Chapter 12 Operations Management

Fundamentals of Entrepreneurship
Oxford Fajar Sdn. Bhd. (008974-T), 2013
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CHAPTER
12
OPERATIONS MANAGEMENT
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Objectives
The objectives of this chapter are to:
introduce operations management, production system, its
importance in business and how it relates to other business
functions
discuss issues on location, layout, process set up, production
and capacity planning, inventory management, material
requirement planning, quality and cost management
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Learning Outcomes
At the end of this chapter, students should be able to:
understand, analyse and apply the knowledge on production
management to their business practicum project and in their
life after graduation.
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Introduction to Operations
Management
Operations management or production management can be
defined as:
the management of the process of marshalling resources
(inputs), organizing and designing the transformation process
(production process) to produce products and services
(outputs) according to the target quality, cost, quantity, delivery
time and safety.
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Management (cont.)
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Management (cont.)
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Operations Management and

Business Strategies
Examples of business strategies that involve operations management:
product
design and development to produce a better or a new product to the

customers
managing quality management system
process and capacity design
location strategy
layout strategy
human resources and job design
supply-chain management
inventory and material requirement planning
job scheduling and project management
maintenance
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Operations Management and

Business Strategies (cont.)
Productivity index is a measurement of the ratio between
total value of outputs to the total value (cost) of input.
Productivity index = Total value of output
Total value of input
In order for a business to be sustainable, productivity index
must be greater than one.
If the transformation process creates a high value added
output, then this ratio will be greater.
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Location Planning
It is crucial for an entrepreneur to choose the right location for his
business because a good location can result in higher sale,
lower operating cost and higher profit.
In general, the choice of location will depend on the following
factors:
close proximity to customers

close proximity to raw materials
lower rental cost
availability of good infrastructures and facilities
availability of manpower
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Location Planning (cont.)
easier accessibility
convenient parking space
less risk to crime
availability of services such as school, hospital, bank, sport facilities,
etc.
in case of retail outlet or a restaurant, the monthly sale forecast from
market study for the selected location must be greater than the
break-even sale volume required to cover all the monthly fixed costs
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Layout Plan
The layout plan refers to the arrangement of the floor plan of the
operation areas. The following are the objectives that need to be
considered when designing the layout:
Ideally the area required should be economical, i.e. minimal but
adequate. Calculation has to be made to estimate the required area
for each of the activities on the process flow diagram.
Layout design should facilitate higher utilization of space,
equipment, and people. It should improve flow of information,
materials, or people. Based on process flow or sequence, certain
activities may need to be placed in close proximity or clustered
together to facilitate (minimize) material movement, minimize
workers movement, create convenience working arrangement and
enable effective supervision.
Wet area, hot area or dangerous area may need to be separated
for safety reason.
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Layout Plan
Where possible the layout plan should be flexible and can
possibly accommodate future expansion.
The layout must provide for adequate space and accessibility
for service and maintenance work.
Specific or customized business objectives may need to be
considered depending on the type of business, e.g. a retail
business shall need a layout arrangement that is attractive,
accessible, and convenient to the customers while at the same
time, it is easier for the entrepreneur to protect goods against
theft. The used of gondola will allow more products to be
displayed and generate more sales per square feet of floor
area.
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Type of Layout
The type of layout can be broadly divided into:
office layout
retail layout
warehouse layout
fixed position layout such as ship building or building
construction
process layout such as metal press job shop
product oriented layout such as assembly line
production
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Type of Layout (cont.)
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Type of Layout (cont.)
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Production Planning and Capacity

Management
Basically, an
entrepreneur must plan and decide on the:

production output rates and raw materials required
number of employees
number of working hours
inventory levels (quantities)
numbers of machines (capacities)
work that needs to be subcontracted
number of suppliers
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Production Planning and Capacity

