Supply chain lessons from Japan

By Gerard Cachon, The Wharton School at the University of Pennsylvania. Source: Matching Supply with Demand.

Gérard Cachon

The devastating earthquake and tsunami in Japan have again raised the issue of supply chain robustness to disruption risk, and in particular, are they too fragile? (3/15/2011) asserts that  ”Strategies that look rational for individual manufacturing companies… can create big macro-level vulnerabilities…”

The reality is that it is too costly to source every component from multiple locations throughout the world just to hedge natural disaster risks. But that doesn’t mean that companies should turn their back to the problem. The best companies follow a few intuitive steps to make their supply chains more robust. I’ll offer two.

First, map your supply chain. If you know your Tier 1, Tier 2 and Tier 3 suppliers, then you won’t have to spend one week figuring out whether you will run out of a part. Most companies know their Tier 1 supply chain, but do they know the other tiers? Do they keep track of changes to the supply chain? This information is crucial because the company that is first to work the phone to find alternative  supplies is most likely to be able to secure those supplies.  This information also gives you information that you can use to make downstream adjustments to your production. For example, should you eliminate an overtime shift or not? Should you redirect scarce parts from one plant to another? Those are difficult decisions to make and are made much more complicated if you don’t even know if you have a problem – why shut down a plant for a potential part shortage that may not materialize?

Second, before disaster strikes, map out vulnerabilities. Some components can be sourced in many locations. Some components have several months of buffer inventory. You don’t need to worry about those. But if the amount of buffer inventory is limited and it is sourced in a few locations, especially a few locations that happen to be close to each other, then you need to consider finding alternative sources or alternative parts. Maybe the conclusion is that the company needs to bear the risk – there are no effective alternatives. But maybe the conclusion is that a substitution to a less risky part is actually feasible.  Finding this substitute is less costly before the disaster. There have been reports of companies that are scrambling to qualify additional suppliers, but that could have been done before disaster struck.

Finally, one risk that will hit many companies, even if they don’t have a shortage of parts, is the risk of exchange rate fluctuations – the Yen has just hit a post WWII high against the US dollar.


Southwest Airlines: Do free bags create problems?

Martin Lariviere

By Martin Lariviere, The Kellogg School of Management at Northwestern University. Source: The Operations Room.

Southwest along with Walmart and Toyota have long been stock examples in Operations Management classes. They have always been reliable go to examples of firms whose success has depended in non-trivial ways on how they manage their operations. Of course, the problem with relying on a stock example is that little things like, I dunno, recalling millions of cars can dampen the persuasiveness of the example. It’s not just Toyota. Walmart too has add some issues and missteps. Now comes word that Southwest is having operational difficulties (As Southwest Airlines tries to cope with its success, problems at Midway will get team’s attention, Mar 3, Chicago Tribune).

Bags still fly for free on Southwest Airlines, but travelers are paying a price in other ways. They’re encountering more lapses in Southwest’s hallmark on-time performance as the carrier departs from what once was its core principles of avoiding congested airports and shunning hub-and-spoke complexity in favor of getting passengers to their destinations on a single aircraft.

Revenue soared as Southwest added business destinations such as New York’s LaGuardia Airport and connecting flights at Chicago’s Midway Airport. But as it struggles to cope with increasing numbers of passengers and bags, Southwest risks tarnishing the reliability it has touted since the 1970s. …

While its rivals shrank their U.S. operations following 2008′s Great Recession, Southwest added 13 million more passengers per year. The carrier also took a scalpel to its schedule, canceling flights that didn’t attract great numbers of passengers and adding more flights to peak periods.

With little room to make up for delays, Southwest’s on-time arrivals in 2010 dipped below the carrier’s historic 80 percent rate. The lapse was magnified as rivals like United Airlines posted the best on-time numbers in their history.

