A strong Partner for Sustainable Development

Entrepreneurship
2nd Quarter, 2nd semester AY: 2021-2022

College of Education
Agricultural Science High School
SENIOR HIGH SCHOOL
 Managing the Operations Function
LEARNING OBJECTIVES
After reading this chapter, you should be able to:
 Distinguish between performance effectiveness and performance efficiency
 Describe a company's operations using the Input-Process-Output (IPO)framework
 Explain the concept of productivity
 Come up with ideas to enhance the productivity of a particular business
 Explain how the balanced scorecard works, and how this can help organizations
improve performance effectiveness
INTRODUCTION
From the perspective of an entrepreneur the main objective of establishing a business
is to earn profit. But to attain this goal, the enterprise has to produce goods and services
which are sold to its clientele. With revenues earned from sales, profit is realized after
deducting the cost of producing the goods and services. Thus, the process of production
together with its allied activities is considered the core of many business enterprises. The
administration of the production process and its related activities is referred to as
operations management of a business enterprise.
In this chapter, the discussion will focus on the management of the production process
although there are other components of managing the operations of an enterprise. As
discussed in the initial chapters of this book the production of a good or service is the
realization of an entrepreneurial intent. From there the intent evolved into an idea and
recognized as a business opportunity. After careful assessment of an opportunity and a
positive evaluation, a prototype is produced. After a series of testing and positive results,
the product is ready for large-scale production.
Managing the operations of an enterprise is a major component in the implementation
of the business plan. This chapter will cover various themes, including the concept of
operations management, the bases for evaluating the performance of a firm, various
approaches in analyzing the operations of a firm, and alternative indicators of a firm's
performance.
CONCEPT OF OPERATIONS MANAGEMENT
Operations management is a component of management that deals with planning,
implementing, and monitoring of the process of producing goods and services. The task of an
operations manager is to oversee the resources available to the enterprise for production
activities. An operations manager plans the structure of production by identifying the output to
be produced, the resources needed, and the procedures on how these resources are mixed to
produce a good or service. In implementing the production plan, the manager supervises the
process of combining materials together with other inputs according to the technology utilized
to produce the identified output. In monitoring the production output, the manager assesses the
performance of production in terms of effectiveness, efficiency, quality, timeliness,
dependability, flexibility, cost, and other criteria.
Although the production process constitutes a significant portion of operations
management, there are other equally important business activities attached to operations
management. These related activities include, among others, warehousing, maintenance,
inventory ,and quality control. Before the product is produced, materials must be secured and
stored within the firm. In warehousing, the company can buy materials in bulk and secure the
stability of the next production round. Likewise, the firm's physical plant and equipment must be
properly cared for. Thus, maintenance is an important operations activity since it ensures the
continuous productivity of the firm's capital equipment. Inventory management is also crucial in
narrowing the gap between the proximate future demand and the next production round. As a
consequence not all outputs produced currently are sold immediately to the customers; a
portion is kept by the firm as reserves or inventories. Furthermore, quality control mechanisms are
instituted to assure customers of the firm that its products are consistent and reliable. Thus, the
firm does not produce for productions sake; it also has to maintain the quality of its product to
sustain the continued patronage of customers.
ASSESSING THE PERFORMANCE OF A BUSINESS ENTERPRISE
Since a significant component of operations management of a business enterprise involves
the process of production, the success of a firm is assessed based on its performance. There are
two levels in evaluating the performance of a business: performance effectiveness and
performance efficiency.
Performance effectiveness. Effectiveness indicates how the output of the firm was able to
achieve the objectives set.by the business enterprise. A business firm is considered effective if it is
able to produce the goods and services that it has planned to produce. For example, the
performance evaluation can be set in terms of the amount of production (maximum production).
Aside from the volume, the performance can also be scaled in terms of the quality of production.
As mentioned in the previous chapters the production of a good or service is meant to answer a
need of the customers. This process of evaluation must be taken in the light of how the product or
service evolved from an idea to its final production.
Aside from the intent of the entrepreneur, another way of undertaking performance
effectiveness is to relate it with the needs of the customers. For example, if the objective is to
introduce a totally different product or service in the market, is the new commodity differentiated
in terms of its physical attributes (size,color, texture, and others)?
