Operations Management Issues at ABC Manufacturers - Term Paper Example

Operations Management Issues at ABC Manufacturers I. Introduction A. Understanding Solar Water Heaters Flat plate collectors 2. Integral collector-storage system 3. Evacuated tube solar collector 4. Active systems 5. Passive systems II. Strategic Analysis A. Market Considerations 1. Lack of experience 2. Competition cost of entry 3. Market maturity III. Operations Modeling A. Issue I - Inventory Ordering 1. Total Cost method 2. EOQ method 3. Recommendations B. Issue II - Market Share Under a Market with Increasing Competition 1. Increased Future Competition 2. Market share Matrix 3. Recommendations C. Issue III - Outsourcing vs. In-House Component Production 1. Preliminary cost comparison of both options 2. Recommendations IV. Conclusions and Recommendations A. Cautions B. Former owner still in charge C. Problems with change management D. Recommendations V. Appendices Operations Management Issues at ABC Manufacturers ABC manufacturing is a southwest Florida manufacturer of solar heating systems for domestic hot water and swimming pools. A pre-purchase assessment of ABC reveals a turnkey firm that retails directly to consumers. Due to recent health issues, the owner of ABC Manufacturers wishes to sell the business. The current owner has offered his services as a contract employee for one year after the purchase. An accounting analysis of ABC Manufacturing reveals that the asking price is at a 20% discount to the fair market value. The ROI is at 30% after taxes, based on the asking price. It is expected that these numbers could be even higher, based on preliminary marketing projections. However, ABC has several operational issues that need to be addressed prior to the purchase. The following will discuss these operational issues and will outline a plan for rectifying them. Understanding Solar Water Heaters In order to perform a proper assessment of the market and opportunities that lie in the Solar Hot Water Heater market, it is important to gain an understanding of how they work and the various types that are available on the market. Solar hot water heating systems include storage tanks and solar collectors. Compared to other types of hot water heating systems, they pay for themselves overtime as the customer saves money by not purchasing an alternate fuel source. Solar systems use solar energy from the sun, which is free. The initial cost is paid back over time, after which the cost for the unit is free, other than for repairs. The decision to install a solar hot water heater has a high initial cost that represents a longer-term investment in which its payback is sometime in the future. There are three different types of collector systems for solar water heating units. The first type is the flat-plate collector, which consists of a weatherproofed, insulated box. Inside the box is a dark absorber plat that is under one or more glass or plexiglass panels. The absorber plate itself can be either metal or polymer. The integral collector-storage system has one or more black tanks or tubes in and insulated glazed box. In this system, the solar hot water heater acts as a pre-heater, warming the water before it passes through a conventional system. The third type of solar water heater is the evacuated-tube solar collector. This type of system uses parallel rows of glass tubes. These tubes contain a glass outer tube and a metal absorber tube attached to a fin. The fin absorbs solar energy, but prevents radiant heat loss. The evacuated-tube system is used in a commercial setting. Most residential systems are either the flat-plate collector type, or the integral collector-storage system. Circulation systems can be either direct or indirect systems. The direct system pumps water through the collectors and into the house. They are used in climates that do not experience freezing temperatures. The indirect heating system circulates non-freezing heat-transfer fluid through the collectors and heat exchanger. The water then flows into the home. These units are more popular in climates where freezing temperatures occur. Passive systems are typically less expensive than active systems, but they are less efficient. They work best for houses that need more hot water during the daytime and in the evenings. The thermosyphon system works on the principal that cold water sinks and warm water rises. This type of system cannot be installed in every situation, as they involve placing a large storage tank on the roof. Solar water systems often need a backup for cloudy days or when there is an increase in demand. Backup systems may be in the form of conventional water heaters or a tankless (instantaneous system). There are several factors that will help to determine what type of system is best for a household's needs. The first consideration is economics; this is expressed in terms of how much money is saved, as compared to conventional water heating solutions. The amount of sun that the site receives is another important consideration. Much of Florida receives adequate sunshine for these types of units because they do not experience freezing temperature. Other considerations include the system's overall costs, determining the correct size of system and any local codes or regulations that may apply (US DOE, 2008). Strategic Analysis The opportunity for a turnkey business is exciting, particularly one that offers financials as gleaming as those expressed by ABC Manufacturing. Although, the capital is readily available without going into debt, and the opportunity for not only revenue, but the profit also sounds enticing, there are other considerations that must be carefully examined. The following factors will explore the three most prominent issues surrounding the purchase decision. Market Considerations The first issue that must be addressed is my lack of experience in the solar heating industry. I have experience as a hedge fund manager and manufacturing represents a new career, especially in a specialized field such as solar heating. ABC Manufacturing is a highly technical business in a highly specialized field. The alternative energy sector is lucrative right now, particularly after President Obama's promise to support future development in the area. However, one must be concerned about the eventual flood of the market and competition due to the lucrative nature of the field. The costs