05/23/2024 By: Ashenafi D.

1
 Chapter One
Introduction to production and Operations
Management

Introduction POM
Why study POM
The Scope of Operations Management
Differentiating features of Operations Management
Operations management and decision making
The Historical evolution of Operations Management
Trends in business
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 Introduction
• Operations is part of a business organization that is
responsible for producing goods and/or services.

• Goods: Physical items produced by business organizations.

• Services: Activities that provide some combination of time,
location, form, and psychological value.

Every book you read, every video you watch, every e-mail or text
message you send, every telephone conversation you have,
and every medical treatment you receive involves the
operations function of one or more organizations.

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 …cont’d
• Production and operations management (POM) is the
management of an organization’s production system.

• A production system takes inputs and converts them into

outputs.

• The conversion process is the predominant activity of a

production system.

• The primary concern of an operations manager is the activities

of the conversion process.

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 Organizational Model
• . Finance
Sales HRM

POM
QA
Marketing

MIS
Engineering Accounting

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 ….cont’d
• The three basic functions of business organizations

Working together successfully means that

all members of the organization understand
not only their own role, but they also
understand the roles of others.

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 Three Major Functions
• Every business is managed through three major functions:
finance, marketing, and operations management.

• Operations is at the heart and all the other functions are support
functions
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 ….cont’d
• Operations and supply chains are intrinsically linked, and no
business organization could exist without both.

• A supply chain is the sequence of organizations—their

facilities, functions, and activities—that are involved in
producing and delivering a product or service.

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05/23/2024 By: Ashenafi D. 9
 ….cont’d
• 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
processes (e.g., storing, transporting, repairing).

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 ….cont’d
• The essence of the operations function is to add value during
the transformation process

• Value-added describe the difference between the cost of

inputs and the value or price of outputs.

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 Operations as a System

Requirements

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Examples of inputs, transformation, and outputs

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 ….cont’d
.

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 Transformation Process
What is a transformation process?
– a series of activities along a value chain extending from supplier to
customer.
• activities that do not add value are superfluous and should be
eliminated
• OM tries to ensure that the transformation process is performed
efficiently and that the out put is of greater value than the sum of
inputs.
– Thus, the role of operations is value creation throughout the supply chain.
• Supply chain - a sequence of activities and organizations involved
in producing and delivering a good or service
Transformation Process can take the form of :
– Physical: as in manufacturing operations
– Locational: as in transportation operations
– Exchange: as in retail operations
– Physiological: as in health care
– Psychological: as in entertainment
– Informational: as in communication
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 Operations Management

“Operations management: The management of systems or

processes that create goods and/or provide services.”

 The set of interrelated management activities, which are

involved in manufacturing certain products, is called
Production Management.

 If the same concept is extended to services management,

then the corresponding set of management activities is called
as Operations Management.

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 Why study POM
There are number of good reasons to study it.
1. Operations management activities are at the core of all business
organizations, this is because every aspect of business affects or is
affected by operations.
2. 50% of the jobs are in operations management-related areas- such as
customer service, quality assurance, production planning, scheduling,
job design etc.
3. Activities in all of the other areas of business organizations, such as
finance, accounting, human resources, logistics, management
information systems, marketing, purchasing as well as others are all
interrelated with operations management activities.

So it is essential for people who work in these areas to have a basic

understanding of operations management.
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 …cont’d
.

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 …cont’d
• Operations interacts with other functional areas of the
organization:

• The legal department must be consulted on contracts with

employees, customers, suppliers, and transporters, as well as on
liability and environmental issues.
• Accounting supplies information to management on costs of labor,
materials, and overhead, and may provide reports on items such as
scrap, downtime, and inventories.
• Management information systems (MIS) is concerned with
providing management with the information it needs to effectively
manage. MIS is also important for managing the control and
decision-making tools used in operations management.

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 ….cont’d
• The personnel or human resources department is concerned
with recruitment and training of personnel, labor relations,
contract negotiations, wage and salary administration, assisting
in manpower projections, and ensuring the health and safety of
employees.

• Public relations has responsibility for building and maintaining a

positive public image of the organization. Good public relations
provides many potential benefits.

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 The Scope of Operations Management
• The scope of operations management ranges across the
organization.

• Operations management people are involved in product and

service design, process selection, selection and management of
technology, design of work systems, location planning, facilities
planning, and quality improvement of the organization’s
products or services.

• The operations function includes many interrelated activities,

such as forecasting, capacity planning, scheduling, managing
inventories, assuring quality, motivating employees, deciding
where to locate facilities, and more.
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 OPERATIONS MANAGEMENT AND DECISION MAKING
• The chief role of an operations manager is that of
planner/decision maker.
• Most decisions involve many possible alternatives that can
have quite different impacts on costs or profits.
• Operations management professionals make a number of key
decisions that affect the entire organization. These include the
following:
What
When
Where
How
Who
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 ….cont’d
1. Strategic Decisions: These decisions are of strategic
importance and have long-term significance for the
organization.

