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Operations and Supply
Chain Management
for MBAs

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Sixth Edition

Jack R . Meredith

Scott M. Shafer
Wake Forest University

Operations and Supply
Chain Management
for MBAs

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VICE PRESIDENT & DIRECTOR George Hoffman

EXECUTIVE EDITOR Lise Johnson

DEVELOPMENT EDITOR Jennifer Manias

ASSOCIATE DEVELOPMENT EDITOR Kyla Buckingham

SENIOR PRODUCT DESIGNER Allison Morris

MARKET SOLUTIONS ASSISTANT Amanda Dallas

SENIOR DIRECTOR Don Fowley

PROJECT MANAGER Gladys Soto

PROJECT SPECIALIST Nichole Urban

PROJECT ASSISTANT Anna Melhorn

PROJECT ASSISTANT Emily Meussner

EXECUTIVE MARKETING MANAGER Christopher DeJohn

ASSISTANT MARKETING MANAGER Puja Katariwala

ASSOCIATE DIRECTOR Kevin Holm

SENIOR CONTENT SPECIALIST Nicole Repasky

PRODUCTION EDITOR Ezhilan Vikraman

This book was set in 10/12 Times LT Std by SPi Global and printed and bound by Lightning Source Inc.

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ISBN: 978-1-119-23953-6 (PBK)

ISBN: 978-1-119-22321-4 (EVALC)

Library of Congress Cataloging in Publication Data:

Names: Meredith, Jack R., author. | Shafer, Scott M., author.

Title: Operations and Supply Chain Management for MBAs / Jack R. Meredith, Scott M. Shafer.

Description: Sixth edition. | Hoboken, NJ : John Wiley & Sons, 2016. |

Includes bibliographical references and index.

Identifiers: LCCN 2015038625 | ISBN 978-1-119-23953-6 (pbk. : alk. paper)

Subjects: LCSH: Production management. | Business logistics.

Classification: LCC TS155 .M393 2016 | DDC 658.5—dc23 LC record available at http://lccn.loc.gov/2015038625

Printing identification and country of origin will either be included on this page and/or the end of the book. In addition,

if the ISBN on this page and the back cover do not match, the ISBN on the back cover should be considered the correct

ISBN.

Printed in the United States of America

10 9 8 7 6 5 4 3 2 1

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This book is dedicated to the Newest Generation:

Avery, Mitchell, Ava, Chase, and Ian. J.R.M.

Brianna, Sammy, and Kacy S.M.S.

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vi

Part 1 Strategy and Execution 1

1 Operations and Supply Chain Strategy for Competitiveness 2

2 Executing Strategy: Project Management 34

Part 2 Process and Supply Chain Design 65

3 Process Planning 66

4 Capacity and Scheduling 97

5 Supply Chain Planning and Analytics 126

6 Supply Chain Management 157

Part 3 Managing and Improving the Process 199

7 Monitoring and Controlling the Processes 200

8 Process Improvement: Six Sigma 225

9 Process Improvement: Lean 258

Cases 284
Glossary 338
Index 343

Brief Contents

Preface xiii

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vii

Part 1 Strategy and Execution 1

1 Operations and Supply Chain Strategy for Competitiveness 2

1.1 Operations 4

1.1.1. Systems Perspective 5

1.1.2. Inputs 6

1.1.3. Transformation Processes 6

1.1.4. Outputs 7

1.1.5. Control 9

1.1.6. Operations Activities 9

1.1.7. Trends in Operations and Supply Chain Management 10

1.2 Customer Value 11

1.2.1. Costs 11

1.2.2. Benefi ts 12

1.2.3. Innovativeness 12

1.2.4. Functionality 14

1.2.5. Quality 14

1.2.6. Customization 15

1.2.7. Responsiveness 18

1.3 Strategy and Competitiveness 19

1.3.1. Global Trends 19

1.3.2. Strategy 21

1.3.3. Strategic Frameworks 22

1.3.4. Core Capabilities 28

2 Executing Strategy: Project Management 34

2.1 Defi ning a Project 37

2.2 Planning the Project 38

2.2.1. The Project Portfolio 38

2.2.2. The Project Life Cycle 41

2.2.3. Projects in the Organizational Structure 42

2.2.4. Organizing the Project Team 42

2.2.5 Project Plans 43

Contents

Preface xiii

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viii Contents

2.3 Scheduling the Project 46

2.3.1. Project Scheduling with Certain Activity Times:
A Process Improvement Example 47

2.3.2. Project Scheduling with Uncertain Activity Times 50

2.3.3. Project Management Software Capabilities 55

2.3.4. Goldratt’s Critical Chain 56

2.4 Controlling the Project: Earned Value 58

Part 2 Process and Supply Chain Design 65

3 Process Planning 66

3.1 Forms of Transformation Systems 68

3.1.1. Continuous Process 68

3.1.2. Flow Shop 69

3.1.3. Job Shop 75

3.1.4. Cellular Production 79

3.1.5. Project Operations 83

3.2 Selection of a Transformation System 83

3.2.1. Considerations of Volume and Variety 84

3.2.2. Product and Process Life Cycle 86

3.2.3. Service Processes 87

4 Capacity and Scheduling 97

4.1 Long‐Term Capacity Planning 99

4.1.1. Capacity Planning Strategies 100

4.2 Effectively Utilizing Capacity Through Schedule Management 104

4.2.1. Scheduling Services 106

4.3 Short‐Term Capacity Planning 109

4.3.1. Process‐Flow Analysis 109

4.3.2. Short‐Term Capacity Alternatives 115

4.3.3. Capacity Planning for Services 117

4.3.4. The Learning Curve 119

4.3.5. Queuing and the Psychology of Waiting 122

5 Supply Chain Planning and Analytics 126

5.1 Importance of Supply Chain Planning and Analytics 128

5.2 Demand Planning 129

5.2.1. Forecasting Methods 130

5.2.2. Factors Influencing the Choice of Forecasting Method 131

5.2.3. Time Series Analysis 132

5.2.4. Causal Forecasting with Regression 141

5.2.5. Assessing the Accuracy of Forecasting Models 147

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ixContents

5.3 Sales and Operations Planning 148

5.3.1. Aggregate Planning Strategies 149

5.3.2. Determining the Service Level: An Example
Using the Newsvendor Problem 150

5.3.3. Collaborative Planning, Forecasting, and Replenishment 153

6 Supply Chain Management 157

6.1 Defining SCM 160

6.2 Supply Chain Strategy 162

6.2.1. Strategic Need for SCM 163

6.2.2. Measures of Supply Chain Performance 165

6.3 Supply Chain Design 166

6.3.1. Logistics 167

6.4 Sourcing Strategies and Outsourcing 175

6.4.1. Purchasing/Procurement 177

6.4.2. Supplier Management 179

6.5 Inventory and Supply Planning 180

6.5.1. Functions of Inventories 181

6.5.2. Forms of Inventories 182

6.5.3. Inventory‐Related Costs 183

6.5.4. Decisions in Inventory Management 185

6.6 Role of Information Technology 185

6.6.1. ERP 186

6.6.2. Customer Relationship Management Systems 188

6.7 Successful SCM 188

6.7.1. Closed‐Loop Supply Chains and Reverse Logistics 189

Supplement A—The Beer Game 195

Supplement B—The Economic Order Quantity Model (online)

Part 3 Managing and Improving the Process 199

7 Monitoring and Controlling the Processes 200

7.1 Monitoring and Control 201

7.2 Process Monitoring 203

7.2.1. Stages of Operational Effectiveness 203

7.2.2. Balanced Scorecard 204

7.2.3. The Strategy Map 206

7.2.4. ISO 9000 and 14000 207

7.2.5. Failure Mode and Effect Analysis (FMEA) 208

7.3 Process Control 209

7.3.1. Statistical Process Control 210

7.3.2. Constructing Control Charts 213

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x Contents

7.4 Controlling Service Quality 216

7.4.1. Service Defections 217

8 Process Improvement: Six Sigma 225

8.1 Approaches for Process Improvement 228

8.2 Business Process Design (Reengineering) 229

8.3 Six Sigma and the DMAIC Improvement Process 231

8.3.1. Example Six Sigma Project 232

8.4 The Define Phase 235

8.4.1. Benchmarking 235

8.4.2. Quality Function Deployment 236

8.5 The Measure Phase 238

8.5.1. Defects per Million Opportunities (DPMO) 239

8.5.2. Measurement Systems Analysis 241

8.6 The Analyze Phase 243

8.6.1. Brainstorming 244

8.6.2. Cause-and-Effect Diagrams 246

8.6.3. Process Capability Analysis 246

8.7 The Improve Phase 249

8.7.1. Design of Experiments 249

8.8 The Control Phase 251

8.9 Six Sigma in Practice 251

8.9.1. Six Sigma Roles 251

8.9.2. Becoming Certified 252

8.9.3. The Need to Customize Six Sigma Programs 252

9 Process Improvement: Lean 258

9.1 History and Philosophy of Lean 261

9.1.1. Traditional Systems Compared with Lean 262

9.2 Specify Value and Identify the Value Stream 266

9.2.1. Identify the Value Stream 268

9.3 Make Value Flow 271

9.3.1. Continuous Flow Manufacturing 272

9.3.2. The Theory of Constraints 273

9.4 Pull Value through the Value Stream 275

9.4.1. Kanban/JIT in Services 276

9.5 Pursue Perfection 277

9.5.1. 5S 277

9.5.2. The Visual Factory 277

9.5.3. Kaizen 278

9.5.4. Poka Yoke 278

9.5.5. Total Productive Maintenance 278

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xiContents

9.6 Benefits of Lean and Lean Six Sigma 279

9.6.1. Lean Six Sigma 280

Cases 284

BPO, Incorporated: Call Center Six Sigma Project 284

Peerless Laser Processors 297

General Micro Electronics, Inc.: Semiconductor
Assembly Process 302

Heublein: Project Management and Control System 315

D. U. Singer Hospital Products Corp. 327

Automotive Builders, Inc.: The Stanhope Project 331

Case (online)—United Lock: Door Hardware Division (A)

Bibliography (online)

Glossary 338

Index 343

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xiii

The enthusiasm of the users of this MBA‐oriented book has been greatly rewarding for us, and

we thank them for their comments, suggestions, criticism, and support. Although the book is not

the massive seller that an undergraduate textbook can become, it is clear that there is, as we felt,

a need for a solely MBA‐level text. The book was originally written because of the express need

we felt in our many MBA programs at Wake Forest University for an operations management

textbook directed specifically to MBA students and especially to those who had some real‐world

experience. We tried all of the current texts but found them either tomes that left no time for the

cases and other materials we wanted to include or shorter but simplistic quantitative books.

Moreover, all the books were so expensive they did not allow us to order all the cases, readings,

and other supplements and class activities (such as the “Beer Game”; see Chapter  6 Supplement)

that we wanted to include in our course.

What we were looking for was a short, inexpensive book that would cover just the introduc-

tory, basic, and primarily conceptual material. This would allow us, as the professors, to tailor the

course through supplementary cases and other materials for the unique class we would be teach-

ing: executive, evening, full time, short course, and so on. Although we wanted a brief,

supplementary‐type book so that we could add other material, we have colleagues who need a

short book because they only have a half‐semester module for the topic. Or they may have to

include another course (e.g., statistics) in the rest of the semester.

Changes in this Sixth Edition
A lot has happened since our previous edition, and we felt compelled to reorganize the book to

reflect these changes. First, we amended the title to reflect the increased importance of supply

chain management concepts and added an extra chapter ( 5 ) as well, focusing on demand plan-

ning, forecasting, analytics, and sales and operations planning. Also, project management is now

being used for implementing strategic plans through the project portfolio, since the successful

execution of strategy has continued to be a problem. Also, the concepts of lean and six sigma are

now well established in organizations, and the details of their procedures are of less importance

for MBA students.

As a result of all these changes, we reorganized the material into three parts of the book. In

Part I: Strategy and Execution, we discuss operations and supply chain strategy in Chapter  1 and

then follow this up with executing strategy through project management in Chapter  2 . Part II:

Process and Supply Chain Design then covers four chapters. Process planning is described first

in Chapter  3 and then the planning of capacity and schedules in Chapter  4 . Chapter  5 : Supply

Chain Planning and Analytics is our first chapter on the supply chain as described above, and then

Chapter  6 covers many of the details on managing the supply chain. Part III: Managing and

Improving the Process then begins with Chapter  7 on monitoring and controlling the processes,

followed by Chapter  8 on process improvement through the use of six sigma. The last chapter,

also on process improvement, covers the concepts of lean management.

The book then concludes with six cases, one of which—General Micro Electronics—is

new. This is followed by a Glossary of key terms to help students quickly refresh their memories

on the terminology used in the chapters. We have also updated the examples and added a few new

Preface

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xiv Preface

short cases to those at the back of the chapters. To conserve space and improve the pace of the

book, we have cut about 80 pages from the previous edition and moved the bibliographies online,

as well as some of the supplements. Of course, we have added a lot of new material as listed

below so the book may still run about the same total length:

Process mapping

Supply chain disruptions

Total cost of ownership

Strategic sourcing

Sustainability

Collaborative planning and replenishment

SCOR model

Change management

Reverse logistics

Triple bottom line

Analytics

Demand planning

Forecasting

Sales and operations planning

In revising the book, we have kept the elements of our earlier philosophy. For example, we

kept the other majors such as marketing and finance in mind—what did these students need to know

about operations to help them in their careers? And we still minimize the heavier quantitative mate-

rial, keeping only discussions and examples that illustrate a particular concept since finance and

marketing majors would not be solving operations problems. Moreover, even operations managers

probably wouldn’t themselves be solving those problems; more likely, they would be assigned to an

analyst. For those chapters in which exercises are included, they are intended only to help illustrate

the concept we are trying to convey rather than make experts of the students.

We continued to add service examples throughout the text, since the great majority (over 80

percent these days!) of our students would be, or are already, employed in a service organization.

And since these students will be working and competing in a highly global economy, we employ

many international examples. We also kept the textual flow of material in the chapters away from

the current undergraduate trend of fracturing the material flow with sidebars, examples, applica-

tions, solved problems, and so forth, in an attempt to keep the students’ interest and attention.

Given the maturity of MBA students, we instead worked these directly into the discussions to

attain a smoother, clearer flow. As noted below, the Instructor’s Manual includes suggestions for

readings, cases, videos, and other course supplements that we have found to be particularly helpful

for MBA classes since this book is intended to be only a small part of the MBA class.

Supplements
Our approach to supplementary MBA‐level material here is to reference and annotate in the

Instructor’s Manual additional useful cases, books, video clips, and readings for each of the nine

textbook chapters. The annotation is intended to help the instructors select the most appropriate

materials for their unique course. Although we have added some of our own and our colleagues’

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xvPreface

cases to the rear of this edition, we also rely on our favorite Harvard, Darden, Western Ontario, and

European cases, plus Harvard Business Review readings to fully communicate the nature of the

chapter topic we are covering. Although we didn’t think that Test Bank Questions or PowerPoint

slides would be used by most MBA instructors, these materials are available from the publisher

also. For that matter, the publisher can also custom bind selected content from this text, our larger

undergraduate (or any other) Web text, along with cases and articles, should this approach be of

interest to the professor. Please contact your local Wiley representative for more details.

Your Inputs Appreciated
We would once again like to encourage users of this book to send us their comments and sugges-

tions. Tell us if there is something we missed that you would like to see in the next edition (or the

Instructor’s Manual or web site) or if there is perhaps material that is unneeded for this audience.

Also, please tell us about any errors you uncover or if there are other elements of the book you

like or don’t like. We hope to continue keeping this a living, dynamic project that evolves to meet

the needs of the MBA audience, an audience whose needs are also evolving as our economy and

society evolve and change.

We want to thank the many reviewers of this book and its previous editions: Alexander Ansari,

Seattle University; Dennis Battistella, Florida Atlantic University; Linda Brennan, Mercer

University; David Cadden, Quinnipiac University; Satya Chakravorty, Kennesaw State University;

Okechi Geoffrey Egekwu; Michael H. Ensby, Clarkson University; James A. Fitzsimmons,

University of Texas; Lawrence D. Fredendall, Clemson University; William C. Giauque, Brigham

Young University; Mike Godfrey, University of Wisconsin–Oshkosh; Damodar Golhar, Western

Michigan University; Suresh Kumar Goyal, Concordia University, Canada; Hector Guerrero, The

College of William & Mary; Robert Handfield, North Carolina State University; Mark Gerard

Haug, University of Kansas; Janelle Heineke, Boston University; Zhimin Huang, Hofstra University;

David Hollingworth, Rensselaer Polytechnic Institute; James L. Hoyt, Troy State University;

Kendra Ingram, Texas A&M University–Commerce; Jonatan Jelen, NYU–Poly; Mehdi Kaighobadi,

Florida Atlantic University; Casey Kleindienst, California State University–Fullerton; Archie

Lockamy III, Samford University; Manoj Malhotra, University of South Carolina; Gus Manoochehri,

California State University–Fullerton; Robert F. Marsh, Sacred Heart; Ron McLachlin, University

of Manitoba; Ivor P. Morgan, Babson College; Rob Owen, Thunderbird School of Global

Management; Seungwook Park, California State University–Fullerton; Ranga V. Ramasesh, Texas

Christian University; Jaime S. Ribera, IESE–Universidad de Navarra, Spain; Gary D. Scudder,

Vanderbilt University; Sue Perrott Siferd, Arizona State University; Samia Siha, Kennesaw State

University; Donald E. Simmons, Ithaca College; William J. Tallon, Northern Illinois University;

Forrest Thornton, River College; Richard Vail, Colorado Mesa University; Asoo J. Vakharia,

University of Florida; Jerry C. Wei, University of Notre Dame; and Jack Zhang, Hofstra University.

For this edition we thank the following reviewers: Patrick Jaska, University of Mary

Hardin–Baylor; Deborah Kellogg, University of Colorado, Denver; JD McKenna, Colorado

Technical University; Madeleine Pullman, Portland State University; Anthony Steigelman,

California Lutheran University.

Jack Meredith

School of Business
Wake Forest University, P.O. Box 7897
Winston‐Salem, NC 27109
[email protected]
www.mba.wfu.edu/faculty/meredith
336.758.4467

Scott Shafer

School of Business
Wake Forest University, P.O. Box 7897
Winston‐Salem, NC 27109
[email protected]
www.mba.wfu.edu/faculty/shafer
336.758.3687

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part

1

Strategy and Execution

In this first part of the book, we describe the importance of operations and the supply

chain to the global competitiveness of all organizations. We then move into a discussion

of their role in designing and executing a competitive strategy for the organization.

Chapter  1 first describes the functions of operations and the supply chain in an organiza-

tion and then lists the aspects of value that customers and clients desire of the products

and services they buy. Next, a range of strategic frameworks are described that organiza-

tions commonly employ. However, selecting and carefully designing a strategy for the

organization are only half the battle for survival in a very competitive global economy—

the organization must be able to successfully execute the strategy. As discussed in

Chapter  2 , a major tool for achieving this is project management, which has developed

into a field in itself, with a full range of tools and techniques for executing projects of all

kinds, including strategy.

ROLE OF OPERATIONS AND SUPPLY CHAINS IN

THE ORGANIZATIONS’ COMPETITIVENESS

PART II: Process and

Supply Chain Design

PART I: Strategy

and Execution

Chapter. 1: Operations

and Supply Chain Strategy

for Competitiveness

Chapter. 2: Executing

Strategy: Project

Management

Chapter. 6: Supply

Chain

Management

Chapter. 5: Supply

Chain Planning

and Analytics

Chapter. 4: Capacity

and Scheduling

Chapter. 3: Process

Planning

Chapter. 7: Monitoring

and Controlling the

Process

Chapter. 9: Process

Improvement:

Lean

Chapter. 8: Process

Improvement: Six

Sigma

PART III: Managing and

Improving the Process

I

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1

2

chapter
Operations and Supply Chain
Strategy for Competitiveness

CHAPTER IN PERSPECTIVE

The crucial role that operations and the supply chain play in the global competi-
tiveness of all organizations is achieved through the execution of an operations
strategy devoted to designing, improving, and then executing the production
process by which the organization ’ s services and products are created.

In Chapter  1 , we first describe the nature of the operations function within the
global competitive environment. Then, we analyze what customers value such
as innovativeness, functionality, quality, customization, and responsiveness at
minimal cost. Last, we explore the major strategic frameworks used in opera-
tions to provide these valued benefits at low cost.

Introduction
• No discussion of global competitiveness would be complete without the inclusion of Apple

Inc. ’ s amazing comeback from its near‐death experience over a decade ago. Under the futur-

istic vision of the late Steve Jobs, the firm has innovated in the electronics market like no firm

has ever done before, with high quality and reasonable pricing to bring magical capabilities to

small gadgets and overwhelm its competitors.

Over the five‐year period from February 2010 to February 2015, Apple ’ s share price has

risen to 338.3 percent, compared to the S&P 500 ’ s increase of 89.6 percent. At the end of

2014, Apple became the most valuable company of all time as its market capitalization crossed

the $700 billion mark.

This example of Apple ’ s uniqueness shows how important operations capabilities in

areas such as innovation, quality, customization, and cost can be to an organization ’ s global

competitiveness (Cheng and Intindola 2012).

• As in sports, numerous intense rivalries exist in the world of business, such as the rivalries

between Visa and MasterCard, Microsoft and Apple, Ford and General Motors, Energizer and

Duracell, and Nike and Reebok. Certainly, any list of top business rivalries would be incom-

plete without Coke and Pepsi. Interestingly, while these two firms compete in the same indus-

try, one has had considerable success on the important dimension of share price performance,

while the other ’ s performance has been rather dismal. More specifically, over the 10‐year

period ending in February 2015, Pepsi ’ s stock price increased by 85.6 percent, while Coke ’ s

increased by 100.6 percent. The result was that Coke ’ s market capitalization increased to

$182.4 billion compared to Pepsi ’ s market capitalization of $145.8 billion. This difference in

market capitalization is even more dramatic when one considers the fact that Pepsi ’ s sales are

significantly higher than Coke ’ s—$66.4 billion versus $46.9 billion in 2013.

A question that naturally arises is: What accounts for these very different outcomes?

One explanation offered by analysts and critics is that Pepsi simply took its eye off the ball.

In particular, while Coke focused its attention on beverages, Pepsi has been distracted by

attempting to develop nutritious snacks. One result is that Pepsi Cola went from being the

number‐two soda to the number‐three soda behind Coke and Diet Coke. To address its

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3Introduction

weakened performance, Pepsi’s board of directors initiated a strategic review of the company.

A  variety of opinions have been offered regarding what the outcome of Pepsi’s strategic

review will be, from reducing its payroll to free up additional resources for marketing its soft

drink products to breaking up the company into a beverage company and a snack food com-

pany (Esterl 2012).

• General Motors’ market share had been in a long downward decline from about 45 percent in

1980 to about 20 percent in 2008 when the entire automotive industry got hit with a powerful

one‐two punch, throwing all the weakened American automobile producers into chaos. First,

in early 2008, extreme gasoline prices killed the truck and SUV market, and then, the sudden

credit crisis and recession killed the rest of the automobile market. The high cost of debt,

unionized labor, and unfunded liabilities (pensions and health care) forced GM and Chrysler

to go begging to the government for bailouts, with GM getting a $50 billion lifeline from US

taxpayers, for example. By late 2008, GM was burning through billions of dollars of cash

every month. One industry analyst calculated that GM’s obligations in March of 2009

amounted to $62 billion, 35 times its market capitalization (Denning 2009, p. C10)! Finally,

both GM and Chrysler had to file for a prepackaged structured bankruptcy. The bankruptcy

helped GM to cut its labor costs, get rid of a lot of its debt, get rid of some of its pension and

health care obligations, and cut the number of models it was offering to the public.

So how did the restructuring work out? In 2011, GM had the largest annual profit, at

$7.6 billion, in its 103‐year history, up 62 percent from 2010. GM’s revenues were up 13 per-

cent on sales of 1.37 million cars (Chrysler’s sales were up 26 percent), and GM had hired

100,000 workers in each of the previous five months! GM’s car sales are growing quickly in

China as well as in North America, and the company now has very little debt, over $38 billion

in liquidity, and minimal taxes (as a part of their bankruptcy agreement). This represents a

tremendous turnaround in the competitiveness of the US automobile industry.

But the news is not all good. GM’s European business is in trouble, having lost $747

million in 2011 (but $2 billion in 2010). And its share of the US market also continues to slip,

dropping to 17.8 percent in 2014 (Bennett 2012; Terlep 2012; McIntyre 2014).

These brief examples highlight the diversity and importance of operations while providing a

glimpse of two themes that are central to operations: customer satisfaction and competitiveness.

They also illustrate a more subtle point—that improvements made in operations can simultane-

ously increase customer satisfaction and lower costs. The Apple example demonstrates how a

company obtained a substantial competitive advantage by improving their innovation capability,

their production process, and their supply chain. The American automobile industry example

shows how losing an operations focus can drive a firm into bankruptcy but how, through restruc-

turing, the firm can regain its operational competitiveness. The Pepsi example illustrates a funda-

mental principle in strategy and competitiveness—namely, that organizations that focus on doing

a few things well usually outperform organizations that lack this focus. And Apple’s success

demonstrates how quickly technology can upend an industry and change the major players and

their competitiveness.

