Revision Notes: Module 4

Operations and Project Management

Compiled by: Sohail B. Ansari (0321-6828888)

Operations and Project Management

The nature of operations
Operations management is an area of business that is concerned with the production of
good quality goods and services, and involves the responsibility of ensuring that
business operations are efficient and effective. It is the management of resources, the
distribution of goods and services to customers.
4.1.1. Inputs, outputs and the transformation process
The task of production and operations management is to manage the efforts and
activities of people, capital, and equipment resources in changing raw
materials into finished goods and services profitably and to do so it is essential to
set up a business. To start any new business proper business plan is required, regarding
the nature, location and finances of the business.
It is very essential to allocate the factors of production in the best efficient way to
guarantee the optimum output. Land, labour, capital and intellectual skills are to be
utilised effectively to transform inputs into desired output/outputs via most cost
effective method of production. A business having all its operations managed properly
experiences high level of productivity.
To assure the survival and profitability of the business, decisions are to be made in the
best efficient way and always in the benefit of the business. Production decisions are to
be efficient and most cost effective to take the first step towards the optimum profit of
the business. The most important aspects of controlling production activity are stock
management and quality control (TQM).
Value added is defined as the difference between selling price and cost price of the good.
A cost effective production method along with a successful marketing campaign increases
this difference. As, value added is one of the business objects, it has to be properly linked
with the marketing strategy and operations of the business. Because marketing is always
aimed at developing a consumer panel by publicizing the product in such a way that it
establishes consumer confidence and catch their interests. This enables the business to
charge a higher price for its products and it is only possible when all the essentials of
marketing are well coordinated with each other and such a product is produced which
satisfy the consumers.

operations encompasses products and services

process: from idea/need to final product/service
resources: land, labour, capital (including intellectual capital)

Revision Notes: Module 4

Operations and Project Management
Compiled by: Sohail B. Ansari (0321-6828888)

4.1.2 Effectiveness, efficiency and productivity

difference between effectiveness and efficiency
productivity: measuring efficiency

Productivity: A tool used to measure the efficiency of the business i.e. how well
the resources are employed to derive the output. In simple terms
i.

Labour Productivity = Total output / Workers employed

Capital Productivity = Total Output / Amount of capital employed

4.1.3 Value added
how value added is linked to marketing, the operations process and
operations decisions
4.1.4 Capital versus labour intensity
benefits and limitations of capital and labour intensive processes
Capital Intensity and Labour Intensity
Capital intensity is the relative term used to describe a businesss nature when it has
employed large proportion of finances to complete the production process. Capital word
usually refers to the employment of mechanized resources in the line of production.
Benefits
i) per unit cost decreases,
ii) continuous production,
iii) minimal waste,
iv) economies of scale could be
implemented.

Limitations
i) high fixed cost,
ii) high maintenance cost,
iii) skilled labour required,
iv) breakdowns.

Labor intensity is the relative proportion of labor (compared to capital) used in a

process. The term "labour intensive" can be used when proposing the amount of work that
is assigned to each worker/employee, emphasizing on the skill involved in the respective
line of work.
Benefits
i) low capital,
ii) suitable for small businesses,
iii) workforce could be mobilize to apply
delegation.

Limitations
i) labour issues,
ii) more wastage,
iii) training.

Revision Notes: Module 4

Operations and Project Management
Compiled by: Sohail B. Ansari (0321-6828888)

Production Decision Making

Industrial Location: This is the decision that a business or an industry makes concerning
its geographical placing in a country. Wise location decisions could be important enough to
make a business survive and further lead to growth. There are many factors which
influence the precise location of a business or an industry, including:

The cost and the availability of land. Land in an urban area is clearly less abundant
(and therefore more expensive) than land in rural locations or on the edge of towns and
cities. Therefore it would be advisable, and also more feasible, for a business which
requires a large amount of land to locate away from the centre of an urban area.

The cost and the availability of labour. The unemployment rate varies in different
areas of the UK, and a business which is labour-intensive may choose to locate near to
an area of high unemployment in order to take advantage of the availability of labour
at a fairly low wage.

Communication links. Many businesses choose to locate near to motorways, rail

links, seaports or airports if they either have a significant amount of raw materials to
receive, or a significant number of products to distribute across a wide area of the
country.

Transport costs/proximity to the market. Some businesses will locate in certain

areas of the country in order to minimise their transportation costs. For example,
producers of fast-moving consumer goods (f.m.c.gs) will often have to distribute their
products nationwide, and therefore will try to locate as near to the market as possible
so their transportation costs are not excessively high.

