 15.7 15.8 15.9 16.0 16.1 16.2 16.3

USL

Process Variability ±3𝜎 Process Variability ±3𝜎

LSL USL

(c) Process variability within specification width

15.7 15.8 15.9 16.0

MEAN 16.1 16.2 16.3

Process Variability

±3𝜎

Specification Width LSL USL

Process Capability • 205

of the process measurement (99.74 percent) falls within ±3 standard deviations, which is a total of 6 standard deviations.

There are three possible ranges of values for Cp that also help us interpret its value:

Cp = 1: A value of Cp equal to 1 means that the process variability just meets spec- ifications, as in Figure 6.7(a). We would then say that the process is minimally capable.

Cp < 1: A value of Cp below 1 means that the process variability is outside the range of specification, as in Figure 6.7(b). This means that the process is not capable of pro- ducing within specification and must be improved.

Cp > 1: A value of Cp above 1 means that the process variability is tighter than specifica- tions and the process exceeds minimal capability, as in Figure 6.7(c).

A Cp value of 1 means that 99.74 percent of the products produced will fall within the specification limits. This also means that 0.26 percent (100% − 99.74%) of the prod- ucts will not be acceptable. Although this percentage sounds very small, when we think of it in terms of parts per million (ppm), we can see that it can still result in a lot of defects. The number 0.26 percent corresponds to 2600 parts per million (ppm) defec- tive (0.0026 × 1,000,000). That number can seem very high if we think of it in terms of 2600 wrong prescriptions out of a million, or 2600 incorrect medical procedures out of a million, or even 2600 malfunctioning aircraft out of a million. You can see that this number of defects is still high. The way to reduce the ppm defective is to increase proc- ess capability.

EXAMPLE 6.6 Computing the Cp Value at Cocoa Fizz

Three bottling machines at Cocoa Fizz are being evaluated for their capability:

Bottling Machine Standard Deviation

A 0.05

B 0.1

C 0.2

If specifi cations are set between 15.8 and 16.2 ounces, determine which of the machines are capable of producing within specifi cations.

• Before You Begin: To solve this problem, you need to compute the process capability index, Cp, for each machine. The machine with a Cp value at or above 1 is capable of producing within specifi cations.

• Solution:

To determine the capability of each machine, we need to divide the specifi cation width (USL − LSL = 16.2 − 15.8 = 0.4) by 6σ for each machine:

Bottling Machine

σ USL − LSL 6σ Cp =

USL − LSL 6σ

A 0.05 0.4 0.3 1.33

B 0.1 0.4 0.6 0.67

C 0.2 0.4 1.2 0.33

Looking at the Cp values, only machine A is capable of fi lling bottles within specifi cations because it is the only machine that has a Cp value at or above 1.

206 CHAPTER 6 • Statistical Quality Control

Cp is valuable in measuring process capability. However, it has one shortcoming: it assumes that process variability is centered on the specification range. Unfortunately, this is not always the case. Figure 6.8 shows data from the Cocoa Fizz example. In the figure the specification limits are set between 15.8 and 16.2 ounces, with a mean of 16.0 ounces. How- ever, the process variation is not centered; it has a mean of 15.9 ounces. Because of this, a certain proportion of products will fall outside the specification range.

The problem illustrated in Figure 6.8 is not uncommon, and it can lead to mistakes in the computation of the Cp measure. Because of this, another measure for process capability is used more frequently:

Cpk = minaUSL − m 3s

, m − LSL

3s b

where μ = the mean of the process σ = the standard deviation of the process

This measure of process capability helps us address a possible lack of centering of the proc- ess over the specification range. To use this measure, the process capability of each half of the normal distribution is computed and the minimum of the two is used.

Looking at Figure 6.8, we can see that the computed Cp is 1:

Process mean μ = 15.9 Process standard deviation σ = 0.067 LSL = 15.8

USL = 16.2

Cp = 0.4

6(0.067) = 1

The Cp value of 1.00 leads us to conclude that the process is capable. However, from the graph you can see that the process is not centered on the specification range and is producing out-of-spec products. Using only the Cp measure would lead to an incorrect

FIGURE 6.8 Process variability not centered across specification width

Specification Width

15.7 15.8 15.9 16.0

MEAN 16.1 16.2 16.3

LSL USL

Process Variability ±3𝜎

Process Capability • 207

conclusion in this case. Computing Cpk gives us a different answer and leads us to a dif- ferent conclusion:

Cpk = minaUSL − m 3s

, m − LSL

3s b

Cpk = mina16.2 − 15.9 3(0.067)

, 15.9 − 15.8

3(0.067) b

Cpk = min(1.49, .45)

Cpk = .45

The computed Cpk value is less than 1, revealing that the process is not capable.

EXAMPLE 6.7 Computing the Cpk Value

Compute the Cpk measure of process capability for the following machine and interpret the fi ndings. What value would you have obtained with the Cp measure?

Machine data: USL = 110

LSL = 50

Process σ = 10

Process μ = 60

• Before You Begin: To solve this problem, you should compute both the Cpk and Cp measures and compare the fi ndings. Remember that each measure needs to be at or above 1 for the process to be considered capable.

• Solution:

Compute the Cpk measure of process capability:

Cpk = minaUSL − μ3σ , μ − LSL

3σ b

= mina110 − 60 3(10)

, 60 − 50

3(10) b

= min(1.67, 0.33)

= 0.33

This means that the process is not capable. The Cp measure of process capability gives us the following measure:

Cp = 60

6(10) = 1

leading us to believe that the process is capable. The reason for the difference in the measures is that the process is not centered on the specifi cation range, as shown in Figure 6.9.

208 CHAPTER 6 • Statistical Quality Control

Six Sigma Quality The term Six Sigma® was coined by the Motorola Corporation in the 1980s to describe the high level of quality the company was striving to achieve. Sigma (σ) stands for the number of standard deviations of the process. Recall that ±3 sigma (σ) means that 2600 ppm are defective. The level of defects associated with Six Sigma is approximately 3.4 ppm. Figure 6.10 shows a process distribution with quality levels of ±3 sigma (σ) and ±6 sigma (σ). You can see the difference in the number of defects produced.

To achieve the goal of Six Sigma, Motorola has instituted a quality focus in every aspect of its organization. Before a product is designed, marketing ensures that product characteristics are exactly what customers want. Operations ensures that exact product

Six Sigma quality A high level of quality associated with approximately 3.4 defective parts per million.

LSL Number of defects

2600 ppm

USL

MEAN ±3𝜎

±6𝜎

3.4 ppm

FIGURE 6.10 PPM defective for ±3σ versus ±6σ quality (not to scale)

Specification Width

30 50 60 75 90 110

LSL USL

Process Variability

FIGURE 6.9 Process variability not centered across specification width for Example 6.7

Six Sigma Quality • 209

characteristics can be achieved through product design, the manufacturing process, and the materials used. The Six Sigma concept is an integral part of other functions as well. It is used in the finance and account- ing departments to reduce costing errors and the time required to close the books at the end of the month. Numerous other companies, such as General Electric, Lockheed Martin, Boeing, American Express, and Texas Instruments, have followed Motorola’s leadership and have also instituted the Six Sigma concept. In fact, the Six Sigma quality standard has become a benchmark in many industries.

There are two aspects to implementing the Six Sigma concept. The first is the use of technical tools to identify and eliminate causes of quality problems. In fact, Six Sigma relies heavily on quantitative and data-driven technical tools. These technical tools include the statistical quality control tools discussed in this chapter and also the problem-solving tools discussed in Chapter 5, such as cause-and-effect diagrams, flowcharts, and Pareto analysis. In Six Sigma programs, the use of these technical tools is integrated throughout the entire organizational system.

The second aspect of Six Sigma implementation is people involvement. In Six Sigma, all employees have the training to use technical tools and are responsible for rooting out quality problems. Employees are given martial arts titles that reflect their skills in the Six Sigma process. Black belts and master black belts are individuals who have extensive train- ing in the use of technical tools and are responsible for carrying out the implementation of Six Sigma. They are experienced individuals who oversee the measuring, analyzing, process controlling, and improving. They achieve this by acting as coaches, team lead- ers, and facilitators of the process of continuous improvement. Green belts are individuals who have sufficient training in technical tools to serve on teams or on small, individual projects.

The Six Sigma approach is organized around a five-step plan known as DMAIC, which stands for Define, Measure, Analyze, Improve, and Control:

STEP 1: Define the quality problem of the process.

STEP 2: Measure the current performance of the process.

STEP 3: Analyze the process to identify the root causes of the quality problem.

STEP 4: Improve the process by eliminating the root causes of the problem.

STEP 5: Control the process to ensure the improvements continue.

The first three steps provide a study of the existing process, whereas the last two steps are involved in process change. All steps extensively utilize quantitative tools, such as measuring the current performance and analyzing the process for root causes of prob- lems. You can also see that like the PDSA cycle described in Chapter 5, this is a circular process that is ongoing and never ends. Part of Six Sigma is to continuously search for quality problems and improve upon them. In organizations, this effort is led by the black belts.

Successful Six Sigma implementation requires commitment from top company leaders. These individuals must promote the process, eliminate barriers to implementation, and ensure that proper resources are available. A key individual is a champion of Six Sigma. This

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is a person who comes from the top ranks of the organization and is responsible for provid- ing direction and overseeing all aspects of the process.

Acceptance Sampling

Acceptance sampling, the third branch of statistical quality control, refers to the process of randomly inspecting a certain number of items from a lot or batch in order to decide whether to accept or reject the entire batch. What makes acceptance sampling different from statistical process control is that acceptance sampling is performed either before or after the process, rather than during the process. Acceptance sampling before the process involves sampling materials received from a supplier, such as randomly inspecting crates of fruit that will be used in a restaurant, boxes of glass dishes that will be sold in a department store, or metal castings that will be used in a machine shop. Sampling after the process involves sampling finished items that are to be shipped either to a customer or to a dis- tribution center. Examples include randomly testing a certain number of computers from a batch to make sure they meet operational requirements and randomly inspecting snow boards to make sure that they are not defective.

You may be wondering why we would inspect only some items in the lot and not the entire lot. Acceptance sampling is used when inspecting every item is not physically possi- ble or would be overly expensive or when inspecting a large number of items would lead to errors due to worker fatigue. This last concern is especially important when a large num- ber of items are processed in a short period of time. Another example of when acceptance sampling would be used is in destructive testing, such as testing eggs for salmonella or crash-testing vehicles. Obviously, in these cases it would not be helpful to test every item! However, 100 percent inspection does make sense if the cost of inspecting an item is less than the cost of passing on a defective item.

As you will see in this section, the goal of acceptance sampling is to determine the cri- teria for acceptance or rejection based on the size of the lot, the size of the sample, and the level of confidence we wish to attain. Acceptance sampling can be used in both attribute and variable measures, though it is most commonly used for attributes. In this section we will look at the different types of sampling plans and at ways to evaluate how well sampling plans discriminate between good and bad lots.

Sampling Plans A sampling plan is a plan for acceptance sampling that precisely specifies the param- eters of the sampling process and the acceptance/rejection criteria. The variables to be specified include the size of the lot (N), the size of the sample inspected from the lot (n), the number of defects above which a lot is rejected (c), and the number of samples that will be taken.

There are different types of sampling plans. Some call for single sampling, in which a ran- dom sample is drawn from every lot. Each item in the sample is examined and is labeled as either “good” or “bad.” Depending on the number of defects or “bad” items found, the entire lot is either accepted or rejected. For example, a lot size of 50 cookies is evaluated for acceptance by randomly inspecting 10 cookies from the lot. The cookies may be inspected to make sure they are not broken or burned. If 4 or more of the 10 cookies inspected are bad, the entire lot is rejected. In this example, the lot size is N = 50, the sample size is n = 10, and the maximum number of defects at which a lot is accepted is c = 4. These parameters define the acceptance sampling plan.

Another type of acceptance sampling is called double sampling. This provides an oppor- tunity to sample the lot a second time if the results of the first sample are inconclusive.

Sampling plan A plan for acceptance sampling that precisely specifi es the parameters of the sampling process and the acceptance/ rejection criteria.

Acceptance Sampling • 211

In double sampling we first sample a lot of goods according to preset criteria for definite acceptance or rejection. However, if the results fall in the middle range, they are consid- ered inconclusive and a second sample is taken. For example, a water treatment plant may sample the quality of the water ten times in random intervals throughout the day. Criteria may be set for acceptable or unacceptable water quality, such as 0.05 percent chlorine and 0.1 percent chlorine. However, a sample of water containing between .05 percent and 0.1 percent chlorine is inconclusive and calls for a second sample of water.

In addition to single- and double-sampling plans, there are multiple-sampling plans. Multiple-sampling plans are similar to double-sampling plans except that criteria are set for more than two samples. The decision as to which sampling plan to select has a great deal to do with the cost involved in sampling, the time consumed by sampling, and the cost of passing on a defective item. In general, if the cost of collecting a sample is relatively high, single sampling is preferred. An extreme example is collecting a biopsy from a hospital patient. Because the actual cost of getting the sample is high, we want to get a large sample and sample only once. The opposite is true when the cost of collecting the sample is low but the actual cost of testing is high. This may be the case at a water treatment plant, where col- lecting the water is inexpensive but the chemical analysis is costly. In this section we focus primarily on single-sampling plans.

Operating Characteristic (OC) Curves As we have seen, different sampling plans have different capabilities for discriminating between good and bad lots. At one extreme is 100 percent inspection, which has perfect discriminating power. However, as the size of the sample inspected decreases, so does the chance of accepting a defective lot. We can show the discriminating power of a sampling plan on a graph by means of an operating characteristic (OC) curve. This curve shows the probability or chance of accepting a lot given various proportions of defects in the lot.

Figure 6.11 shows a typical OC curve. The x axis shows the percentage of items that are defective in a lot. This is called “lot quality.” The y axis shows the probability or chance of

Operating characteristic (OC) curve A graph that shows the probability or chance of accepting a lot given various proportions of defects in the lot.

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10% probability of accepting a lot with 24% defective items

.25 .30 .35.15

FIGURE 6.11 Example of an operating characteristic (OC) curve

212 CHAPTER 6 • Statistical Quality Control

accepting a lot. You can see that if we use 100 percent inspection, we are certain of accept- ing only lots with zero defects. However, as the proportion of defects in the lot increases, our chance of accepting the lot decreases. For example, we have a 90 percent probability of accepting a lot with 5 percent defects and an 80 percent probability of accepting a lot with 8 percent defects.

Regardless of which sampling plan we have selected, the plan is not perfect. That is, there is still a chance of accepting lots that are “ bad” and rejecting “good” lots. The steeper the OC curve, the better our sampling plan is for discriminating between “good” and “ bad.” Figure 6.12 shows three different OC curves, A, B, and C. Curve A is the most discriminating and curve C the least. You can see that the steeper the slope of the curve, the more discriminating is the sampling plan. When 100 percent inspection is not pos- sible, there is a certain amount of risk for consumers in accepting defective lots and a certain amount of risk for producers in rejecting good lots.

There is a small percentage of defects that consumers are willing to accept. This is called the acceptable quality level (AQL) and is generally on the order of 1–2 percent. However, sometimes the percentage of defects that passes through is higher than the AQL. Consum- ers will usually tolerate a few more defects, but at some point the number of defects reaches a threshold level beyond which consumers will not tolerate them. This threshold level is called the lot tolerance percent defective (LTPD). The LTPD is the upper limit of the per- centage of defective items consumers are willing to tolerate.

Consumer’s risk is the chance or probability that a lot will be accepted that contains a greater number of defects than the LTPD limit. This is the probability of making a Type II error—that is, accepting a lot that is truly “bad.” Consumer’s risk or Type II error is generally denoted by beta (β). The relationships among AQL, LTPD, and β are shown in Figure 6.13. Producer’s risk is the chance or probability that a lot containing an accept- able quality level will be rejected. This is the probability of making a Type I error—that is, rejecting a lot that is “good.” It is generally denoted by alpha (α). Producer’s risk is also shown in Figure 6.13.

Acceptable quality level (AQL) The small percentage of defects that consumers are willing to accept.

Lot tolerance percent defective (LTPD) The upper limit of the percentage of defective items consumers are willing to tolerate.

Consumer’s risk The chance of accepting a lot that contains a greater number of defects than the LTPD limit.

Producer’s risk The chance that a lot containing an acceptable quality level will be rejected.