Today, in our international marketplace, consumers purchase their products from the pro-

vider that offers them the most “value” for their money. To illustrate, you may be doing your

course assignments on a Japanese notebook computer, driving a German automobile, or watching

a sitcom on a TV made in Taiwan while cooking your food in a Korean microwave. However,

most of your services—banking, insurance, and personal care—are probably provided domesti-

cally, although some of these may also be owned by, or outsourced to, foreign corporations. There

is a reason why most services are produced by domestic firms while products may be produced

in part, or wholly, by foreign firms, and it concerns an area of business known as operations.

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4 Operations and Supply Chain Strategy for Competitiveness

A great many societal changes that are occurring today intimately involve activities

associated with operations. For example, there is great pressure among competing nations to

increase their exports. And businesses are intent on building efficient and effective supply chains,

improving their processes through “Six Sigma,” and successfully applying the precepts of “lean

management” and other operations‐based programs.

Another characteristic of our modern society is the explosion of new technology, an impor-

tant aspect of operations. Technologies such as smart phones, e‐mail, notebook computers,

tablets, and the Web, to name a few, are profoundly affecting business and are fundamentally

changing the nature of work. For example, many banks are shifting their focus from building new

branch locations to using the Web as a way to establish and develop new customer relationships.

Banks rely on technology to carry out more routine activities as well, such as transferring funds

instantly across cities, states, and oceans. Our industries also rely increasingly on technology:

robots carry and weld parts together, and workerless, dark “factories of the future” turn out a

continuing stream of products. And soft operations technologies, such as “supply chain manage-

ment” and “lean production” (Feld 2000; Womack and Jones 2003), have transformed world

markets and the global economy.

This exciting, competitive world of operations is at the heart of every organization and,

more than anything else, determines whether the organization survives in the international mar-

ketplace or disappears into bankruptcy or a takeover. It is this world that we will be covering in

the following chapters.

1.1 Operations
Why do we argue that operations be considered the heart of every organization? Fundamentally,

organizations exist to create value, and operations is the part of the organization that creates value

for the customer. Hammer (2004) maintains that operational innovation can provide organiza-

tions with long‐term strategic advantages over their competitors. Regardless of whether the

organization is for profit or not for profit, primarily service or manufacturer, or public or private,

it exists to create value. Thus, even nonprofit organizations like the Red Cross strive to create

value for the recipients of their services in excess of their costs. Moreover, this has always been

true, from the earliest days of bartering to modern‐day corporations.

Consider McDonald’s as an example. This firm uses a number of inputs, including ingredi-

ents, labor, equipment, and facilities; transforms them in a way that adds value to them (e.g., by

frying); and obtains an output, such as a chicken sandwich, that can be sold at a profit. This con-

version process, termed as production system, is illustrated in Figure 1.1. The elements of the

figure represent what is known as a system1: a purposeful collection of people, objects, and pro-
cedures for operating within an environment.

Note the word purposeful; systems are not merely arbitrary groupings but goal‐directed or

purposeful collections. Managing and running a production system efficiently and effectively are

at the heart of the operations activities that will be discussed in this text. Since we will be using

this term throughout the text, let us formally define it. Operations is concerned with transforming

inputs into useful outputs according to an agreed‐upon strategy and thereby adding value to some

entity; this constitutes the primary activity of virtually every organization.

Not only is operations central to organizations, it is also central to people’s personal and

professional activities, regardless of their position. People, too, must operate productively, add-

ing value to inputs and producing quality outputs, whether those outputs are information, reports,

services, products, or even personal accomplishments. Thus, operations should be of major inter-

est to every reader, not just professionally but also personally.

1 Note the word system is being used here in a broad sense and should not be confused with more narrow usages such as

information systems, planning and control systems, or performance evaluation systems.

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51.1 Operations

1.1.1 Systems Perspective

As Figure 1.1 illustrates, a production system is defined in terms of the environment, a strategy,

a set of inputs, the transformation process, the outputs, and some mechanism for controlling the

overall system. The strategy includes determining such elements as what customers value (often

referred to as the value proposition), the vision and mission of the organization, an appropriate

framework to execute this vision, and the core capabilities of the organization. We discuss the

strategy in detail a bit later. The environment includes those things that are outside the actual

production system but that influence it in some way. Because of its influence, we need to consider

the environment, even though it is beyond the control of decision makers within the system.

For example, a large portion of the inputs to a production system are acquired from the

environment. Also, government regulations related to pollution control and workplace safety

affect the transformation system. Think about how changes in customers’ needs, a competitor’s

new product, or a new advance in technology can influence the level of satisfaction with a pro-

duction system’s current outputs. As these examples show, the environment exerts a great deal of

influence on the production system.

Because the world around us is constantly changing, it is necessary to monitor the produc-

tion system and take action when the system is not meeting its strategic goals. Of course, it may

be that the current strategy is no longer appropriate, indicating a need to revise the strategy. On

the other hand, it may be found that the strategy is fine but that the inputs or transformation pro-

cesses, or both, should be modified in some way. In either case, it is important to continuously

collect data from the environment, the transformation processes, and the outputs; compare that

data to the strategic plan; and, if substantial deviations exist, design and implement improve-

ments to the system, or perhaps the strategy, so that results agree with the strategic goals.

Environment

Transformation

processes • Facilitating

goods
• Services

• Alteration
• Transportation
• Storage
• Inspection

Inputs

Control

• Capital
• Materials
• Equipment
• Facilities
• Suppliers
• Labor
• Knowledge
• Time

• Measure
• Compare
• Plan
improvements
• Implement

improvements

Output

ActionActionAction Data DataData

• Customers

• Government

• Competitors

• Technology

• Suppliers

• Economy

Strategy

• Value

proposition
• Vision/mission
• Strategic

frameworks
• Core

capabilities

FIGURE 1.1

The production system.

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6 Operations and Supply Chain Strategy for Competitiveness

Thinking in terms of systems provides decision makers with numerous advantages. To

begin with, the systems perspective focuses on how the individual components that make up a

system interact. Thus, the systems perspective provides decision makers with a broad and com-

plete picture of an entire situation. Furthermore, the systems perspective emphasizes the relation-

ships between the various system components. Without considering these relationships, decision

makers are prone to a problem called suboptimization. Suboptimization occurs when one part of

the system is improved to the detriment of other parts of the system and, perhaps, the organiza-

tion as a whole. For example, if a retailer decides to broaden its product line in an effort to

increase sales, this could actually end up hurting the retailer as a whole if it does not have suffi-

cient shelf space or service personnel available to accommodate the broader product line. Thus,

decisions need to be evaluated in terms of their effect on the entire system, not simply in terms of

how they will affect one component of the system.

In the remainder of this section, we elaborate on inputs, the transformation processes, and

outputs. In later sections and chapters, we further discuss both strategy and elements of the con-

trol system in more detail.

1.1.2 Inputs

The set of inputs used in a production system is more complex than might be supposed and typi-

cally involves many other areas such as marketing, finance, engineering, and human resource

management. Obvious inputs include facilities, labor, capital, equipment, raw materials, and sup-

plies. Supplies are distinguished from raw materials by the fact that they are not usually a part of

the final output. Oil, paper clips, pens, tape, and other such items are commonly classified as

supplies because they only aid in producing the output.

Another very important but perhaps less obvious input is knowledge of how to transform

the inputs into outputs. The employees of the organization hold this knowledge. Finally, having

sufficient time to accomplish the operations is always critical. Indeed, the operations function

quite frequently fails in its task because it cannot complete the transformation activities within

the required time limit.

1.1.3 Transformation Processes

The transformation processes are the part of the system that add value to the inputs. Value can be

added to an entity in a number of ways. Four major ways are described here:

1. Alter: Something can be changed structurally. That would be a physical change, and this

approach is basic to manufacturing industries, where goods are cut, stamped, formed,

assembled, and so on. We then go out and buy the shirt, or computer, or whatever the good

is. But it need not be a separate object or entity; for example, what is altered may be us. We

might get our hair cut, or we might have our appendix removed.

Other, more subtle, alterations may also have value. Sensual alterations, such as heat

when we are cold, or music, or beauty, may be highly valued on certain occasions. Beyond

this, even psychological alterations can have value, such as the feeling of worth from obtain-

ing a college degree or the feeling of friendship from a long‐distance phone call.

2. Transport: An entity, again including ourselves, may have more value if it is located some-

where other than where it currently is. We may appreciate having things brought to us, such

as flowers, or removed from us, such as garbage.

3. Store: The value of an entity may be enhanced for us if it is kept in a protected environment

for some period of time. Some examples are stock certificates kept in a safe‐deposit box, our

pet boarded at a kennel while we go on vacation, or ourselves staying in a hotel.

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71.1 Operations

4. Inspect: Last, an entity may be more valued because we better understand its properties.

This may apply to something we own, plan to use, or are considering purchasing, or, again,

even to ourselves. Medical exams, elevator certifications, and jewelry appraisals fall into

this category.

Thus, we see that value may be added to an entity in a number of different ways. The entity

may be changed directly, in space, in time, or even just in our mind. Additionally, value may be

added using a combination of these methods. To illustrate, an appliance store may create value by

both storing merchandise and transporting (delivering) it. There are other, less frequent, ways of

adding value as well, such as by “guaranteeing” something. These many varieties of transforma-

tions, and how they are managed, constitute some of the major issues to be discussed in this text.

1.1.4 Outputs

Two types of outputs commonly result from a production process: services and products.

Generally, products are physical goods, such as a personal computer, and services are abstract or

nonphysical. More specifically, we can consider the characteristics in Table 1.1 to help us distin-

guish between the two.

However, this classification may be more confusing than helpful. For example, consider a

pizza delivery chain. Does this organization produce a product or provide a service? If you

answered “a service,” suppose that instead of delivering its pizzas to the actual consumer, it made

the pizzas in a factory and sold them in the frozen food section of grocery stores. Clearly, the

actual process of making pizzas for immediate consumption or to be frozen involves basically

the same tasks, although one may be done on a larger scale and use more automated equipment.

The point is, however, that both organizations produce a pizza, and defining one organization as

a service and the other as a manufacturer seems to be a little arbitrary. In addition, both products

and services can be produced as commodities or individually customized.

We avoid this ambiguity by adopting the point of view that any physical entity accompany-
ing a transformation that adds value is a facilitating good (e.g., the pizza). In many cases, of

course, there may be no facilitating good; we refer to these cases as pure services.

The advantage of this interpretation is that every transformation that adds value is simply a

service, either with or without facilitating goods! If you buy a piece of lumber, you have not

purchased a product. Rather, you have purchased a bundle of services, many of them embodied

in a facilitating good: a tree‐cutting service, a sawmill service, a transportation service, a storage

service, and perhaps even an advertising service that told you where lumber was on sale. We refer

to these services as a bundle of “benefits,” of which some are tangible (the sawed length of lum-

ber, the type of tree) and others are intangible (courteous salesclerks, a convenient location, and

payment by charge card). Some services may, of course, even be negative, such as an audit of

your tax return. In summary, services are bundles of benefits, some of which may be tangible and

others intangible, and they may be accompanied by a facilitating good or goods.

■ TABLE 1.1 Characteristics of Products and Services

Products Services

Tangible

Minimal contact with customer

Minimal participation by customer in the delivery

Delayed consumption

Equipment‐intense production

Quality easily measured

Intangible

Extensive contact with customer

Extensive participation by customer in the delivery

Immediate consumption

Labor‐intense production

Quality difficult to measure

Meridth-c01.indd 7 11/5/2015 4:15:27 PM

8 Operations and Supply Chain Strategy for Competitiveness

Firms often run into major difficulties when they ignore this aspect of their operations.

They may think of, and even market themselves as, a “lumberyard” and not as providing a bundle

of services. They may recognize that they have to include certain tangible services (such as cut-

ting lumber to the length desired by the customer) but ignore the intangible services (charge

sales, having a sufficient number of clerks). Another reason for not making a distinction between

manufacturing and services is that when a company thinks of itself as a manufacturer, it tends to

focus on measures of internal performance such as efficiency and utilization. But when compa-

nies consider themselves as providing services, they tend to focus externally and ask questions

such as “How can we serve our customers better?” This is not to imply that improving internal

performance measures is not desirable. Rather, it suggests that improved customer service should

be the primary impetus for all improvement efforts. It is generally not advisable to seek internal

improvements if these improvements do not ultimately lead to corresponding improvements in

customer service and customer satisfaction.

In this text, we will adopt the point of view that all value‐adding transformations (i.e.,

operations) are services, and there may or may not be a set of accompanying facilitating goods.

Figure 1.2 illustrates how the tangible product (or facilitating good) portion and the intangible

service portion for a variety of outputs contribute to the total value provided by each output. The

outputs shown range from virtually pure services to what would be known as products. For

example, the Plush restaurant appears to be about 75 percent service and 25 percent product.

Although we work with “products” as extensively as with services throughout the chapters in

this book, bear in mind that in these cases we are working with only a portion of the total service,

the facilitating good. In general, we will use the nonspecific term outputs to mean either products

or services.

One particular type of output that is substantially different from products and many other

types of services is that of knowledge or information. These outputs often have the characteristic

that the more they are used, the more valuable they become. For example, in a network, the more

entities that belong to the network, the more useful it may be. If you are on Facebook® or use e‐

mail, the more other people that are also there, the more valuable it is to you. And when you share

this output, you don’t lose anything, you gain. Some other characteristics of information or

knowledge that differ from normal goods and services are as follows.

100 50 0

Magazine purchase

Flour purchase

50 100

Plush restaurant

Theatrical performance

Travels

Auto repair

Hand-made suit

Movie rental

Medical examination

% Service % Product

FIGURE 1.2

The range from services

to products.

Meridth-c01.indd 8 11/5/2015 4:15:29 PM

91.1 Operations

• Giving or selling the information/knowledge to someone doesn’t mean you can’t give or sell

it to someone else.

• The information/knowledge doesn’t wear out.

• The information/knowledge isn’t subject to the law of diminishing returns.

• The information/knowledge can be replicated at minimal cost and trouble.

• The more the knowledge is used, the more valuable it becomes.

1.1.5 Control

Suppose that in our production system, we make a mistake. We must be able to observe this

through, for example, accounting records (measurement data), compare it to a standard to see

how serious the error is, and then, if needed, plan and implement (usually via a project) some

improvements. If the changes are not significantly affecting the outputs, then no control actions

are needed. But if they are, management must intercede and apply corrective control to alter the

inputs or the transformation processes and, thereby, the outputs. The control activities illustrated

in Figure  1.1 are used extensively in systems, including management systems, and will be

encountered throughout this text.

One example of the components of the production system for a school would be as follows:

A strategy of providing a safe, trustworthy, friendly environment for passing knowledge on to the

students. The inputs would be, among others, the teachers, facility, books, and students that are

exposed to a transformation system of learning, counseling, motivating, and so on to produce

outputs of educated, skilled students. Control is exercised through examinations, demographics,

grievance procedures, and constant oversight. This all occurs in a physical and structural environ-

ment that includes state and county school boards to provide oversight policies and tax systems

to provide the resources.

1.1.6 Operations Activities

Operations include not only those activities associated specifically with the production system

but also a variety of other activities. For example, purchasing or procurement activities are con-

cerned with obtaining many of the inputs needed in the production system. Similarly, shipping

and distribution are sometimes considered marketing activities and sometimes considered opera-

tions activities. Because of the important interdependencies of these activities, many organiza-

tions are attempting to manage these activities as one process commonly referred to as supply
chain management.

As organizations begin to adopt new organizational structures based on business processes

and abandon the traditional functional organization, it is becoming less important to classify activ-

ities as operations or nonoperations (e.g., sales, marketing, and accounting). However, to under-

stand the tasks more easily, we commonly divide the field of operations into a series of subject

areas such as scheduling, process design, inventory management, maintenance, and quality con-

trol. These areas are quite interdependent, but to make their workings more understandable, we

discuss them as though they were easily separable from each other. In some areas, a full‐fledged

department may be responsible for the activities, such as quality control or scheduling, but in other

areas, the activities (such as facility location) may be infrequent and simply assigned to a particu-

lar group or project team. Moreover, some of the areas such as supply chain management are criti-

cally important because they are a part of a larger business process or because other areas depend

on them. Finally, since we consider all operations to be services, these subject areas are equally

applicable to organizations that have traditionally been classified as manufacturers and services.

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10 Operations and Supply Chain Strategy for Competitiveness

1.1.7 Trends in Operations and Supply Chain Management

As has been previously discussed in this chapter and will be further emphasized in the remaining

chapters, an organization’s operations play a critical role in its overall competitiveness and long‐

term success. Given the critical role played by operations, it is important to stay abreast of the

significant trends in the operations area as well as general business trends that may impact the

operations function.

As in other disciplines, technology is having a significant impact on the practice of opera-

tions. For example, communication technologies such as the Internet and cloud computing are

greatly facilitating the ability of organizations to share real‐time information with their suppliers

and customers. Having more timely information enhances the opportunities for supply chain

partners to coordinate and integrate their operations, which ultimately leads to a more effective

and efficient supply chain that benefits both the end customer and the trading partners in the sup-

ply chain.

One exciting technology that promises to greatly enhance the ability of organizations to

have real‐time information on their inventory and other assets is radio‐frequency identification

(RFID); RFID tags are attached to individual inventory items, and these tags transmit identifica-

tion and location information. For example, by attaching an RFID tag to a part, its progress

through the production process can be monitored and, when finished, its location in the ware-

house tracked.

RFID tags are classified as passive or active. Passive RFID tags contain no power source

and therefore rely on the power source of an RFID reader to transmit their information. Active

RFID tags contain a power source such as a battery and use this power source to periodically

transmit a signal that provides identification information. Perhaps the greatest challenge to

greater adoption of RFID tags is the cost of the tags themselves. As with other technologies, the

cost of RFID has decreased dramatically and is expected to continue on this trajectory. The cost

of basic passive RFID tags ranges from $0.10 to $1.50, depending on the volume of tags pur-

chased and the environmental factors they are designed to withstand. The cost of active RFID

tags starts from $15 to $20 and again increases depending on the features desired. Thus, at pre-

sent, the costs of active RFID tags are mainly justified for tracking expensive assets such as a rail

car or delivery truck.

Beyond technology, another important trend in business is the increasing emphasis organi-

zations are placing on effectively managing their supply chains. Indeed, to remain competitive,

organizations are discovering the importance of leveraging the volumes of customer data that are

a natural by‐product of our computerized society, developing stronger relationships with their

supply chain partners, and proactively managing the risks associated with disruptions to their

supply chain. Regarding the increasing volumes of data, as will be discussed in greater detail in

Chapter 5, many organizations are finding ways to combine the volumes of data they accumulate

with advanced analytical techniques to manage and improve their supply chains in ways that

were unthinkable in the past.

Another area gaining increasing attention in supply chain management is the development

of strong relationships with supply chain partners through increased collaboration. It is now

widely accepted that all supply chain partners can benefit through greater collaboration. For

example, including all supply chain partners in the development of the demand forecast not only

increases the amount of information available from different perspectives but also helps ensure

that the detailed plans of suppliers and customers are aligned and working toward achieving the

same goals. We return to the issue of building relationships with supply chain partners and the

benefits of greater collaboration in Chapter 5.

Related to the area of developing stronger relationships with supply chain partners is the

emphasis organizations are placing on the sourcing of their products. In the past, sourcing decisions

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111.2 Customer Value

were frequently viewed as primarily tactical in nature with the overarching goal of obtaining the

lowest possible unit cost. Often, the strategy used to obtain the lowest cost was to play one sup-

plier against another. Now, we see organizations increasingly discussing strategic sourcing and

thinking more holistically in terms of the total cost of ownership, not just the unit cost. Likewise,

the potential benefits of outsourcing overseas are being increasingly questioned, and new terms

such as reshoring and next‐shoring have entered the lexicon. The topic of strategic sourcing is

discussed in greater detail in Chapter 6.

Managing the risk of disruptions to the supply chain is yet another area gaining increasing

attention. For example, consider the impact of the earthquake and the tsunami that hit Japan in

2011 on the availability of product components and finished goods. Disruptions to the supply

chain are generally either the result of nature (natural disasters such as earthquakes, blizzards,

floods, and hurricanes) or human behavior (terrorist strikes, glitches in technology, and workers

going on strike). Managing such disruptions is especially challenging because they are often dif-

ficult to predict. The best approach for dealing with these types of disruptions to the supply chain

is to brainstorm potential disruptions, assess the impact of the identified disruptions, and develop

contingency plans to mitigate the risk of the disruption.

A final important trend impacting the practice of operations management is the increasing

levels of concern for the environment which in turn have led many organizations to place greater

emphasis on issues related to sustainability. Addressing environmental concerns impacts virtu-

ally all aspects of operations management from the design of the organization’s output to the

sourcing of parts, the distribution of the product, and even the disposal or recycling of the product

or its components once it reaches the end of its useful life. Green sourcing, for example, seeks to

identify suppliers in such a way that the organization’s carbon footprint and overall impact on the

environment are minimized.

As a result of the increasing importance organizations are placing on sustainability, some

organizations are adopting the triple bottom line approach for assessing their performance. In

addition to assessing profits, organizations that employ the triple bottom line approach also assess

themselves on social responsibility (people) and their environmental responsibility (planet).

Reducing the waste associated with products is another top sustainability priority of organ-

izations that seek to minimize the negative impact they have on the environment. In this case,

organizations can deploy a strategy often referred to as the three Rs: reduce, reuse, and recycle.

As its name suggests, the reduce strategy seeks to decrease the amount of waste associated with

a product. One way to accomplish this is to minimize the amount of product packaging used. In

services, switching to electronic copies of documents helps reduce waste, such as when a bank

switches to electronic statements. Reuse is a second strategy for minimizing waste. The idea

underlying reuse is to identify alternative uses for an item after its initial use. For example, there

are kits available for converting old computer monitors into fish aquariums. Finally, recycling

involves using the materials from old products to create new products. For example, many greet-

ing cards are made from recycled paper.

1.2 Customer Value

1.2.1 Costs

In the “Introduction” to this chapter, we mentioned that customers support the providers of goods

and services who offer them the most “value.” In this section, we elaborate on this concept. The

equation for value is conceptually clear:

Value perceived benefits costs/

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12 Operations and Supply Chain Strategy for Competitiveness

The perceived benefits can take a wide variety of forms, but the costs are usually more

straightforward:

• The upfront monetary investment

• Other monetary life‐cycle costs of using the service or product, such as maintenance

• The hassles involved in obtaining the product or service, such as travel required, obtaining

financing, the friendliness of service, and so on

The cost to the customer is, of course, the price paid, but this is usually highly correlated

with the cost of producing the service or product, which is itself largely based on the “efficiency”

of the production process. Efficiency is always measured as output/input; for example, a standard

automobile engine that uses gasoline is usually about 15 to 20 percent efficient (that is, the energy

put into the engine in terms of gasoline vs. the energy put out in terms of automobile motion).

However, electric and jet engines are more efficient, and rocket engines can reach almost 70 per-

cent efficiency.

The primary method of attaining efficiency in production is through high productivity,

which is normally defined as output per worker hour. This definition of productivity is actually

what is known as a partial factor measure of productivity, in the sense that it considers only

worker hours as the productive factor. Although in the past, labor often constituted as much as

50 percent of the cost of a product—or even more for a service—it is now frequently as little as

5 percent, so labor productivity is no longer a good measure of efficiency. Clearly, labor produc-

tivity could easily be increased by substituting machinery for labor, but that doesn’t mean that

this is a wise, or even cost‐saving, decision. A multifactor productivity measure uses more than a

single factor, such as both labor and capital. Obviously, the different factors must be measured in

the same units, such as dollars. An even broader gauge of productivity, called total factor produc-

tivity, is measured by including all the factors of production—labor, capital, materials, and

energy—in the denominator. This measure is to be preferred in making any comparisons of pro-

ductivity for efficiency or cost purposes.

Last, we also frequently hear of “effectiveness,” which is a measure of the achievement of

goals; where efficiency is sometimes considered to be “doing the thing right,” effectiveness is

instead considered to be “doing the right thing” or being focused on the proper task or goal.

1.2.2 Benefits

In contrast to the role of costs in the customer’s value equation, the benefits can be multiple. We

will consider five of these in detail: innovativeness, functionality, quality, customization, and

responsiveness.

1.2.3 Innovativeness

Many people (called “early adopters” in marketing) will buy products and services simply

because they are so innovative, or major improvements over what has been available formerly. It

is the field of research and development (known as R&D) that is primarily responsible for devel-

oping innovative new product and service ideas. R&D activities focus on creating and developing

(but not producing) the organization’s outputs. On occasion, R&D also creates new production

methods by which outputs, either new or old, may be produced.

Research itself is typically divided into two types: pure and applied. Pure research is sim-

ply working with basic technology to develop new knowledge. Applied research is attempting to

develop new knowledge along particular lines. For example, pure research might focus on

developing a material that conducts electricity with zero resistance, whereas applied research

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131.2 Customer Value

could focus on further developing this material to be used in products for customers. Development
is the attempt to utilize the findings of research and expand the possible applications, often con-

sisting of modifications or extensions to existing outputs to meet customers’ interests. Figure 1.3

illustrates the range of applicability of development as the output becomes more clearly defined.

