1. Matching Supply with Demand: An Introduction to Operations Management Gérard Cachon ChristianTerwiesch
All slides in this file are copyrighted by Gerard Cachon and Christian Terwiesch. Any instructor that adopts Matching Supply with Demand: An Introduction to Operations Management as a required text for their course is free to use and modify these slides as desired. All others must obtain explicit written permission from the authors to use these slides.

2. The Process View

3. Examples of processes Factory University wood guitars metal students
alumni
Distribution
center
bulk items
small parcels
approved loans
Calculate
credit risk
mortgage applications
rejected loans
Processes can involve both goods and services.
Processes can have multiple inputs and/or multiple outputs.

4. Defining a process’ scope
A process is a set of activities that accepts inputs and produces outputs.
A process can be defined at an aggregate level:
A process can be defined at a micro level, with multiple sub-processes:
approved loans
Calculate
credit risk
mortgage applications
rejected loans
Collect data
from client
Evaluate
loan metrics
approved loans
mortgage applications
rejected loans
Underwriting
decision
Communicate
decision to sales

5. Defining a process’ flow unit
The flow unit is what is tracked through the process and generally defines the process output of interest.
Processes
Flow unit
University
students
alumni
A person
Processing
plant
milk
milk powder
Lbs of milk powder
Blood
donation
center
people
blood
Pints of type AB blood

6. 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:
For example:
Inventory = Flow Rate x Flow Time or
I = R x T
incoming calls
Call center
completed calls
R = On average 11 callers per minute
T = On average a caller spends 2.5 minutes with the call center
I = Average number of callers on the phone with the call center
= R x T = 11 x 2.5
= 27.5 callers

7. 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
I = R x T = 15,000 x 2 = 30,000 units are in-transit on average
I = 30,000 wetsuits
R = 15000/month
R = 15000/month
T = 2 months

8. Four different ways to count inventory
In terms of flow units (The “ I ” in I = R x T):
Number of wetsuits, patients, tons of wheat, semiconductor chips, etc.
Useful when the focus is on one particular flow unit.
In terms of $s (The “ I ” in I = R x T):
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.

9. Days-of-supply calculations
Days-of-supply is the “T ” in I = R x T
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
R = 15000/month
I = 30,000 wetsuits

10. Inventory turns calculations
Inventory Turns = 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 = x 12 = 180,000 per year
I = 30,000
T = 2 months = 1/6 year
Annual Turns = R / I = 180,000 / 30,000 = 6
Annual Turns = 1/T = 1 / (1/6) = 6

11. Turns and days-of-supply at Walmart in 2010*
* All figures in $Million from 2010 balance sheet and income statement
R = COGS = $304,657
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 = $304,657 / $33,160 = 9.19
Days-of-supply = $33,160 / ($304,657 / 365) = 39.7

12. Walmart’s turns change from year to year
Days-of-supply
(red squares)
Annual turns
(blue diamonds)

13. 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, you can solve for the third:
Indirect measurement of flow rate:
Indirect measurement of inventory:
Indirect measurement of flow time
Inventory: 500 vehicles
Flow Time: 30 days on the lot
Flow Time: 6 hours
Flow Rate: 200 patients per day
Flow Rate: 5000kg/week
Inventory: 2500kg

14. Inventory Turns Cost of Goods sold: 20,000 mill $/year
Computed as:
Based on Little’s law
Careful to use COGS, not revenues
Cost of Goods sold: 20,000 mill $/year
Inventory: 391 mill $
Inventory turns=
Inventory Turns at Dell
Cost of Goods sold: 25,263 mill $/year
Inventory: 2,003 mill $

15. Inventory Turns in Retailing and Its Link to Inventory Costs
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

16. Dell’s Cash Conversion Cycle
Inventory
Accounts
Payable
Accounts
Receivable
Cash
Source: Randall, Public data
Cash Conversion Cycle
Measures duration between purchase of inventory and collection of accounts receivable:
Cash Conversion Cycle=
Inventory processing period (days) Days to Collect Accounts receivable Days to Pay Accounts Payable
How long does it take between outlay of cash and collecting the reward?