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Operations Management

Unit 1 Overview of Operations Management

1.1 Introduction
1.2 The Meaning of Operations Management
Aspects of Operation Management
Scope of Operations Management
1.3 Evolution of Operations Management
1.4 Operations Function
Resources in Operating Systems
Role of Operations in an Organisation
1.5 Current Trends in Manufacturing in India
1.6 World-class Manufacturing Practices
1.7 Services as a Part of Operations
Service and Manufacturing Organisations
1.8 Operations Management-A Systems Perspective
1.9 Challenges in Operations Management
Quality Management Issues
Lead Time Issues
Labour Productivity Issue
1.10 Emerging Trends in Business
1.11 Summary
1.12 Terminal Questions
1.13 Answers
1.14 Case Study
1.15 Glossary

1.1 Introduction
Operations Management deals with designing and managing products, processing, and
servicing. Manufacturing, service, and agriculture are the major economic activities in
any country. In India, manufacturing and servicing together constitute nearly 75% of the
Gross Domestic Product (GDP). In recent years, growth in GDP has been primarily due
to the growth in these sectors of the economy. Therefore, managing manufacturing and
service operations are important economic activities. Utilising appropriate Operations
Management Unit 1 .: 2
methods for planning and control of operations in manufacturing and service
organisations can result in significant productivity improvements and cost savings. It can
also positively influence the overall health of the economy. „Operations Management‟ is
a discipline that focuses on this aspect.
Operations Management (OM) is important for both society as well as organisation
because the consumption of goods & services is an integral part of our society.
Operations Management is responsible for creating goods and services. Hence,
operations are the core function of an organisation.
Learning Objectives:
After studying this unit you will be able to:
 Define “Operations Management” and its meanings, aspects and scope.
 Distinguish between functions and activities of operations managers/ personnel.
 Distinguish between servicing operations and manufacturing operations.
 Explain the manufacturing trends in India and compare with World class
manufacturing trends.
 Explain the emerging business trends in Operations Management.
 Discuss the role of services as a part of Operations Management.
 Identify the challenges in Operations Managements.

1.2 The Meaning of Operations Management

Operations Management is a systematic approach to all the issues pertaining to the
transformation process that converts inputs into useful outputs, and fetches revenue to
the organisation. Operations Management, deals with the production of goods &
services. The variety and types of goods & services that we see everyday are produced
under the supervision of operations managers. A modern industrialised society cannot
exist without effective management of „operations‟.
Operations Managers
Operations managers have important positions in every company. They are collectively
responsible for producing the supply of products in a manufacturing business. This
group also includes those managers at the corporate level (example, Vice President)
who are overall in charge or are holding staff functions related to operations such as:
Operations Management Unit 1 .: 3
 The Plant Manager
 Production Manager
 Inventory Control Manager
 Quality Manager
 Line Supervisors

1.2.1 Aspects of Operation Management

The focus of the Operations Management is on the various aspects of design in the
transformation process as well as planning and operational control.
A systematic approach involves understanding the issues and problems, establishing
measures of performance, collecting relevant data, using scientific tools & techniques
and solution methodologies for analysing and developing effective as well as efficient
solutions to the problem at hand. Another aspect of Operations Management pertains to
addressing several issues that an organisation faces. These issues vary markedly in
terms of the time horizon, the nature of the problem to be solved and the commitment of
the needed resources.
For example, performing the task even though the machine breaks down or during
shortage of time or taking decisions on critical issues related to product and service
require greater commitment of time and resource.
Operations Management provides alternative methodologies to address such wide-
ranging issues in an organisation. Through careful plan and control of the operations, the
organisation can keep „costs‟ to the minimum and definitely below „revenues‟ obtained
from the market. In order to ensure this, an appropriate performance evaluation system
is required, the development of which is also the job of Operations Management.

1.2.2 Scope of Operations Management

The scope of Operations Management ranges across the organisation and is vast. It
commences with the selection of location followed by activities such as acquisition of
land, constructing building, procuring and installing machinery, purchasing and storing
raw materials and converting them into saleable products.
Quality management, maintenance management, production planning and control,
methods improvement and work simplification and other related items come under the
scope of operations management.
Operations Management personnel are involved in activities such as:
 Product and service design.
 Process selection, selection & management of technology.
 Design of work systems.
 Location planning.
 Facilities planning and quality improvement of the organisation‟s products or
services, which mostly involve relatively longer-term decisions.