of entry into the alternative energy industry are high. Manufacturing of components or complete units requires an intensive capital outlay and expensive equipment. In addition, alternative power represents a highly technical field and one must be able to pay for and maintain highly trained staff. In fact much of the technology being implemented is relatively new and the technology is in a rapid state of improvement and maturation. As technology becomes obsolete quickly and staff will need to continually upgrade their skills and knowledge to be able to keep up with the market. In terms of the age of the market, the alternative energy field is in the early stages of the market cycle. This means that over the next several years, one can expect the entry of many competitors into the field. Demand will continue to increase as a result of increased persuasion of the American public that we need to turn to alternative energy choices and decrease our dependence on foreign fossil fuels. The market will eventually mature and begin to level off, but that could take years to see. In fact every new or existing home represents a potential customer, particularly in the sunbelt, where the sun's energy is in continual supply. The market for alternative energy products is lucrative, but as with any newly emerging industry, it poses many potential risks. In order to evaluate the situation realistically, a quantitative modeling approach will be used to address the three most pressing issues regarding the decision to purchase the manufacturing facility. Operations Modeling The key to success for any business that wishes to deliver a quality product to the customer while maintaining that competitive advantage is effective operations management. Quantitative modeling can play an important role in the decision-making process. The following will outline three operational management issues that will affect the ability of ABC manufacturing to meet or exceed the promised expectations. Due diligence revealed several important factors that will have an impact on the ability of ABC manufacturing to retain its high earning potential. The products include three different product lines: domestic hot water systems and solar pool heaters. Some customers want both solar pool heaters and domestic hot water heaters. However, these two phases of the operation are treated as if they are separate departments. Therefore, those customers who wish both types of systems will count as one sale in each department. An audit of the accounting books reveals several important factors in the operations. The first and most important factor is that the company has only been in business for one year. No long-term averages or trends are available. The sales were seasonal and peaked during the months of October and November. This seasonality could be expected to continue, particularly for the pool heater sector. The closed loop domestic hot water system sells to the consumer at a retail price of $5,000 including installation. The swimming pool units are a similar closed loop system and sells for the same price. Issue I - Inventory Ordering An examination of the demand and costs necessary for both models of solar water heaters is based on the assumption that reliable data was provided by the previous owner. Every day, the company is able to produce 10 units of residential heating units. The costs of producing these units, including purchased goods, are $50 and an ordering cost of $9. The holding cost rate is 24% of the item's cost. The company works for 240 days a year. The lead time for producing the units is 4 days. The daily demand for units is 10 units per day. As one can see, supply is equal to demand in this case. Currently, the owner uses the Total Cost (TC) method for determining the reorder level for components. This means that the company orders once per month. The owner chose this method for convenience. Under the Total Cost method, ABC ordered only 12 times per year. They will order enough for 200 units per order. When we calculate the Total Inventory Costs using this method, the total costs for ordering is $1308 (see Appendix I). Let us see what happens when we calculate the ordering cycle using the EOQ method. Using this method, the reorder level for components is 40 units. As one can see the current rule is to order 60 batches of components when the inventory level falls to 40 units. This equals an annual inventory cost of $720 per year. The number of units produced in a year will be calculated at 10 units per day for 240 working days per year, which equals 2400 units. This equals a cycle of 6 days. The problem in this case is that 200 units have a much higher holding cost than 60 units. Using the Total cost method, rather than the EOQ method is costing the plant close to $588 dollars per unit. It is suggested that the company switch to the EOQ method for deciding when to order new components and how many to order, this will significantly decrease their operating costs per unit, translating into an additional profit amount. Issue II - Market Share Under a Market with Increasing Competition As mentioned earlier in this analysis, the alternative energy industry is in a rapidly changing market situation. It is early in the market maturation cycle and therefore, it can be expected that additional competition will enter the marketplace quickly over the next several years. Currently, there are three companies producing solar heating products that are similar to those produced by ABC manufacturing. We discussed differences in solar heating technology. The other competitors offer different technology at different prices than ABC manufacturing. However, once a unit is installed into a home, it is unlikely that the owner will switch brands. Currently, the market share between the three companies is unequal. ABC currently maintains 30% of the total market share, Florida Solar maintains 20% and Solex maintains 50%. Assuming a market equilibrium condition at some future time, the potential flow of customers between the existing groups of competitors in southwestern Florida is displayed in Figure 1 below. ABC Florida Solar Solex ABC .6 .2 .2 Florida Solar .1 .6 .2 Solex .3 .2 .6 1.0 1.0 1.0 The illustration is Figure 1. does not represent market conditions as the market continues to grow and change in the first several years. In essence this chart represents a theoretical market condition