Availability of raw materials. Some businesses will try to locate near to their
suppliers or to the source of their raw materials. For example, businesses which require
bulky raw materials, such as timber, will often try to locate near their suppliers so to
reduce the lead-time between ordering and receiving the raw materials.

Government location incentives. The UK government has over the past 30 years
offered a range of incentives to businesses to locate in depressed areas of the UK, in
order to reduce the unemployment rates in those areas by creating jobs. The incentives
(such as grants, tax breaks, and reduced rent and rates) are offered both to existing
businesses to relocate to the depressed areas, as well as to new businesses which are
about to set up.

Industrial inertia refers to the situation when a business or an industry decides to

remain in its original location and is very reluctant to relocate, even after the reasons for it
locating there in the first place are exhausted. Possible reasons for this include:
1. The cost of moving may be very large.
2. Strong links with the local community and with other local businesses may have
been developed and a move away from there may destroy those links.

Revision Notes: Module 4

Operations and Project Management
Compiled by: Sohail B. Ansari (0321-6828888)

3. Some areas and products have an international reputation which may be difficult to
establish if the business were to locate elsewhere (e.g. Scottish whisky).
However, industrial inertia can actually make an area become depressed if that area
depends on a particular industry or business for employment and wealth-creation. If the
industry goes into decline and no other industries or businesses wish to move to this area,
then mass unemployment is created, and many of these unemployed will not be trained to
perform any other jobs.
International location of industry is also a very important factor in today's global
business environment. As well as the reasons for location mentioned earlier, there are a
number of other factors that a business will need to consider before choosing a foreign
country in which to locate.
These factors include:

the language spoken

legal differences

the economic environment

the stability of the political structure.

Over the past 25 years, the UK government has encouraged much foreign investment into
the UK from outside Europe - specifically from Japan. These Japanese companies (e.g.
Nissan, Sony) create wealth for the UK by providing employment and income to workers,
and paying tax to the UK government. They can help to rejuvenate depressed areas and
often purchase their supplies and raw materials from other UK businesses.
The Japanese companies are enticed to locate in the UK through a number of
factors:
1. English is the first foreign language taught in Japan.
2. Low wage rates in the UK.
3. Government incentives to locate in the UK (e.g. cheap rent, rates, etc).
4. Gateway for selling goods to other EU countries.
Production Methods
There are four ways for manufacturing businesses to organise their production - job
production, batch production, flow production and cell production.
Job production: This method of production involves an item being manufactured entirely
by one worker or by a group of workers. This method is often used for producing
customised products for each customer.

Revision Notes: Module 4

Operations and Project Management
Compiled by: Sohail B. Ansari (0321-6828888)

These items are often made according to customer requirements, rather than being mass
produced. This type of production is usually undertaken by small businesses and craft
industries (e.g. carpenters), although larger businesses which specialise in 'one-off'
products (e.g. bridges) may also use this production method.
Advantages

Businesses having small capital are best suited to job production and during their
early phase, they usually apply job production,
Workers are motivated working under job production methods as they get a
chance to produce the whole product by them and take pride in it,
Specialisation could be achieved at individual or firm level,
Products meet up with consumers requirements.
May help in creating a good image of the business as each order is completed in
accordance with customers requirements.

Disadvantages

Expensive and time consuming as each product has to be completed first before
moving to the next product,
Most of the time, this method is labour intensive so labour issues are always to be
considered,
Skilled labour force is required.

Batch production: This method of production involves the manufacture of an item being
divided into a number of small tasks. A collection (or 'batch') of items each have one of
these tasks completed, and then the batch moves onto the next manufacturing task. In
other words, several items have the same task performed on each of them and then they
move onto the next task together in a group.
Advantages

This production method can result in the build-up of large amounts of stock. (This
may be a problem if the business is in a fashion industry, where customers' tastes
can change quickly and unpredictably, leaving the business with much stock that it
is unable to sell).
Allows division of labour to be applied thus shares the workload,
May lead to economies of scale in increase productivity.

Disadvantages

Could be boring and demotivating for the workers,

Factors of production like labour and machinery has to be readjusted in accordance
with every next batch,
May lead to high level of work-in-progress thus increasing the bound stock.