Self Assessment Questions

1. Operations Management, deals with the production of ________ and _______.

2. Through careful plan and control of the __________, the organisation can keep
______ to the minimum and definitely below „revenues‟ obtained from the market.
1.3 Evolution of Operations Management
During the Industrial Revolution in the 1770s, it was common for one person to be
responsible for making a product, such as horse-drawn cart or a piece of furniture, from
start to finish. Modern machines were not available.
Innovations in the 18th century replaced human power with machine power. Craft
production was slow and costly in the early days. Many companies emerged, each with
its own set of standards. Factories began to spring up and grow rapidly, providing jobs
for countless people. In spite of changes, management theory and practice did not
progress well. Enlightenment and more systematic approach to management were

Scientific Management movement

Scientific Management brought an extensive change to the management of factories.
Frederick W. Taylor1, headed the Scientific Management

1 The father of Scientific Management Operations Management

movement along with Frank Gilbreth, Henry Gantt, Harrington Emerson and Henry Ford.
Taylor‟s methods emphasised on maximising outputs but they were not popular with
workers as the latter felt they were exploited. To improve efficiency of operations, Ford
adopted Scientific Management. He introduced Mass Production and division of labour
in the automobile industry. These concepts helped Ford to increase the production rate
at his factories as he used the readily available inexpensive labour. Both Taylor and
Ford were despised by many workers, because they held workers in such low regard,
expecting them to perform like robots. This paved the way for the human relations
The Human Relations movement
While the Scientific Management movement heavily emphasised on the technical
aspects of work design, the human relations movement emphasised the importance of
the human element in job design. Lillian Gilbreth, a psychologist, worked with her
husband, Frank Gilbreth, focusing on the human factor in work. Many of her studies in
the 1920s dealt with worker fatigue. During the 1930s, Elton Mayo‟s studies at
Hawthorne division of Western Electric revealed that, in addition to the physical and
technical aspects of work, worker motivation is critical for improving productivity.
Decision Models and Management Science
The factory movement was followed by the development of several quantitative
techniques. In 1915, a mathematical model for inventory management was developed.
In the 1930s, three co-workers at Bell Telephone Labs - Dodge, Romig and Shewart –
developed statistical procedures for sampling and quality control.
The Computer Revolution
Development in communications technologies and computer has allowed companies to
easily manage international operations and to work on projects in globally dispersed
teams. Extensive use of e-mail allows employees to quickly and cheaply communicate
with vendors and customers, resulting in fast decisions and improved operational
performance. New technologies are forcing organisations to change the ways they do
business and conduct their operations. These technologies, in turn, have created
additional challenges for operations managers.
Self Assessment Questions
3. Innovations in the 18th century replaced ________ with _________.
4. In the 1930s, three co-workers at Bell Telephone Labs ______,______ and
_________ developed statistical procedures for sampling and quality control.

1.4 Operations Functions

An operating system is a group of resources combined to provide goods or services. For
example, bus/taxi services, motels, dentists, fire services, retail organisations, hospitals,
builders are all operating systems.

1.4.1 Resources in Operating Systems

Operations managers are principally concerned with the use of physical resources.
Therefore, the focus is on a physical view of operating systems and concentrating on the
physical resources used by the system, which for convenience is categorised as follows:
 Materials: The physical items consumed or converted by the system like raw
materials, fuel, and indirect materials.
 Machines: The physical items used by the system, example plant, tools, vehicles,
buildings, and so on.
 Labour: The people who provide or contribute to the operation of the system, without
which neither machines nor materials are effectively used.

The examples given above illustrate the variety of systems that may be considered as
operating systems. A simple categorisation these systems would distinguish between
goods-producing and service-producing systems. The function of an operating system is
a reflection of the purpose it serves for its customer, i.e. the utility of its output to the
customer. Four principal types of systems that can be identified, they are:
 Manufacture: The principal common characteristic is that something is physically
created, i.e. the output consists of goods which differ physically – in form or content –
from the input materials to the system.
 Transport: The principal common characteristic is that a customer or something
belonging to the customer is moved from place to place.
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 Supply: Unlike in manufacture, goods output from the system are physically the
same as the inputs to the system. There is no physical transformation and the system
function is primarily one of change in possession utility of a resource.
 Service: There is a change in state of utility of a resource, that is, the state or
conditions of physical outputs differ from inputs.

Many organisations comprise several systems with different functions. For example, an
airline depends on operating systems that serve the purposes of transport, supply and
service where as a typical manufacturing organisation will have internal transport and
service systems.
1.4.2 Role of Operations in an Organisation
Operations functions help to appreciate the role of operations in an organisation and its
relationship with other functional areas of business. Every organisation has a few
important activities to be performed. This includes:
 Operations
 Marketing
 Finance
 Human Resource Management

Operations manage the „conversion‟ process in the organisation. The marketing

function, understands the customer‟s needs, creates a demand for the products and
services, and satisfies the customers‟ requirements by delivering the right products and
services at the right time, and at the right place. Finance estimates the activities related
to operations and marketing. Every organisation employs a number of people who have
varied skills, backgrounds, and work requirements. Human Resources Management
function deals with the issues related to them.
Every organisation has five layers of functions/activities that make up its „Value Chain‟.
These five layers are:
 Customer layer: This layer consists of the customer and dealers/ retailers.
 Layer of Innovation: This layer consists of innovative strategies and Research and
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 Core Operations layer: This layer consists of fabrication, machining, assembly,
testing and service delivery system.
 Supplier layer: This layer consists of suppliers, sub-contractors and other service
 Operations Support layer: This layer consists of marketing, maintenance, quality,
costing planning, tooling, material, IT, design and industrial engineering.