A more interesting assessment of performance effectiveness is the use of Roberto's MADI
questions. If the reason for introducing a product is the missing component in existing products,
was the new product able to fill the gap which is missing in the current products and services? If
the current products and services are annoying, is the new product able to mitigate, if not
remove, the annoyance experienced by the customers with the current product? If existing
products are disappointing and irritating, was the disappointment and irritation removed or
reduced with the introduction of your new product or service?
 Meanwhile, performance effectiveness can also be assessed in terms of quality, speed,
dependability, and flexibility. In terms of quality, the product has fulfilled the minimum
requirements set by the market and regulatory bodies. Speed, on the other hand, refers to the
punctual delivery of the product to its customers. Dependability is the consistency and reliability
of the product over several production runs. Flexibility is the adaptability of the operations of the
company to changing market environments.’
Performance efficiency. The concept of efficiency denotes how the output of the firm was
realized through the use of resources. It is a relative concept since the production performance
is evaluated in terms of the costs incurred. If the objective of the company is to maximize profit,
it has to be efficient in the use of its resources. Thus, efficiency involves the monetary outlay in
the use of inputs to produce a good or service.
The good or service produced by the firm may be effective since it has addressed the intent
of the entrepreneur, the demand of the customers and other criteria of effectiveness. Although
effective, the firm's performance can be considered inefficient since its production was very
expensive in terms of the use of resources. Thus, not all products and services that are assessed
to be effective are also efficient.
Why is efficiency important in assessing a firm's performance? If the firm is inefficient, it can
threaten its profitability and survival in the market. There is a possibility that the demand for
products of inefficient firms may decline as a result of higher prices. In addition, inefficient firms
with low productivity can easily be threatened by more productive and more efficient
competitors.
Thus, performance evaluation based on effectiveness is inadequate since it only focuses on
attaining the objectives of the firm. But such objectives entail the use of resources which will
need funds to acquire them. Furthermore. there are opportunity costs or sacrifices in achieving
these objectives. In this light, a more appropriate assessment of performance must be based on
efficiency.
FRAMEWORK FOR ANALYZING THE OPERATIONS OF AN ENTERPRISE
In order to properly assess the performance of an enterprise it is necessary 1o
understand how the production is structured. There are two ways of understanding how
the operations proceeds in an enterprise-the systems approach and the value chain
approach.
SYSTEMS APPROACH:INPUT-PRDCESS-OUTPUT (IPO) FRAMEWORK
Under the systems approach the structure of production is understood as an
arrangement of relationships between inputs and outputs. There are three major
components in this production relationship: inputs, process, and outputs. This production
relationship is called the Input-Process-Output (IPO) framework. The firm will need several
inputs for its operations. These inputs, in turn, have to be processed by technology and
other transforming inputs to produce a final output.
Resource Inputs(5Ms).
The first component of IPO framework is the resource inputs used in the production
process. In the operation of a business enterprise there are five major resource inputs.
These are known as the 5Ms representing materials, manpower, machinery, methods, and
money.
 Materials are semiprocessed goods that will be subjected to further transformation in
the production process. They are also called raw materials or intermediate inputs. For
example, in the process of producing pan de sal, we need several materials that serve
as intermediate inputs including flour, sugar, butter, eggs, salt, and other ingredients.
 Manpower is the human resource input used in the production process. Manpower does
not only include labor or muscular power but also intellectual, creative abilities, and other
qualities of individuals that can contribute to production. In the production of pan de sal,
manpower resources include the baker and his assistants who will implement the recipe
using the available equipment and technology. The manager, sales clerks, and janitors are
also part of the manpower resources of the bakery.
 Machinery represents all man-made physical capital used in the production process. Aside
from machines, the tools, durable equipment, and the physical plant are also. In our
example on the production of pan de sal, the machinery comprises the oven, baking
utensils, and the bakery itself.
 Method denotes the process of combining raw materials and how these are going to be
transformed using the other factor inputs of production. This resource input is also called
technology or techniques of production since it prescribes the intensity in the use of factor
inputs. If labor is abundant and cheap in the locality, the firm may utilize more labor-
intensive techniques. This implies that it will use more labor relative to other factor inputs. If,
on the other hand, labor is expensive and capital is cheap, the firm may implement
capital-intensive technology. This means that the firm will use more capital relative to other
factor inputs. In the production of pan de sal, the mixing of ingredients will use manual
labor intensively as applied by many small bakeries. On the other hand, large bakeries in
urban areas will use modern baking equipment and utensils that are capital-intensive.
