OM2

CHAPTER 3

MEASURING PERFORMANCE
IN OPERATIONS
DAVID A. COLLIER
AND
JAMES R. EVANS
OM2, Ch. 3 Measuring Performance in Operations
2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in
whole or in part.

Chapter 3 Learning Outcomes

learning outcomes
LO1 Describe the types of measures used for
decision
making.

LO2 Explain how to calculate and use

productivity
measures.

LO3 Explain how internal and external measures

are
related.

LO4 Explain how to design a good performance

measurement system.

LO5 Describe four models of organizational

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2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in
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performance.

Chapter 3 Measuring Performance in Operations

magine entering the cockpit of a modern jet airplane and
seeing only a single instrument there. How would you feel
about boarding the plane after the following conversation with
theIm
pilot?
Passenger:
surprised to see you operating the plane with only a
single instrument. What does it measure?
Pilot: Airspeed. Im really working on airspeed this flight.
Passenger: Thats good. Airspeed certainly seems important. But what
about altitude? Wouldnt an altimeter be helpful?
Pilot: I worked on altitude for the last few flights and Ive gotten pretty
good on it. Now I have to concentrate on proper airspeed.
Passenger: But I notice you dont even have a fuel gauge. Wouldnt that
be useful?
Pilot: Youre right; fuel is significant, but I cant concentrate on doing too
many things well at the same time. So on this flight Im focusing on
airspeed. Once I get to be excellent at airspeed, as well as altitude, I
intend to concentrate on fuel consumption on the next set of flights.

What do you think?

What measures do you use to evaluate a

companys goods or services? Provide some examples.
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Chapter 3 Measuring Performance in Operations

Why Measure Performance?

Managers make many important decisions
that affect how an organization provides
value to its customers.
To know if decisions are effective and to
guide the organization on a daily basis, they
need a means of understanding performance
at all levels of the organization, as well as in
operations.
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whole or in part.

Chapter 3 Measuring Performance in Operations

What is Measurement?
Measurement is the act of quantifying the
performance criteria (metrics) of
organizational units, goods and services,
processes, people, and other business
activities.

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2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in
whole or in part.

Chapter 3 Measuring Performance in Operations

The Scope of Performance Measurement

Important categories of performance
measurements in operations:
Financial
Customer and
market
Safety
Quality

Time
Flexibility
Innovation and
learning

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2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in
whole or in part.

Exhibit 3.1

The Scope of Business and Operations Performance Measurement

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Chapter 3 Measuring Performance in Operations

Financial Measures
Often take top priority in for-profit
organizations.
Traditional financial measures include
revenue, return on investment, operating
profit, pretax profit margin, asset
utilization, growth, revenue from new
goods and services, earnings per share,
and other liquidity measures.

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whole or in part.

Chapter 3 Measuring Performance in Operations

Financial Measures
Cost of quality is not used in most
organizations; it measures what poor
quality is costing an organization.
Nonprofit organizations focus more on
minimizing costs and maximizing value
to their target markets, customers, and
society.

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Chapter 3 Measuring Performance in Operations

Customer and Market Measures

An effective customer-satisfaction
measurement system provides a company with
customer ratings of specific goods and service
features, and indicates the relationship between
those ratings and the customers likely future
buying behavior.

Measured in three areas: 1) goods quality, 2)

service quality, and 3) response time.

Other customer-focused measures include

customer retention, gains and losses of customers
and customer accounts, customer complaints,
warranty claims, measures of perceived value,
OM2, Ch. 3 Measuring Performance in Operations
loyalty, positive referral, and customer
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whole or in part.
relationship building.

Chapter 3 Measuring Performance in Operations

Safety
Measuring safety is vital to all
organizations, as the well-being of its
employees and customers should be an
organization's principal concern.
Performance measures include accident
rates, parts per million of arsenic in a
public water supply, or security in a hotel
room.
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Chapter 3 Measuring Performance in Operations

Quality
Quality measures the degree to which
the output of a process meets
customer requirements.
Goods quality relates to the physical
performance and characteristics of a
good.

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Chapter 3 Measuring Performance in Operations

Quality
Service quality is consistently meeting or exceeding customer
expectations (external focus) and service delivery system
performance (internal focus) for all service encounters.
Five key dimensions of service quality:
Tangibles physical facilities, uniforms, equipment,
vehicles, and appearance of employees (i.e., the physical
evidence).
Reliability ability to perform the promised service
dependably and accurately.
Responsiveness willingness to help customers and
provide prompt recovery to service upsets.
Assurance knowledge and courtesy of the serviceproviders, and their ability to inspire trust and confidence in
customers.
Empathy caring attitude and individualized attention
provided to its customers.
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Chapter 3 Measuring Performance in Operations

Service and Environmental Quality

Every service encounter provides an opportunity for
error. Errors in service creation and delivery are
sometimes called service upsets or service failures.
Environmental quality focuses on designing and
controlling work processes to improve the
environment.

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Chapter 3 Measuring Performance in Operations

Time

Time relates to two types of performance

measures:
the speed of doing something (average) and
the variability of the process.

Processing time is the time it takes to

perform some task.

Queue time is a fancy word for wait time

the time spent waiting.

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Chapter 3 Measuring Performance in Operations

Flexibility
Flexibility is the ability to adapt quickly
and effectively to changing requirements.
Goods and service design flexibility
is the ability to develop a wide range of
customized goods and services to meet
different or changing customer needs.
Volume flexibility is the ability to
respond quickly to changes in the volume
and type of demand.
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Chapter 3 Measuring Performance in Operations

Innovation and Learning

Innovation refers to the ability to create
new and unique goods and services that
delight customers and create competitive
advantage.
Learning refers to creating, acquiring,
and transferring knowledge, and
modifying the behavior of employees in
response to internal and external change.
Microsoft is always two years away
from failure. Bill Gates

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Chapter 3 Measuring Performance in Operations

Quantity of
Productivity = Output
Quantity of Input

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whole or in part.

