Ch.2 – The OM Blog by Heizer, Render, & Munson

OM in the News: The Case of the $6.75 Bangladeshi Shirt

The recent tragedies at several Bangladeshi garment factories have claimed over 1,000 lives—and focused international attention on this important industry. So far, much of the discussion has focused on Bangladesh’s minimum wage law–the average garment worker gets take-home pay of $70-$80 per month. But The Wall Street Journal (May 17, 2013) raises the question of how that minimum wage is being paid.

While the worker is sewing, on another floor of the same factory building negotiations are under way between the factory owner and a retailer’s rep. The factory owner is offering a shirt to the buyer at $6.75 per piece. Of that, the owner will spend $4.75 buying the 1.9 yards of 100% cotton with a fine 50s thread count, and another $1 buying the labels, accessories and other components the retailer specifies. The remaining $1 per shirt funds the “cutting and making,” which includes wages for the workers. Part of it funds the letters of credit the manufacturer will use to ensure a steady supply of raw materials. Part of it goes toward capital expenses–and part will become the manufacturer’s profit.

An order for 400,000 shirts typically means that 400 workers produce 3,077 pieces per day. The wage cost works out to about 38 cents per shirt. Another 15 cents goes to sending the shirt for a fine washing spin. Rent and utilities for the factory floor works out to about 11 cents per shirt, and head-office and marketing costs for the factory are 11 cents.

The remaining 25 cents may cover repaying a 10-year bank loan at 18% interest, which the factory owner has used for set-up costs. All is at a delicate equilibrium, writes the Journal, until the owner feels compelled to give in to a firmly worded request from the retailer for an additional discount, or a demand to air-freight some boxes of shirts that suffered a 2-week production delay.

Discussion questions:

1. If the cost of upgrading factory safety averages $128,000, where should the money come from?

2. How do students feel about paying more for clothes to help raise the living and safety standards in the country making the product?

OM in the News: Japan’s Inability to Fire Workers

Th japan oecd e Wall Street Journal (May 11-12, 2013) provides an interesting insight into Japan’s weakening international competitiveness that will make for a good class discussion when you cover Chapter 2, “Operations Strategy in a Global Environment.” Japanese Prime Minister Shinzo Abe has quietly put aside plans to overhaul a rigid labor system that is blamed for many of the woes facing once-dominant Japanese corporations.

A government study estimated that businesses maintained 4.6 million jobs that were actually unnecessary. And with few mid-career job changes, there is little opportunity for entrepreneurship. Japan’s corporate start-up rate is the lowest among Organization for Economic Cooperation and Development (OECD) countries. “Japan should move toward a more flexible employment and wage system that is based more on ability rather than age to encourage productive workers to remain employed,” an OECD report states. “Labor mobility would help to foster start-ups,” says one Japanese professor. “New businesses won’t be created unless human resources are set free, but big corporations are trying to prevent their workers from being free.”

The workforce at Japan’s largest corporations is one of the most inflexible among developed nations, with a tradition of lifetime employment, a low participation rate among women and strict labor laws. These have combined to make it difficult for companies to shed excess workers, because of the legal issues it would raise and the cultural issues involved. As part of their role in society, corporations have been expected to help ensure full employment.

At least seven Japanese electronic manufacturers still produce flat-panel televisions, almost all at a loss. However, some industry executives have said privately that they don’t pull the plug on the unprofitable business because they would need to find other jobs within the company for those TV employees.

Discussion questions:

1. Compare US and Japanese labor laws.

2. What can Japan do to increase its manufacturing productivity?

OM in the News: Manufacturing Makes Its Comeback

“Made in the USA is making a comeback,” writes Time (April 11, 2013). The U.S. has seen its manufacturing growth outpace that of other advanced nations, with 500,000 jobs created in the past 3 years. It marks the first time in more than a decade that the number of factory jobs has gone up instead of down. Apple just decided to assemble one of its Mac computer lines in the U.S., and Walmart, which pioneered global sourcing, said it would pump up spending with American suppliers by $50 billion over the next decade. Airbus will build JetBlue’s new jets in Alabama.

