Targeting Improvement Module

§ Key Operational Metrics: Time T, Inventory I, Throughput rate R

q Link through Little’s Law
§ Link Operational Metrics to Financial Metrics
§ Levers for Improvement
q Firm & Divisional Level: MBPF Inc.
q Mkt-Ops: Armadio da Sorella (AdS)

Process Analysis & Improvement © Van Mieghem

What is an improvement? (What is Operational Excellence?)
1. If it improves the alignment between strategy and
operating systems
= improved link between strategy and operations

2. If it brings us closer to the frontier

= competitive perspective

3. If it improves value creation

= improved link between financials and operations

Process Analysis & Improvement © Van Mieghem

Operational Key Performance Indicators
§ Throughput = flow rate R
§ Inventory I
§ Flow time T
§ Process Cost (“Operational Expense”)
§ Quality

flow rate R
Inventory I

Flow time T
Process Analysis & Improvement © Van Mieghem
What is Toyota doing now?

Taiichi Ohno’s answer was very simple:

“All we are doing is looking at the time line from the moment the
customer gives us an order to the point when we collect the cash. And
we are reducing that time line by removing the non-value-added
wastes.”
Simple but brilliant.

(Taiichi Ohno. Toyota Production System: Beyond Large-Scale Production. p. ix.)

Process Analysis & Improvement © Van Mieghem

How reduce flow time?
There are only two available levers

Process Analysis & Improvement © Van Mieghem

Takt Time “The rhythm of the
conductor to keep the
is super important orchestra in time”
metronome
§ Takt time = the time between successive departures
– the pace at which customers demand product
– and the production pace (”cycle time”) to stay synchronized with demand

§ How identify takt time?

– Observe the process output and measure time between successive departures!
q Use a (mobile phone) timer: "Tesla speed" at Shanghai gigafactory

– Calculate it (next slide)

Process Analysis & Improvement © Van Mieghem

Takt Time “The rhythm of the
conductor to keep the
is super important orchestra in time”
metronome
§ Takt time = the time between successive departures
– the pace at which customers demand product
– and the production pace to stay synchronized with demand

§ For continuous operation: Takt time = 1 / throughput

– Demand = 30 sandwiches per hour
– Takt = 1 / (30 sandwiches per hour) = 0.033 hr/sandwich = 2 min / sandwich

Total available operating time

§ Otherwise, and in general, Takt time =
– Demand = 150,000 cars per year Customer demand
– Total available production time = 2 x 8 hrs/day x 250 days/yr = 4,000 hrs/year
– Takt = 4,000 hrs/150,000 cars = 1hr/37.5 cars = 96 sec / car

§ What does Little’s Law say about takt time?

Process Analysis & Improvement © Van Mieghem

Linking operational measures:
Little’s Law

Flow rate = Throughput R

Inventory I [units/hr]
... ... ... [units] ... ...

Flow Time T [hrs]

§ Inventory = Throughput x Flow Time

I = RxT

§ Inventory Turnover = Throughput / Inventory

= 1/ T

Process Analysis & Improvement © Van Mieghem

Things to remember…

Throughput R is a rate, e.g. 1000 units/week.

– Requires both physical units and time units.

I, R, & T are all long run averages.

The unit of time in T and R must be consistent.

• if R is units/week then T is in weeks

The process must be stable (i.e., in steady state).

• What goes in, must go out.

Process Analysis & Improvement © Van Mieghem

Little Today
Facebook facts:
Avg daily active users: 1.23 billion
Avg time spent per day = 21min

Question:
# Eye ball pairs = ?

Process Analysis & Improvement © Van Mieghem

A Process Example using Little’s Law at each process step
25% quit

4 patients/hr
75% Doctor
Patient Initial doctor requests Nurse takes
checks in consultation tests for tests
Wait patient Wait

5 min 2 patients 12 min 5 min 1 patient 30 min

https://youtu.be/pfC6hivsUH0
Process Analysis & Improvement © Van Mieghem
Your Body as an Inventory

Inventory dynamics (rate) =

Inflow rate – Outflow rate

Stability:
Inflow rate = Outflow rate = Throughput
Process Analysis & Improvement © Van Mieghem
 Targeting Improvement Module
§ Key Operational Metrics: Time T, Inventory I, Throughput rate R
q Link through Little’s Law

Ø Link Operational Metrics to Financial Metrics

Process Analysis & Improvement © Van Mieghem

The business imperative: economic value creation

Improvement levers
Price 1. Increase price
Revenues x 2. Increase throughput
Quantity

