Chapter 18

Production of Goods and Services

Production is the effective management of resources in producing goods and
services.

The operations department in a firm overlooks the production process. They must:

 Use the resources in a cost-effective and efficient manner
 Manage inventory effectively
 Produce the required output to meet customer demands
 Meet the quality standards expected by customers

Productivity
Productivity is a measure of the efficiency of inputs used in the production process
over a period of time. It is the output measured against the inputs used to produce it.
The formula is:

Businesses often measure the labour productivity to see how efficient their
employees are in producing output. The formula for it is:
 Businesses look to increase productivity, as the output will increase per employee
and so the average costs of production will fall.

Ways to increase productivity:

 improving labour skills by training them so they work more productively
and waste lesser resources
 introducing automation (using machinery and IT equipment to control
production) so that production is faster and error-free
 Improve employee motivation so that they will be willing to produce more
and efficiently so.
 improved quality control and assurance systems to ensure that there are no
wastage of resources

Inventory Management
Firms can hold inventory (stock) of raw materials, goods that are not completed yet
(a.k.a work-in-progress) and finished unsold goods. Finished good stocks are kept
so that any unexpected rise in demand is fulfilled.

 When inventory gets to a certain point (reorder level), they will be reordered
by the firm to bring the level of inventory back up to the maximum level again.
The business has to reorder inventory before they go too low since the reorder
supply will take time to arrive at the firm
 The time it takes for the reorder supply to arrive is known as lead time.
 If too high inventory is held, the costs of holding and maintaining it will be
very high.
 The buffer inventory level is the level of inventory the business should hold
at the very minimum to satisfy customer demand at all times. During the lead
time the inventory will have hit the buffer level and as reorder arrives, it will
 shoot back up to the maximum level.

Lean Production
Lean production refers to the various techniques a firm can adopt to reduce
wastage and increase efficiency/productivity.

The seven types of wastage that can occur in a firm:

 Overproduction– producing goods before they have been ordered by

customers. This results in too much output and so high inventory costs
 Waiting– when goods are not being moved or processed in any way, then
waste is occurring
 Transportation-moving goods around unnecessarily is simply wasting time.
They also risk damage during movement
 Unnecessary inventory-too much inventory takes up valuable space and
incurs cost
 Motion-unnecessary moving about my employees and operation of
machinery is a waste of time and cost respectively.
 Over-processing-using complex machinery and equipment to perform simple
tasks may be unnecessary and is a waste of time, effort and money
 Defects– any fault in equipment can halt production and waste valuable time.
Goods can also turn out to be faulty and need to be fixed- taking up more money
and time

By avoiding such wastage, a firm can benefit in many ways

 less storage of raw materials, components and finished goods- less money
and time tied up in inventory
 quicker production of goods and services
 no need to repair faulty goods- leads to good customer satisfaction
 ultimately, costs will lower, which helps reduce prices, making the business
more competitive and earn higher profits as well
Now, how to implement lean production? The different methods are:

 Kaizen: it’s a Japanese term meaning ‘continuous improvement’. It aims to

increase efficiency and reduce wastage by getting workers to get together in small
groups and discuss problems and suggest solutions. Since they’re the ones directly
involved in production they will know best to identify issues. When kaizen is
implemented, the factory floor, for example, is rearranged by re-positioning
machinery and equipment so that production can flow smoothly through the factory
in the least possible time.

Benefits:

 Increased productivity
 Reduced amount of space needed for production
 Improved factory layout may allow some jobs to be combined, so freeing up
employees to do other jobs in the factory

 Just-in-Time inventory control: this techniques eliminates the need to hold

any kind of inventory by ensuring that supplies arrive just in time they are
needed for production. The making of any parts is done just in time to be used in
the next stage of production and finished goods are made just in time they are
needed for delivery to the customer/shop. The firm will need very reliable
suppliers and an efficient system for reordering supplies.

Benefits:
  Reduces cost of holding inventory
 Warehouse space is not needed any more, so more space is available
for other uses
 Finished goods are immediately sold off, so cash flows in quickly

 Cell Production: the production line is divided into separate, self-contained

units each making a part of the finished good. This works because it improves
worker morale when they are put into teams and concentrate on one part alone.

