Week 2: Process Analysis

Defining Process Measures I, R, T

Linking process measures to
Financial Measures
Applications of Little’s Law

Capacity and Flow Time Analysis

Kristen Cookies
What is Improvement?
Jonah asks Alex three questions when they
discuss how to measure improvement:


The business imperative: creating
economic value
Improvement levers
Price 1. Increase price
Revenues x 2. Increase throughput
Quantity

Profit - Material
+
Labor
Costs + 3. Reduce costs
Economic value Energy 4. Improve quality
added (EVA) - +
Overhead
PP&E
Capital + 5. Reduce capital intensity
Inventory
invested 6. Reduce inventory
+
Opportunity x Other
cost Reduce
Weighted average
cost of capital Flow Time

Financial metrics Operational metrics

 Process View of Operations
Process
Information Management
structure

Network of
Activities and Buffers
Inputs Outputs
Flow units Goods
(customers, data, Services
material, cash,
etc.)

Labor & Capital

Resources
Advantages of Adopting a Process
View of Organizations
 Applies to any organization
 Applies at any level
 “horizontal,” i.e., across functions, view of the organization in contrast to the
usual vertical views along the lines of functional departments
 Highlights externalities
 Highlights integration and problems
 Is always “customer aware” and focused on outcomes

 Key Property: focus on flows rather than snapshots

 Rationalized management (vs. fighting fires)
 Focus on process rather than people has higher likelihood of leading to
cooperation and significant improvement
→ the process view is a unified, customer-centric model of the organization that
facilitates analysis and improvement in a systematic manner.
 Relating operational measures (flow time
T, throughput R & inventory I) with
Little’s Law
Flow Rate / Throughput
Inventory I R
... ... [units] ... ...
[units/hr, units/day,
units/week]
Flow Time T
[hrs,days,weeks,]

Average Number of Units in Process (I) = Average Processing Rate (R) * Average Flow Time
(T)
Units = (Units / Time) *
(Time)
I = R * T

 Inventory Turns (Turnover) = Throughput / Inventory = R / I

= 1/ T
6
INVENTURY TURNS
Applications of Little’s Law

Wal-Mart DC Dell
A general manager at Dell states
that the inventory turns 35 times
a year. She also states that
everything that Dell procures
gets processed and leaves the
docks within 5 days.

Are these statements consistent?

Practice: Application of Little’s Law
Fast Food
Wendy’s processes an average of
5,000 lb. of hamburgers per week.
The typical inventory of raw meat is
2,500 lb. What is the average flow
time of hamburgers and Wendy’s
turnover?
Sales at Motorola
Motorola sells $300 million worth
of cellular equipment per year.
The average accounts receivable
in the cellular group is $45
million. What is the average
billing to collection process flow
time?
ABC Inc. Consolidated Statement
Net Sales 250.0

Costs and expenses

Cost of Goods Sold 175.8
Selling, general and administrative expenses 47.2
Interest expense 4.0
Depreciation 5.6
Other (income) expenses 2.1
TOTAL COSTS AND EXPENSES 234.7

INCOME BEFORE INCOME TAXES 15.3

PROVISION FOR INCOME TAXES 7.0
NET INCOME 8.3

RETAINED EARNINGS, BEGINNING OF YEAR 31.0

LESS CASH DIVIDENDS DECLARED 2.1
RETAINED EARNINGS AT END OF YEAR 37.2

NET INCOME PER COMMON SHARE 0.83

DIVIDEND PER COMMON SHARE 0.21
ABC Inc.: Balance Sheet
CURRENT ASSETS
Cash 2.1
Short-term investments at cost (approximate mkt.) 3.0
Receivables, less allowances of $0.7 mil 27.9
Inventories 50.6
Other current assets 4.1
TOTAL CURRENT ASSETS 87.7

PROPERTY, PLANT AND EQUIPMENT (at cost)

Land 2.1
Buildings 15.3
Machinery and equipment 50.1
Construction in progress 6.7
Subtotal 74.2
Less accumulated depreciation 25.0
NET PROPERTY, PLANT AND EQUIPMENT 49.2

Investments 4.1
Prepaid expenses and other deferred charges 1.9
Other assets 4.0
TOTAL 146.9
ASSETS
ABC Inc. : Inventory and Cost of
Goods
INVENTORY
Raw materials (roof) 6.5
Fabrication WIP (roof) 15.1
Purchased parts (base) 8.6
Assembly WIP 10.6
Finished goods 9.8
TOTAL 50.6

