JWI 550 Operations Management, week7 summary, 2/24/13
This week I learned what it takes to win with LEAN principles in
manufacturing as well as service firms. It all begins with the
specification of the goal by the customer, mapping the value stream
inside the firm, making value creating steps flow - fully leveraging the
DBR (Drum-Buffer-Rope) concept of TOC (Theory of Constraint), pushing innovative products through supply chain while
allowing customers to pull the supply chain for standard products, and
continuously driving change within the firm to get closer and closer to
perfection in terms of QCDTV (Quality, Cost, Delivery, Teamwork, client
value).
I enjoyed meshing the LEAN principles (Womack &
Jones, 2002) with Theory of Constraint approach in THE GOAL (Goldratt,
Cox, 2011). Together these concepts equip me with a powerful approach to
cut through "conflict clouds" in complex systems and find leverage
points to continuously improve productivity, throughput, Turn Around
Times, on-time-shipment and ultimately client satisfaction.
never really thought operations management can be so exciting...wow !
Dr DP
THE GOAL (Goldratt & Cox, 2012) is an excellent novel woven around
the five core principles of lean manufacturing (Womack & Jones,
2003) including:
1. Specify Value - THE GOAL
Externally:
The goal is to always begin with the customer definition of value
Use dedicated product teams in direct dialog with customers to detect shifting customer demand.
Internally:
The goal of the firm is to make money
Increase Throughput while simultaneously decreasing Inventory & Operating expense
Inspect for value at every step of production and align reward system
2. Identify entire Value stream
This is comprised of problem solving, information management and physical transformation
(i) Build systems to get "first time right"
(ii) Systematically eliminate non-value add activities in entire value stream
(iii)
Reduce waste: overproduction (doing more than necessary), waiting,
wasted transport (motion), inventory(excess parts through out the system
ie. fat), under utilized people (not leveraging people's unique
abilities and realizing people's full potential), defects, repair/rework
(iv) Continually reduce effort, time, cost & space requirements to minimize travel distance
(v) Get the team involved
- develop partnerships with suppliers & educate them about customer needs
- develop and empower employees to take action
3. Make value creating steps Flow
(i)
Identify the system's constraints ie bottlenecks to flow and use DBR
(Drum, Buffer, Rope) model to achieve global optimization
Make the entire factory march to the Drum beat of the bottleneck
Use a buffer before the bottleneck to ensure operation at full capacity
Release materials into the system at a rate no greater than that the bottleneck can handle
(ii) Decide how to exploit the bottleneck
-
make the most of the bottleneck; prioritize only critical work through
it; get support & off load work; run at full capacity
- beware of dependent events & statistical fluctuations
- use small batch sizes & JIT to eliminate inventory
(iii) Subordinate all else to the bottleneck
(iv) Elevate the importance of the bottleneck and give it enterprise-wide visibility- increase capacity; find a way to fill it
(v) Beware of new inertia settling in and causing a new bottleneck
4. Let customers Pull value from enterprise
Let customers pull the enterprise's supply chain for commodities and relatively standardized products.
Push innovative products to customers as customers may not yet know what they really need eg. innovative iphone.
5. Perfection
Be on guard to detect new bottlenecks, traveling bottlenecks
Key Questions to ask continually are:
(i) What to change ?
(ii) What to change to ?
(iii) How to cause the change ?
Vast
majority of lean principles described in THE GOAL and explained above
apply equally well to manufacturing and service firms. Beginning with
the customer's definition of value, for instance, is a golden rule for all
types of businesses. Firms that take their eyes off of the customer
spell their own doom sooner or later as IBM found out the hard way in
1993 when barreling towards a near-death experience.
The concept
of using a buffer to keep a bottleneck fully loaded is more applicable
in the manufacturing space. This I would consider as an example of a
difference between applications of lean principles in the manufacturing
and service industries.
References
http://www.toc-lean.com/Goal_Overview.htm
http://manufacturing-works.com/lean/eight_wastes.php
Sunday, February 24, 2013
Finance Tools to evaluate a project's worth - DCF, NPV, IRR, Hurdle rate
JWI 530, Financial Management I, week7 summary, 2/24/13
1. Evaluate if a project is worthy of investment
***************************************
Understand time value of money: estimate future value with projected cash flows, required rate of return, hurdle rate. To determine potential ROI for various project choices, use Discounted Cash Flow (DCF), Net Present Value (NPV), IRR.
DCF
****
The true value of a project is the sum of its discounted future cash flows.
DCF helps calculate the returns for an investment and how long it will take for getting the returns
NPV
****
NPV is a component of the DCF - it is another metric used to assess the profitability of a project
It is simply the difference between the present values of cash inflows and cash outflows of a project.
It is a type of discounted cash flow analysis, usually applied to a specific capital project, which involves an initial and immediate cash outflow
followed by a string of net cash inflows.
If NPV>0, then Rate of Return (RoR) >= hurdle rate => better off selecting the project
If NPV<0, then Rate of Return (RoR) < hurdle rate => better to reject the project
IRR
****
IRR is the discount rate that makes the project's NPV equal to zero.
If IRR >hurdle rate, accept the project
If IRR<hurdle rate, reject the project
2. How does discount rate influence the overall financial strategy of the organization?
**********************************************************************
Vision, Mission, Strategy, Structure, Process
***************************************************
After a firm has defined its vision and mission (with objectives and scope), planning for strategy, operations and finance begins.
A strategic plan provides clarity about the big a-ha (Welch, 2005) - a unique and differentiated competitive position in the marketplace,
and a vision of what the firm's top management expects (brigham, ehrhardt, 2011).
Financial plan
*****************
The financial plan is the fuel that propels the firm's strategy and typically involves five steps:
(1) forecast financial statements under alternative versions of the operating plan and sales projections
(2) determine the amount of capital needed to support the plan
(3) forecast funds that will be generated internally and funds to be raised through external financing
(4) establish performance based management compensation system
(5) monitor operations to spot deviations and take corrective actions
Risk
*****
Business risk is the variability in the projected earnings due to the inherent risks in carrying out the firm's operations.
Due to the risk involved for the financial investment, shareholders expect to be compensated with a high enough rate of return which is known as the discount rate.
3. Factors in choosing a discount rate
*******************************
Discount rate is also known as the risk premium or expected rate of return.
Discount rate is a trade-off between risks and returns. Higher the risk, higher the expected rate of return while risk averse investors will forego high risk projects.
Discount rate = Risk free rate + beta (equity market risk premium)
To choose the appropriate discount rate for projects, investors and financial managers would ask:
(1) how mature is the company that is seeking investment ? - is the leadership trust worthy and committed for long run ?
(2) what are the risks involved in the market, firm and the project ? - is the industry structure attractive to invest ?
(3) what are the expected rates of return ?
(4) does the rate of return compensate adequately for the risks ?
(5) what are the bounds - the worst case, nominal case and best case scenarios for projected cash flows ?
(6) How much risk is acceptable for the firm to take ? - how badly does the firm want to proceed with the project ?
(7) what is the opportunity cost of proceeding with the project or not proceeding with the project? (every project is only as good as its next best alternative)
Dr DP
1. Evaluate if a project is worthy of investment
***************************************
Understand time value of money: estimate future value with projected cash flows, required rate of return, hurdle rate. To determine potential ROI for various project choices, use Discounted Cash Flow (DCF), Net Present Value (NPV), IRR.
DCF
****
The true value of a project is the sum of its discounted future cash flows.
DCF helps calculate the returns for an investment and how long it will take for getting the returns
NPV
****
NPV is a component of the DCF - it is another metric used to assess the profitability of a project
It is simply the difference between the present values of cash inflows and cash outflows of a project.
It is a type of discounted cash flow analysis, usually applied to a specific capital project, which involves an initial and immediate cash outflow
followed by a string of net cash inflows.
If NPV>0, then Rate of Return (RoR) >= hurdle rate => better off selecting the project
If NPV<0, then Rate of Return (RoR) < hurdle rate => better to reject the project
IRR
****
IRR is the discount rate that makes the project's NPV equal to zero.
If IRR >hurdle rate, accept the project
If IRR<hurdle rate, reject the project
2. How does discount rate influence the overall financial strategy of the organization?
**********************************************************************
Vision, Mission, Strategy, Structure, Process
***************************************************
After a firm has defined its vision and mission (with objectives and scope), planning for strategy, operations and finance begins.
A strategic plan provides clarity about the big a-ha (Welch, 2005) - a unique and differentiated competitive position in the marketplace,
and a vision of what the firm's top management expects (brigham, ehrhardt, 2011).
Financial plan
*****************
The financial plan is the fuel that propels the firm's strategy and typically involves five steps:
(1) forecast financial statements under alternative versions of the operating plan and sales projections
(2) determine the amount of capital needed to support the plan
(3) forecast funds that will be generated internally and funds to be raised through external financing
(4) establish performance based management compensation system
(5) monitor operations to spot deviations and take corrective actions
Risk
*****
Business risk is the variability in the projected earnings due to the inherent risks in carrying out the firm's operations.
Due to the risk involved for the financial investment, shareholders expect to be compensated with a high enough rate of return which is known as the discount rate.
3. Factors in choosing a discount rate
*******************************
Discount rate is also known as the risk premium or expected rate of return.
