OPERATIONS MANAGEMENT

What is Operations Management?

• Operations Management is the ability to maintain and/or continually improve the day-to-day operations of a business using analysis and management skills in a planned and organized way.

• It is an integral part of a sturdy business foundation.

• This model can be explained this: Rooted in common values and a shared vision, the management team creates a business and organizational structure supported by key people.

• Together, they successfully accomplish day-to-day operations using investment wisely. Production systems are continually honed to achieve short- and longer-term goals that prove to be successful.

• LightWorks was founded in January 1997. Our vision is to become the premier supplier of prototype and production custom optical systems. At LightWorks we collaboratively work with our customers as an extension of their product development team to develop and manufacture high-quality, high-reliability, integrated optical systems.

• Our goal is to provide our customers a comprehensive capability to design, engineer, manufacture, integrate, and test high-technology optical systems.

• LightWorks customers include space, defense and commercial companies, with applications ranging from space-based telescopes and optical systems to airborne, ground and sea-based optics for military applications, to commercial optics for medical, microlithographic, test and measurement and other commercial applications.

Case

• LightWorks Optics• Could a small, employee-owned company

meet its ambitious growth goals without compromising its high-involvement culture? LightWorks Optics, based in Orange County, California, made highly sophisticated optical components for defense aeronautics, space exploration, and commercial applications.

• Early in its history, LightWorks had set up an employee stock ownership plan, or ESOP, under which employees gradually built up equity in the closely held firm. In 2007, the three founders indicated that they hoped to sell their shares to the ESOP trust in a leveraged buyout in 2012.

• In order for that to happen, the company needed to improve its revenue and profitability significantly; that, in turn, would require that it bring in more contracts, especially ones requiring high-volume production. But, LightWorks had to pay attention to its core capabilities and what it could, and could not, do effectively.

• Moreover, the company prided itself on its culture of ownership--one in which all employees had a stake in the business and a voice in its decisions. Could the president, Dan Barber, and his top management team reach a consensus on how to expand production without losing the benefits of a culture of ownership?

• Employee empowerment• Employee Stock Ownership plans• Entrepreneurship• Open book management• Organizational change

• Organizational development• Small & medium-sized enterprises

LightWorks Optics, INC

• LightWorks Optics was founded in 1997 by Dan Barber, Roger Johnson, and Don Small. The three men – all physicists with expertise in optics (the study of physical properties of light) – had worked closely together for more than a decade at another Orange-Country, Califonia-based firm, the West Coast division of PerkinElmer.

• In 1996, the three men learned that Corning, a major multinational, was going to acquire OCA. They became concerned about their future, and that of many of their colleagues, and decided to leave to start their own company.

• Over a six-month period as they planned their departure, the three partners attended business classes and worked with an advisor from Small Business Administration. Quietly, they set about developing a business plan, pro forma financials, and an operating approach. Their initial plan was simply to seek the kinds of contracts they were familiar with – to, as Barber put it, “recreate OCA in the marketplace” as Corning exited the business.

• In one important respect, however, the founders did not want to model their company after their former employer. Barber commented.

• There were some management issues that we thought weren’t handled particularly well. PerkinElmer and OCA didn’t do a very good job of keeping employees informed and involved in what was going on.

• In early 1997, the partners incorporated LightWorks Optics. Each contributed $15,000 and a computer – the sum total of their startup capital.

• Over the following decade, the company prospered, gradually building a business making high-quality optical components. In 2006, LightWorks’ revenue was around $9 million. Around 90 percent of this amount came from defense contracts.

• The building housed both LightWorks’ corporate offices and production facility under one roof.

A Highly Skilled Workforce

• As it expanded over the first decade of operations. LightWorks recruited almost exclusively from a network of contracts in defense contractors in and around Orange Country, including their former employer.

• Barber commented: “It would have been very hard to do our recruiting from colleges, or doing it blind. It’s very risky recruiting people you don’t know. About 70 percent of our staff now are former OCA employees. They didn’t all come over right away, but over these past years, they’ve migrated over”.

• Instability at other firms worked to LightWorks’ advantage.

• The downsizing of the industry has let us pull together people who can do this kind of work. A lot of these people have been kicked around in acquisitions, where if the bottom line on the income statement looks bad, well, you’re laid off.