Part of the issue is that Southwest has tweaked its traditional business model (something we have written about before), flying to more congested airports and operating more of a hub-and-spoke system. Part of this is related to growth. At some point, Southwest was bound to run out of secondary airports in relatively populous areas. That would leave a choice of going into smaller cities (where reliably filling a 737 would be hard) or sucking it up and going to busier airports that pose operational challenges but at least have lots of traffic. That seems a pretty obvious choice. As does a hub-and-spoke system. Once Southwest began flying to cities on both coasts, it was inevitable that passengers would look to book long trips. Having five-hour layovers then costs you business and you start to have more peaked flight schedules. The next thing you know, half of Southwest’s Midway traffic is connecting passengers.

Of course, peaked schedules with tight connection times makes for challenging operations. The proof is in the data. Not only has Southwest’s on-time performance suffered, Midway’s has. It is now last in on-time departures .

And Southwest’s bags fly free policy doesn’t help.

It’s not unusual for bags and passengers on a flight landing at Midway to connect to 12 departing flights, sending workers scurrying to sort and deliver the luggage to 12 points around the airport.

“The planes are coming in with more bags, period, because people check more bags,” [Charles] Cerf[ president of TWU Local 555, which represents ground workers at Southwest] said. “They’re having to hold some of those departures because normal connecting time isn’t enough to get the bags over there. We feel we don’t have enough agents.”

This too makes sense. Ryanair claims to emphasize baggage fees in order to keep costs down. If Southwest is going to welcome check bags, they have to expect higher costs. The question is what can they do? The article says they are loathe to increase the scheduled time for flights or scheduled layover since that would dramatically decrease their productivity. That leaves adding resources (for example, they are renting more gates at Midway and adding workers) or revising the work. The latter is obviously the most desirable outcome. It will be interesting to see if they can pull it off.

McDonald’s medicine

By Christian Terwiesch, The Wharton School at the University of Pennsylvania. Source: Matching Supply with Demand.

Christian Terwiesch

Americans want instant gratification – that is true for fast food as much as it is for healthcare. Consequently, the traditional model of general practitioner in which you make appointments and then (a week later – if you are lucky) see a doctor is getting increasingly challenged. Patients have found the McDonald’s of healthcare. It is called the ER. You go there when you want and they will get you what you want. One stop shopping for all your healthcare needs.
In the following article, two ER doctors describe their view of the problem – and make us think if we have to invent the way we deliver care:,8599,2044392,00.html

Better ways to manage waiters

Martin Lariviere

By Martin Lariviere, The Kellogg School of Management at Northwestern University. Source: The Operations Room.

It’s been a tough couple years for restaurants. When the economy goes south, dining out is something relatively easy to cut from the family budget. Throw in rising food prices, and you gotta brutal business. Thus it is not surprising that firms are looking to save a little cash on the labor front. The Wall Street Journal had an interesting story on steps Chili’s Grill and Bar (a division of Brinker International) is taking to reduce the amount of labor it needs in its restaurants (Chili’s Feels Heat to Pare Costs, Jan 28). Some of these steps are straight out of our core Ops class in terms of reducing the amount of time resources need to spend with each unit flowing through the process:

With costs in mind, Chili’s studied how its kitchen operations could be more efficient. It determined employees were spending too much time performing solo tasks, such as hand-mashing potatoes in a skillet or minding ribs in the oven.

Now it is testing in 10 restaurants a new combination oven that replaces the skillet and the smoker. The chain wouldn’t disclose the ovens’ cost but said that they can smoke ribs and cook bacon at three times the current capacity. That, in turn, frees employees to do other things until the timer buzzes.

Other steps include experimenting with conveyor belt ovens for burgers and quesadillas and shifting food prep from line cooks to (presumably less expensive) prep cooks. All of these are fine and good and don’t necessarily affect the customer. The customer doesn’t see what happens in the kitchen and could probably care less about who dices up the onions. The more interesting part is what they are doing in the front of the house.

Last year, the chain shifted the way tables are served. Now, waiters work in pairs in zones and table bussers have been eliminated. Chili’s said it noticed that dedicated bussers were slowing service because they held onto tubs used to remove dirty plates, making servers reliant on them to clear tables. If the busser didn’t clean fast enough, new customers couldn’t be seated. Without bussers— who now have been gone since July—servers no longer have to share tips with them and have an incentive to turn over tables faster.

