Little’s Law everywhere – even in the “body of Christ”

Little’s Law dictates the relationship between three performance metrics in a process, Inventory, Flow Rate and Flow Time:

Inventory = Flow Rate x Flow Time

If you know two of them, then you can calculate the third. It is hard to not be a Little’s Law junkie – seeing the application of Little’s Law everywhere.  Here is an application that you might not expect – the production of communion wafers. The New York Times published an article about a company in Rhode Island that makes a lot of communion wafers – about 1 billion per year. It comes with a short audio slide show which is reasonably interesting.

So what is the Little’s Law question from the article? Wafers are produced at the rate of 100 per second. They spend 15 minutes in a cooling tube. How many wafers does the cooling tube hold on average? Use Little’s Law! Inventory = 100 x 15 x 60 = 90,000, or enough for 360 Sundays at a medium sized church that serves 250 per service. (360 Sundays is almost 7 years.)

If Little’s Law isn’t your thing, then you can calculate out their process utilization. At 100 wafers per second, that is 100 x 60 x 60 x 24 x 365 = 3.2 billion wafers per year.  They only sell about 1 billion per year, so their process utilization is about 1 b / 3.2 b  = 31%

New York Times, December 24, 2008: http://www.nytimes.com/2008/12/25/business/smallbusiness/25sbiz.html?pagewanted=2&partner=rss

Is JIT dragging us down?

We all know these are tough economic times, but do we know why the economy is struggling so mightily? One theory is that JIT (and other lean manufacturing practices) are to blame. See, for example,

http://jamesfallows.theatlantic.com/archives/2008/12/pensee_dept_followup_on_the_no.php

The metaphor is simple, animals with stored fat are more likely to survive in times of scarcity than thin animals.  Alternatively, think of a group of hikers on a glacier. JIT means they all tied together with very short ropes so when one falls, they all fall in quick succession.  Are these metaphors correct? Is lean manufacturing the cause of our woes? There is reason to believe it is in fact the scapegoat.

Consider the auto industry and GM in particular.  Their demand is now much lower than their capacity.  (Actually, it has been for a long time, just now there is a very large discrepancy.) If they maintain production at their capacity, then their inventory continues to build, converting cash into inventory. This can work for a little while but eventually you run out of cash, risking bankruptcy.  This is the problem they currently have.  The alternative is to stop production, but then you pay your workers to do nothing, so you still burn through cash but then have no product to show for it. This is very costly – in theory, inventory can eventually be converted into some revenue.  

Now consider the role of lean production in this mess. If you turn back time to one year ago, had GM been less lean, then they would have had less cash and more inventory.  Consequently, they would have had less of a buffer to weather the current storm, so their problems would have hit earlier or would have been more severe.  If they had been even leaner, then they would have had less inventory at that time and more cash, thereby giving them a bigger cushion to survive the downturn.  Based on this reasoning, their current problems are as bad as they are because they weren’t lean enough, not the other way around. 

It is possible to defend JIT in another way – if JIT were the problem, then we would expect the leanest of the auto manufacturers to be suffering the most.  Toyota and Honda are among the leanest, and they are suffering, but not by as much, which is again consistent with the notion that during this crisis, being lean is a help and not a hindrance. Maybe the better metaphor is the following.  Two people are thrown overboard a cruise ship and nobody notices, so they need to fend for themselves. They see an island in the distance and start to swim for safety.  Who is more likely to make it, the fit and lean person or the “master of the buffet” person?

Out of stock for Christmas

Believe it or not, there is actually a product out of stock this Holiday season – Amazon’s Kindle. Oprah announced that she loves her Kindle and sales have exceeded Amazon’s expectations. The forecast is that they will not be in stock until February.  The key question is how many unit sales will they lose because they are not available in the peak month of the year? Probably more than they want. Even if those sales are deferred to the next holiday season, it is a costly situation for the company.  Of course, there is no way to know if they are just the victim of bad luck (or too much good luck) or bad planning, but it does illustrate that challenges of meeting highly uncertain demand.

Wall Street Journal Dec 4, 2008 – Better Scratch That Kindle Off Your List

Lean manufacturing gone too far?

“5S” in the world of lean manufacturing stands for “sort”, “straighten”, “shine”, “standardize”, and “sustain”. While it is hard to argue with the success of lean manufacturing on the assembly line, how far should the concept be taken? For example, can an employee add a hook on a door to hang a sweater? According to some 5S proponents, the answer is “no” – it doesn’t contribute to “aesthetic uniformity”.  Put a box of papers on top of a file cabinet – another “no no”.  This raises the question of how far a employer should go to dictate how employees do their job. One might argue that the employer should care only about output and not about process. Another may argue that employees will not maximize output because they will not choose the right process.  It would be nice to see some data on whether application of 5S to office environments indeed yields improvement.

Wall Street Journal, October 27, 2008 – Neatness Counts at Kyocera and at others in the 5S Club

Aldi’s operational simplicity

Aldi, the German founded grocery chain,  is a fascinating retail concept.  Like the wholesale club stores (e.g., Costcos) they sell a limited number of different items within each category.  Unlike the wholesale club store, and like a convenience store, they sell through a small physical layout.  Consequently, not only do they have limited variety within each category, they have limited overall variety – a typical grocery store carries 45,000 different items whereas an Aldi carries about 1,300 different items.  And unlike grocery stores, Aldi prides itself on its no-frills approach to service - you have to bag your own groceries, you can’t pay with a credit card or check, items are displayed in the boxes they were shipped in, most items are private label and you have to rent a grocery cart.  So why are people shopping at Aldi – in a word, “price”. Aldi claims “its private-label products were 16 percent to 24 percent below those at discounters and big-box stores, and 40 percent less than those at traditional supermarkets.”  This strategy is very much akin to Southwest’s initial approach in the airline industry – offer a very specific service to customers, with absolutely no additional service, and charge them a noticeably lower price.  It can be argued that Southwest has drifted away from that strategy.  In the current economic climate, Aldi may have extra reason to stick to its approach.