Revision Notes: Module 4

Operations and Project Management
Compiled by: Sohail B. Ansari (0321-6828888)

Flow production: This method of production involves the tasks which were identified in
'batch' production becoming continuous for each unit, often with the use of a moving
conveyor belt (e.g. a car assembly line or a electronic parts production line). Each unit is
produced individually, instead of being produced in batches. An example could be coca
cola, where large quantity is produced as its demand remain consistent.
This type of production is usually undertaken by large businesses. This method of
production was first established by Henry Ford in the 1920s, when he developed the
world's first automated production line. This involved each car passing the workers on a
moving conveyor belt, rather than the workers continually moving to the car. This method
should boost labour productivity and reduce average cost of production even further.
Advantaged

Labour cost tends to be low,

Whole production line could be
monitored easily at different stages.

Large number of output could be

produced as its a continuous method
Disadvantages
of production,
Quality is improved as it a capital
Huge capital is required for setup,
intensive
way
of
production
Skilled labour may be required,
(standardisation),
May alienate the workers due to its
Average cost decreases because of
repetitive nature of work,
economies of scale,

NOTE: It is often argued that flow production leads to high rates of alienation,
demotivation and absenteeism amongst the employees - it is for these reasons that much
machinery is today used on these production lines to perform simple, repetitive tasks
which humans may easily become bored in performing.
Cell production: This method of manufacturing an item organises workers into 'cells'
within the factory, with each cell comprising several workers who each possess different
skills. It was first started in USSR and its aim was to create motivation and friendly
competition. Each cell is independent of the other cells and will usually produce a
complete item, and each cell will usually have an output target to achieve for a given
period of time. Cellular production, being the full form is type of flow production. Coca cola
has different cells responsible for their line of production like sprite and mountain dew
(one line, two line production or more).
It is often argued that if the group of workers in each cell can see the completion of the
finished product, then their work will have more meaning and therefore their levels of
motivation and job satisfaction will be greatly enhanced.
Mass Production: Large scale production of similar or identical items. First pioneered by
Henry Ford, his production system for car manufacture led to substantial productivity
improvements. For example, HP can make a customised computer to suit every individual
clients specific needs in a matter of hours by changing just a few of the key components
and keeping the rest the same.
Research and Development (R&D)
All businesses need to develop long-term strategies, and an important part of this strategy
must be the continual development and launch of new products, or amendments made to
existing products. This is the purpose of research and development (R&D).
R&D can basically be defined as: 'carrying out extensive scientific research into the
product and its design, and then developing a range of prototypes, each to a
slightly different specification'.
The prototype which best meets the needs of the customers and the business is then likely
to be commercialised. The development of products can take several years to complete
and many businesses spend a huge amount of money on this process (e.g. Unilever spent
over 600 million on R&D in 1997). It can often be a very risky process, since much
money can be spent on ideas that will never be commercialised.
It is within the 'sunrise' industries (i.e. industries which are fairly young and have rapid
growth potential, such as computers and aerospace) that extensive R&D spending today
can result in a huge competitive advantage in the future. The benefit of being the first
company to launch a new, innovative product is immeasurable, since the company can
charge a high price and build up a strong market share as it faces no competition..

The businesses which are most likely to succeed in the future are those which develop
more new products than their closest rivals, bring their new products to the market in less
time than their rivals, compete in more product- and geographic-markets than their rivals,
and provide very strong after-sales service to customers.
Economies of scale
As a business grows in size and produces more units of output, then it will aim to
experience falling average costs of production (i.e. on average, each unit of output costs
less to produce). This is known as benefiting from economies of scale. In other words,
the business is becoming more efficient in its use of its inputs to produce a given level of
output.
Economies of scale can be divided into internal and external economies:
o

Internal economies of scale simply benefit a single business as it grows (i.e. its
average cost of production starts to fall).

External economies of scale, however, benefit all the businesses in a particular

industry (i.e. the average cost of production will fall for all the businesses in a
particular industry).

INTERNAL economies of scale fall into following main categories:

Technical: This refers to the fact that the use of automated equipment and
machinery to produce output is far more cost-effective than using labour, since the
machinery can be used 24 hours a day, with no breaks and with a constant level of
output per hour.

Purchasing: Larger businesses are more likely to be able to bulk-buy their supplies
and their raw materials, and therefore secure their supplies at a far lower cost per
unit than a smaller business.

Financial: Banks and other financial institutions are more likely to offer a lower rate
of interest on a loan repayment to a larger business than to a smaller business,
since the larger business represents less of a risk because it is more financially
secure.

Managerial: Larger businesses are more likely to be able to afford to employ

managers who are specialists in a particular field. These managers can therefore
devote all their time to specialising in one particular field (resulting in higher levels
of efficiency and hopefully falling average costs). Smaller businesses will often
employ managers who have to perform a variety of tasks and therefore cannot
specialise in a single area of the business.

