Operations Management: 5.1, 5.2, 5.4, 5.5

What is operations management

Operations Management involves the planning, organising, coordinating and controlling of all activities involved in the transformation of inputs into outputs. It plays an important role in the business’s success.

The aim of operations management (operational targets)

• Operational targets: 

  • Effectiveness of operations

    • Consistently producing products in the;

      • Right qualities

      • Right specifications

  • Efficiency of operations

    • Producing and delivering products in a cost-efficent manner

  • Sustainability of operations

    • Meeting the company’s and the government’s sustainability targets and requirements

Job production 

• A labour-intensive manufacturing method that involves making customized, one-off, and unique goods or services that meet the specific needs of a specific customer. 

• Each product is completed before the next is started

Advantages of Job Production

• Higher customer satisfaction as products are made specifically for them.

• Possible higher prices.

• High quality due to skilled workers (USP).

• Higher employee motivation due to changing requirements.

• Low inventory costs: No need to stockpile finished goods (made-to-order).

• Direct interaction with customers fosters brand loyalty.

Disadvantages of Job Production

• Labour-intensive, so higher labour costs.

• Time-consuming and product-specific decisions must be made → less potential for automation.

• Fewer economies of scale due to low output over time.

• Possible cash flow challenges as each order is unique and will thus have different costs involved

Batch production

• Involves producing a set of identical products

• Each batch is fully completed before production switches to another batch.

• Each batch may have slightly different specifications

Advantages of Batch Production:

• More variety within a given product.

  • More customers are satisfied overall.

• Some flexibility to change the product between batches.

• Lower unit costs → more economies of scale as more products are made at once.

• If there is a high demand, the business can satisfy it, meaning more profit in absolute terms

Mass production

Involves large-scale production of a standardized product using production-line technology, making it heavily automated

Advantages of Mass Production:

• Economies of scale (high volume).

• High labour efficiency (workers specialize in one job).

• Consistent brand image (standardized products).

• Lower labour costs (low labour intensity).

• Fewer issues due to lack of motivation.

Disadvantages of Mass Production

• High initial set-up costs (machinery purchases).

• Lower employee motivation (specialization → repetitive tasks).

• Difficult to offer different product choices to consumers.

• Higher storage costs (high volume of products).

Disadvantages of Mass/Flow Production

• High set-up costs (must buy production line machinery).

• Lower employee motivation due to repetitive tasks.

• More difficult to offer different product choices to consumers.

• Higher storage costs due to higher production volume

• Higher costs for mass marketing / above the line promotion

Mass customization

• Uses technology to produce a variety of models on the same production line.

• Combines high production volume (mass production) with flexibility to tailor products to customer demands (e.g., car configuration)

Advantages of Mass Customization

• Potentially higher pricing due to higher customization and general uniqueness of each product

• Economies of scale through high production volume

• Higher customer satisfaction

Disadvantages of Mass Customization

• Heavy investment in technology (capital-intensive).

• High set-up costs.

Choosing the Most Appropriate Production Method Depends On

• The best method depends on:

  • Demand for the product (size of the market):

    • High volume → mass production.

    • Low volume → job/batch production.

    • Demand for customization vs. standardization.

  • Financial considerations:

    • Initial capital expenditure.

    • Source of finance.

    • Ongoing production costs.

  • Marketing considerations:

    • Pricing and profitability.

    • Product positioning (quality vs. standardization, USP, personalized product).

  • Operations considerations:

    • Loss of operational flexibility.

    • Economies of scale.

    • Technical capabilities (R&D and worker skills).

Problems of Changing Production Methods

• Demand factors:

  • Total market volume and consistency of demand.

• Financial constraints:

  • Capital investment and ongoing costs.

• Marketing challenges:

  • Aligning product positioning with new method.

• Operational disruptions:

  • Loss of flexibility, scaling issues, or skill gaps.

5.4 Location

Location

Refers to the geographical position of the business.

