[MUSIC] As we discussed in the first session, scalability is the ability of a system, network or a firm to take additional work or demand in a capable and cost-effective manner. We will now show how to use the ROIC tree to predict the impact of such a growth plan on the financial value created. Specifically, the goal is to include scaling implications of your growth plan in your road tree. What is the predicted impact on other operational indicators like inventory, quality, capacity leads. If the focus demand to grow, we call these predictions, scaling laws. Here are three typical settings for which we will present a scaling law. One, what's the impact of increasing demand in product based firms on inventory holding and shipping costs? Two, what's the impact of increasing demand in service systems? And three, what's the impact of consolidating location both in service and good oriented firms? The goal of this session is not to teach you operations, but rather to expose you to important rules that have been shown to be quite robust. Your knowledge of these scaling laws is what you bring to the table and what sets you apart from uneducated intuition, which typically assumes a linear law. Here's our first law. If demand increases at a fast pace in product-oriented firms with significant fixed costs, such as shipping or setup costs when moving one product line to another, costs should increase at a slower pace. Indeed, if the firm continually optimizes its operations, it can be shown that the average shipping and inventory costs scale with the square root of the demand. This means that if demand quadruples, average shipping and inventory costs only double. This has immense benefits for firms such as Aldi and Walmart. Here is law number two. In service-oriented firms that incur significant penalties from customer delays, waiting times increase in a non-linear manner when demand increases. The important metric here is asset utilization. Rho, which is the ratio of demand over capacity and falls between zero and 100%. As demand increases, keeping everything else constant, rho increases proportionally, but waiting times increase much faster by rho divided by 1 minus rho. Say, demand increases asset utilization from 80% to 90%, which is a 12.5% growth, then waiting times increase by a factor of 125%. In other words, for this example, waiting times grow ten times faster than demand. For hospitals and small professional services that aim to offer timely response, the implication is that if you plan to offer good service level, you may need to increase your staffing level to accommodate the increased demand, even though you are not at capacity and thus have slack. Here's our third law, which is about consolidation. Consider a service provider that consolidates several locations. For example, consolidating multiple small call centers for customer services or consolidating multiple kitchens for the mafia restaurant chain, even consider a product based firm consolidating its warehouses. Here is law three. Assuming demand remains the same and is unaffected by the consolidation, then the firm is capable of offering the same service level at significantly lower cost, whether it is staffing or inventory costs. In fact, when consolidating N such facilities, the benefits scale as the square root of N. Doing so gives significant advantages to firms, such as Amazon with it's centralized warehouses, or McDonalds with it's consolidated order taking by several call centers. Armed with these three scaling laws, you can now predict how some key operational indicators, like inventory, service quality and capacity needs to scale with growth and demand. The exercises will ask you to include these scaling relationships in your rho tree, so you can perform a scaling test of your operating system and your growth plan. Before you do that, let us summarize what we've learned in this session. We now have shown how to build a ROIC map, identify the operational KPIs and prepare a detailed improvement and growth plan with milestones. These three activities are powerful ingredients to help you communicate your operational plan and its value to any stakeholder. When done right by incorporating both data and knowledge about operational scaling relationships, you have a tool to communicate the need for change coupled with an action plan grounded in operational reality. [MUSIC]