U.S. factories increasingly have access to cheap energy thanks to oil and gas from the shale boom. For companies outside the U.S., it’s the opposite: high global oil prices translate into costlier fuel for ships and planes. And workers from China to India are demanding and getting bigger paychecks, while U.S. companies have won massive concessions from unions over the past decade. One economist went so far as to say: “The offshoring boom does appear to have largely run its course.”

Modern factories, though, have more machines and fewer workers — and many new manufacturing jobs require at least a 2-year tech degree to complement artisan skills such as welding or milling. Some experts believe it won’t be too long before employers will expect a 4-year degree. “Manufacturing is coming back, but it’s evolving into a very different type of animal than the one most people recognize today,” says a McKinsey director. “We’re going to see new jobs, but nowhere near the number some people expect, especially in the short term.”

Still, manufacturing represents a whopping 67% of private-sector R&D spending as well as 30% of the country’s productivity growth. Every $1 of manufacturing activity returns $1.48 to the economy. “The ability to make things is fundamental to the ability to innovate things over the long term,” says one Harvard prof.

Discussion questions:

1. Why will the US never recover all of the manufacturing jobs lost in the past 50 years?

2. What factors create more opportunities for “reshoring”?

OM in the News: Japan Ascends From Parts Supplier to Plane Maker

Japan’s golden era of aviation, with its feared Mitsubishi Zero fighter planes, ended in 1946 when American occupiers allowed that nation to manufacture only parts for American military jets. But this year, reports The New York Times (April 10, 2013), Mitsubishi plans the first flight of its Regional Jet, a sleek, 90-seat commercial plane that is Japan’s bid to break into the industry’s big leagues after almost 70 years. Mitsubishi’s comeback was abetted in large part by Boeing’s outsourcing more of its aircraft manufacture to overseas suppliers. As Boeing came to rely on foreign contractors, Japanese manufacturers moved in, designing and supplying some of the jet’s most vital sections.

Over a third of Boeing’s new 787 Dreamliner is supplied by Japanese manufacturers, including Mitsubishi, which makes the jet’s carbon-fiber composite main wings. Japanese suppliers have played an increasingly bigger role in building Boeing aircraft, supplying 15% of the older 767 jet and 21% of the 777. The Japanese government is one of the largest financial backers of these parts projects, handing out billions of yen (about $1.6 billion) in subsidies to help Japanese suppliers develop technology and win lucrative contracts from Boeing. These Boeing contracts have kept tens of thousands of Japanese workers busy for years, and still account for about 40% of jobs in the industry. And in a cozy quid pro quo, Japan’s biggest airlines have for years bought their planes almost exclusively from Boeing — an unusual practice among global carriers.

Mitsubishi has 165 firm orders for the $42 million jet, and it aims to secure as many as 5,000 orders over the next two decades — a goal some experts dismiss as unrealistic. It faces well-established rivals like Bombardier (Canada) and Embraer (Brazil), while the Russians and Chinese are also making jet inroads.

Discussion questions:

1. Did Boeing make a mistake in outsourcing so much of its planes to a future competitor?

2. Why did Boeing outsource over a third of the 787 to Japanese firms?

OM in the News: A Toy Maker Comes Home to the U.S.

As every American child knows, toys come from the North Pole or—more likely—China. But as The Wall Street Journal (March 11, 2013) writes, Philadelphia’s K’Nex Brands is trying to prove they can still be made in America. Over the past few years, K’Nex has brought most of the production of its plastic building toys back to its U.S. factory from subcontractors in China. To make that possible, the company has redesigned some of the toys and even handed over to kids a bit of the assembly formerly performed by hand in China.