Discount rate is a trade-off between risks and returns. Higher the risk, higher the expected rate of return while risk averse investors will forego high risk projects.
Discount rate = Risk free rate + beta (equity market risk premium)
To choose the appropriate discount rate for projects, investors and financial managers would ask:
(1) how mature is the company that is seeking investment ? - is the leadership trust worthy and committed for long run ?
(2) what are the risks involved in the market, firm and the project ? - is the industry structure attractive to invest ?
(3) what are the expected rates of return ?
(4) does the rate of return compensate adequately for the risks ?
(5) what are the bounds - the worst case, nominal case and best case scenarios for projected cash flows ?
(6) How much risk is acceptable for the firm to take ? - how badly does the firm want to proceed with the project ?
(7) what is the opportunity cost of proceeding with the project or not proceeding with the project? (every project is only as good as its next best alternative)
Dr DP
Sunday, February 17, 2013
Tools to manage financial health of firms - Capex, FCF, Operating Leverage, CCC
JWI 530 Financial Management I, week6 summary, 2/17/13
We learned about more concepts and tools to manage the financial health of a business: capex, free cash flow, operating leverage, difference between net income and free cash flow and the importance of cash conversion cycle.
I understand the importance of free cash flow and how it can mean the difference between life and death of a firm.
Dr DP
JWI 530 Operations Management, week6 summary
***********************************************************
1. To run a company efficiently, examine things from the perspective of
- cash a business is generating
- what it does with the cash
- costs involved with running and growing the business
2. Three metrics to track how cash physically moves through the business are:
(a) Capital Expenditures: long term investment a company makes in durable assets for generating future business and increasing profits eg, machinery, construction of new plant, land
(b) Free Cash Flow: how much discretionary money a firm has after paying costs needed to run the business
(c) Operating leverage: Ratio of fixed costs to variable costs (change in operating income/change in sales); higher the fixed/variable ratio, higher the operating leverage
3. Net Income - Profit, in principle, over long haul
********************************************************
Net income reflects how much of every dollar of sales a company keeps as its own profit (JWI 530, W3 L2).
The calculation includes expectations about revenues over a time period into the future. Net Income can be inflated through imaginary numbers from accrual accounting by unscrupulous business owners eg. Enron.
4. Cash Flow - lifeblood to keep business running today
****************************************************************
Cash flow is the lifeblood of a company (JWI 530, W6 L1). Free cash flow is the cash a company has after all expenses and investments are made in order to keep the business running. This metric shows the actual cash-generation power of the business and the amount of cash available for distribution to investors.
Difference between Net Income and Cash Flow
*******************************************************
1. Net income can be manipulated through creative accounting of theoretical expectations which may or may not materialize in the future. Cash flow is harder to manipulate under GAAP. eg. Enron showed high net income but the cash flow did not support the high expectations.
2. Net income is the basis of a firm's share price while how much unrestricted cash a business can deliver in any given period is directly tied to the value of a company.
3. Cash flow is critically important than profits for small business owners who are struggling keep the lights on for an embryonic firm as well as big businesses that are rapidly losing their market share and barreling towards disaster. A looming negative cash flow situation means the firm will soon not be able to pay their bills. This is what happened to IBM in 1993 when Lou Gerstner parachuted in to stop the bleeding and reverse the ship that was within months of going into bankruptcy. Business owners need to monitor cash budgets in order to make sure they know their cash flow positions.
5. Cash Conversion Cycle (CCC)
******************************
The definition of cash conversion cycle, is “the length of time a company’s cash is tied up in working capital before that money is finally returned when customers pay for the products sold or services rendered”(http://www.nysscpa.org/cpajournal/2007/807/essentials/p42.htm)
Cash Conversion Cycle (CCC) is the number of days it takes a firm in converting its cash in the bank to buying raw materials, creating inventory, selling inventory and receiving more cash from sales. CCC shows how much of a firm's cash flow is tied up in each part of the transaction. Shorter or negative cash-to-cash CCC cycle is better, indicating the firm is managing its capital efficiently. CCC is calculated as follows:
CCC = DIO + DSO - DPO, where
DIO = Days Inventory outstanding
DSO = Days Sales outstanding
DPO = Days Payables outstanding
A positive CCC could mean the firm's capital is tied up in its inventory or the firm may be having trouble with collecting money from customers.
A negative CCC means DPO > DIO + DSO
A firm with negative CCC, such as Amazon, enjoys a unique competitive advantage over its rivals - it does not pay for raw materials or inventory until after the sale of the final products are complete and cash is received from the customer. While most firms have to wait for their cash to turn into inventory and then finished good and finally transformed into more cash returned from customer, Amazon gets the customer's money up front and enjoys a great deal of flexibility in financing the firm's operations. Amazon can use its working capital efficiently to fuel other income generating activities.A lower CCC suggests that a company is more efficient in managing its cash flows, because it turns its working capital over more times per year and generates more sales per dollar
invested. http://www.nysscpa.org/cpajournal/2007/807/essentials/p42.htm
While negative CCC is desirable, one of the disadvantages of a negative CCC is that the suppliers waiting a long time for their money from a firm like Amazon may feel a lot of pressure to switch.
We learned about more concepts and tools to manage the financial health of a business: capex, free cash flow, operating leverage, difference between net income and free cash flow and the importance of cash conversion cycle.
I understand the importance of free cash flow and how it can mean the difference between life and death of a firm.
Dr DP
JWI 530 Operations Management, week6 summary
***********************************************************
1. To run a company efficiently, examine things from the perspective of
- cash a business is generating
- what it does with the cash
- costs involved with running and growing the business
2. Three metrics to track how cash physically moves through the business are:
(a) Capital Expenditures: long term investment a company makes in durable assets for generating future business and increasing profits eg, machinery, construction of new plant, land
(b) Free Cash Flow: how much discretionary money a firm has after paying costs needed to run the business
(c) Operating leverage: Ratio of fixed costs to variable costs (change in operating income/change in sales); higher the fixed/variable ratio, higher the operating leverage
3. Net Income - Profit, in principle, over long haul
********************************************************
Net income reflects how much of every dollar of sales a company keeps as its own profit (JWI 530, W3 L2).
The calculation includes expectations about revenues over a time period into the future. Net Income can be inflated through imaginary numbers from accrual accounting by unscrupulous business owners eg. Enron.
4. Cash Flow - lifeblood to keep business running today
****************************************************************
Cash flow is the lifeblood of a company (JWI 530, W6 L1). Free cash flow is the cash a company has after all expenses and investments are made in order to keep the business running. This metric shows the actual cash-generation power of the business and the amount of cash available for distribution to investors.
Difference between Net Income and Cash Flow
*******************************************************
1. Net income can be manipulated through creative accounting of theoretical expectations which may or may not materialize in the future. Cash flow is harder to manipulate under GAAP. eg. Enron showed high net income but the cash flow did not support the high expectations.
2. Net income is the basis of a firm's share price while how much unrestricted cash a business can deliver in any given period is directly tied to the value of a company.
3. Cash flow is critically important than profits for small business owners who are struggling keep the lights on for an embryonic firm as well as big businesses that are rapidly losing their market share and barreling towards disaster. A looming negative cash flow situation means the firm will soon not be able to pay their bills. This is what happened to IBM in 1993 when Lou Gerstner parachuted in to stop the bleeding and reverse the ship that was within months of going into bankruptcy. Business owners need to monitor cash budgets in order to make sure they know their cash flow positions.
5. Cash Conversion Cycle (CCC)
******************************
The definition of cash conversion cycle, is “the length of time a company’s cash is tied up in working capital before that money is finally returned when customers pay for the products sold or services rendered”(http://www.nysscpa.org/cpajournal/2007/807/essentials/p42.htm)
Cash Conversion Cycle (CCC) is the number of days it takes a firm in converting its cash in the bank to buying raw materials, creating inventory, selling inventory and receiving more cash from sales. CCC shows how much of a firm's cash flow is tied up in each part of the transaction. Shorter or negative cash-to-cash CCC cycle is better, indicating the firm is managing its capital efficiently. CCC is calculated as follows:
CCC = DIO + DSO - DPO, where
DIO = Days Inventory outstanding
DSO = Days Sales outstanding
DPO = Days Payables outstanding
A positive CCC could mean the firm's capital is tied up in its inventory or the firm may be having trouble with collecting money from customers.
A negative CCC means DPO > DIO + DSO
A firm with negative CCC, such as Amazon, enjoys a unique competitive advantage over its rivals - it does not pay for raw materials or inventory until after the sale of the final products are complete and cash is received from the customer. While most firms have to wait for their cash to turn into inventory and then finished good and finally transformed into more cash returned from customer, Amazon gets the customer's money up front and enjoys a great deal of flexibility in financing the firm's operations. Amazon can use its working capital efficiently to fuel other income generating activities.A lower CCC suggests that a company is more efficient in managing its cash flows, because it turns its working capital over more times per year and generates more sales per dollar
invested. http://www.nysscpa.org/cpajournal/2007/807/essentials/p42.htm
While negative CCC is desirable, one of the disadvantages of a negative CCC is that the suppliers waiting a long time for their money from a firm like Amazon may feel a lot of pressure to switch.
