1CHAPTER 1: Operations Management and Value Chains

1Operations Management and Value Chains

Apple has mastered the art of blending physical goods

with services to create value for its customers. Think

iPod + iTunes, iPhone/iPad + apps, Apple stores +

Genius Bar; well, you get the picture. Managing all oper-

ations involved—from the creation of goods and services

through their delivery to the customer and postsale

services—is one of Apple’s core competencies.

“Operations expertise is as big an asset for Apple as

product innovation or marketing,” says Mike Fawkes, the

former supply chain chief at Hewlett-Packard. “They’ve

taken operational excellence to a level never seen

before.”

Managers and engineers often work at global sup-

plier and manufacturer sites to refine their operations,

and designers work with suppliers to create new tooling

equipment. When the iPad 2 debuted, Apple employees

monitored every handoff point—suppliers, production,

loading dock, airport, truck depot, and distribution

center—to make sure each unit was accounted for and of

the highest quality.

Learning Objectives After studying this chapter, you should be able to:

1-1 Explain the concept and importance of operations management.

1-2 Describe what operations managers do.

1-3 Explain the differences between goods and services.

1-4 Define the concept of value and explain how the value of goods and services can be enhanced.

1-5 Describe a customer benefit package.

1-6 Explain the difference between value chains and supply chains, and identify three general types of processes in a business.

1-7 Contrast the three different frameworks for describing value chains.

1-8 Summarize the historical development of OM.

1-9 State the current and future key challenges facing OM.

Apple’s significant profit margins are in large part due to a focus on its global supply chain and operational excellence.

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2 PART OnE: Basic Concepts of OM and Value Chains

Apple’s retail stores give it a final operational advan-

tage. The company can track demand by the store and

by the hour, and adjust production forecasts daily. If it

becomes clear that a given part will run out, teams are

deployed and given approval to spend millions of dollars

on extra equipment to undo the bottleneck. Apple’s sig-

nificant profit margins are in large part due to this focus

on its global supply chain and operational excellence.1

What DO YOu th ink?

Cite some other examples in which digital content has been combined with a physical good. How does this change the way companies must manage their operations?

1-1 Operations Management Creating and delivering goods and services to customers depends on an effective system of linked facilities and processes, and the ability to manage them effectively around the world. Apple, for example, manages a large, global network of suppliers in countries such as Malaysia and Indonesia, and factories in the United States, China, and other countries to produce its physical goods, which must be coordinated with the develop- ment and production of software and other digital content, retail sales, and service and support. As the opening anecdote suggests, coordinating these goods-producing and service-providing processes can be challenging. Operations management (OM) is the science and art of ensuring that goods and services are created and delivered successfully to customers. OM includes the design of goods, services, and the processes that create them; the day- to-day management of those processes; and the continual improvement of these goods, services, and processes.

The way in which goods and services, and the processes that create and support them, are designed and managed can make the difference between a delightful or an unhappy customer experience. That is what OM is all about! Operations management is the only function by which managers can directly affect the value provided to all stakeholders— customers, employees, investors, and society (See the box, “What Do Operations Managers Do?”).

Why is OM important? To answer this, we might first ask the question: What makes a company successful? In 1887, William Cooper Procter, grandson of the founder of Procter & Gamble, told his employees, “The first job we have is to turn out quality merchandise that consumers will buy and keep on buying. If we produce it efficiently and economically, we will earn a profit, in which you will share.” Procter’s statement—which is still as relevant today as it was over 100 years ago—addresses three issues that are at the core of operations management: efficiency, cost, and quality. Efficiency (a measure of how well resources are used in creating outputs), the cost of operations, and the quality of the goods and services that create customer satisfaction all contribute to profitability and ultimately the long-run success of a company. A company cannot be successful without people who understand how these concepts relate to each other, which is the essence of OM, and who can apply OM principles effectively in making decisions.

Copyright 2021 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

3CHAPTER 1: Operations Management and Value Chains

1-2 OM in the Workplace Many people who are considered “operations managers” have titles such as chief operating officer, hotel or restaurant manager, vice president of manufacturing, customer service man- ager, plant manager, field service manager, or supply chain manager. The concepts and meth- ods of OM can be used in any job, regardless of the functional area of business or industry, to better create value for internal customers (within the organization) and for external customers (outside the organization). OM principles are used in accounting, human resources manage- ment, legal work, financial activities, marketing, environmental management, and every type of service activity. Thus, everyone should understand OM and be able to apply its tools and concepts. Following are some examples of how the authors’ former students (who were not OM majors!) are using OM in their jobs.

