CHAPTER -ONE

THE NATURE OF OPERATIONS MANAGEMENT

1.1. INTRODUCTION
Today companies are competing in a very different environment than they were only a few years
ago. To survive they must focus on quality, time-based competition, efficiency, international
perspectives, and customer relationships. Global competition, e-business, the internet, and
advances in technology require flexibility and responsiveness. This new focus has placed
operations management in the limelight of business, because it is the function through which
companies can achieve this type of competitiveness. Consider some of today’s most successful
companies, such as Wal-Mart, Southwest Airlines, General Electric, Starbucks, Toyota, FedEx,
and Procter & Gamble. These companies have achieved world-class status in large part due to a
strong focus on operations management. In this course we will learn specific tools and
techniques of operations management that have helped these, and other companies, achieve their
success.
The purpose of this course is to help prepare you to be successful in this new business
environment. Operations management will give you an understanding of how to help your
organization gain a competitive advantage in the marketplace. Regardless of whether your area
of expertise is marketing, finance, MIS, or operations, the techniques and concepts, this course
will help you in your business Career. This material will teach you how your company can offer
products and services cheaper, better, and faster.
What is Operations Management?

Every business is managed through three major functions: finance, marketing, and operations
management. Figure 1-1 illustrates this by showing that the vice presidents of each of these
functions reports directly to the president or CEO of the company. Other business functions –
such as accounting, purchasing, human resources, and engineering etc. support these three major
functions. Finance is the function responsible for managing cash flow, current assets, and capital
investments. Marketing is responsible for sales, customer demand, and understanding customer
wants and needs. Most of us have some idea of what finance and marketing are about, but what
does operations management do?

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 President or CEO

Marketing Operations Finance

V.P. of Marketing V.P. of Operations V.P. of Finance
Managers; Customer Managers; People, Managers; Cash flow,
demands Equipment, Current assets
Generates; sales for Technology, and
goods and Materials, and Capital
services Information investments
Generates; good and/or
services

Figure 1-1:Organizational chart showing the three major business functions.

Operation management (OM) deals with the production of goods and services that people buy
and use every day. Operations Management is the business function that plans, organizes,
coordinates, and controls the resources needed to produce a company’s goods and services.
Operations management is a management function. It involves managing people, equipment,
technology, information, and many other resources. Operations management is the central core
function of every company. This is true whether the company is large or small, provides a
physical good or a service, and is for profit or not for profit. Every company has an operations
management function. Actually, all the other organizational functions are there primarily to
support the operations functions. Without operations, there would be no goods or services to sell.
Consider a retailer such as Gap that sells casual apparel. The marketing function provides
promotions for the merchandise, and the finance function provides the needed capital. It is the
operations function, however, that plans and coordinates all the resources needed to design,
produce, and deliver the merchandise to the various retail locations. Without operations, there
would be no goods or services to sell to customers.
The role of operations management is to transform a company’s inputs into the finished goods or
services. Inputs include human resources (such as workers and managers), facilities and
processes (such as buildings and equipment), as well as materials, technology, and information.
Outputs are the goods and services a company produces. Figure 1-2 shows this transformation
process. At a factory the transformation is the physical change of raw materials into products,
such as transforming leather and rubber into sneakers, denim in to jeans, or plastic into toys. At

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an airline it is the efficient movement of passengers and their luggage from one location to
another. At a hospital it is organizing resources such as doctors, medical procedures, and
medications to transform sick people into healthy ones.

Customer Feedback

Inputs
Inputs
The Transformation
The Process Outputs Outputs
Human Resources
 Human
Transformation Goods
 Goods
Facilities & Processes
 Resources Services
 Services
Technologies
 Facilities & Process
Materials Processes
 Technologi
es
 Materials