Turn On the Lean Service Machine ! for superior customer service
JWI 550 Operations Management, week6 summary, 2/17/13
Never did I fully appreciate how lean principles can apply well in the service industry !
This week's learning and the thought provoking discussions helped transform my thinking. I am especially excited that the application of this fundamental concept in a large market like India can do wonders to improve the lives of millions of people.
IBM was founded on three core values - respect for the individual, superior customer service and excellence in everything we do. This week's learning helps me tremendously in translating the core value of superior customer service to reality in every organization I will lead going forward.
Takeaways from this week's learning below.
thrilled
Dr DP
JWI 550 Operations Management, week6 summary, 2/17/13
I. What is Muda? (Womack & Jones, 2003)
**************************************************
Muda is a Japanese word that means "waste". Specifically it is any human activity which absorbs resources but creates no value:
mistakes that require rectification, production of items no one wants so that inventories pile up, processing steps that are unnecessary, movement of employees and transport f goods from one place to another without any purpose, groups of people in a downstream activity standing around and waiting because an upstream activity has not delivered on time, and goods and services that don't meet the needs of the customer.
II. What is Lean thinking ?
******************************
Lean is the antidote to Muda. It provides a way to specify value - from the customer's point of view, line up value-creating actions in the best sequence, conduct those activities without interruption whenever someone requests them, and perform them more and more effectively. It provides a way to do more and more with less and less - less human effort, less equipment, less time and less space - while coming closer and closer to providing customers exactly what they want.
Similarities in application of Lean principles in both service and manufacturing industries
The features of lean operations apply to services just as they do in manufacturing (Heizer & Render, 2011).
Lean thinking, techniques and organization apply to practically any activity, whether a good or a service (Womack & Jones, 2003).
The lean way to a hassles-free experience for customers begins with always keeping the customer's definition of value in mind, letting the customers pull the product or service from the enterprise rather than pushing products or services on customers, using small batch sizes, making value-creating steps flow using JIT techniques that eliminate inventory, building systems that help employees produce perfect parts or services every time, reducing space requirements to minimize travel distance, developing partnerships with suppliers and educating them to understand the needs of the ultimate customer, eliminating non-value add activities in the entire value stream and developing and empowering employees to take action.
Example of a product manufacturing firm that uses Lean would be the famous Toyota Inc. Toyota has perfected the lean way of operations and is know for its "Toyota way" of continuous improvement. Example of a services firm would be the billion dollar Ronald Reagan UCLA medical center that provides health and healing services.
III. Can Lean be applied to services ?
*******************************************
Lean can be applied in process driven service environment. But this is challenging as processes are not as visible as in a factory. Ways to overcome the challenge and deliver services to customers under continuously changing demand, suppliers need to be reliable, inventories lean, cycle times short, and schedules nimble (Heizer, Render, 2011) include:
- Analyze the Voice of Customer (VOC): define what constitutes value in the mind of the customer
- Apply Kano model and determine key dissatisfiers, satisfiers, delighters
- Design or re-design services to have a strong impact
- "What gets measured, Gets done", Peter Drucker
"What gets measured and rewarded, gets done well!" Dr Richard Chua
- "Everything can improve; Efficiencies are lurking everywhere in every type of service and or process. Drive to find what can be made better" George Degnon
IV. Turn on The Lean Service machine ! (Swank, 2003)
*********************************************
(1) Place linked processes near one another
***************************************************
For employees in functional silos - where they are personally responsible,
develop acute awareness that they part of the integrated whole enterprise whose purpose is customer service
break through "my work is all that matters" silo mentality
(2) Standardize procedures
********************************
Balance employee freedom with discipline needed to
- improve performance of employee primarily on the job
- workload balancing
- manage absences & transfers
(3) Eliminate loop-backs that lead to delay and waste
**************************************************************
- remove confusion about who should be doing what and when
- keep work flowing smoothly
(4) Set a common tempo
*****************************
Takt: heartbeat of lean operations, baseline pacing of work according to customer demand
challenge employees to create shorter baseline times with improvements
(5) Workload balance evenly among employees
*******************************************************
- Eliminate unnecessary delays with full utilization of employees bandwidth, reduce idle time
- Make work flow smoothly from one employee to next
- Be fair to employees
(6) Segregate complexity
************************
- cluster tasks of similar levels of difficulty eg. put tasks with longer TAT into a separate group
Do not let long TAT items delay short TAT items
(7) Post Performance Results Scorecard for all to see
***************************************
clarify individual performance metrics, unit performance metrics
Display hourly productivity rate vs company's expectations
Help employees see where and when performance is suffering
Use displays as rallying point for setting new performance records & celebrate success
not just a place to assign blame and punish low performers
evaluate employees with objective results they track themselves vs subjective observations of bosses
(8) Set performance goals - spread accountability and rewards throughout the system instead of concentration at top
**************************
- Measure performance and productivity from customer's perspective
- overhaul ways to measure costs, speed, quality, profitability
beware of corporate party line metrics that actually inhibit productivity
- ask who is working hard ? who is waiting ? how are defects handled ?
how is profitability calculated ? what would make the process better ?
- use hoshin kanri policy depoloyment principle of Toyota
link front line worker productivity - ie shop-floor operational goals - to CEO's strategic performance
(9) Convince the skeptics - explain why and how to get far reaching changes
****************************************************************************************
eg. Airplane game
highest profit = f(output - work in progress - defects)
Help people question basic aspects of their job
- how is profitability measured ?
- who uses my work ?
- how close do I sit with rest of process team ?
- is my neighbour idle while I scramble to keep pace ?
- does the work come in batches that allow a single step to become a bottle neck ?
or does work move forward one piece at a time ?
- are we waiting until end of process to check defects ?
or are we inspecting at every point in the process ?
- are there steps that can be eliminated ?
am I pushing the management to implement the changed ?
V. References
*****************
- http://www.lean.org/WhatsLean/History.cfm
- lean six sigma in the U.S. army.
http://www.army.mil/standto/archive/2011/04/11/
http://www.isixsigma.com/industries/government/lean-six-sigma-army-now-improving-efficiency/
- VSM
http://www.lean.org/Bookstore/ProductDetails.cfm?SelectedProductId=9
http://www.amazon.com/Learning-See-Stream-Mapping-Eliminate/dp/0966784308
Never did I fully appreciate how lean principles can apply well in the service industry !
This week's learning and the thought provoking discussions helped transform my thinking. I am especially excited that the application of this fundamental concept in a large market like India can do wonders to improve the lives of millions of people.
IBM was founded on three core values - respect for the individual, superior customer service and excellence in everything we do. This week's learning helps me tremendously in translating the core value of superior customer service to reality in every organization I will lead going forward.
Takeaways from this week's learning below.
thrilled
Dr DP
JWI 550 Operations Management, week6 summary, 2/17/13
I. What is Muda? (Womack & Jones, 2003)
**************************************************
Muda is a Japanese word that means "waste". Specifically it is any human activity which absorbs resources but creates no value:
mistakes that require rectification, production of items no one wants so that inventories pile up, processing steps that are unnecessary, movement of employees and transport f goods from one place to another without any purpose, groups of people in a downstream activity standing around and waiting because an upstream activity has not delivered on time, and goods and services that don't meet the needs of the customer.
II. What is Lean thinking ?
******************************
Lean is the antidote to Muda. It provides a way to specify value - from the customer's point of view, line up value-creating actions in the best sequence, conduct those activities without interruption whenever someone requests them, and perform them more and more effectively. It provides a way to do more and more with less and less - less human effort, less equipment, less time and less space - while coming closer and closer to providing customers exactly what they want.
Similarities in application of Lean principles in both service and manufacturing industries
The features of lean operations apply to services just as they do in manufacturing (Heizer & Render, 2011).
Lean thinking, techniques and organization apply to practically any activity, whether a good or a service (Womack & Jones, 2003).
The lean way to a hassles-free experience for customers begins with always keeping the customer's definition of value in mind, letting the customers pull the product or service from the enterprise rather than pushing products or services on customers, using small batch sizes, making value-creating steps flow using JIT techniques that eliminate inventory, building systems that help employees produce perfect parts or services every time, reducing space requirements to minimize travel distance, developing partnerships with suppliers and educating them to understand the needs of the ultimate customer, eliminating non-value add activities in the entire value stream and developing and empowering employees to take action.
Example of a product manufacturing firm that uses Lean would be the famous Toyota Inc. Toyota has perfected the lean way of operations and is know for its "Toyota way" of continuous improvement. Example of a services firm would be the billion dollar Ronald Reagan UCLA medical center that provides health and healing services.