After graduating from college, Shelly Decker and her sister embarked on an entre- preneurial venture to manufacture and sell natural soaps and body products. Shelly was an accounting and information systems major in college, but she was using OM skills every day:

▶▶ Process design: When a new product was to be introduced, the best way to produce it had to be determined. This involved charting the detailed steps needed to make the product.

▶▶ Inventory management: Inventory was tightly controlled to keep cost down and to avoid production that wasn’t needed. Inventory was taken every four weeks and adjusted in the inventory management system accordingly.

What Do Operations Managers Do? Some key activities that operations managers perform include the following:

•  Forecasting: predict the future demand for raw materials, finished goods, and services.

•  Supply chain management: manage the flow of materials, information, people, and money from suppliers to customers.

•  Facility layout and design: determine the best configuration of machines, storage, offices, and departments to provide the highest levels of efficiency and customer satisfaction.

•  Technology selection: use technology to improve productivity and respond faster to customers.

•  Quality management: ensure that goods, services, and processes will meet customer expectations and requirements.

•  Purchasing: coordinate the acquisition of materials, supplies, and services.

•  Resource and capacity management: ensure that the right amount of resources (labor, equipment, materials, and information) is available when needed.

•  Process design: select the right equipment, information, and work methods to produce high-quality goods and services efficiently.

•  Job design: decide the best way to assign people to work tasks and job responsibilities.

•  Service encounter design: determine the best types of interactions between service providers and customers, and how to recover from service upsets.

•  Scheduling: determine when resources such as employees and equipment should be assigned to work.

•  Sustainability: decide the best way to manage the risks associated with products and operations to preserve resources for future generations.

Copyright 2021 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

4 PART OnE: Basic Concepts of OM and Value Chains

▶▶ Scheduling: Production schedules were created to ensure that enough product was available for both retail and wholesale customers, taking into account such factors as current inventory and soap production capacity.

▶▶ Quality management: Each product was inspected and had to conform to the high- est quality standards. If a product did not conform to standards (e.g., wrong color, improper packaging, improper labeling, improper weight, size, or shape), it was removed from inventory to determine where the process broke down and to initiate corrective action.

Without an understanding of OM, the company would never have gotten off the ground! Tom James started as a senior software developer for a small software development com-

pany that creates sales proposal automation software. Tom uses OM skills in dealing with quality and customer service issues related to the software products, and he is also extensively involved in project management activities related to the development process, including iden- tifying tasks, assigning developers to tasks, estimating the time and cost to complete projects, and studying the variance between the estimated and actual time it took to complete the project. He is also involved in continuous improvement projects; for example, he seeks to reduce development time and increase the efficiency of the development team. Tom was an information technology and management major in college.

United Performance Metals, formerly known as Ferguson Metals, located in Hamilton, Ohio, is a supplier of stainless steel and high-temperature alloys for the specialty metal market. The company’s primary production operations include slitting coil stock and cutting sheet steel to customer specifications with rapid turnaround times from order to delivery. With only 78 employees, about half of whom are in operations, the director of operations and quality is involved in a variety of daily activities that draw upon knowledge of not only OM and engineering, but also finance, accounting, organizational behavior, and other subjects. He typically spends about 50 percent of his time working with foremen, supervisors, salespeople, and other staff discussing such issues as whether or not the company has the capability to accomplish a specific customer request, as well as routine production, quality, and shipping issues. The remainder of his time is spent investigating such issues as the technical feasibility and cost implications of new capital equipment or changes to existing processes, trying to reduce costs, seeking and facilitating design improvements on the shop floor, and motivating the workforce. The ability to understand customer needs, motivate employees, work with other departments, and integrate processes and technology are skills that all operations managers need.

united Performance Metals: the Life of an Operations Manager

Coiled steel awaiting processing.

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Some of Ferguson’s finished products.

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5CHAPTER 1: Operations Management and Value Chains

Brooke Wilson began as a process manager for JPMorgan Chase in the credit card divi- sion. After several years of working as an operations analyst, he was promoted to a production supervisor position overseeing “plastic card production.” Among his OM-related activities are:

▶▶ Planning and budgeting: Representing the plastic card production area in all meet- ings, developing annual budgets and staffing plans, and watching technology that might affect the production of plastic credit cards.

▶▶ Inventory management: Overseeing the management of inventory for items such as plastic blank cards; inserts such as advertisements; envelopes, postage, and credit card rules and disclosure inserts.

▶▶ Scheduling and capacity: Daily to annual scheduling of all resources (equipment, peo- ple, and inventory) necessary to issue new credit cards and reissue cards that are up for renewal, replace old or damaged cards, as well as cards that are stolen.

