4.1.

Production of Goods and Services

4.1.1 THE MEANING OF PRODUCTION

Learning Outcomes:
• Managing resources effectively to produce goods and services.
• Differences between production and productivity.
• Benefits of increasing efficiency and how to increase it, e.g. increasing productivity by automation and
technology, improved labor skills.
• Why businesses hold inventories.
• The concept of lean production: how to achieve it, e.g. just-in-time inventory control and Kaizen; benefits of
lean production.

MANAGING RESOURCES EFFECTIVELY TO PRODUCE GOODS AND SERVICES

Production refer to business processes that transform business inputs or factors of production (land,
labor, and capital) into goods and services to be sold to customers (e.g. clothes, phones).
Operations management is the managing of resources throughout the production processes in order
to produce finished goods and services to be sold to customers or other businesses.
Operations management needs to:

• Use resources in the most cost-effective way

• Produced the required quality and quantity of output that meets consumer demand
The input-output model of operations suggests that all finished goods and services (outputs) are
processed from factors of production (inputs).

Figure 4.1.1: Input-Output Model

Factors of Finished Goods

INPUT Production OUTPUT and Services
Production

For example, the manager of a cake shop will hire a baker (labor) who will use ingredients such as
flour (land) and mixers and ovens (capital) to make cakes (output) to be sold customers at the shop.

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DIFFERENCE BETWEEN PRODUCTION AND PRODUCTIVITY
Production measures the total amount or value of output produced over a period of time.
Productivity measures the total amount of output produced in comparison to the amount of input
used. It measures the efficiency of production.
𝑡𝑜𝑡𝑎𝑙 𝑜𝑢𝑡𝑝𝑢𝑡
𝐿𝑎𝑏𝑜𝑢𝑟 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑣𝑖𝑡𝑦 =
𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑤𝑜𝑟𝑘𝑒𝑟𝑠

If production increases, the productivity may not necessarily increase.

Example 4.1.1: Ben’s Coffee Shop

Ben owns a coffee shop. He buys coffee beans from Colombia and coffee-brewing
machines from Germany. He then hires two baristas to use the brewing machines and
buys coffee beans to make coffee. The shop sells about 500 cups of coffee per day.
In the example above, production refers to the process of combining coffee beans, the brewing machines,
and the baristas to make coffee. It is measured by 500 cups of coffee sold in a day.
However, productivity refers to how much coffee each barista can brew per worker. Since Ben hired two
baristas, the productivity of the shop is 250 cups of coffee per worker.

Assume Ben hires another barista and the shop can now sell 600 cups of coffee in a day.
Clearly, the production has increased from 500 to 600 cups per day. However, the productivity decreased
from 250 down to just 200 cups per worker.
This suggests that an increase in production does not mean that productivity will increase.

Exercise 4.1.1: Gracious Garments

Gracious Garments manufactures hand-knitted sweaters using recycled material. Due to growing concern for
climate change, demand for Gracious Garments’ sweaters had increased every year. In response, the
company steadily increased the number of workers it employs. The owner, Grace, thinks this is good for the
business as output increased.
(a) Do you agree with Grace? Use the information in the table below to justify your answer. [2]
__________________________________________________________________________________
__________________________________________________________________________________
Year Output Number of workers Output per worker
2017 5,000 100
2018 6,000 120
2019 6,400 160

(b) Suggest one way how Grace could increase the productivity of Gracious Garments. [2]
Way: ______________________________________________________________
Explanation:
___________________________________________________________________________________________
___________________________________________________________________________________________

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BENEFITS OF INCREASING PRODUCTIVITY/EFFICIENCY AND HOW TO INCREASE IT
Businesses will aim to improve their productivity/efficiency as this way they can benefit from:

• lower average costs due to less inputs used

• fewer workers are needed hence lower wage costs
• greater profitability due to higher output
• less waste
• fewer production error/defected products
They can do so by either (1) increase output without increasing the number of workers or (2) keeping
output the same but with less workers.

Improve employee
motivation: workers
are encouraged to
work longer hours
to increase output

Implement lean Introduce new

production Ways to technology:
methods: JIT automation will
inventory control
Increase produce much
helps to reduce Productivity faster than manual
input wastage. labour.

Provide staff
training: so that
they may possess
the necessary skills
to produce more
using less input.

