OPSM 501: Operations Management Week 3: Process measurement Little’s Law The House Building Game Koç University Graduate School of Business MBA Program Zeynep Aksin

KEEP DESKS CLEAR!  Only need a pen or pencil.  Please keep desks and aisles clear of notebooks, PCs, backpacks etc.  Please do not disturb materials!

HouseBuilding.com: Manufacturing Operations Production Control (color sheets, log sheets, scissors) (scissors) Base Punch (scissors) Final Assembly (tape) Base Weld (stapler) Quality Control Customer Roof Base Form

Production Control Operating Procedures  Prepare a batch of 4 units. –Cut each sheet (one at a time) into two: roof and base. –Write the batch number on the roof and the base. All items in the same batch have the same number. The numbers have to match in assembly. –Repeat –4 times, which yields one batch  When 4 units (one batch) are complete, “release” the batch. –Put the batch in your out-basket: it’s ready for pickup by the trucker. –Record release time for each batch.  Release one batch each minute.

Truckers Operating Procedures  Truckers are responsible for transporting work in process inventory between production steps.  You can carry only one batch of 4 roofs or 4 bases at a time. Not both! Production Control (color sheets, log sheets, scissors) (scissors) Base Punch (scissors) Final Assembly (tape) Base Weld (stapler) Quality Control Customer Roof Base Form (scissors)

Roof Operating Procedures  Cut the roof along double lines, one at a time.  Fold roof along dotted line at top. Think quality!  Work in batches of 4 units.  When a batch is ready, call the trucker and send to Final Assembly.  Ask trucker for inputs when needed.

Base Punch (Cut) Operating Procedures  Cut the base along double lines, one at a time. Think quality!  Work in batches of 4 units  When a batch is ready, call the trucker and send to Base Form.  Ask trucker for inputs when needed.

Base Form Operating Procedures  Fold the lines on the base (4 folds).  Work in batches of 4 units  When a batch is ready, call the trucker to send them to Base Weld.  Ask trucker for inputs when needed

Base Weld Operating Procedures  Staple base on top and bottom about 0.5 cm from the edge.  Work in batches of 4 units.  When a batch is ready, call the trucker to send them to Final Assembly.  Ask trucker for inputs when needed.

Final Assembly Operating Procedures  Tape the roof to the base (2 tapes).  Work in batches of 4 units.  When a batch is ready, send them to QA. (No trucker required.)  Ask trucker for inputs when needed.

Quality Assurance Operating Procedures  Check each batch if they conform to quality standards!  If the house conforms to quality standards, put it on the market. Once on the market no more rework!  Customers can reject houses Quality Standards  Batch numbers must match.  Folds and cuts should be along appropriate lines. –Folds should be crisp and cuts should be straight.  Roof should be centered and door should be visible. –Top of base should be flush with roof.  Staples and tape should be centered and parallel to the ground. –Not too much tape. About 1 cm –Staples about 0.5 cm from edge.

House Game Overview  Quality Standards  Batch numbers must match.  Folds and cuts should be along appropriate lines. –Folds should be crisp and cuts should be straight.  Roof should be centered and door should be visible. –Top of base should be flush with roof.  Staples and tape should be centered and parallel to the ground. –Not too much tape. About 1 cm. –Staples about 0.5 cm from edge. Production Control (color sheets, log sheets, scissors) (scissors) Base Cut (scissors) Final Assembly (tape) Base Weld (stapler) Quality Control Customer Roof Base Form (scissors)

HouseBuilding.com: Operational Performance Flow time T House # 1 T o - T i = T Quality Q = R/ R o Inventory I Output R o Input R i House # 16 T o - T i = T Sales R Team (color)

The process view of an organization

The Dynamics of a Process  We examine processes from the perspective of flow  To study process flows, we first answer three important questions: –On average, how many flow units pass through the process per unit time? –On average, how much time does a typical flow unit spend within process boundaries? –On average, how many flow units are within process boundaries at any point in time?

Operational Measures  On average, how many flow units pass through the process per unit time? THROUGHPUTor FLOW RATE (R)

Throughput or Flow Rate (R) The average output of a production process per unit time. At the firm level, it is defined as the production per unit time that is sold Terminology

Operational Measures  On average, how much time does a typical flow unit spend within process boundaries? FLOW TIME (T)

Terminology Flow Time (T) The flow time (also called variously throughput time, cycle time) of a given routing is the average time from release of a job at the beginning of the routing until it reaches an inventory point at the end of the routing Flow time

System Cycle Time The average interdeparture time between two jobs leaving a routing 1234 System cycle time Terminology

Operational Measures  On average, how many flow units are within process boundaries at any point in time? INVENTORY (I)

Work in Process inventory (I) The average inventory between the start and end point of a product is called work in process Inventory 1234 WIP (9 for this realization) Terminology

Slope (R), verical distance (I), horizontal distance(T)

Relating operational measures (flow time T, throughput R & inventory I) with Little’s Law  Inventory = Throughput x Flow Time I = R x T  Inventory Turns = 1/ T Inventory I [units] Flow rate/Throughput R [units/hr]... Flow Time T [hrs]

... Inventory I [units] Flow Rate [units/hr]... Flow Time T [hrs] Time=0... Inventory I [units] Flow Rate [units/hr]... Flow Time T [hrs] Time=t... Inventory I [units] Flow Rate [units/hr]... Flow Time T [hrs] Time=T Understanding Little’s Law: Consider a first come first served Queue