Factors that affect the location of a business (Quantitative)

• ^{Cost of rent/mortgage.}

• ^{Labour costs}

• ^{Government policies,}

• ^{Distance to market}

  • ^{How far from customers}

• ^{Distance to inputs.}

• ^{Availability of government grants and incentives}

Factors that affect the location of a business (Qualitative)

• ^{External economies of scale}

  • ^{Infrastructure}

  • ^{Potential employees}

  • ^{Near suppliers.}

• ^{Political and legal factors.}

  • ^{E.g. Maximum working hours.}

• ^{Brand image}

• ^{location of competition}

• ^{Space for expansion}

• ^{Quality of life in an area}

  • ^{How attractive is the area}

  • ^{Facilities quality}

  • ^{Standard of living}

Ways of reorganizing production both nationally & internationally [AO3]

Offshoring

• ^{Refers to when a business relocates part or all of its functions and processes to another country}

• ^{the part of the business might stay internally or go to an external company}

Advantages of Offshoring

• ^{Lower costs}

  • ^{Labour costs}

  • ^{Import costs}

  • ^{Government tax advantages}

• ^{Potentially access specialized labour}

  • ^{Leads to higher production quality,}

  • ^{decision-making-factors}

• ^{Less strict regulation on}

  • ^{Health and safety}

  • ^{Environmental protection.}

  • ^{Employee rights}

• ^{Can be closer to market where products are sold}

  • ^{Can lead to better market research thus better decision-making}

Disadvantages of Offshoring

• ^{Culture/language barriers}

  • ^{Can lead to misunderstandings}

  • ^{Or misinterpretation of the task.}

  • ^{Lower quality output}

  • ^{Or lower productivity.}

• ^{Increased transportation costs.}

  • ^{As finished goods may have to be transported back}

• ^{Negative brand image}

  • ^{If employees are not treated well (ethically)}

  • ^{If the environment is damaged in the process}

• ^{Redundancy of home country workers.}

  • ^{As jobs are moved overseas.}

  • ^{Bad PR for the company}

  • ^{Demotivation of remaining workers}

• ^{Loss of control over quality}

Outsourcing

• ^{Refers to when a business subcontracts a process, such as packaging or manufacturing, to another business or organization.}

• ^{The business buys the service from another company rather than doing it internally}

• ^{(Can be onshore or offshore)}

Advantages of Outsourcing

• ^{Business can focus on core functions.}

  • ^{Increases efficiency and productivity}

• ^{Can lead to lower costs}

  • ^{The outsourced business may have specialized equipment that the business would not invest in given operations.}

• ^{Quick increase in capacity,}

  • ^{without needing internal methods of growth.}

• ^{Cost advantage}

Disadvantages of Outsourcing

• ^{Loss of control}

  • ^{The business loses control over the operation methods used for that specific function}

  • ^{Can lead to lower customer satisfaction due to declining quality.}

• ^{Redundancy after outsourcing}

  • ^{Can lead to negative publicity as the business may be seen as unethical.}

  • ^{Also lead to resistance from existing workforce}

• ^{The outsourcing supplier may not deliver according to business's needs}

  • ^{Deliver on time so other operations are not held up}

  • ^{Could cause internal diseconomies of scale.}

• ^{Working conditions of other producer}

  • ^{Negative brand image affect brand image of business which is outsourcing its functions}

  • ^{Unethical practices of producer}

Insourcing

Refers to when a business transfers a previously outsourced function back to the organization's own resources

Advantages of Insourcing

• ^{Assurance of quality}

  • ^{Methods and standards can be better overseen and changed by the business.}

• ^{Cheaper than paying the outsourced organization}

Disadvantages of Insourcing

• ^{May cause short term reduction in cash flow}

  • ^{Purchasing specialist/ required equipment}

• ^{May distract the business from its core Function}

  • ^{Must recruit and train employees to work in that part of the business}

  • ^{Must oversee quality.}

  • ^{Can negatively impact cash}

  • ^{takes Longer to generate revenue.}

5.5 Break-Even Analysis

Governing Equation for Break-Even Analysis

Contribution per unit

• ^{CPU (Contribution Per Unit)}

• ^{The amount of money a business makes from selling each unit of a product after covering variable costs.}

• ^{CPU = Price - Variable cost}

Total Contribution

• ^{The total amount of money which contributes to the fixed costs}

• ^{The total profit after selling all units of production and covering variable costs}