Core operations layer represents the manufacturing setup in case of a manufacturing

organisation. In every organisation, other activities, represented by operations support
layer, interact with the core operations layer and provide a variety of support services.
Issues in Operations Management
The two major issues in Operating Management are:
 Design
 Operational Control Analysis

These two issues help you in assessing Operations Management functions better.
Design issues relate to configuration of the operations system and provide an overall
frame work under which the operations system functions. Design issues in Operations
Management lay down the overall constraints under which the operations system
functions. For example, once the capacity of the resources to be used in the system is
decided, it sets limits for the actual use of the system in operation.
Once the design choices are exercised, Operations Management amounts to putting the
available resources to best use and handling various issues. The available capacity, for
example, can be better utilised by planning production and carefully scheduling
operations so that idle time is minimised. Further, required capacity and material could
be estimated and made available through purchasing and scheduling procedures. All
these constitute operational control decisions in Operations Management.
Every issue addressed in design is inevitably addressed once again in operational
control. The context, however, differs between the two. Design issues often turn out to
be strategic in nature. Strategic decisions frequently involve large capital outlay and are
taken with critical inputs from an operations strategy process. The top management take
such decisions to Operations Management Unit 1 .: 9
improve the competitiveness of the organisation. On the other hand, operational control
issues are tactical, repetitive and routine in nature. Lower level operations managers and
production supervisors often make such decisions.
Operational decision can be long term, short term or medium term. Table 1.1 gives a
comparison of operational decisions.
Table 1.1: Comparison Short term Medium term
of Operational
Decisions Long term
Operations decision Operations decisions are Operations decision
taken once in five to ten taken for the short run of taken in fixed cycles of
years. a week or less. one year.
Decisions of multiple Decisions include Business plan with
levels and huge capital detailed scheduling of specific targets of sales,
outlay are taken. operations, quality The annual business
management and control production planning,
and reacting to master production
disruptions and changes scheduling and material
in plans. and capacity
requirements planning
are done.

Unit 2 Frameworks for Operations Management

2.1 Introduction
2.2 Operations as Systems
The Systems View
Operations as Transformation Systems
2.3 Dimensions of Competitiveness
2.4 Operations Mix: the Six P.s of Operations
2.5 Porter.s Value Chain
2.6 Order Winners, Order Qualifiers, and the Kano Model
2.7 Product Life Cycle
2.8 Volume Variety Matrix and Product Process Matrix
2.9 Quality and Productivity
2.10 Universal Principles
2.11 Summary
2.12 Terminal Questions
2.13 Answers
2.14 Case Study
2.15 Glossary

2.1 Introduction

By now you must be familiar with the basic concepts of operations management. This unit
explains the partnership between operations and marketing, which is crucial to the success of any
Several organisations are involved in three basic activities:
. Identifying potential customers, seeking to understand their needs, and encouraging them to use
the product or service
. Providing the product or service efficiently and effectively
. Managing the organisation.s finances to ensure continuing success
You can refer to these three activities as marketing, operations, and finance. Even though the first
and last activities are usually named in even a small organisation, it is comparatively rare, outside
manufacturing companies, for the operations function to be identified. Various organisations
resolve issues
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related to operations in an informal way. This may be sufficient. However, an organisation of any
size needs to take these three activities very seriously irrespective of what they are called.
Typically, in a manufacturing organisation, these three activities are in a state of tension. Thus
marketing seeks to advance service and to offer a greater variety of product choice to the
customer. Operations or production seeks to improve competence by reducing inventories and by
longer runs of fewer products. This conflicts with marketing objectives. Finance seeks to reduce
cost, by restricting inventories and by reducing expenses on machines and staff. This conflicts
with both marketing and operations objectives.
The typical contradictions between these activities are no longer as strict as was once thought.
With the use of Just-In-Time (JIT) inventory systems and such other flexible manufacturing
systems, it is now often possible to have,
. Low inventories
. High quality products
. Good customer service
. High productivity
. Relatively low investment in machines
Marketing and operations are, or should be, equal partners in the success of the organisation. In
this view, although from different perspectives, they share numerous common reference
frameworks. We consider each in the following sections.
Learning Objectives:
This unit of operations management familiarises you with partnership between operations and
marketing and different frameworks available for the operations management. After reading this
unit, you will be able to:
. Discover the relation between operations and marketing
. Explain system view of operations
. Explain dimensions of competitiveness
. Analyse the six P.s of operations mix
. Explain Porter.s value chain
. Explain order winner, order qualifier and Kano model
. Describe product life cycle stages
. Differentiate between volume variety and product process matrix
. Differentiate Quality and Productivity
. List out the universal principles

