Section 4 Notes: Operations Management

Production of Goods and Services

Production Process

• Production: making a product or service to satisfy consumer wants and needs.

• The factors of production or ‘inputs’ include:

o Land – For factories or materials

o Labour – Employees

o Capital – Money/finance

o Enterprise – Managers

• A business combines these inputs to produce a more valuable output (this is added
value).

• Labour-Intensive Production: A larger workforce is used than machinery to make

goods. Usually done in countries with low wages so that it is more efficient (ex: SHEIN).

• Capital-Intensive Production: businesses use machinery rather than workers. Usually

done in developed countries where the wages are high.

Operations Department

• The operations department’s role is to transform inputs into outputs for consumers.

• An operations manager ensures raw materials are available and made into finished
goods.

• Most manufacturing businesses have:

o Factory Manager - responsible for quality and quantity of products

o Purchasing Manager – responsible for providing the required materials and

equipment

o Research and Development Manager – responsible for design and training of

employees for new products

• In the retail business, the factory manager will be replaced by the managers for the
shop.

• In service businesses, e.g. Restaurants, the operation department will include managers
for each shop.

Productivity
 • Productivity: a way of measuring a business’s efficiency.

• Note: Production is the making of the product, while productivity is how efficiently the
product is made.

• Productivity=Quantity of outputQuantity of inputProductivity=Quantity of inputQuantity

of output

• Labour Productivity=outputno. of employeesLabour Productivity=no. of employeesoutp

ut

• As employees become productive, per-employee output rises, and costs of production

fall

• Many ways to increase productivity:

o Improve factory layout to reduce time waste and raise efficiency

o Introduce automation

o Improve labour skills by training

o Improve quality control

o Improve employee motivation

o Improve inventory control

• Benefits of increasing efficiency:

o More output compared to inputs.

o Lower costs per unit (and therefore lower average cost)

o For example, if the business has a limited workforce, raising their wages will
increase motivation and, therefore, also increase productivity.

Inventory

• Inventory can take various forms. Inventory includes:

o Raw materials

o Work in progress goods

o Finished goods

• Why do businesses hold inventory?

o To ensure enough inventory is available to satisfy sudden changes in demand.

o Production and opportunity costs will also be high if inventory levels are high.

• Inventories can be managed:

 • The business buys in inventory to fill its holding capacity, known as the maximum
inventory level.

• As resources are depleted, inventory levels drop. At this stage, reorders will be made so
it reaches the business in time before it runs out.

• Buffer Inventory Level: inventory held to deal with uncertainty in customer demand and
deliveries of supplies.

Lean Production

• Lean Production: various techniques to cut down waste and raise efficiency.

• Types of Waste:

o Transportation - when the goods are being moved unnecessarily → fuel price,
chance goods may get damaged

o Overproduction - leads to high storage costs and possible damage to goods

while in storage.

o Overprocessing - when sophisticated machines are being used to do simple

tasks

o Waiting - when goods are not moving or being processed, waste occurs due to
inefficiency

o Motion - any action made by an employee that does not relate to the production
of goods, wastes time

o Unnecessary inventory

o Defects - when goods have faults/defects that require them to be

inspected/fixed, wastes time

• Advantages of lean production

o Less storage costs

o Quicker production

o Better use of equipment

 o Less money tied up in inventory

o Speed up production by cutting out processes

o Improved health and safety lead to less time off work due to injuries.

o No need to repair defects or provide replacement services for a dissatisfied

customer.

o All these save/reduce costs that lead to lower customer prices and
increased business competitiveness and profit.

Types of Lean Production

• Kaizen

• Just-in-time inventory (JIT)

• Cell production

Kaizen

• Kaizen means continuous improvement in Japanese

• Its primary focus is to eliminate waste

• Ideas are thought of by holding frequent meetings with workers to discuss problems and
possible solutions.

• Advantages:

o High productivity

o Less space needed for production

o Work in progress is low

o Improved layout of the factory may lead to combining jobs. This will reduce
labour demand.

Just in Time

• A production method that reduces or virtually eliminates the need to hold inventories of
raw materials or unsold inventories of the finished product.

• Advantages:

o All this reduces the costs of holding inventory.

o ‘Warehouse‘ space is not needed, reducing costs.

o The finished product is sold quickly, so money will return to business quickly.
Helping cash flow.

