Operations management is the process that uses the resources of an organisation to provide the right goods or services for the customer.
Issues that are all aspects of operational management:
Location, the mix of resources in production (labour, land, enterprise and capital), managing capacity utilisation, stock control, quality, customer service, working with suppliers to improve efficiency and using technology.
Operational Targets
Operational targets are the goals or aims of the operations function of the business.
These may be set in terms of:
1. Improvement in unit costs
Measured by reduction in costs, potentially leading to increased profits
2. Improvement in quality
Measured by a reduction in wastage, decrease in level of complaints etc.
3. Increased capacity utilisation
Measured by an increase in actual output as a percentage of maximum possible output.
Unit Costs
The unit cost is the cost of producing 1 unit of output. It is calculated by the formula:
Unit Cost = Total Cost
Units of Output
Example: What is the average or unit cost of a firm that produces 6,000 units of output at a total cost of £27,600?
Answer: £4.60 (27,600 / 6,000)
- The unit cost is also known as the average cost (AC) or average total cost (ATC).
- Normally, the higher the units of output, the lower the unit cost.
- To measure efficiency, the company could compare its unit costs with those of its competitors. The business with the lowest unit costs will be the most efficient, in this type of measure.
- The higher the labour productivity, the lower the wage costs per unit
Measures of Quality
Quality is defined as 'those features of a product or service that allow it to satisfy (or delight) customers'.
Examples of different measures of quality:
- Customer satisfaction ratings - (e.g. 1 to 10 or 'excellent' 'good' or 'poor')
- Customer complaints - This calculates the number of customers who complain (it is sometimes measured as a percentage of the total number of customers).
- Scrap rate - This calculates the number of items rejected during the production process as a percentage of the number of units produced.
- Punctuality - This calculates the degree to which a business delivers its products (or provides its services) ON TIME.
Total Deliveries x 100
Capacity Utilisation
Capacity: The maximum total level of output or production that a business can produce in a given time period. A company producing at this level is said to be producing at full capacity.
Capacity Utilisation: The percentage of a firm's total possible production level that is being reached. If a company is large enough to produce 100 units a week, but is actually producing 92 units, its capacity utilisation is 92%.
Spare capacity (or under-utilisation) is when a firm's output is below the maximum possible. Thus, a company on 90% capacity utilisation has a spare capacity of 10%.
Many people believe that 90% capacity utilisation is a sensible level. At 100% there is no scope for maintenance and repair, to respond to sudden orders or to deal with emergency situations that my occur.
Every percentage point below 100 represents 'unused' resources and higher fixed costs per unit produced.
Links between capacity utilisation and other operational targets
Capacity utilisation and unit costs
- The higher the level of capacity utilisation, the more efficient.
- This is because fixed costs are spread over a larger output.
- Therefore unit costs are lowered
- The company is more profitable or more able to lower prices to attract demand.
Capacity Utilisation and Quality
- At high levels of capacity utilisation there is a possibility that quality will DECREASE (an even greater problem if quality is the firm's USP!)
- There is no scope for maintenance work or ensuring staff are not overworked.
- At low levels of capacity utilisation, quality may also decrease due to demoralised workers (bored)
Spare Capacity
Under-utilisation of capacity: When a firm's output is below the maximum possible. Also known as spare capacity or excess capacity. It represents a waste of resources and means that the organisation is spending unnecessarily on its fixed assets.
Disadvantages of Spare Capacity
- Higher proportion of fixed costs per unit - Utilisation falls, fixed costs must be spread over fewer units of output --> Leads to higher unit costs.
- Higher unit costs lead to lower profit levels or need to increase price to maintain the same profit levels --> To lower sales volume.
- Spare capacity can portray a negative image of a firm - Suggests it is unsuccessful, e.g. club with low utilisation can be physically seen --> Put customers off --> Lower sales
- Employees bored and demoralised - Due to less work to do --> Lowering motivation and efficiency. Problem is permanent --> Workers are worried about loosing their jobs.