“In the long-term, it’s much better for us to manufacture here,” says the chairman of K’Nex. By moving production closer to U.S. retailers, K’Nex said it can react faster to the fickle shifts in toy demand and deliver hot-selling items to stores faster. It also has greater control over quality and materials, often a crucial safety issue for toys (see the Ethical Dilemma box in Chapter 5). And as wages and transport costs rise in China, the advantages of producing there for the U.S. markets are waning.

But K’Nex has found it impossible so far to produce 100% U.S.-made toys, the firm’s goal. The K’Nex experience shows both the attractions of “reshoring” production and the difficulties of making that happen in a country whose manufacturing infrastructure has atrophied. Lining up suppliers has been a complicated chore in the U.S., where toy-making skills have faded. China, by contrast, has a vast, efficient network of suppliers and skilled labor. “In China, you can go over with just a drawing and say, ‘I need a million of these,'” says K’nex CEO. That helps account for a huge U.S. deficit in the toy trade. In 2012, U.S. imports of toys, games and sporting goods, mostly from China, totaled $33.5 billion, or 3 times U.S. exports of such items.

Discussion questions:

1. Why is reshoring difficult?

2. What re-engineering changes were needed to make it more feasible to manufacture here?

OM in the News: China Holiday Roils Factories

Chinese migrant workers at Beijing RR station

Florida toy maker Laser Peg Ventures works with three different factories in China. Each year, about 25% of the workers there don’t return after the Chinese New Year holiday. Last year, the company received its orders 45 days late because of the holiday, meaning hundreds of thousands of dollars in missed revenue.

Every year, millions of China’s 250 million migrant workers leave their factories and travel across the country to visit their families at home, writes The Wall Street Journal (Feb. 21, 2013). The problem is that fewer and fewer workers are returning to the factories when the break is over. Guangdong Province estimates that 10 million workers, or 61% of the province’s migrant-labor pool, would head home to see their families for the New Year Holiday, with a return rate of around 90%, leaving a labor shortfall of 1.2 million workers after the holiday.

For the world’s manufacturers, post-holiday no-shows are an increasingly frustrating part of China’s tightening labor market. The trend reflects rising expectations among China’s workers, who are seeking out higher pay even as they show less inclination to work in factories. Many workers use the break to look for new jobs or start families. In 2010, 34% of rural migrant workers left their factory jobs to move back home.

The exodus is putting a kink in a long supply relationships. For years, American companies have worked closely with Chinese factory owners to improve production times and reduce error rates. Now, changes in China’s labor patterns are setting back that progress. The New Year exodus typically forces factories to rush to hire new employees, which often creates quality-control issues. Following the holiday last year, apparel maker Jordache found loose seams, holes and other problems, which meant goods had to be resewn or made over. The developments have American companies scouring other countries for factory sites.

Discussion questions:

1. Why is the Chinese holiday a concern to US operations managers?

2. What can American companies do to compensate for the post-holiday problems and shortages?

OM in the News: Dreamliner Woes Test Boeing’s Corporate Ties in Japan

In the Global Company Profile that opens Chapter 2, we note the important and growing role Japan suppliers have played in Boeing’s 787. But the well-discussed woes of the Dreamliner (see The Wall Street Journal, Jan.29, 2013) are beginning to strain one of the aviation world’s coziest relationships: that between Boeing and its customers in Japan. All Nippon Airways, the first and largest operator of Boeing’s new 787, cancelled 459 flights through Jan. 31 after battery fires on two Dreamliners prompted regulators to ground the planes over two weeks ago. Rival Japan Airlines, which flies 7 Dreamliners and suffered a fire, has also been hit by the plane’s stoppage. “As an airline person, it’s exasperating to think that we’ve got 17 cutting-edge planes sitting here that can’t fly,” says ANA’s VP.

It’s not just the airlines that are affected. More than a third of each 787 is built by Japanese manufacturers before being sent to the U.S. for assembly. Roughly 43% of Japanese aerospace employment is linked to Boeing projects. In other markets, the Dreamliner’s delays and problems might prompt customer defections. But Japanese companies do so much business with Boeing that their fortunes are closely linked.

