Operation and Productivity
Week 9
Lea
○ Define operations
management,
○ Identify the 10 strategic
decisions of operations
management,
Objective
○ Explain the distinction
between goods and services,
○ Explain the difference between
production and productivity,
Productivity ○ Compute single-factor
productivity,
○ Compute multifactor
productivity,
○ Identify the critical variables
in enhancing productivity,
Operation Management
The techniques of OM apply throughout the world to virtually all productive enterprises. It
doesn’t matter if the application is in an office, a hospital, a restaurant, a department store,
or a factory—the production of goods and services requires operations management. And
the efficient production of goods and services requires effective applications of the
concepts, tools, and techniques of OM that we introduce in this book.
As we progress through this text, we will discover how to manage operations in an economy
in which both customers and suppliers are located throughout the world.
Operation Management
Production is the creation of goods and services. Operations management (OM) is the set of
activities that creates value in the form of goods and services by transforming inputs into outputs.
Activities creating goods and services take place in all organizations. In manufacturing firms, the
production activities that create goods are usually quite obvious. In them, we can see the creation of
a tangible product such as a Sony TV or a Harley-Davidson motorcycle.
In an organization that does not create a tangible good or product, the production function may be
less obvious. We often call these activities services.
Operation Management
Organizing to Produce Goods and Services
Operations is one of the three functions that every organization performs.
To create goods and services, all organizations perform three functions. These functions are the
necessary ingredients not only for production but also for an organization’s survival. They are:
1. Marketing, which generates the demand, or at least takes the order for a product or service
(nothing happens until there is a sale).
2. Production/operations, which creates, produces, and delivers the product.
3. Finance/accounting, which tracks how well the organization is doing, pays the bills, and
collects the money.
Operation Management
The Supply Chain
Through the three functions—marketing, operations, and finance—value for the customer is
created. However, firms seldom create this value by themselves. Instead, they rely on a
variety of suppliers who provide everything from raw materials to accounting services.
These suppliers, when taken together, can be thought of as a supply chain. A supply chain
is a global network of organizations and activities that supply a firm with goods and
services.
Operation Management
A supply chain for a bottle of Coke requires a beet or sugar cane farmer, a syrup producer, a bottler,
a distributor, and a retailer, each adding value to satisfy a customer. Only with collaborations
between all members of the supply chain can efficiency and customer satisfaction be maximized.
The supply chain, in general, starts with the provider of basic raw materials and continues all the
way to the final customer at the retail store.
ProStockStudio/Shutterstock
As our society becomes more technologically oriented, we see increasing specialization.
Specialized expert knowledge, instant communication, and cheaper transportation also foster
specialization and worldwide supply chains. It just does not pay for a firm to try to do everything
itself. The expertise that comes with specialization exists up and down the supply chain, adding
value at each step. When members of the supply chain collaborate to achieve high levels of
customer satisfaction, we have a tremendous force for efficiency and competitive advantage.
Competition in the 21st century is not between companies; it is between supply chains.
Operation Management
We study OM for four reasons:
1. OM is one of the three major functions of any organization, and it is integrally
related to all the other business functions. All organizations market (sell), finance
(account), and produce (operate), and it is important to know how the OM activity
functions. Therefore, we study how people organize themselves for productive enterprise.
2. We study OM because we want to know how goods and services are produced.
The production function is the segment of our society that creates the products and
services we use.
3. We study OM to understand what operations managers do. Regardless of your job
in an organization, you can perform better if you understand what operations managers
do. In addition, understanding OM will help you explore the numerous and lucrative
career opportunities in the field.
4. We study OM because it is such a costly part of an organization. A large
percentage of the revenue of most firms is spent in the OM function. Indeed, OM provides
a major opportunity for an organization to improve its profitability and enhance its service
to society.
Operation Management
Fisher Technologies is a small firm that must double its dollar contribution to fixed cost and profit in
order to be profitable enough to purchase the next generation of production equipment.
Management has determined that if the firm fails to increase contribution, its bank will not make the
loan and the equipment cannot be purchased. If the firm cannot purchase the equipment, the
limitations of the old equipment will force Fisher to go out of business and, in doing so, put its
employees out of work and discontinue producing goods and services for its customers.
