IGCSE BUSINESS STUDIES NOTES – SECTION 4: OPERATIONS MANAGEMENT

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IGCSE BUSINESS STUDIES NOTES – SECTION

4: OPERATIONS MANAGEMENT

ANUSHKA SAINI

PRODUCTION OF GOODS AND SERVICES

Production is providing a product

or service to satisfy consumer needs and wants. The process involves adding

value to a product (Difference between the selling price of a product and the

cost of its components). Businesses combine these inputs to make more valuable

and desirable outputs. Business should combine these inputs efficiently to keep

costs low and increase profits.

LABOUR INTENSIVE – MANY WORKERS

AND FEW MACHINES

CAPITAL INTENSIVE – FEW WORKERS

AND MANY MACHINES

The Difference between Production

and Productivity

PRODUCTION – THE OUTPUT OF A

BUSINESS

PRODUCTIVITY – HOW A BUSINESS CAN

MEASURE THEIR EFFICIENCY (OUTPUTS/INPUTS)

Labour Productivity = total output

/ number of workers

Productivity can mean using FEWER

INPUTS to produce the SAME OUTPUT or using the SAME INPUTS to produce GREATER

OUTPUT.

Ways to Increase Productivity:

-

Improved

quality control / assurance reduces waste.

-

Use

machines instead of people to do jobs (automation).

-

Improve

employee motivation.

-

Train

staff to be more efficient.

-

Introduce

new technology.

-

Improve

inventory control.

Benefits of increasing Efficiency/Productivity:

-

Increased

output relative to the inputs required.

-

Lower

costs per unit (average costs).

-

Fewer

workers may be needed, possibly leading to lower wage costs.

-

Higher

wages for workers increase motivation.

Specialization and Division of labour

Specialization breaks up the production process into separate functions,

allowing workers to concentrate on one area. Specialization can help workers to

become very skilled and very efficient at carrying out particular tasks.

However, firms may struggle to continue production if a highly skilled

worker is absent or leaves.

The division of labour involves braking jobs down into very small tasks,

repeated over and over again. These tasks are easy to learn, meaning a firm can

employ less skilled workers and spend less on training. However, repetitive

work can become boring and lead to demotivation.

Why do businesses hold inventories (stock)?

Firms hold stocks just in case there is a delay in supplies that could

bring production to a halt or an unexpected increase in demand. However, they

represent a significant cost to a firm.

Inventories take many forms:

-

Raw

materials

-

Partly

finished goods

-

Finished

products ready for delivery

To ensure that there is always enough stock to satisfy demands, stock

levels must be carefully controlled.

The Stock Control Chart

NO STOCK MEANS NO SALES, but having to much stock can also have bad

effects:

-

Stocks

need to be paid for, using up money that could be use elsewhere.

-

They need

to be stored in conditions that will keep them in good condition.

The buffer inventory level is the inventory held to deal with

uncertainty demand and deliveries of supplies.

Lean Production

Lean production includes all production methods that reduce waste and

therefore increase efficiency. It cuts out any activities (including services)

that do not add value for the customer.

Benefits of Lean Production:

-

Less

storage of raw materials or components

-

Quicker

production of goods and services

-

No need to

repair defects or provide a replacement service for a dissatisfied customer

-

Better use

of equipment

-

Cutting

out some processes which speeds up production

-

Less money

tied up in inventories

-

Improved

health and safety leading to less time off work due to injuries

Just-In-Time Production

Just-in-time production (JIT) production

means that businesses do not hold buffer stocks. JIT is a key part of an

approach know as lean production.

Deliveries of raw materials are

times to arrive just as they are needed in the production process. Output is

also timed to be produced to meet delivery deadlines agreed with customers.

If successfully managed, JIT can

lead to substantial cost savings. There is no need for warehouse building,

staff to manage stocks or expensive insurance.

Kaizen

Kaizen is a Japanese term meaning

‘continuous improvement’ through the elimination of waste. The improvement

doesn’t come from investing in new technology but from the ideas of the workers

themselves. Small groups of workers meet regularly to discuss the problems and

potential solutions to those problems. This has proved effective because no one

knows the problems that exist better than the workers who work with them all

the time.

