Operations Strategy

1. Operations Strategy There’s nothing here to take by storm; to strategy we must conform. Johann Wolfgang von Goethe (Faust,1808)

2. Competitive Strategy • Principle 1 (Value Maximization) The goal of strategy is to maximize the long run NPV of the organization. • Competitive strategy (Business Unit Strategy). Relates a company to its environment. Strengths and weakness of the company (the system) to be related to opportunities and threatens in the environment • Chooses an attractive competitive position  by offering a high customer value proposition.

3. Competitive Strategy: Environmental Scanning (Opportunities and Threats) • Competitor activities • Complementor activities • Changes in consumer needs and preferences • Technological changes • Economic trends (GNP, unemployment, inflation, interests, taxes, tariffs) • Legal, political, and environmental issues

4. Competitive Strategy: Competing Edges of the System (Strengths and Weaknesses) • Human Resources (cheap labor, skilled labor, etc.) • Technology, Facilities, and Equipment • Financial Resources • Customers • Product and Services • Suppliers (low material cost, reliable suppliers) • Management Practices (low overhead)

5. Customer Value Proposition • Customer Value Proposition: a set of benefits that the firm offers to customers. • Customers purchase based on the value they derive from the product/service. This value is the greatest amount a customer is willing to pay (the reservation price). • If this value > price, the customer enjoys positive net value (consumer surplus). Customers will buy the service/product that offers highest consumer surplus. • Zara's main business is the design, manufacture, distribution and retailing of clothing. Differentiates itself from rivals  timely fashion for the masses. The customer value proposition  timely yet limited variety at modest cost and quality.

6. Financial, Marketing, and Operations Strategy To execute its competitive strategy, an organization further defines a • Financial strategy: Source of financial resources and use of funds (how invested). • Marketing and sales strategy: how the market will be segmented and how the product will be positioned and promoted • Operations strategy: Enabling the execution of the competitive strategy- how to best deliver the CVP. What Resources, what Processes, and what Competencies.

7. Mercedes-Benz In 1993, Mercedes-Benz decided to build the first factory outside Germany, in Tuscaloosa, AL to produce the M-class (to cut tariff by 25%). A Consolidation Center opened near the plant to manage the parts/subassemblies from 65 suppliers. A distribution network to transport the vehicles to 135 countries. The firs car was sold in 97. Demand quickly surpassed all forecasts and the capacity of 65,000. The initial $300 million plant was expanded in 98-99 to 80,000 at a cost of $80 million; still insufficient. In 1999-2002, the M-class was also produced by contract developer in Austria. To produce R-class too in AL, a $600M expansion in 2004 doubled the factory size; 4000 workers, 160K vehicles per year.

8. Operations Strategy: Resource View • Organization is a bundle of real recourses. • Real Resources • Tangible real resources: human resources (people) and capital resources (property, plant and equipment). • Intangible resources: relationships with suppliers or customers, reputation and brands, technology and know how. • To pay for the real resources, sell pieces of paper; financial resources; securities.

9. Mercedes' Bundle Of Real Assets Mercedes' bundle of real assets includes real estate in Alabama encompassing a plant with a variety of production and support equipment, such as presses, welding machines, and information systems. Staffed by 2000 employees. Its intangible assets include the supply base relationships, the process and product technologies, its knowledge of the local economic, legal, and social environment, its connections with logistics and transportation providers, ...

10. Operations Strategy: Resource View 1. How many resources should we invest in? The capacity, in aggregate and per main resource type. MB, the aggregate annual capacity was 65000 at 1993. 2. When should we increase or reduce resources? The availability of capacity and the timing of capacity adjustments. MB, 85000 in 99, 160000 in 2004. 3. What kinds of resources are best? HR or CR? To what extent can a capital resource operate unsupervised? i.e., the level trade-off between capital and human. What degree of flexibility is required? from single-task (specialized) to multi-task (flexible)? How the 160K capacity split into M and R-classes? Are the assets specialized to produce one or flexible to produce both?

11. Operations Strategy: Resource View 4. Where should the plants be located and what is their roles in the supply chain? How should the M-class plant location be chosen and what responsibilities should it have. Location decisions are part of network strategy which also includes topology (FedEx: hub-and-spoke, Car companies: tiered or tree) and configuration ( transportation modes). Also whether processes should be standardized or localized; e.g., should Tuscaloosa processes be similar to the German processes?

