Operations Management

CHAPTER ONE
NATURE OF OPERATIONS MANAGEMENT

1.1 Introduction

Operations management is the management of that part of an organization that is responsible for
producing goods and/or services. There are examples of these goods and services all around you.
Every book you read, every video you watch, every e-mail you send, every telephone
conversation you have, and every medical treatment you receive involves the operations function
of one or more organizations. So does everything you wear, eat, travel in, sit on, and access the
Internet with.

Business organizations typically have three basic functional areas: finance, marketing, and
operations. It doesn‘t matter if the business is a retail store, a hospital, a manufacturing firm, a
car wash, or some other type of business; it is true for all business organizations.

Finance is responsible for securing financial resources at favorable prices and allocating those
resources throughout the organization, as well as budgeting, analyzing investment proposals, and
providing funds for operations. Marketing is responsible for assessing consumer wants and
needs, and selling and promoting the organization‘s goods and services. And operations is
primarily responsible for producing the goods or providing the services offered by the
organization.

The set of interrelated management activities, which are involved in manufacturing certain
products, is called as production management. If the same concept is extended to services
management, then the corresponding set of management activities is called as operations
management. Hence, operations management is the management of systems or processes that
create goods and/or provide services.

Therefore, operation management is a business function responsible for planning, coordinating,

and controlling the resources needed to produce products or services for a company as indicated
on the following figure.
Value – added
Inputs Transformation/ Outputs
Conversion
 Land Process  Goods
 Labor  Services
 Capital
 Information Feedback

Feedback Control Feedback

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The creation of goods or services involves transforming or converting inputs into outputs.
Various inputs such as capital, labor, and information are used to create goods or services using
one or more transformation process (e.g., storing, transporting, and cutting). To ensure that the
desired output are obtained, measurements are taken at previous points in the transformation
processes (feedback) and then compared with previously established standards to determine
whether corrective action is needed (control).

The essence of the operations function is to add value during the transformation process: value-
added is the term used to describe the difference between the cost of inputs and the value or price
of outputs. In nonprofit organizations, the value of outputs (e.g., road construction, police and
fire protection) is their value to the society; the greater the value added, the greater the
effectiveness of these operations. In for-profit organizations, the value of outputs is measured by
the price that customers are willing to pay for those goods or services.

1.2 Historical Development of Operation Management

Operations management has existed for as long as people produced goods and services. Although
the origins of operations can be traced to early civilization, here we will focus on the historical
development of operations management in the last 200 years.

In the following discussion, the history of operations management is organized according to

major contributions or theorists rather than in strict chronological terms. On this basis, there are
seven major areas of contribution to operations management field.

1. Division/Specialization of Labor: the division of labor is based on a very simple concept –

specialization of labor to a single task can result in a greater productivity and efficiency than
the assignment of many tasks to a single worker. The first economist to discuss the division
of labor was Adam Smith, author of the classic “Wealth of Nations” (1776). Smith noted
that specialization of labor increases output because of three factors.
 Increased dexterity on the part of the workers,
 Avoidance of lost time due to changing jobs, and
 The addition of specialized tools and machines

Later in 1832, Charles Babbage expanded on these ideas in his study of pin manufacturing. He
noted that specialization not only increases productivity but also makes it possible for only the
specific skills required. Although division of labor has been widely applied, it is now being
reevaluated because of:

 Its effect on work morale

 Turnover
 Job boredom, and
 Poor job performance

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2. Standardization of Parts: parts are standardized so that they can be interchanged.

Standardization was practiced in early Venice, where rudders on warship were made to be
interchangeable. This provided great advantages when rudders were damaged in battles. Eli
Whitney in 1790 used interchangeable parts in musket production. Prior to this time, musket
parts and even ammunitions were tailored to each individual musket. When Henry Ford
introduced the moving automobile assembly line in 1913, his concept required standardized
parts as well as specialization of labor.
3. Industrial Revolution: the industrial revolution was in essence the substitution of machine
power for human power. Great impetus was given to this revolution in 1764 by James Watt‟s
steam engine, which was a major source of mobile machine power for agriculture and
factories. The industrial revolution was further accelerated in the late 1800s with the
development of the gasoline engine and electricity. Early in this century, mass production
concepts were developed when heavy demands for production were placed on American
industry. The age of mass marketing has continued this pressure for automation and high
volume production.