Benefits of Kaizen:

-

Increased productivity

-

Reduced amount of space needed for the production

process

-

Work in progress is reduced

-

Improved layout of the factory floor may all some

jobs to be combined, thereby freeing up employees to carry out some other job

in the factory

Cell Production

Cell Production is where the

production line is divided into separate, self- contained units (cells), each

making an identifiable part of the finished product, instead of having a flow

or mass production line. This method of production improves the morale of the

employees and makes them work harder so they become more efficient. The

employees feel more valued and less likely to strike or cause disruption.

Methods of Production

There are three methods:

JOB PRODUCTION e.g. hair dressers

BATCH PRODUCTION e.g. bakery

FLOW PRODUCTION e.g. cars, microwaves

JOB PRODUCTION is where a single

product is made at a time.

Advantages of job production:

-

Most suitable for personal services or ‘one off’

products.

-

The product meets the exact requirements of the

customer.

-

The workers often have more varied jobs.

-

More varied jobs mean increased motivation for the

employees and also more job satisfaction.

Disadvantages of job production:

-

Skilled labor is often used and skilled labor may be

harder to employ.

-

Costs are higher because it is often labor intensive.

-

Often takes a long time.

-

Materials have to be specifically purchased leading

to higher costs. This is because buying materials in a bulk load is cheaper

than having to purchase materials individually.

BATCH PRODUCTION is where a

quantity of one product is made then a quantity of another item will be

produced.

Advantages of batch production:

-

It is a flexible way of working and production can

easily be changed from one product to another.

-

It still gives workers a variety of tasks to do.

-

Production may not be highly affected if machinery

breaks down.

Disadvantages of batch production:

-

Can be expensive as finished / semi-finished products

need to be moved around.

-

Warehouse space will be needed for stocks of raw

materials and components. This is costly.

-

Machines need to be reset between production batches

which means there will still be a delay in production and output is lost.

FLOW PRODUCTION is where large

quantities of a product are produced in a continuous process. It is sometimes

called MASS PRODUCTION.

Advantages of flow production:

-

High output of standardized products.

-

Costs are kept low and therefore prices are lower.

-

It is easy for capital intensive production methods

to be used – reducing labor costs and increasing efficiency.

-

Little training may be needed for workers.

-

Automated production lines can run for 24 hours,

thereby increasing efficiency.

-

Goods are produced quickly and cheaply.

-

There is no need for goods to be moved from one part

of the factory to another – time is saved.

Disadvantages of flow production:

-

Boring system for workers – little job satisfaction

leading to lack of motivation for the workers.

-

Capital need to set up the production line and this

can be very expensive.

-

If a single machine gets damaged the whole production

process will be needed to be stopped.

-

A lot of storage requirements – both raw materials

and finished products.

Factor Affecting Which Method of

Production to use

-

THE NATURE OF THE PRODUCT: If a fairly unique product

or an individual service is required then job production should be used. If the

product can be mass produced using an automatic production line, then flow

production should be used.

-

THE SIZE OF THE MARKET: If the demand is higher and

more products can be sold but not in very large quantities, batch production

should be used. Small local markets will be served by businesses using job or

batch production. International markets are served by businesses using flow

production.

-

THE NATURE OF DEMAND: I f there is a large and fairly

steady demand for the product, it becomes economic to set up a production line

and continuously produce the product (flow production). If demand us less

frequent, then production is more likely to be job or batch production.

-

THE SIZE OF THE BUSINESS: If the business is small

and does not have that much access to capital then it will not produce on a

large scale using automatic production lines. Only large businesses can operate

on that scale. Small businesses are more likely to use job or batch production

methods.

How technology has changed

production methods

Technological advances have

allowed the mechanisation and automation of production methods in many

industries.

-

AUTOMATION: is where their equipment used in the

factory is controlled by a computer to carry out mechanical processes, such as

paint spraying on a car assembly line. The production line will consist mainly

of machines and only a few people will be needed to ensure that everything

proceeds smoothly.

-

MECHANISATION: is where the production is done by

machines but operated by people, for example, a printing press. Robots are

machines that are programmed to do tasks, and are particularly useful for unpleasant,

dangerous and difficult jobs. They are quick, very accurate and work non stop

for 24 hours a day.

-

CAD (Computer Aided Design) is a computer software

that draws items being designed more quickly and allows them to be rotated to

see the items from all sides instead of having to draw is out several item. It

is used to design new product or to restyle existing ones. It is particularly

useful for detailed technical drawings.

-

CAM (Computer Aided Manufacture) is where computer

monitor the production process and control machines or robots on the factory

floor.