III. Can Lean be applied to services ?
*******************************************
Lean can be applied in process driven service environment. But this is challenging as processes are not as visible as in a factory. Ways to overcome the challenge and deliver services to customers under continuously changing demand, suppliers need to be reliable, inventories lean, cycle times short, and schedules nimble (Heizer, Render, 2011) include:
- Analyze the Voice of Customer (VOC): define what constitutes value in the mind of the customer
- Apply Kano model and determine key dissatisfiers, satisfiers, delighters
- Design or re-design services to have a strong impact
- "What gets measured, Gets done", Peter Drucker
"What gets measured and rewarded, gets done well!" Dr Richard Chua
- "Everything can improve; Efficiencies are lurking everywhere in every type of service and or process. Drive to find what can be made better" George Degnon
IV. Turn on The Lean Service machine ! (Swank, 2003)
*********************************************
(1) Place linked processes near one another
***************************************************
For employees in functional silos - where they are personally responsible,
develop acute awareness that they part of the integrated whole enterprise whose purpose is customer service
break through "my work is all that matters" silo mentality
(2) Standardize procedures
********************************
Balance employee freedom with discipline needed to
- improve performance of employee primarily on the job
- workload balancing
- manage absences & transfers
(3) Eliminate loop-backs that lead to delay and waste
**************************************************************
- remove confusion about who should be doing what and when
- keep work flowing smoothly
(4) Set a common tempo
*****************************
Takt: heartbeat of lean operations, baseline pacing of work according to customer demand
challenge employees to create shorter baseline times with improvements
(5) Workload balance evenly among employees
*******************************************************
- Eliminate unnecessary delays with full utilization of employees bandwidth, reduce idle time
- Make work flow smoothly from one employee to next
- Be fair to employees
(6) Segregate complexity
************************
- cluster tasks of similar levels of difficulty eg. put tasks with longer TAT into a separate group
Do not let long TAT items delay short TAT items
(7) Post Performance Results Scorecard for all to see
***************************************
clarify individual performance metrics, unit performance metrics
Display hourly productivity rate vs company's expectations
Help employees see where and when performance is suffering
Use displays as rallying point for setting new performance records & celebrate success
not just a place to assign blame and punish low performers
evaluate employees with objective results they track themselves vs subjective observations of bosses
(8) Set performance goals - spread accountability and rewards throughout the system instead of concentration at top
**************************
- Measure performance and productivity from customer's perspective
- overhaul ways to measure costs, speed, quality, profitability
beware of corporate party line metrics that actually inhibit productivity
- ask who is working hard ? who is waiting ? how are defects handled ?
how is profitability calculated ? what would make the process better ?
- use hoshin kanri policy depoloyment principle of Toyota
link front line worker productivity - ie shop-floor operational goals - to CEO's strategic performance
(9) Convince the skeptics - explain why and how to get far reaching changes
****************************************************************************************
eg. Airplane game
highest profit = f(output - work in progress - defects)
Help people question basic aspects of their job
- how is profitability measured ?
- who uses my work ?
- how close do I sit with rest of process team ?
- is my neighbour idle while I scramble to keep pace ?
- does the work come in batches that allow a single step to become a bottle neck ?
or does work move forward one piece at a time ?
- are we waiting until end of process to check defects ?
or are we inspecting at every point in the process ?
- are there steps that can be eliminated ?
am I pushing the management to implement the changed ?
V. References
*****************
- http://www.lean.org/WhatsLean/History.cfm
- lean six sigma in the U.S. army.
http://www.army.mil/standto/archive/2011/04/11/
http://www.isixsigma.com/industries/government/lean-six-sigma-army-now-improving-efficiency/
- VSM
http://www.lean.org/Bookstore/ProductDetails.cfm?SelectedProductId=9
http://www.amazon.com/Learning-See-Stream-Mapping-Eliminate/dp/0966784308
Saturday, February 9, 2013
TQM in Manufacturing & Services to drive Variation out
JWI 550 Operations Management, week5 summary, 2/9/13
Great week !
I expected this week's learning to be on home ground. Familiar territory it was but I gained valuable new perspectives and frameworks that add to my skill set significantly.
I. Variation
**************
Welch six sigma video taught us that "variation is evil" and we need to get variation out of the system to save cost, time and quality. I used this statement in a presentation at IBM this week.
II. Manufacturing vs Services
**********************************
Industries can be classified into two sectors broadly:
(a) Manufacturing industry: Create a tangible product
(b) Services industry: Financial services, Education, Utilities & Government, Restaurants, Communications, Hotels, Transportation, Healthcare, Airlines, Entertainment
Both types of industries should be viewed as opportunities for ultimately delivering superior customer service.
III. Total Quality Management (TQM)
******************************************
The way a manufacturing or service organization functions can be continuously improved with business process transformation using TQM methods including SPC such as:
Kano model - Dissatisfiers, Satisfiers, Delighters (especially important in service industry)
PDCA - Plan, Do, Check, Adjust
Six Sigma DMAIC - Design, Measure, Analyze, Improve, Control ( with seven tools: check sheets, scatter diagrams, Fishbone cause and effect diagrams, pareto charts, flow charts, histograms, SPC)
VSM - Value Stream Map to optimize business process
SIPOC - Suppliers, Inputs, Process, Output, Customer to enable business process transformation from status quo to desired state
5S LEAN - identify all types of waste and get rid of them by sorting, straightening, shining, standardizing, sustaining
FMEA - Failure Mode and Effects Analysis
8D - Eight disciplines of Structured Problem Solving (Prepare and Plan, Form Team, Problem statement, containment action, root cause analysis, Fix, Implement & validate, prevention, celebrate)
Benchmarking - against best in class competition
Kai Zen - Continuous improvement every day
Fool proofing - technique that prevents errors
Datamining - correlations; paretos
4Ms for causes - Material, Machinery, Manpower, Methods
SPC - Statistical process control; Cpk control charts
Source Inspection - to monitor and control the cause of variation
Dr DP
Great week !
I expected this week's learning to be on home ground. Familiar territory it was but I gained valuable new perspectives and frameworks that add to my skill set significantly.
I. Variation
**************
Welch six sigma video taught us that "variation is evil" and we need to get variation out of the system to save cost, time and quality. I used this statement in a presentation at IBM this week.
II. Manufacturing vs Services
**********************************
Industries can be classified into two sectors broadly:
(a) Manufacturing industry: Create a tangible product
(b) Services industry: Financial services, Education, Utilities & Government, Restaurants, Communications, Hotels, Transportation, Healthcare, Airlines, Entertainment
Both types of industries should be viewed as opportunities for ultimately delivering superior customer service.
III. Total Quality Management (TQM)
******************************************
The way a manufacturing or service organization functions can be continuously improved with business process transformation using TQM methods including SPC such as:
Kano model - Dissatisfiers, Satisfiers, Delighters (especially important in service industry)
PDCA - Plan, Do, Check, Adjust
Six Sigma DMAIC - Design, Measure, Analyze, Improve, Control ( with seven tools: check sheets, scatter diagrams, Fishbone cause and effect diagrams, pareto charts, flow charts, histograms, SPC)
VSM - Value Stream Map to optimize business process
SIPOC - Suppliers, Inputs, Process, Output, Customer to enable business process transformation from status quo to desired state
5S LEAN - identify all types of waste and get rid of them by sorting, straightening, shining, standardizing, sustaining
FMEA - Failure Mode and Effects Analysis
8D - Eight disciplines of Structured Problem Solving (Prepare and Plan, Form Team, Problem statement, containment action, root cause analysis, Fix, Implement & validate, prevention, celebrate)
Benchmarking - against best in class competition
Kai Zen - Continuous improvement every day
Fool proofing - technique that prevents errors
Datamining - correlations; paretos
4Ms for causes - Material, Machinery, Manpower, Methods
SPC - Statistical process control; Cpk control charts
Source Inspection - to monitor and control the cause of variation
Dr DP
Ratios -Liquidity, Turnover, Effectiveness; ROIC-WACC spread
JWI 530 Financial Management I, Week5 Summary, 2/9/13
************************************************
Ratios - Liquidity, Turnover, Effectiveness, and ROIC - WACC spread are powerful financial tools with which a firm's health can be quickly evaluated vs competition.
Ratios help judge firm's capacity to squeeze profits efficiently - compare the firm's ratios vs competition and against itself over time.
Work the Balance Sheet : it is the best place to study operational/structural health of a business
I. Liquidity Ratios
********************
How well positioned is a company to meet its near-term obligations?
How to side step a Chapter11 filing ?
1. Current ratio = current assets/current liabilities (tgt 2-3)
Does the firm have enough cash to meet its daily operating responsibilities?
2. Quick Ratio (Acid Test) = (Current Assets - Inventories)/Current liabilities (tgt >1-2)
If and when in a pinch, how well can a company meet its short term financial obligations without any cash coming in from sales ?
3. Debt/Equity Ratio (tgt <0.7)
D/E ratio = Financial leverage; must be below peer average
4. Interest coverage Ratio = Earnings before interest and Tax (EBIT) / Interest Expense (tgt >1.5)
Does the company have the ability to meet its short-term debt obligations using cash it generates from operations?
- EBIT is the amount of money the firm is bringing in on a Quarterly or yearly basis = Operating Cash Flow
II. Turnover Ratios
********************
5. Day Sales Outstanding = 365 (Accounts Receivable/Total Credit Sales)
How effectively is the firm managing its capital & collecting its due credit from customers?
How strong are the products ?
How is the DSO trend over time ?
6. Inventory Turn Over = Revenue/Inventory or COGS/Inventory
How long does it takes for an item to transform from a finished product to cash on the books ?
How fast does business move products faster than competition ?