Curve A: Highest Discrimination between “Good” and “Bad” Lots

Curve B: Less Discrimination between “Good” and “Bad” Lots

Curve C: Least Discrimination between “Good” and “Bad” Lots

.05 PROPORTION OF DEFECTIVE ITEMS

IN LOT (LOT QUALITY)

.10 .20 .25 .30 .35.15

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FIGURE 6.12 OC curves with different steepness levels and different levels of discrimination

Acceptance Sampling • 213

Probability of rejecting a “good” lot (producer’s risk α)

Probability of accepting a “bad” lot (consumer’s risk β )

AQL LTPD

.05 .10 .20

Good Lots

Poor Quality Tolerated

Lot Quality Bad Quality Not Tolerated

.25 .30 .35.15

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FIGURE 6.13 An OC curve showing producer’s risk (α) and consumer’s risk ( β)

TABLE 6.2 Partial Cumulative Binomial Probability Table

Proportion of Items Defective (p)

.05 .10 .15 .20 .25 .30 .35 .40 .45 .50

n x

5 0 .7738 .5905 .4437 .3277 .2373 .1681 .1160 .0778 .0503 .0313

1 .9974 .9185 .8352 .7373 .6328 .5282 .4284 .3370 .2562 .1875

2 .9988 .9914 .9734 .9421 .8965 .8369 .7648 .6826 .5931 .5000

1For n ≥ 20 and p ≤ 0.05, a Poisson distribution is generally used.

We can determine from an OC curve what the consumer’s and producer’s risks are. How- ever, these values should not be left to chance. Rather, sampling plans are usually designed to meet specific levels of consumer’s and producer’s risk. For example, one common com- bination is to have a consumer’s risk (β) of 10 percent and a producer’s risk (α) of 5 percent, though many other combinations are possible.

Developing OC Curves An OC curve graphically depicts the discriminating power of a sampling plan. To draw an OC curve, we typically use a cumulative binomial distribution to obtain probabilities of accepting a lot given varying levels of lot defects.1 The cumulative binomial table is found in Appendix C, and a small part is reproduced in Table 6.2. The top of the table shows

214 CHAPTER 6 • Statistical Quality Control

values of p, which represents the proportion of defective items in a lot (5 percent, 10 per- cent, 20 percent, etc.). The left-hand column shows values of n, which represents the sam- ple size being considered, and x represents the cumulative number of defects found. Let’s use an example to illustrate how to develop an OC curve for a specific sampling plan using the information from Table 6.2.

Average Outgoing Quality As we observed with the OC curves, the higher the quality of the lot, the higher the chance that it will be accepted. Conversely, the lower the quality of the lot, the greater the chance

EXAMPLE 6.8 Constructing an OC Curve

Let’s say that we want to develop an OC curve for a sampling plan in which a sample of n = 5 items is drawn from lots of N = 1000 items. The accept/reject criteria are set up in such a way that we accept a lot if no more than one defect (c = 1) is found.

• Solution: Let’s look at the partial binomial distribution in Table 6.2. Since our criteria require us to sample n = 5, we will go to the row where n equals 5 in the left-hand column. The “x” column tells us the cumulative number of defects found at which we reject the lot. Since we are not allowing more than one defect, we look for an x value that corresponds to 1. The row corres- ponding to n = 5 and x = 1 tells us our chance or probability of accepting lots with various proportions of defects using this sampling plan. For example, with this sampling plan we have a 99.74 percent chance of accepting a lot with 5 percent defects. If we move down the row, we can see that we have a 91.85 percent chance of accepting a lot with 10 percent defects, an 83.52 percent chance of accepting a lot with 15 percent defects, and a 73.73 percent chance of accepting a lot with 20 percent defects. Using these values and those remaining in the row, we can construct an OC chart for n = 5 and c = 1. This is shown in Figure 6.14.

FIGURE 6.14 OC curve with n = 5 and c = 1

.9974 OC Curve with n = 5, c = 1 .9185

.8352

.7373

.6328

.5282

.4284

.3370

.2562

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PROPORTION OF DEFECTIVE ITEMS IN LOT (LOT QUALITY)

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Acceptance Sampling • 215

EXAMPLE 6.9 Constructing an AOQ Curve

Let’s go back to our initial example, in which we sampled fi ve items (n = 5) from a lot of 1000 (n = 1000) with an acceptance range of no more than 1 (c = 1) defect. Here we will construct an AOQ curve for this sampling plan and interpret its meaning.

• Solution: For the parameters N = 1000, n = 5, and c = 1, we can read the probabilities of Pac from Fig- ure 6.14. Then we can compute the value of AOQ as AOQ = (Pac)p.

p .05 .10 .15 .20 .25 .30 .35 .40 .45 .50

Pac .9974 .9185 .8352 .7373 .6328 .5282 .4284 .3370 .2562 .1875

AOQ .0499 .0919 .1253 .1475 .1582 .1585 .1499 .1348 .1153 .0938

Figure 6.15 shows a graphical representation of the AOQ values. The AOQ varies, depending on the proportion of defective items in the lot. The largest value of AOQ, called the average outgoing quality limit (AOQL), is around 15.85 percent. You can see from Figure 6.15 that the average outgoing quality will be high for lots that are either very good or very bad. For lots that have close to 30 percent of defective items, the AOQ is the highest. Managers can use this information to compute the worst possible value of their average outgoing quality given the proportion of defective items (p). Then this information can be used to develop a sampling plan with appropriate levels of discrimination.

that it will be rejected. Given that some lots are accepted and some rejected, it is useful to compute the average outgoing quality (AOQ) of lots to get a sense of the overall outgoing quality of the product. Assuming that all lots have the same proportion of defective items, the average outgoing quality can be computed as follows:

AOQ = (Pac)p aN − n N b

where Pac = probability of accepting a given lot p = proportion of defective items in a lot N = the size of the lot n = the sample size chosen for inspection

Average outgoing quality (AOQ) The expected proportion of defective items that will be passed to the customer under the sampling plan.

FIGURE 6.15 The AOQ for n = 5 and c = 1

PROPORTION OF DEFECTIVE ITEMS (p)

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216 CHAPTER 6 • Statistical Quality Control

Usually, we assume the fraction in the previous equation to equal 1 and simplify the equa- tion to the following form:

AOQ = (Pac)

We can then use the information from Figure 6.14 to construct an AOQ curve for different levels of probabilities of acceptance and different proportions of defects in a lot. As we will see, an AOQ curve is similar to an OC curve.

Implications for Managers

In this chapter we have learned about a variety of different statistical quality control (SQC) tools that help managers make decisions about product and process quality. However, to use these tools properly managers must make a number of decisions. In this section we discuss some of the most important decisions that must be made when implementing SPC.

How Much and How Often to Inspect Consider Product Cost and Product Volume As you know, 100 percent inspection is rarely possible. The question then becomes one of how often to inspect in order to minimize the chances of passing on defects and still keep inspection costs manageable. This decision should be related to the product cost and product volume of what is being produced. At one extreme are high-volume, low-cost items, such as paper, pencils, nuts and bolts, for which the cost of 100 percent inspection would not be justified. Also, with such a large volume, 100 percent inspection would not be possible because worker fatigue sets in and defects are often passed on. At the other extreme are low-volume, high-cost items, such as parts that will go into a space shuttle or be used in a medical procedure, that require 100 percent inspection.

Most items fall somewhere between the two extremes just described. For these items, frequency of inspection should be designed to consider the trade-off between the cost of inspection and the cost of passing on a defective item. Historically, inspections were set up to minimize these two costs. Today, it is believed that defects of any type should not be tolerated and that eliminating them helps reduce organizational costs. Still, the inspection process should be set up to consider issues of product cost and vol- ume. For example, one company will probably have different frequencies of inspection for different products.

Consider Process Stability Another issue to consider when deciding how much to inspect is the stability of the process. Stable processes that do not change frequently do not need to be inspected often. On the other hand, processes that are unstable and change often should be inspected frequently. For example, if it has been observed that a particular type of drilling machine in a machine shop often goes out of tolerance, that machine should be inspected frequently. Obviously, such decisions cannot be made without historical data on process stability.

Consider Lot Size The size of the lot or batch being produced is another factor to con- sider in determining the amount of inspection. A company that produces a small number of large lots will have a smaller number of inspections than a company that produces a large number of small lots. The reason is that every lot should have some inspection, and when lots are large, there are fewer lots to inspect.

Statistical Quality Control in Services • 217

Where to Inspect Since we cannot inspect every aspect of a process all the time, another important decision is where to inspect. Some areas are less critical than others. Following are some points that are typically considered most important for inspection.

Inbound Materials Materials that are coming into a facility from a supplier or distribu- tion center should be inspected before they enter the production process. It is important to check the quality of materials before labor is added to them. For example, it would be wasteful for a seafood restaurant not to inspect the quality of incoming lobsters only to later discover that its lobster bisque is bad. Another reason for checking inbound materials is to check the quality of sources of supply. Consistently poor quality in materials from a particu- lar supplier indicates a problem that needs to be addressed.

Finished Products Products that have been completed and are ready for shipment to customers should also be inspected. This is the last point at which the product is in the production facility. The quality of the product represents the company’s overall quality. The final quality level is what will be experienced by the customer, and an inspection at this point is necessary to ensure high quality in such aspects as fitness for use, packaging, and presentation.

Prior to Costly Processing During the production process it makes sense to check qual- ity before performing a costly process on the product. If quality is poor at that point and the product will ultimately be discarded, adding a costly process will simply lead to waste. For example, in the production of leather armchairs in a furniture factory, chair frames should be inspected for cracks before the leather covering is added. Otherwise, if the frame is defec- tive, the cost of the leather upholstery and workmanship may be wasted.

Which Tools to Use In addition to where and how much to inspect, managers must decide which tools to use in the process of inspection. As we have seen, tools such as control charts are best used at various points in the production process. Acceptance sampling is best used for inbound and outbound materials. It is also the easiest method to use for attribute measures, whereas control charts are easier to use for variable measures. Surveys of industry practices show that most companies use control charts, especially x-bar and R-charts, because they require less data collection than p-charts.

Statistical Quality Control in Services

Statistical quality control (SQC) tools have been widely used in manufacturing organiza- tions for quite some time. Manufacturers such as Motorola, General Electric, Toyota, and others have shown leadership in SQC for many years. Unfortunately, service organizations have lagged behind manufacturing firms in their use of SQC. The primary reason is that statistical quality control requires measurement, and it is difficult to measure the quality of a service. Remember that services often provide an intangible product and that per- ceptions of quality are often highly subjective. For example, the quality of a service is often judged by such factors as friendliness and courtesy of the staff and promptness in resolving complaints.

A way to measure the quality of services is to devise quantifiable measurements of the important dimensions of a particular service. For example, the number of complaints

218 CHAPTER 6 • Statistical Quality Control

received per month, the number of telephone rings after which a response is received, or customer waiting time can be quantified. These types of measurements are not subjective or subject to interpretation. Rather, they can be measured and recorded. As in manufactur- ing, acceptable control limits should be developed and the variable in question should be measured periodically.

Another issue that complicates quality control in service organizations is that the ser- vice is often consumed during the production process. The customer is often present during service delivery, and there is little time to improve quality. The workforce that interfaces with customers is part of the service delivery. The way to manage this issue is to provide a high level of workforce training and to empower workers to make decisions that will satisfy customers.

One service organization that has demonstrated quality leadership is The Ritz-Carlton Hotel Company. This luxury hotel chain caters to travel- ers who seek high levels of customer service. The goal of the chain is to be recognized for outstanding service quality. To this end, computer records are kept of regular clients’ preferences. To keep customers happy, employ- ees are empowered to spend up to $2000 on the spot to correct any cus- tomer complaint. Consequently, The

Ritz-Carlton has received a number of quality awards, including winning the Malcolm Baldrige National Quality Award twice. It is the only company in the service category to do so.

Another leader in service quality that uses the strategy of high levels of employee train- ing and empowerment is Nordstrom Department Stores. Outstanding customer service is the goal of this department store chain. Its organizational chart places the customer at the head of the organization. Records are kept of regular clients’ preferences, and employees are empowered to make decisions on the spot to satisfy customer wants. The customer is considered to always be right.

Service organizations must also use statistical tools to measure their processes and monitor performance. For example, the Marriott is known for regularly collecting data in

the form of guest surveys. The company randomly surveys as many as a million guests each year. The collected data are stored in a large database and continu- ally examined for patterns, such as trends and changes in customer preferences. Statistical techniques are used to analyze the data and provide important informa- tion, such as identifying areas that have the highest impact on performance and those areas that need improvement. This information allows Marriott to provide a superior level of customer service, antic- ipate customer demands, and allocate resources to service features most impor- tant to customers.

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NORDSTROM, INC. www.nordstrom.com

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Statistical Quality Control in Services • 219

Statistical Quality Control (SQC) Within OM: How it all Fits Together

The decision to increase the level of quality and reduce the number of product defects requires support from every function within operations management. Two areas of operations management that are particularly affected are product and process design (Chapter 3). Process design needs to be modified to incorporate customer-defined quality and simplification of design. Processes need to be continuously monitored and changed to build quality into the process and reduce variation. Other areas that are affected are job design (Chapter 11), as the role of employees is expanded to become responsible for monitoring quality levels and to use statistical quality control tools. Supply chain management and inventory control (Chapter 12) are also affected as qual- ity standard requirements from suppliers are increased and changes are made on the materials used. All areas of operations management are involved when increasing the quality standard of a firm.

Statistical Quality Control (SQC) Across the Organization

It is easy to see how operations managers can use the tools of SQC to monitor product and process quality. However, you may not readily see how these statistical techniques affect other functions of the organization. In fact, SQC tools require input from other functions, influence their success, and are actually used in designing and evaluating their tasks.

Marketing plays a critical role in setting up product and service quality standards. It is up to marketing to provide information on current and future quality standards required by customers and those being offered by competitors. Operations managers can incorporate this information into product and process design. Consultation with marketing managers is essential to ensure that quality standards are being met. At the same time, meeting quality standards is essential to the marketing department, since sales of products are dependent on the standards being met.

Finance is an integral part of the statistical quality control process because it is respon- sible for placing financial values on SQC efforts. For example, the finance department evaluates the dollar costs of defects, measures financial improvements that result from tightening of quality standards, and is actively involved in approving investments in quality improvement efforts.

Human resources becomes even more important with the implementation of TQM and SQC methods, as the role of workers changes. To understand and utilize SQC tools, workers need ongoing training and the ability to work in teams, take pride in their work, and assume higher levels of responsibility. The human resources department is responsible for hiring workers with the right skills and setting proper compensation levels.

Information systems is a function that makes much of the information needed for SQC accessible to all who need it. Information systems managers need to work closely with other functions during the implementation of SQC so that they understand exactly what types of information are needed and in what form. As we have seen, SQC tools are dependent on information, and it is up to information systems managers to make that information available. As a company develops ways of using TQM and SQC tools, information systems managers must be part of this ongoing evolution to ensure that the company’s information needs are being met.

MKT

FIN

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220 CHAPTER 6 • Statistical Quality Control

The theme of this chapter has been measuring variation of key quality characteristics of the product or process in or- der to ensure a high level of quality. We learned that variation in the production process leads to quality defects and contributes to product inconsistency. We also learned how leading compan- ies, such as Intel, make minimizing product variation a priority. For this reason, Intel has implemented the “copy-exactly” pro- gram, where the production process must be the same at every facility. This concept of minimizing product variation also has to extend to other members of the supply chain who are respons- ible for supplying component parts or delivering the product to the fi nal customer. A product is only as good as the quality of its component parts. Just as variation between production facilities

contributes to product inconsistency, so does variation between suppliers, retailers, or distributors. To minimize product vari- ation, precise standards of quality control must be implemented and SQC tools used by others in the supply chain. These stand- ards must be consistent across the supply chain. To help achieve this, many companies today are using ISO 9000 and ISO 14000 certifi cation as part of the supplier selection process. This helps to determine process capability up front and avoid long-term acceptance sampling needs. These standards are especially im- portant in today’s environment, where companies fi nd sources of supply all around the globe and need a way to ensure sup- plier quality. Otherwise, the consequences will be unreliable product quality. •

THE SUPPLY CHAIN LINK

All functions need to work closely together in the implementation of statistical process control. Everyone benefits from this collaborative relationship: operations is able to pro- duce the right product efficiently; marketing has the exact product customers are looking for; and finance can boast of an improved financial picture for the organization.

SQC also affects various organizational functions through its direct application in eval- uating quality performance in all areas of the organization. SQC tools are not used only to monitor the production process and ensure that the product being produced is within specifications. As we have seen in the Motorola Six Sigma example, these tools can be used to monitor both quality levels and defects in accounting procedures, financial record keep- ing, sales and marketing, office administration, and other functions. Having high quality standards in operations does not guarantee high quality in the organization as a whole. The same stringent standards and quality evaluation procedures should be used in setting stan- dards and evaluating the performance of all organizational functions.