ANA and Japan Airlines flaunt their allegiance to Boeing. ANA, deeply involved in the design of the jet, boasts that its “passion persuaded Boeing” to use a durable Japan-made paint on the 787 and that the Dreamliner’s composition is “Japan 35%; Boeing 35%; Others 30%.” When the Dreamliner faced big delays between 2007 and 2010, Japanese aviation exports plummeted 25%.

The ties go back to U.S. support for Japanese reconstruction after World War II. In the 1970s and 1980s, Japanese airlines became big buyers of U.S. planes, partly to help offset a huge trade imbalance. “Ever since the war, Japan’s aviation industry has been basically America,” says one trade official.

Discussion questions:

1. Why did Boeing outsource such a large percent of its jets to Japanese suppliers?

2. Why have JAL and ANA remained loyal customers?

Good OM Reading: The China Twist

“Want a challenge,” writes Wen-Szu Lin in his wonderful new book, The China Twist. “Try launching your first business in a foreign country where you aren’t familiar with the language or culture. Launch in a city where you have no connections. Introduce a product category (Auntie Anne’s Pretzels) that is completely new to the consumers. Limit your initial investment to a small amount. Oh yeah, for kicks, let this foreign country be China.” Here are a few takes from the Wharton MBA:

Operations is massively under-emphasized. “MBA classes often emphasized the ‘sexy’ part of the businesses. How it is going to be financed? What is the innovative marketing that changed the course of the business? Operations and implementation is only represented in most classes as a tiny aspect of the overall process; thus creating that impression in the overall value. Sad to say, I was part of that group who looked at operations as ‘beneath’ me. My perspective is completely reversed now. Poor operations will sink any business. Operations is hard and it is a daily grind. If you want to build a great business from the ground up, better start loving the operations.”

A corrupt regulatory landscape. “Our MBA program discussed the implications of the US Foreign Corrupt Practices Act and how large corporations deal with working in corrupt environments. I recall the classes portraying all cases as black and white. How does that translate to an entrepreneur getting shaken down by local government employees, all wanting some ‘favors’?”

How to ethically deal with unethical people. “Our procurement manager took bribes and demanded kickbacks from most of our suppliers. If I were in the US, I would have fired that guy as soon as the first supplier called to complain. However, he was the smartest person on our staff and could get prices lower than what we could, even with his kickbacks built in. And if we fired this manager, there is a good chance that we would face the same issue with the next employee. What we ended up doing was turn a blind eye but we checked the prices periodically to ensure that the prices he quotes are the same or lower than what we ourselves could negotiate.”

OM in the News: China Losing Edge as World’s Factory Floor

China is losing its competitive edge as a low-cost manufacturing base, suggests The Wall Street Journal (Jan.17, 2013), with makers of everything from handbags to shirts to basic electronic components relocating to cheaper locales like Southeast Asia. The shift—illustrated in weakened foreign investment in China—has pluses and minuses for an economy’s global growth. Beijing wants to shift to higher-value production and to see incomes rise. But a de-emphasis on manufacturing puts pressure on leaders to make sure other jobs are created. The shift is the result of a long-term trend of rising wages and other costs that have made China less attractive, especially for basic manufacturing.

Foreign capital helped build China into a low-cost manufacturing powerhouse and global growth engine. But its increasingly urban population now has higher expectations in terms of wages and working conditions and louder objections to the pollution that often comes with low-level manufacturing—demands that have eroded China’s cost advantage. “We know we can’t keep relying on a low-cost competitive advantage. We need to accelerate the value-added upgrading of our products,” says the Commerce Ministry spokesman. “You couldn’t say we are happy to see this development.”

For China’s neighbors, the trend means more opportunities. Southeast Asian nations, which claimed 2% of global foreign investment in 1997, now account for about 7.6%.