- More time for maintenance and repair of machinery, for training and improving existing systems. Can use time to improve set up and improve skills. better prepared for an increase in trade.
- Less pressure and stress for employees --> Who may become overworked at full capacity.
- Can cope with sudden increase in demand --> Businesses in expanding markets will increase their capacity beforehand, so their sales are not limited by size of factory/shop.
A firm may use calculations of spare capacity to see the maximum possible sales that it could achieve before it needs to extend its capacity.
Maximum Capacity = Maximum Sales Revenue
Current Capacity Level Current Sales Revenue
e.g. 100% = £x
80% £12m
so x = ((100 x £12m) / 80) = £15 million
Demand
If the business has spare capacity, it may improve its marketing mix in order to increase demand.
e.g. McDonalds increased their product range (McCafe)
But some may have the problem of a capacity shortage.
e.g. High demand for concert tickets.
Solution: Increase selling price --> Reduces demand to a reasonable level and maximises sales revenue.
Supply
If the business has spare capacity, it may follow a policy of rationalisation in order to reduce its capacity and save unnecessary expenditure.
Rationalisation: A process by which a firm improves its efficiency by cutting the scale of its operations.
e.g. reducing its maximum level of output from 200 units to 100 units.
Woolworths reduced the size of many of its stores.
Subcontracting
Subcontracting is when an organisation asks another business to make all or a part of its product.
Subcontracting can be used to reduce capacity utilisation problems. Subcontractors can be asked to supply products to match demand without increasing its own factory.
Similarly it can reduce supply to match a fall in demand by reducing the work it subcontracts without making changes to its own factory size.
Advantages:
- Flexibility to react to changes
- Subcontractors are more specialised and efficient
- Allows the firm to focus on its core business and avoid being involved in areas where it is less competent.
- The subcontractor can deal with non-standard orders, benefitting the business, but without disrupting normal business.
- Quality is no longer under their own control - this may affect the reputation of the company.
- Excessive subcontracting erodes a company's operations base and its ability to initiate and make changes.
- Opportunity cost of subcontracting - would it be cheaper/more profitable to produce in-house? As the producer wants to also make a profit....
- Subcontracting may require a firm to give confidential information away. e.g. to a supplier such as details of methods of patents.
Stock Control
Stock control: The management of levels of raw materials, work in progress and finished goods in order to reduce storage costs while still meeting the demands of the customer.
The ideal stock level
- Low stock levels are ideal if - Rent is high in the area, if it is a perishable good and if it suffers cash-flow problems
- High stock levels are ideal if - The business gains large cost savings by bulk buying a product or the product has unpredictable peaks in demand.
Dealing with Non-standard orders
Non-standard orders - a business decision related to a one-off contract. Usually, the non-standard order requires a response to a request to supply a fixed quantity of a product at a particular price (invariably a lower price than usual).
The key operational factors of non-standard orders:
1. Capacity and its effect on production
- If there is plenty of spare capacity --> The non-standard order may improve efficiency as the firm will be producing closer to full capacity.
If the firm is close to full capacity (or the non-standard order is large and will take the firm beyond its capacity), it may prevent other, more profitable orders from being accepted.
2. The flexibility of capacity in the organisation
If a business subcontracts a large amount of its production, it can adapt readily to non-standard orders.
But if the business relies on its own production, then non-standard orders will present more problems.
3. Impact on costs
Terms of an order may require additional spending on fixed costs in order to meet the specific requirement of the new customer.
Unless the business has plenty of under-used resources, likely to increase variable cost per unit e.g. from paying overtime to staff or purchasing new components.
4. Is there potential for future (profitable) orders?
Although the non-standard order may make a loss, it can build up a relationship with a newer customer.
A satisfied customer may return in the future with many large, profitable orders.
5. Effect on staff
If the workers are under pressure, a non-standard order may add stress and pressures on the workforce.
If the workforce is feeling insecure due to lack of orders, a non-standard order can prevent redundancies, boost morale and productivity.
The nature of the non-standard order may increase variety and interest among the workforce (or add to boredom and monotony).
