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Chapter  2  
Profitability

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 Chapter  Overview 

Chapter 2 focuses on an important, if not the most important, goal of any business--profitability.  Effective management of operations is a critical prerequisite to profitability because of the vast amount of resources that fall within operations.  A quick examination of the three most common profitability measures shows that profitability is measured as a ratio of net income to sales, net income to total assets, or net income to total equity.  They serve as a measure of the productivity of the money invested in sales, total assets, or total equity by showing the relationships between net income (our output) and these inputs.  In Chapter 2 the link between operations resources (inventory, employees, capacity, facilities, and customer relationships) and profitability is examined. Local productivity measures for these resources have direct implications for the global profitability measures.  In addition to the impact operations has on profitability through these resources, which is an impact on the denominator of the ratio, operations also plays a critical role in determining net income--the numerator. It accomplishes this through the creation of value, which determines what customers will pay for products and services.

 

Chapter Resources

Esources 
Esource   2.1 The discussion of EVA in Chapter 2 provides a brief overview to this progressive approach to profitability measurement.  Hughes Software Systems is committed enough to using EVA that it wants its investors to know about it and adds a statement regarding it in it's annual reports. 
Esource  2.2 The balanced scorecard, discussed in Chapter 2 provides a multi-factor productivity measurement approach that deals with quantitative and nonquantitative performance measures.  The Balanced Scorecard Institute  provides a wealth of information, from the basics to advanced, on this important and popular approach to performance measurement.

Reel Operations Video Clips 
Reel Operations  Video 2.1 The effective use of equipment is critical for an acceptable financial return on investments.  High utilization and efficiency measures, for example, are important for capital intensive companies.  Reel Operations Video 2.1 examines a steel mill and how it used technology to increase productivity of its expensive investments. In Nucor Steel: Technology Advancements Improve Productivity and Profitability of Resources we get a tour of exactly what technological improvement can mean for resource productivity.

Interactive Models 
Interactive Model 2.1 

Breakeven Analysis Interactive Model
This interactive model provides an opportunity for exploring the interactions among variables in a Breakeven Analysis of three alternative investments.  Breakeven analysis, introduced in Chapter 2, provides a way to compare the total cost curves for alternative resource investments, and make decisions based on projected fixed and variable costs. 

Excel Tutors 
note: network users may see a dialog box requesting "Please enter your authorization information." Just click "cancel" and your browser will automatically load Excel.
Excel Tutor 2.1 Excel Tutor 2.1  Using Excel Spreadsheets for Average Inventory Level Calculations
Excel Tutor 2.2 Excel Tutor 2.2  Using Excel Spreadsheets for Computing Productivity Measures
Excel Tutor 2.3 Excel Tutor 2.3  Using Excel Spreadsheets for Computing Utilization
Excel Tutor 2.4 Excel Tutor 2.4  Using Excel Spreadsheets for Computing Efficiency
Excel Tutor 2.5 Excel Tutor 2.5  Using Excel Spreadsheets for Breakeven Calculations

Supplementary Readings 
Supplementary 
Reading 2.1		 In "How to Reach John Q. Public" March 26, 2001 some conclusions of the dot-com fallout are discussed.  A key issue brought out is the importance of profitability through the management of costs, value for customers, and diversification of revenue sources.
Supplementary 
Reading 2.2		 For text page 15.  Read "Siemens Climbs Back," Business Week, 6/5/2000.  Siemens appears to be on a rebound, through cost-cutting and other productivity improvement efforts. This article provides an excellent case study of one firm's efforts to turn cost reduction and productivity improvement into enhancement of the bottom line. 
Supplementary 
Reading 2.3		 In "Make Your ROI 'Add Up'", Quality On Line, August 2000, several operations issues are linked to ROI and measures of profitability. A key theme running through the article is the various considerations that must be made when making large capital investment decisions, such as those required for equipment purchases. Making sure the new resource will enhance profitability is critical. The article provides several guidelines for this effort. 

Links to Operations On Site Companies
Operations On Site 2.2 Adobe's products provide a variety of capabilities for website designers. Check out Adobe's product variety at its website.