Performance Information

Figure 1-2 The transformation process

Operations management is responsible for orchestrating all the resources needed to produce the
final product. This includes designing the product; deciding what resources are needed;
arranging schedules, equipment, and facilities; managing inventory; controlling quality;
designing the jobs to make the product; and designing work methods. Basically, operations
management is responsible for all aspects of the process of transforming inputs into outputs.
Customer feedback and performance information are used to continually adjust the inputs, the
transformation process, and characteristics of the outputs. As shown in Figure 1-2, this
transformation process is dynamic in order to adapt to changes in the environment.
Proper management of the operations function has led to success for many companies. For
example, in 1994 Dell Inc. was a second higher computer maker that managed its operations
similar to others in the industry. Then Dell implemented a new business model that completely
changed the role of its operations function. Dell developed new and innovative ways of
managing the operations functions that have become one of today’s best practices. These
changes enabled Dell to provide rapid product delivery of customized products to customers at a
lower cost, and thus become an industry leader.

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Just as proper management of operations can lead to company success, improper management of
operations can lead to failure. This is illustrated by Kozmo.com, a Web-based home delivery
company founded in 1997. Kozmo’s mission was to deliver products to customers- everything
from the latest video to ice cream – in less than an hour. Kozmo was technology enabled and
rapidly became a huge success. However, the initial success gave rise to overly fast expansion.
The company found it difficult to manage the operations needed in order to deliver the promises
made on its Web site. The consequences were too much inventory, poor deliveries, and losses in
profits. The company rapidly tried to change its operations, but it was too late. It had to cease
operations in April 2001.
The Web-based age has created a highly competitive world of online shopping that poses special
challenge for operations management. The Web can be used for on-line purchasing of everything
from CDs, books, and groceries to prescription medications and automobiles. Whereas the
Internet has given consumers flexibility, it has also created one of the biggest challenges for
companies: delivering exactly what the customer ordered at the time promised. As we saw with
the example of Kozmo.com, making promises on a Web site is one thing; delivering on those
promises is yet another. Ensuring that orders are delivered from “mouse to house’ is the job of
operations and is much more complicated than it might seem. In the 1990s many dot-com
companies discovered just how difficult this is. They were not able to generate a profit and went
out of business. To ensure meeting promises companies must forecast what customers want and
maintain adequate inventories of goods, manage distribution centers and warehouses, operate
fleets of trucks, and schedule deliveries while keeping costs low and customers satisfied. Many
companies like Amazon.com manage almost all aspects of their operation. Other companies hire
outside firms for certain functions, such as outsourcing the management of inventories and
deliveries to UPS. Competition among e-trailers has become intense as customers demand
increasingly shorter delivery times and highly customized products. A same-day service has
become common in metropolitan areas. For example, Barnesandnoble.com provides same-day
delivery in Manhattan, Los Angeles, and San Francisco. Understanding and managing the
operations function of an on line business has become essential in order to remain competitive.

For operations management to be successful, it must add value during the transformation
process. We use the term value added to describe the net increase between the final value of a
product and the value of all the inputs. The greater the value added, the more productive a

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business is. An obvious way to add value is to reduce the cost of activities in the transformation
process. Activities that do not add value are considered a waste; these include certain jobs,
equipment, and processes. In addition to value added, operations must be efficient. Efficiency
means being able to perform activities well, and at the lowest possible cost. An important role of
operations is to analyze all activities, eliminate those that do not add value, and restructure
processes and jobs to achieve greater efficiency. Today’s business environment is more
competitive than ever, and the role of operations management has become the focal point of
efforts to increase competiveness, by improving value added and efficiency.

1.2. The Evolution/Historical Development of Operations Management/Reading

assignment

1.3. Objectives of operations/production management

The objectives of production management are to produce goods and services of the right quality,
in the right quantities, according to the time schedule and at a minimum cost. Objectives of
production management may be amplified as under:
 Producing the right kind of goods and services that satisfy customers' needs (effectiveness
objective)
 Maximizing output of goods and services with minimum resource inputs
(efficiency objective)
 Ensuring that goods and services produced conform to pre-set quality
specifications (quality objective).
 Minimizing throughput time - the time that elapses in the conversion process -
by reducing delays, waiting time and idle time.(lead time objective).
 Maximizing utilization of labor, machines, etc. (capacity utilization objective).
 Minimizing cost of producing goods or rendering a service (cost objective).
1.4. Manufacturing Operations and Service Operations
Organizations can be divided into two broad categories: manufacturing organizations and service
organizations, each posing unique challenges for the operations function.
A conversion process that includes manufacturing (or production) yields a tangible output: a
product. In contrast, a conversion process that includes service yields an intangible output: a
deed, a performance, an effort. For example, Mesfin Industries produces a lot of tangible