-

CIM (Computer Integrated Manufacture) is the total integration

of computer aided design and computer aided manufacturing. The computers that

design the products are linked directly to the computers that aid the

manufacturing process.

-

EPOS (Electronic Point of Sale) this is used at check

out where the operator scans the barcode or each item individually. The price

and description of the item is displayed on the checkout monitor and printed on

the till receipt. The inventory record is automatically changed to show one

item has been sold and if inventory is low them more stock can be automatically

ordered.

-

EFTPOS (Electronic Funds Transfer at Point of Sale)

this is where the electronic cash register is connected to the retailer’s main

computer and also to the banks over a wide area computer network.

Advantages of New Technology:

-

Increase in productivity

-

Greater job satisfaction for the workers

-

Better quality products

-

More accurate consumer demand results form computers

-

Computers being used to monitor inventory levels

-

Quicker communication and reduced paperwork

Disadvantages of New Technology:

-

Unemployment increases

-

Expensive to invest in new technology

-

New technology is changing constantly and can become

outdated. This means it may need to be updated.

COSTS, SCALE OF PRODUCTION AND

BREAK-EVEN ANALYSIS

Business

Costs

All

costs are money being spent (going out) of a business.

Fixed

costs are costs that do not vary with output. They remain the same regardless

of the output level. For example, rent will remain the same – it will still

have to be paid if a factory shuts down for a month. NO OUTPUT = SAME FIXED

COSTS

-

Insurance

-

Interest Payments

-

Machinery, tools and

equipment

-

Salaries

-

Rent for premises

-

Business rates

Variable

costs are costs that do vary with output. They go up or down if output goes up

and down. For example, raw materials, packaging, direct labour, etc. NO OUTPUT

= NO VARIABLE COSTS

-

Raw materials

-

Packaging

-

Telephone

-

Power (electricity)

-

Wages

-

Heating

Total

cost is the sum of fixed costs and variable costs. It assumes that all costs

are either fixed or variable. TOTAL COSTS = FIXED COSTS + VARIABLE COSTS

Direct

costs – directly linked to a specific activity or product e.g. raw materials

and labour costs (similar to variable). DIRECTLY LINKED TO OUTPUT

Indirect

costs – are overheads which are the day to day running costs of a business e.g.

insurance, cleaning, office running costs (similar to fixed). NOT LINKED TO

OUTPUT

Average

costs are the average cost of producing one unit of output. Sometimes called

unit costs. AVERAGE COST = TOTAL COST / QUANTITY

Revenue

is the amount of money that a business earns from selling the products or

services that it is producing. TOTAL REVENUE = QUANTITY SOLD x PRICE

What is

Break-even?

A firm

breaks even when its costs of production are equal to its sales revenue. This

means that the firms does not make any profit nor does it make a loss.

Why

would a firm use break-even analysis?

-

When starting up a business

break even analysis is often used to help plan how much money needs to be sold

to make a profit.

-

If a bank loan is required,

the bank manager will often ask to see a break-even chart.

-

Break-even information can

be used to make decisions about prices and costs.

Calculating

Break-even using the formula:

BREAK

EVEN = FIXED COSTS / (SELLING PRICE – VARIABLE COSTS)

Break-even

is always expressed in NUMBER OF UNITS SOLD.

What is

Margin of Safety?

The

margin of safety is the number of sales above the break-even point. A business

can check its margin of safety with following formula: MARGIN OF SAFETY =

ACTUAL OUTPUT – BREAK-EVEN OUTPUT

Advantages

of Break-even Charts:

-

The chart allows managers

to read off expected profit/loss for different levels of output.

-

Helpful in modelling

possible changes e.g. can see the effects of a change in fixed, variable costs

or of price.

-

Quick and simple to

produce.

-

Useful when asking the bank

for a loan as it shows the bank that the business is planning for the future.

-

Enables managers to see the

level of production/sales needed to break-even.

-

Helps to identify the

margin of safety.

Disadvantages

of Break-even charts:

-

The chart does not take

into account the behaviour of competitors and consumers when prices are changed

or set.

-

Figures are only forecast

and the future may turn out differently from what was predicted.

-

Assumes all goods

manufactured will be sold out. It is possible that will not happen.

-

The cost of raw material

may change overtime – it may cost more to produce one product.

-

The number of competitors

in the market may change – which may affect the sales of the business.