 Money is a financial resource used to purchase all the resources needed by the firm for its
operations. The owners of the company contribute seed money for the initial operations of the
firm. Money is also needed to purchase raw materials. It is also used to pay the salaries of
workers and managers. Durable equipment and technology are acquired using financial assets
as payments.
In the economic analysis of production, the resource inputs mentioned above are grouped into
two major categories-intermediate inputs and factor inputs.
 Intermediate inputs are semiprocessed materials that need further transformation to produce a
finished product. They are also called raw materials or materials as classified in the IPO
framework.
 Factor inputs are the transforming inputs that will process the intermediate inputs into finished
products. Because of their transforming properties these inputs are also called productive inputs.
Factor inputs include labor (manpower), capital (machinery), land, and technology (method).
Although important, money is not considered as a factor input in economic analysis. Since the
production process entails the physical production of goods and services, factor inputs such as
labor, capital, land, and technology are physically and actively used in transforming the raw
materials in the process of production. Money is not directly involved in the physical production.
Although money does not have a direct participation in the physical transformation of the
intermediate inputs, it is very crucial in the production process. As mentioned earlier, you cannot
have materials or intermediate inputs that will be processed if you do not have money to purchase
these. Similarly, wages and salaries paid to workers are expressed in monetary terms. Capital
equipment is purchased based on its monetary value. It is the intermediate inputs and factors that
relate with one another in production which were all purchased using money.
Process.
The second component of the IPO framework is the process involved in
production. Process refers to the various forms of transformation that factor inputs
perform on the materials. The process is determined by the type of commodity to be
produced and the technology being used in production. The various forms of
transformation are as follows:
 Physical transformation occurs when the processing of raw materials convert them
into significantly altered new product. Grain production, aquaculture fishing, and
manufacturing of clothes are examples of commercial activities that perform
physical transformation in the production.
 Locational transformation arises when a product changes its location through
various means of transportation and communication. When mangoes from
Guimaras are transported to Manila, the mangoes are occasionally transformed
because they are now available in Metro Manila. When a letter is transmitted
electronically or through snail mail from one place to another it is likewise spatially
transformed. Bus companies, shipping lines, airlines, and other transportation and
communications firms are engaged in locational transformation.
 Information transformation happens when knowledge and specialized skills of
providers are transmitted to their customers. When lawyers provide legal services,
accountants conduct auditing services, professionals perform consultancy services,
and medical doctors prescribe medication, their clients are transformed when they
obtain these specialized skills and services. Social and professional service providers
are engaged in information transformation.
 Exchange transformation takes place when a commodity is transmitted from the supplier
to its buyer. When you buy a bar of soap from a sari. sari store in your neighborhood, there
is exchange transformation because the soap was not produced by the sari-sari store but
by a multinational corporation specializing in toiletries. Similarly, there is an exchange
transformation when you buy an imported commodity like cheese from a supermarket.
Those establishments in retail and wholesale trade are engaged in exchange
transformation.
 Extractive transformation happens when a natural resource is taken out from its habitat.
For example, when you dig gold, copper, and other minerals from mining sites the harvest
has undergone extractive transformation. Similarly, the marine catch from deep sea
fishing underwent extractive transformation. Mining, quarrying, forestry, and fishing are
examples of economic activities engaged in extractive transformation.
Output. The third component in the IPO framework is the output, which refers to the result of
the production process. It can be considered the most important component in the IPO
framework since the goal of production is the realization of an output. After treating the raw
materials with the transforming inputs the outcome is the output of production. The output
can be processed goods or services and are influenced by the process of transformation.
Based on the type of transformation, the following are examples of outputs of production.