WHY BUSINESSES HOLD INVENTORIES

Have you ever been to a store to find that they ran out of what you wanted to buy? If yes, then that
store you’ve been to had stocked out. Stocking out can have adverse consequences to businesses such
as:
• loss of customer loyalty: customers may switch to buying from other competitors
• loss of profit: businesses lose the revenue that it would have gained if it had enough stock
Businesses hold inventory to avoid the risk of stocking out, especially during peak seasons.
When inventory level falls to the reorder point, new inventory will be ordered to bring inventory levels
back up to the maximum level. After placing the order, businesses must allow time for the new
inventory to be delivered (lead time). Inventory level should never fall below the minimum level, also
known as the buffer inventory level, as this is needed to deal with unexpected demand.

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THE CONCEPT OF LEAN PRODUCTION
Lean production involves a variety of production techniques used by businesses to reduce waste and
therefore improve its productive efficiency. It aims to remove activities from the production process
that do not add value for the customer.
Waste in the production process may include:
• Waiting Time (such as waiting for the next stage of production or for raw material).
• Defected Products (defective products that need to be reworked).
• Excess Inventory (when too much raw material was purchased and stored).
• Overproduction (making more than is needed, leading to excess finished stocks).
• Energy (such as leaving lights or air conditioning on when they are not needed).
• Talents (skills and talents of workers not used optimally).

Benefits of lean production include:

• Cost saving from less storage space needed

• Quicker production of goods and services
• More efficient use of production assets
• Improves cash flow as products are quickly produced and sold
• Motivate employees as they play an important role in reducing waste in the production
process
Methods of lean production include:

• Just-in-time Inventory Control (JIT): a production method that focuses on eliminating the
need to hold inventories as they are ordered and used just when they are needed. This helps
to reduce storage costs as warehouse space is not needed. However, in order to work, JIT will
heavily depend on reliable suppliers and an efficient system of ordering supplies.
• Kaizen: Japanese term for ‘continuous improvement’ and is focused on workers collaborating
regularly with the aim to reduce waste. This is efficient as it does not require any technology
and no one understands the production problems more than the workers do. An example of
Kaizen is by reorganizing the factory floor so that it takes less time for workers to move
between jobs, allowing for a smoother and quicker flow of production.

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Practice Exam Questions
Halitec manufactures computers using flow production. There are many other computer
manufacturers, but Halitec has a high market share. The business is well-known for the quality of
its products. It spends a lot of money on quality control. Labour productivity is low and some
machines are old. Halitec does not do any market research.

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4.1.2 THE MAIN METHODS OF PRODUCTION

Learning Outcomes:
• Features, benefits, and limitations of job, batch, and flow production.
• Recommend and justify an appropriate production method for a given situation.

JOB/CUSTOMIZED PRODUCTION
Job production, also known as customized production, is the production of a special “one-off”
product made to a specific order (e.g. personalized wedding cakes). It is normally associated with the
high-end market where emphasis is on quality and exclusivity, thereby allowing the producer to
charge premium prices. It requires careful planning and clear objectives, requiring longer
development phases of the product life cycle.
Advantages Disadvantages
• Higher mark-up, since quality is perceived to be • Production method can be expensive, requiring
better, leading to greater sales revenue. skilled workers and non-standard materials.
• Customer loyalty as customers receive the • Time consuming since production format is
customized design that they want. highly unique which requires more time to
• Production method would likely motivate produce compared to other production
skilled workers as it requires skillful methods.
adaptations. • Low volume production as production is one-
• Can be a flexible production method, as orders off, thereby unlikely to benefit from economies
are uniquely geared towards each individual of scale.
customer’s preferences. • Can be labor intensive and heavily reliant on
skilled workers, driving up labor costs.

BATCH PRODUCTION
Batch production is the production of a group of identical products together (e.g. baking a batch of
cookies). Each batch gets worked on in each stage of the production before moving on to the next.
Batch production emphasizes quality and affordability. Products are market-oriented; customers are
offered customized product while at the same time with a range of standardized options. It requires
careful planning as production parts are interchangeable.
Advantages Disadvantages
• Businesses can achieve economies of scale • Incur changeover costs as machine takes time
(such as bulk buying or pooling resources). to be converted from producing one product to
• Allows customers more choice, thereby another.
capturing more market share. • May need to hold large stocks in case of
• Separate groups of products can be worked on unexpected orders, leading to greater holding
which is useful if different types of products costs.
need to be produced. • Sizes of batches are dependent on the capacity
• May help deal with unexpected orders, of machinery or labor allocated to them. If not
especially unforeseeable sales during peak enough machinery or labor is available, this
seasons. method may not be feasible.