Profit - Material
+
Labor
Costs + 3. Reduce costs
Economic Energy 4. Improve quality
value added - +
(EVA) Overhead
PP&E
Capital + 5. Reduce capital intensity
Inventory
invested 6. Reduce inventory
+
Opportunity x Other
cost
Weighted average Reduce time
cost of capital

Financial metrics Operational metrics

Process Analysis & Improvement © Van Mieghem

Days of Inventory (& Inventory Turns) in Retailing and Its Link to
Inventory Costs
(in millions) Home Depot Home Depot Wal-Mart Wal-Mart
(1/30/2011) (1/29/2020) (1/31/2011) (1/31/2020)
Net Sales $67,997 $110,225 $418,952 $523,964
Cost of sales $44,693 $72,653 $315,287 $394,605
Net Income $ 3,338 $11,242 $ 15,355 $14,881
Inventories $10,625 $14,531 $ 36,318 $44,435
Months of
Inventory
If Wal-Mart carried the same months of inventory as Home Depot,
its inventories would be
I=

This would tie up about $ billion extra in inventory.

Process Analysis & Improvement © Van Mieghem
Days of Inventory: trends in consumer electronics

Process Analysis & Improvement © Van Mieghem

Cash-to-Cash Cycle
Inventory

Accounts Accounts
Payable Receivable

Cash
Cash Conversion Cycle
Measures duration between purchase of inventory and collection of
accounts receivable:

Cash Conversion Cycle=

Days of Inventory
+ Days of Receivables
- Days of Payables

How long does it take between outlay of cash and collecting the reward?
Process Analysis & Improvement © Van Mieghem
Industry Progress 2000-2012:
Cash-to-Cash and Inventory Turns

Process Analysis & Improvement © Van Mieghem

MBPF Inc.: Consolidated Annual Statements (in millions)
Income Balance Sheet

Net Sales $250.00 CURRENT ASSETS

Cash 2.1
Costs and expenses Short-term investments at cost (approximate mkt.) 3
Cost of Goods Sold 175.8 Receivables, less allowances of $0.7 mil 27.9
Selling, general and administrative
expenses 47.2 Inventories 50.6
Interest expense 4 Other current assets 4.1
Depreciation 5.6 TOTAL CURRENT ASSETS 87.7
Other (income) expenses 2.1 PROPERTY, PLANT AND EQUIPMENT (at cost)
TOTAL COSTS AND EXPENSES 234.7 Land 2.1
Buildings 15.3
INCOME BEFORE INCOME TAXES 15.3 Machinery and equipment 50.1
PROVISION FOR INCOME TAXES 7 Construction in progress 6.7
NET INCOME 8.3 Less accumulated depreciation -25
TOTAL PP&E 49.2
TOTAL ASSETS 146.9
(Selected) CURRENT LIABILITIES

Payables 11.9

Process Analysis & Improvement © Van Mieghem

MBPF Inc.: Detailed Inventory and Cost of Goods

INVENTORY
Raw materials (roof) 6.5
Fabrication WIP (roof) 15.1
Purchased parts (base) 8.6
Assembly WIP 10.6
Finished goods 9.8
TOTAL 50.6

COST OF GOODS SOLD

Raw materials 50.1
Fabrication (L&OH) 60.2
Purchased parts 90.3/yr
40.2
Assembly(L&OH) 25.3 Purchasing
TOTAL 175.8 throughput

Process Analysis & Improvement © Van Mieghem

Business Process Flows at MBPF, Inc:
Cash to Cash cycle
§ C2C = - Days payable + Days of inventory + Days receivables

Days Payables Days of Inventory Days Receivables

T = I/R

Process Analysis & Improvement © Van Mieghem

Business Process Flows at MBPF, Inc:
Cash to Cash cycle
§ C2C = - Days payable + Days of inventory + Days receivables

Days Payables Days of Inventory Days Receivables

I $11.9 $50.6 $27.9 Asset

= balance sheet

T = I/R

Process Analysis & Improvement © Van Mieghem

Business Process Flows at MBPF, Inc:
Cash to Cash cycle
§ C2C = - Days payable + Days of inventory + Days receivables

Days Payables Days of Inventory Days Receivables

I $11.9 $50.6 $27.9 Asset

= balance sheet
Revenue dollars
R $90.3/yr $175.8/yr $250/yr Flow
= income statement
Cost dollars
T = I/R

