PRODUCTIONS AND OPERATIONS MANAGEMENT

OPERATIONS AND SUPPLY MANAGEMENT

The set of processes that are needed to transform INPUT to OUTPUT that meet the customers needs.
We could use this function to describe the model:
Q=Q(X,A)

OPERATIONS
The processes, activities that contribute to transform INPUT into valuable OUTPUT.
For the Hotel (booking management, organization of cleaning and sanitation of rooms)

SUPPLY
The movement of input to the firms and the movement of output from the firms to the market.
For the Hotel (organization of product supply and sanitation services, organization and implementation of
customers pick-up services from airports, management of check-in and check-out services).

The study of a firm’s operations can uncover ways to reduce costs, because operations and supply
management are considerable sources of competitive advantages.
For instance, low cost airline companies are able to reduce the turnaround time (Ryanair takes as little as
25 minutes for the whole process for a short-haul flight; they managed to reduce drammatically the time
revoving the seatback pockets from their aircraft).

EFFICIENCY
To do something at the lowest possible cost.

EFFECTIVENESS
To do something for generating the maximum value for a company.

There’s a TRADE-OFF between efficency and effectiveness: increasing one suppose reducing the other.

VALUE= Quality/Price
It rises when:
-a company enhances its quality without modifying its price.
-a company keeps constant its quality but reduces its price.
-a company is able to increase both of them, so that the increment in the former is higher.

SUPPLY CHAIN TRANSFORMATION PROCESS

The ways by which inputs are transformed into valuable outputs.
Include physical (as in manifacturing), location (as in transportation), exchange (as in retailing), storage (as
in warehouse).
Operations and supply management deals with the design and development of the range of trasformation
processes occurring through a firm’s supply chain.

Sourcing processes  logistic  Manifacturing and Service processes  logistic Distribution processes
GOODS AND SERVICES
Goods have physical dimension, are generally produced in facilities, can be produced with a very low
degrees of variations in their characteristics, can be stored and can be designed to meet specific needs.

Conversely, services are intangible, require an interaction with the customer, are heterogeneous,
perishable and evaluated as a package of features.

More and more, products delivered by firms are combination of goods and services.
Profits marging in pure manifacturing industries has decreased by an intense competition.
Differentation leads companies to combine goods and services in attempt to rise profits.

LECTURE 2 - COMPANY MISSION AND STRATEGY

Mission statement: defines the aim to be pursued by a company. It should identify who are the company’s
stakeholders, define how the company’s activities create value for them, and contain a statement of the
company’s core purpose.

Stakeholders: agents interested in the company’s activities because they can be affected by them.

Firm’s strategy: makes up a set of plans, actions, and policies aimed to accomplish a company’s mission.
In each functional area, strategies are also defined to accomplish supporting missions. In doing so, these
strategies will contribute to the realization of the company’s mission.
Business strategies can be based on three components (dimensions):
 Operation effectiveness: efficiency, cost minimization
 Customer management: limits estabilished with the firm’s customers.
 Product or service innovation: creation of new products, processes and
services to meet clients’ needs.

Operation and supply strategy

Defines plans and policies for using firms’ resources to best support their long-term competitive strategy.
Competitive dimensions:
1. Cost or price: minimize costs or set a lower price than competitors’.
2. Quality: identify all the attributes that matter to customers.
3. Delivery speed.
4. Delivery reliability.
5. Handling changes in demand.
6. Flexibility and new product introduction speed.
7. Other criteria (Technical liaison and support. Meeting a launch date. Supplier after sale support.
Other dimensions:  Customization available.  Product mix options.  Environmental considerations.)

Trade-offs in the strategy design

Concept of trade-offs. Companies cannot excel simultaneously on all competitive dimensions.
Consequently, management has to decide which competitive dimensions are critical to the firm’s success
and then concentrate the resources of the firm on these particular dimensions.

Nonetheless, some companies overcome these trade-offs developing ambidextrous operations designs.
Links between marketing and operations
-Order winner: Dimensions and characteristics that differentiate the products and services of one firm
from those delivered by another. These dimensions include price, quality, and reliability of a product,
among others.
-Order qualifier: Dimensions and characteristics of a firm’s products that permit them to be considered as
possible candidate for purchase.
Them both can change over time.

Fitting operational activities to strategies: a firm’s operational activities are related to one another. In
turn, there are links between these activities and those performed by other functional areas.
To handle this, managers can used activity-system maps.

What is the framework for the operations and supply strategy?

Operations and supply strategy have to be defined taking as a reference both customers and the rest of the
functional areas.

Productivity measurement
Productivity is a useful measure in diagnosing problems related to the way operations work, and in
assessing the performance of the company.

It’s a relative measure: must be comparated with something

else. The comparisons can be either intra-company as in the
case of yearto-year comparisons of the same measure, or
intercompany as in the case of benchmarking.

Alternatively, productivity can be also distinguished as follows:

-Technical: Takes into account only the relationship between outputs and inputs measured in their physical
units.
-Economic: Takes into account the relationship between the monetary value of the outputs and costs of the
inputs.
Examples for the case of labor productivity:
 Technical: Quantity Produced/Number of hours worked.
 Economic: Revenue/(No. Hours x hourly wage).
LECTURE 3 – PRODUCT AND SERVICE DESIGN

Defining the role of product and service design

The Polaroid printer CI-700
During the development of the CI-700 printer, the company face several decisions:
• Does the company posses all the core capabilities to make the product design for this product?
• Should the company outsource the product design of the printer?
• How does the product design for this product leverage the strategy of the company?
• In case of carrying out the product development in-house, should the product design team increase
development spending to increase the reliability of the CI-700?

The locus of the product and service design

Decisions on product and service design have to be made by taking into consideration two relevant issues:
 Identification of which functions and activities during the process of product and service development
will be outsourced to other firms, and which ones will be supported in-house.
 Identification and development of a company’s core capabilities.