12. Operations Strategy: Process View • The process view  how resources perform activities and add value. A process is a network of activities with precedences. • By starting with inputs (customer demands) and ending with outputs (served customer demands), the process view is compatible with a customer-centric view of the world. • From this customer-centric view, value stream mapping defines value from the perspective of the customer: a value-added activity is an activity that benefits the customer. • The process view: a horizontal view of the organization that cuts through functional silos ( finance, accounting, production, marketing sales, etc). Inter-functional relationships as well as the interfaces with external customers and suppliers.

13. Operations Strategy: Process View 1. Strategic sourcing decisions: make or outsourcing decisions, supply network (how many suppliers and how to manage them), vertical integration (how far up and downstream?). 2. Which technologies ? Four types of technology: • Coordination and IT: Centralized or distributed planning, control? In planning phase  coordinate financial, sales, marketing, and operations forecasts. In the execution phase  making events happen at the right times. Communication technology (e.g., Internet, RF) and planning systems (e.g., ERP).

14. Operations Strategy: Process View 2. Technology • Product technology: Is the product designed in modules or as an integral system? Does the design take into account manufacturability, testability, or reusability? • Process technology: The transformation process and methods. The layout of the process in terms of the physical arrangement and flow pattern of the unit loads, i.e., job shop or flow shop. • Transportation technology: material handling in the plant and transportation network throughout the supply chain. Also includes how insurance policies are moved between the different processing steps.

15. Facility Layout : Job Shop Product 1 Product 2 Output A B Input C D

16. Job Shop Functional layout: similar resources in the same department. Ex. all press machines are located in stamping department. Ex. Bakeries, law firms, emergency rooms, repair shops. • low volume, high variety customized products • flexible resources • skilled human resources • jumbled work flows • high material handling • large volume of inventories • long flow time • highly structured information system • high cost per unit of product but low investment

17. Facility Layout : Flow Shop Product 1 Product 2 A D B Input Output C B A

18. Flow Shop Product layout or line layout: Resources are arranged according to the sequence of the operations. Usually requires duplication ( and investment) of a resource pool; dedication of resources. Discrete flow shop: assembly line Continuous flow shop: beverage, chemical plant, process plant. • high standardization, high speed • low material handling • short flow time • low unit-processing costs • high investment cost; needs mass production. • special purpose equipment, and low skilled labor prevent flexibility

19. Characteristics of Processes:Job Shop vs. Batch vs. Flow Shop Most processes fall somewhere on the continuum between Job Shop and Flow Shop

20. Operations Strategy: Process View 3. How do we match demand to available supply? The demand management includes demand planning and forecasting as well as tactical capacity allocation and order management; airlines, hotels, and car rental. 4. How and when do we improve and innovate in products and processes? R&D, continuous improvement, and learning throughout the organization.

21. The Competency View of Operations • Values are a third factor that affect what an operation (or an organization) can and cannot do. • Values are the standards by which employees set priorities at every level. Some priorities are programmed into a process but many are not. Ex. whether an order or customer is attractive, whether a suggestion to improve a product or process is attractive, whether an investment is worth making. • As organizations become more complex, consistent values are powerful mechanisms for employees to make independent but consistent decisions. • Values constitute the organization’s culture

22. The Competency View of Operations • The competency view characterizes the abilities of the organization's resources, processes, and values. • Competencies determine the set of outputs that the operation will be particularly good at providing. • A premier management consulting company is good at providing high quality customized advice. • An efficient operation such as Mc­Donald's is good at delivering inexpensive food quickly, but from a standard and limited menu with a well-defined quality level. • Zara is good at quickly delivering a large selection of new designs at a reasonable cost.

23. Operations Strategy: Competency View 1. Cost, including input costs and resource costs. Is important in low margin markets. 2. Response or lead time. The time needed to transform inputs into outputs? Responsiveness is important due to changes in customer preferences and technologies. 3. Quality. Quality refers to the degree of excellence of the process, product, or service. It has design-related dimensions such as performance and features, as well as process-related dimensions such as durability and reliability. Is a key differentiator in luxury and high precision businesses. 4. Flexibility, to change inputs, activities, volumes, or outputs. Similar to quality, flexibility has several dimensions such as scope flexibility (the selection or range of products and services offered, including the level of customization), volume flexibility, and robustness.

24. The Competency View of Operations • Foundations of competencies change over time; they start in resources, gradually migrate to processes, and eventually reside in values. • Most of what gets done in start-up companies is attributable to inputs and resources. Losing a person can be detrimental. • As activities become more recurrent, processes are defined. • As it becomes clear which business needs should be given highest priority, values emerge. • With hundreds of new recruits and departures per year, top management consulting companies remain successful because their processes and values are so strong that project staffing changes have little impact.

