The Operations Management Triangle

 

The Necessity of Trade-offs

The operations management triangle illustrates the relationships between capacity, inventory, and information. While organizations may strive for low inventory, high capacity, and an abundance of information, most fall short in at least one of these areas. Fortunately, a lack in any one of these areas can be compensated by excellence in another–this substitution concept is the premise of the OM triangle. Understanding the necessity of these trade-offs is essential for successful operations.

Inventory

In most cases, inventory reduction leads to a more efficient operation. However, as inventory decreases, the probability of experiencing a stock-out increases. Most organizations keep enough inventory to match normal demand, plus some amount of buffer inventory to cover a reasonable amount of demand variation. In other words, buffer inventory is needed to hedge against a lack of information, i.e. variation in demand, or, a lack of capacity to respond to variation.

Capacity

Like inventory, organizations should strive to have enough capacity to match normal demand in addition to buffer capacity to hedge against variability–typically this means keeping utilization between 70-85%. Having too much capacity wastes resources and ties up capital, e.g. idle machines or workers. Having too little capacity, e.g. utilization greater than 85%, can cause lead times to increase exponentially. As information increases, such as demand forecasts, required capacity decreases.

Information

It’s unlikely an organization will ever suffer from an overabundance of information. Many emerging trends in business are focused on increasing the ease of access and completeness of information. Big data analytics, the internet of things (IoT), industry 4.0, business intelligence software, and machine learning are all driven by information. While different organizations have different strategies regarding customer demand, all strategies should aim to match demand as close as possible–not to exceed or fall short of demand. To perfectly match demand would mean having total knowledge of how much inventory or capacity is required at any given time. While such knowledge is impossible to attain in most cases, the relationships illustrated by the OM triangle reveals that a lack of information can be substituted for additional inventory or capacity. The compounding effect of a lack of information within a supply chain is often illustrated by the bullwhip effect, in which the variation of customer demand drives increasing variability in demand up the supply chain from the retailers, wholesalers, distributors, manufacturers and raw material suppliers.

Sources

Lovejoy, W. S. (1998), Integrated Operations: A Proposal for Operations Management Teaching and Research. Production and Operations Management, 7: 106–124. doi:10.1111/j.1937-5956.1998.tb00443.x

Kingman, J. (1962). On Queues in Heavy Traffic. Journal of the Royal Statistical Society. Series B (Methodological), 24(2), 383-392.