Matching Supply with Demand: An Introduction to Operations Management Gérard Cachon ChristianTerwiesch All slides in this file are copyrighted by Gerard Cachon and Christian Terwiesch. Any instructor that adopts Matching Supply with Demand: An Introduction to Operations Management as a required text for their course is free to use and modify these slides as desired. All others must obtain explicit written permission from the authors to use these slides.

The Process View

Examples of processes Factory University wood guitars metal students alumni Distribution center bulk items small parcels approved loans Calculate credit risk mortgage applications rejected loans Processes can involve both goods and services. Processes can have multiple inputs and/or multiple outputs.

Defining a process’ scope A process is a set of activities that accepts inputs and produces outputs. A process can be defined at an aggregate level: A process can be defined at a micro level, with multiple sub-processes: approved loans Calculate credit risk mortgage applications rejected loans Collect data from client Evaluate loan metrics approved loans mortgage applications rejected loans Underwriting decision Communicate decision to sales

Defining a process’ flow unit The flow unit is what is tracked through the process and generally defines the process output of interest. Processes Flow unit University students alumni A person Processing plant milk milk powder Lbs of milk powder Blood donation center people blood Pints of type AB blood

Metrics of process analysis I = Inventory = how many flow units are in the process R = Flow Rate = rate at which flow units enter or leave the process T = Flow Time = total time a flow unit is in the process Little’s Law: For example: Inventory = Flow Rate x Flow Time or I = R x T incoming calls Call center completed calls R = On average 11 callers per minute T = On average a caller spends 2.5 minutes with the call center I = Average number of callers on the phone with the call center = R x T = 11 x 2.5 = 27.5 callers

A Little’s Law application: In-transit inventory O’Neill, based in California (CA), buys wetsuits from a supplier in Thailand: Each month they order on-average 15,000 wetsuits, R = 15,000 Shipping between Thailand and CA takes on-average 2 months, T = 2 I = R x T = 15,000 x 2 = 30,000 units are in-transit on average I = 30,000 wetsuits R = 15000/month R = 15000/month T = 2 months

Four different ways to count inventory In terms of flow units (The “ I ” in I = R x T): Number of wetsuits, patients, tons of wheat, semiconductor chips, etc. Useful when the focus is on one particular flow unit. In terms of $s (The “ I ” in I = R x T): The $ value of inventory This is an intuitive measure of a firm’s total inventory. In terms of days-of-supply: The average number of days a unit spends in the system. Also, the number of days inventory would last at the average flow rate if no replenishments arrive. In terms of turns: The number of times the average amount of inventory exits the system.

Days-of-supply calculations Days-of-supply is the “T ” in I = R x T Days-of-supply = I / R = Inventory / Average daily flow rate Can also be measured in different time lengths (Keep units consistent): Weeks-of-supply = Inventory / Average weekly flow rate Months-of-supply = Inventory / Average monthly flow rate Years-of-supply = Inventory / Average yearly flow rate Our O’Neill example: T = 2 months-of-supply R = 15000/month I = 30,000 wetsuits

Inventory turns calculations Inventory Turns = 1 / T = R / I Different measures of turns: Yearly turns = Average annual flow rate / Inventory Monthly turns = Average monthly flow rate / Inventory Weekly turns = Average weekly flow rate / Inventory Daily turns = Average daily flow rate / Inventory Keep units consistent! O’Neill’s annual turns: R = 15000 x 12 = 180,000 per year I = 30,000 T = 2 months = 1/6 year Annual Turns = R / I = 180,000 / 30,000 = 6 Annual Turns = 1/T = 1 / (1/6) = 6

Turns and days-of-supply at Walmart in 2010* * All figures in $Million from 2010 balance sheet and income statement R = COGS = $304,657 I = Inventory = $33,160 COGS = Cost of Goods Sold = Flow Rate The Flow Rate is not Sales (which was $405,046) because inventory is measured in the cost to purchase goods, not in the sales revenue that may be earned from the goods. Note: Some companies use the term “Cost of sales” to mean COGS Annual turns = $304,657 / $33,160 = 9.19 Days-of-supply = $33,160 / ($304,657 / 365) = 39.7

Walmart’s turns change from year to year Days-of-supply (red squares) Annual turns (blue diamonds)

Little’s law: It’s more powerful than you think... What it is: Inventory (I) = Flow Rate (R) * Flow Time (T) How to remember it: - units Implications: Out of the three fundamental performance measures (I,R,T), two can be chosen by management, the other is GIVEN by nature Hold throughput constant: Reducing inventory = reducing flow time Given two of the three measures, you can solve for the third: Indirect measurement of flow rate: Indirect measurement of inventory: Indirect measurement of flow time Inventory: 500 vehicles Flow Time: 30 days on the lot Flow Time: 6 hours Flow Rate: 200 patients per day Flow Rate: 5000kg/week Inventory: 2500kg

Inventory Turns Cost of Goods sold: 20,000 mill $/year Computed as: Based on Little’s law Careful to use COGS, not revenues Cost of Goods sold: 20,000 mill $/year Inventory: 391 mill $ Inventory turns= Inventory Turns at Dell Cost of Goods sold: 25,263 mill $/year Inventory: 2,003 mill $

Inventory Turns in Retailing and Its Link to Inventory Costs Inventory Cost Calculation Compute per unit inventory costs as: Per unit Inventory costs= Example: Annual inventory costs=30% Inventory turns=6 Per unit Inventory costs= Source: Gaur, Fisher, Raman

Dell’s Cash Conversion Cycle Inventory Accounts Payable Accounts Receivable Cash Source: Randall, Public data Cash Conversion Cycle Measures duration between purchase of inventory and collection of accounts receivable: Cash Conversion Cycle= Inventory processing period (days) + Days to Collect Accounts receivable - Days to Pay Accounts Payable How long does it take between outlay of cash and collecting the reward?