25. A Framework For Operations Strategy • Operations strategy could emerge from a giant optimization model identifying the resources, processes, and competencies to maximize NPV. Not possible. • Principle 2 (Alignment) Operations strategy is a plan for developing resources and configuring processes such that the resulting competencies to align with competitive strategy –customer value proposition - to maximize NPV

26. A Framework for Operations Strategy Max NPV Competitive Strategy Competencies Operations Strategy Resources (Asset Portfolio) Processes (Activity Network) Sizing How much capacity to invest in? Timing When increase or reduce resources? Type What kinds of resources are best? Location Where should resources be located? Supply When outsource & how manage suppliers? Technology Coordination, product, process transportation Demand How match demand to available supply Innovation How and when to improve and innovate?

27. A Framework For Operations Strategy 1. Organization  Customer value proposition for each market segment? 2. Operations  Prioritize competencies for each market segment? 3. Which resources and processes best provide that competency prioritization? For each targeted customer segment, how the asset portfolio (sizing, timing, type, and location) and the activity network (supply, technology, demand, and innovation management) are configured?

28. Market Driven, Technology Driven Strategies • This "top-down and outside-in" ensures that operations reflect the intended market position. Market driven strategy creates a customer-driven organization. • In “a bottom-up and inside-out”, the building blocks of strategy are not products and markets, but processes and resources. The value proposition offered to customers seeds in the operational capabilities. The technology driven strategy creates a resource-driven organization.

29. Market Driven, Technology Driven Strategies • Organizations must maintain alignment by adopting both perspectives. In order to satisfy a new customer need, the firm may need to build new competencies, processes, and resources. Those operational capabilities may later be used to invent new products and services that may create new markets. • Honda's abilities and knowledge in high-performance engine technology has been the driving force in deciding which markets to enter and which products to offer.

30. Zara: Resource View • High vertical integration  ownership allows tight coordination. A design center, some manufacturing facilities (also outsources locally), two major DCs, and 90% of 724 retail stores. • The design capacity of 11K new styles/yr by over 200 professionals is in line with the timely fashion (design to rack of 3 weeks). • Owns two central warehouses in Spain. The recent 123,000 m2 DC has a capacity of 80K garments/hr. Direct access to highway and RR and proximity to airport favors fast handling of international cargo.

31. Zara: Resource View • Vertical integration  high ratio of tangible fixed assets to sales of 34%. The average capacity utilization is 50%, many facilities are single shift. • The supply network centered in Spain (25% from the rest of Europe and 25% from the rest of the world). The proximity of suppliers  inputs are received quickly  fast speed-to-market. Local facilities are used to produce the products with most demand uncertainty and time-sensitivity, off-shoring for basic products with more predictable demands. Industries exercising (fast response times + high demand volatility) experience low capacity utilization

32. Zara: Process View; Technology • Postpone the dyeing of fabric: almost half the raw materials are purchased undyed. • Short lead time for product with high variability in their demand. Local manufacturing processes have short setup times and run in small batches, while off­shore manufacturing of more predictable demand can have longer lead times. • Distribution is highly centralized to reduce the number of stocking points and the associated handling time and so that one store's upside demand fluctuations can offset another's downside.

33. Zara: Process view; Technology • The hub and spoke system uses the appropriate transportation mode (truck, RR, or air) depending on the store location and the time-sensitivity. Frequent deliveries with short lead times. It maximizes the flexibility of inputs and increases responsiveness while controlling working capital (inventory). • IT enables the daily information flow between store managers (requesting products and providing customer feed­back) and design and production (sharing information on upcoming products).

34. Zara: Process View; Demand • Intentionally short style campaigns that are likely to run out of stock create a scarcity image. Customers visit stores frequently and are likely to buy what is available at that moment because that particular product may no longer be available next time. The combination of short campaigns and limited inventory reduces markdowns and leftovers.

35. Zara: Process View; Innovation • Fast new product design is a key enabler of Zara's strategy. Ideas inspired by urban hot spots, fashion shows, and store customers are transmitted to the creative teams. Design style platforms are created ahead of the season and are modified just before production based on feedback from retailers regarding the most recent fashion. This postponement of design styling requires fast and efficient information transfer.

36. Zara: Process View; Innovation • A firm believer that people, cultures and generations share a special sensitivity for fashion. Standardizes a majority of its designs but allows some adjustments to local taste. Zara originally insisted on a standard set of sizes for all countries but had to add smaller sizes for Japan and larger ones for the U.K. and Ger. • Has tailored the 8 drivers of its operations strategy to its fast-fashion, cheap-chic value proposition.