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products, whereas Ethiopian Airlines provides air transport services to passengers which are an
intangible output.
Difference between Manufacturing and Service Operations
Organizations can be divided into two broad categories: manufacturing organizations and service
organizations, each posing unique challenges for the operations function. There are two primary
distinctions between these categories. First, manufacturing organizations produce physical,
tangible goods that can be stored in inventory before they are needed. By contrast, service
organizations produce intangible products that cannot be produced ahead of time. Second, in
manufacturing organizations most customers have no direct contact with the operation. Customer
contact is made through distributors and retailers. For example, a customer buying a car at a car
dealership never comes into contact with the automobile factory. However, in service
organizations the customers are typically present during the creation of the service. Hospitals,
colleges, theaters, and barber shops are examples of service organizations in which the customer
is present during the creation of the service.
The difference involves the following.
1. Customer Contact By its very nature, service involves a much higher degree of customer
contact than manufacturing does. The performance of service typically occurs at the point of
consumption; that is the two often occur simultaneously. For example surgery requires the
presence of the surgeon and the patient. Repairing a leaky roof must take place where the
roof is on the other hand manufacturing, allows a separation between production and
consumption so that manufacturing often occurs in an isolated environment away from the
customer.
2. Uniformity of inputs. Service operations are subject to more variability of inputs than
manufacturing operations are. Each patient, each TV repair presents a specific problem that
often must be diagnosed before it can be remedied. Low variability of inputs requirements
for manufacturing are generally more uniform than for service.
3. Labor content of Jobs. Service by its nature is labor intensive whereas manufacturing is
capital intensive
4. Uniformity of output. Service is variable but manufacturing is low variable or highly
(uniform).

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5. Measurement of productivity. Productivity measurement in manufacturing is
straightforward and easy but Service productivity measurement is more difficult because,
there are certain intangible variables in service that are difficult to measure objectively.
Table 1.1 Difference between manufacturing and service operations (Summary)
Characteristic Manufacturing Service
Out put Tangible Intangible
Contact with customer Low High
Uniformity of input High Low
Labor content Low High
Uniformity of output High Low
Measurement of productivity Easy Difficult
Storage Output can be inventoried Not
Delivery time Long lead times Short lead time
Quality Objectively determined Subjectively determined
In reality most firms are not selling purely services or goods rather manufacturers provide many
services as part of their product and many services often manufacture the physical product that
they deliver to their customers or consumer goods is creating the services. In essence goods are
considered as vehicles for services. To put in an another way:
 In services outputs cannot be inventoried while for goods products can be inventoried
 There is extensive customer contact for service while for goods production customer
contact is little
 The lead-time is short for services (delivered immediately on spot e.g. doctor) while for
goods it is long.
1.6. Operations Decision making
Hundreds of decisions are made every day in the operation activity. Even minor decisions
determine the company’s success or failure. It ranges from simple judgmental to complex
analysis which can also involve judgment (past experience & common sense). They involve a
way of blending objective and subjective data to arrive at a choice. The use of quantitative
methods of analysis adds to the objectivity of such decisions.
The major areas in which operations managers make decisions are:
1. Strategic decision

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  Product and service plan
 Competitive priorities (TQM, statistical process,
 Location, capacity and layout decision
2. Design decisions
 Deals with actual production system
 Process design technology
 Job design
3. Operating Decision–deals with operating the factory the system once it is in place. It
includes forecasting, materials management, inventory management, aggregate planning,
scheduling.
1.6.1. Quantitative Approaches
Quantitative approaches to problem solving often embody an attempt to obtain mathematically
optimum solutions to managerial problems. The functions are commonly used quantitative
approaches like, Linear programming, Queuing techniques, Inventory models, Forecasting
techniques, Statistical models.
Operation decision become more complex when: it involves many variables, the variable are
highly interdependent or related, and the data describing the variables are incomplete or
uncertain. The necessity of working with incomplete and uncertain data has always been a
problem for decision maker. The following figures depicts the information environment
decisions.
Fig. 1.3 Quantitative methods available to operations managers

How much certainty exists?