Setting standards of performance is a key aspect of redu-cing and measuring variation. Just as we need to measure quality performance and compare it against a standard we need to measure sustainability performance. We also need standards against which to base performance. Standards and metrics are essential to managing environmental outcomes and verifying claims of performance. Otherwise, claims can be seen as just unsubstantiated advertising. The same processes of statistical control can be applied here. However, instead of a quality metric, we would use a sustainability metric. The im- portant issue is developing these metrics and many can be highly industry specifi c.

For sustainability metrics to be effective, they often need to be industry specifi c. Industry-specifi c scoring and measure- ment systems are being developed in a wide range of indus- tries. For example, in the trucking industry companies are

working with the newly expanded Safety Management System from the Federal Motor Carrier Safety Administration. A de- tailed scoring system shows how trucking fi rms compare along metrics such as emission controls, vehicle maintenance, driver fi tness, and crash history. Companies are using this scoring sys- tem to compare track records, assess who is really performing in terms of specifi c metrics, and using that information to choose logistics partners. High scorers such as Ryder Logistics, a company that has consistently ranked in the top 10 percent in safety categories, have found their business growing as cus- tomers read the comparison chart and choose to partner with the high scorers. This system has provided standards of per- formance and objective comparison against standards. We will be seeing more of these types of scoring systems in a wide range of industries. •

THE SUSTAINABILITY LINK

Chapter Highlights 1 Statistical quality control (SQC) refers to statistical

tools that can be used by quality professionals. Statis- tical quality control can be divided into three broad categories: descriptive statistics, acceptance sampling, and statistical process control (SPC).

2 There are two causes of variation in the quality of a product or process: common causes and assignable causes. Common causes of variation are random causes that we cannot identify. Assignable causes of variation are those that can be identified and eliminated.

3 Descriptive statistics are used to describe quality characteristics, such as the mean, range, and vari- ance. Acceptance sampling is the process of randomly inspecting a sample of goods and deciding whether to accept or reject the entire lot. Statistical process con- trol (SPC) involves inspecting a random sample of out- put from a process and deciding whether the process is producing products with characteristics that fall within preset specifications.

4 A control chart is a graph used in statistical process control that shows whether a sample of data falls within the normal range of variation. A control chart has upper and lower control limits that separate com- mon from assignable causes of variation. Control charts for variables monitor characteristics that can be measured and have a continuum of values, such as height, weight, or volume. Control charts for attributes are used to monitor characteristics that have discrete values and can be counted.

5 Control charts for variables include x-bar charts and R-charts. X-bar charts monitor the mean or average value of a product characteristic. R-charts moni- tor the range or dispersion of the values of a product characteristic.

6 Control charts for attributes include p-charts and c-charts. P-charts are used to monitor the proportion of defects in a sample. C-charts are used to monitor the actual number of defects in a sample.

7 Process capability is the ability of the production process to meet or exceed preset specifications. It is measured by the process capability index, Cp, which is computed as the ratio of the specification width to the width of the process variability.

8 The term Six Sigma indicates a level of quality in which the number of defects is no more than 3.4 parts per million.

9 The goal of acceptance sampling is to determine crite- ria for acceptance or rejection based on lot size, sam- ple size, and the desired level of confidence. Operating characteristic (OC) curves are graphs that show the discriminating power of a sampling plan.

10 There are three important decisions managers must make when implementing SPC. The first is deciding how much and how often to inspect. The second is where to inspect, and the third is deciding which tools to use to inspect.

11 It is more difficult to measure quality in services than in manufacturing. The key is to devise quantifiable measurements for important service dimensions.

Key Terms

statistical quality control (SQC) 186

descriptive statistics 186

statistical process control (SPC) 186

acceptance sampling 186

common causes of variation 187

assignable causes of variation 187

mean (average) 188

range 188

standard deviation 188

out of control 189

variable 190

attribute 190

x-bar chart 191

range (R) chart 194

p-chart 198

c-chart 201

process capability 203

product specifi cations 203

process capability index 204

Six Sigma quality 208

sampling plan 210

operating characteristic (OC) curve 211

acceptable quality level (AQL) 212

lot tolerance percent defective (LTPD) 212

consumer’s risk 212

producer’s risk 212

average outgoing quality (AOQ) 215

Key Terms • 221

222 CHAPTER 6 • Statistical Quality Control

Solved Problems (See student companion site for Excel template.) PROBLEM 1

A quality control inspector at the Crunchy Potato Chip Company has taken ten samples with four observations each of the volume of bags fi lled. Th e data and the com- puted means are shown in the following table:

Sample of Potato Chip Bag Volume in Ounces

Sample Number

Observations 1 2 3 4

Average x

1 12.5 12.3 12.6 12.7 12.525

2 12.8 12.4 12.4 12.8 12.6

3 12.1 12.6 12.5 12.4 12.4

4 12.2 12.6 12.5 12.3 12.4

5 12.4 12.5 12.5 12.5 12.475

6 12.3 12.4 12.6 12.6 12.475

7 12.6 12.7 12.5 12.8 12.65

8 12.4 12.3 12.6 12.5 12.45

9 12.6 12.5 12.3 12.6 12.5

10 12.1 12.7 12.5 12.8 12.525

Total 125.0

If the standard deviation of the bagging operation is 0.2 ounce, use the information in the table to develop control limits of 3 standard deviations for the bagging operation.

Before You Begin: To compute the control limits, you must fi rst calculate the mean of the four samples and then use the UCL and LCL formulas.

Solution: Th e center line of the control data is the aver- age of the samples:

x = 125.0

10 = 12.5 ounces

Th e control limits are:

UCL = x + zσ x = 12.5 + 3 a 0.214b = 12.80

LCL = x − zσ x = 12.5 − 3 a 0.214b = 12.20

Formula Review

1. Mean: x = a

n

i = 1 xi

n

2. Standard deviation: s = R a

n

i = 1 (xi − x)

2

n − 1 3. Control limits for x-bar charts: Upper control limit

(ULC) = x + zσx Lower control limit

(LCL) = x − zσx

sx = s1n

4. Control limits for x-bar charts using sample range as an estimate of variability:

Upper control limit

(UCL) = x − A2R

Lower control limit

(LCL) = x − A2R

5. Control limits for R-charts: UCL = D4R

LCL = D3R

6. Control limits for p-charts: UCL = p + z(σp )

LCL = p − z(σp )

7. Control limits for c-charts: UCL = c + z3c LCL = c − z3c 8. Measures for process capability:

Cp = specification width

process width =

USL − LSL 6σ

Cpk = min aUSL − m 3s

, m − LSL

3s b

9. Average outgoing quality: AOQ = (Pac)p

Following is the associated control chart:

Th e problem can also be solved using a spreadsheet.

12.00

12.10

12.20

12.30

12.40

12.50

12.60

12.70

12.80

12.90

1 2 3 4 5 6 7 8 9 10

LCL Sample MeanCL UCL

x-Bar Chart (Based on Known Sigma)

O U

N C

E S

A B C D E F G

1

Crunchy Potato Chip Company2 3

4

5 Bag Volume in Ounces Sample Num6 Obs 1 Obs 2 Obs 3 Obs 4 Average

17 12.50 12.30 12.60 12.70 12.53

28 12.80 12.40 12.40 12.80 12.60

39 12.10 12.60 12.50 12.40 12.40

410 12.20 12.60 12.50 12.30 12.40

511 12.40 12.50 12.50 12.50 12.48

612 12.30 12.40 12.60 12.60 12.48

713 12.60 12.70 12.50 12.80 12.65

814 12.40 12.30 12.60 12.50 12.45

915 12.60 12.50 12.30 12.60 12.50

1016 12.10 12.70 12.50 12.80 12.53

17 12.50

18 Number of Samples 10 Xbar-bar

19 Number of Observations per Sample 4

20

21

22 Computations for X-Bar Chart 23 Overall Mean (Xbar-bar) = 12.50

24 Sigma for Process = ounces0.2

25 Standard Error of the Mean = 0.1

26 Z-value for control charts = 3

27

28 CL: Center Line = 12.50 29 LCL: Lower Control Limit = 12.20 30 UCL: Upper Control Limit = 12.80

F7: =AVERAGE(B7:E7)

F17: =AVERAGE(F7:F16)

D28: =D23

D23: =F17

D29: =D23-D26*D25

D30: =D23+D26*D25

D25: =D24/SQRT(D19)

Solved Problems • 223

224 CHAPTER 6 • Statistical Quality Control

PROBLEM 2

Use of the sample range to estimate variability can also be applied to the Crunchy Potato Chip operation. A quality control inspector has taken four samples with fi ve obser- vations each, measuring the volume of chips per bag. If the average range for the four samples is 0.2 ounce and the average mean of the observations is 12.5 ounces, develop 3-sigma control limits for the bagging operation.

Before You Begin: Recall that to compute control limits from the sample range you need to look up the value of factor A2 from Table 6.1 for the appropriate value of n. In this problem n = 5.

PROBLEM 3

Ten samples with fi ve observations each have been taken from the Crunchy Potato Chip Company plant in order to test for volume dispersion in the bagging process. Th e average sample range was found to be 0.3 ounce. Develop control limits for the sample range.

Before You Begin: To compute the control limits for the sample range, remember to look up the values for D4 and D3 from Table 6.1 for the appropriate value of n. In this problem n = 5.

PROBLEM 4

A production manager at a light bulb plant has inspected the number of defective light bulbs in 10 random samples with 30 observations each. Following are the numbers of defective light bulbs found:

Sample Number

Number of Observations

in Sample

1 1 30

2 3 30

3 3 30

4 1 30

5 0 30

6 5 30

7 1 30

8 1 30

9 1 30

10 1 30

Total 17 300

Solution:

x = 12.5 ounce

R = 0.2 Th e value of A2 is obtained from Table 6.1. For n = 5, A2 = 0.58. Th is leads to the following limits:

Th e center of the control chart is CL = 12.5 ounces.

UCL = x + A2R = 12.5 + (0.58) (0.2) = 12.62

LCL = x − A2R = 12.5 − (0.58) (0.2) = 12.38

Solution:

R = 0.3 ounce n = 5

From Table 6.1 for n = 5: D4 = 2.11

D3 = 0 Th erefore,

UCL = D4R = 2.11(0.3) = 0.633 LCL = D3R = 0(0.3) = 0

Construct a 3-sigma control chart (z = 3) with this information.

Before You Begin: To solve this problem, you should use a p-chart because both the total sample size and the number of defects are provided.

Solution: Th e center line of the chart is:

CL = p = number defective

number of observations =

17

300 = 0.057

sp = Bp(1 − p)n = B (0.057) (0.943)30 = 0.042 UCL = p + z(sp ) = 0.057 + 3(0.042) = 0.183

LCL = p − z(sp ) = 0.057 − 3(0.042) = −0.069 S 0

2

UCL = .183

LCL = 0

CL = .057

4 6 8 10

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E F E

C T IV

E

SAMPLE NUMBER

Th is is also solved using a spreadsheet.

A B C D E F G

1

p-Chart for Light Bulb Quality2 3

4

5

6

7

8

9

10

11

12

13

14

15

16

Sample # # Defectives p

Sample Size 30

Number Samples 10

1 1 0.03333333

2 3 0.1

3 3 0.1

4 1 0.03333333

5 0 0

6 5 0.16666667

7 1 0.03333333

8 1 0.03333333

9 1 0.03333333

10 1 0.0333333317

18

p bar = 0.0566666719

Sigma_p = 0.04221199

3

20

21

22

23

24

25

0.05666667 0

0.18330263

Z-value for control charts =

CL: Center Line =

LCL: Lower Control Limit =

UCL: Upper Control Limit =

C23: =C19

C8: =B8/C$4

C24: =MAX(C$19-C$21*C$20,0)

C19: =SUM(B8:B17)/(C4*C5)

C20: =SQRT((C19*(1-C19))/C4)

C25: =C$19+C$21*C$20

PROBLEM 5

Kinder Land Child Care uses a c-chart to monitor the number of customer complaints per week. Complaints have been recorded over the past 20 weeks. Develop a control chart with 3-sigma control limits using the fol- lowing data:

Week Number of Complaints Week

Number of Complaints

1 0 11 4

2 3 12 3

3 4 13 1

4 1 14 1

5 0 15 1

6 0 16 0

7 3 17 2

8 1 18 1

9 1 19 2

10 0 20 2

Total 30

Before You Begin: Notice that in this problem only the number of defects (complaints) has been collected over time. Th is means that you cannot compute the proportion that is defective and therefore you should use a c-chart.

Solution: Th e average weekly number of complaints is 30

20 = 1.5. Th erefore,

UCL = c + z3c = 1.5 + 331.5 = 5.17 LCL = c − z3c = 1.5 − 331.5 = − 2.17 S 0

Solved Problems • 225

226 CHAPTER 6 • Statistical Quality Control

Th e resulting control chart is shown below.

WEEK

0

1

2

3

4

5

6

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

C O

M P

LA IN

T S P

E R

W E

E K

LCL pCL UCL

PROBLEM 6

Th ree bagging machines at the Crunchy Potato Chip Company are being evaluated for their capability. Th e following data are recorded:

Bagging Machine Standard Deviation

A 0.2

B 0.3

C 0.05

If specifi cations are set between 12.35 and 12.65 ounces, determine which of the machines are capable of pro- ducing within specifi cation.

Before You Begin: To solve this problem, you need to compute the process capability index, Cp, for each of the three bagging machines. Th e machine that has a Cp ⩾ 1 is capable of producing within specifi cation.

PROBLEM 7

Compute the Cpk measure of process capability for the following machine and interpret the fi ndings. What value would you have obtained with the Cp measure?

Solution: To determine the capability of each machine, we need to divide the specifi cation width (USL − LSL = 12.65 − 12.35 = 0.3) by 6𝜎 for each machine:

Bagging Machine σ USL − LSL 6σ Cp =

USL − LSL 6σ

A 0.2 0.3 1.2 0.25

B 0.3 0.3 1.8 0.17

C 0.05 0.3 0.3 1.00

Looking at the Cp values, only machine C is capable of bagging the potato chips within specifications be- cause it is the only machine that has a Cp value at or above 1.

Before You Begin: In this problem you should com- pute both the Cp and Cpk measures following the formu- las from the text. For each measure, a numerical value at or above 1 indicates that the process is capable.

Machine data: USL = 80 LSL = 50 Process s = 5 Process m = 60

Solution: To compute the Cpk measure of process capability:

Cpk = min aUSL − m 3s

, m − LSL

3s b

= mina80 − 60 3(5)

, 60 − 50

3(5) b

= min(1.33, 0.67)

= 0.67 Th is means that the process is not capable. Th e Cp mea- sure of process capability gives us the following measure:

Cp = 30

6(5) = 1.0

which leads us to believe that the process is capable.

Discussion Questions

1. Explain the three categories of statistical quality con- trol (SQC). How are they diff erent, what diff erent in- formation do they provide, and how can they be used together?

2. Describe three recent situations in which you were directly aff ected by poor product or service quality.

3. Discuss the key differences between common and assignable causes of variation. Give examples.

4. Describe a quality control chart and how it can be used. What are upper and lower control limits? What does it mean if an observation falls outside the control limits?

5. Explain the diff erences between x-bar and R-charts. How can they be used together and why would it be im- portant to use them together?

6. Explain the use of p-charts and c-charts. When would you use one rather than the other? Give examples of measurements for both p-charts and c-charts.

7. Explain what is meant by process capability. Why is it important? What does it tell us? How can it be meas- ured?

8. Describe the process of acceptance sampling. What types of sampling plans are there? What is acceptance sampling used for?

9. Describe the concept of Six Sigma quality. Why is such a high quality level important?

Problems

1. A quality control manager at a manufacturing facility has taken four samples with four observations each of the diameter of a part. (a) Compute the mean of each sample. (b) Compute an estimate of the mean and standard

deviation of the sampling distribution. (c) Develop control limits for 3 standard deviations of

the product diameter.

Samples of Part Diameter in Inches

1 2 3 4 5.8 6.2 6.1 6.0 5.9 6.0 5.9 5.9 6.0 5.9 6.0 5.9 6.1 5.9 5.8 6.1

2. A quality control inspector at the Beautiful Shampoo Company has taken three samples with four obser- vations each of the volume of shampoo bottles fi lled.

Th e data collected by the inspector and the computed means are shown here:

Samples of Shampoo Bottle Volume in Ounces

Observation 1 2 3 1 19.7 19.7 19.7 2 20.6 20.2 18.7 3 18.9 18.9 21.6 4 20.8 20.7 20.0

Mean 20.0 19.875 20.0

If the standard deviation of the shampoo bottle- fi lling operation is 0.2 ounce, use the information in the table to develop control limits of 3 standard devi- ations for the operation.

3. A quality control inspector has taken four samples with fi ve observations each at the Beautiful Sham- poo Company, measuring the volume of shampoo

Problems • 227

228 CHAPTER 6 • Statistical Quality Control

per bottle. If the average range for the four samples is 0.4 ounce and the average mean of the observations is 19.8 ounces, develop 3-sigma control limits for the bottling operation.

