Optimization techniques used in Operations Management and the performance of SMEs

Abstract

In this report we investigate the possible relationships among some optimization techniques used in Operations Management and the performance of SMEs that operate in the manufacturing sector. A model based on the qualitative analysis; Structural Equation Modelling (SEM) approach is used to analyze a dataset of operation management practices in a hypothetical company called Jiang Long Food Company. The model is expressed by a system of simultaneous equations and is solved through regression analysis. Taking advantage of the contributions presented by the employees of Jiang Long Food Company and the pre-existing data on production and supply chain, we focus our investigation on highlighting the importance of Operations Management practices, which shall be this firm`s performance major driver.

Nowadays, companies need to operate in highly dynamic environments where key resources are scarce and where uncertainty in business opportunities is common. The market imposes high efficiency standards and firms that fail to meet them are quickly marginalized. In such a scenario, a careful optimization of internal resources is a must for every firm which wants to maintain a competitive edge. This has to be accompanied by the continuous improvement of internal processes and routines. To achieve this aim, knowledge management and skills enhancement processes can play a major role, especially for Small and Medium-sized Enterprises (SMEs). This is because SMEs are often missing a corporate function with which to manage these processes directly, and more frequently favour a learning by doing process. The nature of SMEs can push them into being very operative and into taking ideas from practical issues in order to access information and to develop specific skills. This can cause internal knowledge to be very specialized and strongly connected to the real world; such an approach is clearly extremely important because it allows for the quick analysis and solution of operative problems and also an awareness of the knowledge gap that needs to be filled [1] [2]. However, missing expertise cannot always be acquired by bringing in new resources [3]; therefore, employee training can be extremely important, even if it is often disregarded by many entrepreneurs leading small businesses. The high level of competition in the business environment pushes SMEs towards new learning models, also considering the high value of relationship patterns. This is because SMEs frequently interact – for example with supply chain agents or with members of professional organizations and business unions – thus having the possibility to exchange knowledge and to successfully learn from one another. Moreover, SMEs can now benefit from analytical tools that were previously a privilege only for big enterprises – such as benchmarking methodologies or the diffusion of best practices. The value of a scientific approach in measuring performances and managing knowledge is now widely recognized.

Due to their nature, SMEs are primarily concerned with their core business. Accordingly, Operations Management (OM) activities should for the most part engage with firms that are part of the manufacturing sector. Operations Management identifies all the activities necessary to plan, develop and improve the business processes involved in the manufacturing of a product or in the provision of a service. We therefore refer not just to manufacturing processes, but also to all the operations related to logistics and the development of new products in the food industry basing the investigation on the data of Jiang Long Food Company. So, even if the importance of OM is sometimes neglected, especially in small-sized enterprises, a new and more careful managerial culture is now starting to come into being.

Keywords: small scale enterprise performance, Operations Management, quantitative analysis: Structural Equation Modelling.

Introduction

Jiang Long Food Company is a hypothetical company that was founded in the year 2010 by Lin Jiang, Jet Lee and Bruce Lee.  It is based in Hong Kong. This company is a small-scale enterprise that is privately held. It is a company that imports tea (and some other tea-related food and beverage products) from several suppliers abroad and markets these products to both wholesale and retail customers, primarily in Hong Kong. The idea had been hatched some years earlier when they had met with some friends and discussed the lack of high-quality tea in Hong Kong. Sensing an unmet demand, they resolved to develop a tea to meet the needs of consumers desiring high quality tea. They managed to acquire some “angel” funding and soon developed a devoted following of their brand. They developed unique packaging, including a striking set of graphics and slogans, and they were off and running.

As marketers, the founders were extraordinarily successful. Unfortunately, they were less successful as business operators. They sold the business to Robert Long in 2013. Under Robert`s ownership, more effective business practices were put in place. More effort was spent attracting wholesale business instead of direct appeals to retail customers. The wholesale market constitutes about 85% of their business.

Jiang Long Food Company has had superior growth over the last five years; this growth has caused “growing pains” in the organization structure and operations of the firm. In the “early days” Robert (the owner) made all the major decisions for the company; revenues in the very early years were shy of the $1 million mark, and most of the decisions seemed quite straightforward. Now that revenues are nearing the $25 million mark, Robert is finding that decisions and operational procedures that worked well in the past are inadequate. Jiang Long Food Company`s line of product offerings has risen sharply; the supply chain has become much more complicated and relationships with customers more difficult to manage. In addition, several high-quality competitors have entered the market in the recent years. Although profitability is still good, the company can no longer afford to operate efficiently. The specialty tea market is now crowded with competitors, with all of them attempting to grab a portion of Jiang Long Food Company`s hefty market share. Therefore, I opted to investigate the aspects of operation management practices at Jiang Long Food Company and give possible recommendations to solve the strains it undergoes as commissioned by the owner, Robert Long.