• However, to operate in JIT, businesses need to have reliable suppliers and an efficient
ordering system. If suppliers are late, it can disrupt the system.

Cell Production
 • This is where the production process is divided into separate units, each making an
identifiable part of the good

• Advantages:

o High motivation due to improved morale of employees.

o More production efficiency.

o Employees feel more valued and are less likely to strike or cause disruption.

Methods of Production

• 3 Main Methods of Production:

o Job Production: products made one at a time

o Batch Production: a quantity (batch) of a product is made, then a batch of

another product is made

o Flow Production (mass): large quantity of products made in a continuous

process

• Job Production:

Features Benefits Limitations

Products are made specifically Good for ‘one-off’ products Often labour-intensive, expensive as
for the customer’s order highly skilled workers are needed

Each order is different Meets the exact Production takes longer

requirements of the
customer

E.g. bridges, ships, cakes, Varied work increases Any errors made are expensive to fix
cinema, films, suits employee motivation

Ability to charge higher Materials are more expensive.

prices

No possibility of purchasing
economies of scale

• Batch Production:
Features Benefits Limitations

A similar range of products is made in Flexible work can change Machines must be reset to
batches products easily do different batches

Ex. bakery: makes one type of bread, Gives some variety to worker’s Semifinished products may
then one type of cake and each jobs need to be transported
product is produced in stages or around (+ cost)
batches.

More variety, more consumer Need space for stocks of raw

choice material (high storage costs)

Production may not be High work-in-progress

affected to any grant extent if inventory
the machine breaks down.

Expensive and time-taking

• Flow Production:

Features Benefits Limitations

Large quantities of a product High output, capital intensive, It is very boring for employees,
are produced. more efficient. leading to decreased motivation
over time.

Cars, drinks, electronics, and Costs are low, therefore low High cost of inventory of output
mass-made products are made prices, leading to high sales. & raw materials.
this way.

It requires only relatively unskilled Capital costs for setting up

workers and some training, production are very high.
maybe needed.

There is no need for moving goods If one machine breaks down, the
around (all made in the same whole production stops.
place).

Automated production lines can

operate 24*7.
 Features Benefits Limitations

Benefit from economies of scale.

• Factors influencing which production method to choose:

o Nature of Product - if unique or individual service, job production can be used.

o Size of Market - if demand increases and more products can be sold but not in
large quantities, batch production will be used. International market, flow
production.

o Nature of Demand - if large and fairly steady demand, e.g. soap powder flow
production, can be used.

o The size of the Business - if the business is small and doesn’t have access to
large funds, job production can be used.

Technology in Production Methods

• Automation: Equipment in a factory is controlled by a computer to perform mechanical

processes (i.e., painting a car). Only workers are to ensure it runs smoothly.

• Mechanisation: production is done by machines but operated by people. Used to do

difficult, precise or dangerous tasks. Work 24/7, quicker and more accurate.

• Computer-Aided Design (CAD): software that helps design or re-style products quickly,
allows technical sketches to be very detailed

• Computer-Aided Manufacture (CAM): when computers monitor production and

control machines/robots

• Computer-Integrated Manufacturing (CIM): when software that designs the products

is integrated with the machines that produce (CAM + CAD).

Electronic Payment Methods

• EPOS (Electronic Point of Sale): used at checkouts, where barcodes are scanned and
displayed on the receipt. The inventory is automatically changed and reordered when
the reorder level is reached.

• EFTPOS (Electronic Funds Transfer Point of Sale): it is where an electronic cash

register is connected to the retailer’s bank accounts, and the money is directly
transferred when the shopper’s bank info is entered.

• Contactless Payment: works by the contactless device having an antenna; when

touched against a contactless terminal, it securely transmits intervention about the
purchase. e.g. credit cards, key fobs, mobile devices, etc.
 Advantages of Use of Technology Disadvantages of Use of Technology

Productivity is greater as new, more effective methods are Unemployment could rise.
used, reducing average costs.

Greater job satisfaction stimulates workers. It is expensive to invest in new technology;

this increases the risk as more products
would need to be sold to cover the cost.

More skilled workers may be needed to use and maintain Employees may be unhappy with the
the new technology. Therefore, motivation and work change.
quality will increase as training is provided to existing
employees.

Better quality products New technology is constantly changing and

becoming outdated quickly; thus,
businesses must replace technology to
remain competitive.

