4. Decision Making to Improve Operational Performance

Operational Objectives

Key types of operational objectives include:

• Costs

  • Unit costs

  • Fixed costs (break-even analysis)

  • Productivity/efficiency

• Quality

  • Scrap/defective output minimisation

  • Customer service improvement

  • Customer returns reduction

• Speed/Flexibility

  • Labour productivity enhancement

  • Capacity utilisation maximisation

  • Order lead times reduction

• Dependability

  • Downtime (production) reduction

  • Maintenance costs minimisation

  • Reputation for quality enhancement

• Environmental

  • Waste management improvement

  • Recycling programs implementation

  • Carbon emissions reduction

• Added Value

  • Gross profit maximisation

  • Gross profit margin improvement

  • Unit cost reduction to increase value

Influences on Operational Objectives

Influences on Operational Objectives:

• Internal Influences

  • Corporate Objectives:

    • Alignment of operational objectives (e.g., increased production capacity) with corporate objectives (e.g., lowest unit costs) is critical.

  • Finance:

    • Operational decisions involving investment and costs are directly affected by the financial position of the business (profitability, cash flow, liquidity).

  • Human Resources:

    • The quality and capacity of the workforce significantly affect operational objectives, especially in service businesses; productivity targets are influenced by training and automation investments.

  • Marketing:

    • The nature of the product determines the operational setup; changes to the marketing mix, particularly the product element, can strain operations if production is inflexible.

• External Influences

  • Economic Environment:

    • Impacts capacity utilisation and productivity; changes in interest rates affect costs.

  • Competitor Efficiency and Flexibility:

    • More efficient or higher-quality competitors pressure operations to deliver comparable performance.

  • Technological Change:

    • Especially significant in markets with short product life cycles, rapid innovation, and costly production processes.

  • Legal and Environmental Change:

    • Increased regulation and legislation pose new challenges for operational objectives.

Labour Productivity

• Definition:

  • Labour productivity is the volume of output (units) or value () produced per employee.

• Importance:

  • Labour costs are a significant part of total costs.

  • Business efficiency and profitability are linked to productive labour use.

  • Businesses need to keep unit costs down to remain competitive.

• Factors Influencing:

  • Extent and quality of fixed assets (equipment, IT systems).

  • Skills, ability, and motivation of the workforce.

  • Methods of production organisation.

  • Training and support provided to the workforce (working environment).

  • External factors (reliability of suppliers).

• Calculation:

  • \text{Labour Productivity} = \frac{\text{Output in period (units)}}{\text{Number of employees at work}}

• Ways to improve labour productivity:

  • Measure performance and set targets.

  • Streamline production processes.

  • Invest in capital equipment (automation + computerisation).

  • Invest in employee training.

  • Improve working conditions.

• Potential Problems When Trying to Increase Labour Productivity:

  • Potential ‘trade-off’ with quality- higher output must still be of the right quality

  • Potential for employee resistance- depending on the methods used (e.g introduction of new technology)

  • Employees may demand higher pay for their improved productivity (negates impact on labour costs per unit)

Unit Costs

• Definition:

  • Unit cost measures the average cost per unit produced over a specific period (e.g., month, year).

  • Sensitive to operational scale and the relationship between fixed and variable costs.

• Calculation:

  • \text{Unit Costs} = \frac{\text{Total production costs in period (£)}}{\text{Total output in period (units)}}

Economies of Scale

• Definition:

  • Economies of scale occur when unit costs decrease as output increases.

• Calculation:

  • \text{Economies of Scale} = \frac{\text{Total production costs in period (£)}}{\text{Total output in period (units)}}

• Internal Economies of Scale:

  • Arise from increased output of the business itself.

    • Buying Economies: Bulk buying results in lower prices.

    • Technical: Use of specialist equipment boosts productivity.

    • Marketing: Spreading fixed marketing spend over a larger range.

    • Network: Adding extra customers.

    • Financial: Larger firms have access to more and cheaper finance.