In the early years of a new output, development is oriented toward removing “bugs,” increasing

performance, improving quality, and so on. In the middle years, options and variants of the output

are developed. In the later years, development is oriented toward extensions of the output that

will prolong its life.

Unfortunately, the returns from R&D are frequently meager, whereas the costs are great.

Figure  1.4 illustrates the mortality curve (fallout rate) associated with the concurrent design,

Time

Discovery

E
ff

o
rt

Development

Maturity

Variants

Saturations

Extensions

Decline

Death

Options

Idea

incubation

Idea

refinement
Idea

examination

and

evaluation

Improving

performance

Output

selection

Full marketing

Acceptance

testing,

modification

Pure Research Applied

Growth

FIGURE 1.3

The development effort.

0
0

10

20

30

40

50

60

1 2 3 4 5 6

C
om

m
er

ci
al

iz
at

io
n

an
d

pr
od

uc
ti
on

In
t

he
m

ar
ke

t

D
es

ig
n

an
d

te
st

in
g

D
ev

el
op

m
en

t

Ec
on

om
ic

a
na

ly
si

s

Ev
al

ua
ti
on

a
nd

s
cr

ee
ni

ng

N
um

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r

of
p

ro
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ct
s

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m

ai
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ng

Years

Success FIGURE 1.4

Product mortality curve.

Meridth-c01.indd 13 11/5/2015 4:15:34 PM

14 Operations and Supply Chain Strategy for Competitiveness

evaluation, and selection for a hypothetical group of 50 potential products, assuming that the

50 candidate products are the result of earlier research. Initial evaluation and screening reduce the

50 to about 22, and economic analysis further reduces the number to about 9. Development

reduces this number even more, to about 5, and design and testing reduce it to perhaps 3. After

two and a half more year’s commercialization and production are completed, there is only one

successful product left. (Sometimes there are none!) One study found that, beyond this, only

64 percent of the new products brought to market were successful or about two out of three.

Two alternatives to research frequently used by organizations are imitation of a proven new

idea (i.e., employing a second‐to‐market strategy) or outright purchase of someone else’s inven-

tion. The outright purchase strategy is becoming extremely popular in those industries where

bringing a new product to market can cost huge sums, such as pharmaceuticals and high technol-

ogy. It is also employed in those industries where technology advances so rapidly that there isn’t

enough time to employ a second‐to‐market strategy. Although imitation does not put the organi-

zation first in the market with the new product or service, it does provide an opportunity to study

any possible defects in the original product or service and rapidly develop a better design, fre-

quently at a better price. The second approach—purchasing an invention or the inventing com-

pany itself—eliminates the risks inherent in research, but it still requires the company to develop

and market the product or service before knowing whether it will be successful. Either route

spares the organization the risk and tremendous cost of conducting the actual research leading up

to a new invention or improvement.

In addition to product research (as it is generally known), there is also process research,

which involves the generation of new knowledge concerning how to produce outputs. Currently,

the production of many familiar products out of plastic (toys, pipe, furniture, etc.) is an outstand-

ing example of successful process research. Motorola, to take another example, extensively uses

project teams that conduct process development at the same time as product development.

1.2.4 Functionality

Many people confuse functionality with quality (discussed next). But functionality involves the

activities the product or service is intended to perform, thereby providing the benefits to the cus-

tomer. A contemporary example is the ubiquitous cell phone. These days, it is probably rare to

find a cell phone that is only a phone; many phones include a camera and a way to send its picture

to another person or provide access to the Internet, as well as a myriad of other functions.

However, many products, especially electronics, but also some services, may be advertised

to provide purchasers with a new, unique function and they may do so, but it may not work well
or for long. The former involves performance and the latter has to do with reliability. Clearly,

these are different attributes of the output, and one can be well addressed while others disap-

point. Our discussion of quality, next, elaborates a bit more on the distinction between these

attributes.

1.2.5 Quality

Quality is a relative term, meaning different things to different people at different times. Moreover,

quality is not an absolute but, rather, is based on customers’ perceptions. Customers’ impressions

can be influenced by a number of factors, including brand loyalty and an organization’s reputa-

tion. Richard J. Schonberger has compiled a list of multiple quality dimensions that customers

often associate with products and services:

1. Conformance to specifications. Conformance to specifications is the extent to which the

actual product matches the design specifications, such as a pizza delivery shop that consist-

ently meets its advertised delivery time of 30 minutes.

Meridth-c01.indd 14 11/5/2015 4:15:34 PM

151.2 Customer Value

2. Performance. Customers frequently equate the quality of products and services with their

performance. (Note, however, that this dimension may in some cases actually refer to func-

tionality.) Examples of performance include how quickly a sports car accelerates or the

battery life of a cell phone.

3. Features. Features are the options that a product or service offers, such as side impact air-

bags or leather seats in automobiles. (Again, however, this dimension may also be confused

with functionality.)

4. Quick response. Quick response is associated with the amount of time required to react to

customers’ demands. However, we consider this to be a separate benefit, discussed further

in the following text.

5. Reliability. Reliability is the probability that a product or service will perform as intended

on any given trial or for some period of time, such as the probability that a car will start on

any given morning.

6. Durability. Durability refers to how tough a product is, such as a notebook computer that still

functions after being dropped or a knife that can cut through steel and not need sharpening.

7. Serviceability. Serviceability refers to the ease with which maintenance or a repair can be

performed.

8. Aesthetics. Aesthetics are factors that appeal to human senses, such as the taste of a steak or

the sound of a sports car’s engine.

9. Humanity. Humanity has to do with how the customer is treated, such as a private university

that maintains small classes so students are not treated like numbers by its professors.

It is worth noting that not all the dimensions of quality are relevant to all products and

services. Thus, organizations need to identify the dimensions of quality that are relevant to the

products and services they offer. Market research about customers’ needs is the primary input for

determining which dimensions are important. Of course, measuring the quality of a service can

often be more difficult than measuring the quality of a product or facilitating good. However, the

dimensions of quality described previously apply to both.

1.2.6 Customization

Customization refers to offering a product or service exactly suited to a customer’s desires or

needs. However, there is a range of accommodation to the customer’s needs, as illustrated in

Figure 1.5. At the left, there is the completely standard, world‐class (excellence suitable for all

markets) product or service. Moving to the right is the standard with options, continuing on to

Standard

world-class

Increasing

customization

Increasing

standardization

Standard

with options
Variants

Alternate

models
Customization

FIGURE 1.5

Continuum of

customization.

Meridth-c01.indd 15 11/5/2015 4:15:35 PM

16 Operations and Supply Chain Strategy for Competitiveness

variants and alternative models and ending at the right with made‐to‐order customization. In

general, the more customization, the better—if it can be provided quickly, with acceptable qual-

ity and cost.

Flexibility

However, to offer customization demands flexibility on the part of the firm. Professor Upton

(1994), formerly of the Harvard Business School, defines flexibility as “the ability to change or

react with little penalty in time, effort, cost, or performance” (p. 73). There are more than a dozen

different types of flexibility that we will not pursue here—design, volume, routing through the

production system, product mix, and many others. But having the right types of flexibility can

offer the following major competitive advantages:

• Faster matches to customers’ needs because change over time from one product or service to

another is quicker

• Closer matches to customers’ needs

• Ability to supply the needed items in the volumes required for the markets as they develop

• Faster design‐to‐market time to meet new customer needs

• Lower cost of changing production to meet needs

• Ability to offer a full line of products or services without the attendant cost of stocking large

inventories

• Ability to meet market demands even if delays develop in the production or distribution

process

Mass Customization

Until recently, it was widely believed that producing low‐cost standard products (at the far left in

Figure 1.5) required one type of transformation process and producing higher‐cost customized

products (far right) required another type of process. However, in addition to vast improvements

in operating efficiency, an unexpected by‐product of the continuous improvement programs of

the 1980s was substantial improvement in flexibility. Indeed, prior to this, efficiency and flexibil-

ity were thought to be trade‐offs. Increasing efficiency meant that flexibility had to be sacrificed,

and vice versa.

Thus, with the emphasis on continuous improvement came the realization that increasing

operating efficiency could also enhance flexibility. For example, many manufacturers initiated

efforts to reduce the amount of time required to set up (or change over) equipment when switch-

ing from the production of one product to another. Obviously, all time spent setting up equipment

is wasteful, since the equipment is not being used during this time to produce outputs that ulti-

mately create revenues for the organization. Consequently, improving the amount of time a

resource is used productively directly translates into improved efficiency. Interestingly, these

same reductions in equipment times also resulted in improved flexibility. Specifically, with

shorter equipment setup times, manufacturers could produce economically in smaller‐size

batches, making it easier to switch from the production of one product to another.

In response to the discovery that efficiency and flexibility can be improved simultane-

ously and may not have to be traded off, the strategy of mass customization emerged (see Pine

1993; Gilmore and Pine 1997). Organizations pursuing mass customization seek to produce

low‐cost, high‐quality outputs in great variety. Of course, not all products and services lend

themselves to being customized. This is particularly true of commodities, such as sugar, gas,

electricity, and flour. On the other hand, mass customization is often quite applicable to prod-

ucts characterized by short life cycles, rapidly advancing technology, or changing customer

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171.2 Customer Value

requirements. However, recent research suggests that successfully employing mass customiza-

tion requires an organization to first develop a transformation process that can consistently

deliver high‐quality outputs at a low cost. With this foundation in place, the organization can

then seek ways to increase the variety of its offerings while at the same time ensuring that qual-

ity and cost are not compromised.

In an article published in the Harvard Business Review, Gilmore and Pine (1997) identified

four mass customization strategies:

1. Collaborative customizers. These organizations establish a dialogue to help customers artic-

ulate their needs and then develop customized outputs to meet these needs. For example, one

Japanese eyewear retailer developed a computerized system to help customers select eye-

wear. The system combines a digital image of the customer’s face and then various styles of

eyeware are displayed on the digital image. Once the customer is satisfied, the customized

glasses are produced at the retail store within an hour.

2. Adaptive customizers. These organizations offer a standard product that customers can mod-

ify themselves, such as fast‐food hamburgers (ketchup, etc.) and closet organizers. Each

closet‐organizer package is the same but includes instructions and tools to cut the shelving

and clothes rods so that the unit can fit a wide variety of closet sizes.

3. Cosmetic customizers. These organizations produce a standard product but present it differ-

ently to different customers. For example, Planters packages its peanuts and mixed nuts in a

variety of containers on the basis of specific needs of its retailing customers, such as

Wal‐Mart, 7‐Eleven, and Safeway.

4. Transparent customizers. These organizations provide custom products without the custom-

ers knowing that a product has been customized for them. For example, Amazon.com pro-

vides book recommendations based on information about past purchases.

Example: Hewlett‐Packard

Faced with increasing pressure from its customers for quicker order fulfillment and for more

highly customized products, Hewlett‐Packard (HP) wondered whether it was really possible to

deliver mass‐customized products rapidly while at the same time continuing to reduce costs

(Feitzinger and Lee 1997). HP’s approach to mass customization can be summarized as effec-

tively delaying tasks that customize a product as long as possible in the product supply process.

It is based on the following three principles:

• Products should be designed around a number of independent modules that can be easily com-

bined in a variety of ways.

• Manufacturing tasks should also be designed and performed as independent modules that can

be relocated or rearranged to support new production requirements.

• The product supply process must perform two functions. First, it must cost‐effectively supply

the basic product to the locations that complete the customization activities. Second, it must

have the requisite flexibility to process individual customers’ orders.

HP has discovered that modular design provides three primary benefits. First, components

that differentiate the product can be added during the later stages of production. This method of

mass customization, generally called postponement, is one form of the assemble‐to‐order pro-

duction process, discussed in more detail in Chapter 3. For example, the company designed its

printers so that country‐specific power supplies are combined with the printers at local distribu-

tion centers and actually plugged in by the customer when the printer is set up. Second, produc-

tion time can be significantly reduced by simultaneously producing the required modules. Third,

producing in modules facilitates the identification of production and quality problems.

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18 Operations and Supply Chain Strategy for Competitiveness

1.2.7 Responsiveness

The competitive advantages of faster, dependable response to new markets or to the individual

customer’s needs have occasionally been noted in the business media (Eisenhardt and Brown

1998; Stalk 1988; Vessey 1991). For example, in a study of the US and Japanese robotics indus-

try, the National Science Foundation found that the Japanese tend to be about 25 percent faster

than Americans, and to spend 10 percent less, in developing and marketing new robots. The major

difference is that the Americans spend more time and money on marketing, whereas the Japanese

spend five times more than the Americans on developing more efficient production methods.

Table 1.2 identifies a number of prerequisites for and advantages of fast, dependable re –

sponse. These include higher quality, faster revenue generation, and lower costs through elimina-

tion of overhead, reduction of inventories, greater efficiency, and fewer errors and scrap. One of

the most important but least recognized advantages for managers is that by responding faster,

they can allow a customer to delay an order until the exact need is known. Thus, the customer

does not have to change the order—a perennial headache for most operations managers.

Faster response to a customer also can, up to a point, reduce the unit costs of the product or

service, sometimes significantly. On the basis of empirical studies reported by Meredith et al.

(1994) and illustrated in Figure 1.6, it seems that there is about a 2:1 (i.e., 0.50) relationship between

response time and unit cost. That is, starting from typical values, an 80 percent reduction in response

time results in a corresponding 40 percent reduction in unit cost. The actual empirical data indi-

cated a range between about 0.60 and 0.20, so for an 80 percent reduction in response time, there

could be a cost reduction from a high of 0.60 × 80 percent = 48 percent to a low of 16 percent.

This is an overwhelming benefit because if corresponding price reductions are made, it

improves the value delivered to the customer through both higher responsiveness and lower price.

The result for the producer is a much higher market share.

If the producer chooses not to reduce the price, then the result is both higher margins and

higher sales, for significantly increased profitability.

■ TABLE 1.2 Prerequisites for and Advantages of Rapid Response

1

2

3

4

5

6

7

8

9

10

Sharper focus on the customer. Faster response for both standard‐ and custom‐designed
items places the customer at the center of attention

Better management. Attention shifts to management’s real job, improving the firm’s
infrastructure and systems

Efficient processing. Efficient processing reduces inventories, eliminates nonvalue‐added
processing steps, smoothes flows, and eliminates bottlenecks

Higher quality. Since there is no time for rework, the production system must be sufficiently
improved to make parts accurately, reliably, consistently, and correctly

Elimination of overhead. More efficient, faster flows through fewer steps eliminate the
overhead needed to support the remaining steps, processes, and systems

Improved focus. A customer‐based focus is provided for strategy, investment, and general
attention (instead of an internal focus on surrogate measures such as utilization)

Reduced changes. With less time to delivery, there is less time for changes in product mix,
engineering changes, and especially changes to the order by the customer who just wanted
to get in the queue in the first place

Faster revenue generation. With faster deliveries, orders can be billed faster, thereby
improving cash flows and reducing the need for working capital

Better communication. More direct communication lines result in fewer mistakes, oversights,
and lost orders

Improved morale. The reduced processing steps and overhead allow workers to see the
results of their efforts, giving a feeling of working for a smaller firm, with its greater visibility
and responsibility

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191.3 Strategy and Competitiveness

1.3 Strategy and Competitiveness
Competitiveness can be defined in a number of ways. We may think of it as the long‐term viabil-

ity of a firm or organization, or we may define it in a short‐term context such as the current suc-

cess of a firm in the marketplace as measured by its market share or its profitability. We can also

talk about the competitiveness of a nation, in the sense of its aggregate competitive success in all

markets. The US President’s Council on Industrial Competitiveness gave this definition in 1985:

Competitiveness for a nation is the degree to which it can, under free and fair market conditions,
produce goods and services that meet the test of international markets while simultaneously maintain-
ing and expanding the real incomes of its citizens.

1.3.1 Global Trends

The United States provides a graphic example of global trade trends. The trend in merchandise

trade for the United States is startling. Although some might think that foreign competition has

been taking markets away from US producers only in the past decade, US merchandise imports

have grown considerably for over 30 years. Although exports have increased over this period as

well, they have not increased as fast as imports; the result is an exploding trade deficit with for-

eign countries. Partly as a result of this deficit, the United States is now the biggest debtor nation

in the world, with a cumulative deficit of about $5 trillion, nearly half of the US annual gross

domestic product (GDP), and an annual deficit running about 6 percent of GDP. However, these

values hold only for the period up to mid‐2008, when the global financial/credit/recession crisis

started. It now appears that all these figures will become much worse—not for just the United

States, but globally.

Another important issue relating to the financial crisis involves the exchange rate between

currencies. Let’s consider in more detail what it means when a country’s currency declines in

value relative to foreign currencies. A weaker currency means that citizens in that country will

have to pay more for products imported from foreign countries. Meanwhile, the prices for prod-

ucts produced in that country and exported to foreign countries will decline, making them more

desirable. Thus, a decline in the value of a country’s currency is a double‐edged sword. Such a

decline makes imported goods more expensive for citizens to purchase but at the same time makes

exports less expensive for foreign consumers, increasing the demand for domestic products.

20 40 60

Percentage change in response time

P
e
rc

e
n
ta

g
e
c

h
a
n
g
e
i

n
c

o
st

80 100

20

40

60

80

100

Approximation

Lower range
Upper range

FIGURE 1.6

Cost reductions with

decreases in response

time.

Meridth-c01.indd 19 11/5/2015 4:15:37 PM

20 Operations and Supply Chain Strategy for Competitiveness

As an example, let’s consider the American dollar. In the financial crisis of 2008, the dollar

grew stronger as Americans sold foreign assets and foreigners rushed to hold assets in the dollar,

the world’s strongest currency, as well as a “reserve” (commodities are priced in dollars) cur-

rency. However, given the massive amount of dollars, the US government borrowed and created

to overcome the financial crisis, there is widespread concern that the dollar may weaken or even

collapse in the future.

According to economic theory, a stronger dollar should make American products less

desirable (or competitive) in foreign markets and imports more desirable in American markets.

However, some market actions that governments and businesses often take to keep from losing

customers can alter this perfect economic relationship. For instance, in the 1990s, when the price

of Japanese products in the United States started increasing in terms of dollars, Japanese firms

initiated huge cost‐cutting drives to reduce the cost (and thereby the dollar price) of their prod-

ucts, to keep from losing American customers, which was largely successful. Similarly, China

controls the exchange rate of its currency, the renminbi, to stay at about 7 to the dollar (though

they have been letting it strengthen recently), so it always sells its goods at a competitive price.

In the last decade, particularly with the economic rise of China and India, global markets,

manufacturers, and service producers have evolved in a dramatic manner. With the changes

occurring in the World Trade Organization (WTO), international competition has grown very

complex in the last two decades. Previously, firms were domestic, exporters, or international.

A domestic firm produced and sold in the same country. An exporter sold goods, often someone

else’s, abroad. An international firm sold domestically produced as well as foreign‐produced

goods both domestically and in foreign countries. However, domestic sales were usually pro-

duced domestically, and foreign sales were made either in the home country or in a plant in the

foreign country, typically altered to suit national regulations, needs, and tastes.

Now, however, there are global firms, joint ventures, partial ownerships, foreign subsidiar-

ies, and other types of international producers. For example, Canon is a global producer that sells

a standard “world‐class” camera with options and add‐ons available through local dealers. And

automobile producers frequently own stock in foreign automobile companies. Mazak, a fast‐

growing machine tool company, is the US subsidiary of Yamazaki Machinery Company of Japan.

Part of the reason for cross‐ownerships and cross‐endeavors is the spiraling cost of bringing out

new products. New drugs and memory chips run in the hundreds of millions to billions of dollars

to bring to market. By using joint ventures and other such approaches to share costs (and thereby

lower risks), firms can remain competitive.

Whether to build offshore, assemble offshore, use foreign parts, employ a joint venture, and

so on is a complex decision for any firm and depends on a multitude of factors. For example, the

Japanese have many of their automobile manufacturing plants in foreign countries. The reasons

are many and include to circumvent foreign governmental regulation of importers, to avoid the

high yen cost of Japanese‐produced products, to avoid import fees and quotas, and to placate

foreign consumers. Of course, other considerations are involved in producing in foreign coun-

tries: culture (e.g., whether women are part of the labor force), political stability, laws, taxes,

regulations, and image.

Other complex arrangements of suppliers can result in hidden international competition.

For example, many products that bear an American nameplate have been totally produced and

assembled in a foreign country and are simply imported under a US manufacturer’s or retailer’s

nameplate, such as Nike shoes. Even more confusing, many products contain a significant pro-

portion of foreign parts or may be composed entirely of foreign parts and only assembled in the

United States (e.g., toasters, mixers, and hand tools). This recent strategic approach of finding the

best mix of producers and assemblers to deliver a product or service to a customer has come to

be known as “supply chain management,” a topic we discuss in detail in Chapters 5 and 6.

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211.3 Strategy and Competitiveness

1.3.2 Strategy

The organization’s business strategy is a set of objectives, plans, and policies for the organization

to compete successfully in its markets. In effect, the business strategy specifies what an organiza-

tion’s competitive advantage will be and how this advantage will be achieved and sustained

through the decisions the organization’s business units make in the future. A key element of the

business strategy is determining the window of opportunity for executing this strategy before

competitors do the same. The strategic plan that details this business strategy is typically formu-

lated at the executive committee level (CEO, president, vice presidents) and is usually long range,

at least three to five years.

In fact, however, the actual decisions that are made over time become the long‐range

strategy. In too many firms, these decisions show no pattern at all, reflecting the truth that they

have no active business strategy, even if they have gone through a process of strategic planning.

In other cases, these decisions bear little or no relationship to the organization’s stated or offi-

cial business strategy. The point is that an organization’s actions tell more about its true busi-

ness strategy, or the lack thereof, than its public statements.

But devising a winning strategy is only the first step in being competitive. The organization

and its various business units still need to successfully implement this strategy, and that is where

so many fail. It is now clear that more organizational strategies fail not so much for being a poor

strategy but instead for poor execution. As Morgan, Levitt, and Malek note in their widely her-

alded book, “Executing your Strategy; How to Break it Down and Get it Done” (Morgan et al.

2007, p. 1), “Corporations spend about $100 billion a year on management consulting and train-

ing, most of it aimed at creating brilliant strategy. Yet studies have found that . . . something like

90 percent of companies consistently fail to execute strategies effectively.” They confirm that

thousands of such strategies fail every year because of poor execution.

DILBERT: © Scott Adams/Dist. by United Feature Syndicate, Inc.

Executing a winning strategy is a major project that must be implemented within a limited

time, taking substantial resources and experienced talent, the province of project management
(Meredith et al. 2015). Unfortunately, as Morgan et al. point out, top managers consider the tedi-

ous work of project management as “too ‘tactical’ to take up their precious time . . . leaving the

grunt work of execution to the lower echelons. Nothing could be further from the truth . . . that is

precisely where strategy goes awry.” (p. 2, 4). Morgan et al. suggest that a simple test of this

failure in perspective of top executives is to examine the set of projects—the project portfolio—to

see whether it is aligned with the organization’s stated strategy or not. The execution of strategic

initiatives through project management will be dealt with in the next chapter of this first part of

the book concerning strategy and execution.

Meridth-c01.indd 21 11/5/2015 4:15:37 PM

22 Operations and Supply Chain Strategy for Competitiveness

1.3.3 Strategic Frameworks

We now move to a discussion of the business unit strategies organizations employ to support the

overall strategy of the organization. Clearly, the business unit strategies are also projects—there

will be a marketing strategy, a financial strategy, an R&D strategy, and so on. Here, of course, we

are interested in the operations and supply chain strategy. As it happens, there are a number of

fairly well‐defined such strategies. One that is common to many of the functional areas is related

to the life cycle of the organization’s products or services.

The Life Cycle

A number of functional strategies are tied to the stages in the standard life cycle of products and

services, shown in Figure 1.7. Studies of the introduction of new products indicate that the life

cycle (or stretched S growth curve, as it is also known) provides a good pattern for the growth of

demand for a new output. The curve can be divided into three major segments: (1) introduction

and early adoption, (2) acceptance and growth of the market, and (3) maturity with market satura-

tion. After market saturation, demand may remain high or decline, or the output may be improved

and possibly start on a new growth curve.

The length of product and service life cycles has been shrinking significantly in the last

decade or so. In the past, a life cycle might have been five years, but it is now six months. This

places a tremendous burden on the firm to constantly monitor its strategy and quickly change a

strategy that becomes inappropriate to the market.

The life cycle begins with an innovation—a new output or process for the market, as dis-

cussed earlier. The innovation may be a patented product or process, a new combination of exist-

ing elements that has created a unique product or process, or some service that was previously

unavailable. Initial versions of the product or service may change relatively frequently; produc-

tion volumes are small, since the output has not caught on yet; and margins are high. As volume

increases, the design of the output stabilizes and more competitors enter the market, frequently

with more capital‐intensive equipment. In the mature phase, the now high‐volume output is a

virtual commodity, and the firm that can produce an acceptable version at the lowest cost usually

controls the market.

Clearly, a firm’s business strategy should match the life‐cycle stages of its products and

services. If a firm such as HP is good at innovation, it may choose to focus only on the introduc-

tion and acceptance phases of the product’s life cycle and then sell or license production to others

as the product moves beyond the introduction stage. If its strength is in high‐volume, low‐cost

production, the company should stick with proven products that are in the maturity stage. Most

Introduction

D
e
m

a
n
d

Growth Maturity

Time
FIGURE 1.7

The life‐cycle curve.