COST OF GOODS SOLD

Raw materials 50.1
Fabrication (L&OH) 60.2
Purchased parts 40.2
Assembly(L&OH) 25.3
TOTAL 175.8
 Financial Flows in the
Factory
R= R=
Labor &
Overhead

Labor &
R= Overhead
I= I=
Raw Materials Fabrication
(roofs) (roofs) R= R=
I= I=

R= R= Assembly Finished Goods

I=

Purchased Parts (bases)

 Financial Flows
in the Factory
$60.2/yr $25.3/yr

$50.1/yr $110.3/yr
$6.5 $15.1
Raw Materials Fabrication
(roofs) (roofs) $175.8/yr $175.8/yr
$10.6 $9.8

$40.2/yr Assembly Finished Goods

$8.6
$40.2/yr
Purchased Parts (bases)
ABC Inc.: Flow Times

Raw Fabrication Purchased Assembly Finished

Materials Parts Goods
Throughput R
$/Year 50.1 110.3 40.2 175.8 175.8
$/Week 0.96 2.12 0.77 3.38 3.38
Inventory I ($) 6.5 15.1 8.6 10.6 9.8
Flow Time T = 6.75 7.12 11.12 3.14 2.90
I/R (weeks)
Other Representations of R, T and
I
Flow rate R
($/week)

4.8

3.38
Accounts
Receivable

Assembly
2.12
Finished
Goods
0.96 Fabrication

0.77 Raw
Purchased Parts Materials

11.12 6.75 7.12 3.14 2.90 5.80

Flow Time T (weeks)

16
 Sample Problem: Cheapest Car Rental
Cheapest Car rental rents cars at the DFW airport. The rental market
consists of two segments: The short-term segment, which rents for an
average of 1 week, and the medium–term which rents for an average of
2 weeks. Currently, company rents 200 cars per week to the short term
and 100 car per week to the medium term customers. Approximately,
20% of the cars that are returned (same percentage for both segments)
are found to be in need of repair before they can be rented out again.
The remaining cars are cleaned, filled with gas, and made available for
rent. On average, there are 100 cars waiting to be cleaned. The average
cost of this process is $5/car. The cars needing repair spend about an
average of 2 weeks in the repair shop and incur an average cost of
$150/car. Suppose the cars are rented out immediately as soon as they
are cleaned or repaired (Cars repaired come out clean and with gas).
Short-term renters pat $200/week and medium-term rentals pay
$120/week. Draw Flow Chart & Identify R, I and T at each stage. What
profit does the company generate per week with the current system?
Assume that each car loses $40 in value per week because of
depreciation.
Product Customization

3D Printing
KRISTEN’S COOKIE COMPANY
Business Concept (Value Proposition)
Fresh Customized Cookies
Short Lead Time

Process Type
Make to Order

Resources ( Who is doing the work ?)

You (Kristen) and roommate,
1 oven
Many trays
1 mixer
email
 Professor Savaskan-Ebert (ITOM
21
6203) / Jan 11
REVENUES AND COSTS
Variable material cost per dozen = $0.6/dozen
Cost of the box = $0.1 per box
Each box holds a dozen cookies.
Landlord pays the electricity.

Assumption: Each order is a dozen cookies.

 Online 2 mins 3min
Batch: 1-3 pizza 15 min/2 piz 2 min
(3x pizza)
order 1 min / piz 1 min 3 min/doz 1 min/ piz
Sauce toppings Loading Cooking coo Sta
kneading into pack
prep oven ling

Take Order
Jacquline
Jean

Order Pay Pack Cool Unload

Ready

---
Roommate Roommate Roommate
1 min / order
Kristen’s: Flow Time Analysis (assume
order = 1 dozen cookies)
( Theoretical Flow Time) What is the minimum time it will take Kristen to fill a
rush order, assuming that all steps of the process are started only after the order is
received ?

Can you think of ways to reduce the theoretical flow time?

To reduce Theoretical Flow Time, one needs to
focus on the Critical Path of Activities.

24 hrs
30 min

Title display Title search

15 min
45 min Collect
documents
Application Credit Check
& copies
25 min 120 minutes

Underwrite
Appraisal
45 min 20 min

Closing Call Customer

5 min
 LEVERS FOR REDUCING FLOW TIME
 Decrease the work content of critical activities.
– work smarter ( do parallel processing)
– e.g. Concurrent Engineering
– work faster (Automate)
– e.g. Call Center automated answering
– do it right the first time
– Quality control early in the process
 Reduce waiting time >>> Need to Reduce I or increase R.
 Kristen’s Cookies: Flow Chart
6min
e-mail 1 min/doz Batch size: 1-3 doz 2 min / doz 1 min/doz 9 min/doz
Wash Pace
cookies Load & Bake
& Mix on trays Set Timer

Take Order Roommate

You You Roommate Oven
Oven

Order Pay Pack Cool Unload

Ready

---
Roommate Roommate Roommate
1 min / order 2 min /doz 5 min
 Kristen’s: Flow Rate/Capacity Analysis
What is the maximum number of orders that Kristen can fill per
hour in steady state?