Before the industrial revolution, an item such as a blanket was made by one person, typically
at home. The worker would:

 Shear wool from his/her sheep

 Twist the wool in to yarn
 Dye the yarn
 Weave the blanket manually on a home looms, and then
 Sell the finished product to merchants.
4. Scientific Study of Work: the scientific study of work is based on the notion that the
scientific method can be used to study work as well as physical and natural systems. This
idea was brought by F. W. Taylor in his book principles of Scientific Management,
published in 1915. Believing that a scientific approach to management could improve labor
efficiency, he proposed the following approach:
i. Collect accurate data concerning each elements of the work and develop
standardized procedures for the workers.
ii. Scientifically select, train, and develop workers instead of letting them train
themselves. On the way they can best fit to the scientifically standardized work,
iii. Establish a spirit of cooperation between management and workers so that high
productivity at good pay is fostered.
iv. To divide the work between management and labor so that each group does the
work for which it is suited.

This idea was later refined by husband and wife Frank and Lillian Gilbert (1911) who
developed motion economy studies. They identified 17 various types of motions which they
called them „therbligs‟. Henry Gantt (1914) was also instituted a charting system for scheduling

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production. But the scientific study of work has come under attack by labor unions, workers, and
academics because the approach was misapplied or used as a ‗speed up‘ campaign by
management.

5. Human Relations: the human relations movement highlighted the central importance of
motivation and the human element in work design. Elton Mayo and others developed this
line of thought in the late 1930s at Western Electric, where the now famous Hawthorne
Studies was conducted. These studies indicated that worker motivation – along with the
physical and technical work environment – is a crucial element in improving productivity.
This led to a modernization of the scientific management schools which had emphasized the
more technical aspects of work design. The human relation school of thought has also led to
job enrichment recognized as the method with a great deal of potential for “humanizing the
work place” as well as improving productivity.
6. Decision Making: decision models can be used to present a productive system in
mathematical terms. A decision model is expressed in terms of performance measures,
constraints, and decision variables. The purpose of such a model is to find optimal or
satisfactory values of decision variables which improves systems performance with in the
applicable constraints. These models can then help guide management decision making. One
of the first uses of this approach occurred in 1915, when E. W Harris developed an
Economic Order Quantity (EOQ) formula for inventory management. In 1931, Shewhart
quantitative decision model for use I statistical quality control work. In 1947, George
Dantzling developed the simplex method of solving linear programing, which made
possible the solution of a whole class of mathematical models. In 1950s, the development of
computer simulation models contributed much to the study and analysis of operations.

7. Computers: the use of computers has dramatically changed the field of operations
management since computers were introduced into business in the 1950s. Most
manufacturing operations now employ computers for inventory management, production
scheduling, quantity control, computer aided manufacturing, and costing systems. In
additions, computers are used extensively in office automation, and they are used virtually in
all types of service operations. Today, the effective use of computers is an essential part of
the operations management field. In the same sense, robots are now doing much of the
monotonous, dirty, and possibly dangerous works that can be done by machines. In factories,
they perform assembly, painting, welding and other respective tasks.

The simplest industrial robots are mechanical arms or fingers that are powered to follow a fixed
patter of instructions. Robots that are equipped with micro-processors (or a computers) are
―smart‖. A smart robot can receive instructions, select materials, and proceed with the task on its
own and at high speed.