Approach
Table 1.1 shows a simple profit-and-loss statement and three strategic options (marketing,
finance/accounting, and operations) for the firm. The first option is a marketing option, where
excellent marketing management may increase sales by 50%. By increasing sales by 50%,
contribution will in turn increase 71%. But increasing sales 50% may be difficult; it may even be
impossible.
Operation Management
I.
● Increasing sales 50% increases contribution by $7,500, or 71% (7,500/10,500).
● Reducing finance costs 50% increases contribution by $2,250, or 21% (2,250/10,500).
● Reducing production costs 20% increases contribution by $12,000, or 114% (12,000/10,500).
● Contribution to fixed cost (excluding finance costs) and profit.
II. The second option is a finance/accounting option, where finance costs are cut in half through good
financial management. But even a reduction of 50% is still inadequate for generating the necessary
increase in contribution. Contribution is increased by only 21%.
III. The third option is an OM option, where management reduces production costs by 20% and
increases contribution by 114%.
Solution
Given the conditions of our brief example, Fisher Technologies has increased contribution from
$10,500 to $22,500. It may now have a bank willing to lend it additional funds.
Operation Management
Insight
The OM option not only yields the greatest improvement in contribution but also may be the only
feasible option. Increasing sales by 50% and decreasing finance cost by 50% may both be virtually
impossible. Reducing operations cost by 20% may be difficult but feasible.
Learning Exercise
What is the impact of only a 15% decrease in costs in the OM option? [Answer: A $19,500
contribution; an 86% increase.]
Operation Management
What Operations Managers Do
All good managers perform the basic functions of the management process.
The management process consists of :
❏ planning,
❏ organizing,
❏ staffing,
❏ leading,
❏ controlling.
Operations managers apply this management process to the decisions they make in the OM
function. Successfully addressing each of these decisions requires planning, organizing, staffing,
leading, and controlling.
Operation Management
Design of goods and services: Defines much of what is required of operations in
each of the other OM decisions. For instance, product design usually determines the
lower limits of cost and the upper limits of quality, as well as major implications for
sustainability and the human resources required.
Managing quality and statistical process control: Determines the customer’s
quality expectations and establishes policies and procedures to identify and achieve
that quality.
Process and capacity strategies: Determines how a good or service is produced
(i.e., the process for production) and commits management to specific technology,
quality, human resources, and capital investments that determine much of the firm’s
basic cost structure.
Operation Management
Location strategies: Requires judgments regarding nearness to customers, suppliers,
and talent, while considering costs, infrastructure, logistics, and government.
Layout strategies: Requires integrating capacity needs, personnel levels, technology,
and inventory requirements to determine the efficient flow of materials, people, and
information.
Human resources, job design and work measurement: Determines how to
recruit, motivate, and retain personnel with the required talent and skills. People are an
integral and expensive part of the total system design.
Supply chain management: Decides how to integrate the supply chain into the
firm’s strategy, including decisions that determine what is to be purchased,
Operation Management
The Heritage of Operations Management
The field of OM is relatively young, but its
history is rich and interesting. Our lives
and the OM discipline have been
enhanced by the innovations and
contributions of numerous individuals.
Operation Management
Eli Whitney (1800) is credited for the early popularization of interchangeable parts,
which was achieved through standardization and quality control. Through a contract he
signed with the U.S. government for 10,000 muskets, he was able to command a
premium price because of their interchangeable parts.
Frederick W. Taylor (1881), known as the father of scientific management, contributed
to personnel selection, planning and scheduling, motion study, and the now popular
field of ergonomics. One of his major contributions was his belief that management
should be much more resourceful and aggressive in the improvement of work methods.
Taylor and his colleagues, Henry L. Gantt and Frank and Lillian Gilbreth, were among
the first to systematically seek the best way to produce.