using the current competition in the field. Therefore, it is not known how many competitors will choose to enter into the marketplace or what their impact on ABCs market share will be. As customers flow to other companies, it will have an impact on the ability of ABC to maintain its place in the market. The above chart illustrates the drop in market share, as customers will be enticed by the units produced by competitors. In order to maintain their market share in the face of increasing local competition, it is important that ABC gets to know their customer's wants and needs more intimately and understand what they consider value. When ABC began producing its solar water heaters, it was the only local company that produced them. Their instant success enticed other competitors to enter the marketplace. This is expected to be an increasing problem in the future. ABC must take action to protect their market share, they must look at any distinct competencies that set them apart from the competition. They cannot rely on their position as the first producers or automatic increases in the customer base. In order to protect their market share and retain their position in the market, ABC needs to conduct surveys and research to determine such elements as what their customers are looking for and how much they are willing to pay for it. In addition, they need to conduct a survey regarding the satisfaction levels of their current customer base. Current, satisfied customers are an essential source of future sales through personal recommendations. ABC needs to assess their current level of customer satisfaction and make any necessary changes that are indicated by the survey results. ABC is obviously doing something right; otherwise they would not have the impressive return on their investment that they have experienced in the past. However, they will not be as likely to maintain that level, as competition increases in the future. They need to assess what they have done right in the past, as well as what they may need to improve. Getting to know the customer more intimately is a necessity for the successful company, just as much as it is for one that is new to the market or struggling. Issue III - Outsourcing vs. In-House Component Production ABC manufacturing deals directly with raw materials suppliers in its operations. It handles all of its production in-house, as well as distribution to the final consumer. They have a staff that is responsible for the installation of all units. One of the most complex issues in operations management is how to operate a business more efficiently and efficiently but while continuing to maintain that competitive advantage. It is admirable that ABC has control over every step of the process from a quality standpoint. However, as a potential buyer, one must ask if this is the most economical and efficient solution to the supply chain. The supply chain for ABC Manufacturing has few elements. Component raw materials are ordered, parts are produced, assembled, and distributed directly from their manufacturing facility. Sales are handled by an internal sales staff, as are phases of the installation. Centralized operations can incur high overhead costs as well. The option to outsource some areas of the business may be a more cost effective solution than the total in-house approach that was used by the former owner. Nearly any business activity can be outsourced, but it is important that one identify the correct areas to outsource or major problems will occur. The best model for deciding whether to perform services in-house or to outsource them is to perform a direct comparison of the two options by calculating the net savings of the outsourcing of an activity. The following analysis will compare the costs of outsourcing with the complete in-house system that is currently being used. Cost Comparison In-House Component Production Cost Outsourced Component Supply Cost Staffing Costs Absorbed by ABC and reflected in operating costs Staffing Costs Absorbed by Supplier, may be reflected in slight price increase for finished component Transportation Costs Absorbed by ABC and reflected in operating costs -results in extra staff to carry out this function Transportation Costs Absorbed by Supplier, may be reflected in slight price increase for finished component Extra Equipment Costs Additional Overhead in personnel, equipment, electricity, insurance, repairs etc. Extra Equipment Costs Absorbed by Supplier, may be reflected in slight price increase for finished component This chart does not reflect actual costs, only the types of costs that would be transferred to other entities if they were outsourced. Actual costs would have to be obtained from potential suppliers. However, it is difficult to make the case for complete in-house component production. There are many hidden costs associated with carrying out operations in-house, as compared to outsourcing them. The current owner will not even consider outsourcing as an option, citing the cost saved by not having to pay for the components. However, from an operational standpoint, the initial cost of the item is only the beginning of the costs involved with producing components in-house. If the decision to purchase the business is made, the options regarding outsourcing will have to be further explored. Implementation plan In case of issue 1, the above discussion has proved that the company definitely needs to shift from TC method to EOQ method. There is cost benefit involved which is one thing. The inventory storage, breakage and management issues are also reduced by shifting to EOQ method of inventory purchase. This needs active staff members which can keep a close eye on the available shelf and storage space and keep on ordering accordingly. The calculations made above clearly show that the sales are quite homogeneous all through the year and for the 240 days the firm operates; there can be one implementation plan which can help the company save a lot by switching to EOQ method. Necessary resources required in this case would be first of all an efficient inventory management who is familiar with EOQ method and strongly believes in its benefits. He needs to understand the cost benefit analysis as done in the explanation of this issue above. Rather than purchasing the unit once per month, it is better to purchase inventory on EOQ method and in that case the inventory manager