• Purchasing (bulk buying):

  • A purchasing economy of scale is the benefit that a business receives from purchasing large volumes of a good

  • The supplier is incentivised to offer a discount as the scale of the purchase is substantial

  • The lower costs allow a business to either lower their selling prices to consumers (increasing competitiveness) or maximise their profits (benefiting shareholders)

• Financial economies:

  • As a business grows in scale so it acquires more assets

  • Assets can be used as security against any kind of financial borrowing. This reduces the risk for the lender

  • With a lower level of risk, lenders are prepared to offer larger businesses more money and a much more favourable lending rate than smaller firms

• Technical economies:

  • To enable growth, a business is more likely to increase levels of production and productivity by making greater use of capital equipment

  • The automation of production lines offers cost savings as more can be produced with less waste and greater efficiency than using human capital

  • Drawbacks of this approach include job losses, lower staff motivation and the high initial cost of investment in equipment

• Marketing economies:

  • Increasing growth brings with it the need for additional marketing and promotion campaigns

  • An increased scale of production means that marketing costs are now spread out over more units of output, therefore reducing the average costs of marketing

• Managerial economies:

  • As a sole trader, a business owner would be expected to carry out all tasks to keep the business afloat

  • The business owner would be responsible for marketing, production, sales, finance, HR and logistics

  • As the business grows in size, so the levels of hierarchy within the business increase and they employ specialists (experts) in each field e.g. HR manager, sales manager etc

  • The specialists make fewer mistakes and this means lower costs which brings about managerial economies of scale

• External Economies of Scale:

  • Occur within an industry where all competitors benefit often associated with particular geographic areas

    • Examples:

      • Having many specialist suppliers close by

      • Access to research and development facilities

      • The pool of skilled labour to choose from

Diseconomies of Scale

• Diseconomies of scale occur when a business grows so large that the costs per unit increase i.e. difficulties of managing a larger workforce

• Poor communication

  • There are more layers in the hierarchy that can distort a message and wider spans of control for managers. This may result in workers having less clear instructions from management about what they are supposed to do and when.

  • In addition, there may be more written forms of communication (e.g. newsletters, notice boards, e-mails) and fewer face-to-face meetings, which can result in less feedback and therefore less effective communication.

• Lack of motivation

  • Workers can often feel more isolated and less appreciated in a larger business and so their loyalty and motivation may diminish. It is harder for managers to stay in day-to-day contact with workers and build up a good team environment and sense of belonging.

  • This can lead to lower employee motivation with damaging consequences for output and quality.

  • The main result of poor employee motivation is falling productivity levels and an increase in average labour costs per unit.

• What can a business do about this?

  • Possible solutions include:

    • Delegation of decision-making (empowerment)

    • Making jobs more interesting (job enrichment)

    • Splitting employees into teams (teamworking)

• There is also a close link between communication and motivation (which the motivational theorist Elton Mayo recognised) and so as communication becomes harder, motivation will decline.

  • This is particularly true as managers are less able to take a personal interest in the workers.

• Loss of direction and co-ordination

  • It is harder to ensure that all workers are working for the same overall goal as the business grows. It is more difficult for managers to supervise their subordinates and check that everyone is working together effectively, as the spans of control have widened.

  • A manager may be forced to delegate more tasks, which while often motivating for his subordinates, leaves the manager less in control.

Capacity and Capacity Utilisation

• Capacity Definition:

  • The capacity of a business is a measure of how much output it can achieve in a given period.

• Capacity is a dynamic concept:

  • Capacity can change: e.g. when a machine is undergoing maintenance, capacity is reduced

  • Capacity is linked to labour: e.g. by working more production shifts, capacity can be increased

  • Capacity needs to take account of seasonal or unexpected changes in demand: e.g. Chocolate factories need the capacity to make Easter Eggs in November and December before shipping them to shops after Christmas

• Why Capacity Utilisation Matters:

  • Measures productive efficiency by indicating idle resources.

  • Higher utilisation reduces average production costs.

  • Businesses aim for close to 100% utilisation to minimise unit costs.