2.2 Operations as Systems

2.2.1 The Systems View

A system can be defined as a group of entities together with the association among them. This
simple definition contradicts its importance for the Operations manager or for management in
general. It is essential for an Operations manager to have a systems view because he or she
must be able to see the entire process, from concept to completion. The entire process chain may
include outside suppliers, service delivery and back-up, and the information flows that are
required for the same.
Systems can be described as having either open or closed features. These describe the extent to
which communications and interactions take place freely across the system boundaries.
Boundaries are not just material, like the walls of a particular functional area. They can also be
invisible, and represent, for example, the authority exercised by a manager. In today.s business
world, there is often a global dimension with international companies. Nowadays, the diversity of
boundary crossing communications is increasing continually.
An open system has some boundary regulations. System thinkers argue that every system needs
inputs of resources to produce outputs of goods or services. Without these resources, the system
falls down. What is in debate is the level of control or limitation of freedom placed on a system
boundary. A totally closed system exists only as an abstract model.
Systems and sub-systems can be grouped along the open-closed band, and recognised as a
.relatively-open. or a .relatively-closed. system. There are expenses and threats involved with all
points on the band. When there are more controls on a boundary, the costs are greater. Similarly,
when a boundary is more open, potential loss through theft or mistreatment is greater.

Figure 2.1 gives a pictorial representation of systems showing closed and open features.
Controlled interaction
with the environment
Free interaction with
Closed system
Relatively closed or
Relatively open
Open system
No inputs
Known and
defined inputs
unknown and
No outputs

Figure: 2.1 Open and Closed System Features

The boundaries around systems and sub-systems tend to be defined by the
degree of professional control over the resources being used. Free
movement of resources and easy communications recommends a more
open system. Controlled access and controls tend more towards a closed
system. Closed systems are more expensive to maintain. In severe cases it
leads to failure of the system as it is cut off from its environment. Likewise,
the more closed a system is, the more likely it becomes ill-adapted to the
changing world around it.