Completely certain Extremely uncertain

Risk Situation

Objective information Subjective Information

.

(All information) (Some information) (No information)

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The following are quantitative tools used under the three situations.
Certainty Risk uncertainty
Algebra, Breakeven analysis, Statistical analysis - Game theory
Cost benefit analysis, queuing theory - Decision theory
Calculus, mathematical Simulation
Programming, linear and Net Work analysis;
Non linear, integer, dynamic PERT/CPM
Programming etc. Decision tree, Utility theory etc
Framework for Decisions (process)
An analytical and scientific framework for decisions implies several systematic steps for decision
makers. They are:
Step 1. Define the problem and its parameters
Step 2. Establish the decision criteria and set the objective
Step 3. Formulating a relationship (model) between the parameters and the criteria
Step 4. Generate alternatives by varying the values of the parameters
Step 5. Choose the course of action, which most closely satisfies the organization.
Step 6. Implement the decision and monitor the result
In the following section of this unit you will learn how to apply the quantitative tools in solving
operations related problems. Since it is difficult to illustrate the entire models only one model,
which can be used under the three situations of decision-making are discussed.
A. Decision Making under Certainty
Different approaches to decision making are available to decision makers. The most widely used
decision rule under the certainty situation is break-even analysis (cost-profit-volume analysis),
cost-benefit analysis and mathematical programming. In the next section break-even analysis is
illustrated.
Breakeven Analysis (BEA)
BEA is a widely used decision making tool. It helps to make a decision whether to produce or
not a certain level of output. Breakeven point is a level of output at which, profit is zero or no
loss or no gain. Production or operation level below this point results in a loss, whereas level of
output above this point helps the company to enjoy some level of profit. Therefore, knowing this
point helps the company to take appropriate action.

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Example 1. The cost and revenue information of ABC Company are as follows:
Fixed Cost = Br 120,000
Unit Price = Br. 50
Variable Cost/unit (Vc/unit) = Br. 30
Find the break-even point in terms of unit and sales in Birr.
Fixed Cost
Solution: Break Even Point-BEP (quantity) = Price/unit −VC/unit
120 , 000 120 , 000
BEP = 50−30 = 20
= 6,000 units
BEP (In Birr) = 6,000 X Br. 50 = Br. 300,000.
This can be depicted graphically as follows:
TR

A
TC

Br. 300,000
BEP

6,000 Quantity
Where: TR= total revenue A= represents the profit region
TC= total cost B= represents the loss region
BEP= breakeven point Vc/unit = Variable cost per unit
Interpretation
The company, if it wants to be profitable, should produce and sale more than 6, 000 units of
output. For example, If the external and internal environment force it to produce only 3,000 units
of the product the company will incur a loss. So it has to take some short-term as well as long
term measures to correct the situation.
B. Decision making under Risk
Decision Tree

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Decision tree is a representation diagram used to determine expected value. It shows the
alternative outcomes and independence of choice. It is used in risk situation where there is only
probabilistic information stated in probabilistic value.
Example.ABC manufacturing firms wants to meet the excess demand to its products. The firm’s
management is concerning three alternative courses of action.
Arrange for subcontracting
Begin overtime production
Construct new facilities
The correct choice depends largely on future demand, which may be low, medium or high.
Management ranks the respective probabilities as 10%, 50% and 40% to low, medium and high
product demand in the future respectively. A cost analysis reveals the effect on profit of each
alternative under a given state. This is given in the payoff table below.
Pay off table
Alternatives Profit if Demand is (Birr)
Low (0.1) Medium (0.5) High (0.4)
Arrange for sub contract (A1) 10,000 50,000 50,000
Over time (A2) -20,000 60,000 100,000
New facilities (A3) -150,000 20,000 200,000
Required: Which alternative is the viable choice?
We can use expected monetary value approach and decision tree to answer this question.
1. Expected monetary value (EMV) – Determine the expected payoff of each alternative
and choose the alternative that has the best expected payoff.
EMV (A1) =10,000X0.1+0.5X 50,000+0.4X50, 000
=1000+25,000+20,000
=46,000
EMV (A2) = -20,000X0.1+60,000X0.5+100,000X0.4
= -2,000+30,000+40,000
= Br. 68,000
EMV (A3) = 150,000X0.1+20,000X0.5+200,000X0.4
= -15,000+10,000+80,000
= Br.75, 000 (highest expected value)

