Operation Measurement

1209400
Performance Measurement in SC
 Questions for discussion
• Explain the circumstances that led Kearns to
adopt the ‘Leardership Through Quality’
program. In the backdrop of his initiatives to
retain Xerox’s global competitiveness,
comment on the rationale behind the decision
to implement benchmarking practices at the
company
 Questions for discussion
• Define benchmarking and discuss the various
types of benchmarking. Explain the steps
involved in the implementation of a typical
benchmarking process.
• Describe Xerox’s benchmarking model. How
did Xerox go about implementing
benchmarking practices in the company?
 Questions for discussion
• What benefits did Xerox derive from the
implementation of benchmarking practices?
Why do you think benchmarking initiatives
sometimes fail to give companies the
expected benefits? Explain how you would go
about ensuring the success of the
benchmarking initiatives undertaken by the
company.
What do you think?
What measures do you
use to evaluate a
company’s goods or
services? Provide
some examples.
Measurement is the act of quantifying the
performance criteria (metrics) of organizational
units, goods and services, processes, people, and
other business activities.

Good measures provide a “scorecard” of

performance, help identify performance gaps, and
make accomplishments visible to the workforce,
the stock market, and other stakeholders.
 Process Measurement
• Importance of Measuring Processes
– Is the basis for good management—“If you can’t
measure it, you can’t manage it.”
– Allows a firm to determine if its strategically
important goals and standards are being met.
– Allows for performance comparisons with other
competing firms.
Types of Performance Measures
• Productivity
– The operational efficiency with which inputs are
transformed (converted) into outputs.
• A relative measure that becomes meaningful when
compared to itself over time, similar operations
internally, or externally within its industry.
– Partial measures of productivity can be taken using
the various inputs (e.g., labor, energy, and
materials) that are combined to create a product.

Outputs
Productivity 
Inputs
Partial Measures of Productivity
Types of Performance Measures (cont’d)
• Capacity
– Output of a process in a given period of time—
units of output per unit of time.
– Design capacity
• The ideal output rate at which the firm would like to
produce under normal circumstances and for which
the system was designed.
– Maximum capacity
• The maximum potential output rate that could be
achieved when productive resources are used to
their maximum.
Types of Performance Measures (cont’d)
• Capacity Utilization
– Percentage of available capacity actually used.
• Design capacity versus maximum capacity

Homogeneous output
Capacity Actual output

Utilization Design capacity

Variable output
Capacity  Actual machine hours used
Utilization Total machine hours available
 Example
• If an automobile assembly plant had a design
capacity of 3,600 cars per week, and actually
produced only 2,700 cars in one week. What is
capacity utilization for that week?
 Actual output
Capacity Utilization 
Design capacity

2,700  75%
Capacity Utilization 
3,600

Q: Is capacity utilization possible excess of 100 percent?

Measures of Capacity
 Types of Performance Measures (cont’d)

• Quality
– Usually measured by the defect rate of the
products produced.
• Speed of Delivery
– Product’s lead time—amount of time from when
product is ordered to when it is shipped.
• Inventoried versus customized products
– Variability/Uncertainty in delivery time
• Less uncertainty in delivery times is better.
 Types of Performance Measures (cont’d)
• Flexibility
– The measure of how readily a firm’s transformation
process can adjust to changes in customer demand
(i.e., agile manufacturing).
• Flexibility Measures
– How quickly a process can convert from producing
one product to another product.
– How quickly a process can adjust to changes in
volume (demand).
– How capable is the process in producing more than
one type of product.
Types of Performance Measures (cont’d)
• Process Velocity (Manufacturing Velocity)
– Ratio of total throughput time for a product to the
value-added time.
• Throughput time—the time the product spends in the
process.
• Value-added time—the time it takes to complete the
product.