Activity 1:
Think of a hospital. On what basis you call it a closed
system? On what basis you call it an open system? Why
does it need to be open in some respects and closed in
others? Indicate operations management issues which arise
when we look at these features.
2.2.2 Operations as Transformation Systems
Any operations system can be looked in as a composition of three major
components with significant communication relation. Each component and
its pathway itself are of interest to the Operations manager.
If we need to create a new operational system or resolve a problem in an
active system, the construction of a simple systems diagram showing these
components significantly assists our understanding.
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Figure 2.2 illustrates a basic input-transformation-output model.
Input(s) Transformation Output(s)
Figure 2.2: The Basic Input-Transformation-Output Model
In operations management terms, inputs are resources which are introduced
into the system in an organised and controlled way. These inputs include:
materials, capital, equipment, personnel, energy, skills and time.
The transformation procedure consists of the use of manufacturing or
service operations which change or employ the input resources to add
The outputs of the system include products and services with the right
quality, in the right quantity and at the right time.
2.3 Dimensions of Competitiveness
Operations management plays a key tactical role inside an organisation. In
his book1 argues that there are five performance objectives which allow an
operations-based advantage to be gained:
. Doing things correct results in a quality benefit
. Doing things quick results in a speed benefit
. Doing things on time results in a reliability benefit
. Changing what you do results in a flexibility benefit
. Doing things inexpensively results in a cost benefit
To have an edge over competition, it would benefit organisations if they
consider the following six dimensions of competitiveness:
. Price: For any market there can be only one least price contestant. If
some contestant reduces the price less than the existing least price
contestant then he will become the least price contestant. The difference
between cost and price (i.e., margin) is as significant as the least price.
Efficient operations can make a huge difference to the margin.
1 The Manufacturing Advantage . Achieving Competitive Manufacturing Operations by Nigel
Slack (1991)
Quality: Quality is one of the most important factors of competitiveness. Quality and price are
related two ways. Higher quality typically means that a higher price can be asked. Oddly perhaps,
a higher-quality product can often mean lower cost though less waste, rework, and returns.
. Delivery: Delivery time and delivery consistency are operations-driven dimensions with major
impact for marketing. Frequently being able to deliver ahead of the competition and with greater
reliability can command a price payment.
. Speed: Closely related to delivery is speed. What is meant by speed in this circumstance is
reduced time to bring new products to market, or to devise and make products faster than a
competitor is able to do so.
. Design: Design is what includes .that little something special. to a product or service. Design
may be observed as an aspect of quality, but it is so significant to marketing and operations that
we look at it individually. Good design is not just the work of a motivated artist. It requires co-
operation from both marketing and operations.
. Flexibility: Flexibility is a calculated approach aimed at gaining an advantage in an increasingly
competitive world. In fact, flexibility is regarded as one of the few remaining .order winners..
There are different types of flexibility:
a. To modify easily from making one product to another within a standard range.
b. To change volumes easily.
c. To bring in new products easily.
Self Assessment Questions
1. The three basic activities of organizations are ______, ______ and ____.
2. ________ seeks to reduce cost.
3. ____ and ____ should be, equal partners in the success of the organisation.
4. There are _________ dimensions of competitiveness.
5. _________ closely related to delivery.
6. ______ and ____ are operations-driven dimensions with major impact for marketing.
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2.4 Operations Mix: The Six P¡¯s of Operations
Operations mix are the elements of the operations involved in service and manufacturing
organisations which convert raw materials into finished products. Similar to the marketing mix, the
operations mix offers an easy-to-remember frame of reference. It also offers an integrated
package of the factors that should be measured together when designing a new or revised
operation. The source of the operations mix is not clear, but an early version was developed by
Professor Keith Lockyer of Bradford Management Centre (1988).
The six elements of operations mix are:
. Product: For convenience we refer to .product. but .service. could be evenly applicable. In
operations, it is the design and quality of the product or service that is vital. Product design is the
essential interface between marketing and operations.
. Process: Suppliers, either internal or external, provide the inputs and customers, either internal
or external, receive the outputs. Feedback must function in between customers and the process.
It should also function between process and suppliers. Recently, in operations management,
attention has been given to .process. from the perspectives of quality and time.
. Place: In operations, .place. means location and layout. Discovering the location is a classic
problem of operations management. Having decided on the location, attention turns to layout of
the factory or office.
. Programmes: .Programmes. in operations means the schedules and plans under which
operations are performed. In manufacturing operations, such programmes are comparatively
standardised. They range from the manufacture plan to material requirements plan, capacity
plans, and detailed shop floor schedules.
. Procedures: Procedures cover .how should it be done.. This is a conventional field of study for
operations managers, with its recent origins in the work of Frederick Taylor and the founders of
motion study, such as Frank and Lillian Gilbreth. Whatever the task, there is a best and safest
way of performing it; the issue is therefore how this best and safest way is to be determined.
. People: Last but not the least, comes people. People drive all the other five Ps, indeed their
contribution is growing rather than declining.
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Activity 2:
Most operations-based organisations are part of a .supply chain.. The six elements of operations
mix transform raw materials into finished products when performed in a chain fashion. Select an
everyday product such as news paper and draw out the chain which results in the final product
reaching the customer. Then consider:
. What each stage requires from the previous stage
. What performance measures are critical at each stage
. What communication channels are used between each stage
. What distribution channels are used
. What quality requirements are needed at each stage
2.5 Porter¡¯s Value Chain
The proposal of the value chain is based on the process view of organisations. The idea of seeing
a manufacturing (or service) organisation as a system, made up of subsystems each with inputs,
transformation processes and outputs. Inputs, transformation processes, and outputs involve the
acquisition and utilization of resources such as capital, labour, resources, equipment, buildings,
land, administration and supervision. How value chain activities are carried out determines costs
and affects profits.
According to Porter (1985), the primary activities are:
. Inbound Logistics . includes associations with suppliers and contain all the activities required to
receive, store, and distribute inputs.
. Operations . includes all the activities essential to convert inputs into outputs (products and
. Outbound Logistics . includes all the activities necessary to collect, store, and distribute the
. Marketing and Sales . includes activities notify buyers about products and services, encourage
buyers to purchase them, and assist their purchase.
. Service . includes all the activities required to keep the product or service working efficiently for
the buyer after it is sold and delivered.
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Secondary activities are:
. Procurement . It is the purchase of inputs, or resources, for the firm.
. Human Resource Management . It consists of all activities involved in recruiting, hiring, training,
developing, compensating and (if necessary) dismissing or laying off personnel.
. Technological Development . It pertains to the equipment, hardware, software, measures and
technical knowledge brought to bear in the firm's transformation of inputs into outputs.
. Infrastructure . It serves the company's needs and ties its various parts together. It consists of
functions or departments such as accounting, legal, finance, planning, public affairs, government
relations, quality assurance and general management.

Figure 2.3 gives us a clear idea of the primary and secondary activities of Porter.s Value Chain.

