OM
CHAPTER 3
MEASURING PERFORMANCE
IN OPERATIONS
DAVID A. COLLIER
AND
JAMES R. EVANS
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Chapter 3 Learning Outcomes
learning outcomes
LO1 Describe the types of measures used for decision
making.
LO2 Explain how to calculate and use productivity
measures.
LO3 Explain how internal and external measures are
related.
LO4 Explain how to design a good performance
measurement system.
LO5 Describe four models of organizational
performance.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Chapter 3 Measuring Performance in Operations
magine entering the cockpit of a modern jet airplane and seeing only a
single instrument there. How would you feel about boarding the plane
after the following conversation with the pilot?
Passenger: I’m surprised to see you operating the plane with only a single
instrument. What does it measure?
Pilot: Airspeed. I’m really working on airspeed this flight.
Passenger: That’s good. Airspeed certainly seems important. But what about
altitude? Wouldn’t an altimeter be helpful?
Pilot: I worked on altitude for the last few flights and I’ve gotten pretty good on
it. Now I have to concentrate on proper airspeed.
Passenger: But I notice you don’t even have a fuel gauge. Wouldn’t that be
useful?
Pilot: You’re right; fuel is significant, but I can’t concentrate on doing too many
things well at the same time. So on this flight I’m focusing on airspeed. Once I
get to be excellent at airspeed, as well as altitude, I intend to concentrate on fuel
consumption on the next set of flights.
What measures do you use to evaluate a company’s
goods or services? Provide some examples.
What do you think?
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Chapter 3 Measuring Performance in Operations
Introduction
Managers make many important decisions that
affect how an organization provides value to its
customers.
To know if decisions are effective and to guide the
organization on a daily basis, they need a means of
understanding performance at all levels of the
organization, as well as in operations.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Chapter 3 Measuring Performance in Operations
Introduction
Good decisions are facilitated through
m easurem ent , the act of quantifying the
performance criteria (metrics) of organizational
units, goods and services, processes, people, and
other business activities.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Chapter 3 Measuring Performance in Operations
The Scope of Performance Measurement
The list below details various categories of
performance measurements.
•
•
•
•
Financial
Customer and market
Safety
Quality
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
• Time
• Flexibility
• Innovation and learning
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Exhibit 3.1
The Scope of Business and Operations Performance Measurement
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Chapter 3 Measuring Performance in Operations
Financial Measures
• Often take top priority in for-profit organizations.
• Traditional financial measures include revenue,
return on investment, operating profit, pretax
profit margin, asset utilization, growth, revenue
from new goods and services, earnings per
share, and other liquidity measures.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Chapter 3 Measuring Performance in Operations
Financial Measures
• Cost of quality is not used in most
organizations; it measures what poor quality
is costing an organization.
• Nonprofit organizations focus more on
minimizing costs and maximizing value to
their target markets, customers, and society.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Chapter 3 Measuring Performance in Operations
Customer and Market Measures
•
An effective custom er-satisfaction m easurem ent
system provides a company with customer ratings of
specific goods and service features, and indicates the
relationship between those ratings and the customer’s
likely future buying behavior.
•
Measured in three areas: 1) goods quality, 2) service
quality, and 3) response time.
•
Other customer-focused measures include customer
retention, gains and losses of customers and customer
accounts, customer complaints, warranty claims,
measures of perceived value, loyalty, positive referral,
and customer relationship building.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Chapter 3 Measuring Performance in Operations
Safety
• Measuring safety is vital to all organizations, as
the well-being of its employees and customers
should be an organization's principal concern.
• Performance measures include accident rates,
parts per million of arsenic in a public water
supply, or security in a hotel room.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Chapter 3 Measuring Performance in Operations
Quality
• Quality measures the degree to which the
output of a process meets customer
requirements.
• Goods quality relates to the physical
performance and characteristics of a good.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Chapter 3 Measuring Performance in Operations
Quality
• Service quality is consistently meeting or exceeding customer
expectations (external focus) and service delivery system
performance (internal focus) for all service encounters.
• Five key dimensions of service quality:
– Tangibles – physical facilities, uniforms, equipment, vehicles, and
appearance of employees (i.e., the physical evidence).
– Reliability – ability to perform the promised service dependably
and accurately.
– Responsiveness – willingness to help customers and provide
prompt recovery to service upsets.
– Assurance – knowledge and courtesy of the service-providers,
and their ability to inspire trust and confidence in customers.
– Empathy – caring attitude and individualized attention provided
to its customers.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Chapter 3 Measuring Performance in Operations
Service and Environmental Quality
• Every service encounter provides an
opportunity for error. Errors in service
creation and delivery are sometimes called
service upsets or service failures.
• Environm ental quality focuses on
designing and controlling work processes
to improve the environment.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Chapter 3 Measuring Performance in Operations
Time
• Time relates to two types of performance measures:
 the speed of doing something (average) and
 the variability of the process.
• P rocessing tim e is the time it takes to perform
some task.
• Queue tim e is a fancy word for w ait tim e—the
time spent waiting.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Chapter 3 Measuring Performance in Operations
Flexibility
• Flex ibility is the ability to adapt quickly and
effectively to changing requirements.
• Goods and service design flex ibility is the
ability to develop a wide range of customized
goods and services to meet different or
changing customer needs.
• Volum e flex ibility is the ability to respond
quickly to changes in the volume and type of
demand.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Chapter 3 Measuring Performance in Operations
Innovation and Learning
• I nnovation refers to the ability to create new
and unique goods and services that delight
customers and create competitive advantage.