Another of Taylor’s contributions was the belief that management should assume more
responsibility for:
Operation Management
Another of Taylor’s contributions was the belief that management should assume more
responsibility for:
1. Matching employees to the right job.
2. Providing the proper training.
3. Providing proper work methods and tools.
4. Establishing legitimate incentives for work to be accomplished.
By 1913, Henry Ford and Charles Sorensen combined what they knew about standardized parts with the quasi-
assembly lines of the meatpacking and mail-order industries and added the revolutionary concept of the
assembly line, where workers stood still and material moved.
Quality control is another historically significant contribution to the field of OM. Walter Shewhart (1924)
combined his knowledge of statistics with the need for quality control and provided the foundations for
statistical sampling in quality control. W. Edwards Deming (1950) believed, as did Frederick Taylor, that
management must do more to improve the work environment and processes so that quality can be improved.
Operation Management
Operations management will continue to progress as contributions from other
disciplines, including industrial engineering, statistics, management, analytics,
and economics, improve decision making.
❖ Innovations from the physical sciences (biology, anatomy, chemistry, physics)
have also contributed to advances in OM. These innovations include new
adhesives, faster integrated circuits, gamma rays to sanitize food products, and
specialized glass for iPhones and plasma TVs. Innovation in products and
processes often depends on advances in the physical sciences.
❖ Especially important contributions to OM have come from information technology,
which we define as the systematic processing of data to yield information.
Information technology—with digitalization, wireless links, Internet, and e-commerce
—is reducing costs and accelerating communication.
❖ Decisions in operations management require individuals who are well versed in
analytical tools, in information technology, and often in the biological or physical
sciences. In this textbook, we look at the diverse ways a student can prepare for a
career in operations management.
Operation Management
Operations for Goods and Services
Services are especially important because almost 80% of all jobs are in service firms.
Manufacturers produce a tangible product, while service products are often intangible. But many
products are a combination of a good and a service, which complicates the definition of a service. Even
the U.S. government has trouble generating a consistent definition.
Because definitions vary, much of the data and statistics generated about the service sector are
inconsistent.
However, we define services as including :
➔ repair and maintenance,
➔ government, food and lodging,
➔ transportation,
➔ insurance,
➔ trade,
➔ financial,
➔ real estate,
➔ education,
➔ legal,
➔
Operation Management
The distinction between goods and services
The operation activities for both goods and services are often very similar.
For instance, both have:
➢ quality standards,
➢ are designed and produced on a schedule that meets customer demand,
➢ and are made in a facility where people are employed.
However, some major differences do exist between goods and services.
Operation Management
We should point out that in many cases, the distinction between goods and services is not clear-cut. In reality, almost
all services and almost all goods are a mixture of a service and a tangible product. Even services such as consulting
may require a tangible report. Similarly, the sale of most goods includes a service.
For instance, many products have the service components of financing and delivery (e.g., automobile sales). Many
also require after-sale training and maintenance (e.g., office copiers and machinery). “Service” activities may also be
an integral part of production. Human resource activities, logistics, accounting, training, field service, and repair are
all service activities, but they take place within a manufacturing organization. Very few services are “pure,” meaning
they have no tangible component. Counseling may be one of the exceptions.
Operation Management
Growth of Services
Services constitute the largest economic sector in postindustrial societies. Until about 1900, most Americans were
employed in agriculture. Increased agricultural productivity allowed people to leave the farm and seek employment in
the city. Similarly, manufacturing employment has decreased for the past 60 years.
Services became the dominant employer in the early 1920s, with manufacturing employment peaking at about 32%
in 1950. The huge productivity increases in agriculture and manufacturing have allowed more of our economic
resources to be devoted to services. Consequently, much of the world can now enjoy the pleasures of education,
health services, entertainment, and myriad other things that we call services.
Operation Management
The Productivity Challenge
The difference between production and productivity
The creation of goods and services requires changing resources into goods and services. The more
efficiently we make this change, the more productive we are and the more value is added to the
good or service provided.
★ Productivity is the ratio of outputs (goods and services) divided by the inputs (resources,
such as labor and capital). The operations manager’s job is to enhance (improve) this ratio of
outputs to inputs. Improving productivity means improving efficiency.
Operation Management
An effective feedback loop evaluates performance against a strategy or standard.