Not all of the shift out of China involves low-end industries such as garment-making. Wintek Corp., with about 50,000 workers globally that makes smartphone components for companies including Apple, just said it will invest $930 million in four new plants in Vietnam to make displays and touch screens.

Discussion questions:

1. What are the advantages and disadvantages to this shift for the U.S.?

2. What are the operations issues arising to companies that relocate manufacturing to other S.E Asian countries?

OM in the News: Walmart’s Supply Chain Passage to India

Unrefrigerated truck goes 140 miles in 7 hrs.

Last fall, following a relaxation in India’s foreign-investment rules, Walmart announced it was planning to open its first stores in the country, tapping into a prized $490 billion retail sector. But to cash in, writes The Wall Street Journal (Jan.,12-13, 2013), Walmart will have to solve a fundamental supply chain problem: how to move goods into stores efficiently in a country that offers big retailers little in the way of modern logistics and is plagued by dilapidated infrastructure.

The hurdles are particularly daunting in the food sector. In the world of perishable goods perishing, India has few rivals. Lacking proper storage facilities, enough refrigerated trucks and adequate highways, the world’s second-largest fruit-and-vegetable producer loses about one-third of its produce ($10 billion) each year to spoilage. India also is bogged down by an entrenched system of government-imposed middlemen that can increase costs by 500%.

After passing through the agents and traders in the Chhutmalpur market, for example, produce moves in trucks on a 140-mile journey to New Delhi, often on a 2-lane road so pot-holed and bumpy that top speeds are 15 miles per hour. The trip may include a visit from local thugs demanding bribes for safe passage. It is just one of many human road hazards in India, such as farmer protests.

With a U.S. fleet of 55,000 tractor-trailer trucks, third-party shippers and its own massive distribution centers, Walmart is accustomed to fine-tooth tracking and direct sourcing. In the face of all this it is unlikely Walmart will try to replicate its U.S. supply chain operations, which are focused primarily around massive distribution centers supporting up to 100 stores.”It’s the least mature market they’ve ever had to enter,” says one expert. “They have to create a new playbook.'”

Discussion questions:

1. Compare Walmart’s efforts to those of Hard Rock (noted in Ch.8) when it entered the Russian market.

2. What will be Walmart’s biggest OM challenge in India?

OM in the News: Radical Changes for Foxconn and China’s Electronics Industry

When Pu Xiaolen was hired at the Foxconn plant in Chengdu, China a little over a year ago, she received a short, green plastic stool that left her unsupported back so sore that she could barely sleep at night. Eventually, she was promoted to a wooden chair, but the backrest was much too small to lean against. The managers of this 164,000-employee factory, she surmised, believed that comfort encouraged sloth, writes The New York Times (Dec.27, 2012) in its lead story. Then one day, halfway through a shift inspecting iPad cases, she received a beige wooden chair with white stripes and a comfortable high, sturdy back. She wondered if someone had made a mistake.

But in Spring of 2012, unbeknown to Ms. Pu, a critical meeting had occurred between Foxconn’s top executives and a high-ranking Apple official. “This is a disgrace!” shouted Terry Gou, founder of Foxconn, the world’s largest electronics manufacturer and Apple’s most important industrial partner. Gou — seen by activists as a longtime obstacle to improving conditions inside his factories (which we have blogged about in the past) — was finally committing to a series of wide-ranging reforms. Foxconn’s pledges, if fully carried out next year as planned, could create a ripple effect that benefits tens of millions of workers across the electronics industry.

The firm announced that by July 2013, no employee would be allowed to work more than an average of 49 hours a week — the limit set by Chinese law. Previously, some Foxconn employees worked 100 hours a week. Foxconn also promised to increase wages, so employees’ total pay would not decline despite fewer hours — the equivalent of a 50% raise for many workers. With 1.4 million employees in China, Foxconn is setting a bar that all manufacturers will be judged against.