Marketing: Mass marketing is done to carter a larger population with keeping

marketing budget minimal. Timing and duration of marketing has to be accurate to
make the campaign successful and most efficient. Marketing strategy is dependent

upon the size of the business and the marketing budget. Marketing decisions are
always taken in accordance with other departments of the business like; the
financial department.
EXTERNAL economies of scale fall into three main categories:

Labour. A large pool of available labour in a particular area of the country which
has been trained at a local college, or even at a rival business, will possess
specialised skills which will be useful to the whole industry, rather than simply to
just one business.

Joint ventures. Two or more businesses may decide to join forces (perhaps for
R&D) in order to spread the costs and the risks of developing a new product or
manufacturing process.

Support services. A wide range of commercial and support services often cluster
together in a certain area near a number of rival businesses (e.g. waste disposal,
cleaning, component suppliers, distribution, etc). Clearly this benefits all the
businesses in the area, rather than just one of them.

Dis-economies of scale
It is also possible that as a business grows in size and produces more units of output, then
it will actually experience rising average costs of production (i.e. on average, each unit of
output costs more to produce). This is known as experiencing diseconomies of scale. In
other words, the business is becoming less efficient in its use of its inputs to produce a
given level of output.
Diseconomies of scale can also be divided into internal and external economies:

Internal diseconomies of scale simply affect a single business as it grows (i.e. its
average cost of production starts to rise).

External diseconomies of scale, however, affect all the businesses in a particular

industry (i.e. the average cost of production will rise for all the businesses in a
particular industry).

INTERNAL diseconomies of scale fall into three main categories:

Communication. This refers to the fact that as a business grows in size, the
channels of communication lengthen and are more prone to delay and distortion.
This can result in inefficiency in terms of the time taken to perform a task and,
therefore, this can lead to higher costs.

Co-ordination. As a business grows in terms of the number of employees, the

number of departments and the number of different plants, then the overall coordination of all these can become very difficult. More and more meetings will be
required and this all costs both time and money.

Motivation. As the number of workers increases in a business, each worker will be

seen to be making only a very small contribution to the finished product. This can
result in falling levels of job satisfaction and motivation, which in turn can result in
falling levels of productivity and, therefore, higher costs.

EXTERNAL diseconomies of scale

External diseconomies of scale often result from the overcrowding of businesses in a
particular area and the resulting congestion, the late arrivals of supplies and raw
materials, the late deliveries of finished goods to customers or warehouses, and the late
arrival of employees to work. All these factors will affect all the businesses in a particular
area and therefore push up their costs of production and distribution.
Stock Management
STOCK CONTROL
Re-Order Levels: This is the minimum amount of stock that a business will hold before it
re-orders from its suppliers. The re-order level will vary from business to business and from
industry to industry.
For example: A supermarket is likely to have a higher re-order level than a car dealer,
since in the time taken to receive its supplies, a supermarket is likely to sell far more stock
than a car dealer.
Re-Order Quantities: The re-order quantity is the amount of stock and raw materials
that a business orders from its suppliers each time it reaches its re-order level. This again
will vary from business to business and from industry to industry.
For example: a business selling fast-moving consumer goods (e.g. chocolate bars or
baked beans) is likely to order a far larger amount of stock from its suppliers than a
manufacturer of goods with a slower stock turnover (e.g. televisions or washing
machines).
There are several factors which will influence the amount of stock which a business orders,
including:
1. Lead times (time taken to re-maintain minimum stock level).
2. The expected level of customer demand.
3. The costs of stockholding.
4. The type of stock, whether it is perishable or durable.

