MEASURING PERFORMANCE IN OPERATIONS

1. MEASURING PERFORMANCE IN OPERATIONS CHAPTER 3 DAVID A. COLLIER AND JAMES R. EVANS

2. LO1Describe the types of measures used for decision making. LO2Explain how to calculate and use productivity measures. LO3Explain how internal and external measures are related. LO4Explain how to design a good performance measurement system. LO5Describe four models of organizational performance.

3. Passenger: I’m surprised to see you operating the plane with only a single instrument. What does it measure? Pilot: Airspeed. I’m really working on airspeed this flight. Passenger: That’s good. Airspeed certainly seems important. But what about altitude? Wouldn’t an altimeter be helpful? Pilot: I worked on altitude for the last few flights and I’ve gotten pretty good on it. Now I have to concentrate on proper airspeed. Passenger: But I notice you don’t even have a fuel gauge. Wouldn’t that be useful? Pilot: You’re right; fuel is significant, but I can’t concentrate on doing too many things well at the same time. So on this flight I’m 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. imagine 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 the pilot?

4. What do youthink? What measures do you use to evaluate a company’s goods or services? Provide some examples.

5. Measurementis 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.

6. Types of Performance Measures Important categories of organizational performance measures: • Time • Flexibility • Innovation and Learning • Sustainability • Financial • Customer and Market • Quality

7. Exhibit 3.1 The Scope of Business and Operations Performance Measurement

8. 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.

9. 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 systemprovides a company with customer ratings of specific goods and service features, and indicates the relationship between those ratings and the customer’s likely future buying behavior. • Market measures: Market share, business growth, new product and geographic markets entered, percentage of new product sales.

11. Quality • Qualitymeasures the degree to which the output of a process meets customer requirements. • Goods qualityrelates to the physical performance and characteristics of a good. • Service qualityis consistently meeting or exceeding customer expectations (external focus) and service delivery system performance (internal focus) for all service encounters.

12. Service Quality Dimensions 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 service-providers, and their ability to inspire trust and confidence in customers. Empathy—caring attitude and individualized attention provided to its customers.

13. Service Quality Every service encounter provides an opportunity for error. Errors in service creation and delivery are sometimes calledservice upsetsorservice failures.

14. Time • Time relates to two types of performance measures: • the speed of doing something • the variability of the process • Processing timeis the time it takes to perform some task. • Queue timeis a fancy word for wait time—the time spent waiting.

16. Flexibility • Flexibilityis the ability to adapt quickly and effectively to changing requirements. • Goods and service design flexibilityis 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 flexibilityis the ability to respond quickly to changes in the volume and type of demand. • Measures include the time to change machine setups or time required to “ramp up” to an increased production volume.

17. Innovation and Learning • Innovationrefers 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.

18. 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, 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.

19. Productivity Productivityis the ratio of output of a process to the input Quantity of Output Productivity = [3.1] Quantity of Input Productivity measures include units produced/labor hour, airline revenue per passenger mile, meals served/labor dollar.

20. 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.

21. Exhibit 3.2 Interlinking Internal and External Performance Measures

22. Linking Internal and External Performance Measures • Thevalue of a loyal customer (VLC)quantifies the total revenue or profit each target market customer generates over the buyer’s life cycle. • By multiplying the VLC times the absolute number of customers gained or lost, the total market value can be found.

23. 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. 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 buyer’s 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 buyer’s life cycle The value of a 1 percent change in market share = (100,000 customers)($31.25/customer) = $3,125,000

25. Solution (continued): If customer retention rate is 80 percent, the average customer defection rate is 0.2, and the average buyer’s 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.

26. 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?

27. Designing Measurement Systems in Operations Good performance measures are actionable. Actionable measuresprovide the basis for decisions at the level at which they are applied—the value chain, organization, process, department, workstation, job, and service encounter.

28. 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

29. Baldrige Performance Excellence Framework • Primary purpose of the program is to provide a framework for performance excellence through self-assessment to understand an organization’s 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.

30. Exhibit 3.3 Baldrige Performance Model of Organizational Performance Source: 2011-12 Baldrige Criteria for Performance Excellence, U.S. Depart. of Commerce

31. The Balanced Scorecard Model Purpose is to translate strategy into measures that uniquely communicate an organization’s vision. Four perspectives: • Financial—value to shareholders • Customer—customer satisfaction and market growth • Innovation and Learning—people and infrastructure • Internal—processes that drive the business

32. Exhibit 3.4 The Balanced Scorecard Performance Categories and Linkages Source: Kaplan R. S., and Norton, D. P., “The Balanced Scorecard—Measures That Drive Performance,”Harvard Business Review, January–February 1992, p. 72.

33. 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.

34. Exhibit 3.5 Examples of Value Chain Performance Measurements

35. 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.

36. 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.”

37. 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, March–April 1994, pp. 164-174.

38. IBMRochester – Service Profit Chain Example IBM’s 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, customer satisfaction, and market share.

39. BankUSA: Credit Card Division Case Study What are the major problems facing the credit card division? What steps are required to develop a good internal and external performance and information system? 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? Is the real service level what is measured internally or externally? Explain your reasoning. What are your final recommendations?