“We took a big chunk out of our labor model at the front of the restaurant without compromising the guest experience,” Ms. Valade says.

So I discussed this model of waiter management with some Kellogg econ PhD students some time back. (I believe that they had actually talked to someone at Brinker. That is, many of these changes have been in the works for a while and are not all in response to the impending changes in health care regulation even though that is how Mr. Muroch’s paper pitches things.) There is an interesting trade off here. We basically have an agency problem. The restaurant manager cannot monitor everything that each server does so having them dependent on tips gives them an incentive to put in effort and treat the customer well. As soon as you pool tips, that creates a problem. If Pablo puts in a lot of effort and gets the customer to bump up the tip a couple of bucks, he now has to share that with Mallesh. That implies that Pablo should not put in as much effort as he would if the tip was all his. Or at least that is what a standard model would predict.

So what is the trade off? The trade off arises because there are aspects of the tips that are beyond the control of the waiters. For example, the waiters have no control over whether they end up with a party of teetotalers who don’t buy booze and run up their tab. Or they don’t completely control whether a given table will turn two or three times this evening. That creates variability in their earnings but that variability is dampened out as they have a slice of more tables. Less variability would mean higher utility (assuming they are risk averse) and thus the firm can pay a lower base salary. (If you doubt that servers are that dependent on tip income, check out Steve Dublanica’s recent book Keep the Change: A Clueless Tipper’s Quest to Become the Guru of the Gratuity.)

There are a couple of other points here that might tip the scales toward pooling the waiters. For one, service might actually improve even if the waiters don’t work as hard. One can think of the waiters as a queuing system with random arrival of requests for attention (e.g., foods up for table 5, need more drinks at table 12, etc.). There are economies of scale in queuing systems so doubling the number of servers and doubling the number of requests should result in faster service of requests as long as effort doesn’t drop too much.

The second point is that waiters might not be able to shirk that much. Going back to Pablo and Mallesh, if Pablo is a total slacker, Mallesh will notice even if the manager does not. This is a repeated game and Mallesh may demand a different partner or even a different shift if working with Pablo is too much hassle. Developing a reputation as a loser and consequently being left off high volume shifts is probably more than enough discipline to keep the likes of Pablo in line.

Why is it cheaper to buy airline tickets on Tuesdays?

Gad Allon

By Gad Allon, The Kellogg School of Management at Northwestern University. Source: The Operations Room.

Why do firms dynamically modify their price? There several reasons, but the main goal of dynamic pricing is to allow for better allocation of products to customers according to their preferences while exploiting such differences to improve the overall profitability of the firm. (Prices may also reflect changes in the willingness to pay of customers or changes in the costs of providing the service).

The Wall Street Journal recently had an article (“Whatever You Do, Don’t Buy an Airline Ticket On … “) that made the case that one should not buy airline tickets over the weekend since these are consistently higher than the prices during the middle of the week, which, in my opinion, makes very little sense. Don’t get me wrong: it’s not that I am saying that it does not happen. I am merely saying that it makes very little sense to alter the prices so frequently, in a manner that seems to add very little value to the airlines. What kind of temporal differences does the airline exploit here?

The two main reasons that the article cites are:

When airlines want to push through a fare increase, marking up their basic prices across the board usually by $5 or $10, they often do that on Thursday night, then watch to see if competitors match and if the higher rates stick over the weekend. If competitors balk, prices can be rolled back by Monday morning.


In addition, airlines don’t manage their inventory as actively on weekends, so if cheap seats sell on some flights, prices automatically jump higher. Fare analysts may decide later to offer more seats at cheaper prices, but not until they come back to work on Monday, according to airline pricing executives.

But more than anything, it seems that this cycle is still a remnant from the times most of the sales were done through travel agencies, and airlines wanted sales out early in the week to generate buzz while customers could buy from travel agencies. At that time, sales launched on Friday may not get noticed. Is it possible that with all the sophisticated data analysis methods, airlines are still bound by these traditions?

