Chap 3 PDF

MEASURING PERFORMANCE
IN OPERATIONS
CHAPTER 3
DAVID A. COLLIER AND JAMES R. EVANS
2013 OM4 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
3-1 Describe the types of measures used for

decision making.
3-2 Explain the use of analytics in OM and how

internal and external measures are related.
3-3 Explain how to design a good performance

measurement system.
3-4 Describe four models of organizational

performance.

CHAPTER 3
What do you think?

What measures do
you use to
evaluate a
companys goods
or services?
Provide some
examples.
What measures
do we use to
evaluate a
students at AUIS?
Provide some
examples.

CHAPTER 3
Measurement
act of quantifying 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
make accomplishments visible
to workforce, stock market, and other
stakeholders.
CHAPTER 3
Types of Performance Measures
Financial
Customer
Market
Quality
Time
Flexibility
Innovation &
Learning
Productivity &
Operational
Efficiency
Sustainability

CHAPTER 3
Financial Measures
Top priority for profit organizations

Include:
revenue
return on investment
operating profit
pretax profit margin
asset utilization
growth
revenue from new goods and services
earnings per share
other liquidity measures

CHAPTER 3
Customer
Customer measures:
Customer satisfaction
customer retention
gains and losses of customers and customer accounts
customer complaints
warranty claims,
measures of perceived value
Loyalty
positive referral
customer relationship building
A customer-satisfaction measurement system
provides customer ratings of specific goods and
service features
indicates relationship between ratings and
customers likely future buying behavior
CHAPTER 3
Market measures:
Market share
business growth
new product and geographic
markets entered
percentage of new product sales.

CHAPTER 3
Quality
degree to which output of a process meets

customer requirements
Goods quality
Service quality
relates to the physical performance and

characteristics of a good
consistently meeting or exceeding
customer expectations (external focus) and
service delivery system performance
(internal focus) for all service encounters.

CHAPTER 3
Service Quality Dimensions

1. Tangibles
physical facilities, uniforms, equipment, vehicles, and
appearance of employees (physical evidence)
2. Reliability
ability to perform promised service dependably and
accurately
3. Responsiveness
willingness to help customers
provide prompt recovery to service upsets
4. Assurance
knowledge and courtesy of the service providers
ability to inspire trust and confidence in customers
5. Empathy
caring attitude
individualized attention provided
to customers
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2013
10
CHAPTER 3
Service Quality
Every service encounter provides an

opportunity for error.
service upsets (service failures)
Errors in service creation and delivery

11
CHAPTER 3
Time
Relates to 2 types of performance

measures:
speed of doing something
variability of the process
Processing time
time it takes to perform some task
Queue time
wait time time spent waiting

12
CHAPTER 3
Flexibility
ability to adapt quickly and effectively to changing

requirements
Goods and service design flexibility

ability to develop a wide range of customized goods and
services to meet different or changing customer needs
Measures include:
rate of new product development
percent of product mix developed over past three

years
Volume flexibility
ability to respond quickly to changes in volume and type
of demand.
Measures include: time to change machine setups

time required to ramp up to an increased production
L e a r volume
ning. All Rights Reserved.
13
2013 OM4 Cengage

CHAPTER 3
Innovation and Learning
Innovation
Learning
Measures of innovation and learning include:
ability to create new and unique goods and services that

delight customers and create competitive advantage
Creating, acquiring, and transferring knowledge
Modifying behavior of employees in response to internal
and external change
intellectual asset growth
patent applications
best practices implemented
new product development
employee training
skills development
work system performance and effectiveness

14
CHAPTER 3
Operational Efficiency
ability to provide goods and services to
customers with minimum waste and
maximum utilization of resources

15
CHAPTER 3
Productivity
Ratio of output of a process to the input
Quantity of
Output
Productivity =
Quantity of Input
[3.1]
Productivity measures
units produced per labor hour
airline revenue per passenger mile
meals served per labor dollar
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CHAPTER 3
Productivity and

17
CHAPTER 3
Sustainability
The Triple bottom line (TBL or 3BL)

measurement of environmental, social, and
economic sustainability
Measures of Environmental sustainability
energy consumption, recycling, air emissions, and

solid and hazardous waste rates
Measures of Social sustainability
consumer and workplace safety, community

relations, corporate ethics and governance, and
ethical violations
Measures of Economic sustainability
financial audit results, regulatory compliance,

sanctions and fines, and accomplishment of
strategic initiatives

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CHAPTER 3
Analytics in Operations Management

