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In most organizations that I've worked with, I've encountered a large disconnect
between the world of operations and the world of finance.
Finance people wear a suit, they read the Wall Street Journal, and they deal with
very big numbers. Operations people look like me.
Sit with a stopwatch at the bottleneck trying to count the seconds that go by.
The disconnect that this creates is very unfortunate because operations people tend
to often be confused chasing so many performance measures.
And they forget that a productivity improvements, improvements along other
operational performance measures are not the goal in and by themselves.
For for-profit organization, the goal is to make money, not to increase
productivity. On the other hand, the finance folks often
struggle with the challenge of, how can they go about making their financials more
attractive? Even as a CEO, you don't show up to the
process on Monday morning, roll up the sleeves, and says, well, today I'm going
to improve my margins by ten%. Operational things are the things that are
actionable for management. For this reason, I would argue, that
understanding the operations remains at the heart of business.
Let's go back for our Subway restaurant analysis.
We had previously identified station two as the bottleneck, with a processing time
of 47 seconds per customer. Let's assume that our demand is 100
customers per hour, and that each customer orders $six worth of food.
Let's assume further that the purchasing cost of this foot, food, is $1.50 and that
we have four employees making $fifteen per hour.
Finally, let's assume that we have fixed costs of rent, franchise fee, marketing,
and overhead of roughly $250 per hour during peak times.
How much profits would we make? Let's start computing the top line.
For this, first of all, we need to compute our process capacity.
Since there are 3,600 seconds in the hour, we know that our capacity is driven by the
bottleneck and corresponds to 76 sandwiches or customers served.
Next, we know that the flow rate is the minimum between the demand and the
capacity. Not surprisingly, this tells us that we're
going to serve 76 customers per hour. If we multiply this with the money that
we're making per customer, we see that we are having an expected revenue of $459 per
hour. Now, the food costs are driving our cogs.
And so, the food costs are simply our flow rate multiplied with $1.50.
Our staffing, is simply the number of employees, times the weight trade.
And our fixed costs, are simply the $250. If you combine these numbers, we're going
to get our bottom line profit. In our case here, this is the $459 minus
the cogs minus the staffing minus $250 of fixed cost which gives us $34 for every
hour of peak volume. How did the profit numbers change as we
change some of the operational variables? First, consider changing the food cost.
Imagine, the very meaning of the word, that we could slice the salami more
thinly. We would get a saving of say, ten percent
in our food cost per customers. So instead of $1.50, we would reduce the
cost per order to a $1.35. We see the profits go up from $34 to $46.
An extra $twelve for roughly 33 percent relative to the base line.
Now, let's go back to this base line and evaluate the impact of productivity
improvement. In the same way, let's assume we can cut
the processing time that's a bottleneck by ten%.
This would go down from 47 seconds to 42.3 seconds.
The impact of profits is amazing. You'll notice that profits go up from $34
to over $72. This corresponds well over 100 percent
increase in profits just as a result of a ten percent productivity improvement.
Of course, the changes of the assumption that we have enough demand.
Operations at our demand constraint are not going to be able to materialize big
changes in profits through productivity improvements, unless we are able to lay
off workers. In constant, in contrast, if you
constrained by capacity, productivity improvements and the bottleneck make up
for real profit improvements. In this case, we see that every second
counts. Four seconds at the bottleneck means
doubling your profits. Understanding this connection between the
operational variables and the financial variables is key.
Every second counts. In this session, we saw the productivity
improvements in an operation can lead to very significant financial rewards.
However, not all seconds are created equal.
If you're improving the productivity of a non-bottleneck resource, or if you're
currently constrained by demand rather than by your capacity, productivity
improvements might translate into small labor cost reductions, but they will not
have the big rewards that we saw in the Subway case.
Such big rewards tend to happen primarily in organizations such as high fix cost.
High fix cost operations tend to have lower marginal cost.
And so, every unit of flow, every extra customer that you serve, their revenue
will go directly into the bottom line. Finding out what areas in an operations
will lead you to the biggest financial rewards is a key skill that we will
continue to work on in this module.