Higher ITOs desirable => company turning over products quickly; company products in high demand eg. Apple 63.2
Downward spike in inventory turnover may indicate something bad is beginning to happen in business (net income, revenue could be hit next)
III. Effectiveness Ratios
**************************
7. Return on Equity (ROE) = Net Income / Shareholder's Equity (tgt >10%)
How effectively/efficiently is a firm using the finances its owners have provided ?
For every dollar firm gets from shareholders, what ROE % is returned back to book value of business?
Positives
*********
Most widely used gauge of returns for Wall Street
Analysis takes shareholder's POV
Number is easy to calculate
Brilliant and Flexible - comparable across industries
Excellent first indicator that a firm's management team is making high quality decisions
Flaws
******
Fails to capture debt maintained by firm
ROE can be flat to rising while financial health deteriorates
Profit margin, asset turn over could be falling
Unscrupulous management might be increasing debt to mask that fall
Debt has a crippling effect on a company
Backward looking - High ROE does not necessarily mean the firm is laying a solid foundation for future high returns
Can never be certain a firm can replicate its past success
Can be manipulated - companies report financials differently
Not useful for assessing firms that have negative earnings
Definitions of net income varies by firm eg. income statement: some items may not be expensed
8. Return on Assets = Net income (profit)/Total Assets
How effectively is a firm using its cash, property, equipment ?
Does the business generate sufficient return on large investments it makes on regular basis ?
Limitations:
Does not translate across industries unlike ROE.
Capital intensive and mfg or energy companies need more assets to run their business - they will have lower ROAs than consulting firms
One time items can distort net income - rolling average of net income and total assets key to normalize
Backward looking metric - future may not follow past success
IVa. ROIC - WACC Spread
***********************
Return on Invested Capital (ROIC) = NOPAT/InvestedCapital = OperatingIncome (1-taxrate)/InvestedCapital
How much money does the firm makes back on capital sunk into business ?
Is the firm clearing the hurdle ?
Is the firm doing better job in value creation than competition ?
How effective is the company's management and business's competitive advantage ?
What assets are truly working to create value for shareholders?
Invested Capital = Total Assets - Excess cash and investments - Non interest bearing current liabilities
Figure out which assets are actually ***invested in the business*** and working for shareholders
eg. current portion of long term debt (interest bearing liability)
Strip out those that are not
- cash that does not provide operating return for shareholders (note: insurance firms collect cash and invest as operations)
- Investments are capital that the company can tap if needed but irrelevant to operations
- Most current liabilities (interest free): accounts payable, accrued expenses, accrued salaries, unearned revenue, income taxes payable
NOPAT (Net Operating Profit After Tax) = Operating income (1-taxrate)
What is the profitability of core operations?
Measures operating profit made for all investors (shareholders & debt holders)
Profits paid to shareholders + interest paid on debt
WACC
****
Proportional weighting of costs of various kinds of capitals a firm uses to operate its business
From balance sheet: Find total debt, shareholder's equity in $ amount
Determine relative proportion of capital of each: debt (d %), equity (e%)
Figure out After tax cost of debt: Cd %
Figure out Cost of Equity expected: Ce%
WACC = Cd% * (d%) + Ce% * (e%)
Persistent +ve Spread between ROIC and WACC
****************************************
=> company produced a lot of value vs what it plugs into the business
=> good decision making
=> higher than market average means company has earned a competitive advantage; doing something others cannot
=> great business; something special is happening
=> sustainable outperformance
Negative ROIC - WACC spread
***************************
0 to negative: Destroying value; stay clear of the company or project
exception:
startups like RIM; concept takes off after a period of low and negative ROIC
expanding firms like FexEx => create periods of excellent profitability in future
is it falling over time? => is firm expanding ?
IVb. Ways to increase value ie higher positive ROIC WACC spread
****************************************************************
[OperatingIncome (1-taxrate)/InvestedCapital] - [ Cd% * (d%) + Ce% * (e%)]
(1) Create more value
**********************
Improve operational performance ie ROIC
Invest in higher return projects with Sustainable Competitive advantage
Use capital more efficiently eg. drive high asset turnover
Decrease WACC
Invest in more value creating projects
Get rid of value destroying projects
(2) Lower WACC
***************
(i) Capital structure policy (Brigham, Enhhardt, 2011)
Target Capital Structure: Mix of debt, preferred stock and common equity to minimize WACC
Lower WACC by using more debt instead of equity
Disadvantage: increased risk of debt and risk for equity
Optimal cost structure mminimizes WACC and simultaneously maximizes intrinsic value of stock
(ii) Dividend policy
If payout ratio is too high the firm must issue new stock to fund its capital budget
(iii) Investment policy
Brilliant week! The finance section of the Annual reports are a pleasure to read now.
Dr DP
************************************************
Ratios - Liquidity, Turnover, Effectiveness, and ROIC - WACC spread are powerful financial tools with which a firm's health can be quickly evaluated vs competition.
Ratios help judge firm's capacity to squeeze profits efficiently - compare the firm's ratios vs competition and against itself over time.
Work the Balance Sheet : it is the best place to study operational/structural health of a business
I. Liquidity Ratios
********************
How well positioned is a company to meet its near-term obligations?
How to side step a Chapter11 filing ?
1. Current ratio = current assets/current liabilities (tgt 2-3)
Does the firm have enough cash to meet its daily operating responsibilities?
2. Quick Ratio (Acid Test) = (Current Assets - Inventories)/Current liabilities (tgt >1-2)
If and when in a pinch, how well can a company meet its short term financial obligations without any cash coming in from sales ?
3. Debt/Equity Ratio (tgt <0.7)
D/E ratio = Financial leverage; must be below peer average
4. Interest coverage Ratio = Earnings before interest and Tax (EBIT) / Interest Expense (tgt >1.5)
Does the company have the ability to meet its short-term debt obligations using cash it generates from operations?
- EBIT is the amount of money the firm is bringing in on a Quarterly or yearly basis = Operating Cash Flow
II. Turnover Ratios
********************
5. Day Sales Outstanding = 365 (Accounts Receivable/Total Credit Sales)
How effectively is the firm managing its capital & collecting its due credit from customers?
How strong are the products ?
How is the DSO trend over time ?
6. Inventory Turn Over = Revenue/Inventory or COGS/Inventory
How long does it takes for an item to transform from a finished product to cash on the books ?
How fast does business move products faster than competition ?
Higher ITOs desirable => company turning over products quickly; company products in high demand eg. Apple 63.2
Downward spike in inventory turnover may indicate something bad is beginning to happen in business (net income, revenue could be hit next)
III. Effectiveness Ratios
**************************
7. Return on Equity (ROE) = Net Income / Shareholder's Equity (tgt >10%)
How effectively/efficiently is a firm using the finances its owners have provided ?
For every dollar firm gets from shareholders, what ROE % is returned back to book value of business?
Positives
*********
Most widely used gauge of returns for Wall Street
Analysis takes shareholder's POV
Number is easy to calculate
Brilliant and Flexible - comparable across industries
Excellent first indicator that a firm's management team is making high quality decisions
Flaws
******
Fails to capture debt maintained by firm
ROE can be flat to rising while financial health deteriorates
Profit margin, asset turn over could be falling
Unscrupulous management might be increasing debt to mask that fall
Debt has a crippling effect on a company
Backward looking - High ROE does not necessarily mean the firm is laying a solid foundation for future high returns
Can never be certain a firm can replicate its past success
Can be manipulated - companies report financials differently
Not useful for assessing firms that have negative earnings
Definitions of net income varies by firm eg. income statement: some items may not be expensed
8. Return on Assets = Net income (profit)/Total Assets
How effectively is a firm using its cash, property, equipment ?
Does the business generate sufficient return on large investments it makes on regular basis ?
Limitations:
Does not translate across industries unlike ROE.
Capital intensive and mfg or energy companies need more assets to run their business - they will have lower ROAs than consulting firms
One time items can distort net income - rolling average of net income and total assets key to normalize
Backward looking metric - future may not follow past success
IVa. ROIC - WACC Spread
***********************
Return on Invested Capital (ROIC) = NOPAT/InvestedCapital = OperatingIncome (1-taxrate)/InvestedCapital
How much money does the firm makes back on capital sunk into business ?
Is the firm clearing the hurdle ?
Is the firm doing better job in value creation than competition ?
How effective is the company's management and business's competitive advantage ?
What assets are truly working to create value for shareholders?
Invested Capital = Total Assets - Excess cash and investments - Non interest bearing current liabilities
Figure out which assets are actually ***invested in the business*** and working for shareholders
eg. current portion of long term debt (interest bearing liability)
Strip out those that are not
- cash that does not provide operating return for shareholders (note: insurance firms collect cash and invest as operations)
- Investments are capital that the company can tap if needed but irrelevant to operations
- Most current liabilities (interest free): accounts payable, accrued expenses, accrued salaries, unearned revenue, income taxes payable
NOPAT (Net Operating Profit After Tax) = Operating income (1-taxrate)
What is the profitability of core operations?