  • High utilisation is required if a business has a high break-even output due to significant fixed costs of production

• The Costs of Capacity:

  • Equipment: e.g production line

  • Facilities: e.g building rent, insurance

  • Labour: Wages and salaries of employees involved in production or delivering a service

• Why Most Businesses Operate Below Capacity (Utilisation <100%):

  • Lower than expected market demand: A change in customer tastes

  • A loss of market share: Competitors gain customers

  • Seasonal variations in demand: Weather changes lead to lower demand

  • Recent increase in capacity: A new production line has been added

  • Maintenance and repair programmes: Capacity is temporarily unavailable

• Evaluation: Dangers of Operating at Low Capacity Utilisation:

  • Higher unity costs- impact on competitiveness

  • Less likely to reach breakeven output

  • Capital tied up in under-utilised assets

• Evaluation: Problems Working at High Capacity:

  • Negative effect on quality (possibly):

    • Production is rushed

    • Less time for quality control

  • Employees suffer:

    • Added workloads and stress

    • De-motivating if sustained for too

  • Loss of sales:

    • Less able to meet sudden or unexpected increases in demand

    • Production equipment may require repair

• Capacity Utilisation:

  • The proportion (%) of a business’ capacity actually used over a period.

  • \text{Capacity Utilisation} = \frac{\text{Actual level of output (units)}}{\text{Maximum possible output (units)}} \times 100$$

Efficiency and Productivity

• Refer to labour productivity information above

Lean Production

• Definition:

  • Approaches to management that focus on cutting out waste, whilst ensuring quality

• Lean Production in Summary:

  • Doing the simple things well

  • Doing things better

  • Involving employees in the continuous process of improvement

  • As a result, avoiding waste, thereby reducing costs

• Examples of Waste in Business:

  • Over-production: Making more than is needed- leads to excess stocks

  • Waiting time: Equipment and people standing idle waiting for the production process to be completed or resources to arrive

  • Stocks: Often held as an acceptable buffer, but should not be excessive

  • Defects: Output that does not reach the required quality standard- often a significant cost to an uncompetitive business

• Main Methods of Lean Production:

  • Time-based management

  • Simultaneous engineering

  • Just-in-time production (JIT)

  • Cell production

  • Kaizen (Continuous improvement)

• Effective Lean Production Requires:

  • Good relations with suppliers

  • Committed, skilled and motivated employees

  • A culture of quality assurance; continuous improvement and willingness to embrace change

  • Trust between management and employees

• Time-Based Management:

  • An approach that recognises the importance of time and seeks to reduce wasted time in production processes.

    • Requirements:

      • Flexible production methods (able to change products quickly).

      • Trained employees (multi-skilled staff).

      • Trust between workers and managers.

• Simultaneous Engineering:

  • An approach to project management that helps firms develop and launch new products more quickly. All parts of the project are planned together. Everything is considered simultaneously (together, in parallel) rather than separately (in series)

• Cell Production:

  • A form of team working where production processes are split into cells. Each cell is responsible for a complete unit of work

    • Potential benefits of cell production:

      • The closeness of cell members should improve communication

      • Workers become multi-skilled and more adaptable to the needs of the business

      • Greater employee motivation, from variety of work, team working and responsibility

      • Quality improvements as each cell has ‘ownership’ for quality in its area

• Just-In-Time (JIT):

  • JIT aims to ensure that inputs arrive only when needed for production

    • How JIT works:

      • Based on a ‘pull’ system of production- customer orders determine what is produced

      • Requires complex production scheduling- achieved using specialist software to connect production with suppliers

      • Supplies are delivered to production only when needed

      • Requires close cooperation with reliable suppliers

    • Benefits of JIT:

      • Lower stock holding means a reduction in storage space which saves rent and insurance costs

      • As stock is only obtained when it is needed, less working capital is tied up in stock

      • Less likelihood of stock perishing, becoming obsolete or out-of-date

      • Less time is spent on checking and reworking production as the emphasis is on getting the work right the first time

    • Disadvantages of JIT:

      • There is little room for mistakes as minimal stock is kept for re-working faulty product

      • Production is highly reliant on suppliers and if stock is not delivered on time, the whole production schedule can be delayed

      • There is no spare finished product available to meet unexpected orders because all product is made to meet actual orders

      • A need for complex, specialist stock systems

• Kaizen:

  • Kaizen (or ‘Continuous improvement’) is an approach of constantly introducing small incremental changes in a business to improve quality and/or efficiency

    • How Kaizen works:

      • As ideas come from employees, they are less likely to be radically different and probably easier to implement

      • Small improvements are less likely to require major capital investment than major process changes

      • The culture- all employees should continually look for ways to improve their performance

      • Kaizen encourages employees to take ownership of their work, which can help reinforce teamwork and improve motivation

Operations Resource Mix

What is the optimal mix of resources for operations?