Some companies decide to internalize the entire process of product and service design (in-house);
others decide to outsource a part of the process and on the other hand some decide do outsource the
entire process.
This is where specialized business in manufacturing products or delivering services to other companies
come into play. These businesses are called contract manufacturers, in the first case, and service
providers, in the second.

Ex. of a contract manufacturing company

IDEO is specialized in product and service design for other companies seeking to improve the functionality
of their product and services. IDEO exploits the design thinking philosophy.
Design thinking rests on three elements: • People's Needs. • Technical Viability. • Economic Viability

More on design thinking:

It consists of 5 phases:
1. Empathize: Understand the needs of users
2. Define: Identify key problems whose solution will be key to having an innovative result
3. Devise: Think of possible solutions
4. Prototype: Make simple versions of the product incorporating the most encouraging ideas (lean
management).
5. Test: Observe and analyze the reaction of users in the field. This phase determines if production can
begin, the design must be modified or, directly, cancel the project.

The importance of product and service design: Some examples

The role of product and service design in a firm’s strategy

The design of products and services gives leverage to a firm’s strategy in the following ways:
 Keep the brand and the company's reputation.
 Define the type of innovation that the company requires to meet the needs of its customers.
 Create products and services focused to meet consumers’ needs.

The process of product/service development

-Product and service design refer to the processes through which companies define the “attributes”,
“configuration” and “operations” needed to provide products and services that meet their customers’
needs.
(attributes are related to the design quality; operations have to do with process quality)

- Product and service development process describes the steps followed by a company to create, develop,
test and commercialize new products and services.
Phases: Sources of ideas - Company capacity to develop the idea - Market needs
- Function definitions: how does it work? - Product and service specifications: how does it work?
- Design review: Are the current specifications those that better meet costumers’ needs?
- Market test: Does it meet the costumers’ needs and expectations - Market introduction – Assessment

Types of process of product and service development

Variants of the development process (read this section in chapter 4)
 Generic products (for the market).  Technology driven products.  Platform products.  Process
intensive products.  Custom products.  High risk products.  Products that build fast.  Complex
systems.

Economic analysis of product and service development process

The economic analysis is useful at least in two situations:
Go/no-go milestone: This includes considerations like: Should we try to develop a product to address new
market opportunities? Should we proceed with the implementation of a chosen product concept?
These questions arise typically at the end of each stage of the product development process.
Operational design and development decisions: This involves questions like: Should we spend money to
hire an outside company to develop a given component to save development time? Should we launch the
product in a given period at a unit costs of “x” euros?
Building a base case: The first step is to determine the schedule for the project. This involves estimating
the timing of each stage of the project.
 Second, we need to estimate also the magnitude of the future cash flows.
 Third, we calculate the Net Presence Value (NPV) of the corresponding cash flows.
 To build the base-case, data coming from the project schedule, project budget, sales volume forecasts,
and estimated production costs will be needed.
 Finally, we should make sensitivity analysis to understand the trade-offs of the project. Based on
•Project development time. • Sales volume. • Product costs or selling price. • Development costs.

Net Present Value: Indicates the present value of a monetary flow considering a discount factor (i.e.,
interest rate, inflation, capital costs).

Designing for the customer: the quality function deployment (QFD)

How to become customers’ needs into specifications easily incorporated into products and services.
In order to study this issue, we will use the quality function deployment approach.
This approach gets the voice of the customer into the design specification of products/services.

Step 1: Identify customers’ needs, classifying them into categories called customers’ requirements (what’s).
Stage 2: Identify core processes, activities and operations needed to get the product/service (how’s).
Stage 3: Mapping the what’s and how’s. Link identified customers’ requirements to the defined core
activities.
Stage 4: Conduct competitive analysis.
Designing a Service product
Considerations to design new services or improve existing ones. The question of fit:
 Service experience fit: Additional services must be coherent with existing service experience for
customers.
 Operational fit: Operations to support additional services.
 Financial fit: Financial justification.

What are the main features that distinguish service design? Service design characteristics
The direct customer involvement in service provision makes a difference in the process of service design.
This is because of:  The time that it takes to deliver a service.  Skills and knowledge of employees and
customers.

- Complexity: number of steps required to deliver a service.

- Divergence: number of ways a customer/service provider interaction can vary according to the needs and
ability of each one.

How to measure product development performance?

The following dimensions are considered:
 Time to market
• Measures: This is measured by items like the frequency of new product introductions, time from initial
concepts to new product introductions, number of started and completed projects, among others.
• Impact: Responsiveness to consumers/competitors. Quality design.
 Productivity
• Measures: Engineering hours per project, costs of materials and tooling per project.
• Impact: Frequency of projects, number of projects.
 Quality
• Measures: Conformance-reliability in use, Design – performance and customer satisfaction.
• Impact: Reputation- customer loyalty, customers’ attractiveness – market share, profitability.

LECTURE 4 – CAPACITY MANAGEMENT IN OPERATION AND SUPPLY MANAGEMENT

Capacity: amount of output a production system is able to generate in a given period of time. Capacity
must take into account both resources (inputs) and production (outputs) involved.
Examples In the manufacturing companies:
Automobile: Number of units that can be produced in a single shift.
Computers: Number of computer units assembled in a given period.
In the case of service companies: Hotel: Available rooms per month. Restaurant: Number of tables,
number of menus, or available number of seats per schedule.
Short-range (<1 month): adjustaments that smooth production (ex. overtime use, rotations)
Intermediate-range (from 6 to 18 month): hiring personal, lay-off decisions
Long-range (>12 months): acquisitions of new equipments; capital-intensive input; adjustments in firm size.