Measures operating profit made for all investors (shareholders & debt holders)
Profits paid to shareholders + interest paid on debt
WACC
****
Proportional weighting of costs of various kinds of capitals a firm uses to operate its business
From balance sheet: Find total debt, shareholder's equity in $ amount
Determine relative proportion of capital of each: debt (d %), equity (e%)
Figure out After tax cost of debt: Cd %
Figure out Cost of Equity expected: Ce%
WACC = Cd% * (d%) + Ce% * (e%)
Persistent +ve Spread between ROIC and WACC
****************************************
=> company produced a lot of value vs what it plugs into the business
=> good decision making
=> higher than market average means company has earned a competitive advantage; doing something others cannot
=> great business; something special is happening
=> sustainable outperformance
Negative ROIC - WACC spread
***************************
0 to negative: Destroying value; stay clear of the company or project
exception:
startups like RIM; concept takes off after a period of low and negative ROIC
expanding firms like FexEx => create periods of excellent profitability in future
is it falling over time? => is firm expanding ?
IVb. Ways to increase value ie higher positive ROIC WACC spread
****************************************************************
[OperatingIncome (1-taxrate)/InvestedCapital] - [ Cd% * (d%) + Ce% * (e%)]
(1) Create more value
**********************
Improve operational performance ie ROIC
Invest in higher return projects with Sustainable Competitive advantage
Use capital more efficiently eg. drive high asset turnover
Decrease WACC
Invest in more value creating projects
Get rid of value destroying projects
(2) Lower WACC
***************
(i) Capital structure policy (Brigham, Enhhardt, 2011)
Target Capital Structure: Mix of debt, preferred stock and common equity to minimize WACC
Lower WACC by using more debt instead of equity
Disadvantage: increased risk of debt and risk for equity
Optimal cost structure mminimizes WACC and simultaneously maximizes intrinsic value of stock
(ii) Dividend policy
If payout ratio is too high the firm must issue new stock to fund its capital budget
(iii) Investment policy
Brilliant week! The finance section of the Annual reports are a pleasure to read now.
Dr DP
Sunday, February 3, 2013
Tightly Manage Cash flow & Liquidity
JWI 530 Financial Management I, week4 summary, 2/3/13
This was another fabulous week of learning. I see why managing cash flow and liquidity systematically is a strategic activity.The Garmin assignment led me on an adventure, as I dug deep into corporate 10-K and 10-Q statements and am beginning to see the light and beauty of finance.
Loving this immersion into the numbers side of business.
Dr DP
JWI 530 Financial Management I, week4 summary
I. Explain the difference between information provided in various financial statements
Cash Flow Statement = Company's Cash Register
**********************************************
Goal of Cash Flow Statement:
****************************
show actual cash movements in business & document impact of corporate decisions
********************************************************************************
Cannot be manipulated by accounting procedures
Net income can be fictitiously stated with massive growth that is imaginary
Cash is King !
Cash Flow Statement is all about "Follow the Cash !"
Cashflow statement is the crucial bridge between income statement and balance sheet
reconciles net income with physical, countable cash coming in or leaving the business
where is the cash coming from, how much stays within the business ?
Cash flow statement - pure cash system ie like Cash register receipts
Income statement - mechanics of credit to determine income ie profit
Balance sheet: Assets vs Liabilities + Equity = what firm starts out with owning and owing
Income statement: Includes cash not yet received eg. account receivables; Net Income includes IOUs
Updated Balance sheet: Shows increase in Assets/Equity from cash profit made, reduction in inventory
Cash flow statement: Shows only cash coming in and going out
Cash flow statement consists of:
*******************************
(i) operating activities: what is the net bankable "true cash profit" from operations ?
***************************************************************************************
- Follow the cash involved in firm's core business operations
- Start with net income at the top
- explain how amount in bank is different from net income reported in income statement
- positive means cash is added back to net income eg Depreciation & Amortization
(ii) investment activities: how much money was used for investments made to build the business
**********************************************************************************************
- Capital expenditures (Capex)
- Other movements of cash eg. Acquisitions, short or long term portfolio investments like CDs, property sale
(iii) financing activities: what changes were made to firm's internal capital structure ?
*****************************************************************************************
cash associated with dividends and stock repurchases
cash used to finance company's internal operations and investments
did the firm borrow money ? (this shows up as inflow here and inflow in debt/liabilities on balance sheet)
share repurcahses or shares sold to issue stock options
Final section
*************
Combines cash flows from the 3 subsections and reconciles cash balance from one period to next
how much cash was generated at end of recent year ? (restored in balance sheet)
II. When a firm reports High Margins ask "is it real? is it sustainable?"
*************************************************************************
"is it real based on fundamental industry structure & is it sustainable through durable competitive advantage & pipeline of innovations?"
There are several scenarios under which a high margin business would raise red flags to me.
(1) Ponzi scheme - Too good to be true
***********************************************
Consistently above industry average and unnaturally shows no vulnerability for years when lesser firms are falling like flies. eg. Bernie Madoff
(2) Running out of steam
*******************************
A firm can keep growing explosively for several years but run out of steam eventually without innovative growth products to sustain the torrid pace. Dell in the 1990s had this problem as it focused on being a commodity leader. Without new products and differentiation earnings dropped. Key question to ask is: can the firm keep up the pace ?
3) Accounting tricks
************************
Instead of showing solid growth from excellent products, a firm can shift money around cleverly to give an illusion of high growth when under the covers it is clear that the firm has stagnated or is declining.
(4) Running out of cash
*****************************
A firm with high growth will go out of business if it cannot control its cash flow and meet payroll. Cash flow is king (JWI 530, week4, lecture1). Lou Gerster, former CEO of IBM, states that cash flow is most important for major organizations to survive (Gertstner, 2002).
(5) Cheating & Foreign Corruption Practices Act violation
********************************************************************
When the CEO is behaving erratically and taking the firm into unknown ventures where his family members are involved eg. Satyam computers in India. When the firm can enter easily into foreign territories while other firms that tried have failed eg. WalMart officials bribed public officials in Mexico.
Much like doubting if a super athlete with a consistently stellar and above average performance (eg. Lance Armstrong) has used performance enhancing drugs
or not, we as finance truth-seekers need to be on the look out for shady dealings by firms. We need to quickly pick up tell tale signs in the balance sheet,
income statement, cash flow statements as explained in JWI 530 Week4, Lecture1.
When we see a firm reporting high margins, the key question to ask is "how did the firm get to high margins?".
There are genuinely great firms such as Apple and WalMart which have earned their way to a sustainable competitive advantage through an innovation pipeline
and/or relentless cost reduction.
Then there are firms like HP which were once great that seem to be struggling and wanting to show numbers without a cohesive strategy.
Such firms could bring up Flash in the pan kind of numbers that are not sustainable due to weak fundamentals.
IBM recently reported high margins but has been under criticism since the revenue actually fell.
http://www.businessweek.com/articles/2013-01-22/ibm-makes-more-money-selling-less-of-what-people-want
Is IBM getting to high margins by selling less or what customers want ?
If this is the case, are customers really not buying IBM's vision of the future ?
It is clear that high margins alone are not enough. How a firm gets to show high margins makes all the difference.
Dr Sasha's two questions - is it real and is it sustainable ?- do indeed get to the bottom of it all.
Reality check weeds out Ponzi schemes, accounting tricks and imaginary numbers.
Sustainability check gives us a view of the future based on past performance.
Fundamental determinants of profit margin include:
(a) Industry structure as illuminated by Porter's 5 forces model
(1) Competition among rivals - monopolies typically enjoy high and sustainable profit margins eg. IBM in 1960s and 70s and Microsoft in the 80s; oligopolies enjoy sustainably high margins eg. oil cartels; perfect competition leads to erosion of profit margins eg. retail with many suppliers
(2) Supplier power
(3) Buyer power
(4) Pressure from new entrants
(5) Threat of substitute products
(b) Growth phase of industry
High margins can be reaped at introduction, early user offerings, growth phase of the industry. Mature and declining industries have low to negative profit margins.
(c) PESTEL environment
Political - new political rules can make or break margins eg. tax policies
Economic - recessions lead to lower profit margins as people are buying less. In boom times, even badly run firms can show good margins, eg. real estate firms made a lot of money unyil the 2007 crash.
Social - changing social norms can affect profit margins eg. hostess twinkies went out of business due to health consciousness movement
Technological advancements can make or break profit margins eg. RIM lost big time to Apple and Android phones,
Environmental - For example, tighter EPA laws in California force the car companies to keep reducing emissions. Companies that fail to meet the standards will lose sales and margins
Legal - Change in laws can impact the bottomline eg. insider trading laws, antitrust laws
III. Tightly Manage Cash Flows & Liquidity Rigorously & Systematically, Rigby & Sweig, 2009
**********************************************************************************************
Goal: Support the company's strategy,increase its thrust, Develop forward visibility to manage effectively through even a sustained period of turbulence
Healthy companies like WalMart with cash reserves have more strategic options
Managing cash flow and liquidity is a strategic - not tactical - activity
Understand cash flows to monitor strength & vulnerability of competitors, customers, vendors
Use capital and cash efficiently
Track cash flow weekly and monthly & develop integrated view
Spot patterns & drivers of variance in liquidity & how they flow through P&L statements
Predict business obstacles - peaks and valleys - buy valuable time to respond before options run out
Cash strapped = defensive actions: slash inventories, clamp down expenses, cut back compensation & benefits
This was another fabulous week of learning. I see why managing cash flow and liquidity systematically is a strategic activity.The Garmin assignment led me on an adventure, as I dug deep into corporate 10-K and 10-Q statements and am beginning to see the light and beauty of finance.