Buffer Stocks: This is the minimum stock level which will be held by a business to meet
any unexpected occurrences.
For example: A sudden large order from a customer, deliveries of raw materials not
arriving on time, or computer re-ordering systems breaking down.
Lead Times: This is the amount of time that elapses between a business placing an order
with a supplier for more stock or raw materials, and the delivery of the goods to the
business. The business will wish the lead-time to be as short as possible, so that it can
meet its customer orders and minimise the time between paying for the stock and
receiving the revenue from the customer. However, this may not happen due to a number
of factors, such as delays in the supplier receiving the order, or the breakdown of the
suppliers' lorries delivering the stock to the business.
STOCK ROTATION
Many businesses use a stock rotation system. This is the process of ensuring that the older
batches of stock are used first rather than the newer batches, in order to avoid the
possibility that the older stocks will become obsolete or go past their sell-by-date.
This is often referred to as a First in First out (F.I.F.O) system, to encourage the older
batches of stock to be used first, therefore avoiding the possibility that the older stock will
be left in a warehouse, possibly becoming unusable.
Link to Information Technology (C.A.D/C.A.M)
The production process and stock control systems in a business can be assisted by the use
of Information Technology (I.T).
Sophisticated software packages can enable a business to keep detailed and accurate
records on its purchases of stock and its sales to customers, using such systems as
Electronic Point of Sale (E.P.O.S).
This records every transaction made by a business and can, therefore, enable it to monitor
its stock levels and sales of products to a 100% level of accuracy. This system can
automatically re-order stock when numbers fall to a certain level in the warehouse, as well
as monitoring the quantity of each component that is used in the production process.
This enables a tight control to be kept on both costs and waste, as well as recording the
amount of revenue received from customers and any outstanding customer debts.
Computer Aided Design (C.A.D) is the use of sophisticated computer software to design
three-dimensional images of products quickly and relatively cheaply.

Computer Aided Manufacturing (CAM) is the use of computers and software for a wide
variety of production tasks, including automated production lines and stock control
systems.
Total Quality Management (T.Q.M)
Quality control is the process of checking the quality and the accuracy of raw materials
and supplies as they arrive at the business, and also of the finished products as they leave
the business en route to retailers and customers.
Total quality management refers to an attempt by a business to stop errors and waste
from occurring at all levels within the organisation, and to try to encourage all
employees to be most motivated and efficient make in their daily activities (whether in
production, marketing or personnel).
There are a number of components of T.Q.M:
1. Internal relationships between workers and their superiors and subordinates are
seen to be as important as the external relationships that exist between the
business and its customers and suppliers.
2. TQM must be seen to be a policy that is followed by, and has the commitment of, all
workers, from senior management to shop floor employees.
3. The business must monitor all its activities and processes in order to identify any
areas for improvement and to ensure that quality is being achieved.
4. Team-working is important, since a group of people working together will develop a
wider range of skills, co-operation, and higher motivation than if workers were
performing repetitive tasks on their own.
5. Regular market research must be undertaken to ensure that customers are happy
with the level of service that they receive (any complaints can be used to improve
the existing systems).
Quality Circles: This is a group of workers that meets at regular intervals during the
working week in order to identify any problems with quality within production, to consider
the alternative solutions to these problems, and to then recommend to management the
solution that they believe will be the most successful. The members of the quality circle
are also involved in the implementation and monitoring of the solution.

This should help to improve the level of motivation amongst the workers because it makes
each person in the group feel valued and that they are making a significant contribution to
the improvements on the factory-floor.

Zero Defects: This is the ultimate objective for a business, to produce every product
with no defects, therefore eliminating waste and the time taken to correct mistakes.
Zero defects can lead to an improved business and customer reputation, as well as
increasing levels of both sales and profitability. To assure that zero defects stage of
production is achieved, employees should always be committed and suitably trained. It
also requires that every employee is involved in the production activity at individual level
and this could only be possible when employees are motivated to their maximum.
Continuous Improvement (Kaizen)
Kaizen is a Japanese word which means 'change for the better'. A business will often be
facing increasing demands from customers to add new features to their products, as well
as facing pressures from their competitors who are producing new and improved products,
or offering improved after-sales service. The business will need to continually update and
improve their products and marketing, in order to stay ahead of their competitors and
boost revenue and profitability.
It is widely held that any aspect of the business can be improved, not just the production
processes and, as with zero defects, it is vital that every employee in the business is
involved in this philosophy, not simply those in the production department, but also those
in marketing, finance and personnel. Kaizen aims to eliminate waste, and reduce both the
time and the costs of production. It links in with other concepts such as TQM, quality
circles, productivity improvements and new product development.
Quality Standards
The British Standards Institution (BSI) is the body that is responsible for setting
quality and performance standards in UK industry.
The BSI 'kitemark' on a product implies to customers that it has been manufactured and
produced to a high level of quality, and will be fit for the purpose for which it was
advertised.
Quality assurance refers to the attempt to achieve customer satisfaction, by ensuring
that the business sets certain quality standards and publicises the fact that these
standards are met throughout the business.
British Standard 5750 (BS 5750) was the most common quality certification in the UK. It
is now known as ISO 9000, which is an international standard that tells customers that a
business has reached a required level of quality in its products and processes.
Quality of output is vital for retaining customer loyalty and, therefore, it is necessary for
quality to be an important consideration in the design, the production, the distribution, the
sale and the after-sales service of products.