Change is hard, say officials in several Chinese companies. Reforming labor conditions in China will probably take decades, and labor abuses are an ever-evolving problem without just one right answer. “The days of easy globalization are done,” said an Apple executive.

Discussion questions:

1. What is/should be Apple’s role in this reform?

2. What events caused Chairman Gou to make this major move?

OM in the News: Innovation and U.S. Manufacturing

The government has long heralded the potential of American factories to offer good, stable middle-class jobs. But there might be another advantage to expanding manufacturing: a more innovative economy, says The New York Times (Dec.14,2012). The evisceration of the manufacturing work force over the last 30 years might have dimmed the country’s capacity to innovate and stunted the prospects for long-term growth. “In sector after sector, we’ve lost our innovation edge because we don’t produce goods here anymore,” says ASU’s dean of technology and innovation.

In industries that produce complex, high-technology products, companies that keep their R&D and manufacturing employees close together are more innovative than businesses that develop a schematic and send it overseas for low-wage workers to make. Moreover, clusters of manufacturers, where workers and ideas can naturally flow between companies, are more productive and innovative than the same businesses if they were spread across the country.

At one massive G.E. facility in NY, workers are casting into thin tubes a ceramic that G.E. invented. Those tubes get packaged into batteries and shipped across the world. The plant sits near the research campus where G.E. scientists developed the technology. That allows them to work out kinks on the assembly line, and test prototypes of and uses for the battery. “We’re not thinking about just one generation,” says G.E.. “We’re working on the 2nd, the 3rd, the 4th, the 5th.”

Can such a strategy offer the same benefits for other businesses? M.I.T. analyzed what happened to towns after marquee manufacturing plants, like a BMW factory, moved in. Other factories in the town became more productive. Wages rose, too. Such evidence leads to concerns about the overseas movement of manufacturing jobs and facilities over the past 30 years. “Outsourcing has not stopped with low-value tasks like simple assembly or circuit-board stuffing,” writes the Harvard Business Review. “Sophisticated engineering and manufacturing capabilities that underpin innovation in a wide range of products have been rapidly leaving too.”

Discussion questions:

1. What are the dangers of sending low-end manufacturing jobs overseas?

2. Why is clustering important to manufacturers?

OM in the News: German Auto Makers’ Major Capacity Expansion Outside of Europe

For a bit of good news regarding manufacturing jobs in North America, The Wall Street Journal (Nov.26, 2012) writes that VW, BMW and Mercedes are all ratcheting up capacity investments beyond the troubled European market.

Taking the lead, Volkswagen announced last week that it would invest $65 billion in its global operations over the next three years; this as Germany’s robust auto industry seeks to limit its exposure to Europe. The move cuts a contrast to the belt-tightening of cash-strapped rivals such as France’s Peugeot and Italy’s Fiat which have shed assets or shelved model and technology changes this year as plummeting European sales push those companies deeper into the red. VW’s plan marks its efforts to step on the gas in its bid to dethrone Toyota as the world’s largest auto maker. Billions will go to a new Audi plant in Mexico. VW is likewise pouring money into Russia and China.

“Despite the challenging economic environment, we are investing more than ever before to reach our long-term goals,” says Volkswagen’s CEO.

BMW, which opened a second plant in China this year, is investing an additional €500 million with its Chinese joint-venture partner to boost production there. Meanwhile, it is spending $900 million to expand capacity at its plant in Spartanburg, S.C., and last month finalized plans to build a $261 million plant in Brazil.

Mercedes, which expanded into China later than rivals BMW and Audi, made plans last year to invest €2 billion in its venture with Chinese partner and a further $2.4 billion in expanding its Alabama plant.

Discussion questions:

1. Referring to Chapter 8’s discussion of Mercedes’ selection of Alabama for its 1st overseas plant, what are the benefits to the US of these expansions?