It also evaluates customer satisfaction and sends signals to managers controlling
the inputs and transformation process.
The flowchart is represented here as a list:
● Inputs: Labor, capital, management
● Transformation: The U.S. economic system transforms inputs to outputs with
annual productivity increasing by about 2.5 percent. The productivity increase
is the result of contributions from capital (38 percent), labor (10 percent), and
management (52 percent).
● Outputs: Goods and services
● A feedback loop connects outputs back to transformation and inputs.
Operation Management
This improvement can be achieved in two ways:
★ reducing inputs while keeping output constant or
★ increasing output while keeping inputs constant.
Both represent an improvement in productivity.
❏ In an economic sense, inputs are labor, capital, and management, which are integrated into
a production system.
❏ Management creates this production system, which provides the conversion of inputs to
outputs. Outputs are goods and services, including such diverse items as guns, butter,
education, improved judicial systems, and ski resorts.
❏ Production is the making of goods and services. High production may imply only that more
people are working and that employment levels are high (low unemployment), but it does not
imply high productivity.
Operation Management
Productivity Measurement
Compute single-factor productivity
The measurement of productivity can be quite direct. Such is the case when productivity is
measured by labor-hours per ton of a specific type of steel. Although labor-hours is a common
measure of input, other measures such as capital (dollars invested), materials (tons of ore), or
energy (kilowatts of electricity) can be used. An example of this can be summarized in the following
equation:
★ Productivity= units produced/input used
For example, if units and labor-hours used is 250, then:
Single factor productivity=units produced/ Labor- hours used 1000/250= 4 units per labor/h
Operation Management
The use of just one resource input to measure productivity, as shown in Equation (1-1), is
known as single-factor productivity.
However, a broader view of productivity is multifactor productivity, which includes all
inputs (e.g., capital, labor, material, energy).
Multifactor productivity is also known as total factor productivity. Multifactor productivity is
calculated by combining the input units as shown here:
Multifactor productivity=output/ labor
materials+energy+capital+miscellaneous
Operation Management
Use of productivity measures aids managers in determining how well they are doing. But results
from the two measures can be expected to vary. If labor productivity growth is entirely the result of
capital spending, measuring just labor distorts the results. Multifactor productivity is usually better,
but more complicated. Labor productivity is the more popular measure. The multifactor-productivity
measures provide better information about the trade-offs among factors, but substantial
measurement problems remain. Some of these measurement problems are:
1. Quality may change while the quantity of inputs and outputs remains constant. Compare a
smart LED TV of this decade with a black-and-white TV of the 1950s. Both are TVs, but few
people would deny that the quality has improved. The unit of measure—a TV—is the same, but
the quality has changed.
2. External elements may cause an increase or a decrease in productivity for which the system
under study may not be directly responsible. A more reliable electric power service may greatly
improve production, thereby improving the firm’s productivity because of this support system
rather than because of managerial decisions made within the firm.
Operation Management
Productivity measurement is particularly difficult in the service sector, where the end product can be
hard to define.
For example, economic statistics ignore the quality of your haircut, the outcome of a court case, or
the service at a retail store. In some cases, adjustments are made for the quality of the product sold
but not the quality of the sales presentation or the advantage of a broader product selection.
Productivity measurements require specific inputs and outputs, but a free economy is producing
worth—what people want—which includes convenience, speed, and safety.
Traditional measures of outputs may be a very poor measure of these other measures of worth. Note
the quality-measurement problems in a law office, where each case is different, altering the
accuracy of the measure “cases per labor-hour” or “cases per employee.”
Operation Management
Productivity Variables
productivity increases are dependent on three productivity variables:
1. Labor, which contributes about 10% of the annual increase.
2. Capital, which contributes about 38% of the annual increase.
3. Management, which contributes about 52% of the annual increase.
These three factors are critical to improved productivity. They represent the broad areas in which
managers can take action to improve productivity.
Operation Management
Labor
Improvement in the contribution of labor to productivity is the result of a healthier, better-educated,
and better-nourished labor force. Some increase may also be attributed to a shorter workweek.
Historically, about 10% of the annual improvement in productivity is attributed to improvement in the
quality of labor.