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 Decision: The best alternative is to construct new facilities
because it has the highest expected value.
You can also use decision tree two
depict this information to make a decision as
shown below.
Br. 46,000

Br. 75,000 Br. 68,000

Br. 75,000

Decision: Construct new facility because it have a better return than other two alternatives
C. Decision making under uncertainty
At the opposite extreme is complete uncertainty, no information is available on how likely the
various states of nature are under these conditions, four possible decision criteria are:
A. Minimax regret – determine the worst regret for each alternative , and choose the
alternative with “ best worst”.
The minimax regret strategy is the one that minimize the maximum regret. It is useful for a
risk-neutral decision maker. This is the technique for a “sore loser” who does not wish to
make the wrong decision. Regret in this context is defined as the opportunity loss through
having made the wrong decision. To solve this table showing the size of the regret needs to
be constructed. This means we need to find the biggest pay-off for each alternative strategy
(for each row), then subtract all other numbers in this row from the largest number.
Regret = (best payoff) – (actual payoff)
B. Maximax – determine the best possible payoff and choose the alternative with that
payoff.
C. Laplace – determine the average payoff, and choose the alternative with the best average.

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 D. Maximin- determine the worst possible pay off for each alternative, and then choose the
alternative that has the “ best worst”
Example: Based on the above pay off table and assuming that there is not probability value of
occurrence of each outcome, determine which alternative would be chosen under each of these
strategies.
a. Maximin
b. Maximax
c. Laplace
Solution:
a) Maximin criteria
The worst pay off for the alternatives are Br. 10,000 for subcontracting, Br. -20,000 for overtime
and Br. -150,000 for new facilities and 10,000 is the best out of the worst, hence, the decision is
to choose subcontracting as an alternative using the maximin criteria.
b) Maximax criteriaThe best pay off for each alternative, that is, for Sub contracting is 50,000,
over time Br. 100,000, and New facilities is Br. 2000,000. The decision is to construct new
facility which is an alternative with the best payoff value i.e., Br. 200,000
C) Laplace criteria
The average payoff of each alternative is;
A1 = 10,000+50,000+50,000/3 = 36,667
A2 = -20,000 + 60,000 + 100000 /3 = 46,667
A3 == -150,000 + 20,000 + 200000 / 3 = 23,333
Decision: use overtime to absorb the excess demand.
D)) Minimax regret
Regrets can be tabulated as follows:
Regret = (best payoff) – (actual payoff)
Alternatives Profit if Demand is (Birr)
Low (0.1) Medium (0.5) High (0.4)
Arrange for sub contract (A1) 40,000 0 0
Over time (A2) 120,000 40,000 0
New facilities (A3) 350,000 180,000 0
The maximum regrets for each choice are thus as follows:

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If we decide to use Arrange for sub contract (A1), the maximum regret is 40,000 Birr
If we decide to use Over time (A2), the maximum regret is 120,000 Birr
If we decide to use New facilities (A3), the maximum regret is 350,000 Birr
Therefore, A manager employing the minimax regret criterion would want to minimize that
maximum regret, and therefore choose Arrange for sub contract (A1).
1.7. The Concept of Productivity, its Measurement and Improvement
Productivity is a common measure of how well a country, industry or business unit is using its
resources (or factors of production). Productivity is the value of outputs (goods and services)
produced divided by the values of the input resources (wages, cost of equipment and the like)
used or the ratio of outputs (goods and services) to inputs (e.g. labor and materials). In other
words, productivity is a measure of how efficiently inputs are being converted into outputs. It
measures how well resources are used. The more efficiently a company uses its resources. In its
broadest sense, productivity is defined as:
Outputs
Productivity = Input
To increase productivity, we want to make this ratio of output to inputs as large as practical.
Productivity is what we call a relative measure. In other words, to be meaningful, it needs to be
compared with something else. Comparison can be made with similar operations within its
industry, or it can measure productivity over time within the same operation.
Productivity may be expressed as partial measures, multifactor measures, or total measures. If
we are concerned with the ratio of output to a single input; we have a partial productivity
measure. If we want to look at the ratio of output to a group of inputs (but not all inputs), we
have a multifactor productivity measure. If we want to express the ratio of all outputs to all
inputs, we have a total factory measure of productivity that might be used to describe the
productivity of an entire organization or even a nation.
Output Output Output Output
or or or
Partial Measure = Labor Capital Material energy
Output Output
or
Multifactor Measure = L+K + E L+K +Rm
Output Goods and service produced
or
Total Measure = Inputs All resource used

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Where: L = Labor
K = Capital
E = Energy
Rm = Raw materials
Example1. Let’s say that the weekly dollar value of a company’s outputs, such as finished goods
and work in progress is $10,200 and that the value of its inputs such as labor, materials, and
capital is $8,600. The company’s total productivity would be computed as follows:

Solution
output $ 10,200
Total productivity = = =1.186
input $ 8,600

Example2.A bakery oven produces 346 pastries in 4 hours. What is its productivity?
Solution
numberofpastires 346 pastires
Machine productivity = = =86.5 pa stries/hour
time 4 hours
Example3.Two workers paint tables in a furniture shop. If the workers paint 22 tables in 8 hours,
what is their productivity?
Solution
22tables
Labor productivity = =1.375tables /hour
2 workersx 8 hours
Example4.Let’s say that output is worth $382 and labor and materials costs are $168 and $98,
respectively. A multifactor productivity measure of our use of labor and materials would be
Solution
output $ 382
Multifactor productivity = = =1.436
labor+materials $ 168+ $ 98

Example 5.Determine the productivity of four workers who installed 640 square yards of
carpeting in 8 hours per day.

Solution
Yards of carpet installed
Labor hours worked
Productivity =

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 640 yards
= 4 workers × 8 hours
640
= 32
= 20 yards/hour
Example 6.Calculate the productivity of a machine that produces 60 units in two hours
Solution
Outputs (in units)
Productivity = Production time
60 units
= 2 hours
= 30 pieces /hour
Example 7.A company that produces fruits and vegetable is able to produce 400 cases of canned
peaches in one half hour with two workers. What is labor productivity?
Solution
Labor productivity = Quantity produced
Labor hours
= 400 cases
2workers X1/2 hour /workers
= 400 cases per hour
Examples 8 A wrapping paper Company produced 2000 rolls of paper one day at a standard
price of Br. 1 per roll. Labor cost was Br. 160, material cost was Br. 50, and overhead was Br.
320. Determine the (multifactor and total) productivity.
Solution
Multifactor productivity = quantity produced @standard price
Quantity producedXstandard price
= 2,000 rolls X Br. 1 /roll
= 2000 Br
Labor cost + material cost + overheads
Br. 160 + Br 50 + Br320
= 530 Br

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Then,Multifactor productivity = 2000 /530 = 3.77
Improving Productivity
Factors Affecting Productivity and Improving
Numerous factors affect productivity. Among them are methods, capital, quality, technology,
and management.
There are a number of key steps that a company or a department can take toward improving
productivity:
1. Develop productivity measures for all operations
2. Look at the system as a whole in deciding which operations concentrate on; it is overall
productivity that is important.
3. Develop methods for achieving productivity improvements
4. Establish reasonable goals for improvement.
5. Make it clear that management supports and encourage productivity improvement.
6. Measure improvements, and publicize then

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