Scope of strategic capacity management in the hierarchy

Capacity decisions can be made at different levels within companies. In the case of a manufacturing
company, capacity decisions can be made at the factory level or at the level of the whole company.
-Capacity at the level of one industrial establishment (factory): 300 units assembled per shift.
-Capacity of the whole company: 1,500 units assembled in country “A”.

Strategic capacity planning

The aim of strategic capacity planning is to provide an approach for determining the overall capacity of
capitalintensive resources (e.g., facilities, equipment, building, labor force) that best supports the firm’s
long-run competitive strategy

Let us take into account the potential consequences of wrong capacity decisions:
-Excessive capacity: a firm might have to reduce prices to stimulate demand, underutilize its workforce,
carry out excess inventory, etc.
-Scarce capacity: slow service delivery, loss of customers, increasing entry of new competitors.

Capacity planning concepts

1)Best operating level
This concept refers to the level of capacity for which a process was designed, and thus it corresponds to
the volume of output at which average unit cost is minimized.
For example:
A hotel with 250 double rooms with 500 stays.
A factory with a capacity to produce 2,000 units per shift.

2)Capacity utilization rate

This is the proportion of the current used capacity with respect to the best operating level. It measures how
close a company is to its best operating level

-if a hotel has 500 available rooms per month and currently rents 480 per month, its capacity utilization
rate is 96%.
-If a plant can produce 1200 units per shift and the current production is equal to 800 units, the capacity
utilization rate is 66.67%.

3)Economies/diseconomies of scale
Economies of scale are cost advantages derived from a firm size. As a firm gets larger and volume increases,
average unit costs decline. Diseconomies of scale arise when an increasing firm size and production volume
results in a raise of average unit costs.
Economies of scale can be classified into:
Technical economies: technical reason that increase efficiency
Pecuniary economies: increases in volume may involve reduction in
input prices.
4)Learning curve
This notion refers to saving costs due to a firm’s accumulated experience in the production process. As the
firm produces more, it may gain experience in the best production methods, which can reduce its
production costs.

Increase volume (Q)gain: experience, capabilities, skillsLearningefficiency gainsReduction costs

Larger plants can provide companies with a twofold cost advantage. Not only these plants gain economies
of scale, but they also will produce more, generating thus learning curve advantages.
Larger plants Economies of scale  Low costs Low prices Increasing demand  More volume 
Fast learning

5)Capacity focus
According to this notion, a company works best when it places the attention on limited production
objectives. A way to avoid inconsistencies in capacity focus is to use the notion of plants within plants
(PWP). A focused plant has several PWPs, each one with their own sub-organizations, equipment, process
policies, and workforce policies.

For instance, airlines often assess whether to offer “business class” and “economy class services”, or
alternatively, just to offer “economy class seats”.
The focus on economy class services would mean that a company is placing the attention on a specific
dimension of its competitive strategy: Provision of low-cost services.

6)Capacity flexibility
This relates to the degree of flexibility at which a company can operate its plants. That is, how fast the
company can increase or decrease its production.
This flexibility can materialize in terms of:
Flexible plants: Zero changeover plants. / Flexible process: Flexible manufacturing systems (economies of
scope). / Flexible workers: Multiple skills and training.

Flexibility can lead firms to gain economies of scope. These economies arise when the production of
several products/services in combination reduces the firm’s average unit cost.

7)Economies of scope
Economies of scope occur when producing a wider variety of goods or services in tandem is more cost
effective for a firm than producing less of a variety or producing each good independently.
LECTURE 5 – CAPACITY PLANNING

We need take into account two considerations:

-Considerations in adding capacity.
-Determinations of capacity requirements.

ADDING CAPACITY
The following issues should be considered when assessing the expansion of capacity:
 Maintaining a system balance.  Frequency of capacity additions.  External sources of capacity.

-Mantaining a system balance

In a perfectly balanced plant, the output of each stage provides the exact
input requirement for the subsequent stage.
This condition is difficult to achieve because the best operating levels for
each stage generally differ. Variability in product demand and the processes
may also lead to imbalance, in the short run.
You can face lack or excess of capacity

-Frequency in adding capacity

As regards the frequency of capacity additions, we have to evaluate the
costs associated with at least two options: Infrequent vs. frequent capacity
expansions.

-Adding external capacity

Two common options:
Outsourcing: For instance, outsourcing of catering or cleaning services in a hotel.
Sharing capacity: For instance, suppose the case of two airline companies that fly different routes and face
different seasonal demands. They can exchange aircrafts when one’s routes are heavily used, and the
others are not.

DETERMINING OF CAPACITY REQUIREMENTS

In this process, we can distinguish three stages:
1. Demand forecasting.
2. Identification and evaluation of resources required (e.g., labor and equipment requirements).
3. Determine if:
Demand excesses capacity. Capacity excesses demand. The presence of seasonal demand adjustments.

PLANNING CAPACITY IN SERVICES

Capacity planning in services should consider:
1. Time (services are periodable)
2. Location (ex. tax policy, Ireland)
3. Volatility of demand (consumers can always modify the demand behaviour)
Prior issues makes demand management a critical issue in planning capacity in services.
Demand management includes issues such as: Booking systems. Queue and waiting lines. Pricing and
discounts. Yield Management (pricing strategy based on understanding, anticipating and influencing
consumer behavior).

Some studies suggest that, in services, the best operating point is about
70% of maximum capacity. This allows companies to serve customers
individually, and to keep servers busy

DECISION TREES TO ASSESS CAPACITY OPTIONS

A decision tree is a schematic model of the sequence of steps in a problem, in which conditions and
consequences associated with each step are evaluated.
Expected value (EV) is a weighted average of possible outcomes of a chance event.
The higher the EV, the better a particular decision alternative on average when compared to the other
alternatives in the decision tree.