Figure 2.3: Porter¡¯s Value Chain

2.6 Order Winners, Order Qualifiers and the Kano Model

For a specific product, some of the dimensions of competitiveness are more important than
others in a specific market during a specific time. Hence, it is useful to differentiate between so-
called order winners and order qualifiers.

An order qualifier is your ticket to go into the race. An example of an order

qualifier is the quality assurance standard ISO9000, currently stipulated by
many international companies. An order winner is what lets you to take off
the award. An illustration of an order winner is the operating system of Apple

An optional way of looking at the competitive dimensions is through the

Kano model3. Kano is a Japanese quality specialist who believes that
product characteristics can be classified into .must be., .more is better., and

Figure 2.4 depicts the Kano model which shows the degree of achievement
of customer satisfaction.

More is better
Must Be
Absent Fullfilled
Degree of
Customer Satisfaction
Figure 2.4: The Kano Model
The Kano model:
. Helps to explain requirements. If requirements are satisfied, they
contribute to customer classification, neutrality, or satisfaction.
. Identifies the ¡°Must Be¡± needs, which the client expects. If they are
unfulfilled, the customer is dissatisfied. However, even if they are entirely
satisfied, the customer is not particularly satisfied. An example of a Must
Be need is airline safety.
3 Joiner, 1994.
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. Identifies the ¡°More Is Better¡± needs, which have a linear effect on customer satisfaction: The
more these needs are met, the more satisfied customers are. An example is low-priced airline
. Identifies ¡°Delighter¡± needs, which are those that do not cause dissatisfaction when not
present but satisfy the customer when they are. An example is serving hot chocolate chip cookies
during an airline flight.
. Helps in the prioritization of needs . for example, Must Be needs are usually taken for granted
unless they are absent. These needs are to be taken care first.
2.7 Product Life Cycle
The Product Life Cycle (PLC) is a widespread phenomenon. Marketers regularly identify four or
five stages through which a product passes. The relating of marketing strategy with life cycle
stages is well established. But operations also can be connected to the life cycle stages. Figure
2.5 shows the combination of both marketing and operations implication of the various stages in a
life cycle.
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Development Growth Maturity Decline
and cost
Reduction in
Quality through design
Quality through conformance
Job shop? Batch? Line?
Line but with
no further
Investments (?)
Location is the
Layout of
is the priority
layout is the
Innovation Flexibility Consistency Flexibility
Reduction to
retain or to
gain market
through price
Making money as
long as possible
through pricing for
maximum profit
without further
Not critical
Critical Less critical
Figure 2.5: The Product Life Cycle: Operations Implications
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The product goes through development, growth, maturity, and decline phases. Several products
may travel through PLC in a few weeks, others may take decades. If you demonstrate a graph of
volume versus time, the characteristic shape of a PLC is a stretched out S. In its development
stage, small quantities are produced and the importance is given to design and innovation. As it
reaches this growth step, large quantities are produced at a smaller unit price. This levels out in
the maturity step. You can see the implications for operations management at all stages of the life
cycle as mainly process, procedures and delivery mechanisms should change.
Corresponding with each stage of the PLC, we comment on some features of competitiveness. In
addition, to make the connection with the next section, we comment on process. Process in this
circumstance means the way in which operations are actually arranged and the suitable selection
of technology. We are not suggesting all products evolve through having to adopt particular
technologies or layouts at various stages of their PLC. However, one particular choice of layout or
technology will probably be compatible with marketing strategy at various stages of the PLC. An
Operations manager should appreciate that he or she needs to settle in right through the PLC.
You should refer to section 2.4 and 2.8 to get a better understanding of the operations

