UNIT 3: FUNTIONAL AREAS OF BUSINESS

Operations. The production process.

The operations function concerns all the value creating activities involved in the
transformation of inputs (resources) into outputs (finished goods and services).

Parts of the production process

- Transformation process: it involves the operations required to transform the inputs

into outputs. There are four elements:
o Tasks: actions performed on raw materials, intermediate or finished products.
Tasks can be manual (performed directly by operators without the aid of
machines), mechanized (performed by operators with the aid of machines) or
automated (performed directly by machines).
o Flows: movement of materials or information from one location to another.
o Storage: keeping of materials or information in good conditions for later use.
There is no task or movement.
- Inputs (resources): any item that is used in the transformation process.
o Basic: raw materials, labour, components, information, energy, capital, etc.
o Creative: intellectual capital used in the design of products and processes
(related to R&D).
o Managerial: planning, organizing & monitoring the production process.
- Outputs: goods, services and by-products obtained from the production process (some
by-products are undesirable).
- Feedback: information produced during the production process that may be compared
with the initial plans in order to adjust the production system for better functioning.

Goals of the production process

 Efficiency: a production process is efficient if it is able to produce at minimum costs

per unit. This is relative to what other production systems may achieve.
 Quality:
o Internal quality is concern with how well the product or service meets the
technical specifications.
o The external view of quality refers to how satisfied are the customers with the
product. As such, a product may meet the specifications but still don't be
attractive to customers.
 Lead time: how long it takes to deliver the product after the order of production is
received. When the production is oriented to produce stock, this reduces or eliminates
the lead time completely, since products are waiting for the customer’s demand. In
contrast, firms that produce on demand will have longer lead times.
 Flexibility: ability to adjust or adapt the production process to produce new products
or services, to change from one product to another or to modify production volume.
Flexibility is especially valuable for companies producing on demand.
Types of production systems

Project production: Unique good for each customer; it is manufactured one at a time. Ships,
Aircraft, Bridges and Decoration are examples of this type of production. Characteristics:

 Unique product (one unit at a time)

 Plant layout: fixed position. The product does not move during the transformation
process. The operators, machines, tools, etc. move to the location of the project.
 Unit cost: High. There are no economies of scale.
 Labour: Highly skilled and adaptable to different tasks and different projects.
 Machinery and equipment: versatile (general use), it must be adapted to the next
project.

Job-shop production: Few units are produced at a time, according to the specifications of de
customer. Examples include repair shops, wedding dressmaker. Characteristics:

 Small volumes; high variety (adaptable to the needs of customer).

 Plant layout: process. Similar machines capable of doing similar functions are grouped
together within the plant. The product visits the places in order to perform required
transformations.
 Unit cost: high (high-average in batch production). Economies of scale cannot be
exploited; constant adaptations are required in order to meet customer needs (they
could be exploited in batch production, depending on the size of the batch).
 Labour: Highly skilled and adaptable to the different tasks/specifications of each batch.
 Machinery and equipment: versatile (general use), usually hand tools (flexibility).

Mass production: Large volumes to stock. Uniform flow of materials through a precise
sequence of operations (assembly line). One standardised product at a time. Early examples
include automobile manufacturing or smartphone production.

 Large volumes; low variety, standardised products (adaptations in the assembly line
are needed before starting the production of a new variety).
 Plant layout: product. Assembly line. The product flows in strict order and the
operations are done according to the pace of the line.
 Unit cost: low. Economies of scale are fully exploited.
 Labour: low skilled, repetitive and simple tasks.
 Machinery and equipment: specialised in order to enjoy economies of scale; not
flexibility. Mechanised materials handling, automations, robots…

Continuous production:

Just as mass production but in a non-stop flow with infrequent changes in the assembly line.
Automation substitutes mechanization and few workers are required, mostly the engineers
that prepare the machines and do the maintenance. Volumes are very large and flexibility is
low. Characteristics are the same of mass production but with more automation and fewer
workers. Cost of production per unit is even lower. Examples include: bottle making,
petrochemicals, coke, cement, etc.
Just in time (lean production)

JIT manufacturing tries to combine the advantages of job production (flexibility) with those of
mass production (efficiency. It reduces the need for stock of materials too, but requires a more
sophisticated organization of supplies. Suppliers must be commited with the system and ready
to supply what is needed when is needed. Characteristics:

- Large volumes, high variety, standardised products (allows mass customisation)

- Plant layout: U-shaped. Combines the logic of the assembly line making it adaptable to
different options for each production. The operator can be controlling more than one
repetitive simple operation.
- Unit cost: low. Economies of scale are exploited, while allowing for some
customisation.
- Labour: Skilled multifunctional.
- Machinery and equipment: general purpose, flexible.
- Suppliers: long-term relationships, no stocks, pull system.

Dell is a good example of JIT production. The customer places the order, with the specifications
wanted (within a menu of options). Then Dell obtains the materials required from suppliers
and assembles and delivers the computer just as the customer wants it.