2. What are the dangers of major capacity expansions?

OM in the News: Walmart and the Bangladesh Factory Fire

The garment factory fire in Bangladesh last week that killed 112 workers was a horrible tragedy. Emergency exits were padlocked and fire engines could not reach the blaze through dense and overcrowded roads. But the question for your students becomes: what does Walmart do with its clothing suppliers like this one? The Wall Street Journal (Nov.27, 2012) writes: “Walmart said the factory was no longer authorized to make clothes for the retailer, and that it had cut ties to a supplier that subcontracted with the factory without its authorization.”

Walmart’s ethical-sourcing department claims it notified the factory last year that it had found it to be “high-risk” and yanked its business–yet the chain’s clothing was still being produced there when the factory went up in flames. In its 2012 report on global responsibility, the retailer said it had stopped working with 49 factories in Bangladesh because of fire-safety issues. (Garment factory fires have killed over 600 people in the past 6 years).

Labor activists are scolding global companies for tolerating such terrible conditions in Bangladesh. The Journal (Nov.29, 2012) adds that Walmart is well aware of the reputational risks of sweatshop sourcing, trying hard to monitor working conditions among their suppliers. “But determined factory owners, abetted by local authorities can always fool inspectors.” Worth noting is the fact that a country of Bangladesh’s population—approximately 150 million—is greatly dependent on a single industry in which it has no natural advantage. Garment exports earn around $19 billion per year, accounting for 80% of total export. Clothing is Bangladesh’s only major manufactured product.

The garment industry there enjoys special labor rules, including a ban on unionization, and regulated pay rates that depress wages in the name of competitiveness. In this respect, Bangladesh is like China and other East Asian tiger economies, except that Bangladesh hasn’t pushed the economy further up the value chain. Instead, it has skewed investment toward the garment industry.

Discussion questions:
1. What is Walmart’s responsibility in dealing with global suppliers’ safety issues?

2. Why does Bangladesh support this industry so heavily? Why is it afraid of Ghana?

OM in the News: Comparing Operations Strategies at Delta and Southwest

If there were ever two airlines that had different OM strategies, it would be Southwest and Delta. When you discuss operations strategy (see Southwest’s activity map in Figure 2.8), note that a major part of Southwest’s approach to achieving low-cost competitive advantage is its standardized fleet of Boeing 737’s. This allows for pilot training on one aircraft, reduced maintenance, constant updating of its fleet (only 11 years old on average), and close relations with Boeing.

The Wall Street Journal (Nov.16, 2012) provides a totally different–and industry unique–approach by Delta. Delta, the nation’s 2nd biggest carrier, stunned the industry by becoming the first airline to buy an oil refinery, in a bid to trim its highest operating cost, aviation fuel. It runs a huge maintenance subsidiary that tends to its own planes and does third-party work, while other airlines have scaled down or bailed out of that business. But it also has focused on an asset most airlines avoid: older planes. Today, Delta’s fleet is both old and complex. It has 10 different models among its 725-aircraft, and the fleet’s average age is over 16.6 years. Its 19 DC-9s, which came from the merger with Northwest, clock in at more than 34 years old!

Most of Delta’s rivals already have fewer aircraft types to simplify their fleets because that reduces the cost of training, maintenance and spare parts. They also are chasing every incremental reduction in fuel costs that new aircraft promise to deliver. Delta, by contrast, is picking up the 88 aging Boeing 717s that Southwest is shedding on planes it inherited in its merger last year with AirTran. Southwest was so anxious to maintain its single plane OM strategy that it took a $137 million charge to retrofit them for Delta. Yet even with the planes’ higher fuel and maintenance costs, Delta figures it is saving at least $1 billion on procuring these and other used planes, compared with buying new ones, making them roughly 10% cheaper to operate per seat than new 737s.

Discussion questions:

1. What are the plusses and minuses of Delta’s OM strategy?

2. Why does Delta prefer to purchase, rather than lease, its planes?