4. A production manager at Ultra Clean Dishwashing Company is monitoring the quality of the company’s production process. Th ere has been concern relative to the quality of the operation in accurately fi lling the 16 ounces of dishwashing liquid. Th e product is designed for a fi ll level of 16.00 ± 0.30. Th e company collected the following sample data on the production process:

Observations

Sample 1 2 3 4 1 16.40 16.11 15.90 15.78 2 15.97 16.10 16.20 15.81 3 15.91 16.00 16.04 15.92 4 16.20 16.21 15.93 15.95 5 15.87 16.21 16.34 16.43 6 15.43 15.49 15.55 15.92 7 16.43 16.21 15.99 16.00 8 15.50 15.92 16.12 16.02 9 16.13 16.21 16.05 16.01 10 15.68 16.43 16.20 15.97

(a) Are the process mean and range in statistical control?

(b) Do you think this process is capable of meeting the design standard?

5. Ten samples with fi ve observations each have been taken from the Beautiful Shampoo Company plant in order to test for volume dispersion in the shampoo bottle-fi lling process. Th e average sample range was found to be 0.3 ounce. Develop control limits for the sample range.

6. Th e Awake Coff ee Company produces gourmet instant coff ee. Th e company wants to be sure that the average fi ll of coff ee containers is 12.0 ounces. To make sure the process is in control, a worker periodically selects at random a box of six containers of coff ee and measures their weight. When the process is in control, the range of the weight of coff ee samples averages 0.6 ounce.

(a) Develop an R-chart and an x -chart for this process. (b) Th e measurements of weight from the last fi ve

samples taken of the six containers follow :

Sample X R

1 12.1 0.7 2 11.8 0.4 3 12.3 0.6 4 11.5 0.4 5 11.6 0.9

Is the process in control? Explain your answer.

7. A production manager at a Contour Manufacturing plant has inspected the number of defective plastic molds in 5 random samples of 20 observations each. Following are the number of defective molds found in each sample:

Sample Number of

Defects

Number of Observations

in Sample 1 1 20 2 2 20 3 2 20 4 1 20 5 0 20

Total 6 100

Construct a 3-sigma control chart (z = 3) with this information.

8. A tire manufacturer has been concerned about the number of defective tires found recently. In order to evaluate the true magnitude of the problem, a produc- tion manager selected 10 random samples of 20 units each for inspection. Th e number of defective tires found in each sample are as follows:

Sample Number Defective 1 1 2 3 3 2 4 1 5 4 6 1 7 2 8 0 9 3 10 1

(a) Develop a p-chart with a z = 3. (b) Suppose that the next four samples selected had 6,

3, 3, and 4 defects. What conclusion can you make? 9. U-learn University uses a c-chart to monitor student

complaints per week. Complaints have been recorded over the past ten weeks. Develop 3-sigma control lim- its using the following data:

Week Number of Complaints 1 0 2 3 3 1 4 1 5 0 6 0 7 3 8 1 9 1 10 2

10. University Hospital has been concerned with the num- ber of errors found in its billing statements to patients. An audit of 100 bills per week over the past 12 weeks revealed the following number of errors:

Week Number of Errors 1 4 2 5 3 6 4 6 5 3 6 2 7 6 8 7 9 3 10 4 11 3 12 4

(a) Develop control charts with z = 3. (b) Is the process in control?

11. Th ree ice-cream packing machines at the Creamy Treat Company are being evaluated for their capabil- ity. Th e following data are recorded:

Packing Machine Standard Deviation A 0.2 B 0.3 C 0.05

If specifi cations are set between 15.8 and 16.2 ounces, determine which of the machines are capable of producing within specifi cations.

12. Compute the Cpk measure of process capability for the following machine and interpret the fi ndings. What value would you have obtained with the Cp measure?

Machine data: USL = 100

LSL = 70

Process s = 5

Process m = 80

13. Develop an OC curve for a sampling plan in which a sample of n = 5 items is drawn from lots of N = 1000 items. Th e accept/reject criteria are set up in such a way that we ac- cept a lot if no more than one defect (c = 1) is found.

14. Quality Style manufactures self-assembling furniture. To reduce the cost of returned orders, the manager of its quality control department inspects the fi nal pack- ages each day using randomly selected samples. Th e defects include wrong parts, missing connection parts, parts with apparent painting problems, and parts with rough surfaces. Th e average defect rate is three per day.

(a) Which type of control chart should be used? Construct a control chart with 3-sigma control limits.

(b) Today the manager discovered nine defects. What does this mean?

15. Develop an OC curve for a sampling plan in which a sample of n = 10 items is drawn from lots of N = 1000. Th e accept/reject criteria are set up in such a way that we accept a lot if no more than one defect (c = 1) is found.

16. Th e Fresh Pie Company purchases apples from a local farm to be used in preparing the fi lling for its apple pies. Sometimes the apples are fresh and ripe. Other times they can be spoiled or not ripe enough. Th e company has decided that it needs an acceptance sampling plan for the purchased apples. Fresh Pie has decided that the acceptable quality level is 2 defective apples per 100, and the lot tolerance proportion de- fective is 5 percent. Producer’s risk should be no more than 5 percent and consumer’s risk 10 percent or less.

(a) Develop a plan that satisfi es the above requirements.

(b) Determine the AOQL for your plan, assuming that the lot size is 1000 apples.

17. A computer manufacturer purchases microchips from a world-class supplier. Th e buyer has a lot tolerance pro- portion defective of 10 parts in 5000, with a consumer’s risk of 15 percent. If the computer manufacturer de- cides to sample 2000 of the microchips received in each shipment, what acceptance number, c, would it want?

18. Joshua Simms has recently been placed in charge of purchasing at the Med-Tech Labs, a medical testing laboratory. His job is to purchase testing equipment and supplies. Med-Tech currently has a contract with a reput- able supplier in the industry. Joshua’s job is to design an appropriate acceptance sampling plan for Med-Tech. Th e contract with the supplier states that the acceptable quality level is 1 percent defective. Also, the lot tolerance proportion defective is 4 percent, the producer’s risk is 5 percent, and the consumer’s risk is 10 percent.

(a) Develop an acceptance sampling plan for Joshua that meets the stated criteria.

(b) Draw the OC curve for the plan you developed. (c) What is the AOQL of your plan, assuming a lot size

of 1000? 19. Breeze Toothpaste Company makes tubes of toothpaste.

Th e product is produced and then pumped into tubes and capped. Th e production manager is concerned whether the fi lling process for the tubes of toothpaste is in statistical control. Th e process should be centered on 6 ounces per tube. Six samples of fi ve tubes were taken and each tube was weighed. Th e weights are:

Problems • 229

230 CHAPTER 6 • Statistical Quality Control

Ounces of Toothpaste per Tube

Sample 1 2 3 4 5 1 5.78 6.34 6.24 5.23 6.12 2 5.89 5.87 6.12 6.21 5.99 3 6.22 5.78 5.76 6.02 6.10 4 6.02 5.56 6.21 6.23 6.00 5 5.77 5.76 5.87 5.78 6.03 6 6.00 5.89 6.02 5.98 5.78

(a) Develop a control chart for the mean and range for the available toothpaste data.

(b) Plot the observations on the control chart and comment on your fi ndings.

20. Breeze Toothpaste Company has been having a problem with some of the tubes of toothpaste leaking. Th e tubes are packed in containers with 100 tubes each. Ten con- tainers of toothpaste have been sampled. Th e following number of toothpaste tubes were found to have leaks:

Sample Number of

Leaky Tubes Sample Number of

Leaky Tubes 1 4 6 6 2 8 7 10 3 12 8 9 4 11 9 5 5 12 10 8

Total 85

Develop a p-chart with 3-sigma control limits and evaluate whether the process is in statistical control.

21. Th e Crunchy Potato Chip Company packages potato chips in a process designed for 10.0 ounces of chips with an upper specifi cation limit of 10.5 ounces and a lower specifi cation limit of 9.5 ounces. Th e packaging process results in bags with an average net weight of 9.8 ounces and a standard deviation of 0.12 ounce. Th e company wants to determine whether the process is capable of meeting design specifi cations.

22. The Crunchy Potato Chip Company sells chips in boxes with a net weight of 30 ounces per box (850 grams). Each box contains ten individual 3-ounce packets of chips. Product design specifications call for the packet-filling process average to be set at 86.0 grams so that the average net weight per box will be 860 grams. Specification width is set for the box to weigh 850 ± 12 grams. Th e standard deviation of the packet-filling process is 8.0 grams per box. The target process capability ratio is 1:33. The production manager has just learned that the packet-filling process average weight has dropped down to 85.0 grams. Is the packaging process cap- able? Is an adjustment needed?

Case: Scharadin Hotels

Scharadin Hotels is a national hotel chain started in 1957 by Milo Scharadin. What started as one upscale hotel in New York City turned into a highly reputable national hotel chain. Today, Scharadin Hotels serves over 100 1ocations and is recognized for its customer service and quality. Scharadin Hotels are typically located in large metropolitan areas close to convention centers and centers of commerce. Th ey cater to both business and nonbusiness customers and off er a wide array of services. Maintaining high customer service has been considered a priority for the hotel chain.

A Problem with Quality

Th e Scharadin Hotel in San Antonio, Texas, had recently been experiencing a large number of guest complaints due to billing errors. Th e complaints seemed to center around guests disputing charges on their fi nal hotel bill. Guest complaints ranged from extra charges, such as meals or services that were not purchased, to confusion for not being charged at all. Most hotel guests use express check- out on their day of departure. With express checkout, the

hotel bill is left under the guest’s door in the early morning hours and, if all is in order, does not require any additional action on the guest’s part. Express checkout is a service welcomed by busy travelers who are free to depart the hotel at their convenience. However, the increased num- ber of billing errors began creating unnecessary delays and frustration for the guests who unexpectedly needed to settle their bill with the front desk. Th e hotel staff often had to calm frustrated guests who were rushing to the air- port and were aggravated that they were getting charged for items they had not purchased.

Identifying the Source of the Problem

Larraine Scharadin, Milo Scharadin’s niece, had recently been appointed to run the San Antonio hotel. A recent business school graduate, Larraine had grown up in the hotel business. She was poised and confi dent and understood the importance of high quality for the hotel. When she became aware of the billing problem, she immediately called a staff meeting to uncover the source of the problem.

During the staff meeting, discussion quickly turned to problems with the new computer system and soft- ware that had been put in place. Tim Coleman, head of MIS, defended the system, stating that it was sound and the problems were exaggerated. Tim claimed that a few hotel guests made an issue of a few random problems. Scott Schultz, head of operations, was not so sure. Scott said that he noticed that the number of complaints seemed to have signifi cantly increased since the new system was installed. He said that he had asked his team to perform an audit of 50 random bills per day over the past 30 days. Scott showed the following num- bers to Larraine, Tim, and the other staff members.

Day

Number of Incorrect

Bills Day

Number of Incorrect

Bills Day

Number of Incorrect

Bills

1 2 11 1 21 3

2 2 12 2 22 3

3 1 13 3 23 3

4 2 14 3 24 4

5 2 15 2 25 5

6 3 16 3 26 5

7 2 17 2 27 6

8 2 18 2 28 5

9 1 19 1 29 5

10 2 20 3 30 5

Everyone looked at the data that had been presented. Th en Tim exclaimed, “Notice that the number of errors increases in the last third of the month. Th e computer system had been in place for the entire month, so that can’t be the problem. Scott, it is probably the new employees you have on staff that are not entering the data properly.” Scott quickly retaliated, “Th e employees are trained properly! Everyone knows the problem is the computer system!”

Th e argument between Tim and Scott became heated, and Larraine decided to step in. She said, “Scott, I think it is best if you perform some statisti- cal analysis of that data and send us your fi ndings. You know that we want a high quality standard. We can’t be Motorola with Six Sigma quality, but let’s try for 3 sigma. Would you develop some control charts with the data and let us know whether you think the process is in control?”

Case Questions

1. Set up 3-sigma control limits with the given data.

2. Is the process in control? Why?

3. Based on your analysis, do you think the problem is the new computer system or something else?

4. What advice would you give to Larraine based on the information that you have?

Case: Delta Plastics, Inc. (B)

Jose De Costa, director of manufacturing at Delta Plas- tics, sat at his desk looking at the latest production quality report, showing the number and type of prod- uct defects per week (see the quality report in Delta Plastics, Inc. Case A, Chapter 5). He was faced with the task of evaluating production quality for products made with two diff erent materials. One of the materials was new and called “super plastic” due to its ability to sus- tain large temperature changes. Th e other material was the standard plastic that had been successfully used by Delta for many years.

Th e company had started producing products with the new “super plastic” material only a month earlier. Jose suspected that the new material could result in more defects during the production process than the standard material they had been using. Jose had been

opposed to starting production until R&D had fully completed testing and refi ning the new material. How- ever, the CEO of Delta had ordered production despite objections from manufacturing and R&D. Jose carefully looked at the report in front of him and prepared to analyze the results.

Case Questions

1. Prepare a 3-sigma control chart for both produc- tion processes, using the new and standard material (use the quality report in Delta Plastics, Inc. Case A, Chapter 5). Are both processes in control? What can you conclude?

2. Are both materials equally subject to the defects?

3. Given your fi ndings, what advice would you give Jose?

Case: Delta Plastics, Inc. (B) • 231

232 CHAPTER 6 • Statistical Quality Control

Interactive Case: Virtual Company

On-line Case: Cruise International, Inc.

Assignment: Statistical Process Control at Cruise Inter- national, Inc. For this assignment, you will work again with Meghan Willoughby, Chief Purser. Th is assign- ment involves analyzing some of the data collected through our Quality Improvement Teams. While CII is concerned about quality in all aspects of its operations, there are six areas that seem to be critical in terms of customer satisfaction. Customers quickly become dissatisfi ed as a result of (1) mistakes made in their onboard accounts, (2) housekeeping issues (3) qual- ity problems in the restaurants and bars, (4) problems associated with shore excursions, (5) problems with

the entertainment, and (6) problems with the onboard shops. You will be using statistical process control tech- niques to analyze some data collected by the Quality Improvement Teams. Th is assignment will enhance your knowledge of the material in Chapter 6 of your textbook while preparing you for future assignments.

To access the Web site: • Go to www.wiley.com/college/reid

• Click Student Companion Site

• Click Virtual Company/Cruise International, Inc.

• Click Consulting Assignments

• Click Statistical Process Control at CII

On-line Case: Statistical Quality Control at Valley Memorial Hospital

Assignment: Statistical Quality Control Th is assignment involves controlling nursing hours at Valley Memorial Hospital. Lee Jordan, director of the hospital’s Medical/ Surgical Nursing Unit, has already told you that VMH employs more than 500 nurses, with an annual nurs- ing budget of $5,000,000. “We’re trying for a 5 percent reduction in nursing FTEs—full-time equivalents,” he says. “I’ve been personally recording the nursing hours per patient per day for over three months in Med/Surg.

I would like you to look at the numbers and see whether you can tell me how to meet our goals.”

To access the Web site: • Go to www.wiley.com/college/reid

• Click Student Companion Site

• Click Virtual Company/Valley Memorial Hospital

• Click Kaizen Consulting, Inc.

• Click Consulting Assignments

• Click Statistical Quality Control

www.wiley.com/college/reid

Internet Challenge: Safe-Air

To gain business experience, you have volunteered to work at Safe-Air, a nonprofi t agency that monitors airline safety records and customer service. Your fi rst assignment is to compare three airlines based on their on-time arrivals and departures. Your manager has asked you to get your information from the Internet. Select any three airlines. For an entire week check the daily arrival and departure schedules of the three air- lines from your city or closest airport. Remember that it is important to compare the arrivals and departures from the same location and during the same time period to account for factors such as the weather. Record the data that you collect for each airline. Th en decide which

types of statistical quality control tools you are going to use to evaluate the airlines’ performances. Based on your fi ndings, draw a conclusion regarding the on-time arrivals and departures of each of the airlines. Which is best and which is worst? Are there large diff erences in performance among the airlines? Also describe the statistical quality control tools you have decided to use to monitor performance. If you have chosen to use more than one tool, are you fi nding the tools equally useful or is one better at capturing diff erences in per- formance? Finally, based on what you have learned so far, how would you perform this analysis diff erently in the future?

Selected Bibliography

Defeo, J., and J.M. Juran. Juran’s Quality Handbook: Th e Com- plete Guide to Performance Excellence, Sixth Edition. New York: McGraw-Hill, 2010.

Feigenbaum, A.V. Total Quality Control. New York: McGraw- Hill, 1991.