Methodology

In my investigation, I administered questionnaires to employees of Jiang Long Food Company. I also obtained financial records from the owner which I observed and analyzed. The owner of the company also organized a meeting in which I interviewed the management team in order to discuss ways in which the company could operate more efficiently.

The effectiveness of OM practices: literature review

In this section I shall briefly analyze the most commonly used OM practices meant to enhance a firm’s performance. As previously described in our introduction, we include Survey Research and also the other main empirical approaches which have been shown to have some relevance in the literature. By “OM practices” we refer to every procedure or methodological solution which is carried out on the “shop floor” and which is meant to improve the efficiency of production and logistic processes for industrial goods. Therefore, we include general approaches like the “World Class Manufacturing” (WCM) approach – which embraces detailed tools conceived to optimize workplace organization, professional maintenance and so on. More specific methodologies are also considered, such as the “Total Quality Management” (TQM) approach with regard to quality management (this approach also includes specific tools such as Statistical Process Control and Six Sigma), or the “Total Productive Maintenance” (TPM) approach, with regard to maintenance practices, or the “Just-in-Time” (JIT) approach, with regard to production operations. Other more specific methodologies, meant to address particular problems, can be important as well; among these we recall those conceived to optimize order processing, warehouse management and material management. Since Jiang Long Food Company is a Small scale enterprise, it is heterogeneous and operate in a complex and dynamic system, therefore we shall analyze the firm while following a two-step approach in the analysis:

• first, check the non-correlation between size and perceived importance of OM practices;
• second, test the relationship between the importance accredited to OM practices and the firm’s performance.

Operations

The operations of the Jiang Long Food Company are divided into five segments. These segments are as follows;

The Supply Chain of Jiang Long Food Company

My investigation of the supply chain process for Jiang Long Food Company showed that the chain begins with the sourcing of raw materials (primarily tea) in several Asian countries (Taiwan, India, Sri Lanka and Japan).  A relatively small portion of the goods are imported directly from these countries by the company; the majority of the goods are imported from Ketepa, a company located in the suburbs of Nairobi, Kenya. This company processes the teas according to proprietary specifications for Jiang Long Food Company.

However, Jiang Long Food Company is a relatively small customer of Ketepa; as such, it only produces specialized blends in batches about twice a year. More frequent production runs are considered economically infeasible by it, as each run requires Ketepa to adjust the settings on the production equipment to the proper specifications. There is substantial time and cost associated with this set up process, effectively limiting the number of runs per year. At present, Ketepa only ships to Jiang Long Food Company in container size lots; each container holds about 12,000 kilos of tea.

The Purchase orders are generated from the production facilities just outside Nairobi, Kenya. The chief of purchasing also functions as the controller of the company; although product purchases rarely vary in quality, there are times when a particular specialized ingredient for the tea blend is unavailable. In these cases, substitute ingredients need to be identified; this will occasionally result in production delays. Further, any changes in the production formula need to be cleared with the head of Sales & Marketing. This division is based in Los Angeles, however, since California accounts for the largest concentration of sales. Ketepa requires a three-month lead time from Jiang Long Food Company to deliver the orders. This lead time is established as:

1) two months to acquire/process the tea from the source, and

2) one-month transit time to Jiang Long Food Company.

In the current arrangement, some of the “favorites” (high volume tea) are produced and shipped on a regular schedule. Other products are ordered and shipped on an irregular basis. The shipments arrive from Nairobi, Kenya in large sealed bags. Upon arrival at the plant, the tea is packaged into retail-sized containers, which are then held until shipped to a retailer (and, in some cases, directly to the consumer). Typically, about two months’ worth of sales are held as inventory. However, this average inventory size masks several problems associated with inventory management. Order volume is not only seasonal, but also irregular. Although many of the retailers with which Jiang Long Food Company does business order tea on a relatively predictable basis, some of the large customers order infrequently, and these large orders (often in excess of HK$200,000 per order) are not wholly predictable. The processing plant is able to pack approximately HK$100,000 worth of tea per day (about 20,000 lbs). Although the company usually has sufficient quantities of packaged product available for shipment, they are sometimes caught “short” on large orders. In some cases, the delay caused by the limited processing capacity results in it needing to air freight orders to these customers. Management of Jiang Long feels this to be necessary since the potential loss of business to these large customers would be disastrous.