 Outputs from physical transformation: Food grains, canned food, clothes, bread,
furniture, gasoline, construction materials, cars, electronic gadgets, and other
manufactured goods
 Outputs from locational transformation: taxi services, bus services, train services, sea
transport, air transport, postal services, telephone services, and other
telecommunication services
 Outputs from information transformation: educational services, health services, legal
services, consultancy services, auditing services, and other professional services
 Outputs from exchange transformation: retail services of sari-sari stores, groceries,
supermarkets and department stores, and wholesale services of large distribution
outlets
 Outputs from extractive transformation: gold ores, copper ores, timber, logs, sand,
seafood, and other products derived from natural resources
VALUE CHAIN APPROACH
Aside from the systems approach such as the IPO framework, the process of
production can also utilize the value chain approach. The value chain approach traces
the value of a commodity in terms on how factor inputs are adding value to the raw
materials. Thus,the value of a commodity is represented by the value of raw materials and
the 'value-added' from factor inputs like labor, capital, land, and technology that were
used to transform these raw materials into the final output.
 In physical transformation, the raw materials were already valued by firms producing the
raw materials and the value that is added is the cost of processing. The cost of processing, in
turn, consists of the various costs of transforming inputs. Thus, the value-added is the
summation of wages(cost of labor), interest (cost of capital), rent (cost of land), royalty (cost
of technology), and profit (return to entrepreneur). On the other hand, the value of
production is computed as the value of raw materials and the value-added by the factor
inputs.
Figure 9.1 The Concept of Value-Added
A B A B A B A B
Value of
Value of Value of Galapong
Grain Wheat
Grain

D C
C D Value-Added

Value-Added
E F E F
Valu-Added
G H G H
 In the diagram, we trace the physical transformation of grain into a bibingka (rice
cake).When food grains are processed they are transformed into wheat.The cost of
transforming grain into wheat is the value-added in wheat production. In turn, wheat
becomes a raw material in the production of flour or galapong. The cost of
transforming wheat into flour or galapong is the value-added in flour production.
Finally, the flour plus other ingredients become raw materials in the production of
bibingka. The cost of these factor inputs in transforming flour into bibingka is the value-
added in the production of bibingka.
Using the concept of value-added, we can understand why the price of mangoes
from Guimaras is more expensive in Manila.The cost of transporting mangoes
(locational transformation) from Guimaras to Manila adds value to Guimaras mangoes.
In addition, the cost of exchange transformation also adds another value to the
Guimaras mangoes once it is purchased by a buyer in Manila. For example, if mangoes
costs PHP 25 per kilo in Guimaras while the costs of transporting (locational
transformation) to Manila is estimated to be PHP 30 per kilo and the additional cost of
wholesalers of PHP 10 per kilo and cost of retailers (exchange transformation) is PHP 55
per kilo, the price of Guimaras mangoes in Manila can reach up to PHP 120 per kilo.
As observed in the examples given, there is a series of transformation before a
product reaches its final consumer. In each stage, the firm may decide to pursue
further transformation or not. If the additional value is greater than the additional cost,
then it may be rational to pursue the activity Otherwise, if the marginal benefit is lower
than marginal cost, it may not be profitable to pursue the commercial activity.
 For example, if mangoes are sold at PHP 60 per kilo in Guimaras, the additional cost of
locational transformation of PHP 30 per kilo and the additional cost of exchange
transformation (wholesale and retail) of PHP 65 per kilo will result in the sale of mangoes at PHP
155 per kilo in Manila. At this price, Guimaras mangoes may not be competitive if sold in Metro
Manila. Even if Guimaras mangoes are sweet, mangoes from Zambales and Pangasinan are
likewise sweet. Moreover, these mangoes from Luzon can be purchased at PHP 100 per kilo in
Manila. In this case, it may be difficult to sell Guimaras mangoes in Manila because the price
of the raw material (Guimaras mangoes) has gone up. As a result, an entrepreneur may
temper, if not cancel, his order of mangoes from Guimaras.
It is also possible that the competitiveness of the mangoes may be threatened by the
change in transformational cost. The Guimaras mangoes may stil be priced at PHP 25 at
source but the cost of locational transformation may increase to PHP 40 per kilo because of an
increase in the cost of transport. The cost of wholesale exchange transformation remains at
PHP 10 per kilo. If these mangoes are going to be sold in supermarkets or malls, and the cost of
retail exchange transformation can reach up PHP 70 per kilo, the cost of mangoes can go up
to PHP 145 per kilo in supermarkets in Metro Manila. However, if these mangoes were sold in
public markets where the cost of retail exchange transformation is cheaper say PHP 40 per kilo,
the price of Guimaras mangoes can be sold at PHP 115 per kilo in Metro Manila public
markets. This may explain why it is cheaper to buy mangoes in a public market than in
supermarkets or malls because the costs of exchange transformation differ in alternative
outlets.