Total throughput time

Process velocity =
Value-added time
 Process Performance Metrics

Example 1

5 min/unit 8 min/unit 3 min/unit

Stage 1 Stage 2 Stage 3

(Assume 8-hour working day)

Cycle time = 8 minutes

Throughput rate = 60 units/day

Throughput time = 19 minutes

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 Process Performance Metrics

Example 2
5 min/unit 8 min/unit 3 min/unit
Buffer
Stage 1 Stage 2 Stage 3

(Assume 8-hour working day)

Cycle time = 8 min

Throughput rate = 60 units/day

Throughput time = 5 + 144 + 8 + 3 = 160 min

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 Example
• If the throughput time for a product is six
weeks, and the actual value-added time to
complete the product is four hours, what is
the process velocity of this product?
 Total throughput time
Process velocity =
Value-added time

6 wks x 5 days per wk x 8 hrs per day

Process velocity =
4 hrs
= 60

Process velocity of 60, means that it takes 60 times as long to

complete the product as it does to do the actual work on the
product itself
In other words, process velocity is like a golf score – the lower it is,
the better
Process Performance Metrics
Types of Performance Measures
Important categories of organizational
performance measures:

• Financial • Time
• Customer and Market • Flexibility
• Quality • Innovation and Learning
• Sustainability
Exhibit 3.1 The Scope of Business and Operations Performance Measurement
 Productivity

Effectiveness Efficiency
 Efficiency
• Is the degree to which a process generates
outputs with the minimal consumption of
inputs or generates a maximum amount of
outputs for a given amount of inputs
• Is a measure of how well a certain aspect is
performing (doing the things “rights”)
 Effectiveness
• Is achieving the organization’s objectives,
mission, or goal through the eyes of the
customer; that is doing the right things
efficiently
• Means the capability of producing an effect
(doing the right things)
Productivity
Productivity is the ratio of output of a process to
the input

Quantity of Output
Productivity =
Quantity of Input

Productivity measures include units produced/labor hour,

airline revenue per passenger mile, meals served/labor
dollar.
Total Productivity
Total Productivity is the ratio of total output to
total input

Total Output
Total Productivity =
Total Input

Total input consists of all resources used in the creation and

delivery of goods and services; for example, total input
includes labor, capital (building, equipment), raw materials,
information, and energy.
Multifactor Productivity
Multifactor Productivity is the ratio of total
output to a subset of inputs

Total Output
Multifactor Productivity =
Subset of Input

Subset of inputs might consist of only labor and materials,

or only labor and capital
Partial-factor Productivity
Partial-factor Productivity is the ratio of total
output to a single input

Partial-factor Total Output

Productivity =
Single Input
Subset of inputs might consist of only labor and materials,
or only labor and capital
 Example: Miller Chemicals
• Miller Chemicals that produces water
purification crystal of swimming pools
• The major inputs used to production process
are labor, raw materials, and energy
 Example: Miller Chemicals
2005 2006
Outputs Pounds of crystals 100,000 150,000
Inputs Direct labor-hours 20,000 28,000
Direct labor cost $180,000 $350,000
Energy used (kWh) 350,000 400,000
Energy cost $5,000 $6,000
Raw materials used (lb) 120,000 185,000
Raw material cost $30,000 $40,000
 Calculation
• Find multifactor productivity by non-labor-
dollar in 2005 and in 2006
• Find Total productivity by total cost in 2005
and in 2006
 Problem #1
• Costs, revenue, and other relevant
information for two nursing units that admit
and treat similar patients during a 6-month
period are shown in the table. Compute the
total dollar value of inputs for each unit, total
productivity, and the partial-productivity
measure of direct nursing labor productivity.
How do the units compare?
 Problem #1
Nursing Unit Productivity Measure Unit A Unit B
Total patient days 5,000 6,120
Direct nursing hours/patient day 4.70 4.60
Total direct nursing care cost/hour $15.75 $17.85
Total indirect nursing care cost/patient day $35.50 $42.25
Average room and bed cost/patient day $267.00 $325.00
Variable overhead cost/patient day $31.50 $28.80
Fixed overhead cost/nursing unit $102,311.00 $110,425.00
Revenues generated per unit $2,394,500.00 $2,887,000.00
Total inputs $2,142,436.00 $3,036,764.20
Total productivity 1.12 0.95
Total direct nursing cost $370,125.00 $502,513.20
Total direct (partial) labor productivity 6.47 5.75
 Solution
• Total inputs in dollar are calculated by
multiplying total patient days by the number
of nursing hours per patient day and the total
direct nursing care cost per hour, and adding
the remaining costs per patient day multiplied
by the number of patient day to the fixed
overhead cost.
 Solution
• For Unit A, the total dollar value of inputs are
• (5,000)(4.7)($15.75) + (5,000)($35.50) +
(5,000)($267.00) + (5,000)($31.50) +
($102,311.00) = $2,142,436.00
 Solution
• For Unit A, the total productivity is computed
as the total revenues generated (output)
divided by the total dollar value of inputs
used,
• $2,394,500/$2,142,436 = 1.12
 Solution
• For Unit A, the total direct nursing cost are
computed as
• (5,000)(4.7)($15.75) = $370,125
Linking Internal and External Performance
Measures
• Managers must understand the cause and
effect linkages between key measures of
performance. These relationships often explain
the impact of operational performance on
external results.