• Labour Intensive Processes:

  • Key features:

    • Labour costs are higher than capital costs

    • Costs are mainly variable

    • Labour supply (quantity and quality) and cost are key issues

  • Examples:

    • Hotels and restaurants

    • Fruit farming/picking

    • Hairdressing and other personal services

• Capital-Intensive Processes:

  • Key features:

    • Capital costs are higher than labour costs

    • Costs are mainly fixed (including depreciation)

    • Significant investment is often required (e.g automation) but with longer-term benefits on unit costs

  • Examples:

    • Oil extraction and refining

    • Car manufacturing

    • Pharmaceutical production

• Capital and Labour Intensive:

  • The production operations of any business combine two-factor inputs:

    • Labour – i.e. management, employees (full-time, part-time, temporary etc)

    • Capital – i.e. plant & machinery, IT systems, buildings, vehicles, offices

  • Labour intensive:

    • Food processing (e.g. ready meals)

    • Hotels & restaurants

    • Fruit farming/picking

    • Hairdressing & other personal services

    • Coal mining

  • Capital intensive

    • Oil extraction & refining

    • Car manufacturing

    • Web hosting

    • Intensive arable farming

    • Transport (airports, railways etc)

  • The main features of each category can also be summarised as follows:

    • Labour intensive operations

      • Labour costs higher than capital costs

      • Costs are mainly variable in nature = lower breakeven output

      • Firms benefit from access to sources of low-cost labour

    • Capital intensive operations

      • Capital costs higher than labour costs

      • Costs are mainly fixed in nature = higher breakeven output

      • Firms benefit from access to low-cost, long-term financing

Quality Control Explained

• Quality Control:

  • The process of inspecting products to ensure that they meet the required quality standards, mainly about ‘detecting’ defective output- rather than preventing it

    • Usually requires sampling, spots and removes sub-standard output and it can be very costly

• Quality control and Inspection:

  • When raw materials are received before entering production

  • Whilst products are going through the production process

  • When products are finished- takes place before products are dispatched to customers

• Business benefits of quality control:

  • Sub-standard output is spotted before it reaches the customer

  • Minimise disruption to production

  • Applies a consistent standard of quality

• Some problems with quality inspection:

  • Costly

  • Often at the end of the production process- i.e potentially too late

  • Inconsistent inspections

  • Often not compatible with modern production systems

  • Done by inspectors rather than workers themselves

Quality Management

• Poor quality is a reason for competitive disadvantage

  • Examples of poor quality:

    • Product fails- e.g. a breakdown or unexpected wear and tear

    • The product does not perform as promised

    • The product is delivered late

    • Poor instructions/directions for use

    • Unresponsive customer service

  • Cost of poor quality:

    • Cost of reworking or remaking products

    • Costs of replacements or refunds

    • Wasted materials

    • Lost customers (expensive to replace- and they may tell others about their bad experience)

  • How poor quality damages competitiveness:

    • Financial costs (e.g. compensation)

    • Lost customer loyalty

    • Damaged business reputation

    • Need for greater controls and checks

    • Competitors take advantage

Quality Assurance Explained

• Two main approaches to quality management:

  • Quality control:

    • Based on inspection

    • Takes defects out

  • Quality assurance:

    • Based on processes

    • Builds quality in

• Quality assurance:

  • The processes that ensure production quality meet the requirements of customers

    • The aim: design the way a product or service is produced or delivered to minimise the chances that output will be sub-standard

    • The focus of quality assurance is on the product design/development stage

      • If the production process is well controlled- then quality will be ‘built-in’

      • If the production process is reliable- there is less need to inspect production output (quality control)

• Quality assurance:

  • Focus on processes

  • Achieved by improving production processes

  • Targeted at the whole business

  • Emphasises the customer

  • Quality is built into the product

• Quality control:

  • Focus on outputs

  • Achieved by sampling and checking (inspection)