• ^{TC=CPUxQuantity = (Price-Variable cost)x Quantity}

Break-even quantity

• ^{The level of output or production at which a business's sales generate just enough revenue to cover all costs}

• ^{No profit or loss is made at this point.}

• ^{0 = Total Revenue - Total Costs}

Solve for Break-even quantity (BEQ)

Solve for Break-Even Revenue

• ^{Revenue = Price Quantity} 

• ^{Break-even Revenue = Price Break-Even Quantity}

Break-Even Point

The point where the total revenue and total costs are equal

Target Profit

• ^{The amount of profit that a business aims to earn within a given time period}

• ^{This is usually given and you will have to solve for}  

  • ^Quantity

  • ^Price

Target Profit output (Q)

• ^{The quantity of sales required to reach the firm's target profit}

• ^{Set Q as unknown}

Target price

• ^{The price of a product per unit in order to reach the firm's target profit}

• ^{Set price as unknown}

Break-even price

A special case of target price where the target profit equals , namely when the business breaks even

Margin of safety

The difference between how much a business sells and its BEQ

Steps for drawing a break-even chart

• ^{X axis is "Sales quantity (product)"} 

• ^{Y-axis is "Costs and revenues (currency)"} 

• ^{Step 1: Calculate BEQ & B-E Revenue} 

• ^{Step 2:}

  •  ^{Make x-axis range 2x or 1.5x BEQ} 

  • ^{Make y-axis range 2x or 1.5x BE Revenue} 

• ^{Step 3: Draw total fixed cost line} 

• ^{Step 4: Add Break-even point on chant (BEQ, BE-Revenue)} 

• ^{Step 5: Draw total Revenue line connecting (0,0) to BEP} 

• ^{Step 6: Draw total cost line from TFC to BEP} 

• ^{Step 7: Title and labels:} 

  • ^{Break-even chart for xxx}

  • ^{Axes (see above)} 

  • ^{Label BEP, BEQ, BE- Revenue} 

• ^{Step 8: Add arrows & a dotted line for margin of safety.} 

Effect of price on the profit and margin of safety

• ^{Increase in price} 

  • ^{Profit = (Price -Variable cost)x Quantity-Fixed cost} 

  • ^{Revenue = Price x Quantity} 

  • ^{BEQ ↓ CPU ↑ Margin of safety ↑} 

  • ^{Margin of Safety increases because the BEP is at a lower quantity} 

• ^{Decrease in price} 

  • ^{Opposite of above}

Effect of fixed costs on the profit and margin of safety

• ^{Increase in fixed costs.} 

  • ^{TC = FC + VC} 

  • ^{TC shifts upwards (y-int)} 

  • ^{CPU stays the same} 

  • ^{Profit margin.} 

  • ^{GPM stays the same} 

  • ^{BEQ ↑ Margin of safely ↓}

Effect of Variable cost per unit on profit and margin of safety

• ^{Increase in variable cost:} 

  • ^{TC = FC + Q x VC} 

  • ^{TC will pivot upwards.} 

  • ^{CPU ↓} 

  • ^{CPU= Price-Variable costs} 

  • ^{Profit margin ↓} 

  • ^{BEQ ↑} 

  • ^{Margin of Sales ↓} 

  • ^{Profit ↓} 

• ^Decrease 

  • ^{Opposite of above} 

Advantages of Break-Even Analysis

• ^{Visual and easy to interpret} 

  • ^{Provides guidelines} 

• ^{Will the business make a profit?} 

  • ^{How close to a loss is the business} 

• ^{Facilitates Scenario Analysis} 

  • ^{profit under different.} 

  • ^{at situations} 

  • ^Check 

• ^{Can be of value in supporting a business's application for a bank loan}

^{Disadvantages of Break-Even Analysis}

• ^{Costs and prices change frequently} 

  • ^{Break even analysis may not be realistic} 

• ^{Costs and Revenues are not usually Straight lines} 

  • ^{Total Revenue line does not consider demand} 

  • ^{TC: Economies of scale may exist} 

• ^{Assumes all stock is sold}