▶▶ Quality: Embossing the card with accurate customer information and quickly getting the card in the hands of the customer.

Brooke was an accounting major in college.

1-3 Understanding Goods and Services Companies design, produce, and deliver a wide variety of goods and services that consumers purchase. A good is a physical product that you can see, touch, or possibly consume. Examples of goods include cell phones, appliances, food, flowers, soap, airplanes, furniture, coal, lumber, per- sonal computers, paper, and industrial machines. A durable good is one that does not quickly wear out and typically lasts at least three years. Vehicles, dishwashers, and furniture are some examples. A nondurable good is one that is no longer useful once it’s used, or lasts for less than three years. Examples are toothpaste, software, clothing and shoes, and food. Goods-producing firms are found in industries such as manufacturing, farming, forestry, mining, construction, and fishing.

A service is any primary or complementary activity that does not directly produce a physical product. Services represent the nongoods part of a transaction between a buyer (customer) and a seller (supplier).2 Service-providing firms are found in industries such as banking, lodging, education, health care, and government. The services they provide might be a mortgage loan, a comfort- able and safe place to sleep, a college degree, a medical procedure, or police and fire protection.

Designing and managing operations in a goods-producing firm is quite different from that in a service organization. Thus, it is important to understand the nature of goods and services, and particularly the differences between them.

Goods and services share many similarities. They are driven by customers and provide value and satisfaction to customers who purchase and use them. They can be standardized for the mass market or customized to individual needs. They are created and provided to cus- tomers by some type of process involving people and technology. Services that do not involve significant interaction with customers (e.g., credit card processing) can be managed much the same as goods in a factory, using proven principles of OM that have been refined over the years. Nevertheless, some very significant differences exist between goods and services that make the management of service-providing organizations different from goods-producing organizations and create different demands on the operations function.3

1. Goods are tangible, whereas services are intangible. Goods are consumed, but services are experienced. Goods-producing industries rely on machines and “hard technology” to perform work. Goods can be moved, stored, and repaired, and generally

Copyright 2021 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

6 PART OnE: Basic Concepts of OM and Value Chains

require physical skills and expertise during production. Customers can often try them before buying. Services, on the other hand, make more use of information systems and other “soft technology,” require strong behavioral skills, and are often difficult to describe and demonstrate. A senior executive of the Hilton Corporation stated, “We sell time. You can’t put a hotel room on the shelf.”4

2. Customers participate in many service processes, activities, and transactions. Many services require that the customer be present either physically, on a telephone, or online for service to commence. In addition, the customer and service provider often coproduce a service, meaning that they work together to create and simultane- ously consume the service, as would be the case between a bank teller and a customer to complete a financial transaction. The higher the customer participation, the more uncertainty the firm has with respect to service time, capacity, scheduling, quality per- formance, and operating cost.

A service encounter is an interaction between the customer and the service provider. Some examples of service encounters are making a hotel reservation, asking a grocery store employee where to find the pickles, or making a purchase on a website. Service

encounters consist of one or more moments of truth—any episodes, trans- actions, or experiences in which a customer comes into contact with any aspect of the delivery system, however remote, and thereby has an opportunity to form an impression.5 A moment of truth might be a gracious welcome by an employee at the hotel check-in counter, a grocery store employee who seems too impatient to help, or trying to navigate a confusing

website. Customers judge the value of a service and form perceptions through service encounters. Therefore, employees who interact directly with customers or design ser- vice processes need to understand the importance of service encounters.

3. The demand for services is more difficult to predict than the demand for goods. Customer arrival rates and demand patterns for such service delivery systems as banks, airlines, supermarkets, call centers, and courts are very difficult to forecast. The demand for services is time-dependent, especially over the short term (by hour or day). This places many pressures on service firm managers to adequately plan staffing levels and capacity.

4. Services cannot be stored as physical inventory. In goods-producing firms, inventory can be used to decouple customer demand from the production process or between stages of the production process and ensure constant availability despite fluc- tuations in demand. Service firms do not have physical inventory to absorb such fluc- tuations in demand. For service delivery systems, availability depends on the system’s capacity. For example, a hospital must have an adequate supply of beds for the purpose of meeting unanticipated patient demand, and a float pool of nurses when things get very busy. Once an airline seat, a hotel room, or an hour of a lawyer’s day are gone, there is no way to recapture the lost revenue.