Gitlow, H.S., and D.M. Levine. Six Sigma for Green Belts and Champions: Foundation, DMAIC, Tools, Cases

and Certification. Upper Saddle River, N. J.: FT Press, 2014.

Grant, E.L., and R.S. Leavenworth. Statistical Quality Control, Sixth Edition. New York: McGraw-Hill, 1998.

Juran, J.M., and F.M. Gryna. Quality Planning and Analysis, Second Edition. New York: McGraw-Hill, 1980.

Kubiak, T.M., and D.W. Benbow. Th e Certifi ed Six Sigma Black Belt Handbook, Second Edition. Milwaukee: Amer- ican Society for Quality, 2009.

Montgomery, D.C. Statistical Quality Control. New York: John Wiley & Sons, 2013.

Pyzdek, T., and P. Keller. Th e Six Sigma Handbook, Fourth Edition. New York: McGraw-Hill Education, 2014.

Spector, Robert E. “How Constraint Management Enhances Lean and Six Sigma,” Supply Chain Management Review, January–February 2006, 42–47.

Wadsworth, H.M., K.S. Stephens, and A.B. Godfrey. Modern Methods for Quality Control and Improvement. New York: John Wiley & Sons, 1986.

Selected Bibliography • 233

234

Before studying this chapter you should know or, if necessary, review

1. JIT as a trend in OM, Chapter 1. 2. Time as a competitive priority,

Chapter 2.

3. Total quality management concepts, Chapter 5.

Learning Objectives After studying this chapter you should be able to 1 Explain the core beliefs of the

just-in-time (JIT) philosophy. 2 Describe the elements of JIT. 3 Explain the key elements of JIT

manufacturing. 4 Explain the elements of total

quality management (TGM) and their role in JIT.

5 Describe the role of people in JIT and why respect for people is so important.

6 Describe the benefi ts of JIT. 7 Discuss the implementation

process of a successful JIT system.

8 Describe the impact of JIT on service and manufacturing organizations.

Just-in-Time and Lean Systems7

© M

ar k

M e

rc e

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H ow many times have you looked frantically for a school paper or note- book, only to find it much later in the most unexpected place? Have you ever wasted time looking for a personal item—say, a particular shirt

or shoes or maybe a bill you needed to pay—and wondered how much easier life would be if everything was in its place? Have you ever purchased extra amounts of an item, maybe paper towels or laundry detergent, and then found that they were taking up space and getting in the way? Wouldn’t life be much simpler if you could somehow receive the items that you need exactly when you need them, without having to keep extra quantities in storage?

We have all experienced these situations. They illustrate the problem of waste: wasted time looking for things we misplaced, wasted space and cost of keeping extra items, and wasted energy because of the frustration of not finding things when we need them. These are the types of problems that just-in-time systems (JIT) seek to eliminate.

Waste has a large nega- tive impact on the function- ing of a business, resulting in high cost and lost cus- tomers. To eliminate these problems, many companies have turned to JIT. In fact, today the entire auto indus- try uses JIT as a standard of operations. Ford Motor Company’s plants use JIT principles to keep low levels of inventories of raw materials and parts. Toyota relies on JIT principles to keep a uniform flow of parts from its suppliers. BMW is using JIT principles to create an easy vehicle-ordering system for customers and a flexible operation that can rapidly respond to customer demands. However, JIT principles are not just used in manu- facturing. They are equally applicable in services and are seen in companies such as McDonald’s, Wendy’s, Pizza Hut, and FedEx. •

The Philosophy of JIT • 235

The Philosophy of JIT The just-in-time ( JIT) philosophy in the simplest form means getting the right quantity of goods at the right place and at the right time. The goods arrive just-in-time, which is where the term JIT comes from. Although many people think that JIT is an inventory reduc- tion program or another type of manufacturing process, it is far more than that. JIT is an all-encompassing philosophy that is founded on the concept of eliminating waste. The word waste might make you think of garbage, or paper, or inventory. But JIT considers waste any- thing that does not add value—anything.

The broad view of JIT is now often termed lean production or lean systems. Its imple- mentation has contributed to the success of many organizations and is used by compa- nies worldwide. The benefits that can be obtained through JIT are so impressive that JIT has become a standard of operations in many industries, including the auto and computer industries. However, JIT is applicable to service organizations as well as to manufacturing and can even be used in your everyday life. JIT is not about any one factor, such as quality or inventory or efficiency. It is an entirely different way of looking at things. As we will see, JIT is a philosophy that overrides all aspects of the organization, from administrative issues to manufacturing, worker management, supplier management, and even housekeeping. It has contributed to the success of companies like Toyota (called the Toyota Production System or “TPS”) and Honda (called “the Honda Way”), and it can even contribute to success in your own life.

The philosophy of JIT originated in Japan. After World War II, the Japanese set them- selves the goal of strengthening their industrial base, which included full employment and a healthy trade balance. Just-in-time ( JIT) developed out of the nation’s need to survive after the devastation caused by the war. Although many authors say that the origins of JIT can be traced back to the early 1900s, no one can argue that the philoso- phy gained worldwide prominence in the 1970s. It was developed at the Toyota Motor Company, and the person most often credited with its development is Taiichi Ohno, a vice president of the company. JIT helped propel Toyota into a leadership position in the areas of quality and delivery. Since then, JIT has been widely adopted in all types of industries and has been credited with impressive benefits, including significant reduc- tions in operating costs, improved quality, and increased customer responsiveness. Companies such as Honda, GE, Ford, Boeing, Lockheed Martin, Hewlett-Packard, and IBM are among those that have made JIT part of their operations. Even the retailer Zara relies on JIT.

The central belief of the JIT philosophy is elimination of waste, but there are other beliefs that help define JIT philosophy. These include a broad view of operations, simplicity, continuous improvement, visibility, and flexibility. Next we look more closely at each of these beliefs.

Eliminate Waste The underlying premise of JIT is that all waste must be eliminated. Many think that the roots of the philosophy can be traced to the Japanese environment, which lacks space and natural resources. As a result, the Japanese have been forced to learn to use all their resources very efficiently, and waste of any kind is not tolerated. In JIT waste is anything that does not add value. Types of waste can include material, such as excess inventory to protect against uncertain deliveries by suppliers or poor quality. Waste can be equipment that is used as a backup because regular equipment is not maintained properly. Other types of waste include time, energy, space, or human activity that does not contribute to the value of the product or service being produced.

Just-in-time (JIT) philosophy Getting the right quantity of goods at the right place at the right time.

Waste Anything that does not add value.

A broad view of JIT A philosophy that encompasses the entire organization.

Defi ning beliefs of JIT Broad view of operations, simplicity, continuous improvement, visibility, and fl exibility.

Types of waste Material, energy, time, and space.

236 CHAPTER 7 • Just-in-Time and Lean Systems

The concept of waste addresses every aspect of the organization and has a far-reaching impact. For example, waste can be found in the production process itself, and JIT requires perfect synchronization in order to eliminate waiting and excess stock. Waste is also found in improper layout that necessitates the transportation of goods from one part of the facility to another. JIT requires a streamlined layout design so that resources are in close proximity to one another and material handling is kept to a minimum. Also, JIT requires compact layouts and increased visibility so that everyone can see what everyone else is doing. Waste can also take the form of poor quality, because scrap and rework cost money and add no value. Total quality management (TQM) programs thus are an integral part of JIT. Waste is also found in unnecessary motion, and JIT requires studying processes to eliminate unnecessary steps.

A Broad View of Operations Part of the philosophy of JIT is that everyone in the organization should have a broad view of the organization and work toward the same goal, which is serving the customer. In tradi- tional organizations, it is very easy for employees to focus exclusively on their own jobs and have a narrow view of the organization that includes only their assigned tasks. Companies whose employees have a narrow view become production-oriented, forgetting that individual tasks and procedures are important only if they meet the overall goals of the company. One example is an employee who will not help a customer with a problem, saying, “It’s not my job.” This might occur at a grocery store when a customer asks for the location of an item from an employee who is “only responsible for stocking shelves.” A broad view of operations involves understanding that all employees are ultimately responsible for serving the customer.

Simplicity JIT is built on simplicity—the simpler the better. JIT encourages employees to think about problems and come up with simple solutions. Although this may seem easy and crude, it is actually quite difficult. It is often tempting to solve an organizational problem using a complex and perhaps expensive method. It is far more difficult to think of a sim- ple solution that goes directly to the root of the problem. The value of simple solutions is demonstrated by a company whose delivery truck was lodged in a passageway because it was too high to pass through. Many costly and complex solutions were being consid- ered, such as getting a smaller truck or expanding the height of the doorway. After a bit of thought, an employee came up with a simple solution: reduce the air in the tires to bring down the height of the truck. The solution worked.

Continuous Improvement A major aspect of the JIT philosophy is an emphasis on quality. Continuous improve- ment, called kaizen by the Japanese, in every aspect of the operation is a cornerstone of this philosophy. Continuous improvement applies to everything from reducing costs to improving quality to eliminating waste.

To understand the full impact of continuous improvement, try answering this question: When has JIT been implemented fully? The answer: Never. The reason is that an organiza- tion is never perfect and can always be improved in some way.

A number of companies are utilizing a powerful JIT approach called the “kaizen blitz.” This is an improvement tool that utilizes cross-functional teams to plan and deliver improvements to specific processes during two- or three-day marathon sessions. This pro- cess allows a small group of people to concentrate on a bite-size chunk of the problem for a short period of time. Companies find that a kaizen blitz can quickly deliver dramatic and low-cost improvements to processes.

Broad view of the organization Tasks and procedures are important only if they meet the company’s overall goals.

Simplicity The simpler a solution, the better it is.

Continuous improvement (kaizen) A philosophy of never-ending improvement.

MKT HRM

Elements of JIT • 237

Visibility Part of the JIT philosophy is to make all waste visible. Waste can be eliminated only when it is seen and identified. Also, if we see waste we can come up with simple solutions to elimi- nate it. When waste is hidden we forget about it, which creates problems.

Think about the closets in your home. Because the closet doors are closed, we often for- get the clutter and junk we have inside. Now imagine that the closet doors were open and the inside was visible to us and everyone else. Certainly it would remind us that we need to eliminate the clutter.

JIT facilities are open and clean, with plenty of floor space. There is no clutter, and every- one can see what everyone else is doing. No one can hide extra inventory in a corner of his or her office or take a short nap in the afternoon. Also, part of the JIT philosophy is that a cluttered environment creates confusion and disrespect toward the workplace. By con- trast, a clean and orderly environment creates calm and clear thoughts. Just because space is available, it should not automatically be filled. Visibility allows us to readily see waste. We can then eliminate it.

Flexibility JIT was based on the need for survival, and survival means being flexible in order to adapt to changes in the environment. A company can be flexible in many ways. First, flexibility can mean being able to make changes in the volume of a product produced. JIT accomplishes this by keeping the costs of facilities, equipment, and operations at such a low level that breaking even typically is not a problem.

A second way in which a company can be flexible is by being able to produce a wide variety of products. Although this is difficult to achieve, JIT systems are designed with the ability to produce different product models with different features through a manufacturing process that can easily switch from one product type to another by flexible workers who can perform many different tasks. Part of the JIT philosophy is to design operations that are highly efficient but flexible in order to accommodate changing customer demands.

Elements of JIT Now that you understand the core beliefs that define the philosophy of JIT, let’s look at the major elements that make up a JIT system. Three basic elements work together to com- plete a JIT system: just-in-time manufacturing, total quality management, and respect for peo- ple. These are shown in Figure 7.1 as overlapping circles. Often, it is assumed that JIT refers only to just-in-time manufacturing. However, this is only one element of JIT. Each of the three elements is dependent on the others to create a true JIT system.

Just-in-Time Manufacturing JIT is a philosophy based on elimination of waste. Another way to view JIT is to think of it as a philosophy of value-added manufacturing. By focusing on value-added processes, JIT is able to achieve high-volume production of high-quality, low-cost products while meeting precise customer needs. Just-in-time manufacturing is the element of JIT that focuses directly on the production system to make this possible. Many aspects of JIT manufacturing combine to provide a performance advantage. Later in the chapter we will look at some aspects of JIT manufacturing in more detail. First, let’s take an overall view.

The manufacturing process in JIT starts with the final assembly schedule, often called the master production schedule, which is a statement of which products and quantities will

Visibility Problems must be visible to be identifi ed and solved.

Flexibility An organizational strategy in which the company attempts to offer a greater variety of product choices to its customers.

JIT system The three elements are just-in-time manufacturing, total quality management, and respect for people.

Just-in-time manufacturing The element of JIT that focuses on the production system to achieve value- added manufacturing.

238 CHAPTER 7 • Just-in-Time and Lean Systems

be made in specific time periods. The master production schedule is usually fixed for a few months into the future to allow all work centers and suppliers to plan their schedules. For the current month, the schedule is “leveled,” or developed so that the same amount of each product is produced in the same order every day. Note that with this arrangement there is repetition in the schedule from day to day, which places a constant demand on suppliers and work centers. Also, some quantity of every item is produced every day in accordance with what is needed. This is very different from traditional operations, which typically pro- duce a large quantity of one product on one day. Since this quantity is usually more than what is immediately needed, the goods are stored in inventory. On a second day a large quantity of another product is produced, and it, too, is stored in inventory, resulting in high inventory costs.

JIT relies on a coordination system that withdraws parts from a previous work center and moves them to the next. The system typically relies on cards, called kanban, to pull the needed products through the production system. For this reason, JIT is often referred to as a pull system. The kanban specifies what is needed. There is no excess production because the only products and quantities produced are those specified by the kanban. Traditional manufacturing systems, in contrast, are push systems: they push products through the pro- duction system by producing an amount that has been set by a forecast of future demand. This type of production results in a higher level of inventory, which is stored for future con- sumption. Later in the chapter we will look in detail at how the kanban system works.

The reason traditional systems produce large quantities of one type of product before switching to production of another is high setup cost. This is the cost incurred when equip- ment is set up for a new production run. Setup includes activities such as recalibrating and cleaning equipment, changing blades, and readjusting equipment settings. Because setup costs are high in traditional systems, the objective is to produce as many units of a product as possible before having to incur the setup cost again. Of course, that means incurring a high inventory cost because of the extra goods that are kept in storage. JIT systems have been very efficient at reducing setup costs, which is a key to the success of JIT manufactur- ing. Setup times have been reduced from hours to mere seconds, and the goal is to reduce them to zero. Low setup times mean that small lot sizes of products can be produced as needed and that production lead times will be shorter. The ultimate goal of JIT is to produce products in a lot size of 1.

A major aspect of JIT manufacturing is its view of inventory. JIT manufacturing views inventory as a waste that needs to be eliminated. According to JIT, inventory is carried to

Setup cost Cost incurred when setting up equipment for a production run.

FIGURE 7.1 The three elements of JIT

Just-in-Time Manufacturing

Total Quality Management

Respect for People

Elements of JIT • 239

cover up a wide variety of problems, such as poor quality, slow delivery, inefficiency, lack of coordination, and demand uncertainty. Inventory costs money and provides no value. Inventory also hurts the organization in another way: it does not allow us to see problems. According to JIT, by eliminating inventory we can clearly identify problems and work to eliminate them. An analogy that is often used to describe JIT’s view of inventory is that of a stream, as shown in Figure 7.2. The rocks in the stream represent problems. When the water in the stream covers the rocks, we cannot see what they are. By reducing the amount of water in the stream (by reducing inventory), we can finally identify the problems. However, identifying the problems is not enough—we have to solve them.

In sum, JIT manufacturing is an efficiently coordinated production system that makes it possible to deliver the right quantities of products to the place they are needed just in time.

Total Quality Management (TQM) The second major element of JIT is total quality management (TQM), which is integrated into all functions and levels of the organization. The foundation of JIT is to produce the exact product that the customer wants. Quality is defined by the customer, and an effort is made by the whole company to meet the customer’s expectations.

Quality is an integral part of the organization; it permeates every activity and function. The benefits of JIT cannot occur if the company is not working toward eliminating scrap and rework. Traditional quality control systems use the concept of acceptable quality level (AQL) to indicate the acceptable number of defective parts. In JIT there is no such measure— no level of defects other than zero is acceptable.

Poor quality is considered a waste in JIT. Quality defects lead to scrap, rework, servicing returned parts, and customer dissatisfaction. Quality defects cost money and can lead to lost customers. In JIT the entire organization is responsible for quality. Rather than hide poor quality or blame it on others, it is everyone’s goal to uncover and correct quality problems.

The concept of quality at the source is part of JIT. The objective is not only to identify a quality problem but to uncover its root cause. Simply identifying and removing a defec- tive product does not solve the problem. If the cause of the problem is not identified, the

Total quality management (TQM) Philosophy that seeks to improve quality by eliminating causes of product defects and by making quality the responsibility of everyone in the organization.