Customer Orders

As noted above, large orders (from the biggest customers) are made directly to headquarters in Nairobi. However, most of the orders are smaller, and are made by members of sales representative organizations hired by Jiang Long Food Company. It is too small a company to have their own nationwide sales force. Regional sales organizations are hired to “service” the accounts; the size of the accounts varies widely. Some are as small as $1,000/year (annual sales). The sales representatives (“reps”) receive 10% of the amount sold; payment is made to the reps upon receipt of funds by SF. The volume of sales order may be described as moderately predictable. Like any consumer product, though, there is a substantial degree of uncertainty in the order patterns, particularly in the peak order months of July through October. Orders are sent by fax, phone and via the firm’s website. The firm would prefer to have all orders sent electronically but many of the sales reps continue to use the phone or fax. When the company`s sales managers push the reps to use the website, some complain the process is “complicated”. Many of these reps have been in the business for fifteen or more years and are reluctant to change their method of doing business. The management suspects many find using the phone or fax simpler and are unwilling to make the investment in learning the web technology. It feels that some sales are “left on the table” since the sales representative organizations are of varying efficiency. Anecdotal evidence suggests that some retailers order product from competitors if the sales representatives do not make timely visits to the store. In effect, if shelf inventory disappears and no sales representative appears to take an order, the retailer will simply fill the shelf space with other items (usually from a competitor). In most cases, the retailer has limited loyalty to Jiang Long Food brand. The extent of lost sales from lack of attention is unknown, but believed to be substantial. A further complication to the company order flow and inventory management is the reluctance of most retailers to keep much inventory in house. This often results in calls from retailers, either directly or through the sales representatives, to send a shipment “yesterday”. These orders are frequent, and tend to be small. They are also irregular in their timing.

Payments

Payment terms for the company`s customers are net 30. In theory, the thirty-day time period starts at the time that an order is shipped from Nairobi. Typically, the invoice is mailed or faxed to the customer; a copy of the invoice is also sent with the physical shipment. In practice, the average collection period averages 52 days. Some smaller companies with weaker credit histories have different payment requirements. Some pay with credit cards; others must pay in cash prior to delivery. These accounts represent less than 5% of total revenues, however.

The Growth Strategy

I was requested about a year ago to commence a systematic study of the marketing practices of the firm by Robert Long (the owner of the firm). In the past year and a half, the number of tea varieties (“stock keeping units”, or SKUs) sold to retailers has nearly doubled. The company has always introduced new blends on a periodic basis, especially in anticipation of the winter holiday season. Last year, a line of green teas that appealed to a more health conscious public was very successful. However, other new product launches were less successful. A new line linked to a successful healthy snack proved to be a “bust”. Wholesale customers were also concerned about the number of stocks keeping units that the company requested them to carry. In many cases, some of the newer products were not selling well, and they were collecting dust on the shelves. This problem is especially acute in smaller retail outlets that are not well serviced by the sales rep groups. This situation is a “lose-lose” for all concerned; the firm is foregoing sales that could be generated with a better selling product, and the retail outlet has idle shelf space. In the longer run, the retail outlet is likely to eliminate some shelf space allocated to it. A second issue involved the long-standing policy of selling only to “quality” commercial customers. The owner and manager of Sales periodically received requests from “mass” retailers such as Kung Lang Ltd, Shivling Ltd, Costco Company, and Walmart to carry their product. Acquiring these new customers would boost sales substantially but profit margins would erode as these large customers would require discount pricing. Further, the firm is concerned that selling through these outlets would erode the brand image.

Pricing

In the early years of Jiang Long Food Company`s operations, product pricing appeared to have little effect on demand. The typical customer was willing to pay a higher price for the perceived higher quality. In recent years a number of competitors have entered the market and, though many current Jiang Long`s customers remain intensely loyal, this has caused more pricing pressure from retailers. With increases in materials costs, this has inevitably resulted in a reduction in profit margins. Although pricing decisions are generally associated with marketing, such decisions inevitably impact profitability. Both Robert Long and the controller have a strong desire to maintain substantial gross profit margins. Other potential financial decisions loom as well. There have been some proposals to perform more blending on site in the Hong Kong headquarters and reduce the dependence on their Nairobi supplier. Of course, this would require substantial capital expenditures as well as hiring capable staff. Further, some of the blending formulas, though developed jointly between Ketepa and Jiang Long Food Company, were “owned” by Ketepa. Formula recipes could be closely mimicked through a reverse engineering process, but this process would be costly and time consuming.

