Matching Supply with Demand:
An Introduction to Operations Management
The Process View of the Organization
Examples of processes
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wood metal
bulk items
mortgage applications
Factory University
guitars alumni
small parcels
approved loans rejected loans
Distribution center
Calculate credit risk
Processes can involve both goods and services.
Processes can have multiple inputs and/or multiple outputs.
Defining a process’s flow unit
The flow unit is what is tracked through the process and generally defines the process output of interest.
Lbs of milk powder
Pints of type AB blood
milk powder
University
Processing plant
Blood donation center
Metrics of process analysis
I = Inventory = how many flow units are in the process
R = Flow Rate = rate at which flow units enter or leave the process
T = Flow Time = total time a flow unit is in the process
Little’s Law: Inventory = Flow Rate x Flow Time or
For example: incoming
R = On average 11 callers per minute
T = On average a caller spends 2.5 minutes with the call center
Call center completed calls
I = Average number of callers on the phone with the call center
A Little’s Law application: In-transit inventory
O’Neill, based in California (CA), buys wetsuits from a supplier in Thailand:
Each month they order on-average 15,000 wetsuits, R = 15,000
Shipping between Thailand and CA takes on-average 2 months, T = 2
R = 15000/month
I = ________? wetsuits
T = 2 months
R = 15000/month
units are in-transit on average
Four different ways to count inventory, perspectives
Intermsofflowunits(The“I”inI=RxT):
Number of wetsuits, patients, tons of wheat, semiconductor chips, etc.
Useful when the focus is on one particular flow unit.
Intermsof$s(The“I”inI=RxT):
The $ value of inventory
This is an intuitive measure of a firm’s total inventory.
In terms of days-of-supply:
The average number of days a unit spends in the system.
Also, the number of days inventory would last at the average flow rate if no replenishments arrive.
In terms of turns:
The number of times the average amount of inventory exits the system.
Days-of-supply calculations
Days-of-supplyisthe“T”inI=RxT
Days-of-supply = I / R = Inventory / Average daily flow rate
Can also be measured in different time lengths (Keep units consistent):
Weeks-of-supply = Inventory / Average weekly flow rate
Months-of-supply = Inventory / Average monthly flow rate
Years-of-supply = Inventory / Average yearly flow rate
Our O’Neill example:
T = 2 months-of-supply wetsuits
I = 30,000 wetsuits
R = 15000/month
Inventory turns calculations
InventoryTurns=1/T=R/I
Different measures of turns:
Yearly turns = Average annual flow rate / Inventory
Monthly turns = Average monthly flow rate / Inventory
Weekly turns = Average weekly flow rate / Inventory
Daily turns = Average daily flow rate / Inventory
Keep units consistent!
O’Neill’s annual turns:
R=15000×12=180,000peryear
I = 30,000
T=2months=1/6year
AnnualTurns=R/I=180,000/30,000=6
AnnualTurns=1/T=1/(1/6)=6
Turns and days-of-supply at Walmart
* All figures in $Million from balance sheet and income statement
I = Inventory = $33,160
COGS = Cost of Goods Sold = Flow Rate
The Flow Rate is not Sales (which was $405,046) because inventory is measured in the cost to purchase goods, not in the sales revenue that may be earned from the goods.
Note: Some companies use the term “Cost of sales” to mean COGS
Annual turns = ?
Days-of-supply = ? 9
Walmart’s turns change from year to year
R = COGS = $304,657
9 8 7 6 5 4 3 2 1
120 100 80 60 40 20
Days-of-supply (red squares)
Annual turns (blue diamonds)
00 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 Ye ar
Little’s law: It’s more powerful than you think…
What it is: Inventory (I) = Flow Rate (R) * Flow Time (T)
How to remember it: – units
Implications:
• Out of the three fundamental performance measures (I,R,T), two can be chosen by management, the other is GIVEN by nature
• Hold throughput constant: Reducing inventory = reducing flow time
Given two of the three measures, if we do not know the third, we can figure it out!
• Indirect measurement of flow rate: Vehicles
Inventory: 500 vehicles
Flow Time: 30 days on the lot
• Indirect measurement of inventory: Emergency Room
Flow Time: 6 hours
Flow Rate: 200 patients per day
• Indirect measurement of flow time:
Flow Rate: 5000kg/week Inventory: 2500kg
Inventory Turns: which one is more competitive?
Inventory Turns
Computed as:
Based on Little’s law
Careful to use COGS, not revenues
Inventory Turns at Dell
Cost of Goods sold: 20,000 mill $/year Inventory: 391 mill $
Cost of Goods sold: 25,263 mill $/year Inventory: 2,003 mill $
Inventory turns= COGS Inventory
100 90 80 70 60 50 40 30 20 10 0
Inventory Turns in Retailing Inventory Costs
A vs B, which one is more competitive?
Inventory Cost Calculation
Compute per unit inventory costs as:
Per unit Inventory costs= Annual inventory costs Inventory turns
• Annual inventory costs=30%
• Inventory turns=6
Per unit Inventory costs= ?
What’s Next
Class 3: we will discuss National Cranberry Case
Textbook Chapters 2-3: read as case prep
Practice problems, case instructions, hints and templates on Blackboard
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