Meridth-c01.indd 22 11/5/2015 4:15:39 PM

231.3 Strategy and Competitiveness

common, perhaps, are firms that attempt to stick with products throughout their life cycle, chang-

ing their strategy with each stage.

One approach to categorizing an organization’s business strategy is based on its timing of

introductions of new outputs. Two researchers, Maidique and Patch (1979), suggest the following

four product development strategies:

1. First‐to‐market. Organizations that use this strategy attempt to have their products available

before the competition. To achieve this, strong applied research is needed. If a company is

first‐to‐market, it has to decide if it wants to price its products high and thus skim the market

to achieve large short‐term profits or set a lower initial price to obtain a higher market share

and perhaps larger long‐term profits.

2. Second‐to‐market. Organizations that use this strategy try to quickly imitate successful out-

puts offered by first‐to‐market organizations. This strategy requires less emphasis on applied

research and more emphasis on fast development. Often, firms that use the second‐to‐

market strategy attempt to learn from the mistakes of the first‐to‐market firm and offer

improved or enhanced versions of the original products.

3. Cost minimization or late‐to‐market. Organizations that use this strategy wait until a product

becomes fairly standardized and is demanded in large volumes. They then attempt to com-

pete on the basis of costs as opposed to features of the product. These organizations focus

most of their R&D on improving the production process, as opposed to focusing on product

development.

4. Market segmentation. This strategy focuses on serving niche markets with specific needs.

Applied engineering skills and flexible manufacturing systems are often needed for the

market‐segmentation strategy.

Be aware that a number of implicit trade‐offs are involved in developing a strategy. Let us

use the first‐to‐market strategy to demonstrate. A first‐to‐market strategy requires large invest-

ments in product development in an effort to stay ahead of the competition. Typically, organiza-

tions that pursue this strategy expect to achieve relatively higher profit margins, larger market

shares, or both as a result of initially having the market to themselves. The strategy is somewhat

risky because a competitor may end up beating them to the market. Also, even if a company suc-

ceeds in getting to the market first, it may end up simply creating an opportunity for the competi-

tion to learn from its mistakes and overtake it in the market. To illustrate, although Sony introduced

its Betamax format for VCRs in 1975, JVC’s VHS format—introduced the following year—is the

standard that ultimately gained widespread market acceptance.

Such trade‐offs are basic to the concept of selecting a business strategy. Although specific

tasks must be done well to execute the selected strategy, not everything needs to be particularly

outstanding—only a few things. And, of course, strategies based on anything else—acquisitions,

mergers, tax loss carry‐forwards, even streams of high‐technology products—will not be suc-

cessful if the customer is ignored in the process.

Performance Frontiers

As we know from the earlier “Customer Value” section, there are a wide range of benefits and

costs that organizations can compete on and various groups of customers value. If, say, n of these

factors are important for an organization to consider, we might then conceive of a graph or space

with n dimensions on it showing the organization’s measures on each of the n factors as well as

their competitors’ measures. The curve connecting all these measures would then be called the

organization’s performance frontier (Clark 1996). For simplicity, let us use just two factors, say,

cost and variety, as shown in Figure 1.8, with the performance frontier curve labeled 1.

Meridth-c01.indd 23 11/5/2015 4:15:39 PM

24 Operations and Supply Chain Strategy for Competitiveness

As illustrated by the points A, B, and C, improvement on one dimension can usually only

be attained by sacrificing performance on another dimension. For example, as shown in Figure 1.8,

increasing output variety may result in higher unit costs. In effect, this curve represents the level

of performance that organizations in an industry can achieve across two dimensions given the

technology available at a given point in time. According to the figure, company A is apparently

pursuing more of a customization strategy than the two other competitors shown, offering a wider

variety of outputs but incurring greater cost. We might think of a high end furniture store as per-

haps fitting point A. Company C, perhaps Costco, seems to be pursuing a standardization strat-

egy, offering a smaller range of furniture but incurring lower unit costs.

An interesting use of this framework is to investigate and evaluate the impact of a change

in technology or operational innovation (Hammer 2004). For example, in Figure 1.9, assume a

new innovation such as “cross‐docking” has been developed by company B, perhaps represented

by Wal‐Mart, shifting its performance frontier to curve 2. In this case, company B could hold its

unit price constant and offer higher output variety than company A and at lower unit cost (posi-

tion B
1
). Alternatively, company B could maintain its current level of output variety and lower its

unit cost to levels below company C’s (position B
2
) or perhaps choose a position somewhere

between points B
1
and B

2
.

Suppose you were employed at company A and company B chose to operate at point B
1
. In

effect, company B can now offer a wider variety of outputs and at lower unit costs. What are your

options? As it turns out, there are two generic options or improvement trajectories company A

could try to follow. One improvement trajectory would be for company A to streamline its opera-

tions and make cost‐variety trade‐offs, moving down curve 1 toward company C. Upon stream-

lining its operations, company A could then attempt to adopt the new technology and choose a

position on the new frontier. A second improvement trajectory would be for company A to attempt

to directly adopt the new technology and move to the new frontier without streamlining its cur-

rent operations.

Output variety

U
n
it
c

o
st

C
B

A

1

FIGURE 1.8

Example performance

frontier.

Output variety

U
n
it
c

o
st

C
B

B2

B1

A
2

1

FIGURE 1.9

Development of new

technology results in

shift in the performance

frontier.

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251.3 Strategy and Competitiveness

There are advantages and disadvantages associated with both trajectories. An advantage of

streamlining operations first is that this might provide a better understanding of current processes.

In turn, this better understanding might increase company A’s options in choosing a location on

the new frontier and might even better position it to adopt the new technology. One drawback of

streamlining its current operations first is that the knowledge gained might be irrelevant when the

new technology is eventually adopted and delaying the adoption of the new technology might

mean reduced market share and profits. Another important factor is the amount of time required

to execute the improvement trajectory and get to the new position on the new performance fron-

tier. However, although it might appear that streamlining the current operation first before adopt-

ing the new technology should take more time than immediately adopting the technology, when

ease of implementation is considered, the former approach might in fact be more expedient.

On a more practical note, Kmart some years ago tried to challenge Wal‐Mart on low prices

but was unsuccessful. Then, Sears and Kmart merged instead, but that didn’t seem to work well

either; now, both seem to be in trouble.

One final point. In Figure 1.9, it was assumed that the result of the new technology/innova-

tion was simply a shift in the performance frontier. It is also important to be aware of the possibility

that a new technology can change the shape as well as the location of the performance frontier.

Such a change in shape can have important implications regarding choosing a location on the new

frontier as well as the nature of the trade‐off facing the industry. In either case, the way to beat your

competition is through developing or using new technology to move to a new frontier.

Focus

In the past, firms primarily competed on one factor, such as low cost or innovation, because that

was what they were good at. Obviously, they could not ignore the other factors of competition,

which they had to do acceptably on, but their heavy attention to their one strength was based on

a strategic framework called focus (Skinner 1974).

McKinsey & Company, a top management consulting firm, studied 27 outstanding firms to

find their common attributes. Two of the major attributes reported in Business Week are directly

related to focus:

1. Stressing one key business value. At Apple, the key value is developing innovative new prod-

ucts that are easy to use; at Dana Corporation, it is improving productivity.

2. Sticking to what they know best. All the outstanding firms define their core capabilities (or

strengths) and then build on them. They resist the temptation to move into new areas or

diversify.

When an organization chooses to stress one or two key areas of strength, it is referred to as

a focused organization. For example, IBM is known for its customer service, General Electric for

its technology, and Procter & Gamble for its consumer marketing. In general, most but not all

areas of focus relate to operations. Some firms, such as those in the insurance industry, focus on

financial strength and others focus on marketing strengths. For example, Harley‐Davidson con-

siders its strength to be in building relationships with its dealers and motorcycle owners. And

many health care organizations are achieving significant operational efficiencies by focusing on

a narrow range of ailments. For example, by treating only long‐term acute cases, Intensiva

HealthCare has been able to reduce its costs to 50 percent of those of a traditional intensive‐care

ward. Clearly, adopting a focus strategy means knowing not only what customers to concentrate

on but also knowing what customers you do not want.

Table 1.3 identifies several areas of focus that organizations commonly choose when form-

ing their competitive strategy; all are various forms of differentiation. Recent competitive behavior

among firms seems to be dividing most of the factors in Table 1.3 into two sets that Hill (2000), an

operations strategist and researcher in England, calls order qualifiers and order winners.

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26 Operations and Supply Chain Strategy for Competitiveness

An order qualifier is a characteristic of the product or service that is required if the product is even

to be considered or in the running. In other words, it is a prerequisite for entering the market. An

order winner is a characteristic that will win the bid or the purchase. These qualifiers and winners

vary with the market, of course, but some general commonalties exist across markets. For example,

response time, performance, customization, innovation, and price seem to be frequent order win-

ners, and the other factors (e.g., quality, reliability, and flexibility) tend to be order qualifiers.

Working with marketing and sales to properly identify which factors are which is clearly of major

strategic importance.

In addition to the advantages of being focused, there are also some dangers. A narrowly

focused firm can easily become uncompetitive in the market if the customers’ requirements

change. In addition to being focused, a firm must also be flexible enough to alter its focus when

the need changes and to spot the change in time. Frequently, a focus in one area can be used to an

advantage in another way if there is enough time to adapt—for example, to move into a new

product line or alter the application of the focus. Moreover, as products go through their life

cycle, the task of operations often changes, as shown in Figure 1.10, from being flexible enough

■ TABLE 1.3 Common Areas of Organizational Focus

Innovation. Bringing a range of new products and services to market quickly

Customization. Being able to quickly redesign and produce a product or service to meet customers’
unique needs

Flexibility of products and services. Switching between different models or variants quickly to satisfy
a customer or market

Flexibility of volume. Changing quickly and economically from low‐volume production to high
volumes and vice versa

Performance. Offering products and services with unique, valuable features

Quality. Having better craftsmanship or consistency

Reliability of the product or service. Always working acceptably, enabling customers to count on the
performance

Reliability of delivery. Always fulfilling promises with a product or service that is never late

Response. Offering very short lead times to obtain products and services

After‐sale service. Making available extensive, continuing help

Price. Having the lowest price

Introduction

S
a
le

s

Growth

Time

Maturity

Design changes

Quality

Performance

Volume

Capacity

Emphasis required

Price

FIGURE 1.10

Product life cycle: stages

and emphasis.

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271.3 Strategy and Competitiveness

to accept changes in design, to meeting the growing demand in the marketplace, and to cutting

costs. Throughout this life cycle, the focus of the organization has to change if it stays with the

same output. Many firms, however, choose to compete at only one stage of the life cycle and

abandon other stages so that they can keep the strength of their original focus.

An organization can also easily lose its focus. For example, in the traditional functional

organization, purchasing may buy the cheapest materials it can. This requires buying large quan-

tities with advance notice. Scheduling, however, is trying to reduce inventories, so it orders mate-

rials on short notice and in small quantities. Quality control is trying to improve the output, so it

carefully inspects every item, creating delays and extensive rework. In this example, each func-

tional department is pursuing its own objectives but is not focusing on how it can support the

organization’s overall business strategy.

However, the most common reason a firm loses its focus is simply that the focus was never

clearly identified in the first place. Never having been well defined, it could not be communicated

to the employees, could therefore not gain their support, and thus was lost. Sometimes a focus is

identified but not communicated throughout the organization because management thinks that

lower‐level employees don’t need to know the strategic focus of the firm in order to do their jobs.

The Sand Cone

For many organizations that relied on the focus framework of strategy, the traditional view was

that competing on one competitive dimension required trading off performance on one or more

other dimensions (e.g., higher quality results in higher costs). However, research suggests that, at

least in some cases, building strengths along alternative competitive dimensions may in fact be

cumulative and that building a strength on one dimension may facilitate building strengths on

other dimensions (Ferdows and De Meyer 1990).

Furthermore, according to this research, there is a preferred order in developing strengths

on various competitive dimensions. According to the sand cone model (as it is called), shown in

Figure 1.11, organizations should first develop the capability to produce quality outputs. Once an

organization has developed this proficiency, it is next appropriate to address the issue of delivery

dependability. Next, according to the model, the competitive dimensions of speed and cost should

be addressed, respectively.

In addition to providing guidance to organizations regarding the order in which to focus

their attention and initiatives, the model has intuitive appeal. For example, it makes little sense to

focus on improving delivery dependability before an organization can provide a consistent level

of quality. In today’s competitive marketplace, providing defective outputs in a timely fashion is

not a recipe for long‐term success.

Likewise, organizations should achieve consistent quality levels and delivery dependability

before attempting to reduce lead times. Of course, the model is not set in stone (remember that it

is called the sand cone) and organizations facing different circumstances may choose to address

the competitive dimensions in a different order.

Cost

Speed

Dependability

Quality

FIGURE 1.11

The sand cone model.

Adapted from Ferdows

and De Meyer 1990,

p. 175.

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28 Operations and Supply Chain Strategy for Competitiveness

1.3.4 Core Capabilities

One important result of developing a business strategy is identifying the organization’s core com-

petencies and capabilities that provide those product/service dimensions important to customers

and hence are the source of customer value. Core competencies (Prahalad and Hamel 1990) are

the collective knowledge and skills an organization has that distinguish it from the competition.

In effect, these core competencies become the building blocks for organizational practices and

business processes, referred to as core capabilities (Stalk et al. 1992). (Hereafter, we will refer to

both of these simply as “core capabilities.”) The importance of these core capabilities derives

from their strong relationship to an organization’s ability to integrate a variety of technologies

and skills in the development of new products and services. Clearly, then, one of the top manage-

ment’s most important activities is the identification and development of the core capabilities the

organization will need to successfully execute the business strategy.

In effect, core capabilities provide the basis for developing new products and services and

are a primary factor in determining an organization’s long‐term competitiveness. Hammer (2004)

points out the importance of “operational innovation” in the organization as one basis for sus-

tained competitive advantage, the clear result of a core capability. Therefore, two important parts

of strategic planning are identifying and predicting the core capabilities that will be critical to

sustaining and enhancing the organization’s competitive position. On this basis, an organization

can also assess its suppliers’ and competitors’ capabilities. If the organization finds that it is not

the leader, it must determine the cost and risks of catching up with the best versus the cost and

risks of losing that core capability.

Hayes and Pisano (1994) stress the importance of a firm not looking for “the” solution to a

current competitive problem but rather the “paths” to building one or two core capabilities to

provide the source of customer value for the indefinite future. Moreover, the firm should not think

in terms of “trade‐offs” between core capabilities (e.g., moving from flexibility as a strength to

low cost), but rather of “building” one capability on top of others and determining which set will

provide the most customer value.

Often, it is more useful to think of an organization in terms of its portfolio of core capabili-

ties, rather than its portfolio of businesses or products. For instance, Sony is known for its exper-

tise in miniaturization; 3M for its knowledge of substrates, coatings, and adhesives; Black and

Decker for small electrical motors and industrial design; Boeing for its ability to integrate large‐

scale complex systems; and Honda for engines and power trains. Had Sony initially viewed itself

as primarily a manufacturer of Walkmans, rather than as a company with expertise in miniaturiza-

tion, it might have overlooked several profitable opportunities, such as entering the camcorder

business. As another example, Boeing has successfully leveraged its core capability related to

integrating large‐scale systems in its production of commercial jetliners, space stations, fighter‐

bombers, and missiles.

As these examples illustrate, core capabilities are often used to gain access to a wide vari-

ety of markets. Canon used its core capabilities in optics, imaging, and electronic controls to

enter the markets for copiers, laser printers, cameras, and image scanners. In a similar fashion,

Honda’s core capabilities in engines and power trains comprise the basis for its entry into other

businesses: automobiles, motorcycles, lawn mowers, and generators.

In addition to providing access to a variety of markets, a core capability should be strongly

related to the benefits provided by the product or service that customers value. In Sony’s case, its

expertise in miniaturization translates directly into important product features such as portability

and aesthetic designs. Alternatively, suppose Sony developed a core competence in writing

understandable user manuals. Since people who purchase an HD TV or a camcorder rarely base

their purchase decision on the quality of the user manual (when was the last time you read a user

manual?), this core capability would provide little of any competitive advantage.

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291.3 Strategy and Competitiveness

Another characteristic of core capabilities is that they should be difficult to imitate. Clearly,

no sustainable competitive advantage is provided by a core capability that is easily imitated. For

example, Sony’s expertise in miniaturization would mean little if other electronics manufacturers

could match it simply by purchasing and taking apart Sony’s products (this is called reverse engi-
neering). Bartmess and Cerny (1996) identify three elements of a core capability that hinder

imitation:

• It is complex and requires organizational learning over a long period of time.

• It is based on multiple functional areas, both internal and external to the organization.

• It is a result of how the functions interact rather than the skills/knowledge within the functions

themselves.

The topic of core capabilities is also strongly related to the recent surge in outsourcing and

offshoring. Outsourcing involves subcontracting out certain activities or services. For example, a

manufacturer might outsource the production of certain components, the management and main-

tenance of its computer resources, employee recruitment, or the processing of its payroll.

When we consider the concept of core capability, it is important to recognize that not all

parts, services, and activities are equal. Rather, these activities and parts can be thought of as fall-

ing on a continuum ranging from strategically important to unimportant. Parts and activities are

considered strategically important when:

• They are strongly related to what customers perceive to be the key characteristics of the prod-

uct or service.

• They require highly specialized knowledge and skill, a core capability.

• They require highly specialized physical assets, and few other suppliers possess these assets.

• The organization has a technological lead or is likely to obtain one.

Activities that are not strategic or core are candidates for outsourcing. These parts or activi-

ties are not strongly linked to key product characteristics, do not require highly specialized

knowledge, and do not need special physical assets, and the organization does not have the tech-

nological lead in this area. Thus, if it is beneficial to outsource these parts or activities—perhaps

because of lower cost or higher quality—no loss in competitiveness should result. On the other

hand, when a firm’s strategic parts and activities have been outsourced, particularly to a foreign

supplier, called offshoring, the firm has become hollow (Jonas 1986). As we have stated, the wise

firm will outsource only nonstrategic, simple, relatively standard parts and processes such as

screws or types of processes that are not worth the time for the firm to produce itself; the com-

plex, proprietary parts and processes that give their products an edge in the marketplace are

produced internally. If the firm outsources these parts and processes as well, it soon finds that the

engineering design talent follows the production of the part outside the firm, too, and its core

capabilities have been lost. Then, the firm has been hollowed out, becoming merely a distributor

of its supplier’s products.

Given the huge potential effects of outsourcing, both positive and negative, a firm should

consider such a move very carefully. Management needs to think about both the long‐term and

short‐term effects. They also need to consider the impact of this decision on their core capabili-

ties and everything else they do within the company. Such a major decision as outsourcing will

affect other decisions as well, such as sourcing materials, hiring/releasing labor and management,

marketing, finance, and a wide range of other areas.

So what is the problem? If a supplier can deliver the parts at lower cost and better quality

when they are needed, why not use the supplier? The problem is that the supplier gains the

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30 Operations and Supply Chain Strategy for Competitiveness

expertise (and core capabilities) to produce the critical parts you need, and as Hayes and Pisano

(1994), among others, note, organizations quickly forget how they produced those critical

parts. After a while, when the supplier has improved on the process and you have forgotten

how to make the parts, it is likely to start competing with you, producing the products you have

been selling and dropping you as a customer. This is even more dangerous if, as already noted,

the product and transformation system has also been hollowed out, following the production

activities to the supplier. This happened extensively in the television industry, where the

Japanese learned first how to produce and then how to engineer black‐and‐white and, later,

color television sets. They then started tentatively introducing their own brands, to see if US

customers would buy them. Their products were inexpensive, of high quality, and caught on

quickly in the free‐enterprise American markets. The Japanese and Koreans now virtually con-

trol this industry.

E X P A N D Y O U R U N D E R S T A N D I N G

1. Why is it so hard to increase productivity in the service

sector?

2. Identify other major differences between services and prod-

ucts in addition to those listed in Table 1.1.

3. Many foreign firms have been successful in the following

areas: steel, autos, cameras, and televisions. Are services more

protected from foreign competition? How?

4. It is commonly said that Japanese firms employ 10 times as

many engineers per operations worker as US firms and 10

times fewer accountants. What effect would you expect this to

have on their competitiveness? Why?

5. How might the concept of a “facilitating good” alter the way

we perceive a product? A service?

6. Is it wise for a firm to stick to what it knows best, or should it

expand its market by moving into adjoining products or ser-

vices? How can it avoid losing its focus?

7. Can you think of any other areas of possible focus for a firm

besides those identified in Table 1.3?

8. What core capabilities do you think China possesses? India?

Japan? The United States?

9. According to K. Blanchard and N. V. Peale (The Power of
Ethical Management, New York: Morrow, 1988), the follow-

ing three ethical tests may be useful: (1) Is it legal or within

company policy? (2) Is it balanced and fair in the short and

long term? (3) Would you be proud if the public or your fam-

ily knew about it?

Apply these tests to the following situations:

a. A foreign firm subsidizes its sales in another country.

b. A foreign firm dumps its products (sells them for less than

cost) in another country.

c. A country imports products that, had they been made

domestically, would have violated domestic laws (e.g.,

laws against pollution).

10. In responding faster to customers’ needs, where might the

cost savings come from? What benefits would result?

11. Can you think of companies that have moved the performance

frontier of their industries?

12. Why do Americans invest more in marketing new products

while the Japanese invest more in engineering? What advan-

tages accrue to each investment?

13. Using new technologies, it is not uncommon for firms to cut

their response times by a factor of 10. What effect would you

expect this to have on their unit costs?

14. What are the order winners and order qualifiers for Wal‐Mart?

Toyota? BMW? Sony?

15. Given the recent trends in products and services, does the

focus strategy or sand cone strategy seem most applicable

these days?

16. Why don’t we see more mass customization in products and

services?

Meridth-c01.indd 30 11/5/2015 4:15:46 PM

31Apply your Understanding

A P P LY Y O U R U N D E R S T A N D I N G
■ IZMIR NATIONAL UNIVERSITY

Izmir National University (INU) was chartered in 2010

to facilitate Turkey ’ s expected eventual entry into the

economy of Europe, via the EU. To foster growth and

development in the European economy, engineering, sci-

ence, and business were deemed to be the institution ’ s

primary areas of intellectual endeavor. The university

grew rapidly during its first three years. By 2015, the

enrollment had reached just over 9300 students. However,

with this rapid growth came a number of problems. For

example, because the faculty had to be hired so quickly,

there was little real organization, and curriculum seemed

to be decided on the basis of which adviser a student

happened to consult. The administrative offices were

often reshuffled, with vague responsibilities and short

tenures.

The faculty of the new Business School was typi-

cal of the confusion that gripped the entire university.

The 26 faculty members were mostly recent graduates of

doctoral programs at major European and Turkish uni-

versities. There were 21 Assistant Docents and Lecturers,

3 Docents, and 2 full Professors, spread fairly evenly

over the four departments, each overseen by a Kürsü pro-

fessor (department head). In addition, funds were avail-

able to hire three additional faculty members, either

assistant or regular Docents. The background of the

newly recruited Dekan (administrative head, dean) of the

Business School included five years of teaching at a pri-

marily Muslim university in Turkey and two years of

departmental administration at a large southern European

university.

Upon arriving at the Business School, the Dekan

asked the faculty to e‐mail their concerns to her so that

she could begin to get a handle on the major issues con-

fronting the school. Her office assistant selected the fol-

lowing comments as representative of the sentiments

expressed:

• “Our student–teacher ratio is much higher than what it

was at my former university. We need to fill those open

slots as quickly as possible and ask the university to

fund at least two more faculty positions.”

• “If we don ’ t get the quality of enrollments up in the

MBA program, the graduate school will never approve

our application for a doctoral program. We need the doc-

toral program to attract the best faculty, and we need the

doctoral students to help cover our courses.”

• “Given that research is our primary mission, we need to

fund more graduate research assistants.”

• “The travel budget isn ’ t sufficient to allow me to attend

the meetings I ’ m interested in. How can we improve and

maintain our visibility if we get funding for only one

meeting per year?”

• “We need better staff support. Faculty members are

required to submit their exams for copying five days

before they are needed. However, doing this makes it dif-

ficult to test the students on the material covered in class

right before the exam, since it ’ s difficult to know ahead

of time exactly how much material we will cover.”

• “I think far too much emphasis is placed on research. We

are here to teach.”

• “Being limited in our consulting is far too restrictive. In

Europe, we were allowed one day a week. How are we

supposed to stay current without consulting?”

• “We need a voice mail system. I never get my important

messages.”

Questions

1. What do the comments by the faculty tell you about

INU ’ s strategy?

2. What would you recommend the Dekan do regarding the

Business School ’ s strategic planning process? What role

would you recommend the Dekan play in this process?

3. Productivity is defined as the ratio of output (including

both goods and services) to the input used to produce it.

How could the productivity of the Business School be

measured? What would the effect be on productivity if

the faculty all received a 10 percent raise but continued

to teach the same number of classes and students?

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32 Operations and Supply Chain Strategy for Competitiveness

■ TARACARE, INC.