Three key variables for improved labor productivity are:
1. Basic education appropriate for an effective labor force.
2. Diet of the labor force.
3. Social overhead that makes labor available, such as transportation and sanitation.
Illiteracy and poor diets are a major impediment to productivity, costing countries up to 20% of their
productivity. Infrastructure that yields clean drinking water and sanitation is also an opportunity for
improved productivity, as well as an opportunity for better health, in much of the world.
Operation Management
Illiteracy and poor diets are a major impediment to productivity, costing countries up to 20% of
their productivity. Infrastructure that yields clean drinking water and sanitation is also an opportunity
for improved productivity, as well as an opportunity for better health, in much of the world.In
developed nations, the challenge becomes maintaining and enhancing the skills of labor in the midst
of rapidly expanding technology and knowledge.
Overcoming shortcomings in the quality of labor while other countries have a better labor force is a
major challenge.
Perhaps improvements can be found not only through increasing competence of labor but also via
better utilized labor with a stronger commitment. Training, motivation, team building, and the
human resource strategies, as well as improved education, may be among the many techniques
that will contribute to increased labor productivity. Improvements in labor productivity are possible;
however, they can be expected to be increasingly difficult and expensive.
Operation Management
Capital
Human beings are tool-using animals. Capital investment provides those tools. Capital investment has
increased in the U.S. every year except during a few very severe recession periods. Annual capital
investment in the U.S. has increased at an annual rate of 1.5% after allowances for depreciation.
Inflation and taxes increase the cost of capital, making capital investment increasingly expensive. When
the capital invested per employee drops, we can expect a drop in productivity. Using labor rather than
capital may reduce unemployment in the short run, but it also makes economies less productive and
therefore lowers wages in the long run. Capital investment is often a necessary, but seldom a sufficient,
ingredient in the battle for increased productivity.
The trade-off between capital and labor is continually in flux. The higher the cost of capital or perceived
risk, the more projects requiring capital are “squeezed out”: they are not pursued because the potential
return on investment for a given risk has been reduced. Managers adjust their investment plans to changes
in capital cost and risk.
Operation Management
Management
Management is a factor of production and an
economic resource.
Management is responsible for ensuring that labor
and capital are effectively used to increase
productivity.
Management accounts for over half of the annual
increase in productivity. This increase includes
improvements made through the use of knowledge
and the application of technology.
Operation Management
The effective use of capital often means finding the proper trade-off between investment in capital
assets (automation, top) and human assets (a manual process, bottom). While there are risks
connected with any investment, the cost of capital and physical investments is fairly clear-cut, but
the cost of employees has many hidden costs including fringe benefits, social insurance, and legal
constraints on hiring, employment, and termination.
Guy Shapira/Shutterstock
Using knowledge and technology is critical in postindustrial societies. Consequently, post-industrial
societies are also known as knowledge societies. Knowledge societies are those in which much of
the labor force has migrated from manual work to technical and information-processing tasks
requiring ongoing education. The required education and training are important high-cost items that
are the responsibility of operations managers as they build organizations and workforces. The
expanding knowledge base of contemporary society requires that managers use technology and
knowledge effectively.
Operation Management
More effective use of capital also contributes to productivity. It falls to the operations manager,
as a productivity catalyst, to select the best new capital investments as well as to improve the
productivity of existing investments.
The productivity challenge is difficult. A country cannot be a world-class competitor with second-
class inputs.
Poorly educated labor,
inadequate capital,
and dated technology are second-class inputs.
High productivity and high-quality outputs require high-quality inputs, including good operations
managers.
Operation Management
Productivity and the Service Sector
The service sector provides a special challenge to the accurate measurement of productivity and
productivity improvement. The traditional analytical framework of economic theory is based
primarily on goods-producing activities. Consequently, most published economic data relate to
goods production. But the data do indicate that, as our contemporary service economy has
increased in size, we have had slower growth in productivity.