37. Should Every Retailer Adopt the Zara Model? • Zara's operational system is not a panacea. Sweden's Hennes & Mauritz AB competes with Zara. It produces much fewer new styles per year with a much slower design-to-rack time of 16 weeks. •  Without the stringent speed requirement, H&M has more leeway in configuring its operations; more outsourcing and higher capacity utilizations resulting in much lower fixed capital. The lower safety capacity and responsiveness is replaced by higher safety stock to buffer demand uncertainty.

38. Should every retailer adopt the Zara model? • The Zara model is not used in other industries such as toy, cell phone, or auto manufacturing. Zara model requires: 1. High customer willingness to pay for speed-to-market. 2. Short product life cycles with high demand uncertainty. 3. Low cost of excess capacity with low importance of scale economies. 4. Low cost of stockouts and distribution relative to inventory holding. • Great operations strategies are tailored to each company's competitive strategy. While companies may share some elements, a complete tailored operations system is unique

39. Competitive Product Space Variety B A Cost Efficiency (1/cost) Responsiveness Competitive Product Space: A representation of the firm’s product portfolio in the four dimensional space: Q, C, Var., Res. Another firm: expensive and customized products. One firm: low cost and standardized products

40. Strategic Positioning Responsiveness B A High Low Price Defines those positions that the firm wants to occupy in its competitive product space. The current position, direction, and goal position.

41. Operational Effectiveness • What distinguishes an effective business process? • Operational effectiveness: developing operations strategy (resources, processes, values, competencies) that support the strategic positioning(customer value proposition) better than the competitors. • How does effective differ from efficient? • Cost Efficiency: achieving an output with minimal level of input and resources • Effective Process: supports execution of company’s strategy

42. Focused Strategy, Focused Operations • Focused Strategy: Committing to a limited, congruent set of objectives in terms of demand (product, market) and supply (input, technologies, and volumes). • Aravind Eye Hospital, 100 cataract surgeries a day, operational excellence, 40% gross margin, 70% of patients pay almost nothing, and the hospital does not depend on donations. • A focus process is not limited to a few products. • Focused process: one whose products all fall within a small region of the 4 dimensional product space.

43. Plant Within Plants (PWP) • PWP: The business strategy is diverse. But the entire business is divided into several mini-plants each with focused processes. One PWP may focus on low cost, the other on quick response. • To sustain competitive advantage, a firm must ensure that its competitors are not able to imitate its chosen position. An sculpture not a block. • Supporting the strategic position with multiple mutually reinforcing activities creates a sustainable competitive advantage. It is harder for competitors to imitate an array of interlocked activities.

44. Shouldice Hospital, Corolla, Ferrari Corolla: flow shop, decentralized assembly plants close to market, short flow time, low cost Ferrari: job shop, only a single plant in Italy, longer flow time, high cost

45. Focus and the Efficient Frontier in Health-care sector World-class Emergency Room Efficient operations frontier One general facility Responsiveness World-class (non-emergency) Hospital Costefficiency

46. Strategic Positioning and Operational Effectiveness Responsiveness A B efficient frontier C High Low Price Firms located on the same ray share strategic priorities. World class firms are on the efficient frontier. the minimal curve containing all current positions in an industry

47. Efficient Frontier • Firms not on the EF, are not on strict trade-off, they can make simultaneous improvement on more than one dimension. • Firms on EF need to trade-off • Trade-off: decreasing on one dimension to increase on the other dimension. • World class firms also try to push the EF outward. • As technology and management practices advances, the EF moves upward. But the impact is not the same in all industries. Internet impact • In book industry pushes EF along both the dimensions of cost and variety • In grocery increases the quality of service to customers, but increases the cost and reduces the responsiveness and variety

48. Strategic Positioning and Operational Effectiveness • Strategic positioning defines the direction of the improvement from current position, and thus the position on the EF the company wants to occupy. • Operational effectiveness measures the distance of the current position to the operations frontier along the direction of improvement. To bring a company closer to a frontier or to push the frontier. (direction is not horizontal)

49. Wal-Mart Corporate Strategy (Gain competitive advantage by) providing customers access to quality goods, when and where needed, at competitive prices. • Operations Structure • Cross docking • EDI • Fast transportation system • Focused locations • Communication between retail stores • Operations Strategy • Short flow times • Low inventory

50. Wal-Mart (Resulting Benefits) Inventory at retail stores turned over twice a week (Industry averages once every two weeks) Improved targeting of products to markets Sales per square foot increased from $102 in 1985 to $140 in 1991 (Industry average increased from $102 to $110)