  • Targeted at production activities

  • Emphasises required standards

  • Defective products are inspected out

• Approach to quality assurance:

  • A management philosophy committed to a focus on continuous improvements of products and services with the involvement of the entire workforce

Total Quality Management (TQM)

• TQM is essentially an ‘attitude’

• The whole business understands the need for quality and seeks to achieve it

• Everyone in the workforce is concerned with quality at every stage of the production process

• Workers but not inspectors ensure quality

  • Advantages of TQM:

    • Puts the customer at the heart of the production process

    • Motivational since workers feel more involved and are making decisions

    • Less wasteful than throwing out defective finished products

    • Eliminates cost of inspection

  • Disadvantages of TQM:

    • Requires strong leadership- often missing in a business

    • Substantial investment in training and support- but return on investment not immediate

    • May become bureaucratic

    • Disruption and cost may outweigh the benefits

• Kaizen:

  • Another kind of quality assurance

  • Based on the concept/culture of continuous improvement

  • Encourages employees to engage fully with finding ways to improve quality processes

Inventory Management

• Three main types of stock:

  • Raw materials and components

  • Work in progress

  • Finished goods

• Why do we use Stock Control Charts?

  • The overall objective of stock control is to maintain stock levels so that the total costs of holding stocks are minimised

• Key parts of a Stock Control Chart:

  • Maximum level: Max level of stock a business can or wants to hold

  • Re-order level: Acts as a trigger point, so that when the stock falls to this level, the next supplier order should be placed

  • Lead time: Amount of time between placing the order and receiving the stock

  • Minimum stock level: The business would want to hold a minimum amount of product in stock. Assuming the minimum stock level is more than zero, this is known as buffer stock

• Factors affecting when/how much stock to re-order:

  • Lead time from the supplier

    • How long it takes for the supplier to deliver the order

    • Higher lead times may require a higher re-order level

  • Implications of running out (stock-outs)

    • If stock-outs are very damaging, then have a high re-order level and quantity

  • Demand for the product

    • Higher demand normally means higher re-order levels

• Advantages of low stock levels:

  • Lower stock holding costs (e.g. storage)

  • Lower risk of stock obsolescence

  • Less capital (cash) tied up in working capital- can be used elsewhere in the business

  • Consistent with operating ‘lean’

• Advantages of high stock levels:

  • Production fully supplied- no delays

  • Potential for lower unit costs by ordering in bulk/high quantities

  • Better able to handle unexpected changes in demand or need for higher output

  • Less likelihood of ‘stock-outs’

Stocks and Stock Management

• What are Stocks?

  • Stocks represent the raw materials, work-in-progress and finished goods held by a firm to enable production and meet customer demand

• Three main types of stock:

  • Raw materials and components

    • Bought from suppliers

    • Used in the production process

    • E.g. parts for assembly or ingredients

  • Work in progress

    • Semi or part-finished production

    • E.g. construction projects

  • Finished goods

    • Completed projects ready for sale or distribution

    • E.g. products on supermarket shelves; goods in Amazon warehouses

• Key reasons to hold stock:

  • Enable production to take place

  • Satisfy customer demand

  • Precaution against delays from suppliers

  • Allow efficient production

  • Allow for seasonal changes

  • Provide a buffer between production processes

• Main influences on the amount of stock held:

  • Need to satisfy demand

    • Failure to have goods available for sale is very costly

    • Demand may be seasonal or unpredictable

  • Need to manage working capital

    • Holding stocks ties up cash in working capital

    • There is an opportunity cost associated with stockholding

  • Risk of stock losing

    • The longer stocks are held, the greater the risk that they cannot be used or sold

• The costs of holding stocks:

  • Cost of storage: More stocks require large storage space and possibly extra employees and equipment to control and handle them

  • Interest costs: Holding stocks means tying up capital (cash) on which the business may be paying interest

  • Obsolescence risk: The longer stocks are held, the greater the risk that they will become obsolete ( not capable of being sold)

• Stock out costs:

  • A stock out happens if a business runs out of stock. This can result in:

    • Lost sales and customer goodwill

    • Cost of production stoppages or delays

    • Extra costs of urgent, replacement orders