Understand and describe the concepts of value and profitability'

1
Learning Objectives

• Understand and describe the concepts of value and
  profitability.
• Understand and describe the effects operations
  management has on profitability measures.
• Describe Economic Value Added (EVA).
• Calculate the average level of inventory from a
  delivery pattern.
• Understand productivity measures for resources.
• Calculate utilization and efficiency.
• Explain the importance of customer relationships.
  
• Distinguish between local and global productivity
  measures.
• Identify conflicts between productivity measures.
  
• Describe how to improve productivity measures.
• Set up and complete a decision tree analysis.
• Describe the balanced scorecard approach.

2
The Link Between Value andInvestment Results

• Operations provides the means to accomplish
  financial goals.
• Financial return must be good enough, given other
  alternatives.
• Uncertainty comes from not knowing, in advance,
  how customers will value outputs (NPV).

3
Cost/Benefit Decisions

• When Examining alternatives, we need to consider
  our competitors actions.

Insert Exhibit 2.1
Exhibit 2.1 Realistic Cost/Benefit Decisions
4
Evaluating Progress Toward The Goal

• Net income
• Net Sales Cost of Goods sold Depreciation
  Interest - Taxes

Challenge of Net Income ? My business made
50,000 last year How did I do???

• Consider the amount invested to generate the
  profit
• If I used 10,000
• If I used 1,000,000
• If I used 10,000,000

5
Evaluating Profitability

• Profit Margin
• Income/salesProfit generated per dollar of sales.
• Low costs ? efficient use of operations resources
  in processes
• High sales ? high levels of value created by
  those processes

6
Evaluating Profitability

• Return on Assets (ROA)
• Net Income / Total Assets
• Profit per dollar of assets
• Efficient use of resources reduces asset needs
• Relevant because operations managers control so
  many valuable assets
• Return on Equity (ROE)
• Net Income / Total Equity
• Productivity of stockholder investment
• Less directly applicable to operations managers
  because ROA measures the assets themselves
• But ultimately how the company is judged by
  investors

7
Economic Value Added

• Economic Value Added (EVA)
• Operating profit minus cost of capital
• Not a ratio, but an absolute measure of the value
  created

• Book Example
• You use 3,000 to start your business.
• Cost of Capital is 8
• 3,000 8 240
• 240 is the opportunity cost of the resources
  you used.
• Profit gt 240 means you created economic value
• Profit lt 240 means you destroyed economic value

• EVA is increased by reducing cost or by selecting
  high return investments for the firm.

8
Profitability from Operations Resources

• Resource categories
• Inventory
• Workforce
• Capacity
• Facilities
• Customer relationships
• Productivity measures for resources are often
  like local profitability measures.

9
Inventory

• Products and components of products sold
• Average inventory level is basis for productivity
  measurement.
• Inventory turnover is most common productivity
  measure.

Exhibit 2.2 Daily orders vs Monthly Orders to
Meet 100 unit/Month Demand
10
Inventory

• Inventory turnover is the most common inventory
  productivity measure
• Inventory Turnover Net Sales /Average Inventory
• Average inventory level is basis for productivity
  measurement

Beginning Inv. Ending Inv. 2
11
Inventory

• Financial consequences of inventory turnover

• What is average level of inventory?
• What is average level of inventory if we change
  from weekly to daily delivery?

Example 2.1 Deliveries of 800 cases weekly
(assume all are consumed evenly during a five-day
week) Cases are valued at 265
Average investment in inventory Weekly
106,000 Daily 21,200 -------------------------
Difference 84,800
12
Capacity Equipment

• Capacity is the capability to produce output in a
  given amount of time.
• Utilization Comparison of time spent actually
  working against theoretical time available to
  work
• Actual running time/time available

13
Capacity Equipment

• Efficiency
• Efficiency is the comparison of what actually
  happened to what should have happened
• Actual output/ Standard output

Standard 5400/hour
14
Facilities

• Buildings used to house all aspects of a
  business.
• Expensive, long-term investments.
• Output per square foot of facilities is common
  productivity measure.

15
Workforce

• Often the greatest resource
• Often the most difficult resource to manage
• Productivity measurement depends on the objective
  and the behavior desired.

16
Local vs. Global Optima Productivity Tradeoffs

• It is not always possible to maximize
  productivity everywhere
• Tradeoffs are required.
• Example Inventory vs. Service Levels
• Service Level ? Percent of demand satisfied from
  stock

To increase service level, Inventory levels must
be increased.
Svc. Level
17
Measurement Improvement

• Two ways to increase productivity Increase
  output (numerator), decrease input (denominator),
  or both.
• For profitability, increase net income or
  decrease costs (or assets) or do both.

18
Decision Tree Analysis

• A Decision Tree is a useful tool for organizing
  decisions by identifying expected revenues
  associated with alternatives.
• They provide a very structured framework for a
  decision, so that all alternatives can be
  understood
• They enable the decision maker to quantify
  uncertainty
• They allow the decision maker to mix facts and
  predictions
• They provide the best outcome, given the
  available information

19
Decision Tree Analysis

• Decision Tree for a New Product Design Decision

Insert Exhibit 2.7
20
Decision Tree Analysis

• Example 2.5

Insert Exhibit 2.8
21
The Balanced Scorecard

• Measuring performance beyond financial measures.