Another thing that somewhat surprises me is the weekend effect. We live in a world in which people purchase tickets and communicate 24/7. Yet, airlines have to wait until after the weekend for managers to come and override the system’s recommendations. If this had to be done once or twice, I would understand. But it seems that this has to be done at the beginning of many weeks. Can’t someone fix it? Can’t one predict the impact of price changes? Maybe I shouldn’t be so surprised, as this may be another explanation why airlines do so poorly financially.

Why China – cheap capital?

By Gerard Cachon, The Wharton School at the University of Pennsylvania. Source: Matching Supply with Demand.

Gérard Cachon

In 2008 Evergreen Solar opened up a solar panel factory in Devens,  Massachusetts, but they just announced that they will layoff their 800 workers and move production to China (NY Times 1/14/11). Why? Well, of course, it is too expensive to manufacturer in the U.S. And low cost production is critical – the price of solar panels has fallen from $3.39 per watt in 2008 to $1.90 per watt now. Evergreen Solar has reduced its cost to $2.00 per watt, but Chinese manufacturers are producing at $1.00 per watt.

But labor is NOT the reason for the high cost of production in the U.S. – labor is a small portion of the cost to make solar panels. Nor does it seem a lack of technical skills. Instead, the issue is the cost of capital – a solar panel plant can cost $400 million and Chinese manufacturers have access to low cost bank loans.

It it is likely that there will be more movement to China for reasons other than the cost of labor.

Robots or people?

By Gerard Cachon and Christian Terwiesch, The Wharton School at the University of Pennsylvania. Source: Matching Supply with Demand.

Christian Terwiesch

Gérard Cachon

Maybe the biggest challenge for e-commerce retailers is dealing with the huge surge in sales in the fourth quarter.  How can you build enough capacity cheaply enough to satisfy the rapid growth in demand during October, November and December, only to have most of that demand disappear by January? The traditional approach is to hire lots of seasonal workers. The trick with this is to be able to train them quickly enough for them to be productive in time for when they are actually needed. The Wall Street Journal reports that one company, Kiva Systems, has a different idea – instead of hiring workers, install robots (Dec 19, 2010).  To see these robots in action, check out the video (click here).

You might assume that these robots would “walk” around a warehouse picking products, putting them into a basket and bringing them to a place to be packaged. That is what humans do. Instead, these robots move shelves of inventory around. (See the photo – the robot is the orange contraption at the bottom of the shelf.) One advantage of this system is that you don’t need permanent aisles between the inventory – the shelves can be packed in tightly with the computer controlling the sequence (so that the one pink doll you need isn’t buried deep within a sea of shelves).

The next thing you may notice is that these robots are not particularly fast. It is not like the robots move product through the warehouse at twice the speed a human can walk. However, assuming these things are reliable (e.g., treads don’t need replacing every couple of days) they don’t need to take breaks, and they are instantly trained. One downside of this system is that the robot must move the entire shelf and not everything on the shelf may be needed at one time. Humans pushing a cart around a warehouse only put into their cart what is needed at the time.

But the point of the article is how to deal with the holiday surge in demand. While a robot might replace a human, it doesn’t eliminate the problem – the company simply needs a lot more capacity in the 4th quarter. If it buys these robots, then they are likely to be idle most of the rest of the year. Seasonal employees are just that – seasonal – that is, they go into the deal with the expectation that their work will be temporary.

The article ends with an idea for making the robots more cost effective for the retailer – Kiva Systems will rent the robots to the company for just the peak demand period. But I don’t see why this solves the problem – now Kiva Systems is sitting on expensive and idle capacity for most of the year (even in the Southern Hemisphere, Christmas falls in December).  Rental systems work well when potential customers need the product at different times. Given that the 4th quarter is the same for all retailers, I am not seeing this as an idea that works. Interestingly, the founders of Kiva Systems worked previously at Webvan. If there was ever a company that invested too much in replacing human workers with technology, it was Webvan – they may have survived if they didn’t blow all of their capital on hugely expensive warehouses. That said, I suspect there are surely applications of the Kiva Systems for some retailers. But as a solution to the 4th quarter demand surge, I am skeptical.