Example A tour agency specializing in boat tours is experiencing a substantial backlog, and the firm's
management is considering three courses of action:
A) Arrange for subcontracting. B) Buy new boats. C) Do nothing (no change).
The correct choice depends largely upon demand, which may be low, medium, or high. By consensus,
management estimates the respective demand probabilities as 10% (low), 50% (medium), and 40% (high).
LECTURE 6-7 – PROCESS ANALYSIS
Definition of process: A process consists of any part of the organization that becomes inputs into outputs.
A process can produce “goods” and/or “services”. In any case, it is expected that the value of the resulting
output will be greater than the value of the inputs.
Example Iberia: The company uses aircrafts, reservation systems, fuel, personnel, among other inputs to
transport clients to one place to another.

Using process analysis, we will try to answer the following sort of questions:
How many clients a process can deal with per hour?
How long does it take to serve a customer?
How does a company can increase its capacity?
How much does a process cost?

The objective of process analysis consists of:

Resolving a problem: For instance, this analysis helps us detect and eliminate bottlenecks.
Understanding the implications derived from changes in how a business will be done in the future.
Improving production: To identify inefficient tasks, spot possible effectiveness improvement tasks.

Analysis of a process
1)Mapping
2)Measuring its performance

Analyzing a slot machine as a set of processes  The slot machine is activated when a client puts one of
several coins in it.  Next, the client pulls the arm on the machine.  Three bands start spinning for a
while. Then, the bands stop, and each one displays a given symbol.  The machine pays money when a
given combination of symbols arises.
How to map it:
Process flowcharting A flowchart will assist us in representing the element involved in a process.
These elements can include: • Tasks. • Flows (e.g., flows of inputs and outputs, clients, information). •
Decision points. • Storage areas.

Cycle time refers to the average time that elapses to complete successive units in a process. It is the
elapsed time between starting and finishing a job. Let’s get back to the case of the slot machine. Assume
that a “representative client” puts 1 coin of one euro every 20 second. Then, this time, 20 second, define a
cycle time.

Utilization is the ratio of time that a resource is currently used relative to the time it is available. In the
setting of the slot machine, let’s suppose the machine operates 12 out of the 24 hours per day. Thus, in
each day its utilization ratio is equal to 0.5.

Types of processes
A single-stage process: The simplest process that only includes one stage.
A multiple-stage process: More complex, made it up by several stages, some of which are sequential.
Multiple-stage with buffer: A sequential process in which some of its stages are separated by buffers
(storage areas).

Other types of processes

Serial flow process: A single path for all stages of production.
Parallel process: Some of production has alternative paths where two or more machines are used to
increase capacity.
Logistics processes: The movement of things, such as materials, people, or finished goods.
Without buffering: Blocking and starving problems
A blocking takes place when the activities in a stage must stop because of the lack of place to storage items
just finished.
If items processed by stage 1 cannot be stored, then stage 1 must stop until
the subsequent stage can process incoming inputs from stage 1. The lack of
buffering results in a blocking.

Starving comes about when the activities in a stage stop because of the lack of work.
This situation implies that employees will remain inactive until they receive inputs coming from previous
stages.

Let’s calculate the cycle time of each process:  The cycle time in the first stage is 12 seconds per unit.
 The cycle time in the second stage is 36 seconds per unit.
 In order to produce 100 units, this two-stage process will take 3612 seconds (36 seconds/unit x 100 units
+ 12 seconds). The second process is starved 12 seconds at the beginning.

Bottlenecks occur when there is a lack of capacity in a process. This brings about accumulated backlogs. In
addition, resulting units in a bottleneck will be distributed unevenly to subsequent stages.
If a worker accumulates backlogs in a given stage of a process, he may limit the capacity of the whole
process. As a result, this workers will become into a bottleneck.

Stage 1  Stage 2
Let’s consider the cycle time of each process: What would happen if the first stage required 45 seconds
per unit and the second stage 30 seconds per unit? In this case the first stage would be the bottleneck and
each unit would go directly from the first stage to the second. The second stage would be starved for 15
seconds waiting for each unit to arrive.

A bottleneck is the process stage with the longest cycle time.

Which of the following production process terms best describes the situation when activities in a stage of
production stop because there is no work? a) Blocking. b) Buffering. c) Starving. d) Bottleneck.

Another way to classify/characterize a process

Make-to-order: The production process is activated in response to a current order. Inventory (work-in-
progress and finished goods) are kept to a minimum. This option allows the company to deliver customized
products. Make-to-stock: It involves a large volume production-process, where highly standard products
are produced. This option maintains highvolume of work-in-progress and finished goods using storage. The
product is usually delivered very quickly
An advantage of a make-to-stock process is which of the following? a) It features rapid delivery of a
standard product. b) All units of output are unique. c) It responds directly to customer orders. d) It allows
the firm to avoid inventory costs. e) It combines the best features of other processes.

Measuring process performance

Productivity.  Utilization.  Efficiency.  Throughput time.  Operation time.  Cycle time. 
Throughput rate.

Productivity: As shown in previous sessions, productivity defines a relation between the value of the
output generated and the inputs used by a process. There are partial and multi-factor measures.
= Output/Input

Utilization: As already discussed, utilization is the ratio of the time that a resource is currently used to the
time that it is available.
= Time currently used/Time available

Efficiency: is defined as the ratio of the current output of a process regarding some standard.
= Current output/Standard output
For instance, suppose that an employee is typically able to serve 5 clients/minute. Some days, however,
he/she can serve 7 clients/minutes. In those days, the employees’ efficiency is equal to 140%. That is, a 40%
more than expected.

Operation time: is the sum of the setup time and run time.
 Setup time refers to the time needed to prepare an equipment (service) to make (deliver) an item
(client).
 Run time is the time required to produced a batch of parts, or to serve a group of clients.