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Table 1.1 summary of historical miles stones in the evolution of operations management

Approx. Date Contribution/Concept Originator

1776 Division of Labor Adam Smith
1790 Interchangeable Parts i.e., Standardization Eli Whitney
1911 Motion Study, use of industrial psychology Frank and Lillian Gilbert
1912 Chart for scheduling activities Henry Gantt
1913 Moving Assembly Lines Henry Ford
1915 Mathematical model for inventory management F. W. Harris
1930 Hawthorn studies for work motivation Elton Mayo
1935 Statistical procedure for sampling quality control W. Shewhart, Tippett
1940 Operation research (OR) in warfare in WW II Operations Research group
1947 Linear Programing George Dantzing
1951 Commercial digital computers Sperry Univac
1960 Extensive development of quantitative tools Numerous
1975 Emphasis on manufacturing strategy W. Skinner
1980s Emphasis on quality, flexibility, time-based Japanese manufacturers
composition

1.3 Manufacturing Operations and Service Operations

Operating system converts inputs in order to provide outputs which are required by a customer. It
converts physical resources into outputs, the function of which is to satisfy customer wants i.e.,
to provide some utility for the customer. In some of the organization the product is a physical
good (hotels) while in others it is a service (hospitals). Bus and taxi services, tailors, hospital and
builders are the examples of an operating system.

An operation is defined in terms of the mission it serves for the organization, technology it
employs and the human and managerial processes it involves. Operations in an organization can
be categorized into manufacturing operations and service operations. Manufacturing operations
is a conversion process that includes manufacturing yields a tangible output: a product, whereas,
a conversion process that includes service yields an intangible output: a deed, a performance, an
effort.

Manufacturing and service organizations differ chiefly because manufacturing is goods-oriented

and service is act-oriented. The difference involves the following:

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1. Degree of customer contact

Often, by its nature, service involves a much higher degree of customer contact than
manufacturing. The performance of service often occurs at the point of consumption. For
example, repairing a leaky roof must take place where the roof is, and surgery requires the
presence of the surgeon and the patient. On the other hand, manufacturing allows a separation
between production and consumption, so that manufacturing can occur away from the consumer.
This permits a fair degree of latitude in selecting work methods, assigning jobs, scheduling work,
and exercising control over operations. Service operations, because of their contact with
customers, can be much more limited in their range of options. Moreover, customers are
sometimes part of the system (e.g., self-service operations such as supermarket shopping), so
tight control is impossible.

2. Uniformity of Input

Service operations are subject to greater variability of inputs than typical manufacturing
operations. Each patient, each lawn, and each auto repair presents a specific problem that often
must be diagnosed before it can be remedied. Manufacturing operations often have the ability to
carefully control the amount of variability of inputs and thus achieve low variability in outputs.
Consequently, job requirements for manufacturing are generally more uniform than those of
service.

3. Labor content of jobs

Many services involve higher labor content than manufacturing operations.

4. Uniformity of Output

Because high mechanization generates products with low variability, manufacturing tends to be
smooth and efficient; service activities sometimes appears to be slow and awkward, and output is
more variable. Automated services are an exception to this.

5. Measurement of Productivity

Measurement of Productivity is more straightforward in manufacturing due to the high degree of

uniformity of most manufactured items. In service operations, variations in demand intensity and
in requirements from job to job make productivity measurement considerably more difficult. For
example, compare the productivity of two doctors. One may have a large number of routine
cases while the other does not, so their productivity appears to differ unless a very careful
analysis is made.

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6. Production and delivery

In many instances customers receive the service as it is performed (e.g., haircut, dental care).

7. Quality assurance

Quality assurance is more challenging in service when production and consumption occur at the
same times. Moreover, the higher variability of inputs creates additional opportunity for the
quality of output to suffer unless quality assurance is actively managed. Quality at the point of
creation is typically more evident for service than for manufacturing, where errors can be
corrected before the customer receives the output.