5. Service management skills are paramount to a successful service encounter. Employees who interact with customers require service management skills such as knowledge and technical expertise (operations), cross-selling other products and services (marketing), and good human interaction skills (human resources). Service management integrates marketing, human resources, and operations functions to plan,

Customers judge the value of a service and form perceptions

through service encounters.

Copyright 2021 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

7CHAPTER 1: Operations Management and Value Chains

create, and deliver goods and services, and their associated service encounters. OM principles are useful in designing service encounters and supporting marketing objectives.

6. Service facilities typically need to be in close proximity to the customer. When customers must physically interact with a service facility—for example, post offices, hotels, and branch banks—they must be in a location convenient to customers. A manufacturing facility, on the other hand, can be located on the other side of the globe, as long as goods are delivered to customers in a timely fashion. In today’s Internet age, many services are only a few mouse clicks away.

7. Patents do not protect services. A patent on a physical good or software code can provide protection from competitors. The intangible nature of a service makes it more difficult to keep a competitor from copying a business concept, facility layout, or ser- vice encounter design. For example, restaurant chains are quick to copy new menu items or drive-through concepts.

These differences between goods and services have important implications to all areas of an organization, and especially to operations. These are summarized in Exhibit 1.1. Some are obvious, whereas others are more subtle. By understanding them, organizations can better select the appropriate mix of goods and services to meet customer needs and create the most effective operating systems to produce and deliver those goods and services.

OM Activity Goods Services

Forecasting Forecasts involve longer-term time horizons. Goods- producing firms can use physical inventory as a buffer to mitigate forecast errors. Forecasts can be aggregated over larger time frames (e.g., months or weeks).

Forecast horizons generally are shorter, and forecasts are more variable and time-dependent. Forecasting must often be done on a daily or hourly basis, or sometimes even more frequently.

Facility Location Goods-producing facilities can be located close to raw materials, suppliers, labor, or customers/markets.

Service facilities must be located close to customers/mar- kets for convenience and speed of service.

Facility Layout and Design Factories and warehouses can be designed for efficiency because few, if any, customers are present.

The facility must be designed for good customer interac- tion and movement through the facility and its processes.

Technology Goods-producing facilities use various types of automa- tion to produce, package, and ship physical goods.

Service facilities tend to rely more on information-based hardware and software.

Quality Goods-producing firms can define clear, physical, and measurable quality standards and capture measurements using various physical devices.

Quality measurements must account for customer’s per- ception of service quality and often must be gathered through surveys or personal contact.

Inventory/Capacity Goods-producing firms use physical inventory such as raw materials and finished goods as a buffer for fluctuations in demand.

Service capacity such as equipment or employees is the substitute for physical inventory.

Process Design Because customers have no participation or involvement in goods-producing processes, the processes can be more mechanistic and controllable.

Customers usually participate extensively in service creation and delivery (sometimes called coproduction), requiring more flexibility and adaptation to special circumstances.

Job/Service Encounter Design Goods-producing employees require strong technical and production skills.

Service employees need more behavioral and service management skills.

Scheduling Scheduling revolves around the movement and location of materials, parts, and subassemblies and when to assign resources (i.e., employees, equipment) to accomplish the work most efficiently.

Scheduling focuses on when to assign employees and equipment (i.e., service capacity) to accomplish the work most efficiently without the benefit of physical inventory.

Supply Chain Management Goods-producing firms focus mainly on the physical flow of goods, often in a global network, with the goal of maxi- mizing customer satisfaction and profit, and minimizing delivery time, costs, and environmental impact.

Service-providing firms focus mainly on the flow of peo- ple, information, and services, often in a global network, with the goal of maximizing customer satisfaction and profit, and minimizing delivery time, costs, and environ- mental impact.

A similar classification of OM activities in terms of high/low customer contact was first proposed in the classic article by R. B. Chase, “Where Does the Customer Fit in a Service Operation?” (Harvard Business Review, november–December 1978, p. 139).

eXhibit 1.1 how goods and services affect Operations Management activit ies

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8 PART OnE: Basic Concepts of OM and Value Chains

1-4 The Concept of Value

Today’s consumers demand innovative products, high quality, quick response, impeccable service, and low prices; in short, they want value in every purchase or experience. One of the most important points that we emphasize in this book is that the underlying purpose of every organization is to provide value to its cus- tomers and stakeholders.

Value is the perception of the benefits associated with a good, service, or bundle of

goods and services in relation to what buyers are willing to pay for them. The decision to purchase a good or service or a customer benefit package is based on an assessment by the customer of the perceived benefits in relation to its price. The customer’s cumulative judgment of the perceived benefits leads to either satisfaction or dissatisfaction. One of the simplest functional form

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