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FLOW PRODUCTION
Flow production refers to the high volume production of standardized products that are continuously
being worked on along an assembly line (e.g. toy factory). Additional features are added to the product
at each stage of production until it reaches its final state. Labor is relatively unskilled and employed
mainly for quality control or robotic functions; thus the process is often automated for increased
reliability and efficiency. The end product is often sold to the low-end market in large quantities. Mass
production requires careful planning in order to synchronize all stages of the production process.
Advantages Disadvantages
• Once set up, it needs little maintenance so is • High set up costs due to initial capital
cost saving for the business. expenditure on machinery and equipment.
• Economies of scale, as this method can cater for • Costly breakdowns when entire assembly stops.
large orders. • Highly dependent on steady demand from a
• Labor costs may be low as little skill is required, large segment of the market.
automation allow workers to be replaceable. • Work is repetitive and can be demotivating.
• Can respond to increase in orders very quickly • Higher holding and storage costs as this
once set up, hence reducing lead time in production method relies on large volume
delivery. orders.

CHOOSING AN APPROPRIATE METHOD OF PRODUCTION

There is no one correct method as the most appropriate method varies from business to business. It
depends on factors including but not limited to:

• The target market

• State of existing technology
• Availability of resources and capital
• Government regulations
Combining production methods can be a less costly way to improve on the business as integrating the
advantages of each production model can increase efficiency. This way a business may take advantage
of economies of scale from mass produced products while at the same time satisfying demand for
more exclusive customized products.

Exercise 4.1.2
Clarendon Fashion manufactures women’s clothing. Its large factory is divided into three areas,
each of which uses different methods of production. The company’s main customers are:
• A large fashion retailer with many outlets in Country Y
• Small independent clothing retailers in Country Y
• A bespoke service for wedding dresses, which are designed and then produced by the
company’s designers following a meeting with the customer.

What do you think is the most appropriate method of production for each of Clarendon Fashion’s
main markets?
_________________________________________________________________________________
_________________________________________________________________________________
_________________________________________________________________________________

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4.1.3 HOW TECHNOLOGY HAS CHANGED PRODUCTION METHODS
Technology has revolutionized modern forms of production. These new methods retain the
advantages of traditional ones while at the same time avoid their flaws.
Computer-aided-design (CAD) for example allows businesses to design and display 3D projections of
their products on computer screens. Businesses can also test features of the product (e.g. quality
checks) using special software. This helps the business save a significant amount of money as they
no longer have to build and rebuild expensive prototypes.
After the product has been designed and tested, it can be produced with the help of computer-aided
manufacturing (CAM), where computers control the machinery and equipment used in the
production process. As CAM is more capital intensive, it reduces the need for labor and therefore
helps businesses reduce their labor costs.
Technology has also changed the way services are provided. Many retailers allow customers to use
credit cards, Apple Pay, and other forms of electronic payments instead of cash.
Advantages Disadvantages
Businesses • Economies of scale • Expensive to purchase
• Less time to design new products • Need to train employees
• Greater productivity • Needs to be changed constantly to
• Improves quality remain competitive
Consumer • Lower prices • Hacking of personal information
• Better quality products • May become outdated quickly
Workers • Technology can complete repetitive • Technology makes workers
tasks that workers find boring redundant
• Allows workers to be more • Smaller workforce reduces
productive at work opportunity for promotion

Master Your Definitions

Production: business processes that transform business inputs or factors of production (land, labor, and capital) into
goods and services to be sold to customers (e.g. clothes, phones).

Operations Management: the managing of resources throughout the production processes in order to produce finished
goods and services in a cost-effective way that satisfies customers’ demands.

Production: measures the total amount or value of output produced over a period of time.

Productivity: measures the total amount of output produced in comparison to the amount of input used.

Lean production: production techniques used by businesses to reduce waste and therefore improve its productive
efficiency.

Just-in-time Inventory Control (JIT): a production method that focuses on eliminating the need to hold inventories as
they are ordered and used just when they are needed.

Kaizen: Japanese term for ‘continuous improvement’ and is focused on workers collaborating regularly with the aim to
reduce waste.

Job production: the production of a special “one-off” product made to a specific order.

Batch production: the production of a group of identical products together through each stage of production.

Flow production: the high-volume production of standardized products that are continuously being worked on along an
assembly line. Additional features are added at each stage until it reaches its final state.