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. This way, they
will be able to sell more while also being able to lower prices.
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

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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 of 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 technique 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 product. 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 moving 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

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 the
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).

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.

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.

E.g.: 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. E.g.: 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 firm’s 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 its
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 in 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, its 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 cost is 5000 across all output (since it is fixed!).

The variable cost is $3 per unit so it will be $0 at output 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 break-even 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 is 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 causes
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!

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

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 and 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.
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 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 providing 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 government rules and
restrictions in setting up, e.g.: 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, they need 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 a large number of workers are required in
the firm, then it will need to be located 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 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 do 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 that are overcrowded or
renowned for natural beauty. Planning restrictions can be put into
place to do so.

Sources:
https://igcseaid.wordpress.com/notes/business-studies-0450/4-1-production-of-good
s-and-services/
https://igcseaid.wordpress.com/notes/business-studies-0450/4-2-costs-scale-of-prod
uction-and-break-even-analysis/
https://igcseaid.wordpress.com/notes/business-studies-0450/4-3-achieving-quality-pr
oduction/
https://igcseaid.wordpress.com/notes/business-studies-0450/4-4-location-decisions/