Management (cont.)
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Capacity Management
Capacity is the maximum output, or throughput, or
the number of units a facility or a system can
produce, hold, store or accommodate in a period of
time (Heizer &Render, 2008).
Capacity is the upper limit or yield an operating
system can handle or perform (Stevenson, 2009).
The objective of capacity planning is to specify the
capacity level that will meet the market demands in
a cost efficient way.
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Capacity Management (cont.)
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The importance of capacity planning is for planning purposes; it

affects decisions or plans related to orders and market demand
(Stevenson, 2009). Following are some of its importance:
The ability to meet future demands for product and services.
Having capacity to satisfy demand will allow you as entrepreneur
to capture business opportunities.
Capacity planning affects initial set up costs and operating costs.
Practically, it is best that capacity and demand requirements
match so as to minimize operating costs. Running a business with
under capacity is not economical for business. The greater the
capacity, per unit cost is lesser.
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The importance of capacity planning is for planning purposes; it
affects decisions or plans related to orders and market demand
(Stevenson, 2009). Following are some of its importance:
Capacity planning involves long-term commitment and resources.
This also affect competitiveness in business
Factors such as types of product, processes, use of facilities
(electricity, water and gas) need to be considered during capacity
planning. The example below shows the capacity planning for an
oven for a bakery operation.
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Production Schedule
The main objective of a production schedule is:
to ensure that the quantity of production is enough to fulfil the
expected market demand for the schedule period, say for the next
four months.
Normally the market demand varies from month to month. An
entrepreneur can decide to have a level production strategy where he
produces equal amount of quantities every month and uses the
finished good inventory as a buffer to meet varying demand.
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Production Schedule (cont.)

He also can use a chase production strategy where his
quantity of production varies according to the demand.
Normally, a manufacturing business will opt for a level
production strategy as it is more convenient and
economical to plan and stock finished goods.
A services business may opt for a chase production
strategy because the services offered to customers
could not be inventoried. As an option, the problem of
excess service capacity can be solved by pushing for a
more aggressive marketing effort during a market
demand.
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Inventory Management
Managing inventory stocks is important to a business,

particularly to meet market demand for your products.
Inventory refers to stocks, or items, products or
resource used in your business or operations. Inventory
is actually valuable capital and having too much
inventory will increase holding or storage (carrying)
costs, and stocks also occupy more space; while too
little inventory may cause stock out and affect service
to customers.
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Inventory Management (cont.)

The objective of inventory management is to determine the levels of
inventory that should be maintained and secondly, when to order and
replenish stocks, and thirdly how much (quantity) to order (Davis,
Aquilano & Chase, 2008).
The importance of inventory management is:
To provide a stock of goods or products that will be able to meet
demand by customers.
To protect against shortages and uncertainty. Uncertainty may
occur such as delays of raw materials, supply shortages, quality
problems, and improper deliveries. Safety stocks or buffers in hand
reduce risks of stock outs.
To ensure operations to run smoothly and continue without delay or
line stoppages by keeping or carrying some work in process (WIP)
stocks.
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The importance of inventory management is:
To take advantage of quantity discounts and economies of scales. Bulk
purchases can substantially reduce costs of products and cheaper cost per
unit. Also, each time an order is placed, an order cost (set up costs) are
incurred as we have to pay for the telephone, fax charges and the ordering
clerk wages, and the supplier has to get ready the invoices, transportation
and delivery of the order, respectively.
To hedge against inflation and price changes or increase; it is advisable to
keep stocks before prices of raw materials or resources increase so as to
minimize the cost impact to the business.
If stocks are available, we do not need to hassle the production staff to work
longer hours for sudden or rush orders from customers. For example, if the
product demand is high for specific festive seasons, one may build up and
keep stocks during the low demand period. Most businesses keep high
volume stocks on festive cookies for the festive Malay celebration or Chinese
New Year.
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There are several inventory models available to suit the nature of

your business. The inventory models are:
ABC store inventory model (for managing a store or retail business)
Independent inventory model, economic order quantity (EOQ)
model
Dependent inventory model (materials requirement planning for
purchase of raw materials)
Just in time (JIT) delivery model
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Dependent Demand Inventory System or Materials Requirements Planning

(MRP)
Master Production Schedule
Bill of Materials (BOM)
Inventory Stock Level
Purchase Order (PO) Outstanding
Lead Time Delivery
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Quality Management
Quality is defined as the totality of features and characteristics of
a product or service that bears on its ability to satisfy stated or
implied needs (MS ISO9001: 2008 Standard).
Quality is defined as a measure of how close a product or service
conforms to standards and specifications (Stevenson, 2009).
Quality is also defined as a products fitness for use; its success
in offering features that consumers want (Juran, J.M).
Quality is simply innate excellence (in appearance, style,
performance, price, delivery, or after sales service).
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Quality Management (cont.)