Employee involvement and participation in quality programmes (e.g. quality circles and
suggestion-schemes) will serve two purposes:
1. Improve the overall quality of the output and processes.
2. Help motivate the workers by making them feel that their contributions and their
suggestions are highly valued.
Lean production is the term given to a range of measures traditionally used by Japanese
businesses in an attempt to reduce waste and costs in production. Lean production refers
to the theme of efficiency; it is a present-day instance of the larger recurring theme in
human life of increasing efficiency, decreasing waste, and using empirical methods to
decide what matters, rather than uncritically accepting pre-existing ideas of what matters.
Just-In-Time
This is a method of manufacturing products which aims to minimise:

the production time

the production costs

the amount of stock held in the factory.

Raw materials and supplies arrive at the factory as they are required, and consequently
there is very little stock sitting idle at any one time. Each stage of the production process
finishes just before the next stage is due to commence and therefore the lead-time is
significantly reduced.
With a just-in-time production system, the level of production is related to the demand for
the output (i.e. the number of orders) rather than simply producing finished goods and
waiting for orders. This means that raw materials and stock only needs to be ordered from
suppliers as required - this reduces the amount of money tied up in stocks, and leaves
more money available for investment elsewhere.
The advantages of a just-in-time production system are:
1. Cash flow is improved, as less money is tied up in raw materials, work-in-progress
and finished goods.
2. Less need for storage space for raw materials and finished goods.
3. The business builds up strong relationships with its suppliers.
4. Communication and co-operation between the marketing and the production
departments are improved.

The disadvantages of a just-in-time production system are:

1. The business may struggle to meet orders if their suppliers fail to deliver the raw
materials on time.
2. The business is unlikely to 'bulk-buy' its raw materials and, therefore, it may lose
the benefit of achieving economies of scale.
3. Buffer stocks are minimal and this may lead to the business having to reject
customer orders requiring delivery immediately.
Cell Production
This method of manufacturing an item organises workers into 'cells' within the factory,
with each cell comprising several workers who each possess different skills. Each cell is
independent of the other cells and will usually produce a complete item, and each cell
will usually have an output target to achieve for a given period of time.
It is often argued that if the group of workers in each cell can see the completion of the
finished product, then their work will have more meaning and therefore their levels of
motivation and job satisfaction will be greatly enhanced. This method of production is
often combined with the just-in-time approach.
The advantages of cell production are:
1. Improved job satisfaction and motivation.
2. Improved quality as the group of workers take responsibility for the output.
3. Multi-skilling of workers means that job rotation can occur.
4. Stockholdings are reduced (leaving less money tied up in stocks).
5. The factory space can be used more efficiently.
6. Lead-times are reduced.
The disadvantages of cell production are:
1. Output may not be as high as a 'flow' production system.
2. Different 'cells' may work at different speeds (leading to conflict and tension).
3. The business may need to invest heavily in new machinery and equipment, as each
cell will require the same capital items.

Benchmarking refers to a business finding the best methods and processes that are used
by other businesses, and then trying to emulate these in order to become more efficient in
its operations. Benchmarking can be used in all areas and processes in a business, not just
for production. For example, it can be used to improve customer service, advertising
campaigns, Human Resource Management, and budgeting procedures. Data for
benchmarking is collected and used with the full co-operation of the other businesses, and
often the results will help both businesses to improve their systems and procedures.
There are several stages involved in implementing a benchmarking system:
1. Researching the areas in a business which needs improvement.
2. Deciding how an improvement in these areas can be measured.
3. Identifying 'best practice' in other businesses.
4. Agreeing the exchange of information with other businesses.
5. Comparing the 'best practice' with the existing processes, systems and procedures
in the business.
6. Altering the processes, systems and procedures in order to improve performance.
7. Evaluating how successful the changes have been.
In order for benchmarking to be successful, the business must ensure that firstly every
employee is committed and involved in the system, (from senior management to shopfloor employees), and secondly that sufficient time and finance is available for the
gathering of data and the implementation of new procedures.
Benchmarking will fail to deliver improvements to the business if there is a lack of
willingness by other businesses to disclose information, or if the systems and procedures
used by the 'best practice' businesses are not appropriate for the business in question.
In summary, benchmarking can help a business identify those areas in its operations
which need improvement, as well as considering alternative processes and procedures for
achieving its objectives. 'Best practice' can be emulated and the competitiveness of the
business should improve as it strives to improve and become more efficient.
Time-based Management
Time is a very valuable resource and time-based management is concerned with reducing
both the length of time taken to produce the product and also, therefore, reducing the
lead-time (the time lag between the customer placing an order and the business
delivering the finished product).

