OPERATIONS STRATEGY STUDY GUIDE - Pearson Education



CHAPTERS 4 and 5

CAPACITY, CONFIGURATION AND DYNAMICS

Introduction

Not only does size matter in operations, size is a vitally important issue in determining how well an operation can serve its markets. Nor is capacity a straightforward issue. It is complex, both in the sense that it is not always easy to measure and in the sense that two similar operations with similar levels of overall capacity can, in reality, be very different in how they deploy their capacity. Two chapters are devoted to this topic. Chapter 4 takes a steady state view of capacity. It more or less ignores issues of growth or decline and concentrates on how organizations can configure their capacity given a particular level of demand. Chapter 5 deals with capacity dynamics. In other words, how the quantity and nature of a company’s capacity is changed to match changing patterns of demand.

Key points

• The capacity of any operation is usually taken to mean its capability of operating at a particular level. Often this is measured as output of products or services per unit of time. So, each of General Motors’ car plants will have a capacity of so many automobiles per week or per year. However, not all types of operation can measure their capacity in output. For example a retail chain of stores could measure its capacity in terms of the number of customers it serves, but that would not be a very meaningful figure. In fact such an organization would measure its capacity in thousands of square feet of floor space devoted to retailing. This is an input measure of capacity.

• The capacity of any operation’s unit also depends on the mix of products or services produced. Each of General Motors’ car plants will need to take into account whether the mix of automobiles it makes remains constant. If it does not then its effective capacity will change.

Capacity configuration

• Chapter identifies three main issues which apply to any operation configuring its capacity in the long term. They are:

• What should the overall level of capacity be?

• What type of capacity should the organisation have (what is the balance between the number and size of sites which make up the overall capacity)?

• Where should each site be located?

• A key issue in capacity configuration is that of economies of scale. Broadly this means that for any operation’s unit, as its size increases, so its costs of producing its goods and services decrease. However, after a particular point diseconomies of scale start to kick-in. Thus there is a theoretical optimum point for any operation where costs minimize.

• Economies of scale are really important in most industries, but don’t think this optimum level of capacity is always easy to discover. It can change with the mix of activities the operation has to cope with and it is just as influenced by “soft” or attitudinal issues as it is by hard technical ones.

• Consider the following example which was not included the book (it turned out bigger than we thought anyway). It demonstrates how creativity and innovation should also be factored into our thinking about scale.

The paradoxes of scale in the pharmaceutical industry[1]

There is a fundamental and intriguing paradox in the pharmaceutical industry. Scale is increasingly seen as important. Drugs companies are merging to form a handful of industry giants. Yet these giants are obsessed with the dynamic innovation capabilities exhibited by companies at the very opposite end of the scale spectrum, such as the small biotech companies with their start-up mentality and innovative culture. For example, GlaxoSmithKline (GSK) merged together from Glaxo Wellcome and SmithKline Beecham, then the number two and three in the industry, to form a $180 billion giant which became the largest company in the industry. Then, within three or four months it announced plans to separate out part of its research operations into six competing ‘biotechnology-like companies’. Each of these would concentrate on different disease areas, for example asthma and cancer.

Tachi Yamada, head of research and development at GSK, was quoted at the time as justifying the move in terms of trying to achieve both scale economies and small company advantages at the same time. “We have to be big and small at the same time. I had to design something that would take advantage of scale. But we know for a fact that big can sometimes mean bad. So we had to design something that could also maintain agility and entrepreneurial spirit.”

Scale is particularly important, especially in the early stages of drug development where many hundreds of thousands of compounds are checked out on an almost production line basis, using advanced technologies to look for ‘hits’ against biological targets. Scale is also important in the later stages of development which rely on massive worldwide trials to establish the effectiveness of the drug and meet a myriad of regulatory standards around the world. Scale is again important to ensure that a company has all the required skills. Small companies cannot afford the investment in establishing a deep knowledge base across all the different specialisms necessary for modern drug development.