Methods of Production
 Job Production: products are made specifically to order, customized for each
customer. Eg: wedding cakes, made-to-measure suits, films etc.
Advantages:
 Most suitable for one-off products and personal services
 The product meets the exact requirement of the customer
 Workers will have more varied jobs as each order is different,
improving morale
 very flexible method of production

Disadvantages:
 Skilled labour will often be required which is expensive
 Costs are higher for job production firms because they are usually
labour-intensive
 Production often takes a long time
 Since they are made to order, any errors may be expensive to fix
 Materials may have to be specially purchased for different orders,
which is expensive
 

 Batch Production: similar products are made in batches or blocks. A small

quantity of one product is made, then a small quantity of another. Eg: cookies,
building houses of the same design etc.
Advantages:
 Flexible way of working- production can be easily switched between
products
 Gives some variety to workers
 More variety means more consumer choice
  Even if one product’s machinery breaks down, other products can still
be made

Disadvantages:
 Can be expensive since finished and semi-finished goods will need
mocing about
 Machines have to be reset between production batches which delays
production
 Lots of raw materials will be needed for different product batches, which
can be expensive.
 

 Flow Production: large quantities of products are produced in a continuous

process on the production line. Eg: a soft drinks factory.

Advantages:
 There is a high output of standardized (identical) products
 Costs are low in the long run and so prices can be kept low
 Can benefit from economies of scale in purchasing
 Automated production lines can run 24×7
 Goods are produced quickly and cheaply
 Capital-intensive production, so reduced labour costs and increases
efficiency

Disadvantages:
 A very boring system for the workers,leads to low job satisfaction
and motivation
 Lots of raw materials and finished goods need to be held in
inventory- this is expensive
 Capital cost of setting up the flow line is very high
 If one machinery breaks down, entire production will be affected

Batch production-similar products are in blocks or botches certain number of

product is made, then a certain number of another product is made, and so on.

Advantages
 Flexible way of working and production can easily be changed from one
product to another
 It gives variety of workers job
 Allows more variety to products which would otherwise be identical. This
gives more consumer choice
 Production may not be affected to any great extent if machinery breaks
down.
  Disadvantages

 It can be expensive as semi-finished products will need moving about to the

next production stage
 Machines have to be reset between production batches which means there is
a delay in production and output is lost
 Warehouse space will be needed for inventories of raw materials,
components and finished batches of goods. This is costly.

Factors that affect which production method to use:

 The nature of the product: Whether it is a personal, customized-to-order
product, in which case job production will be used. If it is a standard product,
then flow production will be used
 The size of the market: For a large market, flow production will be required.
Small local and niche markets may make use of batch and flow production.
Goods that are highly demanded but not in very large quantities, batch
production is most suitable.
 The nature of demand: If there is a fair and steady demand for the product, it
would be more suitable to run a production line for the product. For less frequent
demand, batch and job will be appropriate.
 The size of the business: Small firms with little capital access will not produce
using large automated production lines, but will use batch and job production.

Technology and Production

 Automation:  equipment used in the factory is controlled by computers to
carry out mechanical processes, such as spray painting a car body.
 Mechanization: production is done by machines but is operated by people
 CAD (computer aided designing): a computer software that draws items
being designed more quickly and allows them to be rotated, zoomed in and
viewed from all angles.
 CAM (computer aided manufacturing): computers monitor the production
process and controls machines and robots-similar to automation
 CIM (computer integrated manufacturing): the integration of CAD and
CAM. The computers that design the product using CAD is connected to the
CAM software to directly produce the physical design.
 EPOS (electronic point-of-sale): used at checkouts/tills where operator scans
the bar-code of each item bought by the customer individually. The item details
and price appear on screen and are printed in the receipt.  They can also
automatically update and reorder stock as items are bought.
 EFTPOS (electronic funds transfer at point-of-sale): the electronic cash
register at the till will be connected to the retailer’s main computer and different
banks. When the customer swipes the debit card at the till, information is read by
the scanner and an amount is withdrawn from the customer’s bank account (after
the PIN is entered).
 CONTACTLESS PAYMENT-increasing being used in countries. Fast and
easy way to pay purchases that are less than a small amount.

Advantages of technology in production.