In order for a business to successfully operate a time-based management system, it is

important that machinery is flexible and production runs can be shortened or lengthened
at short notice, in order to produce more of an existing product or to start the production
of an alternative product.
It is also essential that staffs are multi-skilled and can rotate between different tasks, as
they may be required to perform a number of different jobs in a short space of time.
Time-based management makes it easier for a business to implement other lean
production techniques (such as just-in-time and cell production), and since these
techniques require less time and fewer stocks of raw materials than more traditional mass
production techniques, then the business will save money.
However, it is often argued that the move away from mass production and lengthy
production-lines will reduce the chance of the business benefiting from economies of scale
in its manufacturing techniques.
It is also likely that a business will be able to implement the time-based management
philosophy to its R&D processes, as well as to the production-line.
A business which can develop and launch more products in a shorter time than
its competitors will benefit from a number of advantages:
1. If the business is the first to launch a product on the market, then it can charge a
premium price to reflect the innovative nature of the product.
2. Premium prices help to quickly recoup R&D costs, as well as earning the business a
significant profit-margin per unit sold.
3. Brand loyalty is likely to develop - enabling the business to use this strong customer
base as a 'launch pad' for new products in the future.
4. The diversity of products that are on sale will increase the product portfolio of the
business, as well as reduce the risk of business failure should one or two of the
products prove unsuccessful.
Capacity Utilization
Capacity utilization is a concept in economics which refers to the extent to which an
enterprise or a nation actually uses its installed productive capacity. Thus, it refers to the
relationship between actual output that 'is' produced with the installed equipment and the
potential output which 'could' be produced with it, if capacity was fully used.

Economic significance: If market demand grows, capacity utilization will rise. If demand
weakens, capacity utilization will slacken. Economists and bankers often watch capacity
utilization indicators for signs of inflation pressures. It is believed when utilization rises
above somewhere between 82% and 85%, price inflation will increase. Excess capacity
means that insufficient demand exists to warrant expansion of output.
All else constant, the lower capacity utilization falls (relative to the trend capacity
utilization rate), the better the bond market likes it. Strong capacity utilization (above the
trend rate) reports leads to bonds being sold off, as investors expect higher interest rates
(which decreases bond prices) to offset the higher expected rate of inflation.
Implicitly the capacity utilization rate is also an indicator of how efficiently the factors of
production are being used. Much statistical and anecdotal evidence shows many industries
in the developed capitalist economies suffer from chronic excess capacity. Critics of
market capitalism therefore argue the system is not as efficient as it may seem, since at
least 1/5 more output could be produced and sold, if buying power was better distributed.
However, a level of utilization somewhat below the maximum prevails, regardless of
economic conditions.
Measurement
In economic statistics, capacity utilization is normally surveyed for goods-producing
industries at plant level. The results are presented as an average percentage rate by
industry and economy-wide, where 100% denotes full capacity. This rate is also sometimes
called the "operating rate". If the operating rate is high, this is called "overcapacity", while
if the operating rate is low, a situation of "excess capacity" or "surplus capacity" exists.
The observed rates are often turned into indexes.
There has been some debate among economists about the validity of statistical measures
of capacity utilization, because much depends on the survey questions asked, and on the
valuation principles used to measure output. Also, the efficiency of production may change
over time, due to new technologies.
For example, Michael Perelman has argued the US Federal Reserve Board measure is just
not very revealing. Prior to the early 1980s, he argues, American business carried a great
deal of extra capacity. Running close to 80% indicated at the time approaching capacity
restraints. Since that time, firms have scrapped much of their most inefficient capacity. As
a result, 77% capacity utilization now would be equivalent to a historical level of 70%.
Engineering and economic measures
One of the most used definitions of the "capacity utilization rate" is the ratio of actual
output to the potential output. But potential output can be defined in at least two different
ways.
One is the "engineering" or "technical" definition, according to which potential output
represents the maximum amount of output that can be produced in the short-run with the

existent stock of capital. Thus, a standard definition of capacity utilization is the