Consider the operation time of an airline worker, responsible for checking in flights. Suppose this worker
can deliver 3 passengers per minute in the case of international flights, and 4 passengers per minute in the
case of domestic flights. Once an international flight is done, it takes 2 minutes to get ready the computer-
system to check in a domestic flight. What is the operation time needed to check in a domestic flight of
200 passengers after serving an international flight?

Operational time= 120s + 15s (50people) = 3120s = 52min

SET UP + RUN TIME

Throughput time: It is the sum of the operation time and queue time.
It is the time a unit spends being worked on along with the time spent waiting in a queue.
In services, it is the time a customer spends being served together with the time spent in waiting lines.
= Operational time + Waiting time

Cycle time: As mentioned above, this is the time, on average, that elapses between the beginning and
completion of a process.
How can we determine capacity using these measures?

Throughput rate: This rate gives us the number of products a process can generate over a given period.
In services, it represents the number of customers a process can deliver in a certain period.
Formally, the throughput rate is mathematically the inverse of the cycle time.
= 1 / Cycle time

Useful to determine capacity

The capacity of a task is the physical limitation in terms of how much can be processed at this task.
Cycle time: Average time for completion of a unit at a production step or process. Does not include waiting.
Measured as time/unit
Throughput rate: Average number of units processed over a time interval. Measured as units/time.

Little’s law
establishes a mathematical relationship between the throughput rate, throughput time and the amount of
work-in-process (WIP). The Little’s law gives us the time that an item will spend in work-in-process
inventory. This law is useful to estimate the throughput time of a whole process.

How can we put into practice what we have learnt so far?

 Assembling is the bottleneck

If 2 pizza bases remain in the WIP inventory, how much time, on average, are those bases kept in the
inventory?

Taking into prior information, let us analyze this

process by focusing the attention on the following
issues:
 Detection of bottlenecks.
 Determination of the process capacity.
 Evaluation of storage areas necessities.
 Calculation of the throughput time of the process.

Bottleneck and capacity: Let’s start the analysis by determining the cycle time of each step. Putting
everything in terms of batches of 100 loaves, we have that:
 Cycle time of the bread-making step is equal to 1 hour/batch.
 Cycle time of the packaging step is 0.75 hour/batch.
As a result, the first step is a bottleneck because it has a larger cycle time. This is also evidenced by the
throughput rates:
 The bread-making stage has a rate of 1 batch/hour.
 The packaging stage has a rate of 1.33 batches/hour.
If both steps are operated the same number of hours each day, the bakery has a capacity of 1 batch/per
hour (100 loaves/hour).

Storage between the steps: Given the presence of a bottleneck in the first stage, inventory would not build
between bread making and packaging. In fact, packaging operations will be starved for quarter-hour
periods.
The throughput time: In this case, it is the sum of the cycle time of each step. The throughput time of the
bakery is: 1 + 0.75 = 1.75 hour/batch.

This option expands the capacity of the first step.

Now, the cycle time of the two bread-making
operation is ½ hour/batch.
The throughput rate is equal to 2 batches/hour.

In this setting, packaging operation turns into the bottleneck of the process. This is so because it has a
larger cycle time and a smaller throughput rate:
 Throughput rate of two bread-making step: 2 batches/hour.
 Throughput rate of packaging: 1.33 batches/hour.

We can solve the bottleneck problem by:

-Creating two shifts of 8 hours each for the bread-making operations.
-Creating three shifts of 8 hour each for the packaging operation.
-Creating storage areas between the steps.

This strategy would eliminate the presence of bottlenecks by balancing the capacity of each step. Look why:
If 1 batch is made in ½ hour, in 16 hours the first stage will produce 32 batches.
If 1 batch is packaged in ¾ of an hour, in 24 hours the second stage will package 32 batches.

Bread making runs two shifts: Produces 2 x 8 x 2 = 32 batches

Packaging runs three shifts: Produces 1.33 x 8 x 3 = 32 batches

We will produce for 16 hours but we will pack for 15 hours because we need to wait for the first set of
bread to come through.
Max WIP = 16 x 2 – 15 x 1.33 = 12 batches
Average WIP = 12/2 = 6 batches
What methods could be used to deal with capacity imbalances?
There are various ways of dealing with capacity imbalances.
1. One is to add capacity to those stages that are the bottlenecks. This can be achieved by temporary
measures such as overtime, leasing equipment, or subcontracting.
2. Another approach is to use buffer inventories so that interdependence between two departments can
be loosened.
3. A third approach involves duplicating the facilities of one department upon which another is
dependent.

a) What is the current maximum output of the process assuming no one work overtime?

b) How long will the picking and packing operations must work if we have a day where the order taker
works at his maximum capacity?

c) Given b), what is the maximum number of orders waiting to be picked? And waiting to be packed?

d) If we double the packing capacity (from 60 to 120 orders per hour), what impact does this have on the
answers given previously?
LECTURE 8 – MANIFACTURING AND SERVING PROCESSES

Types of Processes  Distribution by project.  Work center (workshop).  Manufacturing cell.

 Assembly line.  Continuous process.

Break-even points for alternative processes

Suppose a manufacturer has identified the following options for obtaining a machined part:
 It can buy the part at $200 per unit (including materials)
 It can make the part on a numerically controlled semiautomatic lathe at $75 per unit (including
materials).
 It can make the part on a machinery center at $15 per unit(including materials).
There is negligible fixed costs if the items is purchased. A semiautomatic lathe costs $80,000, and a
machine center costs $200,000.

Manufacturing process flow design

It evaluates the specific processes to which raw materials, parts, etc. follow as they move through the
plant.
Assembly charts Route sheets

Flow process chart Assembly drawing

What issues should we take into account in the design of services?

Service design
Service design comprises the set of steps by which a service is created, implemented, and delivered to
firms’ customers. The way companies, such as “Ryanair”, “Ritz Carlton” and “Burger King” provide their
services is founded on a set of service design choices that align with their service strategies.
A key idea is that the process of service design can be managed. In this regard, management focuses on
aspects related to the interaction between customers and the service delivery system.