Quality at the source The belief that it is best to uncover the source of quality problems and eliminate it.

FIGURE 7.2 Inventory hides problems

Machine Breakdowns

Machine Breakdowns

Poor Vendors

Poor Vendors

Poor Design

Poor Design

Poor Quality

Poor Quality

Insufficient Layout

Insufficient Layout

(a) Inventory hides problems (b) Reducing inventory exposes problems

In ve

n to

ry

In ve

n to

ryLong Setups

Long Setups

240 CHAPTER 7 • Just-in-Time and Lean Systems

problem will keep repeating itself. For example, a quality control check in a bakery might reveal that pies are overcooked and burned. Quality at the source tells us to identify the cause of the problem, such as an incorrect temperature setting or too long a baking time. Simply removing the burned pies does not eliminate the cause of the problem; overcooking will continue to occur.

The concept of continuous improvement is embedded in quality, which means that the company must continuously and actively work to improve. In JIT continuous improvement governs everything, from reducing the number of defects to lowering setup costs and lot sizes. For example, when implementing a JIT program, we cannot expect to eliminate inven- tories immediately. Continuous improvement tells us that we must do it gradually, slowly identifying and solving problems and then reducing inventory appropriately. However, con- tinuous improvement goes beyond JIT manufacturing. It includes improvement of worker skills, supplier quality and relationships, and even the performance of management.

Respect for People The third element of JIT is respect for people. Often, the study of JIT focuses exclusively on JIT manufacturing. However, the involvement of workers is central to the JIT philoso- phy. None of the improvements developed by JIT could be possible without respect for peo- ple. JIT requires total organizational reform and participation by everyone in the company. Everyone is equally important and equally involved. In a JIT system all functions of the com- pany must work together to meet customer needs. Managers are not isolated in an admin- istrative wing but spend time on the production floor.

Employees in JIT organizations are expected to be active participants in meeting cus- tomer needs, from developing improvements in the production process to making sure quality standards are met at every level. JIT also relies on workers to perform multiple tasks and to work in teams, including management, labor, staff, and even suppliers.

JIT considers people to be a company’s most precious resource. The JIT philosophy believes in treating all employees with respect, providing job security, and offering signifi- cant rewards for well-performed tasks. Respect for people extends to suppliers. JIT believes in developing long-term relationships with suppliers in a partnership format.

Numerous companies, such as Texas Instruments, Boeing, AT&T, and the Saturn Cor- poration, provide excellent examples of the success that can be achieved by respecting and

empowering people. These companies have also become models for successful use of self-managed teams. Self-managed teams are groups of workers that have no supervisors, inspectors, time clocks, or union stewards. Each team is responsible for every aspect of its business, such as productivity, quality, cost, production, and people. The crux of self-managed teams is respect for employees and their ability to be in charge of their own work. Peo- ple are empowered to make decisions, and every- one is involved in the decision-making process. Workers are motivated through a system that directly rewards them for achieving their goals. The workforce is viewed as a long-term asset, pro- viding ongoing training and encouraging a sense of security and organizational belonging. These companies demonstrate the success that can be attained when an organization respects its people.

Respect for people An element of JIT that considers human resources as an essential part of the JIT philosophy.

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Just-in-Time Manufacturing • 241

Just-in-Time Manufacturing The Pull System Traditional manufacturing operations are push-type systems. They are based on the assumption that it is better to anticipate future production requirements and plan for them. Traditional systems produce goods in advance in order to have products in place when demand occurs. Products are pushed through the system and are stored in anticipation of demand, which often results in overproduction because anticipated demand may not materialize. Also, there are costs associated with having inventories of products sitting in storage and waiting for consumption.

As noted earlier, JIT uses a pull system rather than a push system to move products through the facility. Communication in JIT starts either with the last workstation in the pro- duction line or with the customer and works backward through the system. Each station requests the precise amount of products that is needed from the previous workstation. If products are not requested, they are not produced. In this manner, no excess inventory is generated.

To see the difference between a push and a pull system, suppose that you have decided to have a backyard cookout for your friends. You have invited 20 people and are anticipating that each one will eat at least one hamburger and one hot dog. When your friends arrive, you decide to cook all the meat as quickly as you can process it on your grill, given your anticipation of demand for food. Your goal is to make it available for your guests. At the end of the party, however, you find that you are left with some hamburgers and quite a few hot dogs. Some people didn’t want both a hamburger and a hot dog, some people didn’t like one or the other, and some were vegetarian and didn’t want either one. As a result, after the party you are left with some cold, dried-out meat. This is the problem with a push system that produces large quantities in anticipation of demand that may or may not materialize.

Another way you could handle the cookout would be to grill a smaller quantity of meat— say, three hamburgers and three hot dogs, an amount that will fit on a serving tray. When the serving tray becomes empty, you could fill it with the meat on the grill, again enough to fill the tray. When the meat that was on the grill is removed, you can put fresh meat on the grill, again in a small quantity. No additional meat is placed on the grill until the cooked meat on the grill is removed. In this example, consumption of the food is pulling the meat through the system in small quantities. By “producing” the food in this manner, you will not end up with large amounts of “inventory” at the end of the cookout.

Kanban Production You can see that for the pull system to work, there must be good communication between the work centers. This communication is made possible by the use of a device called a

Pull system JIT is based on a “pull” system rather than a “push” system.

You should know that JIT is an all-encompassing philosophy that affects every level and function of the organization. The beliefs that make up the JIT philosophy include the follow- ing: (1) elimination of waste, (2) a broad view of operations, (3) simplicity, (4) continuous improvement, (5) visibility, and (6) fl exibility. The philosophy of JIT is founded on these beliefs,

and they govern all aspects of the organization. These beliefs are embodied in three specifi c elements: (1) JIT manufactur- ing, (2) total quality management, and (3) respect for people. In the next section we look at specifi c features of each of these elements.

BEFORE YOU GO ON HRM

242 CHAPTER 7 • Just-in-Time and Lean Systems

kanban card; kanban means “signal” or “card” in Japanese. Most often a kanban card has such information on it as the product name, the part number, and the quantity that needs to be produced. The kanban is attached to a container. When workers need products from a preceding workstation, they pass the kanban and the empty container to that station. The kanban authorizes the worker at the preceding station to produce the amount of goods specified on the kanban. In effect, the kanban is a production authorization record. In our cookout example, the tray size served the purpose of the container. Now imagine that you had a card attached to the tray that specified three hamburgers and three hot dogs and that you could not produce any more or less than that amount. This procedure is similar to the way a kanban card works.

To make the system work smoothly and control the movement of empty and full con- tainers, there are actually two types of kanban cards: production cards that authorize pro- duction and withdrawal cards that authorize withdrawal of materials. Figure 7.3 shows a diagram of how a pull system with two kanban cards works.

Let’s look at the steps involved in this process.

STEP 1: The worker at workstation B received an empty container to which a production kanban is attached. This means that the worker must produce enough of the requested material to fill the empty container.

STEP 2: To fill the requirement of the production kanban, the worker at workstation B takes a full container of material from its input area.

STEP 3: To replenish the material just taken, the worker at workstation B generates a request for more input from workstation A by sending a withdrawal kanban to the out- put area of process A.

STEP 4: Notice that workstation A already has some parts available in its output area. The worker at workstation A attaches the withdrawal kanban to the full container and sends it immediately to workstation B.

Kanban card A card that specifi es the exact quantity of product that needs to be produced.

Production card A kanban card that authorizes production of material.

Withdrawal card A kanban card that authorizes withdrawal of material.

FIGURE 7.3 The pull system with two kanban cards

Supplying Work Center

Input Area

Container with withdrawal kanban Material flow

Kanban flow Container with production kanban

Step 5

P W P

P

W

Step 3 Step 1

Step 2Step 4Step 6

Workstation A

Workstation B

Input AreaOutput Area Output Area

Withdrawing Work Center

Just-in-Time Manufacturing • 243

STEP 5: The worker at workstation B takes the production kanban that was originally attached to the full container and places it on an empty container, generating produc- tion at workstation A.

STEP 6: The worker at workstation A removes a container of materials from its input area. The same sequence of steps is then repeated between all the workstations.

When this process is used, the amount produced at any one time is the amount in one container. Production cannot take place unless a container is empty and a production card has authorized production. A full container cannot be withdrawn unless a withdrawal kanban authorizes it. It is the kanban cards that coordinate the pull production system. Without kanbans, the withdrawal and production of materials cannot take place. Another advantage of the kanban is that it is visual. Kanban cards and containers are all placed in clearly visible areas for everyone to see.

There are as many kanban cards in the system as there are containers. If there are too many kanbans in the production system, there may be too much production and too much inventory. On the other hand, if there are not enough kanbans, the system may not be producing quickly enough. Sometimes the production manager may decide to add to or subtract from the number of kanbans to bring the system into balance. Remember, however, that the goal is to continually improve the efficiency of the sys- tem. This means striving to reduce the number of kanbans and the amount of inventory in the system.

The number of kanbans and, therefore, the number of containers in the system is a very important decision. The formula to compute the number of kanbans needed to control the production of a particular product is as follows:

N = DT + S

C

where N = total number of kanbans or containers (one card per container) D = demand rate at a using workstation T = the time it takes to receive an order from the previous workstation (also

called the lead time) C = size of container S = safety stock to protect against variability or uncertainty in the system

(usually given as a percentage of demand during lead time)

Problem-Solving Tip The demand (D) and lead time (T ) have to be in the same time units.

You can see from this equation that the number of containers needed at a worksta- tion is dependent on four things: the demand rate, the size of the container, the lead time, and the safety stock level. To control the amount of inventory, the size of contain- ers used is typically much smaller than the demand. For example, the containers gener- ally do not hold more than 10 percent of the daily demand. The number of kanbans in the system can be reduced as efficiency improves. Let’s look at an example to see how this would work.

Variations of Kanban Production In many facilities the kanban system has been modified so that actual cards do not exist but some other type of signal is used to pull the goods through. This may be as simple as an empty place on the floor that identifies where the material should be stored. This is called

244 CHAPTER 7 • Just-in-Time and Lean Systems

a kanban square and is shown in Figure 7.4. An empty square indicates that it is time for the supplying operation to produce more goods. A full square indicates that no parts are needed.

Another type of signal might be some type of flag, as shown in Figure 7.5, that is used to indicate it is time to produce the next container of goods. This is called a signal kanban and is often used when inventory between workstations is necessary. When the inventory level is reduced to the point of reaching the signal, the signal is removed and placed on an order post, indicating that it is time for production.

The system of kanbans can also be used to coordinate delivery of goods by suppliers. These are called supplier kanbans. The suppliers bring the filled containers to the point of usage in the factory and at the same time pick up an empty container with a kanban to be filled later. Since a manufacturer may have multiple suppliers, “mailboxes” can be set up

EXAMPLE 7.1 Computing the Number of Kanbans

Jordan Tucker works for a production facility that makes aspirin. His job is to fi ll the bottles of aspirin, and he is expected to process 200 bottles of aspirin an hour. The facility where Jordan works uses a kanban production system in which each container holds 25 bottles. It takes 30 minutes for Jordan to receive the bottles he needs from the previous workstation. The factory sets safety stock at 10 percent of demand during lead time. How many kanbans are needed for the fi lling process?

• Solution:

D = 200 bottles per hour

T = 30 minutes = 1 2

hour

C = 25 bottles per container

S = 0.10 a200 × 1 2 b = 10 bottles

N = DT + S

C

= (200 bottles�hour)a1

2 hourb + 10

25 bottles = 4.4 kanbans and containers

The number of containers can be rounded up or down. Notice that rounding down to four containers would force us to make improvements in the operation. Rounding up to fi ve would provide additional slack.

FIGURE 7.4 A kanban square

Just-in-Time Manufacturing • 245

FIGURE 7.5 A signal kanban

Signal kanbans on boxes

Signal kanban shows that more of part C needs to be produced.

A

B

C

A

B

C

at the factory for each supplier. The suppliers can check their “mailboxes” to pick up their orders. Kanbans are usually made of plastic or metal, but there are also bar-coded kanbans and electronic kanbans that further ease communication with suppliers.

Small Lot Sizes and Quick Setups A principal way of eliminating inventory and excess processing while increasing flexibility is through small-lot production, which means that the amount of products produced at any one time is small—say, 10 versus 1000. This allows the manufacturer to produce many lots of different types of products. It also shortens the manufacturing lead time, the actual time it takes to produce a product, since it takes less time to produce 10 units than to pro- duce 1000. Shorter lead time means that customers receive the specific products they want faster. The ultimate goal of JIT is to be able to economically produce one item at a time as the customer wants it.

Small-lot production gives a company a tremendous amount of flexibility and allows it to respond to customer demands more quickly. However, to be able to achieve small-lot pro- duction, companies have to reduce setup time. Recall that setup time is the time it takes to set up equipment for a production run. This includes cleaning and recalibrating equipment, changing blades and other tools, and all other activities necessary to switch production from one product to another.

To see the impact of setup time, let’s pretend that we are a producer of ice cream and that we make two different flavors—chocolate and vanilla—on the same production line. The sys- tem works by first producing a certain amount of chocolate ice cream. The equipment is then cleaned and the machines are reset for the proper ingredients (this is setup time) in order to switch production to vanilla ice cream. A traditional manufacturing approach would be to produce as much chocolate ice cream as possible, since everything is already set up for this product. Then we would set up the machines for production of vanilla ice cream and make as much of it as possible before we have to clean the equipment again. The problem with this approach is that we end up producing extra amounts of ice cream. The extra ice cream is inventory. It costs money and requires storage space, and some of it will probably go to waste.

Small-lot production The ability to produce small quantities of products.

246 CHAPTER 7 • Just-in-Time and Lean Systems

A more effective approach would be to lower the time it takes to change from produc- tion of one flavor of ice cream to another. Then we can produce only what we need and no more. We would not have the cost of extra inventory. This approach would also allow us to respond quickly to changes in demand. For example, if a customer needed extra chocolate ice cream, producing it would not be a problem. This has been the approach used by JIT. Many large manufacturers have been able to reduce setup times from many hours to only a few minutes, which has resulted in tremendous flexibility.

To produce economically in small-lot sizes, JIT has found ways to reduce setup times. The goal is to achieve single setups, or setup times in single digits of minutes. There are a number of ways to achieve these low setup times. One approach is to separate setup into two components: internal setups and external setups. Internal setups require the machine to be stopped for the setup to be performed. External setups can be performed while the machine is still running. Almost all setups in traditional manufacturing systems are inter- nal. With JIT, much of the setup process has been converted to external setups. This requires engineering ingenuity and cleverly designed fixtures and tools. In a number of companies, the workers even practice the setup process and try to increase their speed.

Uniform Plant Loading Demand for a product can show sudden increases or decreases, which can mean disruptive changes in production schedules. These demand changes are typically magnified through- out the production line and the supply chain. They contribute to inefficiency and create waste. The JIT philosophy is to eliminate the problem by making adjustments as small as possible and setting a production plan that is frozen for the month. This is called uniform plant loading or “leveling” the production schedule. The term leveling comes from the fact that the schedule is uniform or constant throughout the planning horizon.

To meet demand and keep inventories low, a “level” schedule is developed so that the same mix of products is made every day in small quantities. This is in contrast to tradi- tional systems, which produce large quantities of one product on one day and of another product on the next day, causing large buildups of inventory. Table 7.1 shows how a level production system works in contrast to a traditional production system. In the table, a company produces five products: A, B, C, D, and E. The weekly production requirements for all products are met with both types of system. However, with the JIT system there is day-to-day repetition in the schedule, which prevents the company from having to carry large amounts of inventory and places predictable demands on all work centers and suppliers.

Flexible Resources A key element of JIT is having flexible resources in order to meet customer demands and produce small lots. One aspect of flexibility is relying on general-purpose equipment capa- ble of performing a number of different functions. For example, a general-purpose drilling machine may be able to drill holes in an engine block and also perform some milling and threading operations. This is very different from having specialized equipment that can perform only one task. General-purpose equipment provides flexibility of operations and eliminates waste of space, movement from one machine to another, and setup of other machines. You can see how this concept works in your own life. Isn’t it easier to have one machine that is a printer, copier, and fax machine all in one, rather than have three different machines? With the press of a button you can print a copy and then fax it, rather than walk from one machine to the other, setting up each machine, not to mention solving the space requirements of three machines.

Internal setup Requires the machine to be stopped in order to be performed.

External setup Can be performed while the machine is still running.

Uniform plant loading A constant production plan for a facility with a given planning horizon.

Just-in-Time Manufacturing • 247

Another element of flexibility is the use of multifunction workers who can perform more than one job—an essential aspect of JIT. To meet changing production requirements, workers in JIT are trained to operate and set up different machines. This provides flexibility in the schedule because workers can be moved around as needed. Also, workers in JIT are responsible for performing simple maintenance on their machines and are trained to per- form quality control procedures. As we will see later in the chapter, workers in JIT have con- siderable responsibility and perform many duties. Their many abilities give a tremendous amount of flexibility to JIT.