The objective of quality management is:
to ensure the products or services produced are of high quality and
meet the customers requirements (Heizer and Render, 2008).
Producing high quality products/services assure customer
satisfaction, and they will become regular and loyal customers. This
simply means, higher sales will result in high profitability, and
therefore assured repeated business and retained market share.
Besides, quality drives company growth, and reduces operational
costs, thus provides an additional competitive edge.
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The importance of quality in a business is to:
remain competitive in market and business survival
retain market share
acquire profitability
achieve customer satisfaction
assure greater customer loyalty
produce high quality products/services
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The importance of quality in a business is to:
reduce operational costs (reduced quality problems, scraps, yield
loss, wastages)
produce high productivity or yields
control processes with less variations
create sense of pride and image to the products and organization
establish a quality management system in the organization
achieve ISO 9001: 2008 certification and to comply with international
trade regulations
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Entrepreneurs must realize that cost of non-quality is very high.
The external cost of non-quality involves:
poor reputation,
loss of repeat customers,
cost of rejected or return product.
The internal cost involves:
wasted cost on material and labour,
rework cost and
low workers morale.
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An entrepreneur should focus of the preventive effort of eliminating
defective products or services through:
Identification of the most frequent form of defects and seek out the
causes of the defects. The cause of the defects could be due to
method, material, manpower, equipment, management procedure and
system, layout and work place.
Work out a suitable solution to solve the causes of these defects. As
an implementation strategy, an entrepreneur can use quality control
circle (QCC) to mobilize his workers to solve his quality problems.
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Operational Cost and Product

Costing
One of the operation management objectives is to minimize the
cost per unit of production so that product can be sold at
competitive prices.
Operational cost includes cost of direct materials, direct labour
and overhead. Direct materials and labours are money spent on
materials and labours that are directly used for the production of
the product. Overhead costs include other indirect cost such as
wages for administrative, marketing and finance staff, rental, utility,
transportation, maintenance, depreciation of asset (equipment)
and interest.
Total operational cost
= Direct cost of materials + Direct labour
cost + Overhead cost
Cost per unit
= Total cost/ Total number of output
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Operation Plan
The sales forecast from market study will be the basis of an
entrepreneurs operation plan.
He has to decide on the product design, its specification, type of
production process, capacity of production, input required, i.e.
manpower, equipment, fixed asset, location, layout, control
procedure, etc. He has to prepare operation budget which include
cost of asset, working capital and other items (see Chapter 7).
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Fundamentals of Entrepreneurship

Oxford Fajar Sdn. Bhd. (008974-T), 2013

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Operations Management and

design and development to produce a better or a new product to the

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Operations Management and

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close proximity to customers

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Location Planning (cont.)

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Location Planning (cont.)

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Location Planning (cont.)

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Location Planning (cont.)

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The type of layout can be broadly divided into:

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Type of Layout (cont.)

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Type of Layout (cont.)

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Production Planning and Capacity

entrepreneur must plan and decide on the:

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Production Planning and Capacity

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Capacity Management (cont.)

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Capacity Management (cont.)

The importance of capacity planning is for planning purposes; it

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Capacity Management (cont.)

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Capacity Management (cont.)

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Production Schedule (cont.)

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Managing inventory stocks is important to a business,

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Inventory Management (cont.)

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Inventory Management (cont.)

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Inventory Management (cont.)

There are several inventory models available to suit the nature of

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Inventory Management (cont.)

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Inventory Management (cont.)

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Inventory Management (cont.)