Unit Load Resource Capacity Process Resource

Resource Unit # of Total Capacity Utilization
Time/job Capacity units Units/hr
Kristen’s: Average Flow Time (Little’s Law)
A customer emails a new order for 1 dozen cookies and
wants to know how long before she can pick up her order.
You look at the process and see that there are 5 orders, each
waiting to go into the oven and the room mate is just about
to start loading and setting the oven for a tray (6th order).
What due date should Kristen promise ?
 Kristen’s Cookies: Current Work-in Progress
6min
e-mail Batch size: 1-3 doz
2 min / doz 1 min/doz 9 min/doz
1 min/doz
Wash Pace
cookies
6th &
Load Bake
New order & Mix 5 orders
on trays order
Set Timer

Take Order Roommate You You Roommate Oven

Oven

Order Pay Pack Cool Unload

Ready

---
Roommate Roommate Roommate
1 min / order 2 min /doz 5 min
Product Pricing
Eventually, Kristen would like to hire two student
employees to run this operation. She will pay $8/hr per
employee. What should be the minimum price per dozen
cookie to break even?
Variable Cost:
material : $0.6/dozen
box: $0.1/dozen
Capacity Investment Decisions
 The cookies have become wildly popular and Kristen feels
that she can easily sell 12 dozen cookies per hour. Should
Kristen rent another oven from the landlord at $10 per
operating hour? What would be the contribution margin
from each hour of operation of the process (assume that
Kristen and her roommate do all the work)?
– Resource cost = $10/hr
– Material cost =$0.7/dozen
– Cookies are sold for $5/dozen
Kristen’s: Flow Rate/Capacity Analysis with
2 Ovens !
Unit Load Resource Capacity Process Resource
Resource Unit # of Total Capacity Utilization
Time/job Capacity units Units/hr
Is it worth renting the second oven for $10/hr?
 Can you reallocate tasks to make 2nd oven
profitable?
Summary: Capacity Investment
Decisions
Identifying the Bottleneck in a process will tell you where to focus your
process (capacity) improvement efforts.

Doubling the Bottleneck capacity will not guarantee doubling your

throughput (sales) because another resource may become the bottleneck.

Cross training is useful only if it takes load off the bottleneck resource.

We should value the investment in resources not in isolation but as they

relate to the rest of the process.
With one oven, what is the minimum number of
trays needed to run the process at a capacity of 6
orders/hr?
Unit Load Resource Capacity Process Resource
Resource Unit # of Total Capacity Utilization
Time/job Capacity units Units/hr
Product Mix Decisions:
Kristen Cookies offers 2 products

Sale Price of Chocolate Chip Cookies: $5.00/dozen

Cost of Materials: $2.50/dozen

Sale Price of Oatmeal Raisin Cookies: $5.50/dozen

Cost of Materials: $2.40/dozen
Product Mix Decisions: Its Impact on
Capacity and Profitability
Processing
Times
Mix Load Bake Cool Pack Receive
in Oven

Chocolate 8mins 10min 5min 2 min 1min

Chip

Oat 5mins 15min 2min 2 min 1min

Raisin

Resources Kristen RM Oven RM RM

Oven
Product Mix Decisions
Margin per dozen Chocolate Chip cookies = $2.50
Margin per dozen Oatmeal Raisin cookies = $3.10

Profit Rate from Chocolate Chip cookies

= $2.50 * 6 /hr = $ 15/hr
Profit Rate from Oatmeal Raisin cookies
= $3.10 * 4 / hr = $ 12.4/hr
Capacity Investment Decisions
Identifying the Bottleneck in a process will tell you where to focus your
process (capacity) improvement efforts.

Doubling the Bottleneck capacity will not guarantee doubling your

throughput (sales) because another resource may become the bottleneck.

Cross training is useful only if it takes load off the bottleneck resource.

We should value the investment in resources not in isolation but as they

relate to the rest of the process.

Product choices should consider how much bottleneck time that each
product uses in a capacity constrained environment.