Productivity of the service sector has proven difficult to improve because service-sector work is:
1. Typically labor intensive (e.g., counseling, teaching).
2. Frequently focused on unique individual attributes or desires (e.g., investment advice).
3. Often an intellectual task performed by professionals (e.g., medical diagnosis).
4. Often difficult to mechanize and automate (e.g., a haircut).
5. Often difficult to evaluate for quality (e.g., performance of a law firm).
Operation Management
Siemens, a multi-billion-dollar German
conglomerate, has long been known for its
apprentice programs in its home country.
Because education is often the key to efficient
operations in a technological society, Siemens
has spread its apprentice-training programs
to its U.S. plants. These programs are laying
the foundation for the highly skilled workforce
that is essential for global competitiveness.
Operation Management
The more intellectual and personal the task, the more difficult it is to achieve increases in
productivity. Low-productivity improvement in the service sector is also attributable to the growth
of low-productivity activities in the service sector.
These include activities not previously a part of the measured economy, such as child care, food
preparation, house cleaning, and laundry service.
These activities have moved out of the home and into the measured economy as more and more
women have joined the workforce. Inclusion of these activities has probably resulted in lower
measured productivity for the service sector, although, in fact, actual productivity has probably
increased because these activities are now more efficiently produced than previously.
However, despite the difficulty of improving productivity in the service sector, improvements are
being made. Indeed, what can be done when management pays attention to how work actually gets
done is astonishing!
Operation Management
Current Challenges in Operations Management
One of the reasons OM is such an exciting discipline is that an operations manager is confronted with
ever-changing issues, from technology, to global supply chains, to sustainability.
Operations managers work in an exciting and dynamic environment. This environment is the result of a
variety of challenging forces, from globalization of world trade to the transfer of ideas, products, and
money at electronic speeds. Let’s look at some of these challenges:
♦Globalization: The rapid decline in the cost of communication and transportation has
made markets global. Similarly, resources in the form of capital, materials, talent, and labor
are also now global. As a result, countries throughout the world are contributing to
globalization as they vie for economic growth. Operations managers are rapidly seeking
creative designs, efficient production, and high-quality goods via international collaboration.
♦Supply-chain partnering: Shorter product life cycles, demanding customers, and fast
changes in technology, materials, and processes require supply-chain partners to be in tune
with the needs of end users. And because suppliers may be able to contribute unique
expertise, operations managers are outsourcing and building long-term partnerships with
critical players in the supply chain.
Operation Management
♦Sustainability: Operations managers’ continuing battle to improve productivity is concerned with
designing products and processes that are ecologically sustainable. This means designing green
products and packaging that minimize resource use, can be recycled or reused, and are generally
environmentally friendly.
♦Technological change: Why is this considered the fourth industrial revolution? The first industrial
revolution included the harnessing of water and steam power in the late 1700s, leading to rapid
mechanization and division of labor. This was followed quickly by electricity and the second industrial
revolution assembly lines and mass production. The third, in the 20th century, yielded communication
between man and machine with computers, automation, and robots. Finally, the fourth, is the
widespread use of precision sensors and digital signals—in a word, digitalization. From raw materials
to design to manufacturing to logistics, services, and ultimately the end consumer, digital signals
surround us. Moreover, digitalization suggests connecting this massive amount of data in real time.
Harnessing the vast and growing array of digital signals is a huge opportunity for operations
management, but it is also a significant challenge.
♦Mass customization: Once managers recognize the world as the marketplace, the cultural and
indi
Operation Management
♦Mass customization: Once managers recognize the world as the marketplace, the cultural and individual
differences become quite obvious. In a world where consumers are increasingly aware of innovation and
options, substantial pressure is placed on firms to respond in a creative way. And OM must rapidly respond
with product designs and flexible production processes that cater to the individual whims of consumers. The
goal is to produce customized products, whenever and wherever needed.
♦Lean operations: Lean is the management model sweeping the world and providing the standard against
which operations managers must compete. Lean can be thought of as the driving force in a well-run
operation, where the customer is satisfied, employees are respected, and waste does not exist. The theme
of this text is to build organizations that are more efficient, where management creates enriched jobs that
help employees engage in continuous improvement, and where goods and services are produced and
delivered when and where the customer desires them. These ideas are also captured in the phrase Lean.