 Greater productivity
 Greater job satisfaction among workers as boring, routine jobs are done by
machines
 Better quality products
 Quicker communication and less paperwork
 More accurate demand levels are forecast since computer monitor inventory
levels
 New products can be introduced as new production methods are introduced

Disadvantages of technology in production

 Unemployment rises as machines and computers replace human labour
 Expensive to set up
 New technology quickly becomes outdated and frequent updating of
systems will be needed- this is expensive and time-consuming.
 Employees may take time to adjust to new technology or even resist it as
their work practices change.
 
 .Chapter 19
Costs, Scale of Production and Break-
even Analysis
Costs
Fixed Costs are costs that do not vary with output produced or sold in the short
run. They are incurred even when the output is 0 and will remain the same in the
short run. In the long-run they may change. Also known as overhead costs.
Eg: rent, even if production has not started, the firm still has to pay the rent.
Variable Costs are costs that directly vary with the output produced or sold. Eg:
material costs and wage rates that are only paid according to the output produced.

TOTAL COST = TOTAL FIXED COSTS + TOTAL VARIABLE COSTS

TOTAL COST =   AVERAGE COST * OUTPUT

AVERAGE COST (unit cost) = TOTAL COST/ TOTAL OUTPUT

A business can use these cost data to make different decisions. Some examples
are: setting prices (if the average cost of one unit is $3, then the price would be set
at $4 to make a profit of $1 on each unit), deciding whether to stop
production (if the total cost exceeds the total revenue, a loss is being made, and so
the production might be stopped), deciding on the best location (locations with
the cheaper costs will be chosen) etc.

Scale of production
As output increases, a firms average cost decreases.

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

business increases in size. The five economies of scale are:
 Purchasing economies: For large output, a large amount of components
have to be bought. This will give them some bulk-buying discounts that reduce
costs
 Marketing economies: Larger businesses will be able to afford it’s own
vehicles to distribute goods and advertise on paper and TV. They can cut down
on marketing labour costs. The advertising rates costs also do not rise as much as
the size of the advertisement ordered by the business. Average costs will thus
reduce.
 Financial economies: Bank managers will be more willing to lend money to
large businesses as they are more likely to be able to pay off the loan than small
businesses. Thus they will be charged a low rate of interest on their borrowings,
reducing average costs.
 Managerial economies: Large businesses may be able to afford to hire
specialist managers who are very efficient and can reduce the business’ costs.
 Technical economies: Large businesses can afford to buy large machinery
such as a flow production line that can produce a large output and reduce
average costs.
 

Diseconomies of scale are the factors that lead to an increase the average costs of a
business as it grows beyond a certain size. They are:
 Poor communication: as a business grows large, more departments and
managers and employees will be added and communication can get difficult.
Messages may be inaccurate and slow to receive, leading to lower efficiency and
higher average costs in the business.
 Low morale: when there are lots of workers in the business and they have
non contact with their senior managers, the workers may feel unimportant and
not valued by management. This would lead to inefficiency and higher average
costs.
 Slow decision-making: As a business grows larger, it’s chain of command
will get longer. Communication will get very slow and so any decision-making
will also take time, since all employees and departments may need to be
consulted with.
Businesses are now dividing themselves into small units that can control
themselves and communicate more effectively, to avoid any diseconomies from
arising.

Break-even
Break-even level of output is the output that needs to be produced and sold in order
to start making a profit. So, the break-even output is the output at which total
revenue equals total costs (neither a profit nor loss is made, all costs are covered).
A break-even chart can be drawn, that shows the costs and revenues of a business
across different levels of output and the output needed to break even.

Example:
In the chart below, costs and revenues are being calculated over the output of 2000
units.
The fixed costs is 5000 across all output (since it is fixed!).
The variable cost is $3 per unit so will be $0 at output is 0 and $6000 at output
2000- so you just draw a straight line from $0 to $6000.
The total costs will then start from the point where fixed cost starts and be parallel
to the variable costs (since T.C.=F.C.+V.C. You can manually calculate the total
cost at output 2000: ($6000+$5000=$11000).
The price per unit is $8 so the total revenue is $16000 at output 2000.
Now the breakeven point can be calculated at the point where total revenue and
total cost equals– at an output of 1000. (In order to find the sales revenue at output
1000, just do $8*1000= $8000. The business needs to make $8000 in sales revenue
to start making a profit).