8. Amount of inventory

Due to the nature of manufacturing, manufacturing system usually have more inventory on hand
(e.g., raw material, partly completed items, finished goods inventories) than service firms.
Nonetheless, all business organizations carry at least some items in inventory that are necessary
for the operation of their businesses (e.g., office supplies, spare parts for equipment). And some
service organizations have substantial amounts of inventory (e.g., firms that supply replacement
parts for automobiles, construction equipment, or farm equipment).

1.3.1 Manufacturing Operations

Manufacturing is characterized by tangible outputs (products), outputs that customers consume

overtime, jobs that use less labor and more equipment, little customer contact, no customer
participation in the conversion process (in production), and sophisticated methods for measuring
production activities and resource consumption as product are made.

1.3.2 Service Operations

Service is characterized by intangible outputs, outputs that customers consumes immediately,

jobs that use more labor and less equipment, direct consumer contact, frequent customer
participation in the conversion process, and elementary methods for measuring conversion
activities and resource consumption. Some services are equipment based namely rail-road
services, telephone services and some are people based namely tax consultant services, hair
styling.

1.4 Operations Decision Making

Operations managers manage all the activities of the production systems, which converts inputs
into the organization‘s products and services. This definition states in very general terms what

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operation management does, but how operations managers manage may be more important to an
understanding of operations management. Perhaps no other approach helps us understand how
operations managers manage than the examination of the decisions in operations management,
because, in large part, operations managers manage by making decisions about all activities of
production systems. These decisions can be broadly categorized into three: strategic decisions,
operating decisions, and control decisions.

1. Strategic Decisions: are decisions related to products, processes, and facilities. They are
concerned with operations strategies and long-range plan for a company. These decisions are
so important that typically people from production, personnel, engineering, marketing and
finance get together to study the business opportunities carefully and to arrive at a decision
that puts the company in the best position of achieving its long-term goals. Example of
strategic decision includes:
i. Products and production process: decides whether to launch a new-product
development project; and deciding on the design for a production process for a new
product.
ii. Production Technology: selecting and managing production technology.
iii. Allocating resources to strategic alternatives: deciding how to allocate scarce raw
materials, utilities, production capacity, and personnel among new and existing
business opportunities.
iv. Long range capacity planning and facility location: deciding on how much long-
range production capacity and deciding what new factories are needed and where to
locate them.
v. Facility Layout: deciding the arrangement of facilities in producing company‘s goods
and services.
2. Operating Decisions: concerned with decision about planning production to meet demand.
These decisions are necessary if the ongoing productions of good and services is to satisfy
the demand of the market and provides profit for the company. The principal responsibility
of operations is to take the order for products and services from customers, which the
marketing function has generated, and deliver products and services in such a way that there
are satisfied customers at reasonable costs. In carrying out this responsibility, numerous
decisions are made such as:
i. Production Planning Systems: deciding on the company‘s Aggregate Production
Planning (APP) and Masters Production Schedule (MPS).
ii. Independent Demand Inventory System: deciding how much finished goods inventory
to carry for each product.
iii. Material Requirement Planning (MRP) System: planning materials and capacity
requirements.
iv. Shop-floor Planning and Control: short-range decision about what to produce and
when to produce at each work center.

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v. Planning and Scheduling Service Operations: decisions about planning and

controlling production of services.
vi. Just in time (JIT) Manufacturing: decision about planning and operating JIT
manufacturing systems.
vii. Materials Management and Purchasing: managing all facets of the material system.

3. Control Decision: are concerned with decisions about planning and controlling operations.
These decision concerns the day to day of workers, quality of products and services,
production and overhead costs, and maintenance of machines. In this regard operations
management are engaged in planning, organizing, and controlling activities so that poor
worker performance, inferior product quality, and excessive machine breakdowns do not
interfere with the profitable operations of the production system. Major decision areas
include:
i. Productivity of employees: planning for the effective and efficient use of human
resources in operations.
ii. Total Quality Management (TQM): planning the system for the quality of products
and services.
iii. Quality Control: applications of statistical quality control tools to decide what quality
control acceptance criteria should be for products.
iv. Planning and Control Projects: management of projects so that they could be
accomplished within specified time frame and resource allocated.
v. Maintenance management and reliability: planning for maintaining the machines and
facilities of production. Essentially, it focuses on how often to perform preventive
maintenance on key pieces of production machinery.