Taracare, Inc. operates a single factory in Ensenada,

Mexico, where it fabricates and assembles a wide range

of outdoor furniture for the US market, including chairs,

tables, and matching accessories. Taracare ’ s primary

production activities include extruding the aluminum

furniture parts, bending and shaping the extruded parts,

finishing and painting the parts, and then assembling the

parts into completed furniture. Upholstery, glass table-

tops, and all hardware are purchased from outside

suppliers.

Jorge Gonzalez purchased Taracare in 2011.

Before that, Jorge had distinguished himself as a top

sales rep of outdoor furniture for the western region of

one of the leading national manufacturers. However,

after spending 10 years on the road, he wanted to settle

down and spend more time with his family back in

Mexico. After searching for a couple of months, he

came across what he believed to be an ideal opportunity.

Not only was it in an industry that he had a great deal of

knowledge about, but he would be his own boss.

Unfortunately, the asking price was well beyond Jorge ’ s

means. However, after a month of negotiation, Jorge

convinced Jesus Garza, Taracare ’ s founder, to maintain

a 25 percent stake in the business. Although Jesus had

originally intended to sell out completely, he was

impressed with Jorge ’ s knowledge of the business, his

extensive contacts, and his enthusiasm. He therefore

agreed to sell Jorge 75 percent of Taracare and retain

25 percent as an investment.

Jorge ’ s ambition for Taracare was to expand it

from a small regional manufacturer to one that sold to

major national retailers. To accomplish this objective,

Jorge ’ s first initiative was to triple Taracare ’ s sales force

in 2012. As sales began to increase, Jorge increased the

support staff by hiring an accountant, a comptroller, two

new designers, and a purchasing agent.

By mid‐2015, Taracare ’ s line was carried by sev-

eral national retailers on a trial basis. However, Taracare

was having difficulty both in meeting the deliveries its

sales reps were promising and in satisfying the national

retailers ’ standards for quality. To respond to this prob-

lem, Jorge hired Alfredo Diaz as the new manufacturing

manager. Before accepting Jorge ’ s offer, Alfredo was the

plant manager of a factory that manufactured replace-

ment windows sold by large regional and national

retailers.

After several months on the job—and after making

little progress toward improving on‐time delivery and

quality—Alfredo scheduled a meeting with Jorge to discuss

his major concerns. Alfredo began:

I requested this meeting with you, Jorge, because I am not
satisfied with the progress we are making toward improving
our delivery performance and quality. The bottom line is that
I feel I ’ m getting very little cooperation from the other
department heads. For example, last month purchasing
switched to a new supplier for paint; and although it is true
that the new paint costs less per gallon, we have to apply
a thicker coat to give the furniture the same protection. I
haven ’ t actually run the numbers, but I know it is actually
costing us more, in both materials and labor.

Another problem is that we typically run a special promotion
to coincide with launching new product lines. I understand
that the sales guys want to get the product into the stores as
quickly as possible, but they are making promises about deliv-
ery that we can ’ t meet. It takes time to work out the bugs and
get things running smoothly. Then, there is the problem with
the designers. They are constantly adding features to the
product that make it almost impossible for us to produce.
At the very least, they make it much more expensive for us to
produce. For example, on the new “Destiny” line, they
designed table legs that required a new die at a cost of 250,000
pesos. Why couldn ’ t they have left the legs alone so that we
could have used one of our existing dies? On top of this, we
have the accounting department telling us that our equipment
utilization is too low. Then, when we increase our equipment
utilization and make more products, the finance guys tell us
we have too much capital tied up in inventory. To be honest,
I really don ’ t feel that I ’ m getting very much support.

Rising from his chair, Jorge commented:

You have raised some important issues, Alfredo. Unfortunately,
I have to run to another meeting right now. Why don ’ t you
send me a memo outlining these issues and your recommen-
dations? Then, perhaps, I will call a meeting and we can dis-
cuss these issues with the other department heads. At least
our production problems are really no worse than those of
our competitors, and we don ’ t expect you to solve all of our
problems overnight. Keep up the good work and send me that
memo at your earliest convenience.

Meridth-c01.indd 32 11/5/2015 4:15:46 PM

33Apply your Understanding

Questions

1. Does Alfredo ’ s previous experience running a plant

that made replacement windows qualify him to run a

plant that makes outdoor furniture?

2. What recommendations would you make if you were

Alfredo?

3. Given Jorge ’ s background and apparent priorities, how

is he likely to respond to Alfredo ’ s recommendations?

On the basis of this likely response, is it possible to

rephrase Alfredo ’ s recommendations so they are more

appealing to Jorge?

Meridth-c01.indd 33 11/5/2015 4:15:46 PM

34

chapter

2
Executing Strategy: Project
Management

CHAPTER IN PERSPECTIVE

In the last chapter, we discussed the importance of successfully implementing the
organization’s strategic plans. Such efforts are executed through major projects
involving changes in the organization’s systems and procedures. In this chapter,
we address the management of such projects. We use a process improvement
project as an example, but projects are used in all kinds of organizations for every
conceivable purpose. They range from simple combinations of tactical tasks to
strategic organizational change and from setting up a party to putting a person
on the moon.

The chapter begins with a discussion of the crucial topics of project selection,
project planning, and organizing the project team. We then move on to an expla-
nation of some project scheduling techniques, showing some typical project man-
agement software printouts that are available to project managers. The chapter
continues with a discussion of controlling project cost and performance, primarily
through the use of “earned value,” and then concludes with a brief description of
Goldratt’s “critical chain.”

Introduction

Meridth-c02.indd 34 10/29/2015 3:23:25 PM

35Introduction

Meridth-c02.indd 35 10/29/2015 3:23:25 PM

36 Executing Strategy: Project Management

right
won’t

Meridth-c02.indd 36 10/29/2015 3:23:25 PM

372.1 Defining a Project

2.1 Defining a Project

process
process

project

stakeholders

how

Meridth-c02.indd 37 10/29/2015 3:23:25 PM

38 Executing Strategy: Project Management

production

assembly
scheduling control

2.2 Planning the Project

project portfolio

2.2.1 The Project Portfolio

aggre-
gate project plan

Meridth-c02.indd 38 10/29/2015 3:23:25 PM

392.2 Planning the Project

distribution

set

1. Derivative projects

R & D
projects

Extensive
process
changes

Extensive
product
changes

Minor
process
changes

Minor
product
changes

Platform projects

Derivative
projects

Breakthrough
projects

FIGURE 2.1

The aggregate project

plan.

Meridth-c02.indd 39 10/29/2015 3:23:26 PM

40 Executing Strategy: Project Management

2. Breakthrough projects

3. Platform projects
platform

4. R&D projects

manage

Extensive
process
changes

Extensive
product
changes

Minor
process
changes

Minor
product
changes

FIGURE 2.2

An example aggregate

project plan.

Meridth-c02.indd 40 10/29/2015 3:23:26 PM

412.2 Planning the Project

2.2.2 The Project Life Cycle

a

b

Time

(a)

Project
initiation

Project
implementation

Project
termination

%
p

ro
je

c
t

c
o
m

p
le

ti
o
n

Time

(b)

Project
initiation

Project
implementation

Project
termination

%
p

ro
je

c
t

c
o
m

p
le

ti
o
n

FIGURE 2.3

Two project life cycles.

(a) stretched‐S.

(b) exponential.

Meridth-c02.indd 41 10/29/2015 3:23:26 PM

42 Executing Strategy: Project Management

2.2.3 Projects in the Organizational Structure

2.2.4 Organizing the Project Team

Meridth-c02.indd 42 10/29/2015 3:23:26 PM

432.2 Planning the Project

1. Credibility

2. Sensitivity

3. Leadership, ethics, and managerial style

4. Ability to handle stress

2.2.5 Project Plans

project
charter project plan

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44 Executing Strategy: Project Management

Purpose

Objectives

Overview

Schedule and milestones

Resources project budget

Stakeholders

team

Risk management plan

Evaluation method

Meridth-c02.indd 44 10/29/2015 3:23:26 PM

452.2 Planning the Project

work breakdown structure
project schedule

project Gantt chart

Performance
(“scope”)

Target

Time
(“schedule”)

Cost

Required performance

Budget limit

Due date

FIGURE 2.4

Three project objectives.

Reprinted with

permission from

J. Meredith,

S. J. Mantel, Jr., and

S. M. Shafer, Project

Management: A

Managerial Approach,

9th ed. New York:

Wiley, 2015.

E.

Implement and

start-up

A.

Determine

need

B.

Solicit

quotations

C.

Appropriation

request

Quick Response Teams

D.

Purchase

resources

2.

Equipment

1.

Order

3.

Write

2.

$

1.

Contacts

2.

Where

1.

Benefit

3.

Materials

1.

Hire

3.

Test

2.

Train
1.

Equipment
FIGURE 2.5

Work breakdown

structure.

Meridth-c02.indd 45 10/29/2015 3:23:26 PM

46 Executing Strategy: Project Management

program evaluation and review technique critical path method

Planning precede

Scheduling when can
must critical

slack

2.3 Scheduling the Project

Responsibility

Project OfficeWBS

Subproject Task

A1 A

A

I A

I

I R

C I

C

C

R C

C

I

I

R

A

R

A

R

R

C

C

R

A2

B1

C1

C2

C3

Project

Manager

Contract

Admin.

Program

Mgr.

Portfolio

Mgr.

Field

Manager

Field Oper.

Determine

need

Solicit

quotations

Write approp.

request.

Legend:
Responsible

Consult

Inform

”

”

”

”

”

”

A Approval

FIGURE 2.6 Linear

responsibility chart or

RACI matrix. Reprinted

with permission

from J. Meredith,

S. J. Mantel, Jr., and

S. M. Shafer, Project

Management:

A Managerial Approach,

9th ed. Hoboken, NJ:

Wiley, 2015.

Meridth-c02.indd 46 10/29/2015 3:23:27 PM

472.3 Scheduling the Project

Activity

Event

Network
nodes

Path

Critical path

Critical activities

2.3.1 Project Scheduling with Certain Activity Times: A Process
Improvement Example

activity completion times durations

Project Completion and Critical Paths

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48 Executing Strategy: Project Management

early start times T early finish times T
T T

T T

■ TABLE 2.1 Data for a Bank’s Mortgage Refinancing Project

Activity Expected time, t
e
Preceding activities

A: Identify all stakeholders

B: Develop the project charter

C: Uncover all relevant regulations

D: Set up project procedures

E: Determine total refinancing time

F: Use accounting data for total cost

G: Interview to determine unknown risks

H: Redesign so as to reduce task times

I: Determine cost reductions of new design

J: Uncover any new constraints on design

10

10

5

7

5

7

2

5

8

4

—

—

—

A

B, C

B, C

B, C

C

G, H

D, E

A, 10
0, 10
0, 10

B, 10
0, 10
1, 11

0

Start

21

End

C, 5
0, 5
3, 8

D, 7
10, 17
10, 17

J, 4
17, 21
17, 21

Activity, te
TES, TEF

TLS, TLF

E, 5
10, 15
12, 17

F, 7
10, 17
14, 21

G, 2
10, 12
11, 13

H, 5
5, 10
8, 13

I, 8
12, 20
13, 21FIGURE 2.7

Network diagram for

mortgage process

improvement project.

Meridth-c02.indd 48 10/29/2015 3:23:28 PM

492.3 Scheduling the Project

both

latest

T T

T T latest

T T latest start time T latest finish time T
backward T T

T T

earliest

Slack Time

T T T T

Meridth-c02.indd 49 10/29/2015 3:23:30 PM

50 Executing Strategy: Project Management

T T T
T

slack float

T T T T

2.3.2 Project Scheduling with Uncertain Activity Times

to tp
tm optimistic time

pessimistic time
most

likely time

Meridth-c02.indd 50 10/29/2015 3:23:31 PM

512.3 Scheduling the Project

Calculating Activity Durations

to tm not tp tm

te2

t
t t t

e
o m p4

6

2
2

6
t tp o

■ TABLE 2.2 Six Sigma Activity Times (Days)

Project activity Optimistic time to Most likely time tm Pessimistic time tp

Expected time te, and

variance 2

A 5 11 11 10, 1

B 10 10 10 10, 0

C 2 5 8 5, 1

D 1 7 13 7, 4

E 4 4 10 5, 1

F 4 7 10 7, 1

G 2 2 2 2, 0

H 0 6 6 5, 1

I 2 8 14 8, 4

J 1 4 7 4, 1

Meridth-c02.indd 51 10/29/2015 3:23:47 PM

52 Executing Strategy: Project Management

95 3 3
90 2 6

% : / .
% : / .

t t

t t
p o

p o

Probabilities of Completion

V 2 2 2 1 4 1 6

Z
V

23 21
6

0 818.

®

D te, , , D

21 1 28 24 14( . ) .V ®

te
0 90 21 2 449 24 14. , , . .

Meridth-c02.indd 52 10/29/2015 3:23:49 PM

532.3 Scheduling the Project

Simulating Project Completion Times

21

Time (days)

F
re

q
u
e
n
c
y

Area =
79%

23

V = 6

FIGURE 2.8

Probability distribution

of path completion time.

Start

A, 32.1, 1.2 C, 22.2, 2.2

B, 24.6, 3.1

D, 26.1, 5.2

E, 34.4, 6.2

F, 34.5, 4.1

End

FIGURE 2.9

Network for simulating.

Meridth-c02.indd 53 10/29/2015 3:23:49 PM

54 Executing Strategy: Project Management

®

®

3 3 3

1

2

3

4

5

6

7

8

9

10

11

12
13

Activity

A

A

32.1

Formulae:

Cell G3

Cell H3

Cell I3
Cell J3

= A3 + C3 + F3

= B3 + D3 + F3

= B3 + E3
= MAX (G3:I3)

Activity

B

B

24.6

Activity

C

C

22.2

Activity

D

D

26.1

Activity

E

E

34.4

Activity

F

F

34.5

Path

G

ACF

88.8

Path

H

BDF

85.2

Path

I

BE

59

Completion

J

Time

88.8

Assumption Cells Forecast Cell

FIGURE 2.10

Spreadsheet for

simulating the network.

FIGURE 2.11

Simulation results.

Meridth-c02.indd 54 10/29/2015 3:23:50 PM

552.3 Scheduling the Project

2.3.3 Project Management Software Capabilities

WBS Name Duration Sch. start Sch. finish 4 11 18 25 1 8 15 22 29 5 12 19 25 5 12 19 26 2 9 16

December January February March April

1

2

3

4

4.1

4.2

4.3

5

6

7

7.1

7.2

7.3

7.4

8

9

10 Purchase order prepared

Purchase recommendation prepared

Check out references

Evaluate demos

Survey participants

Software loaded on system

Participants selected

Demo evaluation

Price evaluation

Demos received

Reference list

Prices gathered

Demos ordered

Vendor calls

Literature reviewed

Literature search

Software review begins 0d

2d

12d

10d

10d

1d

1d

1d

5d

40d

1d

1d

9d

30d

3d

5d

0d Mar 14 Mar 14

Mar 14

Mar 7

Mar 7

Mar 8

Dec 28 Dec 30

Jan 25

Jan 11 Jan 11

Jan 11 Jan 11

Jan 11

Jan 10 Jan 16

Jan 10

Jan 9

Jan 9

Jan 10

Dec 27

Dec 27

Dec 27

Dec 27

Dec 27

Dec 27

Dec 7 Dec 7

Dec 7 Dec 8

Dec 9 Dec 26

Jan 12 Jan 24

Project: software evaluation

Date: 1/20/94

Critical

Noncritical

Progress

Milestone

Summary

Rolled up

FIGURE 2.12

Microsoft project’s Gantt

chart for a software

information system

upgrade.

Meridth-c02.indd 55 10/29/2015 3:23:50 PM

56 Executing Strategy: Project Management

2.3.4 Goldratt’s Critical Chain1

Critical Chain

Inflated Activity Time Estimates

pad

12/9/98

Project approval

1

12/3/98

0d

12/3/98

Begin scheduling

4

12/3/98

0d

12/3/98

Scheduling complete

8

12/16/98

0d

12/16/98

Deliver video to
client

14

12/4/99

0d

12/4/99
Schedule shoots

7

12/10/98

5d

12/16/98

Propose shoots

5

12/3/98

5d

12/9/98

Hire secretary

6

12/3/98

5d

ID

Scheduled start

Duration

Critical Milestone

Noncritical Summary

Subproject

MarkedScheduled finish

Script writing

2

12/3/98

14d

12/22/98

Schedule shoots

3

12/3/98

10d

12/16/98

Script approval

9

12/23/98

5d

12/29/98

Revise script

10

12/30/98

5d

1/5/99

Shooting

11

1/6/99

10d

1/19/99

Editing

12

1/20/99

7d

1/28/99

Final approval

13

1/31/99

5d

2/4/99

Name

FIGURE 2.13

PERT chart generated by

Microsoft Project for a

video sales tool.

Project Management in Practice

Meridth-c02.indd 56 10/29/2015 3:23:51 PM

572.3 Scheduling the Project

delay starting the
task student syndrome

Activity Time Variability with Path Interdependencies

Resource Dependence

project buffer

not

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58 Executing Strategy: Project Management

critical chain

feeding buffer

2.4 Controlling the Project: Earned Value

Critical chain

Project buffer

Feeding buffer

FIGURE 2.14

Project and feeding

buffers.

Meridth-c02.indd 58 10/29/2015 3:23:51 PM

592.4 Controlling the Project: Earned Value

a

b

earned value

cost variance
schedule variance

time
variance

assignable cause

favorable variance

TE TA TE TA
Time

P
ro

g
re

ss

A
m

o
u
n
t

sp
e
n
t

(a)

Time

Time varianceTime variance

(b)

Planned
Actual

0

100%

Planned
Actual

PV

AC

EV

FIGURE 2.15

Cost–schedule

reconciliation charts.

1 2

Month

D
o
ll
a
rs

Time
variance

(10-day delay)

Cost variance

Schedule variance

3

Cost–schedule plan
(baseline)
Actual cost
Value completed

TE TA

PV

AC

EV

FIGURE 2.16

Earned value chart.

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60 Executing Strategy: Project Management

E X P A N D Y O U R U N D E R S T A N D I N G

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

11.
®

12.

13.

A P P LY Y O U R U N D E R S T A N D I N G

■ E‐RAZOR, INC., A STRATEGIC BUDGETING DECISION

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61Apply your Understanding

■ NUTRI‐SAM: THE LATIN AMERICAN EXPANSION DECISION

Questions

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62 Executing Strategy: Project Management

Activity Optimistic time (months) Most likely time (months) Pessimistic time (months)

A: Concept development 3 12 24

Plan definition

B: Define project scope 1 2 12

C: Develop broad schedule 0.25 0.5 1

D: Detailed cost estimates 0.2 0.3 0.5

E: Develop staffing plan 0.2 0.3 0.6

Design and construction

F: Detailed engineering 2 3 6

G: Facility construction 8 12 24

H: Mobilization of employees 0.5 2 4

I: Procurement of equipment 1 3 12

Start‐up and turnover

J: Prestart‐up inspection 0.25 0.5 1

K: Recruiting and training 0.25 0.5 1

L: Solving start‐up problems 0 1 2

M: Centerlining 0 1 4

Questions

®

E X E R C I S E S

2.1

2.2

2.3

Activity

Times (weeks) Required
precedenceOptimistic Most likely Pessimistic

A

B

C

D

5

10

2

1

11

10

5

7

11

10

8

13

—

—

—

A

Start

A, 4

B, 3

End

C, 1

D, 5

E, 4

F, 1

I, 1

G, 3

H, 5

J, 2

Meridth-c02.indd 62 10/29/2015 3:23:52 PM

63Exercises

Activity

Times (weeks) Required
precedenceOptimistic Most likely Pessimistic

E

F

G

H

I

J

4

4

2

0

2

1

4

7

2

6

8

4

10

10

2

6

14

7

B

B

B

C

G,H

D, E

2.4

Activity t
e
(Weeks)

Preceding
activities

a

b

c

d

e

f

g

h

i

3

5

3

1

3

4

2

3

1

None

a

a

c

b

b, d

c

g, f

e, h

2.5

Activity

Times (days)

Required
precedenceOptimistic

Most
likely Pessimistic

A

B

C

D

E

F

G

H

6

8

2

6

5

5

4

2.7

7

10

3

7

5.5

7

6

3

14

12

4

8

9

9

8

3.5

—

—

—

A

B, C

B, C

D, E

F

(a)
(b)
(c)

2.6

# Activity

Times

Optimistic
Most
likely Pessimistic

Preceding
tasks

1

2

3

4

5

6

7

8

9

Lay
foundation

Dig hole
for scale

Insert scale
bases

Erect frame

Complete
building

Insert
scales

Insert
display
cases

Put in
office
equipment

Give
finishing
touches

8

5

13

10

11

4

2

4

2

10

6

15

12

20

5

3

6

3

13

8

21

14

30

8

4

10

4

—

—

2

1, 3

4

5

5

7

8, 6

2.7

Meridth-c02.indd 63 10/29/2015 3:23:52 PM

64 Executing Strategy: Project Management

2.8

2.9

2.10

A, 5

B, 3

C, 6

D, 7

Start End

F, 6

E, 5

G, 10

H, 8

I, 4

(a)
(b)
(c)

2.11

Activity
Times

(weeks)
Preceding
activities

A

B

C

D

E

F

G

H

I

3

6

8

7

5

10

4

5

6

—

—

—

A

B

C

C

D, E, F

G

(a)
(b)
(c)

2.12

Activity Duration
Preceding
activities

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

1

2

3

4

3

8

2

4

2

6

5

10

11

1

9

3

8

6

—

—

—

3

2, 4

3

2, 4

1, 5

17

2, 4

6, 10

7, 8, 11

7, 8, 11

6, 10

12

6, 10

12

13, 14, 15

(a)
(b)
(c)

2.13

(a)

(b)
(c)
(d)
(e)

Start

A, 2

B, 4

End

C, 3

D, 3

F, 6

E, 5

G, 4

H, 4

KL, 3

J, 2

I, 8

Meridth-c02.indd 64 10/29/2015 3:23:53 PM

part

65

Process and Supply Chain Design

In this second part of the book, “Process and Supply Chain Design,” we first describe

in Chapter  3 how to plan and design the organization ’ s transformation and supply

processes to produce services and/or products for its customers and clients. In

Chapter  4 , we go further into the design details by elaborating the importance of plan-

ning for the amount to be offered as well as its timing through proper scheduling of

the processes. In Chapters  5 and  6 , we describe how to plan and manage the supply

chain. Chapter  5 focuses on the planning and analysis of the supply chain and its criti-

cal ties to the sales function. Chapter  6 then gets into the details of supply chain strat-

egy in terms of its design, such as sourcing, inventory management, and the role of

information technology.

Chapter. 3: Process
Planning

Chapter. 4: Capacity
and Scheduling

Chapter. 5: Supply
Chain Planning
and Analytics

Chapter. 6: Supply
Chain

Management

Chapter. 2: Executing

Strategy: Project

Management

Chapter. 7: Monitoring

and Controlling the

Process

Chapter. 8: Process
Improvement: Six

Sigma

Chapter. 9: Process
Improvement:

Lean

PART I: Strategy
and Execution

PART II: Process and
Supply Chain Design

Chapter. 1: Operations and

Supply Chain Strategy

for Competitiveness

PART III: Managing and
Improving the Process

Role of Operations and Supply Chains in

The Organizations’ Competitiveness

II

Meridth-p02.indd 65 10/29/2015 3:50:52 PM

66

chapter
Process Planning

CHAPTER IN PERSPECTIVE

Chapters  1 and  2 in PART I focused on determining a competitive strategy for the
organization and planning its implementation. As we start PART II, our first task is
the selection and design of the transformation process that can execute that strat-
egy in an efficient and effective manner. If an organization is using the wrong trans-
formation process, frequently because the organization has changed or the mar-
ket has changed over time, it will not be competitive. The chapter begins with an
overview of the five major types of transformation processes and their respective
advantages and disadvantages. Next, issues related to the selection of a competi-
tive transformation process, such as considerations of volume, variety, and prod-
uct life cycles, are discussed. Last, explicit attention is given to some of the unique
aspects of designing service operations.

Introduction

3

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67 Introduction

virtual
organizations focused factories

efficiency effectiveness volume
capacity lead time flexibility

layout
analysis

Meridth-c03.indd 67 10/29/2015 3:29:20 PM

68 Process Planning

waiting line queuing theory

3.1 Forms of Transformation Systems

3.1.1 Continuous Process

continuous transformation process

commodities
continuous process

job shops flow
shops

Meridth-c03.indd 68 10/29/2015 3:29:21 PM

693.1 Forms of Transformation Systems

3.1.2 Flow Shop

flow shop

production
line

assembly line

Advantages of the Flow Shop

Meridth-c03.indd 69 10/29/2015 3:29:21 PM

70 Process Planning

buffer

Disadvantages of the Flow Shop

rate

paced

Shipping

Storage

Out

In

FIGURE 3.1

A generalized flow shop

operation.