Loving this immersion into the numbers side of business.
Dr DP
JWI 530 Financial Management I, week4 summary
I. Explain the difference between information provided in various financial statements
Cash Flow Statement = Company's Cash Register
**********************************************
Goal of Cash Flow Statement:
****************************
show actual cash movements in business & document impact of corporate decisions
********************************************************************************
Cannot be manipulated by accounting procedures
Net income can be fictitiously stated with massive growth that is imaginary
Cash is King !
Cash Flow Statement is all about "Follow the Cash !"
Cashflow statement is the crucial bridge between income statement and balance sheet
reconciles net income with physical, countable cash coming in or leaving the business
where is the cash coming from, how much stays within the business ?
Cash flow statement - pure cash system ie like Cash register receipts
Income statement - mechanics of credit to determine income ie profit
Balance sheet: Assets vs Liabilities + Equity = what firm starts out with owning and owing
Income statement: Includes cash not yet received eg. account receivables; Net Income includes IOUs
Updated Balance sheet: Shows increase in Assets/Equity from cash profit made, reduction in inventory
Cash flow statement: Shows only cash coming in and going out
Cash flow statement consists of:
*******************************
(i) operating activities: what is the net bankable "true cash profit" from operations ?
***************************************************************************************
- Follow the cash involved in firm's core business operations
- Start with net income at the top
- explain how amount in bank is different from net income reported in income statement
- positive means cash is added back to net income eg Depreciation & Amortization
(ii) investment activities: how much money was used for investments made to build the business
**********************************************************************************************
- Capital expenditures (Capex)
- Other movements of cash eg. Acquisitions, short or long term portfolio investments like CDs, property sale
(iii) financing activities: what changes were made to firm's internal capital structure ?
*****************************************************************************************
cash associated with dividends and stock repurchases
cash used to finance company's internal operations and investments
did the firm borrow money ? (this shows up as inflow here and inflow in debt/liabilities on balance sheet)
share repurcahses or shares sold to issue stock options
Final section
*************
Combines cash flows from the 3 subsections and reconciles cash balance from one period to next
how much cash was generated at end of recent year ? (restored in balance sheet)
II. When a firm reports High Margins ask "is it real? is it sustainable?"
*************************************************************************
"is it real based on fundamental industry structure & is it sustainable through durable competitive advantage & pipeline of innovations?"
There are several scenarios under which a high margin business would raise red flags to me.
(1) Ponzi scheme - Too good to be true
***********************************************
Consistently above industry average and unnaturally shows no vulnerability for years when lesser firms are falling like flies. eg. Bernie Madoff
(2) Running out of steam
*******************************
A firm can keep growing explosively for several years but run out of steam eventually without innovative growth products to sustain the torrid pace. Dell in the 1990s had this problem as it focused on being a commodity leader. Without new products and differentiation earnings dropped. Key question to ask is: can the firm keep up the pace ?
3) Accounting tricks
************************
Instead of showing solid growth from excellent products, a firm can shift money around cleverly to give an illusion of high growth when under the covers it is clear that the firm has stagnated or is declining.
(4) Running out of cash
*****************************
A firm with high growth will go out of business if it cannot control its cash flow and meet payroll. Cash flow is king (JWI 530, week4, lecture1). Lou Gerster, former CEO of IBM, states that cash flow is most important for major organizations to survive (Gertstner, 2002).
(5) Cheating & Foreign Corruption Practices Act violation
********************************************************************
When the CEO is behaving erratically and taking the firm into unknown ventures where his family members are involved eg. Satyam computers in India. When the firm can enter easily into foreign territories while other firms that tried have failed eg. WalMart officials bribed public officials in Mexico.
Much like doubting if a super athlete with a consistently stellar and above average performance (eg. Lance Armstrong) has used performance enhancing drugs
or not, we as finance truth-seekers need to be on the look out for shady dealings by firms. We need to quickly pick up tell tale signs in the balance sheet,
income statement, cash flow statements as explained in JWI 530 Week4, Lecture1.
When we see a firm reporting high margins, the key question to ask is "how did the firm get to high margins?".
There are genuinely great firms such as Apple and WalMart which have earned their way to a sustainable competitive advantage through an innovation pipeline
and/or relentless cost reduction.
Then there are firms like HP which were once great that seem to be struggling and wanting to show numbers without a cohesive strategy.
Such firms could bring up Flash in the pan kind of numbers that are not sustainable due to weak fundamentals.
IBM recently reported high margins but has been under criticism since the revenue actually fell.
http://www.businessweek.com/articles/2013-01-22/ibm-makes-more-money-selling-less-of-what-people-want
Is IBM getting to high margins by selling less or what customers want ?
If this is the case, are customers really not buying IBM's vision of the future ?
It is clear that high margins alone are not enough. How a firm gets to show high margins makes all the difference.
Dr Sasha's two questions - is it real and is it sustainable ?- do indeed get to the bottom of it all.
Reality check weeds out Ponzi schemes, accounting tricks and imaginary numbers.
Sustainability check gives us a view of the future based on past performance.
Fundamental determinants of profit margin include:
(a) Industry structure as illuminated by Porter's 5 forces model
(1) Competition among rivals - monopolies typically enjoy high and sustainable profit margins eg. IBM in 1960s and 70s and Microsoft in the 80s; oligopolies enjoy sustainably high margins eg. oil cartels; perfect competition leads to erosion of profit margins eg. retail with many suppliers
(2) Supplier power
(3) Buyer power
(4) Pressure from new entrants
(5) Threat of substitute products
(b) Growth phase of industry
High margins can be reaped at introduction, early user offerings, growth phase of the industry. Mature and declining industries have low to negative profit margins.
(c) PESTEL environment
Political - new political rules can make or break margins eg. tax policies
Economic - recessions lead to lower profit margins as people are buying less. In boom times, even badly run firms can show good margins, eg. real estate firms made a lot of money unyil the 2007 crash.
Social - changing social norms can affect profit margins eg. hostess twinkies went out of business due to health consciousness movement
Technological advancements can make or break profit margins eg. RIM lost big time to Apple and Android phones,
Environmental - For example, tighter EPA laws in California force the car companies to keep reducing emissions. Companies that fail to meet the standards will lose sales and margins
Legal - Change in laws can impact the bottomline eg. insider trading laws, antitrust laws
III. Tightly Manage Cash Flows & Liquidity Rigorously & Systematically, Rigby & Sweig, 2009
**********************************************************************************************
Goal: Support the company's strategy,increase its thrust, Develop forward visibility to manage effectively through even a sustained period of turbulence
Healthy companies like WalMart with cash reserves have more strategic options
Managing cash flow and liquidity is a strategic - not tactical - activity
Understand cash flows to monitor strength & vulnerability of competitors, customers, vendors
Use capital and cash efficiently
Track cash flow weekly and monthly & develop integrated view
Spot patterns & drivers of variance in liquidity & how they flow through P&L statements
Predict business obstacles - peaks and valleys - buy valuable time to respond before options run out
Cash strapped = defensive actions: slash inventories, clamp down expenses, cut back compensation & benefits
Drum, Rope, Buffer & The Theory of Constraint
JWI 550 Operations Management, Week4 Summary, 2/3/13
An extremely valuable TOC (Theory of Constraint) principle was taught to us this week. We learned how to identify key bottlenecks in an operating system and use the drum, rope, buffer concepts to strategically increase throughput while taking down inventory and reducing operating expenses. This strategic planning technique works very well to improve operations in multiple operating systems including major firms, organizations as well as small families. This is the most important take away for me this week.
I also recognize the limitations of this TOC-JIT (Just in Time) principle eg. during war conditions firms with inventory will have a competitive advantage (eg. IBM before world war). Lean works better when times are good. Fat works better under some conditions when survival is at stake. Interestingly, this principle applies to the human body as well.