Process Analysis & Improvement © Van Mieghem

Business Process Flows at MBPF, Inc:
Cash to Cash cycle
§ C2C = - Days payable + Days of inventory + Days receivables

Days Payables Days of Inventory Days Receivables

I $11.9 $50.6 $27.9 Asset

= balance sheet
Revenue dollars
R $90.3/yr $175.8/yr $250/yr Flow
= income statement
Cost dollars
T = I/R 0.13yr x 52wk/yr 0.29yr x 52wk/yr 0.11yr x 52
= 6.8 weeks = 15.0 weeks = 5.8 weeks

§ C2C = -6.8 +15 + 5.8 = 14 weeks

Process Analysis & Improvement © Van Mieghem

Amazon
Income Statement (in millions) Balance Sheet (in millions)
Quarterly (10-Q statement) Mar 31, 2020 Period Ending Mar 31, 2020

Net product sales $41,841

Cash And Cash
$27,201
Net service sales (AWS = $10,219) 33,611 Equivalents
Total Net sales 75,452 Short Term Investments 22,091

Net Receivables 17,836

Operating Expenses Inventory 18,857
Total Current Assets
Cost of sales 44,257
Fulfillment 11,531 Property Plant and Equipment 77,779

Marketing 4,828 Goodwill 14,739

Operating leases 26,279
Technology & content 9,325
Other Assets 16,456
General and Administrative + other 1,522 Total Assets 221,238

Total operating expenses (AWS = $7,144) 71,463 Accounts Payable 40,056

Total Current Liabilities 79,711
Operating Income (Loss) $3,989
Total Stockholder Equity 65,272
Net Income $2,535 Total Liabilities + SE 221,238

Process Analysis & Improvement © Van Mieghem

Amazon:
Cash to Cash cycle
§ C2C = - Days payable + Days of inventory + Days receivables

Days Payables Days of Inventory Days Receivables

T = I/R

Process Analysis & Improvement © Van Mieghem

Amazon:
Cash to Cash cycle
§ C2C = - Days payable + Days of inventory + Days receivables

Days Payables Days of Inventory Days Receivables

I $40,056 $18,857 $17,836

R $44,257 (assuming $44,257 (may include $75,452

minimal processing some cost of media
so COGS almost & services, so true
equal to purchasing) DOI is higher)

T = I/R = 0.90 quarter x = 0.42 quarter x = 0.23 quarter x

(365/4) = 82.6 days 365/4 = 38.9 days 365/4 = 21.6 days

§ C2C = - 82.6 + 38.9 + 21.6 = -22.1 days

Process Analysis & Improvement © Van Mieghem
MBPF Inc.: Detailed Financial Flows

$60.2/yr $25.3/yr
Labor & OH Labor & OH

$50.1/yr $110.3/yr
$6.5 $15.1
Raw Materials Fabrication
(roofs) (roofs) $175.8/yr $175.8/yr
$10.6 $9.8

$40.2/yr Assembly Finished Goods

$8.6
$40.2/yr
Purchased Parts (bases)

Process Analysis & Improvement © Van Mieghem

MBPF Inc.: Apply Little’s law > Detailed Flow Times

Raw Fabrication Purchased Assembly Finished

Materials Parts Goods
Throughput R
$/Year 50.1 110.3 40.2 175.8 175.8
$/Week 0.96 2.12 0.77 3.38 3.38
Inventory I ($) 6.5 15.1 8.6 10.6 9.8
Flow Time T = 6.75 7.12 11.12 3.14 2.90
I/R (weeks)

Process Analysis & Improvement © Van Mieghem

Where target improvement?

Flow rate R
($/week)

5.0

3.38
Accounts
Receivable

Assembly
2.12
Finished
Goods
0.96 Fabrication
Raw Materials
0.77 Purchased Parts
11.12 6.75 7.12 3.14 2.90 5.80
Flow Time T
(weeks)
Process Analysis & Improvement © Van Mieghem
 Handouts to be distributed in class

Case: Armadio da Sorella (AdS)

Linking Financial and Operational Flows

&
Targeting Areas for Improvement

Process Analysis & Improvement Slide 34 © Van Mieghem

AdS flow chart

CAT-DDC
Return Off-Rental
Spotter
Shipping Processing 30%
70%
Waiting to
CAT-RDC 15% Ship to 3PV