The service triangle

According to this view, the customer is the center of things, including the service
strategy, support systems and employees who serve him or her. The rational behind a
company is to serve well its customers’ needs. Systems and employees exist to achieve
this goal.

How can we classify services?

Considering the role of the customer, services can be classified according to the degree of customer
contact involved in the creation of the service.
In this categorization, three elements are considered:
 The presence or not of the customer.  The role of customer in the
creation of the service.  Extent of contact.

The extent of contact can be approximately defined as the percentage of time the customer must remain
in the system relative to the total time it takes to deliver the customer service.
As one might suppose, service systems with a greater degree of customer contact are much more difficult
to control and manage than those with less customer contact. This fact is due to factors such as:
-The nature of the service and the time of demand can be altered by the customer.
-Quality or perceived quality.

As services cannot be stored, service capacity becomes a dominant issue.

- Too much capacity brings about additional costs.
- Lack of capacity leads to lost of customers.
In services, the process is the product. They come together. Service operations lack legal protection
typically offered in the case of good production. Service supply can change quickly, which gives service
companies more flexibility than that prevailing in the case of manufacturing companies

How can we structure service encounters? In order to answer this question, we will use THE SERVICE-
SYSTEM DESIGN MATRIX. This matrix is defined from the interception of three elements:
 The degree of customer contact.
 The marketing proposition: The greater the customer contact, the greater the opportunity to sale.
 Impact on production efficiency of customer contact.
-Process efficiency decreases as the customer has more contact. However, face to face contact provides a
high sales opportunity to sell additional products.
-Conversely, low contact (email) allows the system to work more efficiently (no disruptions) but there is
little opportunity for additional sales.

Strategic uses of the matrix

Integration between operations and marketing. Definition of the company’s service portfolio.
Performance of competitive analysis. Analysis of the evolution of the service delivery process.

In the service-system design matrix, a mail contact service encounter is expected to have which of the
following? a) High sales opportunity b) High degree of customer/server contact c) High production
efficiency d) Low sales opportunity e) None of these

Tools to implement service design

Service blueprints and poka-yokes.
Customer experience maps.
Others: • Service scripting. • Service recovery

Service blueprints and poka-yokes

We use flowcharts as blueprints. The idea is to map into a flowchart the set of activities comprising a
service encounter. Service blueprints describes the elements of a service design. They include:
-Steps that make up a service delivery process.
-Points of interaction between customers and service providers.
-Poka-yokes. These are actions to prevent failures over the process of service delivery.

Poka-yokes A service blueprint describes the service design characteristics but does not provide any
direction on how to make the service process conform to that design.
The application of poka-yokes helps us solve this problem. Poke-yokes are fail-safe procedures to avoid
that inevitable mistakes turn into a service defect.
The following cases are example of the use of poka-yokes:
 Beepers at restaurants to avoid customers do not miss table calls.  Chains to configure queues.
 Use of take-a-number systems.  Mirrors on telephones to ensure a “smiling voice”.
 Reminder calls for appointments.  Locks on airline lavatory doors that activate lights inside

Customer experience map

A customer experience map analyzes, from the exclusive customer’s viewpoint, her/his experience while
receiving the service. TOUCH POINTS are identified. These are key points of contact between the customer
and the service system provision. Feeling, perceptions and reactions of customers are also represented in
these maps.
Service scripts
This is a guide for employees in contact with customers, which predetermines words, phrases, and
gestures to be adopted during the service delivering process. This guide can be used for:
• Defining rules and procedures to greet customers when they come into play.
• Developing practices, such as “up-selling” and “cross-selling”. • Managing customer complaints.

Service recovery
An important part in the process of service design is to anticipate what to do when something goes wrong.
Recommendations: Break silence. Anticipate the need to recover the service. Get involved quickly.
Provide training to service providers facing customers directly.
Motive employees working at the “front-line”. Implement corrective measures.

Approaches to service design

Production-line approach. This view regards service provision as a manufacturing process. Orientation is
toward production efficiency. This approach dominates in fast-food restaurants.

MC Donald's is a good example of this type of service organization. Mc Donald's philosophy is oriented
toward the efficient production and not toward subordination to the customers. However, the control of its
operations allow the company to provide a service that attracts customers.

Self-service approach. The idea is to change the role of the customer in the process of service delivery.
Instead of being served, the customer produce the service. Examples includes travel on-line agencies, cash
machines, among others.

Buffet in hotels is an example of a design based on a self-service approach. Customers are directly involved
in the production of the service. They design their own menus. The philosophy of this design is to transfer
to customers part of the operations needed to deliver the service.

Personal-attention approach. This design allows a full interaction with the customer. It is based on
relationships built between the customer and the service provider

Ritz Carlton is an example that illustrates the use of this approach. This approach aims to enhance the
customer’s experience and then the perceived quality. Its philosophy is to deliver the best service to meet
customer’s needs.
Which are the main sources of variation in the process of service delivery? Managing customer-
introduced variability
A key decision that operations managers must make is to determine how much they should accommodate
variation introduced by customers into the process of service delivery. Standard approach is to treat this as
a trade-off between cost and quality.
• More accommodation → more cost
• Less accommodation → less satisfaction
Sources of variability that a customer can add up: • Arrival variability. • Request variability. • Capability
variability. • Effort variability. • Subjective preference variability.

Among the strategies to accommodate this variability we have:

-Accommodation: Adding up variations introduced by customers • Classic. • Low-cost.
-Reduction: Restrictions in service delivery to limit variability. • Classic. • Uncompromised.

Behavioral science applications to service design

The front end and the back end of the encounter are not created equal. Segment the pleasure.
Let the customer control the process. Pay attention to norms and rituals.
People are easier to blame than systems. Let the punishment fit the crime in service recovery.