needs to understand the requirement of inventory purchase properly. The company saves a lot if it orders in smaller batches of 40 or 60 units as storage costs are reduced. The inventory supervisor or manager needs to order inventory every week, or every 6 days to make sure the extra cost on inventory storage is reduced. Every week inventory order or on need basis may add a little work, but it reduces cost over all. As far as the second issue is concerned, it is important to have a research and development department in place as soon as possible. No manufacturing firm can survive the effects of changes in your market share without an active research and development department. The implementation to manage this issue should be to have a research and development team who is dedicated towards market testing and test marketing, as well as producing reports of probable future customer behavior trends. With the increase in competition, it becomes important for all firms to highlight their positive points. Here comes proper advertising and marketing campaigns to help you out of this situation. Thus it is important at this stage to build your advertising campaigns for promotion and retaining your market share by having loyal customer base. That is only possible through research, and by supporting your advertising and marketing campaigns through facts. Research and Development department should be forward looking, and the people responsible to make judgments about future market trends need to understand the existing market structure very well. Hiring few people for this purpose may appear to be a short term cost, but the benefits the company could reap by having such an efficient department in place would be quite long lasting. As far as the third issue is concerned, the modern concepts in operations management believe strongly in out sourcing. It is better to specialize in producing one thing rather than being a jack of all and master of none. If the company has a good operations management department, it is an easier and cost effective thing to let some out sources firm work on producing the by parts and from there ABC firm can produce the finished stuff and sell it. This will not only reduce the over head costs of maintenance of the plant but will also reduce issues like storage of work in progress inventory and staff management. Apparently it may seem as if out sourcing increases costs for you, but you get a lot of benefit by sharing your load. The best way here would be to have a proper plan chalked out for out sourcing. The tasks which are independent of each other while you manufacture one unit in this plant can be out sourced. Final assembling should be done in this plant so that quality assurance is there. By taking these steps the firm will be able to have better inventory, operations and cost management as well as being able to retain a good market share. Conclusions and Recommendations An analysis of the market potential and possibilities that lie within the alternative energy industry are promising. However, when one looks at ABC Manufacturing from an operations perspective, several key issues arise. The first is that the current manager, although it appears that he is receiving a considerable return on his investment, one must remember that he is also in a position where he feels that he must make a quick sale. An examination of his operational modeling revealed several issues that need to be resolved if the decisions to purchase the business is made. These issues raise questions as to the methods used for calculation of these promising figures. Thus far, ABC Manufacturing has demonstrated a promising portfolio, but one must also be aware that market conditions in the alternative energy sector are rapidly changing, ABC Manufacturing will inevitably face increasing competition in the coming years. They need to focus on the customer and get to know them better, if they wish to survive. These are not factors that were considered by the former owner of the company. The former owner is proud of the fact that he offers a complete turnkey operation and that all components are made in-house. However, upon closer examination, there are many hidden operating costs associated with complete in-house production. It may be an issue of protecting the patents and protection of proprietary information that is the driving factor in this decision. However, the underlying issues need to be explored further if the decision to purchase the company is finalized. The potential for growth is great for ABC Manufacturing, but there are also many risks as well. The former owner cites health problems as his key reason for wishing to sell the company. His offer to stay around on a contractual basis appears to be a nice gesture. However, due to the operational issues found through this analysis, one must consider that this may have a negative impact from a change management perspective. The former owner will continue to be an influential personality in the company, simply because he will be culturally recognized as "the boss." He may be resistant to the necessary operational changes, which may create turmoil within the organization. Although, he will officially turn over operations to the new owner, he will still have a strong cultural connection and influence with the other employees. If he stays one as anything more than an occasional consultant this would inevitably be the case. This aspect will also have to be further addressed before a definitive purchase decision can be made. In the final analysis, there are still many issues that need to be resolved in order to decide if the potential gains that exist in ABC manufacturing are worth the potential risks. This report gave an overview of the industry and the market. It also explored specific internal issues that were found within the operational models of the company that raise concerns over the accuracy of the information provided. A further examination of company financials will be in order to determine the accuracy of claims made. The decision of whether to purchase, or not to purchase ABC manufacturing is a big decision, placing a large amount of my personal assets at risk. The next step that needs to be implemented is a further investigation of the issues raised in this study. Only when these issues have been resolved and answers have been found can the process of making a commitment begin. Read More