Advantages of break-even charts:

 Managers can look at the graph to find out the profit or loss at each level
of output
 Managers can change the costs and revenues and redraw the graph to see
how that would affect profit and loss, for example, if the selling price is
increased or variable cost is reduced.
 The break-even chart can also help calculate the safety margin- the amount
by which sales exceed break-even point. In the above graph, if the business
decided to sell 2000 units, their margin of safety would be 1000 units. In sales
terms, the margin of safety would be 1000*8 = $8000. They are $8000 safe from
making a loss.
Margin of Safety (units) = Units being produced and sold – Break-even
output

Limitations of break-even charts:

 They are constructed assuming that all units being produced are sold. In
practice, there are always inventory of finished goods. Not everything produced
is sold off.
 Fixed costs may not always be fixed if the scale of production changes. If
more output is to be produced, an additional factory or machinery may be
needed that increases fixed costs.
 Break-even charts assume that costs can always be drawn using straight
lines. Costs may increase or decrease due to various reasons. If more output is
produced, workers may be given an overtime wage that increases the variable
cost per unit and cause the variable cost line to steep upwards.
 

Break-even can also be calculated without drawing a chart. A formula can be used:

Break-even level of production =Total fixed costs/ contribution per unit

Contribution = Selling price – variable cost per unit (this is the value

added/contributed to the product when sold)
In the above example, the contribution is $8 -$3 =$5, so the break-even level is:
$5000/$5 = 1000 units!

Chapter 20
 Achieving Quality Production
Quality means to produce a good or service which meets customer
expectations. The products should be free of faults or defects. Quality is important
because it:
 establishes a brand image
 builds brand loyalty
 maintains good reputation
 increase sales
 attract new customers
If there is no quality, the firm will

 lose customers to other brands

 have to replace faulty products and repeat poor service, increasing costs
 bad reputation leading to low sales and profits
There are three methods a business can implement to achieve quality: quality
control, quality assurance and total quality management.

Quality Control
Quality control is the checking for quality at the end of the production process,
whether a good or a service.
Advantages:
 Eliminates the fault or defect before the customer receives it, so
better customer satisfaction
 Not much training required for conducting this quality check
Disadvantages:
 Still expensive to hire employees to check for quality
 Quality control may find faults and errors but doesn’t find out why the
fault has occurred, so the it’s difficult to solve the problem
 if product has to be replaced and reworked, then it is very expensive for
the firm
 

Quality Assurance
Quality assurance is the checking for quality throughout the  production
process of a good or service.

Advantages:
 Eliminates the fault or defect before the customer receives it, so
better customer satisfaction
 Since each stage of production is checked for quality, faults and errors can
be easily identified and solved
 Products don’t have to be scrapped or reworked as often, so less
expensive than quality control
Disadvantages:
 Expensive to carry out
 How well will employees follow quality standards?
 

Total Quality Management (TQM)

Total Quality Management or TQM is the continuous improvement of of
products and production processes by focusing on quality at each stage of
production. There is great emphasis on ensuring that customers are satisfied. In
TQM, customers just aren’t the consumers of the final product. It is every worker
at each stage of production. Workers at one stage have to ensure the quality
standards are met for the product in production at their stage before they are passed
onto the next stage and so on. Thus, quality is maintained throughout production
and products are error-free.
TQM also involves quality circles and like Kaizen, workers come together and
discuss issues and solutions, to reduce waste ensure zero defects.

Advantages:
 quality is built into every part of the production process and becomes central
to the workers principles
 eliminates all faults before the product gets to the final customer
 no customer complaints and so improved brand image
 products don’t have to be scrapped or reworked, so lesser costs
 waste is removed and efficiency is improved
Disadvantages:
 Expensive to train employees all employees
 Relies on all employees following TQM– how well are they motivated to
follow the procedures?
 

How can customers be assured of the quality of a product or service?

They can look for a quality mark on the product like ISO (International
Organization for Standardization). The business with these quality marks would
 have followed certain quality procedures to keep the quality mark. For services, a
good reputation and positive customer reviews are good indicators of the service’s
quality
   Chapter 21
Location Decisions
Owners need to decide a location for their firm to operate in, at the time of setting
up, when it needs to expand operations, and when the current location proves
unsatisfactory for some reason. Location is important because it can affect the
firm’s costs, profits, efficiency and the market base it reaches out to.

