In most organizations 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. They 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 your productivity improvements, improvements along other operational performance measures are not the goal in it by themselves. For a 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 10%. 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. Lets go back for our Subway restaurant analysis. We are previously at 95. Station two is the bottom line with the processing time of 47 seconds per customer. Let's assume that our demand is 100 customers per hour, and that each customer orders six dollars worth of food. Let's assume further that the purchasing cost of this food is $1.50 and that we have four employees making $15 per hour. Finally, let's assume that we have fixed costs in term of rent, franchise fee, marketing, and overhead of roughly $250 per hour during peak times. How much profits will 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 are 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 a $1.50. Our staffing is simply the number of employees times the weight trade. And fixed cost as simply, the $250. If you combine these numbers, we're going to get our bottom line profit. In our case here, this is $459 minus the cogs minus the staffing, minus $250, a fixed cost. That gives us $34 for every hour of peak volume. How do the profit number change as we change some of the operational variables? First consider a change in food cost. Imagine, in the very meaning of the word, that we could slice a salami more thinly. We would get a saving of, say, 10% in our food cost per customers, so instead of $1.50, we would reduce the cost per order to $1.35. We see the profits go up from $34 to $46. An extra $12 or roughly 33% relative to the baseline. Now lets go back to this baseline and evaluate the impact of productivity improvement. In the same way, lets assume where we can cut the processing time at the bottleneck by 10%. This would go down from 47 seconds to 42.3 seconds. The input of profits is amazing. You notice that profits go up from $34 to over $72. This corresponds to well over 100% increase in profit. Just as a result of a 10% productivity improvement. Of course this hinges on the assumption that we have enough demand. Operations and our demand constraints are not going to be able to materialize big changes in profits for productivity improvements unless they are able to lay off workers. In contrast if you're constrained by capacity, productivity improvements at 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 profit. Understanding this connection between the operational variables and the financial variables is key. Every second counts. In this session we saw that productivity improvement in an operation can lead to very significant financial rewards. However, not all seconds are created equal. If you are improving the productivity of a non-bottleneck resource, or if you are currently constrained by demand rather than by your capacity, productivity improvements might translate into small labor costs 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 that have high fixed costs. High fixed cost operations tend to have lower marginal costs 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.