Quick communication and reduced paperwork,

increasing profitability.

The use of IT is much greater and results in better and

quicker decision-making.

New ‘high-tech’ products are introduced as technology

makes completely new products available.

Costs and Scale of Production

Business Costs

• Fixed Costs (overheads)

o Costs that do not change with output in the short run.

o Also known as overheads or indirect costs

o Fixed Cost = Total cost – Variable cost

o Examples of Fixed Costs:

▪ Rent of factory: even if you produce lots of products, the rent price will
be the same

▪ Insurance: you set the insurance cost beforehand

 ▪ Bank fees: bank fees are a set price; they don’t change depending on the
products produced

▪ Management Salaries: they are set regardless of production

▪ Staff cost (Security)

• Variable Costs (VC)

o Costs which vary directly with output

o Also known as direct costs

o Variable cost = Total cost – Fixed cost

o Examples of Variable Cost:

▪ Raw materials: the more you produce, the more materials you need

▪ Electricity & Gas: Energy is paid by use. If you are producing more, more
electricity is being used

▪ Shipping cost: Making more products means you have to ship more
items, and shipping is paid by weight

• Total Cost: Fixed and variable costs combined.

o Formula 1: Fixed cost + Variable cost.

o Formula 2: Average cost per unit × output

• Average Cost (Per Unit): total cost of production divided by the total output. Referred to
as Unit Cost.

o Formula for Average cost=Total cost of productionTotal outputFormula for Averag

e cost=Total outputTotal cost of production

Usage of Cost Data

• Helps manager set prices

• Deciding whether to stop production or continue.

• Deciding the best location.

• It helps managers to make decisions.

• It is needed to calculate profit and loss.

Economies of Scale (EOS)

• Economies of Scale (EOS): the factors that reduce average costs as a business grows.

• Types of economies of scale:

o Purchasing Economies

▪ When a business buys in bulk, it tends to receive discounts, decreasing

the price of each good.
 o Marketing & Selling Economies

▪ When the company advertises for goods, it will pay the same amount to
advertise a greater number. Therefore, when marketing for a higher
output, unit costs fall, decreasing ATC.

o Financial Economies

▪ Banks tend to lend to larger companies with low-interest rates, as they

borrow high amounts and their collateral value is high.

o Managerial Economies

▪ Large firms have opportunities to employ specialists who will help

reduce wastage and increase efficiency and productivity.

o Technical Economies

▪ More capital to invest in newer, more efficient technology and specialist

equipment.

Diseconomies of Scale (DEOS)

• Diseconomies of Scale (DEOS): the factors that lead to an increase in average costs as
the business grows beyond a specific size.

• Types of diseconomies of scale:

o Poor communication

o Lack of commitment from employees

▪ Large businesses have many employees, and not everyone is connected

to the top management, reducing their motivation levels.

o Slow decision-making & weak coordination

▪ Large businesses have longer chains of command, so information and

instructions take longer to reach the desired person, slowing
communication and decision-making.

Break-Even Analysis

• Break-Even Level of Output: the quantity that must be produced/sold for total revenue
to equal total costs. (also known as break-even point).

• Break-Even Charts: a graph showing how the costs and revenues of a business change
with sales. They show the level of sales the business must make to break even.

• Revenue: the income during a period of time from sales of goods.

o Total Revenue = Quantity sold × Price.

• Break-Even Point: the level of sale at which total costs = total revenue. The point where
they intersect in the graph.

• The break-even point, the calculation method:

 o Contribution: selling price less its variable cost.

o Contribution per unit: Selling price – Variable cost.

o Break-even level of production=Total fixed costsContribution per unitBreak-

even level of production=Contribution per unitTotal fixed costs

• An example of a Break-even chart:

Sales($)= 0 units Sales($)= 1000 units Sales($)= 2000 units

Fixed costs 5000 5000 5000

Variable 0 3000 (1000x$3) 6000 (2000x$3)

Total costs 5000 8000 (3000+5000) 11000 (5000+6000)

Revenue 0 8000 (1000x8) 16000 (2000x8)

• To draw a break-even chart, you must include:

o Fixed Costs line

o Variable Costs line

o Total Costs line

o Sales Revenue line

• The shaded area that can be seen, labelled with ‘Area of loss‘, shows how the sales
revenue line is below the Total cost line, indicating that anything before the break-even
point is a loss.