• Learning refers to creating, acquiring, and
transferring knowledge, and modifying the
behavior of employees in response to internal
and external change.
• “Microsoft is always two years away from
failure.” Bill Gates
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Chapter 3 Measuring Performance in Operations
Productivity =
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
Quantity of Output
Quantity of Input
[3.1]
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Chapter 3 Measuring Performance in Operations
Linking Internal and External Performance Measures
• Managers must understand the cause and
effect linkages between key measures of
performance. These relationships often explain
the impact of operational performance on
external results.
• The quantitative modeling of cause and effect
relationships between external and internal
performance criteria is called interlinking.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
19
Exhibit 3.2
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
Interlinking Internal and External Performance Measures
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Chapter 3 Measuring Performance in Operations
Linking Internal and External Performance Measures
• Another example of an interlinking model is the
financial value of a loyal custom er (VLC) ,
which quantifies the total revenue or profit
each target market customer generates over
some time frame.
• By multiplying the VLC times the absolute
number of customers gained or lost, the total
market value can be found.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Chapter 3 Solved Problem
What is the value of a loyal customer (VLC) in the
small contractor target market segment who buys
an electric drill on average every 4 years or 0.25
years for $100, when the gross margin on the drill
averages 50 percent, and the customer retention
rate is 60 percent? What if the customer retention
rate increases to 80 percent?
What is a 1 percent change in market share worth
to the manufacturer if it represents 100,000
customers? What do you conclude?
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
22
Chapter 3 Solved Problem
Solution:
If customer retention rate is 60 percent, the average
customer defection rate = (1 – customer retention rate).
Thus, the customer defection rate is 40 percent, or 0.4.
The average buyers life cycle is 1/0.4 = 2.5 years. The
repurchase frequency is every four years, or 0.25 (1.4).
Therefore,
VLC (P)(RF)(CM)(BLC) =
($100)(0.25)(0.50)(1/0.4) = $31.25 per year
The value of a 1 percent change in market share =
(100,000 customers)($31.25/customer/year) = $3,125,000
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
23
Chapter 3 Solved Problem
Solution to Solved Problem (continued):
If customer retention rate is 80 percent, the average
customer defection rate is 0.2, and the average buyers life
cycle is 1/0.2 = 5 years.
Then,
VLC (P)(RF)(CM)(BLC) =
($100)(0.25)(0.50)(1/.2) = $62.50 per year
Thus, the value of a 1 percent change in market share
(100,000 customers)($62.50/customer/year) = $6,500,000
The economics are clear. If customer retention can be
increased from 60 to 80 percent through better value chain
performance, the economic payoff is doubled.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
24
Chapter 3 Measuring Performance in Operations
Designing Performance Measurement Systems in
Operations
What makes a good performance measurement
system for operations?
Good performance measures are actionable ,
providing the basis for decisions at the level at
which they are applied.
A systematic process is required to generate
useful operational performance measures.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
25
Chapter 3 Measuring Performance in Operations
Models of Organizational Performance
1. Malcolm Baldrige National Quality Award
Framework
2. Balanced Scorecard
3. Value Chain Model
4. Service-Profit Chain Model
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Chapter 3 Measuring Performance in Operations
Models of Organizational Performance
• The first two models (Baldrige Award and
Balanced Scorecard) provide more of a “big
picture” of organizational performance.
• The last two provide more detailed frameworks
for operations managers.
• It is important to understand these big-picture
models because operations managers must
communicate with all functional areas.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Chapter 3 Measuring Performance in Operations
Malcolm Baldrige National Quality Award Framework
• Organizations receive the awards in each of the
categories of manufacturing, small business,
service, nonprofit education, and health care.
• Primary purpose of the program is to provide a
framework for performance excellence through
self-assessment to understand an organization’s
strengths and weaknesses, thereby setting
priorities for improvement.
• www.baldrige.gov
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Exhibit 3.3
Malcolm Baldrige National Quality Award Model of
Organizational Performance
Source: 2006 Malcolm Baldridge National Quality Award Criteria, U.S. Dept. of Commerce
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
29
Chapter 3 Measuring Performance in Operations
The Balanced Scorecard Model
Consists of four performance perspectives:
1) Financial
2) Customer
3) Innovation and Learning
4) Internal
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Exhibit 3.4
The Balanced Scorecard Performance Categories and Linkages
Source: Kaplan R. S., and Norton, D. P., “The Balanced Scorecard—Measures That Drive Performance,” Harvard Business Review, January–February 1992, p. 72.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Chapter 3 Measuring Performance in Operations
The Value Chain Model
• Evaluates performance throughout the value
chain: synchronized network of processes
including suppliers and inputs, processes and
associated resources, goods and service
outputs and outcomes, customers and their
market segments, synchronized information
and feedback loops, and management of
value chain.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
32
Exhibit 3.5
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
Examples of Value Chain Performance Measurements
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Chapter 3 Measuring Performance in Operations
Service-Profit Chain Model
• Most applicable to service environments.
• Model is based on a set of cause and effect
linkages between internal and external
performance, and defines the key performance
measurements on which service-based firms
should focus.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
34
Exhibit 3.6
The Service-Profit Chain Model
Source: Adapted from J. L. Heskett, T. O. Jones, G. W. Loveman, W. E. Sasser, Jr., Jr., and L. A. Schlesinger,
“Putting the Service-Profit Chain to Work,” Harvard Business Review, March–April 1994, pp. 164-174.
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
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Exhibit 3.7
OM, Ch. 3 Measuring Performance in Operations
©2009 South-Western, a part of Cengage Learning
BankUSA Case: Sample Internal and External Credit Card
Division Performance Data
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