Rented to Deep
Customer CAT-R Cleaning Dry Cleaning/
Repair @ 3PV

CAT-3PV
Outbound
Pick/Pack Inspection
Shipping
CAT-C CAT-O CAT-I
Process Analysis & Improvement © Van Mieghem
 LAST YEAR
Revenue and cost drivers
Flow unit is 1 order of 1 item: Step 1 = compute flow rates

€3.75/unit
R3 = CAT-DDC
Return 8,000/wk Off-Rental 2,400/wk
Spotter
Shipping Processing 30%
70% 5,600/wk
R = 8,000/wk Waiting to
CAT-RDC 15% Ship to 3PV
R2 = 840/wk

Rented to CAT-R Deep

Customer €9.50/week Cleaning Dry Cleaning/
Repair @ 3PV
€2/unit
R1 = 4,760/wk

CAT-3PV
Outbound
Shipping
Pick/Pack Inspection
€3.75/unit CAT-C CAT-O €8.50/unit CAT-I
Process Analysis & Improvement © Van Mieghem
 LAST YEAR
Revenue and cost drivers
Flow unit is 1 order of 1 item Step 1 = compute flow rates

€3.75/unit
R3 = CAT-DDC
Return R = 8,000/wk Off-Rental 2,400/wk 3,240/wk
Spotter
Shipping Processing 30%
70% 5,600/wk
R = 8,000/wk Waiting to
CAT-RDC 15% Ship to 3PV
R2 = 840/wk

Rented to CAT-R Deep

Customer €9.50/week Cleaning Dry Cleaning/
Repair @ 3PV
€2/unit
R1 = 4,760/wk

8,000/wk CAT-3PV
Outbound 3,240/wk
Shipping
Pick/Pack Inspection
€3.75/unit CAT-C CAT-O €8.50/unit CAT-I
Process Analysis & Improvement © Van Mieghem
 LAST YEAR
Revenue and cost drivers
Flow unit is 1 order of 1 item Step 2 = add given flow times and inventories

€3.75/unit
R3 = CAT-DDC
Return R = 8,000/wk Off-Rental 2,400/wk 3,240/wk
Spotter
Shipping 4000 Processing 30% 1000
70% 5,600/wk
R = 8,000/wk Waiting to
CAT-RDC 2000 15% Ship to 3PV
1000
R2 = 840/wk

CAT-R Deep
Rented to Cleaning Dry Cleaning/
4wk €9.50/week
Customer Repair @ 3PV 0.5wk
€2/unit
R1 = 4,760/wk

8,000/wk CAT-3PV
Outbound 3,240/wk
Shipping
Pick/Pack Inspection
800
€3.75/unit CAT-C CAT-O €8.50/unit CAT-I
1wk
Process Analysis & Improvement © Van Mieghem
 LAST YEAR
Revenue and cost drivers
Flow unit is 1 order of 1 item Step 3 = solve for remaining operational metric using LL

€3.75/unit
R3 = CAT-DDC
Return R = 8,000/wk Off-Rental 2,400/wk 3,240/wk
Spotter
Shipping 4000 Processing 30% 1000
70% 5,600/wk
R = 8,000/wk Waiting to
CAT-RDC 2000 15% Ship to 3PV
1000
R2 = 840/wk
Rented to
CAT-R Deep
4wk Customer Cleaning Dry Cleaning/
€9.50/week 0.5wk
I=? Repair @ 3PV
€2/unit
I=?
R1 = 4,760/wk

8,000/wk CAT-3PV
Outbound 3,240/wk
Shipping
Pick/Pack Inspection
I=? 800
€3.75/unit CAT-C CAT-O €8.50/unit CAT-I
1wk
Process Analysis & Improvement © Van Mieghem
We can put this in an Excel table LAST YEAR
Demand = 8,000 orders/week; Average rental = 4 weeks

CAT-3PV
CAT-3PV
CAT-R ORP CAT-RDC CAT-DDC Waiting to CAT-I CAT-O
with Vendor
ship
2400 +
Throughput
8,000 8,000 5600 0.15×5600 3240 3240 3240 8,000
(units/week)
= 3240
Inventory
4000 2000 1000 1000 800
(units)
Time
4 0.5 1
(weeks)

Process Analysis & Improvement © Van Mieghem

In Group:
1. Find 3 inventory unknowns
2. Find inventory utilization
3. Discuss in group: what happened when AdS adopted
the subscription model?
– Advanced: How many operational KPIs do we need
to track on our dashboard to predict profit?

Process Analysis & Improvement © Van Mieghem