Meridth-c03.indd 70 10/29/2015 3:29:21 PM

713.1 Forms of Transformation Systems

balanced

ongoing operation
setup

Layout of the Flow Shop

paced line

Meridth-c03.indd 71 10/29/2015 3:29:24 PM

72 Process Planning

Balancing the Production Line

line balancing

precedence graph

cycle time

takt time
cycle time

cycle time

■ TABLE 3.1 Tasks in Credit Application Processing

Task Average time (minutes) Immediately preceding tasks

a Open and stack applications

b Process enclosed letter; make note of and
handle any special requirements

c Check off form 1 for page 1 of application

d Check off form 2 for page 2 of application;
file original copy of application

e Calculate credit limit from standardized
tables according to forms 1 and 2

f Supervisor checks quotation in light of special
processing of letter and notes type of form
letter, address, and credit limit to return to
applicant

g Administrative assistant types in details on
form letter and mails

Total

0.20

0.37

0.21

0.18

0.19

0.39

0.36

1.90

None

a

a

a

c, d

b, e

f

0.37

0.21 0.19

0.18

0.20 0.39 0.36

b

a c e f g

dFIGURE 3.2

Precedence graph for

credit applications.

Meridth-c03.indd 72 10/29/2015 3:29:25 PM

733.1 Forms of Transformation Systems

idle time

=

=

/

// =

= up

N
T

= ∑

N
T

theoretical

efficiency N
A

NA

longest operation time

Meridth-c03.indd 73 10/29/2015 3:29:26 PM

74 Process Planning

a
b c d

b c d d
a d

b c e c b
b c

f e b e
c e

f
g

f g a
e f

■ TABLE 3.2 Station Task Assignments

Station Time available Eligible tasks Task assigned Idle time

1 0.40
0.20
0.02

a
b, c, d

b, c

a
d

None will fit

0.02

2 0.40
0.03

b, c
c

b
c will not fit

0.03

3 0.40
0.19

c
e

c
e

0.00

4 0.40
0.01

f
g

f
g will not fit

0.01

5 0.40 g g 0.04

0.36

Station 3

Station 1

Station 5Station 4

0.37

Station 2

0.20 0.190.21 0.39

0.18

c e f g

d

b

a

FIGURE 3.3

Station assignments.

Meridth-c03.indd 74 10/29/2015 3:29:27 PM

753.1 Forms of Transformation Systems

Dept. A Dept. B

Dept. E

Dept. G

Dept. C

Shipping

Dept. D Dept. F Receiving

Product B5

Product A63

Product B5

Product A63
FIGURE 3.4

A generalized job shop

operation.

3.1.3 Job Shop

job shop

grouping
variety transport

variations

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76 Process Planning

Advantages of the Job Shop

Disadvantages of the Job Shop

Meridth-c03.indd 76 10/29/2015 3:29:31 PM

773.1 Forms of Transformation Systems

in‐process inventories

Layout of the Job Shop

Directly Specified Closeness Preferences

closeness prefer-
ences

a

Meridth-c03.indd 77 10/29/2015 3:29:31 PM

78 Process Planning

b

Cost–Volume–Distance Model

i j
i j i j D

ij

i j
V

ij

i j C
ij

i j
C

ij
V

ij
D

ij
C V D

j i i j
i j

j i

1
A

3 5

E

4

(a)

2

I I
I

I
A 6

4
I I

5 6

I

1

(b)

2

I A

E A
3

FIGURE 3.5

Closeness preferences

layout: (a) initial layout.

(b) final layout.

*Note:

A = Absolutely

necessary

E = Especially

important

I = Important

O = Ordinary

closeness OK

U = Unimportant

X = Undesirable

■ TABLE 3.3 Directly Specified Closeness Preferences*

Department

Department 1 2 3 4 5 6

1 E A U U U

2 U I I U

3 U U A

4 I U

5 I

6

Meridth-c03.indd 78 10/29/2015 3:29:32 PM

793.1 Forms of Transformation Systems

#1

#2

#3

Cell

Cell

Cell

F W

F

F

T

Job

(a)

(b)

Cell

Raw materials

Welding

Turning

FormingMilling

Raw

materials HT

Heat treat

F F F

W

M

M

HT

T

FIGURE 3.6

Conversion of (a) a job

shop layout into (b) a

cellular layout for part

families.

3.1.4 Cellular Production

a

b
group technology

part families

cell

teams

Meridth-c03.indd 79 10/29/2015 3:29:32 PM

80 Process Planning

classification

Advantages of Cellular Production

Unorganized parts

Parts organized by families

Formed partsGeometric partsTurned parts
FIGURE 3.7

Organization of

miscellaneous parts into

families.

Meridth-c03.indd 80 10/29/2015 3:29:32 PM

813.1 Forms of Transformation Systems

virtual cell
logical cell nominal

Meridth-c03.indd 81 10/29/2015 3:29:33 PM

82 Process Planning

Disadvantages of Cellular Production

Cellular Layout

virtual cell

cell

remainder cell

Meridth-c03.indd 82 10/29/2015 3:29:33 PM

833.2 Selection of a Transformation System

pilot cell

hybrid stage

3.1.5 Project Operations

Project operations

staging area

3.2 Selection of a Transformation System

hybrid

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84 Process Planning

3.2.1 Considerations of Volume and Variety

make‐to‐stock

make‐to‐order

every
engineer‐to‐order

assemble‐to‐order

many

assembled
and already available

a product–process matrix

Meridth-c03.indd 84 10/29/2015 3:29:33 PM

853.2 Selection of a Transformation System

Note the overlap in the different forms

b

Project

Job

Cell

Flow

None

None

One Few Many

Batch size

0 50 100

% make-to-order

(a) (b)

90%
make-to-stock

None

Low

Much

High
0 50 100

O
u
tp

u
t
v
a
ri

e
ty

None

Low

Much

High
O

u
tp

u
t
v
a
ri

e
ty

Continuous
process

∞

FIGURE 3.8

Effect of output

characteristics on

transformation

systems—the product–

process matrix.

Meridth-c03.indd 85 10/29/2015 3:29:33 PM

86 Process Planning

3.2.2 Product and Process Life Cycle

product

process

applying

Meridth-c03.indd 86 10/29/2015 3:29:33 PM

873.2 Selection of a Transformation System

3.2.3 Service Processes

service blueprint

Product innovations
Process innovations

Time

N
o
.
o
f

in
n
o
v
a
ti
o
n
s

FIGURE 3.9

Product–process

innovations over time.

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88 Process Planning

Service Process Design

Meridth-c03.indd 88 10/29/2015 3:29:34 PM

893.2 Selection of a Transformation System

Servicescapes

servicescape

ambient conditions

spatial layout and functionality

Customer contact intensity

Low High

Capital-Intensive

Service factory

Airlines

Package/postal services

Hotels

Recreation

Service shop

Hospitals

Cruise line

Repair services

Expensive restaurants

Labor-Intensive

Mass service

Sporting events

School classes

Retailing

Fast food

Professional service

Legal services

Physicians

Interior decorators

Tax preparers FIGURE 3.10

The service matrix.

Meridth-c03.indd 89 10/29/2015 3:29:34 PM

90 Process Planning

signs symbols and artifacts

Service Gaps

Perceived
received
service

Perceived
delivered
service

Expected
service

Experience
and knowledge

Ideal
service

Need

Gap 8

Gap 1

Gap 2

Gap 3

Gap 10

Gap 7

Gap 9

Gap 6

Gap 5

Gap 4

Selected
service

Perceived
service
need

Designed
service

Communicated
and advertised

service

Actual
delivered
service

FIGURE 3.11

Potential locations for

service gaps.

Meridth-c03.indd 90 10/29/2015 3:29:34 PM

913.2 Selection of a Transformation System

Service Guarantees and Fail‐Safing

the customer’s service expectations

1.

2.

3.

4.

Meridth-c03.indd 91 10/29/2015 3:29:34 PM

92 Process Planning

fail‐
safing

E X P A N D Y O U R U N D E R S T A N D I N G

1.

2.

3.

4.

5.

b

6.

7.

8.

9.

10. a

11. a

Meridth-c03.indd 92 10/29/2015 3:29:35 PM

93Apply your Understanding

A P P LY Y O U R U N D E R S T A N D I N G

■ PARADISE STATE UNIVERSITY

Department Faculty Number of students per year

Accounting 8 100

Finance 6 40

General
management

7 70

MIS 10 150

Marketing 6 50

OM 10 30

Questions

Number of courses taken in respective departments

Concentration Accounting Finance Management MIS Marketing OM

Accounting 4 1 1 1 1 2

Finance 1 4 1 1 1 2

General management 1 1 4 1 1 2

MIS 1 1 1 4 1 2

Marketing 1 1 1 1 4 2

OM 1 1 1 1 1 5

Meridth-c03.indd 93 10/29/2015 3:29:35 PM

94 Process Planning

■ X‐OPOLY, INC.

®

Station

number
Task(s) performed at station

Time to

perform task

1 Get box bottom and place
plastic money tray in box
bottom. Take two dice from bin
and place in box bottom in
area not taken up by tray.

10 seconds

2 Count out 35 plastic houses and
place in box bottom.

35 seconds

3 Count out 15 plastic hotels and
place in box bottom.

15 seconds

4 Take one game piece from
each of eight bins and place
them in box bottom.

15 seconds

5 Take one property card from
each of 28 bins. Place rubber
band around property cards
and place cards in box bottom.

40 seconds

6 Take one orange card from
each of 15 bins. Place rubber
band around cards and place
cards in box bottom.

20 seconds

7 Take one yellow card from each
of 15 bins. Take orange cards
from box and remove rubber
band. Place yellow cards on
top of orange cards. Place
rubber band around yellow
and orange cards and place
cards in box bottom.

35 seconds

8 Count out 25 $500 bills and
attach to cardboard strip with
rubber band. Place money in
box bottom.

30 seconds

Meridth-c03.indd 94 10/29/2015 3:29:36 PM

95Exercises

Station

number
Task(s) performed at station

Time to

perform task

9 Count out 25 $100 bills. Take $500
bills from box bottom and
remove rubber band. Place $100
bills on top of $500 bills. Attach
rubber band around money
and place in box bottom.

40 seconds

10 Count out 25 $50 bills. Take $500
and $100 bills from box bottom
and remove rubber band.
Place $50 bills on top. Attach
rubber band around money
and place in box bottom.

40 seconds

11 Count out 50 $20 bills. Take
money in box and remove
rubber band. Place $20 bills on
top. Attach rubber band
around money and place in
box bottom.

55 seconds

12 Count out 40 $10 bills. Take
money in box and remove
rubber band. Place $10 bills on
top. Attach rubber band
around money and place in
box bottom.

45 seconds

13 Count out 40 $5 bills. Take
money in box and remove
rubber band. Place $5 bills on
top. Attach rubber band around
money and place in box
bottom.

45 seconds

14 Count out 40 $1 bills. Take money
in box and remove rubber band.
Place $1 bills on top. Attach
rubber band around money and
place in box bottom.

45 seconds

15 Take money and remove rubber
band. Shrink‐wrap money and
place back in box bottom.

20 seconds

16 Take houses, hotels, dice, and
game pieces and place in bag.
Seal bag and place bag in box.

30 seconds

Station

number
Task(s) performed at station

Time to

perform task

17 Place two cardboard game
board halves in fixture so that
they are separated by ¼ in.
Peel backing off of printed
game board decal. Align decal
over board halves and lower it
down. Remove board from
fixture and flip it over. Attach
solid blue backing decal. Flip
game board over again and
fold blue backing over front of
game board, creating a ¼ in.
border. Fold game board in
half and place in box covering
money tray, game pieces, and
cards.

90 seconds

18 Place game instructions in box.
Place box top on box bottom.
Shrink‐wrap entire box.

30 seconds

19 Place completed box in carton. 10 seconds

Questions

E X E R C I S E S

3.1

1 2 3

4 5 6

Department 1 2 3 4 5 6

1 I A X O U

2 X E I O

3 O X I

4 I E

5 A

6

Meridth-c03.indd 95 10/29/2015 3:29:36 PM

96 Process Planning

3.2

Task Time required (min) Predecessor tasks

a 4 —

b 5 a

c 3 a

d 2 b

e 1 b,c

f 5 d,e

3.3

(a)
(b)
(c)

3.4

3.5

3.6

Task Time (min) Preceding tasks

1 0.4 None

2 0.3 1

3 1.1 1

4 0.2 3

5 0.5 2

6 0.3 3

7 0.6 5

8 0.6 4, 6, 7

(a)

(b)

3.7

Department

Number of users

Distance by location

1 2 3

1 25 0 3 5

2 30 5 4 3

3 10 2 0 1

4 5 3 2 0

5 14 6 2 3

c

2

h

4

d

8

f

2

i

9

b

4

a

7

e

3

g

2

Meridth-c03.indd 96 10/29/2015 3:29:37 PM

97

chapter

4
Capacity and Scheduling

CHAPTER IN PERSPECTIVE

Now that we have selected a process, we need to determine the detailed specifi-
cations of that process. An important early element in our specifications concerns
the capacity we will require. Having adequate capacity and effectively utilizing
it are critical for dependability, speed, and maximizing revenues, while having
excess capacity will impair costs—all strategic competitive factors. We begin the
chapter with an overview of various measures of capacity and then discuss issues
related to long‐term capacity planning strategies.

Following this, we consider issues related to efficiently using the available
capacity through effective schedule management. The chapter then concludes
with a discussion of short‐term capacity planning, including process‐flow mapping,
capacity planning for services, and how humans’ ability to learn affects capacity
planning.

Introduction

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98 Capacity and Scheduling

Inc

capacity

Meridth-c04.indd 98 10/30/2015 4:23:49 PM

994.1 Long‐Term Capacity Planning

4.1 Long‐Term Capacity Planning

Capacity
rate

time dimension

available seat miles

■ TABLE 4.1 Examples of Measures of Capacity

Production system

Measure of capacity in terms of

outputs produced

Measure of capacity in terms of

inputs processed

Airline Available seat miles per year Reservation calls handled
per day

Hospital Babies delivered per month Patients admitted per week

Supermarket Customers checked out
per hour

Cartons unloaded per hour

Post office Packages delivered per day Letters sorted per hour

University Graduates per year Students admitted per year

Automobile assembly plant Autos assembled per year Deliveries of parts per day

Meridth-c04.indd 99 10/30/2015 4:23:49 PM

100 Capacity and Scheduling

average

bottleneck

yield

Yield management revenue management

where

supply chain manage-
ment

4.1.1 Capacity Planning Strategies

Meridth-c04.indd 100 10/30/2015 4:23:49 PM

1014.1 Long‐Term Capacity Planning

Facility Size Planning

economies of scale

Economies of Scale and Scope

economies of scale

economies of scope

Capacity

U
n
it
o

u
tp

u
t
co

st

Very
large facilities

Large
facilities

Medium-
size

facility

Small-size
facility

A

B
C

E

D

F

G

Economies of scale Diseconomies of scale FIGURE 4.1

Envelope of lowest unit

output costs with

facility size.

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102 Capacity and Scheduling

Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec.

100

200

300

400

500

600

Total

Air conditioners

Furnaces

S
a
le

s
(u

n
it
s)

FIGURE 4.2

Anticyclic product sales.

Capacity Planning for Multiple Outputs

anticyclic

seasonality

seasonality

life cycles

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1034.1 Long‐Term Capacity Planning

Timing of Capacity Increments

a
b

c d

Total current output

Additional required output between years 4 and 7

Capacity requirements for six different outputs

Now 1 2 3 4 5 6 7 8 9 10

R
e
q
u
ir

e
d
c

a
p
a
ci

ty

Year

FIGURE 4.3

Forecast of required

organizational capacity

from multiple life cycles.

Meridth-c04.indd 103 10/30/2015 4:23:50 PM

104 Capacity and Scheduling

Time

Small capacity increments

U
n
it
s

Capacity

Demand

(a)

Time

Large capacity increments

U
n
it
s

(b)

Time

Preceding demand

U
n
it
s

(c)

Time

Following demand

U
n
it
s

(d)

S
in

g
le

i
n
cr

e
m

e
n
t

Capacity
additions

FIGURE 4.4

Methods of adding fixed

capacity.

4.2 Effectively Utilizing Capacity Through Schedule
Management

acquisition
timing

Gantt chart
a

Meridth-c04.indd 104 10/30/2015 4:23:50 PM

1054.2 Effectively Utilizing Capacity Through Schedule Management

■ TABLE 4.2 Sequential Operations Required for Two Jobs

Job Operations resource needed Time required (hours)

1 A 10

C 10

A 30

B 20

C 5

2 B 15

A 10

C 10

A 10

B 10

0 8 16 24 32 40 48 56 64 72 80 88

C

B

A

R
e
so

u
rc

e

Time (hour)

(a)

Job 1

Job 2

0 8 16 24 32 40 48 56 64 72 80 88

C

B

A

R
e
so

u
rc

e

Time (hour)

(b)

FIGURE 4.5

Gantt charts for capacity

planning and

scheduling.

Meridth-c04.indd 105 10/30/2015 4:23:50 PM

106 Capacity and Scheduling

infinite loading

finite loading
b

a

operation splitting preemption

4.2.1 Scheduling Services

Approaches to Resource Scheduling

Meridth-c04.indd 106 10/30/2015 4:23:51 PM

1074.2 Effectively Utilizing Capacity Through Schedule Management

floating

demand
off‐peak pricing

Hospitals

patient
classification system

Urban Alarm Services

smooth

duty tours

Meridth-c04.indd 107 10/30/2015 4:23:51 PM

108 Capacity and Scheduling

+ + =

Educational Services

1.

2.

3.

Yield/Revenue Management and Overbooking

Yield management revenue management

1. Fixed capacity:

2. Perishable capacity:

Meridth-c04.indd 108 10/30/2015 4:23:51 PM

1094.3 Short‐Term Capacity Planning

3. Segmentable market:

4. Capacity sold in advance:

5. Uncertain demand:

6. Low marginal sales cost and high marginal capacity addition cost:

overbooking

4.3 Short‐Term Capacity Planning

4.3.1 Process‐Flow Analysis

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110 Capacity and Scheduling

utilization

=

=

Bottlenecks in a Sequential Process

efficiency versus capacity output rate Efficiency

sequential

bottlenecks

sequentially

throughput time

Raw
materials

Machine D
Finisher

2 minutes

Machine C
Stringer

10 minutes

Machine B
Handler

3 minutes

Machine A
Framer

4 minutes

FIGURE 4.6

King Sports production

process.

Meridth-c04.indd 110 10/30/2015 4:23:51 PM

1114.3 Short‐Term Capacity Planning

slowest
each

cycle time of the
process

double

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112 Capacity and Scheduling

■ TABLE 4.3 Return to King for Using More Machines

Machine times (min)

Number of

machines

Type of

next

machine A B C D

Cycle time

(min)

Total

hourly

output

Efficiency

(%)

4 — 4 3 10 2 10 6 47.5

5 C 4 3 5 2 5 12 76.0

6 C 4 3 3.33 2 4 15 79.2

7 A 2 3 3.33 2 3.33 18 81.4

8 C 2 3 2.5 2 3 20 79.2

9 B 2 1.5 2.5 2 2.5 24 84.4

10 C 2 1.5 2 2 2 30 95.0

11 D 2 1.5 2 1 2 30 86.0

12 A 1.33 1.5 2 1 2 30 79.2

13 C 1.33 1.5 1.67 1 1.67 36 87.5

14 C 1.33 1.5 1.43 1 1.5 40 90.5

0 2 4 6 8 10 12 14
00

1020

2040

3060

4080

50100

Output

Efficiency

H
o
u
rl

y
o

u
tp

u
t
(u

n
it
s)

E
ffi

ci
e
n
cy

(
%

)

Number of machines

FIGURE 4.7

Efficiency and output

change as machines are

added.

Mapping Product and Service Flows

Meridth-c04.indd 112 10/30/2015 4:23:52 PM

1134.3 Short‐Term Capacity Planning

Fabrication

25 lb/component
25 components/hour

Assembly

20 units/hour

Storage

3500-lb cap.

Storage

500 cap.

375
lb/hour

1.5
tons/
day

240
parts/
day

30
parts/hour

15
units/
hour

80
units/
day

40
units/
day

120
units/
day

Raw material

2-ton capacity
1 load/day

Parts

300 cap.

Packaging A
5 minutes

process time

Packaging B
10-minutes

process time

15
components/hour

FIGURE 4.8

Process flow for

manufactured unit.

× =

Meridth-c04.indd 113 10/30/2015 4:23:53 PM

114 Capacity and Scheduling

anticipate

line of visibility

CC 5

20

10

Yes

No

CC 10

F
F

Ask
specifications:

# of copies
type of paper

reduce/enlarge

Inform
customer
of cost

Customer
decision

Take
originals

to
back room

Original
and copies

to
customer

Take
payment

Ring up
on register

Change,
receipt, and

thank
customer

Leaves

Line of visibility

Originals
and

instructions
to operator

45 60

Copier
electricity

Set up
copier

Run
copies

Legend:

Seconds

Failure
point?

Activity

CC 5 CC 20

F

CC 30

Greet
customer

CC 10

F

CC 25

CC 10

F

F F
Customer
contact?

Paper,
toner

F

F

FIGURE 4.9

Process‐flow map for a

service.

Meridth-c04.indd 114 10/30/2015 4:23:53 PM

1154.3 Short‐Term Capacity Planning

swim lanes

Value Stream Maps

within

4.3.2 Short‐Term Capacity Alternatives

Meridth-c04.indd 115 10/30/2015 4:23:53 PM

116 Capacity and Scheduling

■ TABLE 4.4 Techniques for Increasing Short‐Run Capacity

I. Increase resources

1. Use overtime

2. Add shifts

3. Employ part‐time workers

4. Use floating workers

5. Lease workers and facilities

6. Subcontract

II. Improve resource use

7. Overlap or stagger shifts

8. Cross‐train the workers

9. Create adjustable resources

10. Share resources

11. Schedule appointments/reservations

12. Inventory output (if feasible) ahead of demand

13. Backlog or queue demand

III. Modify the output

14. Standardize the output

15. Offer complementary services

16. Have the recipient do part of the work

17. Transform service operations into inventoriable product operations

18. Cut back on quality

IV. Modify the demand

19. Partition the demand

20. Change the price

21. Change the promotion

22. Initiate a yield/revenue management system

V. Do not meet demand

23. Do not supply all the demand

Meridth-c04.indd 116 10/30/2015 4:23:53 PM

1174.3 Short‐Term Capacity Planning

decrease

4.3.3 Capacity Planning for Services

a
daily b

yearly

inputs

Meridth-c04.indd 117 10/30/2015 4:23:53 PM

118 Capacity and Scheduling

1 3 5 7 9 11 1 3 5 7 9 11

2

4

6

8

10

12

14
Building fire alarms

Total fire alarms

Noon

(a)

Distribution of fire alarms by month
Dade County, Florida

Distribution of fire alarms by 2-hour periods
Dade County, Florida

A.M. P.M.

%
o

f
d
a
il
y
t
o
ta

l

Jan. Feb. Mar. Apr. May June July Aug. Sep. Oct. Nov. Dec.

5

10

15

20 Building fire alarms

Outdoor fire alarms

Total fire alarms

(b)

Dry season Wet season

%
o

f
a
n
n
u
a
l
to

ta
l

FIGURE 4.10

Fire alarm histories.

(a) Hourly. (b) Monthly.

Meridth-c04.indd 118 10/30/2015 4:23:54 PM

1194.3 Short‐Term Capacity Planning

4.3.4 The Learning Curve

learning curve

improvement curves production
progress functions performance curves experience curves

Each time the output doubles, the labor hours decrease to a fixed percentage of their previous
value

negative exponential function

M
N M

N

N N N
N

r .

M = mNr

M = N
m =
N =
r =

=

Meridth-c04.indd 119 10/30/2015 4:23:54 PM

120 Capacity and Scheduling

groups systems

Creating Learning Curve Tables

N
N

total

1 4 7 10 13 16 19 22
0.00

20.00

40.00

60.00

80.00

100.00

Labor-hours

Number of units produced, N

L
a
b
o
r-

h
o
u
rs

,
M

(
1
0
0
0
)

FIGURE 4.11

80 percent learning

curve for airplane

production.

Meridth-c04.indd 120 10/30/2015 4:23:54 PM

1214.3 Short‐Term Capacity Planning

80%

100,000

Unit

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

Unit Time

100,000.0

80,000.0

70,210.4

64,000.0

59,563.7

56,168.3

53,449.0

51,200.0

49,295.0

47,651.0

46,211.1

44,934.6

43,791.6

42,759.2

41,819.9

40,960.0

40,168.3

39,436.0

38,755.5

38,120.8

37,526.7

36,968.9

36,443.6

35,947.7

35,478.4

Cumulative

Time

100,000.0

180,000.0

250,210.4

314,210.4

373,774.1

429,942.4

483,391.4

534,591.4

583,886.3

631,537.3

677,748.4

722,683.1

766,474.6

809,233.8

851,053.7

892,013.7

932,182.0

971,618.0

1,010,373.5

1,048,494.3

1,086,021.0

1,122,989.9

1,159,433.5

1,195,381.2

1,230,859.6

Improvement Rate:

Hours for 1st Unit (m): Cell B5: =$C$2*A5^(LN($C$1)/LN(2))

Copy to cells B6:B29

Cell C6: =C5+B6

Copy to cells C7:C29

A B C

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

FIGURE 4.12

Example learning

curve table.