Business analytics
help analyze data more effectively & make better
decisions
Applications of business analytics include:
visualizing data using charts to examine performance trends
calculating statistical measures
e.g. means, proportions, and standard deviations;
comparing results relative to other business units, competitors, or
benchmarks
using correlation and regression analysis to understand
relationships among different measures
Understanding cause and effect linkages between key

measures of performance
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CHAPTER 3
Analytics in Operations Management - Interlinking
Managers must understand cause and effect

linkages between key measures of performance.
They explain impact of operational

performance on external results.
Interlinking
Quantitative modeling of cause and
effect relationships between external
and internal performance criteria

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CHAPTER 3
Exhibit 3.2 Interlinking Internal and External Performance Measures

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CHAPTER 3
Linking Internal & External Performance

Measures
Value of a loyal customer (VLC)
quantifies total revenue or profit each target market

customer generates over the buyers life cycle
Customer Retention Rate (RR)

= 1-Customer Defection Rate (DR)
Contribution to Profit and Overhead (CM)

= Fixed Cost Percentage + Before Tax Profit
Margin
A customer who buys a product every 2 years buys

(.5) product each year (Frequency of Purchase
(RF))
Average contribution to profit and overhead of a new

customer
22
d u p l i c a t e d , o r p o s t e d t o a p u b l=
i c l y(P)*(CM)*
a c c e s s i b l e w e b (RF),
s i t e , i n wWhere
h o l e o r i n P=
p a r t .Price.
CHAPTER 3
Linking Internal & External Performance Measures
Buying Life of Customer (BLC)= 1/Defection Rate

E.g. if DR = 20%, then buying life = 1/.2 = 5
years
Average Value of a customer over his

buying life
= Average contribution to profit and overhead* buying
life of customer
(VLC)= (P)*(CM)*(RF)*(BLC)
Total Market Value

= VLC * Number of Customers Gained (or
Lost)

23
CHAPTER 3
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?

24
CHAPTER 3
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
= (100,000 customers)($31.25/customer)
= $3,125,000
25
CHAPTER 3
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)(1/0.2)
= $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.
26
Problem
CHAPTER 3
What is the average value of a loyal customer (VLC) in a

target market segment if the average purchase price is $75 per
visit, the frequency of repurchase is six times per year, the
contribution margin is 10 percent, and the average customer
defection rate is 25 percent?
VLC = P*CM*RF*BLC, where P = the revenue per unit, CM =
contribution margin to profit and overhead expressed as a fraction (i.e.,
0.45, 0.5, and so on), RF = repurchase frequency = 6 times/year, BLC =
buyers life cycle, computed as 1/defection rate, expressed as a fraction
(1/0.25 = 4 years)
VLC = P*CM*RF*BLC = ($75)(.10)(6)(4) = $180

27
CHAPTER 3
Value of Loyal Customer Solution (continued):

28
CHAPTER 3
Designing Measurement Systems in Operations

Key Questions:
Does the measurement support our mission?
Will the measurement be used to manage change?
Is it important to our customers?
Is it effective in measuring performance?
Is it effective in forecasting results?
Is it easy to understand/simple?
Is the data easy/cost-efficient to collect?
Does the measurement have validity, integrity, and
timeliness?
Does the measurement have an owner?

29
CHAPTER 3
Designing Measurement Systems in Operations

Good performance measures are actionable.
Actionable measures
provide the basis for decisions at the level at
which they are applied:
the value chain
organization
process
Department
Workstation
Job
service encounter
30
CHAPTER 3
Models of Organizational Performance

A) Big picture models of organizational
performance:
Baldrige Performance Excellence

Framework
Balanced Scorecard
B) More detailed frameworks for operations

managers:
Value Chain Model

Service-Profit Chain Model

31
CHAPTER 3
Baldrige Performance Excellence Framework
Provide a framework for performance

excellence through self-assessment to
understand an organizations strengths and
weaknesses, thereby setting priorities for
improvement
Organizations in manufacturing, small

business, service, education, health care,
and non-profit sectors may receive the
Malcolm Baldrige Award.
Recipients receive awards for outperforming

32

CHAPTER 3
Exhibit 3.4 Baldrige Performance Model of Organizational Performance
Source: 2011-12 Baldrige Criteria for Performance Excellence, U.S. Depart. of Commerce

33
CHAPTER 3
The Balanced Scorecard Model

Developed by Analog Devices and popularized by
Robert Kaplan and David Norton in response to
limitations of traditional accounting measures.
Translates strategy into measures that uniquely
communicate an organizations vision.
Has 4 perspectives:
Financialvalue to shareholders
Customercustomer satisfaction and market
growth
Innovation and Learning future success
(people, research, intellectual property and
infrastructure)
Internalprocesses that drive the business

Cengage Learning. All Rights Reserved.
o r p o s(quality,
t e d t o a p u b lproductivity,
i c l y a c c e s s i b l e w e bdesigns,
s i t e , i n w h o l flexibility,
e or in part.
2013 OM4
duplicated,
34
CHAPTER 3
Exhibit 3.5 The Balanced Scorecard Performance Categories and Linkages

35
CHAPTER 3
The Value Chain Model
Evaluates performance throughout

the value chain by identifying
measures associated with suppliers,
inputs, value creation processes, goods
and service outputs and outcomes,
customers and market segments, and
supporting management processes.