(weighted) average of the ratio between the actual output of firms to the maximum that
could be produced per unit of time, with existing plant and equipment (see Johansson
1968). Obviously, "output" could be measured in physical units or in market values, but
normally it is measured in market values.
However, as output increases and well before the absolute physical limit of production is
reached, most firms might well experience an increase in the average cost of production
(even if there is no change in the level of plant & equipment used). For example, higher
average costs can arise, because of the need to operate extra shifts, undertake additional
plant maintenance, and so on.
An alternative approach, sometimes called the "economic" utilization rate, is therefore to
measure the ratio of actual output to the level of output, beyond which the average cost of
production begins to rise. In this case, surveyed firms are asked by how much it would be
practicable for them to raise production from existing plant and equipment, without raising
unit costs (see Berndt & Morrison 1981). Typically, this measure will yield a rate around 10
percentage points higher than the "engineering" measure, but time series show the same
movement over time.
FRB and ISM utilization indexes
In the survey of plant capacity used by the US Federal Reserve Board for the FRB capacity
utilization index, firms are asked about "the maximum level of production that this
establishment could reasonably expect to attain under normal and realistic operating
conditions,
fully
utilizing
the
machinery
and
equipment
in
place.
By contrast, the Institute of supply management (ISM) index asks respondents to measure
their current output relative to "normal capacity", and this yields a utilisation rate which is
between 4 and 10 percentage points higher than the FRB measure. Again, the time series
show more or less the same historical movement.
Data
The average economy-wide capacity utilization rate in the US since 1967 was about 81.6%
according to the Federal Reserve measure. The figure for Europe is not much different, for
Japan only slightly higher.
The average utilization rate of installed productive capacity in industry, in some major
areas of the world, was estimated in 2003/2004 to be as follows (rounded figures):

United States 79.7% (April 2008 - Federal Reserve measure)

Japan 83-86% (Bank of Japan)

European Union 82% (Bank of Spain estimate)

Australia 81% (National Bank estimate)

Brazil 60-80% (various sources)

India 70% (Hindu business line)

China perhaps 60% (various sources)

Turkey 79.8% (September 2008 - Turkish Statistical Institute)

Canada 87% (Statistics Canada)

Break Even Analysis

The break-even point for a product is the point where total revenue received equals the
total costs associated with the sale of the product (TR=TC). A break-even point is typically
calculated in order for businesses to determine if it would be profitable to sell a proposed
product or not. Break even analysis can also be used to analyse the potential profitability
of an expenditure in a sales-based business.

break even point (for output) =

fixed cost
-----------------------------contribution per unit

contribution (p.u) = selling price (p.u) - variable cost (p.u)

break even point (for sales) =

fixed cost
------------------------ X
contribution (pu)

sp (pu)

In break-even analysis, margin of safety is how much output or sales level can fall
before a business reaches its break-even point (BEP).
Budgeted sales - break-even sales
Margin of safety = --------------------------------------------Budgeted sales

x 100%

If the product can be sold in a larger quantity that occurs at the break even point, then the
firm will make a profit; below this point, a loss.

Break-even quantity

Total fixed costs

---------------------------selling price avg. VC

Explanation: in the denominator, "price minus average variable cost" is the variable
profit per unit, or contribution margin of each unit that is sold.
This relationship is derived from the profit equation:
Profit = Revenues - Costs
where Revenues = selling price x quantity of product
and Costs = (average variable costs x quantity) + total fixed costs.
Therefore, Profit = (selling price x quantity) - (avg. VC x quantity + total fixed
costs).

An example:

Assume we are selling a product for $2 each.

Assume that the variable cost associated with producing and selling the product is
60 cents.

Assume that the fixed cost related to the product (the basic costs that are incurred
in operating the business even if no product is produced) is $1000.

In this example, the firm would have to sell (1000 / (2.00 - 0.60) = 715) 715 units to
break even. in that case the margin of safety value of NIL and the value of BEP is
not profitable or not gaining loss.
Break Even = FC / (SP VC)
where FC is Fixed Cost, SP is selling Price and VC is Variable Cost

Limitations

Break-even analysis is only a supply side (i.e. costs only) analysis, as it tells you
nothing about what sales are actually likely to be for the product at these various
prices.

It assumes that fixed costs (FC) are constant

It assumes average variable costs are constant per unit of output, at least in the
range of likely quantities of sales. (i.e. linearity)

It assumes that the quantity of goods produced is equal to the quantity of goods
sold (i.e., there is no change in the quantity of goods held in inventory at the
beginning of the period and the quantity of goods held in inventory at the end of the
period).

In multi-product companies, it assumes that the relative proportions of each product

sold and produced are constant (i.e., the sales mix is constant).