• These people take a lot of pride in what they do, and they don’t appreciate being treated that way. Our competitors’ failures are our gain. We look for people who are unhappy and looking for other employment. It would have been hard without that to build our company.

• Over time. As shares were allocated to the trust, employees would build up their equity stake; the founders’ stakes would, by the same amount, be diluted. When an employee left the company or retired, he or she would be entitled to be “bought out” by either the ESOP or the company at then-current fair market value, as determined by an independent appraiser.

• By 2007, employees owned about 36 percent of the company (the remaining shares were held by the three founders.)

A High-Involvement Culture

• From the beginning, Barber and his partners wanted to couple employees ownership with a high-involvement culture. They quickly recognized the importance of setting up structural mechanisms to enable both the sharing of information and employee participation.

• Barber explained “we have a bi-weekly all- hands meeting where we go through all financials, profit and loss by project, how much money we have in the bank, what invoices we’re issuing, the full financial outlook of the organization. We assess revenue on a monthly basis, compare that to our break-even costs, and each projects’ earned revenue. Are our financial outcomes good this month or bad this month?”

• So, it’s information and training at the same time. In addition, to its all-hands meetings, the company held regular department and project team meetings. Barber maintained an open-door policy and made himself available to talk with any employee who wished to see him.

• He said “I own this job, I own a part of this business.”

• Barber saw many advantages – and a few disadvantages to the company’s ownership culture. On the positive side, employees were highly invested in the company’s success and willing to go the extra mile to make it happen.

• “The ownership culture – that’s why we’ve been successful in doing things here… When we first moved into this building, we set up a committee, gave people decision-making power, and people really made things happen. We accomplished the move more quickly than anyone thought possible.

• There have been numerous times when a particular project faced a crisis that required the team to go above and beyond. Our project teams unfailing do whatever it takes to solve the project issue and satisfy our customers”.

• Barber pointed out: • “we want to feel that they own the business.

But it means that if anyone in the organization is negative enough about a decision, they can affect that decision.

• I can’t just sit at the top of the org chart and dictate a decision.

• That’s just not how things work here. I spend a lot of time working the crowd, so to speak. I’m back in that area (where employees are working) a lot”.

Preparing for the Ownership Transition

• In 2005 and 2006, the three founders decided they wanted to sell their remaining equity in the business to the ESOP trust in 2012, as part of their exit strategy from the business. This would occur through a leveraged buyout, in which a bank would loan money to the ESOP trust (through the company, as sponsor) to buy out the founders.

• (By 2012, the founders estimated their collective ownership share would be around 52 percent; the ESOP would own the rest.) over time, the loan would be paid off out company revenue, and employees would eventually own 100 percent of the company. At the time of the buyout, the founders could decide either to retire or continue working for the firm full – or part-time on a salaried basis.

• In order for the ESOP trust to qualify for a bank loan, the company would have to establish a strong record revenue growth and profitability over the preceding five-year.

Barriers/Challenges

• For one thing, he was concerned that the company was too dependent on military contracts. In fact, a single defense contractor, Lockheed Martin, accounted for more than 70 percent of their projected 2007 earnings. The company anticipated a decline in defense contracts as the wars in Iraq and Afghanistan wound down.

• The greatest potential for future growth, Barber thought, was in space and commercial applications, particularly in biotechnology and medical diagnostics. The ideal mix going forward, he believed, was 20 percent space, 40 percent defense, and 40 percent commercial.

• A large share of LightWorks’ business was building complex prototypes and one-of-a-kind optical devices. Many of the company’s skilled technicians liked this work, but it was not a reliable moneymaker.

• Barber commented:• The culture of a prototyping organization and

the culture of a highly-efficient manufacturing operation are two different things.

• In a one-off system, you hire people who know how to do the job and leave them alone.

• In an assembly environment, you tell people here’s what to do and here’s how to do it.

• In an assembly line operation, it’s still very precise, but it’s a different mindset.

• He added:• I was concerned about the potential for a culture

conflict between the prototyping side of the business and the high volume production side of the business.

• The first requires a culture of focused attention to detail and experimentation, and the latter requires a culture of operational efficiency.