[3.1]

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Chapter 3 Measuring Performance in Operations

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.
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whole or in part.

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Exhibit 3.2

Interlinking Internal and External Performance Measures

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Chapter 3 Measuring Performance in Operations

Linking Internal and External Performance Measures

Another example of an interlinking model
is the financial value of a loyal
customer (VLC), which quantifies the
total revenue or profit each target market
customer generates over the buyers life
cycle.
By multiplying the VLC times the absolute
number of customers gained or lost, the
total market value can be found.
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Chapter 3 Measuring Performance in Operations

Solved Problem
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?
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Chapter 3 Measuring Performance in Operations

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 buyers 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 buyers
life cycle
The value of a 1 percent change in market share =
OM2, Ch. 3 Measuring Performance in Operations
(100,000 customers)($31.25/customer) =
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Chapter 3 Measuring Performance in Operations

Solution (continued):
If customer retention rate is 80 percent, the average
customer defection rate is 0.2, and the average
buyers 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
OM2, Ch. 3 Measuring Performance in Operations
value chain performance, the economic payoff is
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whole or in part.
doubled.

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Chapter 3 Measuring Performance in Operations

Designing Performance Measurement Systems in

Operations
What makes a good performance
measurement system for operations?
Good performance measures are
actionable, providing the basis for
decisions at the level at which they are
applied.
A systematic process is required to
generate useful operational performance
measures.

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Chapter 3 Measuring Performance in Operations

Models of Organizational Performance

1. Malcolm Baldrige National Quality
Award Framework
2. Balanced Scorecard
3. Value Chain Model
4. Service-Profit Chain Model
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Chapter 3 Measuring Performance in Operations

Models of Organizational Performance

The first two models (Baldrige Award and
Balanced Scorecard) provide more of a
big picture of organizational
performance.
The last two provide more detailed
frameworks for operations managers.
It is important to understand these bigpicture models because operations
managers must communicate with all
functional areas.

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Chapter 3 Measuring Performance in Operations

Malcolm Baldrige National Quality Award Framework

Organizations receive the awards in each of
the categories of manufacturing, small
business, service, nonprofit education, and
health care.
Primary purpose of the program is to
provide a framework for performance
excellence through self-assessment to
understand an organizations strengths and
weaknesses, thereby setting priorities for
improvement.
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www.baldrige.gov

28

Exhibit 3.3

Malcolm Baldrige National Quality Award Model of

Organizational Performance

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Chapter 3 Measuring Performance in Operations

The Balanced Scorecard Model

Consists of four performance
perspectives:
1) Financial
2) Customer
3) Innovation and Learning
4) Internal
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Exhibit 3.4

The Balanced Scorecard Performance Categories and Linkages

Source: Kaplan R. S., and Norton, D. P., The Balanced ScorecardMeasures That Drive Performance, Harvard Business Review, JanuaryFebruary 1992, p. 72.

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Chapter 3 Measuring Performance in Operations

The Value Chain Model

Evaluates performance throughout the
value chain: synchronized network of
processes including suppliers and
inputs, processes and associated
resources, goods and service outputs
and outcomes, customers and their
market segments, synchronized
information and feedback loops, and
management of value chain.
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Exhibit 3.5

Examples of Value Chain Performance Measurements

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Chapter 3 Measuring Performance in Operations

Service-Profit Chain Model

Most applicable to service environments.
Model is based on a set of cause and
effect linkages between internal and
external performance, and defines the key
performance measurements on which
service-based firms should focus.

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Chapter 3 Measuring Performance in Operations

IBM Rochester Service Profit Chain

IBMs AS/400 Division in Rochester, Minnesota, used the
Service-Profit-Chain concept to help understand relationships
that existed among measurements such as market share,
overall customer satisfaction, employee morale, job
satisfaction, warranty costs, inventory costs, product scrap,
and productivity in order to determine which factors had the
greatest impact on business performance and improve
management decisions. The analysis helped managers to
understand not only how to manage the workforce more
effectively, but also how decisions at the operations level can
affect long-term business success. Such decisions cannot be
made without considering the ripple-effects throughout the
company. For example, if an action is taken that impacts
employee satisfaction, such as a layoff, managers must
consider counteractions to prevent a decline in productivity,
OM2,
Ch. 3 Measuring Performance
in Operations
customer
satisfaction,
and market share.
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whole or in part.

35

Exhibit 3.6

The Service-Profit Chain Model

Source: Adapted from J. L. Heskett, T. O. Jones, G. W. Loveman, W. E. Sasser, Jr., Jr., and L. A. Schlesinger,
Putting the Service-Profit Chain to Work, Harvard Business Review, MarchApril 1994, pp. 164-174.

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Chapter 3 Measuring Performance in Operations

BankUSA: Credit Card Division Case Study

1. What are the major problems facing the credit
card
division?
2. What steps are required to develop a good
internal
and external performance and information system?
3. How should internal and external performance
data be related? Are these data related? What do
graphs and/or statistical data analysis tell you, if
anything? (Use the data in Exhibit 3.7 to help
answer these questions.)
4. Is the real service level what is measured
internally or
OM2, Ch. 3 Measuring Performance in Operations
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externally? Explain your reasoning.
whole or in part.

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