• The shaded area that can be seen, labelled with ‘Area of profit’, shows how the sales
revenue line exceeded the Total cost line, indicating anything after the break-even (BE)
point is a profit.
 • ‘y’ axis measures money amounts (cost & revenue)

• The ‘x’ axis shows the number of units produced or sold

• Benefits of break-even charts:

o Managers can read off the graph if the company expects profit or loss and can
see how much profit/loss they will have at any level of output

o They can attempt different scenarios and see the impact it will have on the
profit or loss of the business. It lets managers try out different possibilities to
determine which is the best. (i.e. increasing the selling price, increasing
production)

o It can show the SAFETY MARGIN – the number of sales exceeds the break-
even point. For example, if a business’ break-even point is at 1000 units, and
they’re producing 1500 units, their safety margin is 1500 – 1000 = 500.

• Limitations of Break-even Charts:

o Break-even charts assume that all products made will be sold. It does not
show the possibility that inventories may build up if they are not sold

o Fixed costs only stay the same if the scale of production stays the
same (doubling the output will also increase the fixed cost because they must
need a bigger factory, more machinery, labour, etc.)

o Break-even charts assume that costs and revenues can be drawn with
straight lines, which doesn’t happen in real life.

o It assumes costs and revenue increase at a constant rate.

Achieving Quality Production

• Quality: to produce a good or a service which meets customer expectations.

• Quality is important for businesses because:

o It establishes the brand image

o It builds brand loyalty

o It maintains a good reputation

o It will help to increase sales

o Attracts more new customers

• If quality is not maintained, businesses will:

o Lose customers to other brands/competitors

o Have to replace faulty products or repeat poor service, which raises costs for
business

o They have a bad reputation because people with bad experiences will tell others,
etc. This leads to lower sales & revenue.
Quality Control

• Quality Control: Check for quality, whether a product or service, at the end of the
production process.

• Quality control is a traditional way to ensure that products leave the factories without
defects.

• Quality inspectors’ job is to maintain/check quality regularly for errors.

• The whole production batch might have to be redone if errors are found.

• Their job is also to prevent any production errors before they happen during production,
which will lead to money loss.

Advantages of Quality Control Drawbacks of Quality Control

Eliminates faults/errors before the customer It is expensive, as employees need to be paid to check
receives a product or service. the product or service.

Less training is required for the workers. Identifies the fault but not how and why it occurred, so
it is difficult to remove the problem.

Increased costs if products have to be scrapped or

reworked or service repeated.

Quality Assurance

• Quality Assurance: checking for the quality standards throughout the production
process.

• Businesses will ensure quality standards are set, and then employees will apply these
standards throughout the business.

Advantages of Quality Assurance Drawbacks of Quality Assurance

Eliminates faults/errors before the customer It is expensive to train employees to check

receives a product or service. products.

Fewer customer complaints. Relies on employees following instructions of the

standards set by the business.

Reduced costs if products don’t have to be scrapped

or reworked or service repeated.

Total Quality Management (TQM)

• Total Quality Management (TQM): the continuous improvement of products and

processes by focusing on quality at every stage of production
 • Many companies use total quality management.

• It tries to “get it right the first time” and has no defects

• It focuses on ensuring 100% that the customer is always satisfied. The customer is not
just the final user; it also includes other people and departments within the business

• Quality must be maintained throughout the business, and no faults should occur.

Advantages of total quality management Drawbacks of Total Quality

Management

Quality is built into each part of the production. It becomes a It is expensive to train all employees.
habit for the employees.

Eliminates virtually all faults/errors before the customers receive Relies on employees following the
them. ideology of TQM.

No customer complaints, so the brand image is improved.

Waste is removed, and efficiency increases, which means less

money is wasted (higher profits).

Customers can be assured of quality products/services

• Businesses may apply a quality mark but will have to follow certain rules. This mark, e.g.
ISO, makes sure products meet a particular standard.

• For service businesses, recommendations from satisfied customers can be heard or

read from online sites, where bad and good reviews can be shown.

Location Decisions

Businesses look for locations when:

• New business

• The present location is unsatisfactory

• Change in business aims and objectives

• Expansion

Factors that influence the choice of location of a MANUFACTURING business:

• Production methods and location decisions

o Production methods play a significant role in deciding the location of a business.

o Job Production: the business will be small and won’t have much effect on
competitors there. The location of suppliers won’t affect much on the business.
Ex. A small jewellery business.
 o If there is large-scale production, then competitors in that area will be highly
affected, and the business will prefer closer suppliers as raw materials will be
huge. Transportation costs may be high if the supplier is too far.