Examples include deciding:

– the design for a new product’s production process
– where to locate a new factory
– whether to launch a new-product development plan

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 ….cont’d
2. Operating Decisions: These decisions are necessary if the
ongoing production of goods and services is to satisfy market
demands and provide profits.

Examples include deciding:

– how much finished-goods inventory to carry
– the amount of overtime to use next week
– the details for purchasing raw material next month

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 ….cont’d
3. Control Decisions: These decisions concern the day-to-day
activities of workers, quality of products and services,
production and overhead costs, and machine maintenance.

Examples include deciding:

– labor cost standards for a new product
– frequency of preventive maintenance
– new quality control acceptance criteria

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 Trends in Business /Operations Today
• Advances in information technology and global competition have
had a major influence on operations management.

• Business must constantly monitor new trends and take them into
account in their strategies and operations management.

1)The internet and e-business

• E-business: Use of the Internet to transact business.
• E-commerce: Consumer-to business transactions such as buying
online or requesting information.

2) Supply Chain Management

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 …cont’d
Continuing Trends: A number of continuing trends influence business
and operations management.
• Quality and process improvement:
• Technology: Technological advances have lead to a vast array of
new products and processes.
• Globalization: Globalization competition, global markets, global
supply chains and international operations are having a growing
impact on the strategies and operations of businesses large and
small around the world.
• Operations Strategy: Now more and more companies are
recognizing the importance of operations strategy on the overall
success of their business as well as the necessity for relating it to
their overall business strategy.
• Environmental Issues: Pollution control and waste disposal are key
issues managers must contend with.
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 ….cont’d
• Corporate Downsizing: operations managers often have to find
ways to produce more with fewer workers.
. Lean Production: This is a system that uses minimal amount of
resources to produce a high volume of high-quality goods with
some variety.
• Six sigma: A process for reducing costs, improving quality, and
increasing customer satisfaction.
• Agility :The ability of an organization to respond quickly to
demands or opportunities.

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 Manufacturing versus service operations
• Organizations can be classified in two broad categories as either
manufacturing or service.
• Manufacturing organizations produce physical, tangible items
which can be stored as inventory before delivery to the customer.
• Service organizations produce intangible items that cannot be
produced ahead of time.
• One of the key developments in operation management is the
increasing importance of service operations as service industry
accounts for an increasing proportion of the output of
industrialized economies.
• Manufacturing operations: converts input like materials, labor &
capital into some tangible outputs. The objective of each process
is to change the shape or physical characteristics of the raw-
materials or inputs
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 Cont…d

• Service operations: Non-manufacturing or service operations also

transform a set of inputs into a set of outputs, but the outputs are
not tangible. Features intangibility non inventor ability customer
involvement controlled flexibility.
• Intangibility is not tangible like the physical goods. It cannot be seen
physically, but it can be felt.
• Non-inventoried as opposed to physical goods services is not
inventoried, because a service is produced and consumed
simultaneously.
• In this sense a service does not exist, however the result of service
last for some time.
• Customer involvement besides the quality aspects, the storage of
services also means that the customer may be directly involved in
operations, where the production and consumption takes place
simultaneously. So the service and the service provider both are
there with the customer.
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 Cont…d
• Classifications of services: classifications of
services brings tangible actions to peoples
bodies: ex: hair cutting, restaurant, health care
etc. tangible actions to peoples goods: ex:
laundry, repairing centers, tailor etc. intangible
actions directed to peoples mind: ex: training,
information services, broadcasting etc. intangible
actions directed to peoples intangible assets: ex:
banking, insurance & accounting etc. based on
tangible & intangible nature of services.
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 Characteristics of Goods
 Tangible product
 Consistent product
definition
 Production usually
separate from
consumption
 Can be inventoried
 Low customer interaction
 Longer response time
 Capital intensive

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 Characteristics of Service
 Intangible product
 Produced and consumed at same
time
 Often unique
 High customer interaction
 Inconsistent product definition
 Often knowledge-based
 Frequently dispersed
 Shorter response time
 Labor intensive

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Two major dimensions: Degree of tangibility & Degree of customer contact

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 Similarities
• Despite many differences, there are a lot of similarities
between manufacturing & service operations.
• There is an interdependency of products & services, for ex:
customers want both good food as well as good service at a
restaurant.
• Again though service providers cannot inventoried their
outputs, but must have inventory of their inputs, for ex:
hospitals must maintain an adequate supply of medications,
nurses & doctors.
• While buying a car we not only buy a product but also a
guarantee. Hospital cares involves medication, bandages & x-
ray films & so on, so despite a lot of differences both product
& service are part of each other.
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 Cont…d

– Both use technology

– Both have quality, productivity, & response issues
– Both must forecast demand
– Both will have capacity, layout, and location issues
– Both have customers, suppliers, scheduling and
staffing issues
– Manufacturing often provides services
– Services often provides tangible goods

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 Operations Decision Making

 Decision making is analogous to a great stage play, in which all the

actors, the costumes, the music, the orchestra, and the script
must be choreographed and staged by the director, the stage
managers, the author, and the conductor so that everything
comes together for the performance.
The Decision Process in Operations
1. Clearly define the problems and the factors that influence it
2. Develop specific and measurable objectives
3. Develop a model
4. Evaluate each alternative solution
5. Select the best alternative
6. Implement the decision and set a timetable for completion