Findings

1. Lost sales due to poor customer servicing

Though there are a number of relevant factors, the motivation of external sales force members seems to be a prominent issue.  They are not employees of the company, and it is likely that many of their small customers are simply not worth the effort.  There is also a question as to whether the separation of production (Indianapolis) and sales and marketing (Los Angeles) is a problem.

1. Inventory inefficiencies

In particular, the large average levels as well as very high levels just prior to the

peak sales months of July through October.  Further, there are still occasional “stock outs” on some orders.  This occurs primarily when one of the larger customers presents a large order for a particular tea flavor.

1. Collection time

Although credit terms are a uniform “net 30” for all customers, actual receipt of payment varies widely.  The current collections systems is primarily “paper based”; the Accounts Receivable personnel attach a paper copy of the invoice to the actual shipment, and send a duplicate copy to the customer via regular mail.  The customer then sends the invoice to their Accounts Payable department, at which point the “30-day clock” starts, from the perspective of the customer.

1. Quality

The Sales/Marketing manager expressed her concern that the Purchaser/Controller would occasionally purchase cheaper ingredients than those listed on the labels.  He maintained he did this only when the desired ingredients were unavailable or unusually highly priced due to temporary supply problems.  She maintains that such substitutions may impair quality, and damage the company’s reputation.  As SF is perceived as a seller of a high quality product, she argues that the “reputational loss” in value of the brand would be substantial if competitors (or, worse, the press) were to discover the substitutions.  Privately, she is concerned that the Controller/Purchaser has incentives to focus primarily on reducing Cost of Goods sold, and is not looking at the “bigger picture”.

1. Heavy Reliance on TH

TH supplies about 80% of their finished tea.  Several members of the management team expressed concern about this reliance.  Prices were already rising due to exchange rate changes, and both the quality control manager and sales manager were quietly expressing concerns about the quality of shipped product.

1. Product Portfolio

How many products should SF sell?  A relatively small number of blends accounted for a majority of sales (a version of the “80/20” rule).  Yet the owner felt that growth required an expansion of the product line.

Possible recommendations

version of the “80/20” rule).  Yet the owner felt that growth required an expansion of the product line.

POSSIBLE RESPONSES/CONCERNS

The committee of senior staff for SF developed the following list of concerns and possible responses to

them; they felt that the solution to many of the problems identified above requires the assistance of a consultant.

1. Distribution channels. Product distribution to date has either been “in house” or through the network of independent sales representatives.  One possible change is hiring “distributors” to service customers.  Distributors typically require a 20% discount on the wholesale price, and act as dealers (as opposed to the broker function provided by the independent sales representatives).  The distributors visit stores more regularly, physically stock shelves themselves, and hold sufficient inventory to maintain the shelves.  Further, several of the retail chains to whom SF sells regularly use distributors to stock their shelves, and prefer that form of service.

2. The owner is reluctant to hire distributors for two major reasons: first, and most importantly, is the 10% “lost” margin associated with the distributors. Second, once the distributors acquire the merchandise, SF has no real control over the distribution of it.  He is concerned that it may appear in such “low-end” outlets as Walmart or Albertson’s.  Such placement may jeopardize SFs relationship with their current premium customers.  Another possibility is the hiring of additional in-house sales staff, though that is impractical for servicing many of their small customers.
3. A more integrated supply chain. Management agreed this was probably a good idea, but they lack the expertise to develop and manage such a system.  The plant manager, Felicity Hammon, expressed her concern about the company’s reliance of TH for most of the tea.  She noted their costs have been rising substantially, mostly due to the appreciation of the British pound relative to the dollar.
4. Inventory control. In addition to the distribution problems noted above, the current system of infrequent “batch” shipments from England seems inefficient.  Management would like to consider a way to solve this problem.
5. Financial payment system. Some members of the team feel that such a system could speed A/R collections from the current 52 days.  Others question whether it would be “worth it”.
6. Sales/Marketing. Was it time for a substantive review of the entire marketing plan?