• Market

o When a product is heavier than its raw materials, businesses decide to locate its
factory near the markets rather than the supplier, as a business will find it much
cheaper due to transportation costs.

o Due to advances in transportation facilities, the distances between factories and

markets of heavy products don’t play a vital role.

o Perishable products need to be delivered quickly.

• Raw Materials/Components

o Transportation costs will be high if goods and raw materials are very heavy. Then,
a company may want its factory to be located near the supplier.

• External economies of scale

o When two firms support each other or work together, they will be able to respond
quickly to any important decisions to be made or any breakdowns.

• Availability of Labour

o Every manufacturing business requires labour.

o If a business requires only skilled labour, it will try to locate near a place where
people with various skills live.

o If a business requires unskilled labour, it will be located where wage rates are
low and unemployment is high.

• Government Influence

o When a government wants to encourage businesses to locate in a particular

area, it will offer state–funded grants to encourage firms to move there.

o High unemployed areas may provide grants to businesses to locate there.

• Transport and Communication

o Businesses need to be closer to transport systems.

o Exported products, ability to reduce transport costs.

o Reduces time taken.

• Power and water supply

o Availability of power is very important.

o Some businesses need to have reliable power sources to continue production.

o Some production processes require a reliable water source.

 • Climate

Factors that influence the choice of location of a SERVICE SECTOR business:

• Customers

o Services which require direct contact, must be located near the customers.

o Services where personal contact isn’t required, location doesn’t affect.

• Technology

o Technology has allowed e-commerce, so location doesn’t play a vital role.

• Personal preference of owners.

• Availability of labour

o If a business is labour-intensive, it must be located where labour is easily found,

like towns and cities.

• Climate

• Near to other businesses

o Some services/ businesses serve large companies and so should be able to

reach them immediately; therefore, they must located closer to them.

• Rent/ taxes

o If services don’t require personal contact, they can be located in places with
lower rents and tax rates.

Factors that influence the choice of location of a RETAILING business:

• Shoppers

o Retailers want popular areas as they attract customers.

o It depends on the type of product.

o Expensive – a place where high-income people live or visit regularly.

• Nearby shops

o Being located near a frequently visited shop means people may shop in between
while visiting other shops.

o A place with high competition attracts more customers as they have greater
choice.

• Customer parking availability/ nearby

o Convenient and nearby parking lots will encourage people to visit your shop.

• Availability of suitable vacant premises

o If a proper location isn’t available, a company can’t locate there.

• Access to the delivery vehicle

 o Businesses try to find places near transport businesses to gain easy access to
delivery vehicles.

• Rent/ taxes

o Popular area, high demand, and high rent.

o Less popular, low demand, low rent.

• Security

o A place prone to theft may reduce a business’s chances to locate there.

o Insurance companies may not insure such companies.

• Legislation

o Some countries may have laws restricting trade in some parts.

Factors influencing the decision of which country to locate operations in:

• New market overseas - when a business sees an increase in sales overseas, it may
decide to move/relocate there instead of transporting products there.

• Cheaper Source of material – if the raw material runs out, the business must either
bring in alternative supplies from somewhere else or relocate to a new country with
these raw materials, it also might be cheaper than transporting it.

• Difficulties with the labour force and wage costs – if the business is located in a
country where wages keep rising, it may be more profitable to relocate to a country with
lower wages.

• Rents/taxes considerations – if other costs such as rent or taxes increase, this might
cause businesses to relocate to countries where it is lower.

• Availability of government grants and other incentives - If governments want to

increase foreign investment and job opportunities, they will provide grants, subsidies,
and lower taxes. They may do this to provide new skills and increase employment.

• Trade and tariff barriers – If trade barriers are high, the business’s chance of locating
there would reduce costs.

The Role of Legal Controls on Location Decisions

• Reasons the government influences these location decisions:

o To encourage businesses to set up and expand in areas of high unemployment.

o To discourage firms from locating in overcrowded areas or on sites with natural

beauty.

• Two types of measures used by the government to influence where firms are
located:

o Planning regulations (legally restrict business activity from certain areas).

o Government grants or subsidies encourage them to locate in undeveloped

areas.