Dr DP
JWI 550 Operations Management, Week4 Summary, 2/3/13
I. Heizer & Render, Chapter 5: Design of Goods and Services
**********************************************************************
(i) Goods and Services Selection
**************************************
Product decision: Selection, definition, design of product
Product Life Cycle: Introduction, Growth, Maturity, Decline
Product by Value analysis: Dollar contribution by individual product; Total annual dollar contribution by product
(ii) Generate New Products
***************************
Continually Select, define, design products.
with change in product opportunities, products, product volume, product mix
arising from changes in customer need,PESTEL, demographics, market practice, professional standards, suppliers, distributors
(iii) Product Development
******************************
Quality Function Deployment (QFD) - Using a House of Quality matrix map
determine customer wants and translate them into attributes that each functional area can act on
(iv) Product development teams
**************************************
Teams (eg. concurrent) charged with moving from product requirements to product success
Manufacturability and value engineering - activities that help improve a product design, production, maintainability and use
(v) Product Design Issues
******************************
Robustness, Modular, CAD, DFM, CAM, virtual reality, value analysis
(vi) Ethics, Environmentally friendly designs, Sustainability
******************************************************************
Conserve and renew resources
Life Cycle Assessment (LCA) ISO 14000 - assess environmental impact of product from material and energy inputs to disposal and environmental releases
Develop safe and enviornmentally sound products
minimize waste of resources
reduce environmental liabilities
increase cost effectiveness of compliance with environmental regulations
be recognized as a good corporate citizen
(vii) Product Development Strategy
*****************************************
Organic - Develop internally; create new products, enhance or migrate existing products
Acquire - purchase technology or expertise by acquiring the developer
Joint venture - joint ownership between firms to pursue new product markets
Alliances - cooperate but pursue independent missions
(viii) Defining a Product
****************************
Engineering drawing, Bill of materials, make or buy decision, group technology
(ix) Documents for production
*****************************
Assembly drawing & chart, Route sheet, work order, ECN, configuration management, product Life Cyle Management
(x) Service Design
**********************
Techniques to reduce cost and enhance design include
Delaying customization, Modularizing, automating, designing for "moment of truth" eg. Dell PC & Sony LiOn battery
(xi) Decision Tree
*********************
Include All possible alternatives including "do nothing"
Enter payoffs at end of each branch
Determine expected value and prune inferior options
II. THE GOAL, Goldratt & Cox (2012)
************************************
The Theory of Constraints (TOC) along with the drum, rope and buffer framework is explained very nicely at http://www.goldratt.co.uk/resources/drum_buffer_rope/index.html
Clear explanation of concepts including drum, rope and buffer can also be found at
http://www.goalsys.com/books/documents/S-DBRPaper.pdf
The fundamental assumption of TOC is that manufacturing to meet firm orders at defined due dates is preferable to building up inventory stock. To achieve this the following steps need to be taken:
Step 0 – Define the system’s goal or objective
Step 1. Identify the System’s Constraint(s) => what is the bottleneck ?
Step 2. Decide how to Exploit the System’ s Constraint(s).
Bottleneck management techniques include:
(a) release work orders to the system at the pace set by bottleneck's capacity
(b) Drive bottleneck equipment down time to zero eg. ensure coverage; change lunch rules as needed.
lost time at bottleneck represents lost capacity for the whole system
(d) increase capacity of bottleneck as it increases capacity of the whole system
(c) increasing the capacity of a non-bottleneck station is a mirage
(e) Put Quality Control Checks ahead of bottleneck machines - eliminate defective pieces ahead
(f) train all people to give special care to bottleneck parts
(g) activate additional equipment to increase capacity
(h) assign best people to work on bottlenecks
(i) increase or decrease batch sizes as needed
(j) implement plant-wide priority to manage flow towards THE GOAL
Step 3. Subordinate everything else to the above decisions.
Step 4. Elevate the System’s Constraint(s).
Step 5. If in the Previous Steps a Constraint has been Broken, go back to Step 1. (Warning: Do Not Allow Inertia to Cause a System Constraint)
Focus on the Drum's rhythm & tie a Rope to it from the start of work orders
*************************************************************************************
To optimize the throughput of a system, the author Eliyahu Goldratt recommends using the concepts of Drum and Rope that are explained
first by the children of the protagonist in THE GOAL (2012).
To achieve optimum flow through a system, the entry of work orders into production must be synchronized with the production rate of the least capable part of the process which in essence is a capacity constrained resource (CCR). The production rate of this CCR is likened to the rhythm of a drum, which sets the pace of productions for the entire system. The rope is a communication device that connects the CCR to the material release point that ensures that raw material is not inserted into the production process at a rate faster than production rate of CCR. The rope is meant to protect the CCR from being swamped with work in process (WIP) resulting in inventory build up.
III. HBR Case Study, "Product Development at Dell Computer Corporation"
***************************************************************************************
Use decision tree to choose between status quo, risky choice and deferred commitment to design with "moment of truth" data
An extremely valuable TOC (Theory of Constraint) principle was taught to us this week. We learned how to identify key bottlenecks in an operating system and use the drum, rope, buffer concepts to strategically increase throughput while taking down inventory and reducing operating expenses. This strategic planning technique works very well to improve operations in multiple operating systems including major firms, organizations as well as small families. This is the most important take away for me this week.
I also recognize the limitations of this TOC-JIT (Just in Time) principle eg. during war conditions firms with inventory will have a competitive advantage (eg. IBM before world war). Lean works better when times are good. Fat works better under some conditions when survival is at stake. Interestingly, this principle applies to the human body as well.
Dr DP
JWI 550 Operations Management, Week4 Summary, 2/3/13
I. Heizer & Render, Chapter 5: Design of Goods and Services
**********************************************************************
(i) Goods and Services Selection
**************************************
Product decision: Selection, definition, design of product
Product Life Cycle: Introduction, Growth, Maturity, Decline
Product by Value analysis: Dollar contribution by individual product; Total annual dollar contribution by product
(ii) Generate New Products
***************************
Continually Select, define, design products.
with change in product opportunities, products, product volume, product mix
arising from changes in customer need,PESTEL, demographics, market practice, professional standards, suppliers, distributors
(iii) Product Development
******************************
Quality Function Deployment (QFD) - Using a House of Quality matrix map
determine customer wants and translate them into attributes that each functional area can act on
(iv) Product development teams
**************************************
Teams (eg. concurrent) charged with moving from product requirements to product success
Manufacturability and value engineering - activities that help improve a product design, production, maintainability and use
(v) Product Design Issues
******************************
Robustness, Modular, CAD, DFM, CAM, virtual reality, value analysis
(vi) Ethics, Environmentally friendly designs, Sustainability
******************************************************************
Conserve and renew resources
Life Cycle Assessment (LCA) ISO 14000 - assess environmental impact of product from material and energy inputs to disposal and environmental releases
Develop safe and enviornmentally sound products
minimize waste of resources
reduce environmental liabilities
increase cost effectiveness of compliance with environmental regulations
be recognized as a good corporate citizen
(vii) Product Development Strategy
*****************************************
Organic - Develop internally; create new products, enhance or migrate existing products
Acquire - purchase technology or expertise by acquiring the developer
Joint venture - joint ownership between firms to pursue new product markets
Alliances - cooperate but pursue independent missions
(viii) Defining a Product
****************************
Engineering drawing, Bill of materials, make or buy decision, group technology
(ix) Documents for production
*****************************
Assembly drawing & chart, Route sheet, work order, ECN, configuration management, product Life Cyle Management
(x) Service Design
**********************
Techniques to reduce cost and enhance design include
Delaying customization, Modularizing, automating, designing for "moment of truth" eg. Dell PC & Sony LiOn battery
(xi) Decision Tree
*********************
Include All possible alternatives including "do nothing"
Enter payoffs at end of each branch
Determine expected value and prune inferior options
II. THE GOAL, Goldratt & Cox (2012)
************************************
The Theory of Constraints (TOC) along with the drum, rope and buffer framework is explained very nicely at http://www.goldratt.co.uk/resources/drum_buffer_rope/index.html
Clear explanation of concepts including drum, rope and buffer can also be found at
http://www.goalsys.com/books/documents/S-DBRPaper.pdf
The fundamental assumption of TOC is that manufacturing to meet firm orders at defined due dates is preferable to building up inventory stock. To achieve this the following steps need to be taken:
Step 0 – Define the system’s goal or objective
Step 1. Identify the System’s Constraint(s) => what is the bottleneck ?
Step 2. Decide how to Exploit the System’ s Constraint(s).
Bottleneck management techniques include:
(a) release work orders to the system at the pace set by bottleneck's capacity
(b) Drive bottleneck equipment down time to zero eg. ensure coverage; change lunch rules as needed.
lost time at bottleneck represents lost capacity for the whole system
(d) increase capacity of bottleneck as it increases capacity of the whole system
(c) increasing the capacity of a non-bottleneck station is a mirage
(e) Put Quality Control Checks ahead of bottleneck machines - eliminate defective pieces ahead
(f) train all people to give special care to bottleneck parts
(g) activate additional equipment to increase capacity
(h) assign best people to work on bottlenecks
(i) increase or decrease batch sizes as needed
(j) implement plant-wide priority to manage flow towards THE GOAL
Step 3. Subordinate everything else to the above decisions.
Step 4. Elevate the System’s Constraint(s).
Step 5. If in the Previous Steps a Constraint has been Broken, go back to Step 1. (Warning: Do Not Allow Inertia to Cause a System Constraint)
Focus on the Drum's rhythm & tie a Rope to it from the start of work orders
*************************************************************************************
To optimize the throughput of a system, the author Eliyahu Goldratt recommends using the concepts of Drum and Rope that are explained
first by the children of the protagonist in THE GOAL (2012).
To achieve optimum flow through a system, the entry of work orders into production must be synchronized with the production rate of the least capable part of the process which in essence is a capacity constrained resource (CCR). The production rate of this CCR is likened to the rhythm of a drum, which sets the pace of productions for the entire system. The rope is a communication device that connects the CCR to the material release point that ensures that raw material is not inserted into the production process at a rate faster than production rate of CCR. The rope is meant to protect the CCR from being swamped with work in process (WIP) resulting in inventory build up.
III. HBR Case Study, "Product Development at Dell Computer Corporation"
***************************************************************************************
Use decision tree to choose between status quo, risky choice and deferred commitment to design with "moment of truth" data
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