Wall Street Journal, Sep 7, 2008 – The Allure of Plain Vanilla

When the chips are down, do not hold too many of them

Micron Technology reported a $344m loss for the fourth quater, in large part due to a $205m write-down of memory chip inventory.  They report that DRAM chips fell 5% in price from the third quarter and NAND chips fell 15% over the same period.  Those price-decline rates translate to about 19% and 48% on an annual basis.  Holding even an extra week of inventory in such a climate is very expensive!

Wall Street Journal, October 1, 2008 – Micron Post $344 Million Loss

Quality, Incentives and Healthcare

The opportunities for improved quality in healthcare are enormous.  Now, there is more incentive for the industry to take quality seriously – Medicare will stop paying for 10 conditions that it deems to be “reasonably preventable”.  For example, Medicare will no longer pay for the treatment of patients who received incompatible blood transfusions. No doubt, some of the techniques that have been used to improve quality on the factory floor will also be useful in the hospital – reporting defects so that attention can be focused on them, changing labels on sensitive medications so that additional care is given to them, asking all attending a surgery to count sponges and instruments to confirm that no unwanted objects have been left in the patient, etc. And, additional quality improvement techniques may be developed that are tailored just for healthcare.

New York Times, Sep 30, 2008: http://www.nytimes.com/2008/10/01/us/01mistakes.htm

Honda’s Flexible Plants Provide Edge

This has been a tough year for most auto makes :  so far this year sales are down 24% at Chrysler, 18% at GM, 15% at Ford and 7.8% at Toyota.  But U.S. sales at Honda are up 1.7%.  There are two reasons for Honda’s success. (1) Honda’s product mix depends less on SUVs and pickups than the others (i.e., fuel efficient models make up a larger portion of their portfolio). (2) Honda has some of the most flexible plants in the U.S. To illustrate that flexibility, Honda is able to switch from producing  Civics to CR-Vs with only 5 minutes of downtime!  Honda has achieved this flexibility through many different decisions.  For example, the Civic and CR-Vs were designed to be manufacturered in the same sequence of steps, so the same step (such as a door installation) can occur at the same location on the assembly line.  Honda did have to invest $400m several years ago to improve its flexibility.  That looks like a good investment in the current climate.  

Wall Street Journal, Sep 23, 2008 – Honda’s Flexible Plants Provide Edge

Prediction Markets and their Applications

Forecasting demand, especially for new products, has long been the weak spot for those of us interested in matching supply with demand. No matter the amount of market research a company does, forecasts are off target more frequently than we would like. While there exists a number of tools that support companies in planning for and absorbing this demand uncertainty (e.g. the Newsvendor model, models of risk pooling, reactive capacity), nothing solves this problem better than a good forecast.

Over the last decade, prediction markets have often been praised as the new way of creating demand forecasts. Prediction markets resemble betting on sports games: if you see that the betting return on $1 for one horse is $5 and on another horse is $50, you don’t need to be a jockey to figure out that the second horse is most likely a slower one. A fundamental advantage of a prediction market is that it implicitly puts a higher weight on those people’s opinion that have a stronger opinion. Ask 100 people how the weather will be tomorrow in Alaska. You could just take the average over the 100 forecasts that you get. But, chances are that many of the people you ask have little or no information about the weather in Alaska, while others are local experts. In a traditional forecasting approach, everyone is weighted equally. If, however, you ask people to place a bet about tomorrow’s weather in Alaska, you force them to “put their money to where their mouth is”. Those living in Florida, most likley, will not participate in this prediction market or place very small bets. In contrast, the meteoroligist living in Anchorage might be willing to bet a lot more. Since you, as the company who needs to forecast typically do not know who will have the best information for your forecasting problem, you should just let the (prediction) market decide.

Prediction markets have been used a lot for politics, including the US presidential elections (see e.g. http://iemweb.biz.uiowa.edu/graphs/graph_Pres08_WTA.cfm). However, as is discussed in a September 16 Wall Street Journal article, the number of corporate prediction markets is increasing. The article describes how Best Buy uses prediction markets to forecast the sales of new products and services. Every one of Best Buy’s 115,000 employees is allowed to participate. Yet, economic theory suggests that someone selling washing machines will be hesitant in placing bets on new lap-tops…

See WSJ, September 16: Best Buy Taps Prediction Market

Dell likely to shrink its network of factories

For years, Dell has been show-cased for its operational excellence. Because of its make-to-order production, the computer maker managed to work with very low inventory. And, because of its market power and close supply chain integration, it had an extremely short cash conversion cycle – in fact, for many of its products, Dell collected the money from its customers before paying its suppliers.

But, times are changing. In the computer industry, the make-to-order model works brilliantly for corporate customers who want their PCs built according to a very specific configuration. But the recent growth in the industry was fueled by consumers, who want cool notebook computers as part of their mobile lifestyle, most of them do not care if they run processor x123 or x124. In response to this change, Dell now sells a significant part of its computers through BestBuy and Wal-Mart.

However, if you purchase 500,000 computers to then ship them to Wal-Mart, the benefits of a flexible, US-based make-to-order production disappear. Cost is critical – customization is not. Hence, you might as well source the lap-tops in big batches from Taiwan.

Dell’s story reminds us that there exists no one-size-fits-all operation. As firms adjust their strategy in response to a changing world, the constantly have to rethink their operations. That’s what makes Operations Management interesting!

For more on Dell’s recent cost cutting, see: New York Times “Dell likely to shrink its network of factories” September 5, 2008