Operations Management
1.11 Transformation Process
All operations management and production systems involve transformation. The goal of the production/operations department is to transform the inputs (using labor, machines, and materials) into desired qualities of goods and services at the mini- mum cost. Alteration of materials and components adds value and changes them into goods and services that customers want to own. The raw materials and compo- nents before transformation could not be used—and therefore had no utility—for the customer. Service conversions have customer utility even if no transfer of goods takes place. The conversion may be a change of location or related to the customer’s state of well-being (e.g., visiting the doctor, the repairperson fixes the air conditioner on a hot summer day, or a rescue from a disaster area during a hurricane).
The manufacturing transformation of raw materials into finished goods is suc- cessful if customers are willing to pay more for the goods than it costs to make them including selling expenses and other general and administrative costs. Consider what has to be done to make a product. The raw materials for glass, steel, food, and paper have no utility without technological transformations. New processes are constantly being invented for improving the transformations and the products that can be obtained from them.
The same transformation rules apply to services. The conversion is successful if customers are willing to pay more for the services than it costs to provide them, including selling expenses and other general and administrative costs. To illustrate a service transformation, consider an information system in a bank. Depositing a check in a bank results in the electronic transfer of funds (ETF) from the paying account to the paid account, which is clearly an input–output transformation.
Another information transformation is to take raw data and turn it into averages and standard deviations. The latter is characteristic of the operations aspect of market research. As another service example, consider the transformation that is at the heart of the airline business—moving people from one place (input) to another (output) for profit. Other airline inputs are fuel, food, and the attention of the flight attendants.
Figure 1.5 represents a generalized input–output transformation model.
Generalized means that it is a standard form that could be applied to any system where conversions are taking place. Inputs are fed into the transformation box—
representing the process. The “process” often includes many subprocesses. If the process is to make a burger sandwich, then important subprocesses include cooking the hamburger and toasting the buns.
The inputs are combined by the process, resulting in the production of units of goods or the creation of types of services. The transformed units emerge from the facility (factory, office, etc.) at a given rate. Time needed to carry out the transfor- mation determines the production rate. The transformed inputs emerge as outputs to be sold or used beneficially. The transformation model depicts work being done.
This work involves the use of resources made up of people, materials, energy, and machines to achieve transformations.
Figure 1.6 illustrates an expanded version of the input–output transforma- tion model. There are many boxes now within the transformation grid. Each box represents operations that generate the product line, which can be goods or services. Productive P/OM systems have well-designed transformations.
Input Transformation Output
Input–output is the basic P/OM model Figure 1.5 Input–output transformation model.
Transformations are being accomplished when people are served chili at Wendy’s or when they give blood to the Red Cross, have their teeth cleaned by the dentist, or visit Disney World to be entertained. A travel agency will have secured the necessary reservations and tickets for the customer’s flight to Orlando, Florida, and for the hotel. The travel agent designs the trip and fits it to the customer’s specifications concerning dates and costs using reservation and other information systems to complete all necessary transactions. It is a sign of the times that an increasing number of customers are content to act as their own travel agent doing all the transactions on the Internet. The explanations for their willingness to do it yourself (DIY) are many, and travel agencies are adapting to the practices of Priceline, Expedia, etc. Whoever makes the arrangements, when the desired out- puts are fully specified, the transformations can be planned, along with the inputs, and the plan can be carried through to completion. The culmination of the trans- formation process constitutes the desired output—a visit with Mickey Mouse.
1.12 Costs and Revenues Associated with Input–Output (I/O) Models
Cost management is a key function associated with all aspects of P/OM. A major portion of the cost of goods or services originates with operations. Figure 1.7 is meant to illustrate how costs are related to input–output models. Controlling costs is of prime concern to all managers.
For the most part, costs are readily categorized into variable costs and fixed costs. Generally, costs are considered to be easily measured, although the treatment of overhead costs is subject to debate. Also, a variety of accounting methodologies exist. The differences between them are not trivial because they can impact P/OM decisions in significantly disparate ways. P/OM and accounting coexist in the same system, and they are interdependent when the measurement of costs interacts with P/OM decision-making. Quality, another key criteria associated with all aspects of P/OM, interacts with costs in a variety of ways, as do productivity, timeliness of delivery, and styles and sizes of products and services.
Employees Materials
Energy Machines
Factories Offices
Product line
Inputs Transformations Customers
Figure 1.6 Expanded input–output P/OM model.
1.12.1 Inputs Associated with Variable (or Direct) Costs
The input components of the transformation model that apply to an airline trans- portation process include fuel, food, crew pay, maintenance, and other costs.