Characteristics of a well-designed service system

Consistent with the operating focus of the firm. Easy to use. Robust.
Consistent performance by its people and system is maintained. Well-established links between the back
office and the front office. It manages evidence of service quality. Cost-effective.
COST-VOLUME-PROFIT MODEL (CVP)

VOLUME (Q)
The production made by the company during the time or period of reference, in effective or predicted
conditions of sale.

COSTS
Variable cost will be that which depends on the level of activity; probably the clearest example is that of
the raw material consumed.
Fixed cost will be that which is not altered by increasing or decreasing the level of production; for instance,
rental of an industrial unit or amortisation of some installations.

TC=FC+VC
Short-run: period at which there are input or factors that can’t be changed

Linear case: explanation of variable costs

VC= avc Q

avc= VC/Q

it implies that TC= FC + avcQ

Starting with the CVP MODEL
Assumptions:
1-Classification and typology of costs: As explained in the above section, the analysis is carried out in the
short term, whereby any cost may be classified as a fixed cost or variable cost. The volume of production is
the only relevant factor that affects the costs.
2-The revenue function: The sale price remains constant for any level of activity. The revenue function can
also be represented as a straight line. The quantity produced is fully sold for any volume of activity, that is,
there is no variation in stock of finished products.
3-Stability of external factors: Any external factor may affect any of the variables included in the model
(costs, volume and/or profit); it is assumed to remain invariable for any volume of production during the
period of analysis.
4- Multiproduct companies: The CVP model can be applied to any company, independently of the number
of products it sells.
In the case of multiproduct companies, the percentage represented by the quantity produced/sold for each
product out of the total production is considered stable for the relevant interval of production.
5- Determinist model: The CVP model that we are going to describe is deterministic and all the values are
known with certainty. Hence, the model does not take into account adjustments due to risk or uncertainty
for any of its variables.

Limitation 1. Overall analysis of the results: The analysis that is the fruit of the application of the CVP
model must be global and conclusions must not be drawn from isolated data and partial results.
Limitation 2. Qualitative factors are not taken into account.

Determination of the CVP model

P= profit
P = spQ – ( FC + VC(Q)) R= revenues
P = spQ – FC + avcQ sp= selling price
avc= average variable cost
 FC= fixed costs
VC= variable costs
TC= total costs

We shall now define a new concept; we shall call the difference between the price and the average variable
cost the unit contribution margin (CM)

The CM indicates what each unit produced and sold contributes to covering the
fixed costs of the company, and once the fixed costs have been covered, it indicates
the contribution of each unit sold to the profit.

Determination of the break-even point (BEP) or profitability threshold

The premise is that the profit is equal to zero. Thus, the quantity of production units that are necessary in
order to reach break-even point (Qbe), stems from: P=0

Revenue function is STEEPER than TC function

The volume of production in the hotel industry
Companies in the hotel industry obtain their revenue by providing multiple services. Thus, a hotel obtains
revenue from renting out its rooms, from the bar and restaurant units, and other complementary activities.
-The number of rooms available in a hotel is a fixed factor and the revenue from room rental is
determined by the room occupancy rate (ROR) and by the price set for each room.
-On the other hand, revenue from other areas, such as the bars and restaurants does not depend only on
the number of rooms occupied but on the number of people-day (stays) occupying these rooms.

Example: Hotel with 200 double rooms occupied by 200 guests, 100% room occupancy, and a capacity to
generate revenue in other areas of 200 stays.
-This same hotel with 200 double rooms could have 150 rooms occupied by 300 guests; therefore, with a
lower room occupancy rate, it would have a greater capacity to generate revenue in other areas.
-Thus, in calculating the revenue (and hence, also in calculating the costs associated with this revenue) the
volume of production can be expressed in different ways.

Uniform System of Accounts: develops a homogeneous method of direct cost allocation to each of the
hotel’s areas of revenue.
This system establishes cost allocation criteria in such a way that, for each area of revenue (rooms,
restaurant, bar, etc.), the variable costs can be determined and therefore their contribution margin to the
profit of the operation.
MULTIPRODUCT CASE
We assume that multiproduct companies are able to produce distinct, but related products, exploiting the
same fixed assets (same fixed costs).
Besides, we assume that the total amount of production can be decomposed into different shares of
distinct products.

MIXED COSTS
All costs that have a fixed part and another part that is more or less proportional to the volume of the
activity.
Water and electricity costs have a fixed part that corresponds to the minimum costs charged by utility
companies. However, there is also a variable part that depends on the volume of activity.
-In a hotel, activities like lighting common areas, filling a pool, or refreshing common areas using air-
conditioning generate fixed costs. There are charges that do not depend on the number of guests. But,
there are other charges that do depend on the stays and then generate variable costs.
-In an industrial facility, telephone and electricity bills usually involved a two-part tariff regime, where one
part is fixed while the other is variable.

Remember that the CVP model only admits fixed costs and variable costs. Therefore, if we encounter
mixed costs, we cannot apply the model unless we find a way of separating the fixed part from the variable
part.

First of all, it is quite clear that the insurance policy on the property
behaves as a fixed cost, as it remains constant throughout each month
despite fluctuations in level of occupancy.
Meanwhile, we have laundry costs and electricity costs. Neither of
these is a fixed cost, but we do not know whether they are exclusively
variable costs, or whether they have a fixed part and are therefore
mixed costs. In order to find this out, we can divide the cost by the
level of occupancy for two months with different occupancies.
It seems that the laundry cost is strictly variable and the cost per stay is approximately 1.1 €.
Looking at electricity we can observe that there is a difference, which leads us to believe this is a mixed
cost, as the result is lower for higher levels of occupancy.