Quantitative models and techniques of decision making

For many topics in operations management, there are quantitative models and techniques
available that help managers make decisions. Some techniques simply provide information that
the operations manager might use to help make a decision; other techniques recommend a
decision to the manager. Some techniques are specific to a particular aspect of operations
management; others are more generic and can be applied to a variety of decision-making
categories.

These different models and techniques are the ―tools‖ of the operations manager. Simply having
these tools does not make someone an effective operations manager, just as owning a saw and a
hammer does not make someone a carpenter. An operations manager must know how to use
decision-making tools. How these tools are used in the decision-making process is an important
and necessary part of the study of operations management.

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Decision analysis with and without probabilities

In this supplement we demonstrate a quantitative technique called decision analysis for decision
making Situations in which uncertainty exists. Decision analysis is a generic technique that can
be applied to a number of different types of operational decision-making areas.

Many decision-making situations occur under conditions of uncertainty. For example, the
demand for a product may not be 100 units next week but may vary between 0 and 200 units,
depending on the state of the market, which is uncertain. Decision analysis is a set of quantitative
decision-making techniques to aid the decision maker in dealing with a decision situation in
which there is uncertainty. However, the usefulness of decision analysis for decision making is
also a beneficial topic to study because it reflects a structured, systematic approach to decision
making that many decision makers follow intuitively without ever consciously thinking about it.
Decision analysis represents not only a collection of decision-making techniques but also an
analysis of logic underlying decision making.

Decision making without probabilities

A decision-making situation includes several components the decisions themselves and the
events that may occur in the future, known as states of nature. Future states of nature may be
high or low demand for a product or good or bad economic conditions. At the time a decision is
made, the decision maker is uncertain which state of nature will occur in the future and has no
control over these states of nature.

When probabilities can be assigned to the occurrence of states of nature in the future, the
situation is referred to as decision making under risk. When probabilities cannot be assigned to
the occurrence of future events, the situation is called decision making under uncertainty.

To facilitate the analysis of decision situations, they are organized into payoff tables. A payoff
table is a means of organizing and illustrating the payoffs from the different decisions, given the
various states of nature, and has the general form shown in Table.

State of nature
Decision a b
1 Payoff 1a Payoff 1b
2 Payoff 2a Payoff 2b

Each decision, 1 or 2, in the table above will result in an outcome, or payoff, for each state of
nature that will occur in the future. Payoffs are typically expressed in terms of profit, revenues,
or cost (although they may be expressed in terms of a variety of quantities). For example, if

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decision 1 is to expand a production facility and state of nature a is good economic conditions,
payoff 1a could be $100,000 in profit.

Once the decision situation has been organized into a payoff table, several criteria are available
to reflect how the decision maker arrives at a decision, including maximax, maximin, minimax
regret, Hurwitz, and equal likelihood. These criteria reflect different degrees of decision-maker
conservatism or liberalism. On occasion they result in the same decision; however, they often
yield different results. These decision-making criteria are demonstrated by the following
example.

The Southern Textile Company is contemplating the future of one of its plants located in South
Carolina. Three alternative decisions are being considered:
1. Expand the plant and produce lightweight, durable materials for possible sale to the
military, a market with little foreign competition;
2. Maintain the status quo at the plant, continuing production of textile goods that are
subject to heavy foreign competition; or
3. Sell the plant now. If one of the first two alternatives is chosen, the plant will still be sold
at the end of the year. The amount of profit that could be earned by selling the plant in a
year depends on foreign market conditions, including the status of a trade embargo bill in
Congress.

The following payoff table describes this decision situation.