 

OM Exploration for Chapter 2

Check it Out: Internet Reference Sites 
The "Check it Out" websites offers several examples of reference sites. First, sites devoted to a closer look at two increasingly popular techniques-- EVA and the Balanced Scorecard--are provided. They offer more detailed discussions as well as examples of use. In addition, resource-specific sites are provided as a starting point to further exploration into specific topics of resource research.
 EVA.com Economic Value Added for Small Businesses
The Balanced Scorecard Institute U.S Foundation for Performance Meaurement

OM in Action 
OM in Action 2.1 The Stern Stewart website provides an excellent discussion of EVA at What is EVA?.  They also provide success stories of EVA implementations. Compare and contrast the emphasis placed on EVA by two firms from their list.  Select from Herman Miller, SPX, Guidant, or Oppenheimer Capital.
a. Explain the approach used by the two firms you selected. Does each approach to increasing profitability with the EVA focus make sense?  Why? or Why not?  
b. From each firm's perspective, how does EVA enhance decisions made on the operations decision areas of  inventory, employees, capacity, and facilities?

Online Business Tour 
Online Business Tour 2.1 As discussed in Chapter 2, a key to profitability is getting a sufficient return on expensive resources. This is particularly true with production equipment used in manufacturing processes. Volume must be sufficient to warrant the large investment in equipment.  More sophisticated equipment often replaces labor, reducing labor costs, and adding to product consistency, but it may also reduce the value added by experienced craftsmen and artists. Guitar production provides an excellent example of manufacturing that must maintain a balance between sophisticated machinery needed to maintain production volumes and quality and the craftsmanship and knowledge possible only in hand-work.  Rickenbacker, a guitar producer,  provides an excellent example of this phenomenon.   Take the Rickenbacker Factory Tour.
a. Which production processes have been mechanized or automated?  
b. How do the mechanized and automated processes improve profitability? Which processes do you think were mechanized to reduce costs? Which were mechanized to improve product quality? 
c. Which production processes have been left to be completed by hand by skilled craftsmen?. How does the handwork add to the value of the finished product?

Letter from the Top 
Letters from the Top 2.1 TI has long been associated with the production of computer chips utilized throughout the world. More recently, their production of programmable digital signal processors (DSP's) have placed them in an excellent position as a supplier of chips used in a huge spectrum of products, including wireless phones.  Consistent with the discussion of Chapter 2, in TI President and CEO Tom Engibous' letter, profitability is, not surprisingly, a theme.  Read Texas Instruments' Letter to Shareholders in the 1999 Annual Report .
a. From the 1999  letter, describe how the operations decision categories of inventory, employees, capacity, and facilities enter into TI's plans for continued profitability expansion.  
b. Do you believe TI focuses on resources as a means to profitability? Provide some specific examples that justify your answer.

TI's profitability changed drastically between 1999 and 2001. Read the 2001 Letter to Shareholders.
c.  Rather than continue to expand profitability, the 2001 letter discusses how profitability will be regained. In this phase of a business cycle, what plans does TI have for changing its resources in order to once again be profitable?

Putting It All Together:  A Virtual Case Study 
Putting it all Together 2.1:
 Amzon's iimprovement in financial performance has resulted from a two-pronged attack on productivity--increasing the numerator and decreasing the denominator. In How Amazon Cleared the Profitability Hurdle, Business Week, Feb. 4, 2002, Amazon's attainment of positive operating profit is described.  CEO Jeff Bezos provides his perspective in the 2002 letter to shareholders.  Visit the Amazon.com website. 
a. Describe how Amazon.com uses technology to increase profitability from cost reduction and value enhancement perspectives.
b. What do you think is the contribution made by Amazon facilitating customer sales of used products? Does this increase profit? Or does it actually reduce new product sales? Explain your answer.

Additional Reading
Additional Reading 2.1 KPMG's Brave Leap into the Cold, BusinessWeek, May 21, 2001. KPMG goes public and discovers how things change when it sells shares.