2.8 Volume Variety Matrix and Product Process Matrix

A most practical method of viewing operations management is through the product process
matrix4. Figure 2.6 shows the product dimensions of volume and variety and its ordering along
the horizontal axis, and ordering of the process on the vertical axis from project to continuous
4 Hayes and Wheelwright, 1984
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Civil engineering building
Heavy engineering
Expensive restaurant
Insurance policy processing
Electronic components
Food manufacturers
Fast food outlet
Car manufacture
Oil refinery
Job shop
Assembly line
Continuous flow
Low volume
limited variety
High volume
Figure 2.6: The Product Process Matrix
In brief, we can elucidate process types as follows. The project form of
process takes resources to the project, rather than taking the project to the
place of work. A typical case is a civil engineering project, such as
constructing a bridge. On a lesser scale, the start of a new product has
similar characteristics.
In a job shop work is ordered around related skills; in a factory all the lathes
may be assembled together; or in an office all the accountants work in the
same section.
In batch processes, the outline order is similar to the job shop but more
concentration is paid to the flow of work. Here, as the name suggests, work
is done in batches. In an office, application forms for admittance to
university, for example, are processed in groups.
An assembly line takes specialisation further and tends to be more highly
mechanized as is suitable to superior volumes. The car assembly line is the
typical case, but offices too may have assembly lines for cheque approval.
Finally, continuous flow processes are found in the chemical industry.
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A cell is an intermediate stage between batch and assembly line. In a cell, all the machines
needed for a particular product or assembly are ordered in sequence close to one another so that
.one-piece flow. is possible.
We can also use the product process matrix to visualise suitable approaches to scheduling, this is
central to operations management.
2.9 Quality and Productivity
Progressively, managers understand that quality and productivity are partners and not
substitutes. As Deming (1986) has pointed out, enhanced quality cuts fault rates. Cutting fault
rates means less waste, enhanced efficiency, reduced cost, reduced prices. It expands markets
and creates more work. Improving quality and productivity have rightly become a central concern
for operations manager.
Operations managers have realised that they cannot accomplish quality and productivity goals by
themselves. An entire organisational effort is required. Quality received a huge boost in the late
1980s with the extensive implementation of Total Quality Management (TQM). This was possibly
one of the most important developments for operations manager.
Similar to quality, and related to it, productivity is an essential concern of operations
management. Productivity is of particular importance to marketing and finance. Even though,
productivity can be defined in common terms as being the ratio of outputs to inputs, it is suitable
for us to start looking at productivity by first looking at changes in profitability from one period to
the next. An accountant would view a change in profitability from one period to the next resulting
from a change in revenues and/or a change in costs.
Changes in income result from changes in product quantities and/or from changes in product
costs. Similarly changes in costs result from changes in resource quantities and form changes in
resource costs. Figure 2.7 shows the accountants view of profit change.
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Change in
Change in
Change in
product prices
Change in
Change in
Change in
Change in
resource prices
Figure 2.7: Profit Change: The Accountant¡¯s View
This finishes the standard accounting vision. Management accountants will
seek to understand variations from budgets by variances in each of these
four areas. Operations managers are usually more concerned in productivity
change. We may note that a change in productivity results from changes in
the ratio of product quantities to changes in resource quantities. This uses
the parallel definition of productivity as being outputs/inputs. Similarly we
can view a change in price recovery as resulting from a change in the ratio
of product prices to changes in resource prices.
Thus price over-recovery replicates a situation where prices of products
are increased more than the costs of resources, and price under-recovery
replicates the situation where the organisation absorbs some of the cost
increases and does not increase the cost of its products by as much as
resources costs have risen.
2.10 Universal Principles
We have seen the variations in processes, automation and scheduling in the
volume variety and product process matrix. You could ask if there are
principles of operations management that apply across the entire product
process matrix.
Schonberger and Knod (1994) present one of the most useful lists of
principles, applicable both to service and manufacturing operations. They
challenged that these principles can make a massive difference to any
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operations-based organisation. They compiled a list of principles. According to them,
organisations involved in the service and manufacturing sector should:
. Get to understand and team up with the next and last customer
. Become committed to repeated, quick improvement in quality, cost, lead time, flexibility,
inconsistency, and service
. Accomplish unfilled purpose via shared information and team participation in forecasting and
implementation of change
. Get to understand the competition and the world-class leaders
. Cut the number of product or service components or operations and number of suppliers to a
few good ones
. Arrange resources into multiple chains of customers, each focused on a product, service or
customer family; create cells, flow lines and plants-in-a-plant
. Constantly invest in human resources through cross training, education, job and career path
rotation, and improved health, safety and security
. Preserve and improve present equipment and human work before thinking about new
equipment; mechanize incrementally when process inconsistency cannot otherwise be reduced
. Look for simple, flexible, movable, low-cost equipment that can be acquired in multiple copies,
each assignable to focused cells, flow lines and plants-in-a-plant
. Make it easier to make/provide goods or services without error or process variation
. Cut flow time (waiting time), distance and inventory all along the chain of customers
. Cut set-up, changeover, get-ready and start-up times
. Function at the customer.s rate of use, reduce cycle interval and lot size
. Trace and own quality, process and problem data at the workplace
. Make sure that front line improvement teams get first chance at problem solving before staff
. Cut transactions and reporting
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Self Assessment Questions
State whether True or False:
7. Order qualifier is your ticket to go into the race.
8. Kano is a Chinese artist.
9. Product life cycle has five stages.
10. Cell is an intermediate stage between batch and assembly line.
11. Price over-recovery replicates a situation where prices of products are increased more than
the costs of resources.
12. Operating system of Apple computers is an example of order qualifier.
2.11 Summary
Partnership between operations and marketing is crucial to the success of an organization. There
are many frameworks exist to manage the operations. A system view is very important for the
operations manager since he has to visualize the operations from concept to completion.
Dimensions of competitiveness are essential to survive in the business world. Like marketing mix,
the operations mix offers an easy-to-remember frame of reference. It also offers an integrated
package of the factors that should be measured together when designing a new or revised
operation. Value chain process is necessary for success of any organisation, how value chain
activities are carried out determines costs and affects profits. For a specific product, some of the
dimensions of competitiveness are more important than others in a specific market during a
specific time. Hence, it is useful to differentiate between so-called order winners and order
qualifiers5 .Kano model classified product characteristics into must be., .more is better., and
.delighters.. The PLC is a widespread phenomenon. A most practical method of viewing
operations management is through the product process matrix6. Quality and productivity are
partners in the success of an organisation and not substitutes.
2.12 Terminal Questions
1. Explain in brief relation between operations and marketing.
5 Hill, 1993
6 Hayes and Wheelwright, 1984
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2. Explain operations as systems with open and closed features.
3. Describe the six dimensions of competitiveness.
4. Describe operations mix.
5. Explain Porter.s value chain model in detail.
6. What are order winners order qualifiers? Explain with examples
7. Explain Kano model in detail.
8. Describe the different stages of PLC with diagram.
9. Explain Volume variety matrix and Product process matrix.
10. Describe Quality and Productivity role in an organisation.
11. List out five of the universal principles.
2.13 Answers
Answers for Self Assessment Questions
1. Operations, Marketing and Finance
2. Finance
3. Marketing and Operations
4. Six
5. Speed
6. Delivery time and Delivery consistency
7. True
8. False
9. False
10. True
11. True
12. False
Answers for Terminal Questions
1. Refer section 2.1
2. Refer section 2.2
3. Refer section 2.3
4. Refer section 2.4
5. Refer section 2.5
6. Refer section 2.6
7. Refer section 2.6
8. Refer section 2.7
9. Refer section 2.8
10. Refer section 2.9
11. Refer section 2.10