State of Nature
Good foreign Poor foreign
Decision Competitive conditions Competitive conditions
Expand $800,000 $500,000
Maintain status quo $1,300,000 ($150,000)
Sell now $320,00 $320,000

Determine the best decision using each of the decision criteria.

1. Maximax
2. Maximin
3. Minimax regret
4. Hurwicz
5. Equal likelihood

Solution

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1. Maximax
The decision is selected that will result in the maximum of the maximum payoffs. This is how
this criterion derives its name—the maximum of the maxima. The maximax criterion is very
optimistic. The decision maker assumes that the most favorable state of nature for each decision
alternative will occur. Thus, for this example, the company would optimistically assume that
good competitive conditions will prevail in the future, resulting in the following maximum
payoffs and decisions:
Expand: $800,000
Status quo: 1,300,000 ← Maximum
Sell: 320,000
Decision: Maintain status quo

2. Maximin
The maximin criterion is pessimistic. With the maximin criterion, the decision maker selects
the decision that will reflect the maximum of the minimum payoffs. For each decision
alternative, the decision maker assumes that the minimum payoff will occur; of these, the
maximum is selected as follows:
Expand: $500,000 ← Maximum
Status quo: – 150,000
Sell: 320,000
Decision: Expand

3. Minimax Regret Criterion

The decision maker attempts to avoid regret by selecting the decision alternative that minimizes
the maximum regret. A decision maker first selects the maximum payoff under each state of
nature; then all other payoffs under the respective states of nature are subtracted from these
amounts, as follows:
Good competitive conditions Poor competitive conditions
$1,300,000-800,000=500,000 500,000-500,000=0
1,300,000-1,300,000=0 500,000-(-150,000) =650,000
1,300,000-320,000=980,000 500,000-320,000=180,000

These values represent the regret for each decision that would be experienced by the decision
maker if a decision were made that resulted in less than the maximum payoff. The maximum
regret for each decision must be determined, and the decision corresponding to the minimum of
these regret values is selected as follows:

Expand: $500,000 ← Minimum

Status quo: 650,000
Sell: 980,000 Decision: Expand
4. Hurwicz

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A compromise is made between the maximax and maximin criteria. The decision maker is
neither totally optimistic (as the maximax criterion assumes) nor totally pessimistic (as the
maximin criterion assumes). With the Hurwicz criterion, the decision payoffs are weighted by a
coefficient of optimism, a measure of the decision maker‘s optimism. The coefficient of
optimism, defined as α, is between 0 and 1 (i.e., 0 < α <1). If α= 1, the decision maker is
completely optimistic; if α = 0, the decision maker is completely pessimistic. (Given this
definition, 1 - α is the coefficient of pessimism.) For each decision alternative, the maximum
payoff is multiplied by α and the minimum payoff is multiplied by 1 - Α. For our investment
example, if α equals 0.3 (i.e., the company is slightly optimistic) and 1 – α= 0.7, the following
decision will result:

Expand: $800,000(0.3) + 500,000(0.7) =$590,000 ← Maximum

Status quo: 1,300,000(0.3) _ 150,000(0.7) = 285,000
Sell: 320,000(0.3) +320,000(0.7) = 320,000
Decision: Expand

5. Equal Likelihood
The equal likelihood (or La Place) criterion weights each state of nature equally, thus
assuming that the states of nature are equally likely to occur. Since there are two states of nature
in our example, we assign a weight of 0.50 to each one. Next, we multiply these weights by each
payoff for each decision and select the alternative with the maximum of these weighted values.

Expand: $800,000(0.50) + 500,000(0.50) = $650,000 ← Maximum

Status quo: 1,300,000(0.50) _ 150,000(0.50) = 575,000
Sell: 320,000(0.50) + 320,000(0.50) = 320,000
Decision: Expand

The decision to expand the plant was designated most often by four of the five decision criteria.
The decision to sell was never indicated by any criterion. This is because the payoffs for
expansion, under either set of future economic conditions, are always better than the payoffs for
selling. Given any situation with these two alternatives, the decision to expand will always be
made over the decision to sell. The sell decision alternative could have been eliminated from
consideration under each of our criteria. The alternative of selling is said to be dominated by the
alternative of expanding. In general, dominated decision alternatives can be removed from the
payoff table and not considered when the various decision-making criteria are applied, which
reduces the complexity of the decision analysis.