-

Assumes all costs and

revenue are always drawn as straight lines. This is unlikely to be the case in

reality e.g. the cost of materials may change frequently and increased sales

may only be possible if price discounts are given.

-

Managers need to consider

many other factors other than just output. Maintaining quality. Reducing waste,

and promoting sales are examples of other important areas that need attention.

Economies

of Scale

Economies

of Scale are the factors that lead to a reduction in average costs as a

business increases in size.

Purchasing

Economies: When a business buys a large number of components, for example

materials or spare parts, they are able to gain discounts for buying in bulk.

This reduces the unit cost of each item bought and gives the firm an advantage

over small businesses which buy in small quantities.

Marketing

Economies: There are several advantages for a large business when marketing its

products. It might be able to afford to purchase its own vehicles to distribute

goods rather than depend on other firms. Advertising rates in papers and on

television do not go up in the same proportion as the size of an advertisement

ordered by the business. The business will not need as many sales staff to sell

ten product lines as a smaller firm needs to sell five.

Financial

Economies: Larger businesses are often able to raise capital more cheaply than

smaller ones. Bank managers often consider that lending to large organisations

is less risky than lending to small ones. A lower rate of interest is therefore

charged.

Managerial

Economies: Small businesses cannot usually afford to pay for specialist

managers, for example marketing managers and qualified accountants. This tends

to reduce their efficiency. Larger companies can afford specialists and this

increases their efficiency and helps to reduce their average cost.

Technical

Economies: Large manufacturing firms can afford latest machinery/equipment and

this can result in lower average costs (not lower costs). A large business is

likely to have higher total costs than smaller businesses – but lower average

costs.

Diseconomies

of Scale

Diseconomies

of Scale are the factors that lead to an increase in average costs as a

business grows beyond a certain size.

Poor

Communication: The larger the organisation the more difficult it becomes to send

and receive accurate messages. If there is slow or inaccurate communication,

then serious mistakes can occur which lead to lower efficiency and higher

average costs.

Low

morale: Large businesses can employ thousands of workers. It is possible that

one worker will never see the top managers of the business. Workers may feel

that they are unimportant and not valued by the management. In small firms it

is possible to establish close relationships between workers and top managers.

The lack of these relationships in a big firm can lead to low morale and low

efficiency amongst the workers. This will tend to push up average costs.

Slow

decision making: It often takes longer for decisions to be made by managers to

reach all groups of workers and this could mean that it will take a long time

for workers to respond and act upon managers’ decisions. The top managers will

be so busy directing the affairs of the business that they may not have any

contact with all of the customers of the firm and they could become too removed

from the products and markets the firm operates in

ACHEIVING QUALITY PRODUCTION

Quality means to produce a good or

service which meet customer expectation. Quality is important because if a

business gets a reputation for having low quality, consumers will not by the business’s

products. If this happens customers will begin to purchase the business’s

competitors’ products instead- lowering the sales and profits of the business.

Quality can mean different things

to different people:

-

Good product

-

Reliable product

-

Customer service

-

After sales service

-

No complaints

-

Tertiary services/ customer services

But if quality is not maintained

the business will:

-

Lose customers to other firms

-

Have to replace faulty products or repeat poor

service which raises costs for the business

-

Have customers who tell other people about their

experiences and this may give the business a bad reputation leading to lower

sales and profits.

QUALITY CONTOL – is the checking

for quality at the end of the production process, whether it is the production

of a product or service.

Advantages

of Quality Control:

-

Tries to eliminate faults or errors before the

customer receives the product/service.

-

Less training required for the workers.

Disadvantages

of Quality Control:

-

Expensive as employees need to be paid to check the

product or service.

-

Identifies the fault but does not show how the

problem could have occurred.

-

Increased costs if the products have to be scraped or

reworked.

QUALITY ASSUANCE – is the checking

for the quality standards throughout the production process, whether it is the

production of a product of service.

Advantages of Quality Assurance:

-

Tries to eliminate faults or errors before the

customer receives the product/service.

-

Fewer customer complaints.

-

Reduced costs if products do not have to be scraped

or reworked.

Disadvantages of Quality

Assurance:

-

Expensive to train employees to check the product or

service.

-

Relies on the employees following instructions of

standards set.

TOTAL QUALITY MANAGEMENT – is the

continuous improvement of products and processes by focusing on quality at each

stage of production.

Advantages of Total Quality

Management:

-

Quality is built into every part of the production.

-

Eliminates all faults or errors before the customer

receives the product or service.