Variable operating costs increase as there are more flights flown and more peo- ple flying. Variable costs are also called direct costs because they can be applied directly, without ambiguity, to each unit that is processed.
The same reasoning applies to a manufacturing example. The variable costs for the inputs include labor, energy, and all of the materials purchased from suppli- ers and used to make the product. Materials include raw materials, subassemblies, semi-finished materials, and components. The more finished the purchased materi- als, the less work that has to be done by the purchaser (i.e., less value can be added by the purchaser). Less value-adding generally translates into less profit.
1.12.2 Transformations Associated with Fixed (or Indirect) Costs
When Delta or American Airlines buys aircraft from Boeing or Airbus Industries, the airline increases its already substantial fixed cost investment in planes. Fixed costs are also called indirect costs because they are part of overhead and must be allocated to units of output by some formula. Often the charge per year—called depreciation—is calculated by dividing the cost of the investment by the number of years in the estimated lifetime of the investment. For example, a $30 million aircraft with a 15-year lifetime would generate $2 million of depreciation per year. This is called straight-line depreciation because the amount per year does not change.
Employees Materials
Energy Machines Factories
Offices
Product line
Revenues
Customers Information
flows Suppliers
Fixed costs Variable
costs
Transformations Customers Inputs
Figure 1.7 Input–output P/OM model cost and revenue structure.
There still remains the question of how to allocate a portion of the $2 mil- lion as an applicable charge for a particular passenger flying from Milan to New York on that aircraft. Determining the appropriate fixed costs to be charged to each job, unit made, or passenger mile flown is a joint responsibility of P/OM and accounting.
Delta and American airlines also have investments in maintenance facilities, airport terminals, and training and education systems, as well as in their workers and management. The payments that airlines make to support the operations of airports generally are fixed and not variable costs. Airports—like factories—are major fixed-cost facilities; treat them as fixed costs because the same expenses must be met no matter how many flights depart or arrive there. However, if part of the airport charges is based on the number of flights an airline makes, then both fixed and variable (input) costs must be considered.
1.12.3 Outputs Associated with Revenues and Profits
Passengers pay the airline for transportation. The number of passengers (units) that are transported (processed) by the airline is the output (sometimes called through- put to emphasize the output rate) of the system. It usually is measured by passenger miles flown system wide (or between two points) in a period of time. Throughput is managed to balance supply (seat capacity) and demand (for seats). The demand level for transportation between any two points is related to marketing factors, not the least of which is the price for a round-trip ticket.
All airlines do not charge the same amount for a round-trip ticket. By adjusting price, airlines often can affect the percent occupancy of their flights. Such market- ing decisions are part of the total system that affects operations. These marketing decisions typify the need for systems coordination to relate P/OM with the other functional areas within the framework of the transformation model. Southwest Airlines (SWA) has used efficient operations to maintain low costs. This allows them to charge low prices. This business model has made SWA uniquely profitable even though others have been trying to emulate SWA including Spirit which may have even fewer frills. JetBlue, Virgin America, and EasyJet (in Europe) are among other “low-cost airlines.”
DEPRECIATION
Dividing the total cost of an asset to reflect how much of that cost applies to each period of its useful life.
Finance with P/OM’s assistance must control how much overhead has to be paid even when no positive cash flow (revenue) is coming into the company.
The manufacturer can measure output in terms of the number of units of each kind of product it produces. Because there may be many varieties such as sizes and flavors, it is usual P/OM practice to aggregate the output into some common unit, such as standard units of toothpaste produced. Both forms of information would reflect the variability of demand, but the aggregate measure much less so than the detailed product reports. Depending on the demand levels, the marketing depart- ment could stimulate sales by dropping prices or raising prices to slow demand that is exceeding supply capabilities.
If lower prices are effective in generating new business, then the demand is said to be elastic to price. When there is price elasticity, operations must keep costs down so that the advantage of low prices can be obtained. Marketing ulti- mately controls the volume of business that production must process. Financial planning has determined the operating capacity for peak demand. This, in turn, translates back to the dollar amount of inputs that need to be purchased to meet demand.
The systems perspective is required to make sure that all participants are con- nected directly to the revenue-generating capacity of the I/O system. The informa- tion system helps to foster the process of keeping connected. Many kinds of data are regularly transmitted between participants. For example, information about what is selling—and what is in stock—leads to production scheduling decisions. It also leads to initiatives by the sales department. The levels of inventory are perpetually examined to make sure that no stock outages occur, and care is taken to keep track of what is in the finished goods inventory.