MARKETING MIX

Product

Difference between consumer (milk, bread, cars) and industrial goods (vans, working tools).
Difference between goods (can be stored, long life, mostly tangible) and services (cannot be
stored and produced at the same time, one use). Attributes of a product:

- Quality
- Design
- Packaging
- Size and quantity
- Additional services (warranty, transportation)
- Image (brand name, reputation)

Product life cycle

Development stage: the idea is being considered. Potential customers and manufacturing
requirements are evaluated, the product is designed.

Introduction stage: the new product is launched to the market. Sales volume will be low. Costs
are high, since the product must be promoted, distribution channels must be developed and
consumer testing may end up in adaptations of the product. Profits tend to be negative.

Growth stage: both sales and profit grow rapidly; the product is increasingly adopted by more
and more consumers. The increase in sales also reduces production costs since economies of
scale will be exploited. Profits turn to positive in this stage.

Maturity stage: the product is well-known and adopted by most potential customers and
distribution channels are well developed. The challenge now is to maintain the market share.
Profits are high and more competitors are attracted to the market. Efforts to differentiate the
product are the main focus to gain competitive advantage.

Decline stage: eventually sales drop as the product becomes obsolete for new customer needs
or tastes. Profits will be positive for some time but not for long, as sales continue dropping.
Some firms may maintain profitability due to customer loyalty and product differentiation. But
as market size shrinks competition turns more aggressive and costs increase (lower economies
of scale). In the end, losses appear and product is abandoned.

Place

It relates to the delivery of the product, which must be available in the quantity, moment and
place that is convenient for the customer. We can distinguish between direct and indirect
distribution channels. Direct channels connect directly with the final customer (catalogue,
internet, etc.). Indirect channels use intermediaries to reach the final customer
(representatives, wholesalers, retailers).

Price

The price of the product summarizes the commercial policy of the company and must reflect
the value perceived by the customer (with respect to competing firms). The effect of price on
margin and sales must be carefully balanced in order to maximize profits.

Ideally demand based pricing would be the best method to maximize profit, but requires
specific information (the demand function) which is often unavailable. Another way of pricing
is by comparison with competitors. Hedonic pricing techniques can be used for such purpose,
which require gathering complete and updated information about competing products. Mark-
up on cost is less sophisticated and requires much less information and statistical analysis.

Promotion

This variable represents all the communication efforts a company does in order to capture the
attention of the customer and establish long-term relationships with them. Promotion
activities should target a certain audience through effective communication channels.
Different types of promotion activities are: advertising; sales promotion; public relations
(which have deep connections with the CRS policy) or direct marketing.

FINANCING

Firms need funs to back the operations of the real subsystem. This is especially critical at the
moment the business is launched and when the firm grows. The combination of the many
different financing sources of funds determines the financial structure of the firm.

Internal funds

They’re generated from the operations of the firm and ready to be reinvested. Maintenance
self-financing is the amount of money the firm generates ro replace assets with depreciate
over time and will eventually need to be replace. Growth self-financing is the part of the
profits which is reinvested in the firm (retained earnings).
Internal financing is rare. Most firms also need external funds.
External funds

They’re the funds that the firm raises from investors and creditors outside the firm. The
balance sheet distinguishes equity financing from debt.

Equity financing

Money rose from investors in exchange of ownership rights of the company (“shareholder’s
equity); it does not generate interest expenses and it does not have to be paid back.
Moreover, the firm can retain a part of the profits (retained earnings) instead of distributing it
with the shareholders. This retained amount is added to the shareholder’s equity. At the same
time, the firm can issue new shares in order to receive more money from shareholders, which
also increases the shareholder’s equity.

Equity is a permanent and stable source of finance. Unlike debt, equity financing does not
generate any interest expenses. Instead, shareholders obtain their financial return from
dividend payments and from the eventual increases in the market value of the stock.

Debt financing

Money that the firm raises from borrowing is called debt or leverage. Lenders become firm’s
creditors and debt has to be repaid at a future due date with an agreed-upon interest. The
main advantage is that creditors do not become owners. The negative part is that debt has to
be repaid no matter how successful the business is. There’re different sources of financing:

- Trade credit: credit which is granted by the firm’s suppliers. The firm receives the
goods but delays payment to a future day. It is a fundamental source of short-term
financing.
- Prepaid income: revenue received in advance for products which are not delivered yet.
- Bank loan: money borrowed from a bank that has to be repaid with interests. It can be
either short or long-term.
- Bank overdraft or line of credit: the borrower can withdraw money up to some limit.
The main advantage over a bank loan is that interests are only paid on the amount
actually used. This flexibility is paid with higher interest rates.
- Bill of exchange or promissory note: Obligation to pay an amount of money on
demand or at a future date. They’re issued by the debtor.
- Factoring and invoice discounting: The firm sells its invoices to a third party at a
discount. It is a short term source of finance.
- Bonds and debentures: financial assets issued by a company that recognise an
obligation to pay a given amount of money with a specific interest in a future date.
Bonds are secured by a set of assets while debentures are not. They’re typically long
term sources of funds.
- Leasing: It’s a contract that allows renting an asset that the firm needs to use
(equipment). It substitutes buying by renting and therefore is a source of long term
financing.