MEASURING PERFORMANCE

IN OPERATIONS
CHAPTER 3

DAVID A. COLLIER AND JAMES R. EVANS

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 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.

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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

i magine entering the cockpit of a modern jet airplane and

Passenger:
seeing only aIm surprised
single to see you
instrument operating
there. How the plane
would with
you only a
feel
single instrument. What does it measure?
about
Pilot: boarding
Airspeed. the
Im plane after the
really working onfollowing conversation
airspeed this flight. with
the pilot?
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.
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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

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

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.

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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Types of Performance Measures

Important categories of organizational
performance measures:
Financial Flexibility
Customer and Innovation and
Market Learning
Quality Productivity and
Time Operational
Efficiency
Sustainability
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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

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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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Customer and Market Measures

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, and customer relationship
building.
A 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.
Market measures: Market share, business
growth, new product and geographic markets
entered, percentage of new product sales.
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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

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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.
Service quality is consistently meeting
or exceeding customer expectations
(external focus) and service delivery
system performance (internal focus) for all
service encounters.
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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Service Quality Dimensions

1. Tangiblesphysical facilities, uniforms,

equipment, vehicles, and appearance of
employees (i.e., the physical evidence).
2. Reliabilityability to perform the promised
service dependably and accurately.
3. Responsivenesswillingness to help customers
and provide prompt recovery to service upsets.
4. Assuranceknowledge and courtesy of the
service providers, and their ability to inspire trust
and confidence in customers.
5. Empathycaring attitude and individualized
attention provided to its customers.

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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Service Quality

Every service encounter provides an

opportunity for error.

Errors in service creation and delivery

are sometimes called service upsets or
service failures.

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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Time
Time relates to two types of performance
measures:
1. the speed of doing something
2. 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

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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.
Measures include the rate of new product development or
percent of product mix developed over the past three
years.

Volume flexibility is the ability to respond quickly

to changes in the volume and type of demand.
Measures include the time to change machine setups or
2 0 1 3 O M 4 C e ntime
g a g e L erequired
a r n i n g . A l l Rto
i g h tramp
s R e s e r v eup
d. M ato an
y no t b eincreased
s c a n n e d , c o p i production
ed or 16
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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.

Measures of innovation and learning include

intellectual asset growth, patent applications,
best practices implemented, new product
development, employee training and skills
development, satisfaction, work system
performance, and effectiveness. 17
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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Productivity and Operational Efficiency

Productivity is the ratio of the output of a
process to the input.

Productivity = Quantity of Output/Quantity of

Input
Operational Efficiency is the ability to provide
goods and services to customers with minimum
waste and maximum utilization of resources.

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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Productivity
Productivity is the ratio of output of a
process to the input.

Quantity of
Productivity = Output [3.1]
Quantity of Input
Productivity measures include units produced per
labor hour, airline revenue per passenger mile,
meals served per labor dollar.

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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Productivity and
Operational Efficiency

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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Sustainability
The Triple bottom line (TBL or 3BL) refers to
the measurement of environmental, social, and
economic sustainability.

Environmental sustainability measures include

energy consumption, recycling, air emissions, and
solid and hazardous waste rates.
Social sustainability measures include
consumer and workplace safety, community
relations, corporate ethics and governance, and
ethical violations.
Economic sustainability measures include
financial audit results, regulatory compliance,
sanctions and fines, and accomplishment of
strategic initiatives.
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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Analytics in Operations Management

As we noted in Chapter 1, business analytics is helping
operations managers to analyze data more effectively
and make better decisions.
Typical applications of business analytics include
visualizing data using charts to examine performance
trends; calculating basic statistical measures such as
means, proportions, and standard deviations; comparing
results relative to other business units, competitors, or
best-in-class benchmarks; and using correlation and
regression analysis to help understand relationships
among different measures.
Understanding the cause and effect linkages between
key measures of performance is an important application
of analytics.

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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Analytics in Operations Management - Interlinking

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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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Exhibit 3.2 Interlinking Internal and External Performance Measures

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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Sports Analytics

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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Sports Analytics

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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

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 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 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?

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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 =

(100,000 customers)($31.25/customer) = $3,125,000
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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 value
chain performance, the economic payoff is doubled.

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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Value of Loyal Customer Solution (continued):

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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

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?
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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Designing Measurement Systems in Operations

Good performance measures are actionable.
Actionable measures provide the basis for
decisions at the level at which they are
appliedthe value chain, organization,
process, department, workstation, job, and
service encounter.

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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Models of Organizational Performance

Big picture models of organizational
performance:

Baldrige Performance Excellence

Framework
Balanced Scorecard

More detailed frameworks for operations

managers:

Value Chain Model

Service-Profit Chain Model
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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Baldrige Performance Excellence Framework

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. www.nist.gov/baldrige

Organizations in manufacturing, small

business, service, education, health care,
and non-profit sectors may receive the
Malcolm Baldrige Award.
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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Exhibit 3.4 Baldrige Performance Model of Organizational Performance

Source: 2011-12 Baldrige Criteria for Performance Excellence, U.S. Depart. of Commerce

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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

The Balanced Scorecard Model

Purpose is to translate strategy into measures
that uniquely communicate an organizations
vision.

Four perspectives:
1. Financialvalue to shareholders
2. Customercustomer satisfaction and
market growth
3. Innovation and Learningpeople and
infrastructure
4. Internalprocesses that drive the
business
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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Exhibit 3.5 The Balanced Scorecard Performance Categories and Linkages

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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

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.

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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Exhibit 3.6 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.

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

Exhibit 3.7 The Service-Profit Chain Model

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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Service-Profit Chain Model

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.

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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 3.8 to help answer these questions.)
4. Is the real service level what is measured
internally or externally? Explain your
reasoning.
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 CHAPTER 3 MEASURING PERFORMANCE IN OPERATIONS

Extra Slide: IBM Rochester Service Profit Chain Example

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
2 0 1counteractions
3 O M 4 C e n g a g e L e a r n i n gto
. A l lprevent
Rights Resea
r v e decline
d. M a y n o t bin
e s productivity,
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