The disadvantages of scale come in the middle of the development process. This is where the ‘hits’ from the basic screening processes are developed through to prototype drugs with what the industry calls ‘proof of concept’. That is, having sufficient scientific backing to warrant investment in massive drug trials. This part of the process needs creativity, agility, entrepreneurial spirit and, above all, an ability to be fast on your feet. None of these qualities come naturally to large and often bureaucratic drug corporations. This needs what Mr. Yamada at GSK calls ‘autonomy and accountable entrepreneurial spirit that maximises scientific interaction and internal competition for resources. You need something that looks and feels like a biotechnology company. GSK has created six units, two in the UK, one in Italy, and three in the US. Each will concentrate on one of the different disease areas.’

GSK’s six units have no more than 500 scientists (small scale by pharmaceutical company standards) working on the drug hits that have been discovered during the screening process, organised at corporate level. If they manage to turn these leads into safe and effective drugs they could receive significant financial rewards. After all, independent biotech start-up creates plenty of millionaire scientists, “Why, says Mr. Yamada, “should GSK not do the same?”

GSK is not alone in trying to achieve economies of scale and entrepreneurial focus simultaneously. AstraZeneka is reshaping the layout of its largest research unit in the north of England which houses 2500 scientists. Gone are the long corridors with their rows of isolated laboratories working behind closed doors. In their place the company is intending to build hubs around which laboratories will be clustered and where scientists can interact, debate and test out their latest ideas. The idea is to stimulate innovation by mixing different ideas and different disciplines. Many of the most profitable drug discoveries have come from the intersections between different disciplines, or from ideas that have crossed the boundary from one discipline to another. For example, at Novartis, another major drugs company, 18 per cent of drug development projects actually began in another therapeutic area. Perhaps the most famous example of how boundary hopping stimulates creativity comes from Pfizer. Their blockbuster drug Viagra actually started out as a heart drug. Again, here is the paradox. Without entrepreneurial focus Viagra would never have been developed in the way it was. Yet without scale, there may not have been the appropriate therapeutic boundary for it to cross. (The original source of material for this piece came from, David Pilling ‘Big Pharma Sees the Beauty of Thinking Small’, Financial Times, April 2nd, 2001).

• The choice of location is also discussed in this chapter. An example is included of Toyota’s decision to locate one of its recent European plants, not in the UK where it already had a base, but in France. Examining this box gives a good overview of the main factors which influence this type of location decision. These are:

• The UK is within the European Union, a large and affluent market , especially for the products of the companies who have located in the UK. Automobiles and electronic equipment are the obvious examples of this. Importing from outside the European Union would have incurred import duties or even limits on the number of products which could be imported.

• Government funded financial support ( grants and tax concessions to companies.) was available, especially when the chosen locations were in areas of relatively high unemployment. It is also worth noting, although some of the early locations had substantial inducements, later ones had less.

• The UK there has a strong industrial tradition which meant that the labour force had skills which might be useful to the incoming companies, though, that this was also regarded as a disadvantage by some companies who were afraid of the ‘bad habits’ of job demarcation and conservatism which had marked some areas.

• Also important were some factors which were not ‘rational’ as such. . For example,there is the ‘critical mass’ issue. Simply because many other Japanese companies had located in the UK it was perceived as a safe place to come. Partly this is to do with such things as the availability of Japanese schools, Japanese food stores and so on. Partly though it is also merely that the experience becomes a familiar one rather than one which is unfamiliar and therefore perceived as risky.

• Clearly the fact that the English speak English, is an advantage to any company with international operations. The Japanese especially, if they speak a foreign language, it is likely to be English. The box makes the point that this is not only convenient, it also helps to reduce errors and misunderstandings through mistranslation.

• The cost of labour, and just as important the cost of employing labour, it would appear, was an issue. Especially when compared to continental European countries, UK labour rates look attractive.

• The prevailing business culture of the country is also a factor. The UK was seen as a country where it was easy ‘to do business’. This was an image actively promoted by the government of the time.