Different decision criteria often result in a mix of decisions. The criteria used and the resulting
decisions depend on the decision maker. For example, the extremely optimistic decision maker

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might disregard the preceding results and make the decision to maintain the status quo, because
the maximax criterion reflects his or her personal decision-making philosophy.

Decision making with probabilities

For the decision-making criteria we just used we assumed no available information regarding the
probability of the states of nature. However, it is often possible for the decision maker to know
enough about the future states of nature to assign probabilities that each will occur, which
decision is making under conditions of risk. The most widely used decision-making criterion
under risk is expected value, computed by multiplying each outcome by the probability of its
occurrence and then summing these products according to the following formula:

n
EV ( x)   p( xi )( xi )
i 0

where : p ( xi )  probability of outcome i

xi  outcome i

Assume that it is now possible for the Southern Textile Company to estimate a probability of
0.70 that good foreign competitive conditions will exist and a probability of 0.30 that poor
conditions will exist in the future. Determine the best decision using expected value.
Solution
The expected values for each decision alternative are computed as follows.
EV (expand) =$800,000(0.70) + 500,000(0.30) = $710,000
EV (status quo) = 1,300,000(0.70) _ 150,000(0.30) =865,000 ← Maximum
EV (sell) = 320,000(0.70) +320,000(0.30) = 320,000
The decision according to this criterion is to maintain the status quo, since it has the highest
expected value.

1.5 Productivity Measurement

Definition I

Productivity in its simplest form is the ratio of the products and services of an organization to the
inputs consumed to generate them.

Total outputs of the firm

productivity 
Total inputs used by the firm

The goal of productivity management is to make the ratio as large as practical; that would
indicate the highest output return for given inputs. Here outputs represent desired results whereas

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inputs represent the resources used to obtain those results. In all cases, outputs and inputs must
be quantifiable measures to obtain meaningful productivity ratio.

Definition II

Productivity is a process whereby an organization effectively and efficiently converts its

resources into the products and services it offers for sale.

Effectiveness is obtaining desired results; it may reflect output quantities, perceived quality, or
both. Efficiency occurs when certain output is obtained with a minimum of inputs. In order to
assure that productivity measures captures what the company is trying to do with respect to such
vague issues as customer satisfaction and quality, come firms redefine as follows:

Effectiveness Value to customer

productivity  or
Efficiency Cost to produce

Note: Where effectiveness is doing the right things, and efficiency is doing things right.

In general, productivity is a common measures of how well a country, industry, or business

unit is using its resources (or factors of production).

Productivity must be expressed as:

1. Single-factor/partial productivity measure: indicates the ratio of outputs (goods and

services produced) to one/single resources (inputs).

Output Output Output Output

Partial measures  or or or
Labor Capital Material Energy

2. Multifactor productivity measure: indicates the ratio of output to a group of inputs (but
not all inputs).

Output Output Output

Multifactor Measure  or or
Labor  Capital Labor  Capital  Material Labor  Capital  Material  Energy

3. Total factor productivity measure: indicates the ratio of all outputs to all inputs. It may be
used to describe the productivity of an entire organization or even a nation.

Output Goods and Services produced

TotalMeasure  or
Input All resources used

15 AU, Department of LSCM; Compiled by Ararsa B.

 Operations Management

Illustration:

A furniture manufacturing company has provided the following data. Compare

a. Partial productivity of Labor, Material and Supplies

b. Multifactor productivity for Labor, Material and Supplies, and Labor, Capital and others.
c. Total productivity of 2006 and 2007.