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 Decision analysis techniques

• 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.
• Decision analysis represents not only a collection of decision-
making techniques but also an analysis of logic underlying
decision making.
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 Decision-Making Environments
 Decision making under uncertainty
 Complete uncertainty as to which state of nature may occur
 Decision making under risk
 Several states of nature may occur
 Each has a probability of occurring
 Decision making under certainty
 State of nature is known
Decision analysis without probabilities/ uncertainty
 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
05/23/2024 form shown in Table 1 By: Ashenafi D. 39
 State of nature
Decisions a b
1 Payoff 1a Payoff 1b
2 Payoff 2a Payoff 2b

 Each decision, 1 or 2, in the table 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).
 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
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by the following example.
By: Ashenafi D. 40
 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.

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 State of nature
Decision Good competitive condition Poor competitive condition
Expand $ 800,000 $ 500,000
Maintain status quo 1,300,000 -150,000
Sell now 320,000 320, 000
Determine the best decision using each of the decision criteria.
1.Maximax 2.Maximin3.Minimax regret 4.Hurwicz 5. Equal likelihood
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:
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 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:
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Expand By: Ashenafi D. 43
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:
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980,000 Decision: Expand
By: Ashenafi D. 44
4. Hurwicz
• 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
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5. Equal Likelihood
• The equal likelihood 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.
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• 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 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.
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 Decision making with probabilities/ under risk
• 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.
• This happens when it is possible for the decision maker to know
enough about the future states of nature to assign probabilities
that each will occur.
• 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:
EV(x) =
• Where
p (xi) = probability of outcome i
Xi = outcome i
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• 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.
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 Using Decision Trees for Decision Making
 A decision tree is a graphic display of the decision process that
indicates decision alternatives, states of nature and their respective
probabilities, and payoffs for each combination of decision alternative
and state of nature
 Information in decision tables can be displayed as decision trees
 Appropriate for showing sequential decisions
Fundamentals of Decision Making
1. Terms:
a. Alternative – a course of action or strategy that may be chosen by
the decision maker
b. State of nature – an occurrence or a situation over which the
decision maker has little or no control
2. Symbols used in a decision tree:
a. – decision node from which one of several alternatives may be
selected
b. – a state-of-nature node out of which one state of nature will
occur
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 Decision Tree Example

A decision node A state of nature node

Favorable market

ru ct Unfavorable market
on st lant
C ep
larg Favorable market
Construct
small plant

Do Unfavorable market
no
th ing

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 Steps in Decision Trees
1. Define the problem
2. Structure or draw the decision tree
3. Assign probabilities to the states of nature
4. Estimate payoffs for each possible combination of
decision alternatives and states of nature
5. Solve the problem by working backward through
the tree computing the EMV for each state-of-
nature node

05/23/2024 By: Ashenafi D. 52

 Decision Tree Example
EMV for node 1
= $710,000 = (.7)($800,000) + (.3)($500,000)

Payoffs
Favorable market (.7)
$800,000
1
Unfavorable market (.3)
a nd $500,000
exp EMV for node 2 Favorable market (.7)
= $865,000 $1,300,000
Status = (.7)($1,300,000) + (.3)(-$150,000)
2
Unfavorable market (.3)
quo -$150,000
se Favorable market (.7)
ll $320,000
3
Unfavorable market (.3)
$320,000
EMV for node 3 = (.7)($320,000)+(.3)($320,000)
= $320,000
05/23/2024 By: Ashenafi D. 53
 Complex
Decision
Tree
Example

05/23/2024 By: Ashenafi D. 54

 Decision Trees in Ethical Decision
Making

 Maximize shareholder value and behave

ethically
 Technique can be applied to any action a
company contemplates

05/23/2024 By: Ashenafi D. 55

 Decision Trees in Ethical Decision
Making
Action outcome
Yes Do it
Is it ethical? (Weigh the
affect on employees,
customers, suppliers,
Yes community verses
shareholder benefit) No Don’t
Does action do it
maximize
Yes company
returns? Don’t do
Is this Yes
action Is it ethical not to take it
legal? No action? (Weigh the harm to
shareholders verses
benefits to other Do it,
No but notify
stakeholders) No appropriate
parties

Don’t do
it
05/23/2024 By: Ashenafi D. 56
Exercise on Decision Making Under Risk
States of Nature
Favorable Unfavorable
Alternatives Market Market
Construct large plant (A1) $200,000 -$180,000
Construct small plant (A2) $100,000 -$90,000
Do nothing (A3) $0 $0
Probabilities 0.2 0.8

1.Find the expected monetary value for this question

and make a decision.
2. Find the expected monetary value for this question
and make a decision.(using decision trees method
 Effectiveness

• Measures what the system sets out to

accomplish (objective) with what was actually
accomplished; plan vs. actual
• Hence, effectiveness is an output measure. (Is
the output “right” - right quality, right quantity,
on time, etc.)