• The quantitative modeling of cause and effect

relationships between external and internal
performance criteria is called interlinking.
Exhibit 3.2 Interlinking Internal and External Performance Measures
 Interlinking
• Interlinking – tries to quantify the
performance relationships between all parts
of the value chain
• The processes (‘how’), goods and services
outputs (‘what’), and customer experiences
and outcomes (‘why’)
Linking Internal and External Performance
Measures
• The value of a loyal customer (VLC)
quantifies the total revenue or profit each
target market customer generates over the
buyer’s life cycle.

• By multiplying the VLC times the absolute

number of customers gained or lost, the total
market value can be found.
 Value of a loyal customer (VLC)
• VLC = (P)(CM)(RF)(BLC)
• P = the revenue per unit
• CM = contribution margin to profit and overhead
expressed as a fraction
• RF = repurchase frequency = 1/(years or fraction
of years between purchases); that is 1/0.5 = 2 if
repurchased every 6 months, ½ if every 2 years,
and so on
• BLC = buyer’s life cycle, computed as 1/defection
rate, expressed as a fraction (1/0.2 = 5 years,
1/0.1 = 10 years, and so on)
Solved Problem – Value of Loyal Customer
What is the value of a loyal customer (VLC) in the small
contractor target market segment who buys an electric drill
on average every 4 years or 0.25 years for $100, when the
gross margin on the drill averages 50 percent, and the
customer retention rate is 60 percent? What if the customer
retention rate increases to 80 percent?

What is a 1 percent change in market share worth to the

manufacturer if it represents 100,000 customers? What do
you conclude?
Solution
If customer retention rate is 60 percent, the average customer
defection rate = (1 – customer retention rate). Thus, the customer
defection rate is 40 percent, or 0.4. The average buyer’s life cycle
is 1/0.4 = 2.5 years. The repurchase frequency is every four years,
or 0.25 (1.4).

Therefore:
VLC (P)(RF)(CM)(BLC) =
($100)(0.25)(0.50)(1/0.4) = $31.25 over the buyer’s life cycle

The value of a 1 percent change in market share =

(100,000 customers)($31.25/customer) = $3,125,000
Solution (continued):
If customer retention rate is 80 percent, the average customer
defection rate is 0.2, and the average buyer’s life cycle is 1/0.2 =
5 years.
Then:
VLC (P)(RF)(CM)(BLC) =
($100)(0.25)(0.50)(1/.2) = $62.50
Thus, the value of a 1 percent change in market share
(100,000 customers)($62.50/customer/year) = $6,250,000
The economics are clear. If customer retention can be increased
from 60 to 80 percent through better value chain performance,
the economic payoff is doubled.
 Problem #2
• What is the value of a loyal customer in the small
contractor target market segment who buys an
electric drill on average for $100 every 4 years,
when the gross margin on the drill averages 50
percent and the customer retention rate in 60
percent? What if the customer retention rate
increases to 80 percent? What is a 1 percent
change in market share worth to the
manufacturer if it represents 100,000 customers?
What do you conclude?
 Process Performance Metrics
“You can not improve something you can’t measure”

• Operation time = Setup time + Run time

• Throughput time = Average time for a unit to
move through the system
• Cycle time = Average time between completion
of units
• Throughput rate = 1

Cycle time

• Velocity (throughput ratio) = Throughput time

Value-added time

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 “You can not improve something you can’t measure”

Process Performance Metrics (cont.)

• Efficiency =
Actual output

Standard output

• Productivity = Output
Input

• Utilization =
Time activated

Time available

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