0 1 2 3 4 5

0 10 20 30 30

6

40

7

50

8

60

9

70

10

80

L
a
b
o
r-

h
o
u
rs

/u
n
it

No
production

Unit

Time (days)

Theoretical curve

Actual curve

Learning plateau

Breakthrough

“Forgetting” curve

Relearning curve

Natural variability
exceeds improvement

Continuation of
original curve

FIGURE 4.13

Typical pattern of

learning and forgetting.

Meridth-c04.indd 121 10/30/2015 4:23:55 PM

122 Capacity and Scheduling

4.3.5 Queuing and the Psychology of Waiting

queues

input requirements

1. Cost of waiting

2. Cost of service facilities

1. Unoccupied time feels longer than occupied time

Optimal capacity

Cost of waiting

Cost of facility

Total cost

Minimal cost

C
o
st

Service facility capacity

FIGURE 4.14

The relevant queuing

costs.

Meridth-c04.indd 122 10/30/2015 4:23:55 PM

123Expand Your Understanding

2. Preservice waiting feels longer than in‐service waiting

3. Anxiety makes waiting seem longer

4. Uncertain waiting is longer than known, finite waiting

5. Unexplained waiting is longer than explained waiting

6. Unfair waiting is longer than fair waiting

7. Solo waiting is longer than group waiting

8. The more valuable the service, the longer it is worth waiting for

E X P A N D Y O U R U N D E R S T A N D I N G

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

11.

Meridth-c04.indd 123 10/30/2015 4:23:55 PM

124 Capacity and Scheduling

■ EXIT MANUFACTURING COMPANY

Average sales price ($/door) Area sales (in units)

$90 40,000

$103 38,000

$115 31,000

$135 22,000

Questions

A P P LY Y O U R U N D E R S T A N D I N G

■ BANGALORE TRAINING SERVICES

Questions

Meridth-c04.indd 124 10/30/2015 4:23:55 PM

125Exercises

E X E R C I S E S

4.1

(a)
(b)

(c)

(d)

(e)

4.2

(a)

(b)

4.3

4.4

4.5

4.6

4.7

Report Introduction Analysis Conclusion

1 1.5 6 2

2 — (Lost data) —

3 1 3 0.8

4.8

4.9

Meridth-c04.indd 125 10/30/2015 4:23:55 PM

126

chapter

5
Supply Chain Planning
and Analytics

CHAPTER IN PERSPECTIVE

Now that the organization has a transformation process selected to execute its
strategy and has decided on the required capacity and scheduling of that trans-
formation system, the next step is to design the supply chain to feed that system
and get the service/product to its clients or customers. There are two parts to this
endeavor, planning the chain itself and then deciding how to manage the chain.
We discuss the planning of the chain first here in Chapter  5 and then supply man-
agement in the next chapter.

Supply chain planning has become much more sophisticated in the last decade
and a large part of it is concerned with attempting to predict what the actual
demand is going to be for the service or product. The good news is that we now
have a much greater amount of data (“big data”) to help us make this forecast, but
the bad news is that we need substantially more powerful tools to analyze all this
data. To help make these forecasts, organizations are turning to analytics to dissect
and analyze the data to turn it into information for managerial use. The chapter starts
with some elementary statistical forecasting techniques to illustrate how masses of
data can be analyzed to determine some limited range of future demand. Having
these forecasts in hand, the next step is for management to decide how much of
this forecast the organization wants to and can supply, called the service level ,
and then bring sales and operations together to create an aggregate plan for
producing that amount.

Introduction

Meridth-c05.indd 126 10/30/2015 1:21:52 PM

127 Introduction

Meridth-c05.indd 127 10/30/2015 1:21:52 PM

128 Supply Chain Planning and Analytics

5.1 Importance of Supply Chain Planning and Analytics

Meridth-c05.indd 128 10/30/2015 1:21:52 PM

1295.2 Demand Planning

service level

5.2 Demand Planning

Meridth-c05.indd 129 10/30/2015 1:21:52 PM

130 Supply Chain Planning and Analytics

5.2.1 Forecasting Methods

Life-cycle
analysis

Surveys

Delphi
method

Qualitative

Expert
opinion

Consumer
panels

Test
marketing

Historical
analogy

Causal

Quantitative

Informal
(intuitive)

Formal

Forecasting
methods

Time series
analysis

Multiple
regression

Econometric

Box–Jenkins

Exponential
smoothing

Moving
average

Simple
regression

FIGURE 5.1

A classification of

forecasting methods.

Meridth-c05.indd 130 10/30/2015 1:21:53 PM

1315.2 Demand Planning

qualitative

his-
torical analogy

Delphi

life‐cycle analysis

time series analysis
causal

5.2.2 Factors Influencing the Choice of Forecasting Method

Meridth-c05.indd 131 10/30/2015 1:21:53 PM

132 Supply Chain Planning and Analytics

inaccurate

5.2.3 Time Series Analysis

Components of a Time Series

1. T

2. S

3. C

4. R

trend

Seasonal fluctuations

Meridth-c05.indd 132 10/30/2015 1:21:53 PM

1335.2 Demand Planning

FIGURE 5.2

Three common trend

patterns. (a) Constant

change, (b) constant

percent change, and

(c) standard “S” curve.

1

E F G H I J K

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

37

38

39

40

41

42

43

44

45

(a)

(b)

(c)

40

20

0

0

800

600

400

200

0

5

10

15

20

25

30

V
a
ri

a
b
le

o
f

in
te

re
st

V
a
ri

a
b
le

o
f

in
te

re
st

1 2 3 4 5

Time

V
a
ri

a
b
le

o
f

in
te

re
st

6 7 8 9 10 11 12 13 14 15

1 2 3 4 5

Time

6 7 8 9 10 11 12 13 14 15

1 2 3 4 5

Time

6 7 8 9 10 11 12 13 14 15

Meridth-c05.indd 133 10/30/2015 1:21:53 PM

134 Supply Chain Planning and Analytics

cycle cyclical component

Random

1.

2.

3.

Moving Averages

moving average
n n

= n
n

n
n

n
n

F n At

i t n

t

i

t =
Ft 1 =

A
i
= i

n =

Meridth-c05.indd 134 10/30/2015 1:21:53 PM

1355.2 Demand Planning

weighted moving average

A B C D FE G H I J K L M N

Quarter

iPad sales

(millions)

4-Period

moving

average

Q3 2010 3.27

Q4 2010 4.19

Q1 2011 7.33

Q2 2011 4.69

Q3 2011 9.25 4.87

Q4 2011 11.12 6.37

Q1 2012 15.43 8.10

Q2 2012 11.80 10.12

Q3 2012 17.04 11.90

Q4 2012 14.04 13.85

Q1 2013 22.86 14.58

Q2 2013 19.28 16.44

Q3 2013 14.62 18.31

Q4 2013 14.08 17.70

Q1 2014 26.04 17.71

Q2 2014 16.35 18.51

Q3 2014 13.28 17.77

Q4 2014 12.32 17.44

Q1 2015 21.42 17.00

Forecast 15.84

0

5

10

15

20

25

30

Q
3
2

0
1
0

Q
4
2

0
1
0

Q
1
2

0
1
1

Q
2
2

0
1
1

Q
3
2

0
1
1

Q
4
2

0
1
1

Q
1
2

0
1
2

Q
2
2

0
1
2

Q
3
2

0
1
2

Q
4
2

0
1
2

Q
1
2

0
1
3

Q
2
2

0
1
3

Q
3
2

0
1
3

Q
4
2

0
1
3

Q
1
2

0
1
4

Q
2
2

0
1
4

Q
3
2

0
1
4

Q
4
2

0
1
4

Q
1
2

0
1
5

F
o
re

c
a
s
t

U
n
it
s

al
e
s

Date

iPad sales (millions of units)

iPad sales (millions)

4-period moving average

Cell C6: =Average(B2:B5) and copy to cells C7:C21

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

FIGURE 5.3

Four‐period moving

average of iPad sales.

Statista, www.statista.

com, February 8, 2015.

Meridth-c05.indd 135 10/30/2015 1:21:54 PM

136 Supply Chain Planning and Analytics

Exponential Smoothing

= α + − α

F A Ft t t

α F
t

t A
t

t

t

F A Ft t t

F A A Ft t t t

A
t− − α α α

n

n n

A
t

α
A

t−
α − α A

t−
α − α − − α

Meridth-c05.indd 136 10/30/2015 1:21:55 PM

1375.2 Demand Planning

F A F

A F F

F A F

F F

t t t

t t t

t t t

t tAt

A Ft t t
t

α
t t t

t
t t

α

α
α

α

α

α

α
α

n α

α
α

α

F = A

F = A =

F = + =

F = + =

Meridth-c05.indd 137 10/30/2015 1:21:55 PM

138 Supply Chain Planning and Analytics

Simple Regression: The Linear Trend Multiplicative Model

Alpha 0.21

Quarter

iPad unit

sales

(millions)

Exponential

smoothing

Q3 2010 3.27 3.27

Q4 2010 4.19 3.27

Q1 2011 7.33 3.45

Q2 2011 4.69 4.23

Q3 2011 9.25 4.32

Q4 2011 11.12 5.31

Q1 2012 15.43 6.47

Q2 2012 11.80 8.26

Q3 2012 17.04 8.97

Q4 2012 14.04 10.58

Q1 2013 22.86 11.27

Q2 2013 19.28 13.59

Q3 2013 14.62 14.73

Q4 2013 14.08 14.71

Q1 2014 26.04 14.58

Q2 2014 16.35 16.87

Q3 2014 13.28 16.77

Q4 2014 12.32 16.07

Q1 2015 21.42 15.32

Forecast 16.54

0

5

10

15

20

25

30

Q
3
2

0
1
0

Q
4
2

0
1
0

Q
1
2

0
1
1

Q
2
2

0
1
1

Q
3
2

0
1
1

Q
4
2

0
1
1

Q
1
2

0
1
2

Q
2
2

0
1
2

Q
3
2

0
1
2

Q
4
2

0
1
2

Q
1
2

0
1
3

Q
2
2

0
1
3

Q
3
2

0
1
3

Q
4
2

0
1
3

Q
1
2

0
1
4

Q
2
2

0
1
4

Q
3
2

0
1
4

Q
4
2

0
1
4

Q
1
2

0
1
5

F
o
re

ca
st

U
n
it
s

a
le

s

Date

iPad sales (millions of units)

iPad unit sales

(millions)

Exponential

smoothing

Cell C5: =(B$1*B4)+((1B$1)*C4) and copy to C6:C23

A B C D FE G H I J K L M N

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

FIGURE 5.4

Using exponential

smoothing to forecast

iPad sales. Statista,

www.statista.com,

February 8, 2015.

A
1
2
3

4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

Quarter
1

2
3
4
5
6
7
8
9
10
11
12
13
14

b
15461.54

Visitors to

web site
35,000

80,000
55,000
100,000
95,000
140,000
115,000
160,000
155,000
200,000
175,000
220,000
215,000
260,000

a
27252.75

B C D E F G H I J K L

300,000

Medfo.com

250,000

200,000

150,000

100,000

50,000

0

1 2 3 4 5 6

Quarter

7 8 9 10 11 12 13 14

N
u
m

b
e
r

o
f

v
is

it
o
rs

t
o

w
e
b
s

it
e

FIGURE 5.5

Number of visitors to

Medfo.com.

Meridth-c05.indd 138 10/30/2015 1:21:55 PM

1395.2 Demand Planning

T S

X X

X

S

X

Y

T
X

X

Y
X

X T
X

X

T

A

1

2

3 Quarter Tx

Visitors to

web site

Seasonal

factor

(Y/T)

1 35,000 42714.29

58175.82

73637.36

89098.90

104560.44

120021.98

135483.52
150945.05

166406.59

181868.13

197329.67

212791.21

228252.75

243714.29

0.82

1.38

0.75

1.12

0.91

1.17

0.85
1.06

0.93

1.10

0.89

1.03

0.94

1.07

80,000

55,000

100,000

95,000

140,000

115,000
160,000

155,000

200,000

175,000

220,000

215,000

260,000

2

3
4

5

6

7

8

9

10
11

12

13
14

4

5
6

7

8
9

10

11
12

13

14

15

16

17

B C D

FIGURE 5.6

Calculation of quarterly

seasonal factors.

Meridth-c05.indd 139 10/30/2015 1:21:56 PM

140 Supply Chain Planning and Analytics

T

Y

Y 55

Y T Y T

Y

T

Y

T

55
5

T

T

S F

F

F

A B C D E

Year

1

2

3

4

Average

0.82

0.91

0.93

0.94

0.90

1.38

1.17

1.1

1.07

1.18

0.75

0.85

0.89

0.83

1.12

1.06

1.03

1.07

Quarter 1 Quarter 2 Quarter 3 Quarter 41

2

3

4

5

6

FIGURE 5.7

Calculating seasonal

component (S ) for

quarters 1 through 4.

Meridth-c05.indd 140 10/30/2015 1:21:57 PM

1415.2 Demand Planning

5.2.4 Causal Forecasting with Regression

The Simple Linear Regression Model

multiple regression model

Y X

X Y α β
Y

X residual

α β

Y a bX

a b α
β

y mx b

y x
m x

y y
x =

Meridth-c05.indd 141 10/30/2015 1:21:57 PM

142 Supply Chain Planning and Analytics

C
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
37

38
39
40
41

42
43

44
45
46

47

D E F G H I

25
20
15
10
5
0

20

15

10

5

0

10

8

6

4

2

0

0

D
e
p
e
n
d
e
n
t
v
a
ri

a
b
le

Independent variable

Independent variable

Independent variable

No relationship

Non linear relationship

Linear relationship

D
e
p
e
n
d
e
n
t

v
a
ri

a
b
le

D
e
p
e
n
d
e
n
t
v
a
ri

a
b
le

2 4 6 8 10 12

0 2 4 6 8 10 12

0 5 10 15

FIGURE 5.8

Example relationships

between variables.

a y b
b m

errors
least squares regression

Meridth-c05.indd 142 10/30/2015 1:21:57 PM

1435.2 Demand Planning

e
i
,

Y
X Y X

∑e
i

Y X

array function
a b

=

X Y
X

Y X

e1

e2

e3

e4

FIGURE 5.9

Least squares approach

to fitting line to set of

data.

Meridth-c05.indd 143 10/30/2015 1:21:57 PM

144 Supply Chain Planning and Analytics

y

A
1 Lot

number size (ft) price TREND
House

193.7816
b a

-226.688

House
2
3
4
5
6
7
8
9
10
11
12

145
144
119
136
7

114
97
90
108
200

2,620
2,635
3,019
3,049
3,141
3,141
3,264
3,319
3,403
3,578

$266,500
$266,900
$364,500
$384,900
$389,900
$399,900
$439,000
$405,000
$414,500
$442,000

$281,020
$283,927
$358,339
$364,152
$381,980
$381,980
$405,815
$416,473
$432,751
$466,663

13
14
15
16
17
18
19

B C D E F G H I J K

=LINEST(C3:C12,B3:B12)

$500,000

$450,000

$400,000

$350,000

$300,000

$250,000

$200,000

2,500 2,700 2,900

House size (square feet)

3,100 3,300 3,500 3,700

H
o
u
se

p
ri

ce
(

$
)

=TREND(C3:C12,B3:B12)

R2 = 0.9006

FIGURE 5.10

Using Excel’s LINEST

and TREND functions.

70

0

350

300

250

0

120 125 130 135 140 145 150

50

100

150

200

100

200

300

400

90 110 130 150

Independent variable

Independent variable

D
e
p
e
n
d
e
n
t
v
a
ri

a
b
le

D
e
p
e
n
d
e
n
t
v
a
ri

a
b
le

Outlier on dependent variable dimension

Outlier on independent variable dimension

Regression line with

outlier included

Regression line with

outlier excluded

Outlier

Regression line with

outlier included

Outlier

Regression line with

outlier excluded

FIGURE 5.11

Impact of outliers on

regression line fit to set

of data.

Meridth-c05.indd 144 10/30/2015 1:21:58 PM

1455.2 Demand Planning

y

coefficient
of determination R R

R R

cause

R

correlation coefficient, R

R
− + Y

X Y X
X

Y
R R

R
Y X

Regression Analysis Assumptions

The residuals are normally distributed

The expected value of the residuals is zero, E ei

The residuals are independent of one another

The variance of the residuals is constant

Meridth-c05.indd 145 10/30/2015 1:21:58 PM

146 Supply Chain Planning and Analytics

X
Y X Y

X

Using the Regression Model

extrapolation
generalize

R

Meridth-c05.indd 146 10/30/2015 1:21:58 PM

1475.2 Demand Planning

5.2.5 Assessing the Accuracy of Forecasting Models

n
F A

i

n

i i

n
F A

A
i

n
i i

i

n
F A

i

n

i i

F
i
= i

A
i
= i

n =

errors

accuracy

– –

+

Meridth-c05.indd 147 10/30/2015 1:21:59 PM

148 Supply Chain Planning and Analytics

self‐adjust
α

− + α
−

+
− + α

5.3 Sales and Operations Planning

Aggregate
Plan

Meridth-c05.indd 148 10/30/2015 1:21:59 PM

1495.3 Sales and Operations Planning

5.3.1 Aggregate Planning Strategies

pure strategies

1. Level production

2. Chase demand

Meridth-c05.indd 149 10/30/2015 1:21:59 PM

150 Supply Chain Planning and Analytics

5.3.2 Determining the Service Level: An Example Using the
Newsvendor Problem

incremental marginal)

ordering one more

■ TABLE 5.1 Kacy’s Newspaper Demand

Demand (newspapers) Frequency (days) Relative frequency

28 10 0.10

29 20 0.20

30 35 0.35

31 25 0.25

32 10 0.10

Total 100 1.00

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1515.3 Sales and Operations Planning

p = at least
− p = not

=
=

p

p

p below which

p p

p

=
=

p

N N.

■ TABLE 5.2 Probability Table for Kacy’s Newspaper Ordering Problem

Order size, N Probability of selling N units

Cumulative probability of selling

more than N units

28 0.10 0.90

29 0.20 0.70

30 0.35 0.35

31 0.25 0.10

32 0.10 0

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152 Supply Chain Planning and Analytics

p = N =
N =

N =
N less p

p

N p
N N

p

p

Expected
demand

N

p
FIGURE 5.12

Determining the order

size when the

distribution of demand

is normally distributed.

■ TABLE 5.3 Revised Probability Table for Kacy’s Newspaper Ordering Problem

Order size, N Probability of selling N units

Cumulative probability of selling

more than N units

28 0.15 0.85

29 0.25 0.60

30 0.20 0.40

31 0.20 0.20

32 0.20 0

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153Expand Your Understanding

5.3.3 Collaborative Planning, Forecasting, and Replenishment

E X P A N D Y O U R U N D E R S T A N D I N G

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

11.

12.

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154 Supply Chain Planning and Analytics

A P P LY Y O U R U N D E R S T A N D I N G

■ RUSH AIRLINES

Number of no‐shows Number of flights

0 50

1 60

2 40

3 30

4 20

Questions

■ BARDSTOWN BOX COMPANY

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155Exercises

Month 20X1 20X2 20X3 20X4 20X5

January 12,000 8,000 12,000 15,000 15,000

February 8,000 14,000 8,000 12,000 22,000

March 10,000 18,000 18,000 14,000 18,000

April 18,000 15,000 13,000 18,000 18,000

May 14,000 16,000 14,000 15,000 16,000

June 10,000 18,000 18,000 18,000 20,000

July 16,000 14,000 17,000 20,000 28,000

August 18,000 28,000 20,000 22,000 28,000

September 20,000 22,000 25,000 26,000 20,000

October 27,000 27,000 28,000 28,000 30,000

November 24,000 26,000 18,000 20,000 22,000

December 18,000 10,000 18,000 22,000 28,000

Questions

E X E R C I S E S

5.1

Period 1 2 3 4 5 6 7 8 9 10

Demand 60 52 55 42 57 33 26 42 35 31

5.2
α

α

5.3

5.4
α

α

5.5

Month J F M A M J J A S O

Demand
(000)

0.2 0.5 1.0 2.0 4.0 8.0 25 45 59 66

(a)

(b)

(c)

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156 Supply Chain Planning and Analytics

(d)

5.6

Year Winter Spring Summer Fall

20X4 123 133 172 281

20X5 155 189 205 286

20X6 151 186 288 303

20X7 178 225 272 296

5.7

Month 20X4 20X5 20X6

January 12,000 15,000 15,000

February 8,000 12,000 22,000

March 18,000 14,000 18,000

April 13,000 18,000 18,000

May 14,000 15,000 16,000

June 18,000 18,000 20,000

July 17,000 20,000 28,000

August 20,000 22,000 28,000

September 25,000 26,000 20,000

October 28,000 28,000 30,000

November 18,000 20,000 22,000

December 18,000 22,000 28,000

Total 209,000 230,000 265,000

(a)

(b)

(c) α

(d)

5.8

Demand (quarts) Probability

13,000 0.1

15,000 0.5

18,000 0.3

20,000 0.1

5.9

Pizza demand Probability

45 0.15

46 0.15

47 0.25

48 0.20

49 0.15

50 0.10

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157

chapter

6
Supply Chain Management

CHAPTER IN PERSPECTIVE

As the organization designs its processes to achieve its competitive strategy, a
major element is the supply chain for its products and/or services. We now con-
sider the execution, or management, of the supply chain, which often involves
relationships with organizations outside the firm.

Supply chain management fundamentally involves matching supply with de-
mand and as such is strongly related to a firm’s competitiveness. Important supply
chain management topics include designing and restructuring the value chain,
outsourcing, and e‐commerce. Furthermore, competent management of the
supply chain has major impacts on all the strategic sand cone factors described in
Chapter  1 : quality, dependability, speed, and cost.

We first define the concept of supply chains and discuss their strategic impor-
tance. We then describe the many elements involved in their design, such as lo-
gistics, global sourcing, and supplier management. From this, we move to the role
of information technology and provide guidelines for successful supply chain
management. We conclude the chapter with a discussion of closed‐loop supply
chains. Two supplements to the chapter describe a supply chain classroom exer-
cise used by many MBA classes (Supplement A: The Beer Game) and an online
quantitative technique that is popular for some MBA classes (Supplement B: The
Economic Order Quantity Model).

Introduction
• While Apple’s enormous success is most commonly attributed to its ability to design highly

innovative products that are easy to use, the significant contribution its operations makes to its

success gets much less publicity. Nevertheless, experts and analysts that closely follow Apple

readily acknowledge that Apple’s operations excellence is as much an asset to Apple as is its

product innovation and marketing. Indeed, it is Apple’s operational capabilities that allow it to

pull off its massive, high‐volume product launches by managing its inventory efficiently.

It is not widely known, but Apple’s focus on improving its supply chain dates back to

the return of Steve Jobs in 1997. For example, to ensure that there was an adequate supply of

Apple’s new translucent blue iMacs, Apple spent $50 million to acquire all the available holi-

day air transport capacity. Not only did this ensure that Apple could get its products to the

customers but also the move crippled competitors, such as Compaq, that didn’t recognize the

need to ship products by air until it was too late. Based on this example and others like it,

Apple has learned that making investments in its supply chain up front pays for itself in the

long run in the form of greater volume. Greater volumes also yield additional benefits. For

example, when the sales volume of iPods increased in 2001, Apple discovered it could air‐ship

the iPods economically from the Chinese factories directly to its customers’ homes. Not only

does this help Apple reduce its investment in inventory but also it provides an added level of

service for the customer.

Beyond investing financial resources in its supply chain, Apple invests in its human

capital as well. For example, to facilitate the process of translating product prototypes into

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158 Supply Chain Management

successful new products, Apple’s design engineers live in hotels for months to be close to their

suppliers in order to help them perfect their production processes. For example, when Apple

designed a new MacBook with a case that was made from a single piece of aluminum, Apple’s

design engineers worked with the suppliers to develop the equipment to fabricate the cases.

With a huge cash war chest, Apple planned to almost double its supply chain capital

expenditures in 2011 to $7.1 billion. In part, this investment was used to purchase capacity

from its suppliers to ensure the prices and availability of its products. For example, prior to the

introduction of the iPhone 4 in June 2010, supplier capacity for screens was being used for

iPhones, forcing Apple’s competitor HTC to scramble for sources of phone screens. Likewise,

when Apple launched the iPad 2, it purchased so many of the high‐end drills used to produce

the tablet’s internal casing that the lead time for other companies to get these drills extended

to as long as six months.

Turning the tables, being selected by Apple to be one of its suppliers can be very profit-

able. However, this comes at a price. For example, when a potential supplier is asked to pro-

vide a price quote for a part or assembly that will go into an Apple product, the supplier is

required to submit in great detail how it arrived at the quote, including the specific material

costs, labor costs, and its estimated profit. Furthermore, to guard against supply disruptions,

Apple requires its suppliers to maintain a two‐week supply of inventory within a mile of the

Asian assembly plants.

Carefully orchestrated events announcing new products are eagerly anticipated by

industry analysts and loyal customers. Here, too, Apple’s supply chain management (SCM)

practices play an important role. For example, supplier factories work overtime weeks in

advance of new product launches to build up inventory to meet the often overwhelming

demand for new Macs, iPods, iPhones, and iPads. Furthermore, the success of the new product

debuts centers on the secrecy Apple is able to maintain about the features of its new products.