Factors that affect location decisions

Factors that affect the location decisions of a manufacturing firm:
 Production Method: when job production is used,  the business will
operate on a small scale, so the nearness to components/raw materials won’t be
that important. For flow production, on the other hand, production will be on a
large scale- there will be a huge amount of components and transport costs will
be high- so components need to be close by.
 Market: if the product is a consumer good and perishable, the factories
need to be close to the markets to sell out quickly before it perishes.
 Raw Materials/Components: the factories may need to be located close to
where raw materials can be acquired, especially if the raw material is to be
processed while still fresh, like fruits for fruit juice.
 External economies: the business may locate near other firms that support
the business by provide services- eg: business that install and maintain factory
equipment.
 Availability of labour: Businesses will need to locate near areas where they
can get workers of the skills they need in the factory. If lots of unskilled workers
are needed in the factories firms locate in areas of high unemployment. Wage
rates also vary by location and firms will want to set up in locations where wage
rates are low.
 Government Influence: the government sometimes gives incentives and
grants to firms that set up in low-development, rural and high-unemployment
areas. There may also be govt. rules and restrictions in setting up ,eg: in some
areas of great natural beauty. The business needs to consider these.
 Transport & Communication infrastructure: the factories need to be
located near areas where there are good road/rail/port/air transport systems. If
goods are to be exported, it needs to be set up near ports.
 Power and water supply: factories need water and power to operate and a
reliable and steady supply of both should be ensured by setting up in areas where
they are available.
 Climate: not the most important factor but can influence certain sectors. Eg:
the dry climate in Silicon Valley aids the manufacturing of silicon chips.
 Owner’s personal preferences
 

Factors that affect the location decisions of a service-sector firm:

 Customers: service-sector businesses that have direct contact with
customers need to locate in customer-accessible and convenient places. Eg;
restaurants, hairdressers, post offices etc.
 Technology: today, with increasing use of IT to shop and make payments,
customers do not need direct access to services and proximity to the
market/customer is not a very important factor in location decisions. They locate
away from customers in places where there are low rent and wage rates. Eg:
banks
 Availability of labour: if large number of workers are required in the firm,
then it will need to locate close to residential areas. If they want certain types of
worker skills, they will need to locate in places where such skilled workers can
be found. However, with work-from-home and technology, this is not that big of
a factor nowadays.
 Climate: tourism services need to be located in places of good climate.
 Nearness to other business: some services serve the needs of large
companies, such as firm equipment servicing and so they need to be very close
to such businesses. Businesses may also set up where close competitors are to
watch them and snatch away their customers.
 Rent/taxes
 Owner’s personal preferences
 

Factors that affect the location decisions of a retailing firm:

 Shoppers: retailers need to be located in areas where shoppers frequent, like
malls, to attract as many customers as possible.
 Nearby shops: being located to other shops that are visited regularly will
also attract attention of customers into the your shop. Being near competitors
also helps keep an eye on competition and snatch away customers.
 Customer parking availability:  when parking is available nearby, more
people will find it convenient to shop in that area.
 Availability of suitable vacant premises: Obviously, there needs to be a
vacant premise available to set up the business. Vacant premises can also help
the business expand their premises in the future.
 Rent/taxes: rents and taxes on the locations need to be affordable.
 Access to delivery vehicles: if the retailer has home delivery services, then
delivery vehicles will be required.
 Security: high rates of crime and theft can happen in shops. Shopping
complexes with security guards will thus be preferred by firms.
 

Why businesses locate in different countries?

 New markets overseas.
 Cheaper or new raw materials available in other countries.
 Cheaper and/or skilled workers are available overseas.
 Rent/ taxes are lower..
 Availability of government grants and other incentives
 Avoid trade barriers and tariffs: when exporting goods to other countries,
there will be some tariffs, rules and regulations to get by. in order to avoid this,
firms start operating in the country itself, since there is no exporting/importing
involved now.
 

The role of legal controls on location decisions

Governments influence location decisions:

 to encourage businesses to set up and expand in areas of high

unemployment and under-development. Grants and subsidies can be given to
businesses that set up in such areas.
 to discourage firms from setting in areas of that are overcrowded or
renowned for natural beauty. Planning restrictions can be put into place to do
so.