Methods to identify fixed and variable costs from mixed costs

- The high-low method (or extreme values)
Our problem consists of estimating the part of the mixed costs that should be considered fixed and the part
that should be considered variable.

The following steps can be formulated for the application of this method:
1. Select the two extreme values as regards volume of activity (in our example the stays). If there is a
period of abnormal activity it is better to choose the next one that does not have this problem (for
instance, if the hotel is closed for a/some month(s), it is desirable to take the month with the lowest
occupancy out of the months it is open).
2. Calculate the difference between the costs and volume of activity of these two periods. Then, divide the
difference in costs by the difference in the activity. Thus we obtain the variable unit cost. (avc)

3. By multiplying this variable unit cost by the volume of activity of one of these two periods, we have the
total variable cost for this period (VC of period), while the rest corresponds to the fixed cost per period.
(FC of period)
4. We multiply the fixed cost per period by the number of periods considered and this gives us the fixed
part of the mixed cost (for the whole year) (FC)
DEMAND SEASONABILITY
Annually, the dilemma arises as to whether or not it is convenient to keep the hotel open in the low season,
when demand is ostensibly reduced and the prices at which services can be offered are much lower than
the prices for the rest of the year. The solution to this problem is no easy matter, but a profound
knowledge of the behaviour of costs can help us to correctly assess the alternatives. In order to set out the
issue more clearly we shall use an example.

As can be observed in Table 1, the low season covers 3 months, during which time the hotel had 29% room
occupancy with a mean revenue of 15 € per room occupied. The fixed costs amount to 30,000 monthly,
whereby if we perform a profit and loss account for the low season, the hotel had losses of 73.800 €. As the
results in the high season were significantly better, the hotel ended the year with a year on year profit of
288.000€. The question any manager would ask in this situation would be: Is it convenient to close the
hotel during the low season, so as to thereby eliminate the loss and obtain a greater profit over the whole
year? The answer is no. No, because from the cost analysis we know that the fixed costs are independent of
the volume of production; and, therefore, suspension of activity during this season would mean bearing
these costs and not obtaining any revenue whatsoever.

We can observe, in Table 2, what would have happened upon closure during the low season.

As we had suspected, the profit in the event of closing in the low season is lower than if the hotel had
remained open all year. If the fixed costs are going to have to be borne independently of the number of
rooms occupied, it will be convenient to keep the hotel open in the low season, provided the revenue
obtained is higher than the average variable cost, that is, providing the contribution margin is positive.
If the contribution margin is positive, each room sold will contribute to covering the fixed costs, which
would not happen if the hotel were closed.

Thus, the decision to close or to keep the hotel open during the low season will be made knowing the
behaviour and magnitude of the fixed and variable costs of the operation. The correct decision will be to
keep the hotel open, provided the revenue obtained per room occupied is higher than the average
variable cost, and will not depend, in principle, on the expected occupancy in that season.
The problem of fixed costs
Up to now we have assumed that the fact of closing the hotel during the low season cannot entail any
saving in the fixed costs. But suffice to look around us to appreciate that a large proportion of tourist
establishments close during the low season. Is it perhaps impossible for them to market their beds with a
positive contribution margin? This is a possibility, but what probably occurs in most cases is that these
companies adopt cost structures that enable them “to save” part of the costs which we would initially
consider fixed if they close during these periods of low demand. A more profound analysis of the fixed costs
leads us to make a sub-classification which takes into account the fact that some costs can be reduced
when the company closes, whereas others cannot; and there is even a series of costs that only appear
when the company has large periods of inactivity. We could classify fixed costs in the following way:
-COST OF INACTION (CI): all the costs the company bears whether or not it has any activity,
ex. the depreciation of buildings and facilities, some insurance premiums, etc.
-PREPARATORY COSTS (PC): all the costs that are essential for starting (or restarting) the productive
process. Companies bear these cost just when they decide to shut down.
-MINIMUM OPERATING COSTS (MOC): all the costs that are essential for any volume of positive activity,
but which disappear when there is a perspective of inactivity. Companies bear these cost just when they
decide to keep running the activity.

The initial approach is very similar to the previous one. The difference lies in the fact that now the decision
as to whether or not it is convenient to close is not as immediate. We must analyse in depth the extent of
the costs of inaction, the minimum operating costs and the preparatory costs when dealing with a
scenario of closure.

From the analysis of the profit and loss account, we deduce that, in this second case, it is convenient to
close the hotel in the low season. Yes it is, because by closing we manage to reduce the fixed costs in such a
way that the profit at the end of the year is higher than what we would have if we were to keep the hotel
open. The questions that arise now are the following:
-How much should our low season room occupancy increase in order to decide to keep the hotel open
(assuming 15 € revenue per room occupied)?
-What minimum revenue per room occupied would we need in order to keep the hotel open all year
round (assuming low season occupancy of 29%)?

We will answer the first question by assuming that due to market conditions it is difficult to set prices
higher than 15 € per room. The solution depends on reducing the fixed costs we obtain by closing. In order
to keep the hotel open we must sell a quantity of rooms that is large enough so that the contribution
margins cover at least the reduction or savings in fixed costs that would be produced if we were to close
during the low season.
With 43% room occupancy it makes no difference to keep the hotel open or to close it. The decision to
close or not, taking into account all the costs, will depend on the expected occupancy with a revenue of 15
€ per room occupied. If room occupancy during the low season is less than 43% (as in the example, 29%)
we will keep the hotel closed and if it is higher it will be more convenient to keep it open.

In order to answer the second question, the reasoning is similar. Given a known occupancy of 29%, that is,
5,400 rooms during the low season, the unknown quantity is now the price.

What this means is that if we manage to get a price higher than 16.44 €, with 29% occupancy, it will be
convenient to keep the hotel open during the low season. If the price is lower, as in the example (15 €), it
will be more convenient to close the hotel during this season.