36
CHAPTER 3
Exhibit 3.6 Examples of Value Chain Performance Measurements

37
CHAPTER 3
Most applicable to service environments.
Based on a set of cause and effect

linkages between internal and external
performance
defines key performance measurements
service-based firms should focus.

38
CHAPTER 3
Exhibit 3.7 The Service-Profit Chain Model

39
CHAPTER 3
The theory of the Service-Profit Chain is

that employees, through the service
delivery system, create customer value
and drive profitability.
As J.W. Marriott, the founder of Marriott

Hotels said long ago, Happy employees
create happy customers.

40
CHAPTER 3
Study Guide
1. Key activities of an operations manager
2. Value chain integration
3. Customer benefit package (CBP)
4. Evolution of operations management
5. Current challenges to OM?
6. Issues at the core of operations management

41
CHAPTER 3
Study Guide
7. Fixed cost and variable cost?
8. Break-even analysis and outsourcing decision
9. Goods, services and value
10. Outsourcing and offshoring
11. Mass production and customization?

42
CHAPTER 3
Study Guide
12. Sustainability and business practices that support
it
13. Supply chain and value chain
14. Vertical integration, backward integration and
forward integration
15. Economic and noneconomic issues to consider
when making offshore decisions
16. Define process and various types of processes

43
CHAPTER 3
Exhibit 3.1 The Scope of Business and Operations Performance Measurement

44

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MEASURING PERFORMANCE

DAVID A. COLLIER AND JAMES R. EVANS

2013 OM4 Cengage Learning. All Rights Reserved.

MEASURING PERFORMANCE IN OPERATIONS

3-1 Describe the types of measures used for

3-2 Explain the use of analytics in OM and how

3-3 Explain how to design a good performance

3-4 Describe four models of organizational

2013 OM4 Cengage Learning. All Rights Reserved.

MEASURING PERFORMANCE IN OPERATIONS

What do you think?

2013 OM4 Cengage Learning. All Rights Reserved.

MEASURING PERFORMANCE IN OPERATIONS

MEASURING PERFORMANCE IN OPERATIONS

Types of Performance Measures

2013 OM4 Cengage Learning. All Rights Reserved.

MEASURING PERFORMANCE IN OPERATIONS

Top priority for profit organizations

2013 OM4 Cengage Learning. All Rights Reserved.

MEASURING PERFORMANCE IN OPERATIONS

MEASURING PERFORMANCE IN OPERATIONS

2013 OM4 Cengage Learning. All Rights Reserved.

MEASURING PERFORMANCE IN OPERATIONS

degree to which output of a process meets

relates to the physical performance and

2013 OM4 Cengage Learning. All Rights Reserved.

MEASURING PERFORMANCE IN OPERATIONS

Service Quality Dimensions

MEASURING PERFORMANCE IN OPERATIONS

Every service encounter provides an

service upsets (service failures)

Errors in service creation and delivery

2013 OM4 Cengage Learning. All Rights Reserved.

MEASURING PERFORMANCE IN OPERATIONS

Relates to 2 types of performance

2013 OM4 Cengage Learning. All Rights Reserved.

MEASURING PERFORMANCE IN OPERATIONS

ability to adapt quickly and effectively to changing

Goods and service design flexibility

rate of new product development

percent of product mix developed over past three

Measures include: time to change machine setups

2013 OM4 Cengage

MEASURING PERFORMANCE IN OPERATIONS

Innovation and Learning

Measures of innovation and learning include:

ability to create new and unique goods and services that

2013 OM4 Cengage Learning. All Rights Reserved.

MEASURING PERFORMANCE IN OPERATIONS

2013 OM4 Cengage Learning. All Rights Reserved.

MEASURING PERFORMANCE IN OPERATIONS

MEASURING PERFORMANCE IN OPERATIONS

2013 OM4 Cengage Learning. All Rights Reserved.

MEASURING PERFORMANCE IN OPERATIONS

The Triple bottom line (TBL or 3BL)

Measures of Environmental sustainability

energy consumption, recycling, air emissions, and

Measures of Social sustainability

consumer and workplace safety, community

Measures of Economic sustainability

financial audit results, regulatory compliance,

2013 OM4 Cengage Learning. All Rights Reserved.

MEASURING PERFORMANCE IN OPERATIONS