-

No customer complaints which leads to better

reputation.

-

Reduced costs.

-

Waste is removed and efficiency increases.

Disadvantages of Total Quality

Management:

-

Expensive to train workers

-

Relies on workers following TQM ideology.

LOCATION DECSIONS

Factors Affecting Location

Every business has to be located

somewhere. A sole trader who workers as a window cleaner may operate from home,

whereas a multinational car company will have factories, offices and outlets in

many countries. For both businesses however, where to locate may be the most

important decision they make and can determine their success. It is a vet

expensive decision to change.

Factors affecting location

include:

-

Cost of site

-

Availability of Labour

-

Proximity to raw material

-

Proximity to market

-

Infrastructure

-

Government incentives

Factors affecting the location of

manufacturing businesses:

-

Availability of Labour: A manufacturing business may

decide their location based on how easily they can find labour in the area. If

a particularly skilled labour is required, it may be easier and cheaper for the

business to set up where the particular skilled labour can be found. Also if

the manufacturing process requires a large number of workers that do not need

to be highly skilled the business can set up in an area of high unemployment.

-

Government Influence: When a government wants to

encourage a business to set up in the area they may offer state funded grants

to encourage firms to move there. If an area has high unemployment, the government

might give money to a business to locate there. However, some governments may

not allow a business to set up in a particular area at all as it may be

producing harmful waste products during the manufacturing process.

-

Market: Locating a factory near to the market is an

important factor affecting the location of a manufacturing business. If the

product being manufactured is heavy and expensive it can cost a lot of money to

transport the product to its buyers. If the product is being manufactured close

to its market it may not cost as much to transport it.

-

Raw materials/Components: It may be easier and

cheaper for a business to set up near their raw materials/components as the raw

materials may be heavy to transport to the factory and if the business is far

from the materials it may cost them a lot of capital to get their components.

-

Transport and Communications: Businesses usually need

to be near to a transport system, it may be roads, rails, inland waterways, a

port or an airport. Where the product is for export then the ability to easily

get to a port will be important. A nearby motorway can reduce costs by speeding

up the time spent delivering the products to market even when the market is

quite far away.

-

Power and Water Supply: Today electricity is

available in most places and therefore the availability of power is not so

important. But to some industries having a reliable source of power and

therefore no power cuts may be essential. And the same goes for water supplies.

-

Climate: This may be important to some industries but

not all as different climates may aid the manufacture of particular products.

However, for most products climate is not a large factor.

Factors affecting the location of

retailing businesses:

-

A retailing business may want to be near other shops

or stores selling the same products as them as this tends to attract more

people as they have more options in the same area.

-

They may also want to locate to areas of high

population density as this again will attract more people to their business and

eventually increase their sales and profits.

-

Parking: The retailing business may want to locate

somewhere where parking is easily accessible as people often want to visit

places where they can safely leave their cars while they shop around.

-

Cost: Places that are busier charge more rent as

people visit shops more often. If a retail area is popular, there will be a

high demand for sites in the area and therefore the cost of renting these sites

will be higher.

-

Crime Rates/Security: High rates of crimes such as

theft and vandalism may deter a business from locating in a particular area.

Insurance companies may not want to insure a business if it is in an area of

high crime. A shopping area which is patrolled by guards, even though it will

be more expensive to rent, will prove preferable.

-

Legislations: There may be laws preventing a certain

business from setting up in particular areas as it may encourage illegal

behaviour.

Factors affecting the location of

service businesses:

-

Customers: The business may nee to set up in an area

that is close to its customers. This includes services like plumbers and

electricians as direct contact is necessary. However, in some case the business

may not need to be near its customers as no direct contact may be needed. This

includes services that are done over telephone calls, post or internet.

-

Availability of labour

-

Rent rates/taxes

-

Climate

-

Technology

Factors affecting the relocation

of firms:

-

Technology enable relocation of firms and

globalisation can happen easily.

-

New market: A business may relocate to be closer to

where the profit is.

-

Tax considerations: Businesses may move to places

with lower tax rates.

-

Trade and Tariff Barriers: Imported materials cost

import tax, this means that if a business relocates they may not need to pay

import tariffs.

-

Difficulties with labour costs: A business may

relocate to a place with cheaper labour costs especially if the business is

labour intensive.

-

Cheaper or new sources of materials: Businesses may

move to be closer to the materials they need.

-

Government grants or other incentives