To ensure that the secrecy of its new products is not breached and to discourage leaks, Apple

places electronic monitors in a subset of the boxes of parts that go into its products so that it

is able to monitor the parts through the production process. Through this monitoring, Apple is

able to track every part handoff from the loading docks through the distribution centers. And

not to leave anything to chance, once the new products are finished, they are shipped in plain

boxes or even disguised boxes, such as tomato boxes.

A final piece of Apple’s supply chain that contributes to its operational excellence is its

retail stores. Apple tracks the sales at its stores hour by hour and, based on these sales, adjusts

its production forecast each day. When a risk of a product shortage is identified, Apple imme-

diately deploys teams, and the added capacity is acquired (Satariano and Burrows 2011).

• Even with the lean inventories that have resulted from the prevalence of just‐in‐time (JIT)

inventory systems, shifts in economic cycles can still wreak havoc for industry‐wide supply

chains. The electronics industry during the global recession of 2008–2009 illustrates this well.

At one end of the electronics, supply chain are the retailers that sell electronic products

to end consumers. With the financial crisis rapidly escalating in the fall of 2008, Minnesota‐

based retailer Best Buy experienced a significant decline in sales. Best Buy orders electronic

products such as DVD players six weeks prior to when they are needed. With the 2008

Thanksgiving shopping season approaching, Best Buy revised its prior forecast and dramati-

cally reduced its orders to its suppliers, such as Japan’s Toshiba and Korea’s Samsung

Electronics in early October 2008. As the financial crisis was uncharted territory, Best Buy’s

merchandising chief had to make his best guess in deciding how to modify the forecast.

Lacking a direct relationship with the final consumers, Best Buy’s suppliers were caught

off guard by its revised forecast and reduced orders. As expected, these suppliers in turn

reduced orders from their suppliers. As an example, Zoran Corp, a designer of specialty chips

used in electronic products, such as televisions (TVs), cameras, cell phones, DVD players, and

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159 Introduction

digital picture frames, saw its revenue decline in the fourth quarter of 2008 by 42 percent.

Zoran, which only designs chips, relies on companies like Taiwan Semiconductor

Manufacturing Company (TSMC) to produce its chips. Faced with decreased orders for its

chips, Zoran slashed its orders to TSMC. In January and February of 2009, TSMC saw its

revenue decrease by 58 percent compared to the prior year and was only utilizing 35 percent

of its plant capacity.

With decreased demand for its chips, TSMC in turn reduced its orders for chip‐making

equipment by 20 percent. Applied Materials is one company that makes the equipment used

in chip‐making factories. With the downturn in demand for chip‐making equipment, Applied

Materials was forced to lay off 2000 workers and require another 12,000 workers to take an

unpaid leave.

With the downturn in its business, Applied Materials reduced orders to its suppliers. For

example, D&H Manufacturing Company, which makes aluminum parts for chip‐making

equipment, reduced its employment from 600 to 150 workers in 18 months because of the

drop‐off in business. It also found itself sitting on a one‐year supply of inventory versus its

usual three months of inventory.

This example illustrates how the effects and decisions made at one end of the supply

chain are often amplified as they cascade to the other end. And because the players at different

stages in the supply chain are often caught off guard, it is not surprising that they frequently

overreact to the situation. In this particular case, Best Buy was actually having trouble keeping

its shelves stocked in the early part of 2009 despite the decline in demand. In fact, Best Buy

estimated in March 2009 that it could have sold more in the preceding three months had its

suppliers made less drastic reductions to their production plans (Dvorak 2009).

• Milwaukee, Wisconsin, is home to two of the biggest multibillion‐dollar manufacturers of

earth‐moving equipment that sells for up to $180 million: Bucyrus International, Inc. and Joy

Global, Inc. However, they disagree completely on how to locate their production facilities.

Bucyrus makes all their machines in the United States and Europe, where they have developed

highly efficient, low‐cost production processes, and then ships them from there to customers

all over the globe. Moreover, they expect the U.S. dollar and the euro to remain relatively

weak currencies, making manufacturing there affordable. Although they were invited to build

a plant in China in the 1970s, they declined to do so because the Chinese government decided

to make the production of industrial mining machinery “strategically critical,” meaning that

they would be heavily subsidizing their own domestic manufacturers.

• In contrast, Joy prefers to design and engineer in the United States but build their plants close

to emerging markets and in low‐cost developing countries, such as China, where the mining

market is growing and customers and domestic suppliers are plentiful. Joy’s Chinese factory

operating costs are fully 20 percent less than in the United States or Europe, though they admit

to having had some early quality problems. As Bucyrus’s CEO says, “It’s going to be interest-

ing to see how it plays out. One of us is more right than the other” (Matthews 2010).

The concept of SCM has taken on the nature of a crusade in U.S. industry, in part because of the

tremendous benefits that accrue to firms participating in a well‐managed supply chain. The

examples above illustrate this by highlighting the important role SCM plays in an organization’s

competitiveness. In Apple’s case, its supply chain practices ensure a stable supply of its highly

demanded products, which in turn leads to satisfied customers and minimizes potential lost sales.

On the other hand, the Best Buy example illustrates the potential for lost sales and profits when

the supply chain overreacts.

It is also worth noting that, although the benefits of superior SCM are clear for manufactur-

ing and distribution firms, even service organizations benefit from good SCM. This is not only

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160 Supply Chain Management

because services use supplies and facilitating goods in the delivery of their service (as noted in

Chapter 1) but also because they, too, outsource many of their internal functions, such as infor-

mation technology, accounting, and human resource management, just like manufacturers do.

Thus, the provision of these services becomes part of another supply chain, a chain of services

rather than goods, but nonetheless one requiring the same attention to strategy, purchasing, logis-

tics, and management oversight, just like for goods.

We begin the chapter with some definitions of the supply chain and SCM. As with any new

concept, not everyone envisions SCM in the same way. We then discuss some of the important

strategic advantages that accrue from wise management of the supply chain. From this overview,

we then consider the elements of the supply chain in depth, including purchasing/procurement,

logistics, transportation, global sourcing, and supplier management. An important element of

SCM is the critical role of information technology as a major catalyst in the supply chain move-

ment. Next, we provide some guidelines for successful SCM. We conclude with a discussion of

closed‐loop supply chains.

6.1 Defining SCM
The term supply chain generally refers to all the activities involved in supplying an end user with

a product or service. The perception of each organization that is involved—the ore refiners, the

transporters, the component producers, the manufacturer, the wholesaler, the retailer, and the

customer—being a link in the process makes the analogy of a chain quite appropriate. In

Figure 6.1, we show the position of a typical company (A) in the chain, with its suppliers to the

left of it, all the way “upstream” (as it is often called) to the raw materials, and its customers to

the right, all the way “downstream” to the ultimate consumer. However, company C in the chain

(a downstream “customer” as far as company A is considered) sees the same thing as company

A, with its suppliers (including upstream supplier company A) to its left and its customers to its

right. And as is seen, company B in the middle is the customer of one firm and the supplier to

another firm, as is the situation of almost all the companies in the chain.

Of course, all these companies typically need multiple materials and services to serve their

immediate customer in the chain, so there are really a lot of upstream supplier company links

connected on the left side of each link in the chain (only shown with links for company A, arrows

for all others). And most firms typically sell to more than one customer, so there are also multiple

downstream customer links connected on the right side of each link in the chain (again shown

only for company A). Clearly, managing all these links—that is, suppliers and customers—even

if only those directly connected to your company, is a major task!

Downstream

…. C
ustom

ers

…
. C

us
to

m
er

s

Su
pp

lie
rs
..

..

Suppliers ….

Upstream

…. Supplier Supplier
Company A

supplier

Customer
Company B

supplier

Customer
Company C Customer Customer

Customer ….

ConsumerRaw materials

FIGURE 6.1

The supply chain.

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1616.1 Defining SCM

Given such a lengthy process, it may behoove companies to store inventories of their out-

puts (if feasible) for immediate delivery. Moreover, it must be remembered that it is not just

goods that are flowing along the chain but also information, funds, paper, people, and other such

items, and they are flowing in both directions along the chain. In addition, the green revolution

encourages recycling, recovery, and reuse of products, so even the used product may be flowing

back up the chain. (We will return to the topic of closed‐loop supply chains later in this chapter.)

In addition, the supply chain also involves other functional areas and activities such as product/

service design, finance, accounting, marketing, human resources, and engineering. Thus, instead

of a chain, we should probably think of the supply process as more of a network, with everyone

communicating with, and passing monies and items between, everyone else.

SCM, then, concerns the process of trying to manage this entire chain from initial receipt

of the ultimate consumer’s order all the way back to the raw material providers and then ulti-

mate delivery back to the consumer. Note that SCM is not restricted to managing only the links

that connect with your company’s position in the chain, but all the links along the chain, so that

savings (or increased value) in any part of the chain can be shared or leveraged by other com-

panies along the chain. For example, Toyota is famous for teaching their suppliers how to

install and operate their famed Toyota Production System (also known as lean manufacturing).

But the teaching doesn’t stop there, since Toyota’s first‐tier suppliers can gain additional

improvements by teaching their suppliers, the second tier, and so on up the supply chain. The

interest in SCM has exploded primarily because of the development of new information tech-

nologies such as intranets, e‐mail, electronic data interchange (EDI), and, of course, the

Internet. These technologies, in conjunction with greater global competition, have fostered an

interest and ability in improving processes along the entire supply chain, resulting in better

performance at reduced cost.

SCM can also be considered to include a number of other managerial thrusts, such as qual-

ity management (Chapters 1 and 7), inventory management (discussed later), enterprise resource

planning (ERP, also discussed later), and lean production (including JIT; Chapter 9). But it is

even more comprehensive than that. For example, it includes marketing aspects in terms of com-

munication with the customer, engineering issues involved in product/service design, financial

aspects in terms of payments and float, purchasing elements such as sole sourcing, and, of course,

technological initiatives such as the omnipresent Internet. To a large extent, this breakthrough in

conceptualizing the potential for improvement in customer value by including all elements of the

value chain is due to the development of advanced information technologies, such as the Internet.

Other definitions of SCM include the following points (Walker and Alber 1999):

• SCM coordinates and integrates all the supply chain activities into a seamless process and

links all of the partners in the chain, including departments within an organization as well as

the external suppliers, carriers, third‐party companies, and information system providers.

• SCM enables manufacturers to actively plan and collaborate across a distributed supply chain

to ensure that all parties are aware of commitments, schedules, and expedites. By actively

collaborating as a virtual corporation, manufacturers and their suppliers can source, produce,

and deliver products with minimal lead time and expense.

• The goal of SCM is to optimally deliver the right product to the right place at the right time

while yielding the greatest possible profit.

The SCM objective of attempting to manage activities that lie outside a manager’s normal

realm of internal responsibility (i.e., managing second‐ or third‐tier suppliers or downstream cus-

tomers) is to reduce the costs of delivering a product or service to a user and improve its value.

Sometimes, a distinction is made between a “value” chain, a “demand” chain, and a narrowly

defined supply chain that simply manages suppliers to obtain the lowest cost. The conceptualization

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162 Supply Chain Management

of the value chain is that it considers other important aspects of customer value besides cost, such

as timeliness, quality, and functionality. That is, where the supply chain tends to focus on efficiency,

the value chain focuses on effectiveness. These important issues will be discussed in more detail in

the next section.

Also, as many have pointed out (e.g., Lummus and Vokurka 1999), the current conceptual-

ization of the supply chain still has many elements of the old “push” system of production based

on forecasts of demand. (See Section 5.2 on demand planning for more information on this topic.)

The newer “pull” systems, consisting of JIT deliveries, lean manufacturing, and so on, dictate a

different view of the value chain called a demand chain. In this conceptualization, a customer

order pulls the product through the chain on demand, thereby further improving costs and bene-

fits. Of course, acting after the fact rather than anticipating demand will put even further stress on

the ability of the value chain to respond in a timely manner.

Another layer of complexity is often added when managing service supply chains, as the

customers of the service can also serve as suppliers. For example, you supply the yard to your

landscaping service. Likewise, your lifestyle and budget are important inputs to the architect you

hire to design your dream house. Because the customers of a service may also be a supplier, it is

likely that these customer–suppliers need to be handled differently than suppliers that are not

customers. For example, suppliers that are not customers need to be selected, but customer–sup-

pliers need to be attracted.

The dual nature of the customer–supplier role further compounds the complexity of the

service supply chain. With a more manufacturing‐oriented supply chain, the goods tend to flow

in one direction downstream. In service supply chains and the dual customer–supplier role, ser-

vices flow in both directions, with the customer both upstream and downstream from the service

provider. Finally, service providers may require additional flexibility to deal with the added vari-

ation that is associated with customer‐supplied inputs compared to other situations where the

inputs are supplied by a more limited set of suppliers.

Attempts to reduce the costs of supply (previously considered as “purchasing” or “procure-

ment”) have been ongoing for decades, of course. However, management has also realized that

there are costs other than strict materials and production costs in the supply chain that can be

reduced with better information sharing and tighter management, and these costs are at the fore-

front of attention in SCM. For example, costs of multiple shipments, costs of inappropriate func-

tionality, costs of low quality, and costs of late delivery are all costs that can be eliminated with

better information sharing and managerial oversight.

6.2 Supply Chain Strategy
The concept of the value chain was mentioned earlier, and it should be emphasized that an organi-

zation’s supply chain strategy needs to be tailored to meet the needs of its customers, which isn’t

always the lowest cost. In fashion goods, for example, fast response to short fashion seasons is

much more important than lowest cost. And in high technology, new functionality (or reliability

or security) may be more important than cost. Thus, the strategy for building an organization’s

supply chain should focus on maximizing the value to its customers, where value can be consid-

ered to be benefits received for the price paid or benefits/cost.

In situations where the goods are basic commodities with standard benefits (food, home

supplies, and standard clothing), then cost reduction will be the focus. But in fashion goods,

timeliness should be the focus of the supply chain, meaning quick deliveries, stockpiling of long

lead time items, and so on. In new notebook computers, the focus might be on identifying firms

that offer new functionality; in telecom, the focus might be on reliability; and in music, the focus

might be on flexibility to meet quickly changing tastes or talent. Thus, the supply chain needs to

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1636.2 Supply Chain Strategy

be carefully matched to the firm’s market and needs. Where the firm operates in multiple markets

or appeals to multiple needs within the same market, it may find it necessary to operate different

supply chains for each focus. Although most of the remaining discussion in this chapter is directed

toward the traditional supply chain strategy of minimizing costs, which is always an important

consideration and probably the major focus of most supply chains today, the other possible stra-

tegic purposes should be kept in mind also.

It is also important to point out that many organizations choose to outsource portions of the

SCM function to the so‐called third‐party logistics (3PL) companies. These 3PL companies

provide a range of services, including handling the distribution of the organization’s products,

receiving incoming materials, managing the organization’s warehouses, managing the purchasing

function, and handling product returns. The balance of activities kept in‐house and those out-

sourced vary by company and should be driven by the organization’s strategy and competencies.

There a number of reasons why organizations choose to outsource portions of or the entire

supply chain function to a 3PL. First, assuming that SCM is not the organization’s core compe-

tency, shifting these activities to a 3PL allows the organization to focus more directly on its core

competencies. Second, outsourcing these activities reduces the capital investments in the infra-

structure needed to support these activities. In effect, the use of a 3PL converts a significant por-

tion of what was a fixed cost into a variable cost. Finally, by utilizing a 3PL, the organization

gains access to the best practices and technologies that it might not be able to afford or develop

if the function was kept in‐house. 3PLs are able to make the investment to develop these best

practices and technologies because these development costs are spread across multiple organiza-

tions served by the 3PL.

However, there are also disadvantages in using 3PLs, such as the longer response time and

greater risk of disruption in the supply chain when customers are wanting faster, more reliable

response. An added danger of all outsourcing is the natural tendency for management to meas-

ure only the internal response time of the firm when the customer is measuring the total time

from order to obtaining the good or service. In any outsourcing decision, the added time and

risk of delay from outside suppliers need to be considered. This response time is also affected

by the production process adopted, since make‐to‐stock (MTS) will have the fastest response

because the order can simply be pulled off the shelf and sent to the customer, assemble‐to‐order

(ATO) is a bit slower, make‐to‐order (MTO) is slower still, and engineer‐to‐order (ETO) is the

slowest of all.

6.2.1 Strategic Need for SCM

To understand the potential for obtaining strategic advantage from better management of the sup-

ply chain, whether it is kept in‐house or outsourced to a 3PL, it is useful to realize that total sup-

ply chain costs represent more than half, and in some cases three‐quarters, of the total operating

expenses for most organizations (Quinn 1997). To understand these values, bear in mind that the

broader concept of the supply chain includes the supply, storage, and movement of materials,

information, personnel, equipment, and finished goods within the organization and between it

and its environment. The objective of SCM is to integrate the entire process of satisfying the

customer’s needs all along the supply chain. This includes procuring different groups of raw

materials from multiple sources (often through purchasing or recycling or recovery), transporting

them to various processing and assembly facilities, and distributing them through appropriate

distributors or retailers to the final consumer. Within this process are a great variety of activities

such as packaging, schedule coordination, credit establishment, inventory management, ware-

housing, maintenance, purchasing, order processing, and supplier selection and management.

As organizations have continued to adopt more efficient production techniques such as lean

manufacturing, total quality management, and inventory reduction techniques to reduce costs and

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164 Supply Chain Management

improve the quality, functionality, and speed of delivery of their products and services to custom-

ers, the costs and delays of procuring the requisite inputs and distributing the resulting goods and

services are taking a greater and greater fraction of the total cost and time. For example, the cost

of just physical distribution itself is now up to 30 percent of sales in the food industry. To achieve

quick response with quality goods that accurately satisfy the need at the lowest possible cost

requires taking a broad, long‐range, integrated perspective of the entire customer fulfillment

process instead of focusing on the little segments and pieces of the chain.

For instance, if each segment of the supply chain is acting in a way to optimize its own

value, there will be discontinuities at the interfaces and unnecessary costs will result. If an inte-

grated view is taken instead, there may be opportunities in the supply chain where additional

expense or time in one segment can save tremendous expense or time in another segment. If a

broad enough view is then taken, the savings in the one segment could be shared with the losing

segment, so everyone would be further ahead. This broad, integrated view of the supply chain is

more feasible these days due to the recent capabilities of advanced information technology and

computer processing (e.g., bar codes, computerized manufacturing, the Internet, ERP systems,

and electronic funds transfer).

Other factors are also driving the need to better manage the supply chain:

• Increasing global competition. In addition to increased pressure on cost from global competi-

tors who have lower labor rates, they also frequently offer better quality, functionality, and

customer responsiveness. This is pressuring firms to look globally for better or cheaper sup-

pliers, resulting in increased outsourcing and offshoring.

• Outsourcing. Since more organizations are outsourcing and thereby increasing the need for

transportation, this has pushed up transportation costs.

• E‐commerce. The advent of e‐commerce and other electronic technologies has made it easier

and cheaper to outsource, either domestically or even globally.

• Shorter life cycles. Customers are demanding greater variety, faster response, higher quality,

and cheaper prices. One result of these demands is shorter product life cycles, which means

constantly changing supply chains and using more chains over the same period of time.

• Greater supply chain complexity. The increased complexity of supply chains requires much

more attention and better management of these chains. For example, in early 2001, when the

bottom fell out of the telecom market, Solectron Corp., the world’s biggest electronics con-

tract manufacturer, was holding $4.7 billion of inventory from its 4000 suppliers to fill firm

orders from Cisco, Ericsson, Lucent, and other telecoms. But when the telecoms canceled

their orders, no one knew who owned all that inventory (Engardio 2001)!

• Increasing levels of concern for the environment. Addressing environmental concerns impacts

virtually all aspects of SCM from the sourcing of parts to the distribution of the product and

even to the disposal of the product once it reaches the end of its useful life. Green sourcing

seeks to identify suppliers in such a way that the organization’s carbon footprint and overall

impact on the environment are minimized. Reducing the waste associated with products is

another way organizations minimize the negative impact they have on the environment. Along

these lines, and as is discussed in Chapter 1, organizations can deploy a strategy referred to as

the three R’s: reduce, reuse, and recycle.

Implementing SCM has brought significant documented benefits to many companies.

Ferguson (2000) reports, for example, that compared to their competitors, such firms enjoy a

45 percent supply chain cost advantage, an order cycle time and inventory days of supply

50 percent lower, and finished product delivery 17 percent faster. Lummus and Vokurka (1998)

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1656.2 Supply Chain Strategy

note that these firms operate with 36 percent lower logistics costs, which, by itself, translates into

a 4 percent increase in net profit margins. One firm reported a 25 to 50 percent reduction in fin-

ished product inventories, a 10 percent reduction in cost, and a 10 to 25 percent improvement in

production process reliability.

Of course, these are primarily the cost aspects of the SCM process, which are more easily

measured than the qualitative benefits, such as more loyal customers and a larger market share.

There are also significant effects on other important aspects of an organization, such as its ability

to learn new procedures and ways of operating, the morale of its employees, and the ability to

change direction quickly.

6.2.2 Measures of Supply Chain Performance

Better supply chain performance will show up in a number of standard financial measures of a

company’s health. Lower inventories, normally considered an asset, will be reflected in less need

for working capital (WC) and a higher return on assets (ROA) ratio (since assets are reduced).

And the lower cost to carry these inventories (as well as other reduced costs in the supply chain)

will be seen in a reduced cost of goods sold (CGS) and thus a higher contribution margin, return
on sales (ROS), and operating income. Moreover, if the supply chain is also better managed to

provide other benefits to the consumer, as mentioned earlier, the effect should be seen in higher

total revenue, since the consumer will be willing to pay more. Lower costs, if used to reduce

prices, will also result in higher volumes, which will further increase revenues.

One performance measure that provides managers with a broad view of the supply

chain is the cash conversion cycle (CCC). This financial performance metric helps a company

assess how well it is managing its capital. In effect, the CCC is the amount of time the organi-

zation’s cash is tied up in WC before being returned by customers as they pay for delivered

products or services. The key inputs needed to calculate the CCC are inventory (I), accounts

receivable (AR), and accounts payable (AP). These inputs are readily available from the

organization’s financial statements. Before calculating the CCC, the inputs are standardized

into days as follows:

I
inventory

annual cost of goods sold

AR
accounts receiv

365

aable

annual net sales

AP
accounts payable

annual cost of

365

goods sold
365

These standardized inputs are used to calculate the CCC as follows:

CCC AR API

A positive CCC represents the number of days the organization’s capital is tied up waiting

for the customer to pay for the products or services. A negative CCC represents the number of

days the organization is able to receive cash from its sales before it pays its suppliers. Thus, the

smaller the CCC, including negative numbers, the better the organization is performing.

Dell has reduced their supply time so much that they actually receive payment from the

customer before (known as float, another financial term) they have to pay their suppliers for the

parts that make up the customer’s product! In 1998, Dell’s CCC was 29 days. By 2005, it had

improved to 230 days, and by 2009, it was 244 days (Dignan 2002; Magretta 1998).

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166 Supply Chain Management

Beyond these standard financial measures, however, we can also look at some more

operations‐oriented measures that we typically use to see how well operations is performing,

such as defect rates, lead times, inventory turns, productivity ratios, and so on. Since one of the

major cost savings in SCM is the cost of inventories, it is worthwhile to examine some perfor-

mance measures related to inventory reduction. One such measure to track is the percent of the

firm’s assets represented by inventory. First, we calculate the aggregate inventory value (at cost)

on average for the year (AAIV):

AAIV raw materials work in process finished goods- –

% /Assets in inventories AAIV total assets

Another inventory measure is the inventory turnover (or “turns,” as it is sometimes called):

Inventory turnover ( turns ) annual CGS AAIV“ ” /

Note that the inventory turnover is based on the same items that make up total annual

revenues but is based on their cost instead of their price. Turnover essentially represents

how often the average inventory is used up to obtain the total sales for the year. Like ROA, the

more the inventory and assets can be reduced and still maintain the same sales, the better!

Inverting the equation for turns gives us the same information, but through a measure of the

proportion of the year’s sales we are holding in inventory. This is usually expressed in daily (or

weekly) periods:

Days of supply AAIV daily CGS/

In some firms that have achieved supply chain excellence, they measure their supply in

hours instead of days. Dell Computer is one of these firms (Dignan 2002; Magretta 1998) due to

the outstanding job they have done on fine honing their supply chains.

6.3 Supply Chain Design
As shown in Figure 6.2, the supply chain consists of the network of organizations that supply

inputs to the business unit, the business unit itself, and the customer network. Note that the sup-

plier network can include both internal suppliers (i.e., other operating divisions of the same

organization) and external suppliers (i.e., operating divisions of separate organizations). Also,

note how design activities cut across the supplier network and the business unit and how distri-

bution activities cut across the business unit and the customer network. This broader view of the

entire process of serving customer needs provides numerous benefits. For example, it focuses

management attention on the entire process that creates value for the customer, not the individ-

ual activities. When viewed in this way, information is more freely shared up and down the sup-

ply chain, keeping all parties informed of one another’s needs. Furthermore, activities can be

performed at the point in the supply chain where they make the most sense. To illustrate, instead

of providing Johnson Controls with detailed specifications for car seats, car manufacturers pro-

vide broad specifications and rely on Johnson Controls’ expertise to design and manufacture

their car seats.

In this section, we will look at each of the major logistical elements of the supply chain to