• The UK is seen by the Japanese as a good place to live. The climate is familiar to them, entertainment such as golf courses and leisure facilities are regarded as more than adequate, and the historical ‘heritage’ image of the country, it would appear, appealed!

The more interesting question perhaps is now whether the companies who have located in the UK will continue to expand their facilities in that country. Once the company has located in the UK some of the points made above become less important. Government grants, heritage and shopping facilities etc. may fade while other points become more important. The continuance of low labour costs will certainly remain as an important issue.

Capacity dynamics

• Looking at capacity configuration under steady state conditions first does not mean that most organizations are at any point in time at steady state. It’s just that it’s important to understand the broad influences on capacity strategy before thinking about the issues of managing operations under growth or declining markets.

• Again, Chapter 5 identifies three interconnected decisions.

• The timing of capacity change.

• The size of capacity change.

• Changing location.

• The chapter examines various strategies for changing capacity and illustrates them under conditions of increasing demand. Remember however that the same issues will apply when demand is decreasing. However, when managing decline there are an additional set of issues which are illustrated in the boxed example “Sparks from Flint”. “Reducing capacity” sounds neutral when it is written in this technical manner, but of course it often means wrenching social disruption and severe personal individual stress for those people who once staffed the capacity which is being “reduced”.

• This issue of the degree (if any) of social responsibility which a company should bear when making capacity decisions is clearly related to that of location. In some parts of the world where legislation makes it difficult for companies to close plants (for example in some parts of Europe), it is often argued that nearby regions or countries with less restrictive legislation will have their capacity closed down first in any downturn. The counter argument is that those areas which make it difficult for companies to shut plants are unlikely to attract investment in capacity in the first place.

• Whatever your views, the issue of social responsibility and capacity strategy is worth thinking about and debating.

• One of the real big issues for many companies when planning their capacity strategy (often for years ahead) is the reliability of market forecasts. Sometimes these can be spectacularly wrong. This was the case in parts of the telecommunications industry between 1998 and 2002. The problems faced by the dot com companies was dwarfed by the over capacity issues of the companies which built the networks which carry telecommunications traffic. Their problems arose for four main reasons. First, their forecasts were must plain too optimistic. Although the Internet did bring substantial amounts of new traffic, growth was much slower than many in the industry were forecasting. Second, attracted by what they thought would be huge returns on their investment, both established players in the industry and several new entrants all built their own networks. Between 1998 and 2001 the amount of optical fiber cable in the ground increased fivefold. Third, there was a technical development which meant that signals could be put into and taken out of the fiber optic cables considerably faster than using the older technology. This effectively increased the transmission capacity of each strand of fiber by 100 times. Fourth, there is a high fixed cost of digging up the ground to lay the fiber in the first place. It therefore seemed sensible to put in more cable while you are at it. Then came the crash and with demand down, the volume of business slumped while the overcapacity in the industry kept prices low. So profits were hit just as the companies were trying to pay off the debt they had incurred by investing in transmission capacity in the first place.

Hints on answering the Freeman Biotest Inc. case exercise

• This case seems to be about a choice between purchasing two types of technology, and of course it is. However, in making these decisions the company is shaping the configuration of its capacity for the next few years.

• Think about two scenarios. The first assumes just a modest increase in demand for FBXX. The second assumes that the technical breakthrough has occurred and demand is substantially (3 or 4 times) higher.

• Now think about the consequences of increasing capacity through purchasing Brayford machines or Bi-line 8 machines.

Hints on answering the Delta Synthetic Fibres case exercise

• Start of thinking about this case by identifying the different ways in which the company could meet demand for both products in 2002.

• Think about the advantages and disadvantages of doing this and then consider what might happen to the company if it chose to stick with its old product or, alternatively, drop the old product entirely and concentrate on manufacturing the new one.

• Only when you have considered the issues above, start to think about location. What factors do you think are going to influence where the company decides to invest?

• What might limit the company’s ability to meet forecast demand over the next six years?

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[1] From: Slack and Lewis ‘The Operations Advantage’, Forthcoming

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