• We had already started to encounter this culture problem in some of our early production programs.

• He anticipated particular resistance from the quality assurance inspectors if the company moved into high-volume production.

• As it had tried to attract more low-cost, high-volume assembly work, the company had sought to drive down quoted prices. But it had run into a difficult obstacle.

• Each contract had to build in indirect costs (“overhead”) for such things as administration, business development, and quality control. LightWorks had tried to charge a larger share of its overhead to its prototype and one-of-a-kind jobs, to enable it to bid at lower price points on its high-volume work.

• However this was not permitted on military contracts, which were governed by rules set by the Defense Contractors Auditing Agency.

• DCCA required that contractors carefully segregate direct and indirect costs, and then charge all indirect costs to each contract on an “equitable” basis.

• Barber explained:• We were having a lot of problems with our

pricing structure.• Engineering, quality – we’re carrying a lot of

resources here (in Tustin) that aren’t really necessary if you go into a focused manufacturing operation.

• We tried to set up a different rate structure for prototyping projects and manufacturing projects, but we are governed by DCCA rules.

• The only way we can allow a different rate structure is if (we) set up a totally different facility, and the resources of that facility are only used for the products that are produced there.

• To get our cost structure down, we needed to go elsewhere.

• Here (in Tustin) you’re carrying the whole front part of the building (engineering, design, quality control, corporate functions, etc.)

• In other facility, (we) wouldn’t be carrying the whole front part of the building.

The Decision to establish a new facility

• Option 1 was to make no change and continue on the company’s present path.

• Option 2 was to upgrade and expand their existing diamond-turning operation in Tustin and rent local office space nearby for staff displaced by this expansion.

• Option 3 was to try optimize the space they already had – “shifting things around and using the space we’ve got more efficiently”.

• Option 4 was to lease the building next door, which was vacant, to expand their available production space.

• Option 5 and 6 involved opening a dedicated high-volume production facility (HPVF) in Vista, California, about an hour’s drive south, with displaced employees to offices nearby, and develop an offsite location for HPVF.

• Option 8 was to continue to operate the Tustin facility and to open an HPVF out of state in a low-labor cost region, possibly in Mississippi.

Note that:• Opening a plant in Mississippi would be

expensive initially but have the potential of lowering labor costs significantly over the longer term.

• But, could the company operate a second facility at such a distance and still maintain its ownership culture?

• Expansion next door would make it easy for the engineers and quality inspectors to go back and forth as various projects dictated, but would this satisfy the DCAA requirements?

• Barber was concerned that indirect costs at headquarters would have to be allocated to contracts fulfilled to close by.

• But, perhaps that wouldn’t matter so much if the company moved decisively into commercial production.

• The Vista plant would be cheaper than Tustin to operate, although not as cheap as Mississippi.

• It would satisfy the DCAA rules and enable the company to charge less of overhead, Barber thought.

• But would even an hour away be too far?• Perhaps shifting to high-volume

manufacturing anywhere would pose too big a threat to the firm’s culture.

Resistance to Change

• There was a lot of pushback, a lot of resistances to change.

• The message was, basically, don’t make any changes until you’re forced to.

• ‘I’m comfortable where I am, don’t change anything’.

• The (management) group was well aware of resistance from the rank-and-file.

• Our employees were worried that they would have to travel frequently between the two sites.

• Some were concerned that we would gradually shift production to the satellite facility, so there would be less work here in Tustin.

• Eventually, that might lead to layoffs here.• Others were resistant because they felt they

could figure out a way to do our work more efficiently here. They kept saying, ‘we can find a way to make this happen’.

• There was just a fear factor that it wouldn’t work, fear that it would hurt the company.

• kent(Weed), Phil(Eads), and Todd(Sanders) were mostly positive. They were going to lead it (the expansion), so they were on board. But Al(DeLiso), from quality control, said, ‘You’ve got to be crazy’. Greg(Paddock) said point blank, ‘ my people aren’t going to support it, so you’d better watch out.

• Whatever action was taken, Barber knew the support of the whole organization was crucial.

• One of the risks in an employee-owned environment is that the possible (negative) reaction to an autocratic decision is orders of magnitude worse than in any other kind of organization.