An Intuitive Argument for Little's Law  Consider a process with the FCFS queue discipline  An order departs the process: At this moment there are I (Inventory) orders within the process  The orders that are in the process now are the ones that came after our departing order had arrived, in other words, they arrived during the waiting period of the departing order  Since order arrival rate is equal to the flow rate, we have the following relationship: Inventory = Flow Rate x Flow Time

Little’s Law basics  Little’s Law is for a system in steady state: input rate = output rate  Applies to most systems, even those with variability  Uses average values

Example: flow unit is material  Fast food restaurant processes an average of 5000kgs, of hamburgers per week. Typical inventory of raw meat in cold storage is 2500kg.  Throughput R=5000kg/week  Average Inventory I=2500 kg.  Average flow time T=I/R=2500/5000=0.5 weeks

Example: flow unit is customers  A café in Beyoglu serves on average 60 customers per night. A typical night is about 10 hours. At any point there are on average 18 customers in the café.  Throughput R=60 customers/night; 6 customers/hour  Average Inventory I=18 customers  Average flow time T= I/R= 3 hours

Example: flow unit is cash  A steel company processes $400 million of iron ore per year. The cost of processing is $200 million per year. The average inventory is $100 million. How long does a typical dollar spend in the process?  R=$600 million/year  I=$100 million  T=I/R=1/6 year or 2 months

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 Examples: Indirect measurement of flow time Inventory turns: compute right from financial data Throughput: 5000kg/week Inventory: 2500kg Throughput: 1500 customers/day Inventory: 25 customers Cost of Goods sold: 25,263 mill $/year Inventory: 2,003 mill $ Cost of Goods sold: 20,000 mill $/year Inventory: 391 mill $ Little’s law: It’s more powerful than you think...

Retailer A Retailer B Inventory Cost Calculation Compute per unit inventory costs as: Per unit Inventory costs = Example: Annual inventory costs=30% Inventory turns=6 Per unit Inventory costs = Source: Gaur, Fisher, Raman Inventory Turns in Retailing and Its Link to Inventory Costs 2-32

Example: Auto-Moto Financial Services  Auto-moto provides loans to qualified customers. The company receives about 1000 loan applications per 30-day working month and makes accept/reject decisions based on an extensive review of each application

Auto-Moto Financial Services  Currently, Auto-Moto processes each application individually. On average, 20% of all applications received approval. An internal audit showed that, on average, Auto-Moto had about 500 applications in process at various stages of the approval procedure, but on which no decisions had yet been made.  In response to customer complaints about the time taken to process each application, Auto-Moto called in OPSM Consulting Inc.

Current System 1000/month 200/month 800/month review 500 accept reject 20% 80%

Example: cont’d  OPSM Consulting found out that although most applications could be processed rather quickly, some took a disproportionate amount of time because of insufficient and/or unclear documentation. They suggested the following Process II:  Because, the percentage of approved applications is fairly low, and Initial Review Team should be set up to pre- process all applications according to strict but fairly mechanical guidelines.

Auto-Moto Financial Services  Each application would fall into one of three categories: type A (looks excellent), type B (needs more detailed evaluation), and type C (reject summarily). Type A and B applications would be forwarded to different specialist subgroups  Each subgroup would then evaluate the applications in its domain and make accept/reject decisions

Example: (cont’d)  Process II was implemented on an experimental basis. The company found out that, on average, 25% of all applications were of type A, 25% were of B, and 50% were of C. Typically, about 70% of type A and 10% of B were approved on review.

Example (cont’d)  Internal audit checks showed that, on average, 200 applications were with the Initial Review Team undergoing preprocessing. Only 25 were with the Subgroup A Team undergoing the next stage of processing and approximately 150 were with the Subgroup B Team  Auto-moto would like to determine if the implemented changes have improved service performance.

Proposed System initial review 1000 /month 200 Subgroup A review Subgroup B review accept reject 200 /month 800 /month 25% 50% 70% 30% 10% 90%

New process  Flow units: applications  Initial review: R=1000, I=200 T=0.2 months or 6 days  Team A: R=250, I=25, T=3 days  Team B: R=250, I=150, T=18days  Type A: 9 days  Type B: 24 days  Type C: 6 days  Average: R=1000, I=375, T=11.25 days 41

New process: different flow unit definition  Flow units: approved/rejected applications  Approved: 70% of Type A and 10% of Type B= 0.7(250)+0.1(250)=175+25=200 applications/month  T approved =175/(175+25)*(T IR +T A )+ 25/(175+25)*(T IR +T B ) = (175/200)*9 +(25/200)*24= days  Rejected: 30% of Type A and 90% of Type B and all C= =800 applications/month  T reject = days 42

Key learnings: Little’s Law  Relates three leading performance measures based on process flows: throughput, inventory, flow time  Applies to processes in steady state  Important to –First determine process boundaries for analysis –Then identify appropriate flow unit for your analysis

From measurement to analysis  So far we have considered –Measuring process flows-R, T, I –Relating these measures through Little’s Law: I=RxT  Next: understand what drives each measure –What drives flow time? –What drives throughput rate? –What drives inventory?

Announcements  Continue reading The Goal  Read the case Kristen’s Cookie before coming to class-be prepared for in-class group work.