Given the differences in the costs of the value chain, entrepreneurs who are in the
wholesale distribution of mangoes may sell more to retailers in public markets where the price
can be lower and with a possible higher demand than in supermarkets where price is
potentially higher and demand may be lower.
MEASURES OF PRODUCTIVITY
Earlier in this chapter, we discussed various ways of assessing the performance of the
firm. In terms of performance efficiency, one of the key indicators is the firm's productivity.
Productivity is a concept of measuring output relative to the value of inputs used in
production. Since output can be measured in terms of volume of output and its monetary
value and inputs can also be measured in physical units and monetary values, the firm's
productivity can be calculated. A firm that is considered productive can produce more
output per unit of input.
Since factor inputs have different measurements in physical units, we cannot have a
productivity measure for all inputs. For example, a unit of labor is measured in workdays or
man-hours or number of employed workers. These measurements cannot be combined
with a unit of capital or a unit of technology or a unit of land. For this reason we can only
have a measure of partial productivity. The following are some measures of partial
productivity:
 Average productivity of labor: Value of total production per unit of labor input
 Average productivity of capital: Value of totaI production per unit of capital input
 Marginal productivity of labor: Additional output per additional unit of labor input
 Marginal productivity of capital: Additional output per additional unit of capital input
 However, since all these inputs have their values expressed in prices they can be
compared and combined in monetary values. With this, we can calculate another indicator
of productivity measured as cost per unit. This indicator is related with the measurement of
productivity since average cost is the reciprocal of average productivity. Thus, a firm that
exhibits a low cost of production is also a firm with high productivity. Since the cost of
production per unit is lower, the firm can produce more output given its resources. Some
measures of cost are the following:
 Average cost: Total cost of production per unit of output
 Marginal cost: Additional cost of production per additional unit of production
When average cost per unit is compared with the prevailing market price of the
product, the unit profit can be computed. For example, if the market price of pan de sal is
PHP 3 per unit and the Masarap Bakery's unit cost is PHP 2.50 per pan de sal; Masarap Bakery
can earn PHP 0.50 per unit. If the bakery produces and selIs 1,000 pan de sal in a day, the
profit from the sales of pan de sal is computed at PHP 500 per day.
If the marginal cost is compared with the prevailing market price of the product, it can
show what will happen to total profit. In addition, it can set the condition for the
determination of maximum profit. For example, if the owner of the bakery expands its
production to 1010 units and the marginal cost of the additional 10 units is PHP 2.80 per unit
which is lower than the market price(PHP 3) the marginal profit (additional protit) is
computed at PHP 0.20 per unit. This means that total profit may increase to PHP 502. This will
encourage the firm to expand its production because total profit can still be increased.
 If the owner decides to further increase its production to 1020 units and the additional
10 units increases the marginal cost to PHP 3 per unit which is equal to the market price,
the marginal (additional profit) becomes zero. This means that the additional 10 units of
pan de sal will result in a total profit calculated at PHP 502. This is the same level of profit at
1010 production. This implies that the firm has reached the maximum level of profit when
marginal cost is equal to the market price.
If the owner decides to further increase its production to 1030 units of pan de sal and
the additional 10 units of pan de sal further increases its marginal cost to PHP 4 per unit.
With a marginal cost which is higher than the market price (PHP 3), the marginal
(additional) profit becomes negative computed at-PHP 1 per unit. As a result, the total
profit will decrease to PHP 492 at 1030 production level. Thus, it is not sensible for the
bakery to increase its production to 1030 units. The optimal level of production that will
give the bakery its maximum profit is 1020 units of pan de sal.