The flexibilities of workers and machines combine to produce great advantages. Note that the operating time of a machine is usually different from that of a worker because there is a period of time while the machine is running and the worker has nothing to do. A multi- function worker can operate more than one machine at a time.

Facility Layout Proper arrangement and layout of work centers and equipment is critical to JIT manufac- turing, a topic that is covered in detail in Chapter 10. Physical proximity and easy access contribute to the efficiency of the production process. Streamlined production is an impor- tant part of JIT; it relies heavily on assembly lines, dedicated to the production of a family of products.

JIT also relies on cell manufacturing, the placement of dissimilar machines and equip- ment together in order to produce a family of products with similar processing require- ments. These machines create a small assembly line, and their grouping is usually called a cell. The machines in one grouping can be those needed to manufacture a set of parts belonging to the same family of products. The equipment in a work cell is usually arranged in a ∪ shape, with the worker placed in the center of the ∪. This arrangement has a number of advantages. First, the use of cells provides production efficiency with the flexibility to

Multifunction workers Capable of performing more than one job.

Cell manufacturing Placement of dissimilar machines and equipment together to produce a family of products with similar processing requirements.

TABLE 7.1 Contrasting Level versus Traditional Production

Weekly Production Requirements by Product

A: 10 units/week B: 20 units/week C: 5 units/week D: 5 units/week E: 10 units/week

Traditional Production Plan

Monday Tuesday Wednesday Thursday Friday

A A A A A B B B B B B B B B B D D D D D E E E E E

A A A A A B B B B B B B B B B C C C C C E E E E E

JIT Production with Level Scheduling

Monday Tuesday Wednesday Thursday Friday

A A B B B B A A B B B B A A B B B B A A B B B B A A B B B B

C D E E C D E E C D E E C D E E C D E E

Time

248 CHAPTER 7 • Just-in-Time and Lean Systems

produce a variety of different products. Second, the ∪ shape allows workers to have easy reach and flexibility. No special material handling is needed because everything is within reach. Finally, worker satisfaction is higher because of the ability to perform a variety of tasks.

Each cell produces similar items, so setup times within cells are low and lot sizes and inventories can be kept small. Figure 7.6 compares traditional production with cell manufacturing.

Companies such as Whirlpool, Xerox, and Target Stores have adopted JIT as a way of doing business. To achieve their goals, these companies need just-in- time deliveries. For this they use Ryder Integrated Logistics, a global and domestic provider of transportation and distribution management services that offers just-in-time pickup and deliv- ery of goods from suppliers. Ryder

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FIGURE 7.6 Traditional versus cell manufacturing

(b) JIT with cell manufacturing

Supplier A

Cell 1

Cell 2

Painting

Painting

Shipping

Milling

Grinding

Lathing

Drilling

Assembly

AssemblySupplier B

Outbound Transportation

(a) Traditional layout

Supplier A

Work Centers

Painting

Shipping & Receiving

Painting

Milling

Grinding

Lathing

DrillingAssembly

Assembly

Supplier B

Outbound Transportation

Total Quality Management • 249

ensures that materials flow smoothly into assembly or manufacturing plants with prop- erly sequenced deliveries. It uses a dedicated fleet of vehicles, onboard computers, and satellite/cellular communications as well as a sophisticated distribution system that enables it to support multiple suppliers. Also, to reduce cycle time, Ryder uses bar-code technology, EDI, and special software to enable the consolidation and distribution of goods in and out of facilities. All this adds up to an organization dedicated to meeting the challenge of JIT.

Total Quality Management Quality is a difficult term to define because it means different things to different people. A narrow viewpoint, typically used by traditional manufacturers, is to define quality as meeting specified target quality standards. This would mean producing a product within specified tolerances set by engineers and not exceeding the specified acceptable defect rate. However, today’s definition of quality takes a much broader view : quality is defined as meet- ing or exceeding customer expectations.

As customer needs and standards drive the production system, the company must define quality as it is seen by users of the product. The customer’s definition of quality then must be interpreted by engineers and production managers. This process is not always easy; customers are not always sure what they want or may not be able to articulate their needs effectively. However, once quality has been defined in measurable terms, it needs to be monitored on an ongoing basis. Targets for improvement need to be set and systematic methods for improvement developed. These methods include continual training of workers so they can identify and correct quality problems. Together, this process outlines a strategy for quality improvement in JIT, as shown in Table 7.2. Note that the steps in Table 7.2 show an ongoing, dynamic process. Customers’ quality definitions must be monitored continu- ously as customers’ expectations and needs change over time.

Product versus Process The costs of poor quality can be quite high when one includes product redesign, rework, scrap, servicing returned products, or even losing customers. All this represents waste. Phil Crosby, a leading quality “guru,” pointed out that “quality is free.” It is poor quality that is costly. For these reasons, JIT does not tolerate poor quality.

In JIT the quality of the product is distinguished from the quality of the process used to produce the product. The idea is that a faulty product is a result of a faulty process. We may be able to repair a faulty product, but if we do not correct the process, we are not addressing the root cause of the problem and will continue to produce faulty products. Quality in JIT is centered on building quality into the process. A production process that is well within the set quality control limits should not produce a defective product.

TABLE 7.2 Strategy for Quality Improvement

Step 1: Defi ne quality as seen by the customer.

Step 2: Translate customer needs into measurable terms.

Step 3: Measure quality on an ongoing basis.

Step 4: Set improvement targets and deadlines.

Step 5: Develop a systematic method for improvement.

250 CHAPTER 7 • Just-in-Time and Lean Systems

Quality at the Source The notion of quality at the source means that the root cause of quality problems needs to be identified. This could be a problem with the design, suppliers, the process, or any other area. We know that it is much easier and less costly to build quality into a process than to try to correct problems after they occur.

Quality problems can come from many sources. Some examples of sources of quality problems are the following:

Product design. In the design process, customer needs may be misunderstood and not incorporated into the product design.

Process design. Management and equipment problems may stem from the design of the production process. Operator error actually contributes to only about 15 percent of quality problems.

Suppliers. Quality problems caused by suppliers include low-quality materials and are often due to misunderstandings between manufacturer and supplier.

Monitoring quality is the responsibility of everyone in the organization. Workers are given the authority to stop the production line if quality problems are encountered; this is called jidoka. To perform jidoka, each worker can use a switch above his or her workstation to turn on a call light or stop production. A green light means that production is flowing nor- mally; a yellow light is a signal for help; and a red light means that the line is stopped. When a red light goes on, all personnel rush to the troubled spot to determine what the problem is. In JIT environments, stopping the line is not only allowed but expected. At JIT facilities, if a certain amount of time has passed without a line stoppage, personnel become concerned that quality problems are passing undetected.

You can see that workers have much responsibility in a JIT system. Analyzing production problems is considered a serious business and is performed as part of the regular workday, not in one’s spare time. For this reason, JIT systems usually operate with seven hours of production and one hour of problem solving and working with teams. Called undercapacity scheduling, it is necessary in order to leave ample time for problem-solving activities.

To help workers identify quality problems, JIT relies on visual signals. One such signal is kanban control. Others include color coding, bulletin boards, lights, process control charts, and other visual displays. For example, color-coding tools and bins helps workers know which tools belong in which bins. Color-coding different sections of the work area helps workers identify stocking points and different processing sections. Material handling routes are clearly marked in different colors. Instructional photographs located near equipment provide visual explanations of machine usage. Another type of visual signal is poka-yoke. The term means “foolproof ” and refers to a device or mechanism that prevents defects from occurring. The device could be a clamp that can be placed only in a certain way or a lid that can be turned in only one direction.

Preventive Maintenance An important aspect of quality management in JIT is preventive maintenance. Not only do machines rarely break down at convenient times but breakdowns are costly in terms of lost production, unmet deadlines, disruption of work schedules, and unhappy customers—all considered wastes in JIT. To avoid unexpected machine stoppages, a company invests in preventive maintenance, which is regular inspections and maintenance designed to keep machines operational. Although preventive maintenance is costly, the costs are signifi- cantly smaller than the cost of an unexpected machine breakdown. You know from your own experience how important preventive maintenance is, such as taking your car for a tune-up and oil change or going to the dentist for regular cleaning and checkups. Neither is

Jidoka Authority given to workers to stop the production line if a quality problem is detected.

Poka-yoke Foolproof devices or mechanisms that prevent defects from occurring.

Respect for People • 251

fun and both are costly, but we do these things because we know that the alternatives could be much costlier.

According to JIT, workers should perform routine preventive maintenance activities, including cleaning, lubricating, recalibrating, and making other adjustments to equipment. These duties are viewed as part of the worker’s job. JIT also places a great deal of importance on care of equipment and in training workers to operate and maintain machines properly. Included are designing products so they can be easily produced on current machines that can be easily operated and maintained.

Work Environment Another important element of quality management is the overall work environment. Order and simplicity are considered highly important. According to JIT, an orderly environment creates a calm, clear mind, whereas a disorganized environment creates disorganized thoughts. Also, an orderly environment encourages respect for the workplace. It is much easier to hide waste in a cluttered room. When there is plenty of empty space and every- thing is in its place, it is easy to see if something is out of order. When entering a JIT facil- ity, the first thing one notices is that it is very clean and orderly, with ample space and no clutter. Keeping the facility clean is the workers’ responsibility. Every worker is responsible for cleaning equipment and tools after using them and putting them back in their place. Everyone is responsible, so no one can blame anyone else if something is misplaced. All this creates a positive work environment, which is considered essential to the quality of work life and contributes to employee satisfaction.

Respect for People Respect for people is considered central to the JIT philosophy. Of all the issues discussed in this chapter, none departs more from traditional systems than the role of employees in a firm. According to JIT, genuine and meaning ful respect for employees must exist for a com- pany to get the best from its workers. Employees perform a great many functions in JIT, and for true JIT to exist they must be genuinely respected and appreciated. Their inputs must be valued, and they must feel secure. The key words here are genuine and meaning ful. Achiev- ing this state is sometimes difficult in environments with a history of adversarial relation- ships, particularly between labor and management. Managers cannot mandate genuine and meaningful respect. They cannot send out a memo on a Friday saying, “On Monday there will be genuine and meaning ful respect for people!” This is something that requires a com- plete change in organizational culture. Often it takes much effort and time.

JIT organizations rely on all employees to work together, including management and labor. The organizational hierarchy is generally flatter in JIT than in traditional organiza- tions, and organizational layers are not strictly defined. Great responsibility and autonomy are given to ordinary workers. All levels of employees often work in teams, and in many JIT organizations all dress the same way regardless of level, which helps break down traditional barriers and makes it easier for people to work together. In this section we look at some specific issues that relate to respect for people in JIT.

The Role of Production Employees In traditional systems, production employees often perform their jobs in an automatic fashion. In JIT, the role of production employees is just the opposite: workers are actively engaged in pursuing the goals of the company. JIT relies on cross-functional worker skills,

252 CHAPTER 7 • Just-in-Time and Lean Systems

meaning the ability of workers to perform many different tasks on many different machines. Part of workers’ duties is to be actively engaged in improving the production process, mon- itoring quality, and correcting quality problems. Continuous improvement relies heavily on the knowledge and skills of the workers closest to the operation. They are the ones best suited to make improvements in their jobs.

Production workers are required to continually check and monitor the quality of the pro- duction process. This includes inspecting their own work as well as the materials received from previous operations. This is necessary in order to detect quality problems before a defective part can proceed to additional processing. For this system to succeed, workers need to have a very different attitude toward poor quality than in traditional systems. In JIT, discovering quality problems is a goal, not something that should be covered up or blamed on someone else. As we have learned, quality at the source means that all employees are responsible for getting to the root cause of quality problems.

Another part of a worker’s responsibility is recording data, such as the number of set- ups completed, the number of units produced, the number of defects and scrap, quality process control data, equipment malfunctions, and hours worked. It is up to the worker to understand how to use the data. One way to motivate workers is to use visible displays of data, such as performance measures, on a flip chart or chalk board near each worksta- tion. Information such as quality problems or stoppages can be recorded on the chart for everyone to see.

However, merely recording data is not enough. Record keeping and posting results also serve to remind workers that they need to act on the information. The real task of produc- tion employees is to search for causes of problems in quality and production. Time needs to be set aside at the end of a shift for data analysis. Once data have been analyzed, problem-solving activities usually take place, using the team approach in group meetings. When workers become used to their new level of responsibility and respect, they develop the initiative to solve many problems on their own. The key in problem solving is to give workers the authority and incentive to solve problems rather than view problem solving as someone else’s responsibility.

Participation by all employees is vital to the success of JIT. For this reason, JIT uses a style of management called bottom-round management, which means consensus man- agement by committees or teams. When a decision needs to be made, it is discussed at all levels, starting at the bottom, so that everyone in the company contributes to the decision. This decision-making process is very slow, but it achieves consensus among all involved. In JIT, top management is usually concerned with strategic issues and leaves other decisions to employees.

Because everyone needs to work together, teams are an integral part of JIT. One of the most popular types of team is the quality circle. Quality circles are groups of about five to twelve employees who volunteer to solve quality problems in their area. Although participa- tion is usually voluntary, the meetings take place during regular work hours. Quality circles usually meet weekly and attempt to develop solutions to problems and share them with management. Usually these work groups are led by a supervisor or a production employee and are made up of employees from the particular areas involved.

You can see that in JIT the role of production employees is very different from their role in traditional organizations. Employees have much more responsibility and autonomy. Table 7.3 summarizes some of the key elements of the role of production employees in JIT.

Lifetime Employment Japanese companies have traditionally provided lifetime employment for most of their per- manent employees. Employees must feel secure if they are to work in teams, feel free to

Bottom-round management Consensus management by committees or teams.

Quality circles A team of volunteer production employees and their supervisors who meet regularly to solve quality problems.

Respect for People • 253

say what they think, and act on their ideas. Today, lifetime employment covers a relatively small percentage of the total workforce. Even though lifetime employment is rarely possi- ble, a company must do certain things to reduce employee insecurity and encourage trust and openness. One answer is to commit to a policy of making no layoffs as a result of pro- ductivity improvements. This helps alleviate fears that productivity improvements made by employees will result in job loss.

Most JIT facilities have company unions that work to build cooperative relationships between management and labor. It is understood that if the company performs well, the workers will share in the rewards through bonuses. This policy encourages workers to work harder.

The Role of Management Just as the role of production employees is different under JIT, so is the role of management. Actually, it can often be difficult for management to truly accept the new role of production employees as being responsible for duties that traditionally were performed exclusively by management. However, in successful JIT environments managers realize that all employees are on the same team and that a higher level of worker responsibility means more success for the firm as a whole.

The role of management is to create the cultural change necessary for JIT to succeed. This is one of the most difficult tasks of JIT. It involves creating an organizational culture that provides an atmosphere of close cooperation and mutual trust. Remember that JIT relies on ordinary workers to independently solve production problems and take on many tasks. To be able to do this, employees must be problem solvers and be empowered to take action based on their ideas. Workers must feel secure in their jobs and know that they will not be reprimanded or lose their jobs for being proactive. They must also feel comfortable enough to discuss their ideas openly. It is up to management to develop an incentive system for employees that rewards this type of behavior.

In the JIT environment, the role of managers becomes more of a supporting func- tion. Managers are seen as facilitators and coaches rather than “bosses.” Their job is to help develop the capabilities of employees, to teach, make corrections, help individuals develop their skills, and serve as motivators. They assist with teamwork and problem solving. Managers are also responsible for providing motivation and necessary recogni- tion to employees. Their job also includes sharing information such as profitability and performance results, as well as making sure ample time is scheduled for all the activities

TABLE 7.3 Role of Production Employees in JIT

• Workers have cross-functional skills.

• Workers are actively engaged in solving production and quality problems.

• Workers are empowered to make production and quality decisions.

• Quality is everyone’s responsibility.

• Workers are responsible for recording and visually displaying performance data.

• Workers work in teams to solve problems.

• Decisions are made through bottom-round management.

• Workers are responsible for preventive maintenance.

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employees must perform. Remember that the additional activities, such as quality control charting, maintenance, and working in teams, are not done during “free time” but during regular work hours. The role of management, summarized in Table 7.4, is highly impor- tant for JIT to succeed.

Supplier Relationships JIT’s respect for people also extends to suppliers. With JIT, a company respects suppli- ers and focuses on building long-term supplier relationships. The traditional approach of competitive bidding and buying parts from the cheapest supplier runs counter to the JIT philosophy. JIT companies understand that they are in a partnership with their suppliers, who are viewed as the external factory. The number of suppliers is typically much smaller than in traditional systems, and the goal is to shift to single-source suppliers that pro- vide an entire family of parts for one manufacturer.