2006 2007
Output Sales Value 22,000 35,000
Inputs Labor 10,000 15,000
Raw Materials and Supplies 8,000 12,500
Capital Equipment Depreciation 700 1,200
Others 2,200 4,800

Solution:

2006 2007
Partial Productivities
Labor 2.2. 2.33
Raw materials and Supplies 2.75 2.8
Multifactor Productivities
Labor, Materials and Supplies 1.22 1.27
Labor, Capital Equip. Dep. And others 1.71 1.67
Total Productivity 1.05 1.04

Exercise:

A small-scale shoe factory has provided you the following data over the past two fiscal budget
years

2006 2007
Output Sales Value 60,000 80,000
Inputs Labor 22,000 30,000
Raw Materials 26,000 35,000
Supplies 2,000 3,000
Depreciation 6,000 9,000

16 AU, Department of LSCM; Compiled by Ararsa B.

 Operations Management

Compare:

1. Partial Productivity for Labor, Raw Materials, and Depreciation

2. Multifactor productivities for Labor and Supplies, and for Raw Materials, Supplies and
Depreciation.
3. Total productivity.

Factors affecting productivity

Productivity increases are largely dependent up on three productivity variables:

1. Labor: improvement in the contribution of labor productivity is the result of a healthier,

better-educated, and better-nourished labor force. Some increase may also be attributed to
a short workweek. Historically, one six i.e. about 17% of the annual improvement in
productivity is attributed to improvement in the quality of labor.
2. Capital: human beings are tool-using animals. Capital investment provides those tools.
Capital contributes one-six (17%) of the annual increase in productivity. Inflation and
taxes increase the cost of capital making and the capital investment increasingly
expensive, when the capital invested per employee drops, we can expect a drop in
productivity. Using labor rather than capital may reduce unemployment in the short run,
but it also makes economies less productive and therefore lower wages in the long run.
The trade-off between capital and labor is continually in flux. Additionally, the higher the
interest rate, the more projects requiring capital are ―squeezed out‖: they are not pursued
because the potential return on investment for a given risk has been reduced. Thus,
operations managers adjust their investment plans to changes in capital costs.
3. Management: is a factor of production and an economic resources. It is responsible for
ensuring that labor and capital are effectively used to increase productivity. Management
accounts for about two-third (66.67%) of the annual one percent increase in productivity.
It includes improvements made through the application of technology and the utilization
of knowledge.

How to improve productivity:

There are a number of key steps that a company or department can take toward improving
productivity. These are eight steps to improve productivity of an organization. These are:

i. Develop productivity measures for all operations; measurement is the first step in
managing and controlling operation.
ii. Look at the system as a whole in deciding which operations to concentrate on. It is
overall productivity that is important. Therefore, improvements in the bottleneck
operations will lead to increased productivity up to the point that the output rate of the
bottleneck equals the output rate of the operations feeling it.

17 AU, Department of LSCM; Compiled by Ararsa B.

 Operations Management

iii. Develop methods for achieving productivity improvements such as soliciting ideas
from workers, studying how other firms have increased productivity and reexamining
the way work is done
iv. Establish reasonable goals for improvement. The productivity goals should be
realistic and time dependent.
v. Make it clear that management supports and encourages productivity improvement.
Consider incentives to reward workers for contributions.
vi. Measure improvements and publicize them.
vii. Don‘t confuse productivity with efficiency; efficiency is a narrower concept that
pertains to getting the most out of a given set of resources, whereas productivity is a
broader concept that pertains to effective use of overall resources.

How to make the productive ratio large

It is insufficient to measure the ratio of output to input unless something is done to increase that
ratio over time. To do this, management and the organization as a whole have only five options
to make the ratio bigger:

1. Make the output larger for the same output

2. Make the inputs smaller for the same output
3. Increase the output while decreasing the input
4. Increase output greater than the input increase
5. Decrease the output less than the input decrease

18 AU, Department of LSCM; Compiled by Ararsa B.