WAYS OF IMPROVING FIRM'S PRODUCTIVITY
Since measures of productivity and costs are indicators of the efficiency performance
of firms, they conduct various initiatives to improve their productivity. Based on the
indicator of productivity, a firm can improve its productivity by increasing output per unit
of input. This can be done by employing factor inputs that are output enhancing. For
example, hiring skilled and educated laborers can improve labor productivity. In addition,
the existing capital stock of the firm becomes more productive as skilled and productive
workers utilize it. Similarly, the productivity of capital is enhanced when a firm invests in
modern capital equipment. With improved technology, workers become more productive
when utilizing modern equipment.
 Another alternative in improving productivity is to reduce the cost of production.
Firms should be flexible in using production techniques that are sensitive to the price of
factor inputs. For example, if labor is cheap and capital is expensive, the firm may adopt
labor-intensive techniques to exploit the low cost of hiring labor services. In the same
light, in developed countries, where labor is expensive, firms utilize capital-intensive
techniques to save on production cost. Thus, productivity is enhanced and cost is
reduced when prices of factor inputs reflect their relative productivities. This implies
proper allocation of resources.
Aside from employing productive factor inputs and reducing cost, productivity can
also be improved through motivation. Managers and supervisors with excellent people
skills can motivate their workers to excel, enjoy their work, and contribute positively to the
goals of the firm. With no change in factor inputs and no change in production cost,
production increases due to the effects of the positive disposition of laborers in the
workplace. This positive impact of motivation on productivity has been examined in the
literature as the contribution of efficiency to the firm's productivity.'
BALANCED SCORECARD-A WAY OF RECKONING EFFECTIVENESS
As mentioned in an earlier section of this chapter, a firm's performance effectiveness
has been indicated by its output and objectives the firm wants to achieve. However,
Kaplan and Norton proposed a balanced scorecard in assessing the performance of the
firm. The scorecard reflects not only the output of the firm but also the interests of its
various stakeholders.The balanced scorecard considers the variety of interests that the
firm pursues besides the production of an output to earn profit for the owners of the
enterprise as reflected in financial reports.
 Because a business enterprise is a social unit, it has to interact with numerous
stakeholders affecting its operations, stability, and growth. These stakeholders, in turn, have
varied interests beyond production and profit for the firm. To understand the components of
the balanced score card, let us enumerate some of the stakeholders of a firm and their
corresponding interests.
 Shareholders. Aside from a reasonable rate of return to their investments in the firm,
owners of the enterprise are interested in the continuity, stability, and growth of the firm.
 Managers. As administrators of the resources of the firm, operating officers, managers, and
supervisors may want control in decision-making, flexibility in managing risks affecting the
business enterprise and adequate compensation.
 Workers. Adequate compensation, good working environment, and protection of labor
rights are the main concern of workers.
 Customers. Aside from value for money, customers are concerned about the reliability,
consistency, and quality of goods and services.
 Government. Aside from taxes, the government is interested on how force. the firm can
generate and provide employment to a growing labor
 General public. The general public may be interested in the responsibility of the firm to its
immediate neighborhood and the care for the environment.
Given the various stakeholders and their respective interests, Kaplan and Norton developed
a scorecard summarizing these into four perspectives of a Firm. In looking at the firm in each
dimension, there is a need to develop measurements, gather information, and evaluate
these indicators with their responding perspective.
 Learning and growth perspective. To achieve the vision of the firm, how will it sustain the
firm's ability to change and improve? This requires constant training of the workforce and
the inculcation of organizational culture among managers and employees.
 Business process perspective. This view points to the internal processes of the company.
Identification of business activities that the company shareholders and customers. can
excel in and can be considered as best practices that can satisfy
 Customer perspective. To achieve the company vision, how should the company appear
to its customers? Is there a focus on the customer in the vision and mission of the firm? Are
the customers satisfied with the products and services produced by the company? Has
the company developed brand loyalty among the customers on the products and
services of the firm?
 Financial perspective. To succeed financially, how should the company appear to its
shareholders? Timely, accurate, and understandable financial data is not only crucial to
managers in making strategic decisions but also in assuring the shareholders on the
financial health of the company.
From these perspectives, performance effectiveness can be measured by identifying
the objectives to be pursued, devising indicators of effectiveness each perspective, initiating
strategies and key activities to achieve these objectives, and assessing these initiatives on
how they answered the objectives a specific perspective.