The benefits of a long-term relationship with a small number of suppliers are many. Together the supplier and manufacturer focus on improving process quality controls. There are fewer contacts by buyers, and there is a focused effort on developing a personal relation- ship. There is also greater accountability for quality, delivery, or service problems. Having few suppliers makes it easier to develop stable and repetitive delivery schedules and elimi- nate paperwork.

With a long-term relationship, a supplier can act as a service provider rather than a one- time seller. Part of such a relationship is cost and information sharing. The manufacturer shares information about forecasts and production schedules, allowing the supplier to “see” what is going to be ordered. The supplier, in turn, shares cost information and cost-cutting efforts with the manufacturer. Both parties help each other and together reap the bene- fits. Also, long-term relationships provide greater incentive for continuous quality improve- ment. Finally, with a long-term relationship suppliers are better able to plan capacity and production mix requirements, resulting in lower costs.

To provide JIT service to manufacturers, suppliers often locate near their customers. Good examples are the Nissan plant in the Tennessee Valley and the Honda plant in Marysville, Ohio. These plants are surrounded by their suppliers. If close proximity is not possible, many suppliers have small warehouses near the manufacturing plant, which can be used for housing frequently delivered items. Because JIT suppliers are extensions of the manufactur- ing facility, the “pull system” concept applies to them as well. JIT suppliers use standardized containers and make deliveries according to a preset schedule. As companies advance in JIT, they expect progressively shorter delivery cycles from their suppliers and will often fine them for not meeting the schedule. Often, a few suppliers will join together to help each other make small deliveries.

Single-source suppliers Suppliers that supply an entire family of parts for one manufacturer.

TABLE 7.4 Role of Management in JIT

• Be responsible for creating a JIT culture.

• Serve as coaches and facilitators, not “bosses.”

• Develop an incentive system that rewards workers for their efforts.

• Develop employee skills necessary to function in a JIT environment.

• Ensure that workers receive multifunctional training.

• Facilitate teamwork.

Benefi ts of JIT • 255

Many suppliers have become JIT certified, which means that they have received one or more designations that indicate they meet certain high-quality standards. Once a supplier has been certified, fewer quality checks are needed since quality standards are built into the certification process. A certified JIT supplier with a long-term agreement also has the advantage of receiving payment at regular intervals rather than on delivery of goods. Paper- work is eliminated, and electronic linkages can be set up between manufacturer and sup- plier. These result in direct savings for both the supplier and the manufacturer. For example, suppliers to Otis Elevator of North America provide over 40 percent of the total material or component requirements directly to the production line. Replenishment is triggered by a visual kanban system and by a direct link from the Otis receiving dock to the supplier’s computer system.

As you can see, supplier relationships in JIT are another fundamental departure from tra- ditional systems. Companies have learned much from JIT, and the new way of dealing with suppliers is the wave of the future, even for firms that do not fully implement JIT. Table 7.5 shows some of the key aspects of JIT supplier relationships.

Benefits of JIT The benefits of JIT are very impressive. For this reason, many companies rush to adopt JIT without realizing all that is involved. Many of these companies do not reap the ben- efits because they do not take the time to implement the culture necessary for JIT to succeed. A recent study of JIT benefits has found that over a five-year period compa- nies using JIT have experienced an 80–90 percent reduction in inventory investment, an 80–90 percent reduction in lead time, a 75 percent reduction in rework and setup, a 50 percent reduction in space requirements, and a 50 percent reduction in material handling equipment.

The first implementation of JIT took place at the Toyota Motor Company in Japan in the early 1970s. Thus, much of what we have learned about JIT comes from Toyota’s experi- ence. Since then, hundreds of companies have successfully implemented JIT, including Ford, General Electric, IBM, 3M, Renault/Nissan, and many others. Even for companies that do not achieve the dramatic benefits of a full JIT implementation, JIT provides many benefits. Table 7.6 lists key benefits of JIT.

One of the greatest benefits of JIT is that it has changed the attitude of many firms toward eliminating waste, improving responsiveness, and competing based on time. Time- based competition is one of the primary ways in which companies operate today, and JIT is what makes it possible. Even companies that have not implemented JIT have had to make some changes in order to compete in a world that has left behind many traditional ways of doing business.

TABLE 7.5 Key Elements of JIT Suppier Relationships

• Suppliers viewed as external factory.

• Use of single-source suppliers.

• Long-term supplier relationships developed.

• Suppliers locate near customer.

• Stable delivery schedules.

• Cost and information sharing.

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The large benefits JIT can bring to a company are demonstrated by the success achieved by Alcoa, a leader in the aluminum industry. Alcoa’s accomplishments included reducing inventories by more than a quarter of a billion dollars in 1999 while increasing sales by almost $1 billion. This was a direct benefit of implementing Toyota’s JIT system just a year earlier. In 1998, Alcoa found itself ill-prepared to meet customer needs. It was

piling up inventory, yet not providing what the customer wanted. Alcoa turned to a full JIT “pull” manufacturing system. Benefits quickly began to appear at facilities all over the country. For example, an extrusion plant in Mississippi lost money in 1998 but within a year was capable of delivering customer orders in two days. Today Alcoa continues to rely on JIT principles across every aspect of its operations, such as working toward zero work-related injuries at all locations and leading in implementation of sustainability principles.

Implementing JIT We have seen that JIT affects every aspect of the organization. Therefore, the implementa- tion of a true JIT system requires a complete cultural change for the organization. To imple- ment JIT successfully, a company does not need sophisticated systems. What is needed are correct attitude, employee involvement, and continuous improvement. A change of such profound magnitude needs to be driven by top management. JIT implementation cannot succeed if it is done only by middle or lower management.

Implementation needs to start with a shared vision of where the company is and where it wants to go. This vision needs to consider everyone who has a stake in the company, including customers, employees, suppliers, stockholders, and even the community in which the company is located.

Once the vision has been developed, it is up to top management to create the right atmo- sphere. Managers need to involve workers in a meaning ful way and not merely give lip ser- vice to the concept. Part of the change in atmosphere should consist of breaking down the barriers between departments and instilling “we” thinking in place of an “us-versus-them” attitude. Reward systems should be put in place to reward ideas and team cooperation.

TABLE 7.6 Benefits of JIT

• Reduction in inventory

• Improved quality

• Reduced space requirements

• Shorter lead times

• Lower production costs

• Increased productivity

• Increased machine utilization

• Greater fl exibility

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Implementing JIT • 257

A “champion” for JIT implementation must be designated, whether it is a plant manager, the CEO, or a steering committee. The purpose is to have a person or group oversee all the steps necessary in implementing such a large change. This person or group will be respon- sible for reviewing progress, addressing any problems that may develop, making sure ample resources are available, and ensuring that a proper reward system is in place. Another job of the JIT champion is sharing results with everyone in the company. Such information is not shared with production workers in traditional systems. However, in JIT, sharing of this type of information with everyone in the company is considered a key to success and is done frequently and regularly. Financial information cannot be kept secret if everyone is to work together and share in the benefits.

In making specific changes in JIT manufacturing, some changes need to be implemented before others. Not all things can or should be changed at once. Following is a sequence of steps that should be followed in the implementation process:

1. Make quality improvements. Usually it is best to start the implementation process by improving quality. Th e reason is that quality is pervasive and all the JIT objectives are dependent on quality improvement.

2. Reorganize workplace. Reorganizing the workplace is the next step. Th is means proper facility layout, cleaning and organizing the work environment, designating storage spaces for everything, and removing clutter.

3. Reduce setup times. Th e next step is to focus on reducing setup times, which will involve manufacturing and industrial engineering. It will require analysis of current setup procedures, elimination of unneeded steps, and streamlining of motions. Workers will need to be trained in the proper setup procedures.

4. Reduce lot sizes and lead times. Once setup times have been reduced, the focus is on reducing lot sizes and lead times. Th is in turn will reduce the inventory between workstations and free up space. Th e empty space will contribute to visibility.

5. Implement layout changes. Th e next step is to arrange equipment and workstations in close proximity to one another and to form work cells.

6. Switch to pull production. After the preceding changes have been implemented, it is time to switch to pull production. Changing from a push system to a pull system, including worker training, needs to be planned very carefully. However, the change needs to be made at once because a production facility cannot use a push and a pull system at the same time.

7. Develop relationship with suppliers. Changes in relationships with suppliers should be among the last steps implemented. Demands for smaller and more frequent deliveries should be instituted gradually.

By now you should understand that JIT is made up of many ideas that define its phi- losophy. Because of that, implementation of JIT is complicated. Most companies are so eager to receive the benefits of JIT that they jump in and begin making changes without thinking them through. Often, company executives will learn that for JIT implementation to succeed inventory needs to be eliminated, so they begin ordering reductions in inventory. This unplanned approach can have disastrous effects. Inventory is there to cover up prob- lems. Unless the problems are solved first, simply reducing inventory can completely halt production.

Finally, when it comes to implementation, remember that the concept of continuous improvement is an integral part of JIT. This means that the implementation process will not start and end in definite time periods. Rather, it will be a gradual process. Reductions in inventory have to be preceded by improvements in quality, changes in layout, reductions in setup times, and worker training. As improvements are made, inventory can be reduced. As new problems become visible, they must be solved before further reductions in inventory

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are made. This is an ongoing, gradual process. Implementation is never complete because improving performance is a never-ending task.

JIT in Services People who think of JIT as applying only to manufacturing may not see how JIT could be applicable to service organizations. However, we have seen in this chapter that JIT is an all-encompassing philosophy that includes eliminating waste, improving quality, continu- ous improvement, increased responsiveness to customers, and increased speed of delivery. That philosophy is equally applicable to any organization, service or manufacturing.

Following are examples of JIT concepts seen in service firms.

Improved Quality Service quality is often measured by intangible factors such as timeliness, service consis- tency, and courtesy. Building quality into the process of service delivery and implementing concepts such as quality at the source can significantly improve service quality dimensions. For example, McDonald’s has become famous by building quality into the process and stan- dardizing the service delivery system. Regardless of location, McDonald’s customers receive the same product and service consistency.

Uniform Facility Loading The challenge for service operations is synchronizing their production with demand. Many service firms have developed unique ways to level customer demand in order to provide better service responsiveness. For example, hotels and restaurants use reservation systems. Differential pricing systems can also be used to even out demand, such as airlines requiring a Saturday night stay for lower fares or the post office charging more for next-day delivery.

Use of Multifunction Workers The use of multifunction workers in service organizations helps improve quality and cus- tomer responsiveness. An example of this is seen in department stores, where workers make sales, clean sales areas, and arrange displays.

Reductions in Cycle Time Competition based on speed is common in services, as can be seen in such companies as McDonald’s, Wendy’s, FedEx, and LensCrafters. These companies have used JIT concepts to reduce their cycle time and, consequently, increase their speed. One strategy is to eliminate unnecessary activities. For example, any processing step that does not add value is elimi- nated. Processing steps that add some value are reanalyzed and reengineered to improve their efficiency and reduce processing time.

Minimizing Setup Times and Parallel Processing The concept of setup time minimization and parallel processing can be seen in cleaning companies. Merry Maids is a cleaning company that uses teams of workers to clean homes. Each member of the team is designated to carry out a specific category of cleaning tasks. For example, one worker may be responsible for all the dusting, another for all the bathrooms,

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JIT in Services • 259

and another for the vacuuming. This minimizes setup time, and parallel processing reduces the cycle time.

Workplace Organization Improved housekeeping has become a priority for many service organizations, particularly since the customer is present during part of the production process. Service companies like Disney and McDonald’s pride themselves on the cleanliness of their facilities.

JIT and Lean Systems Within OM: How it all Fits Together

As you have seen, JIT is about eliminating waste of every kind in order to be more efficient. As JIT is an overriding philosophy, it affects all other operations decisions. For example, JIT is directly linked to quality improvements within the operation (Chapters 5 and 6), partner- ing with suppliers as in supply chain management (Chapter 4), and changing job designs (Chapter 11) of production employees and management. JIT decisions also impact facility layout (Chapter 10) since they require rearrangements of the flow of materials, changes in the production process (Chapter 3) to a pull system with small lot sizes and uniform facility loading, and changes in inventory levels (Chapter 12). Virtually all operations decisions are linked to the implementation of JIT and lean systems.

JIT and Lean Systems Across the Organization

Implementing a philosophy such as JIT will inevitably have consequences for every aspect of the organization. The entire organization is affected by JIT, primarily because organiza- tional barriers are eliminated. Functions that have not had much communication with each other in the past must now work together. Included are functions such as marketing, man- ufacturing, and engineering, which in traditional systems have separate agendas but now need to work together to achieve the goals of the organization as a whole. Let’s see how some of these functions are affected.

Accounting is strongly affected by JIT. Traditional accounting systems generally allocate overhead on the basis of direct labor hours. The problem with this method is that it does not accurately describe the actual use of overhead by different jobs. For example, jobs that are labor intensive in nature may be assigned a disproportionately high share of overhead. These numbers may lead management to make inappropriate decisions. JIT relies on activity- based costing to allocate overhead. In activity-based costing, specific costs are identified and then assigned to various types of activities, such as inspection, movement of goods, and machine processing. Overhead costs are then assigned to jobs depending on how many activities a particular job takes up.

Marketing plays a large role in JIT, as the interface with customers becomes more important. JIT focuses on customer-driven quality, not quality as defined by the producer. Marketing managers must understand customer needs and ensure that this information is passed on to operations managers for proper design, production, and delivery of the prod- uct or service.

Finance is responsible for approving and evaluating financial investments. Switch- ing to a JIT system proves financially beneficial in the long run but generally requires an

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investment in resources. Included are hiring consultants, training workers, purchasing or modifying equipment, more record keeping, and rearrangement of facilities. Finance must evaluate these investments and measure their performance, which requires an understand- ing of JIT.

Engineering plays a major role in JIT. As we have seen in this chapter, reduction of setup time is critical to the success of JIT. It is up to engineering to design machines so as to reduce setup time and to design poka-yoke, or foolproof devices, that prevent defects from occurring. Engineering is largely responsible for designing the mechanisms that enable JIT to function as desired. Without engineering, true JIT could not exist.

Information systems (IS) create the network of information necessary for JIT to func- tion. JIT is based on the assumption that information about quality, inventory levels, order status, and product returns is available to everyone in the organization. This type of infor- mation needs to be readily available and up-to-date. Otherwise, a JIT system would come to a halt. Communication with suppliers is another prerequisite of JIT that requires a high- level information system. JIT cannot function without the ongoing involvement of IS. In turn, IS needs to understand JIT functioning and information requirements.

MIS

The concept of JIT naturally extends itself to the entire sup-ply chain. The philosophy of JIT teaches us that waste anywhere in the system hinders effi ciency, doesn’t provide value to the customer, and ultimately increases cost. Every organization is just one element of an entire supply chain sys- tem. As such, waste anywhere in the supply chain is ultimately passed down to other members of the chain and the fi nal customer. Also recall that JIT views a company’s suppliers as the external factory, focuses on building long-term relation- ships with suppliers, and promotes sharing data along the supply chain. In fact, a company’s pull system cannot work properly unless its suppliers are also using it. Otherwise, the JIT system of the company would not be able to function properly, as there would be no guarantee of stable deliveries. Therefore, the principles of JIT need to be adopted by all

members of a supply chain in order to have a full impact. This is often referred to as a lean supply chain.

Dell provides a good example of the impact JIT can have when it is implemented along the supply chain. The company has a build-to-order model that produces computers only when there is actual customer demand. Dell has implemen- ted a JIT system throughout its supply chain and shares de- mand information with its suppliers. As a result, Dell is able to introduce new technologies in its computers much quicker than competitors because they are seamlessly available in the supply chain. Dell also works closely with its suppliers to reduce inventories, align processes, and eliminate waste across the supply chain. The result has been high responsive- ness at a competitive price. •

THE SUPPLY CHAIN LINK

THE SUSTAINABILITY LINK

J IT and lean systems are about eliminating waste—a philosophy that is fully compatible with environmental- ism and sustainability. Squeezed by high costs, companies have zero tolerance for unnecessary waste, and consumers and regulators are demanding eco-friendly practices every- where, from forest to factory to display case. The pressure has increased to drive fewer miles, use low-emission and natural-gas-powered trucks, have well-engineered warehouses, design lower-emission factories, and maximize effi ciency. In fact, concerns about water usage and disposal practices are just two of the factors that led Coca-Cola to name a Vice President for Sustainability. The sustainability pressure for

companies is to fi gure out ways to do more with less, which is the basis of JIT and lean systems, and relies on lessons dis- cussed in this chapter. Minimizing waste is an essential part of sustainability and it requires expanding the notion of waste to elements of the operation that impact the environment.