2.14 Case study

Beating the Budget with the Product Life Cycle

Client Organization
A renowned U.S. Home Fashion company had just closed down their trade operations in favour
of shifting to a licensing organization working with U. S. manufacturers and marketers of Home
Decorating and Furnishing products.
Client Objective
The objective was to educate the corporate account executives and staff about the ¡°Product Life
Cycle¡± and how they might use this knowledge in working with licensees to increase sales and
profitability for both the company and the licensees.
Provide a basic understanding of Marketing and the Product Life Cycle.
Help the participants recognize the various stages of the life cycle and the steps that can be
undertaken to extend the life and revenue stream.
Help participants recognize the hidden clues in their relationships.
What was done?
A participative training program was undertaken that involved everyone in the company. Real life
examples were analyzed and used by the participants in an experiential process.
1. Map different stages of Product Life Cycle with this case study.
2. Find out the possible outcomes of this case study.
Operations Management Unit 2
2.15 Glossary
Price over-recovery
Replicates a situation where prices of products are increased more than the costs of resources.
Price under-recovery
Replicates the situation where the organisation absorbs some of the cost increases and does not
increase the cost of its products by as much as resources costs have risen.
The quality of being adaptable or variable.
A remarkable development
Lot size
Measure or quantity increment acceptable to or specified by the party offering to buy or sell.
Problem data
Data which gives definition of the problem.
1. Contemporary Marketing, by David L. Kurtz, H. F. MacKenzie, Kim Snow.
3. Operations Management, by C. Donald J. Waters, Donald Waters.
4. The Manufacturing Advantage . Achieving Competitive Manufacturing
Operations by Nigel Slack (1991)

Unit 3 Competitiveness and Strategies

3.1 Introduction
3.2 Productivity
Different Types of Productivity
3.3 Competitiveness
Competitive Dimensions of Operations
3.4 Strategy
3.5 Business Strategy and Operations Strategy
Operations Strategy model
3.6 Global Environment of Competition
Global Competition
Quality, Customer Service and Cost Challenges
Advanced Technologies
3.7 Summary
3.8 Terminal Questions
3.9 Answers
3.10 Case study
3.11 Glossary

3.1 Introduction
By now you must be familiar with the frameworks of Operations Management. This unit
familiarises you with competitiveness and strategies of organisations with respect to operations
Each competing organisation in the industry has a competitive strategy1. Some of the basic
questions businesses need to consider are:
„h What factors drive competition in the industry we are concerned with?
„h What are our competitors doing to gain an advantage and how can we best respond?
1 Reference:
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„h How do we, as an organisation, position ourselves to compete in the long run?
There is an increasing awareness that operation strategies should lead to global competitiveness
and not merely limit to the firm.s products and services. This can be done by contributing
distinctive capability (or competence) to the business and continually improving the products and
processes of the business.
Operations are either a competitive weapon or a corporate milestone. Operations should be fully
connected with business strategy. Operations strategies and decisions should fulfil the needs of
the business and should add competitive advantage to the firm.

We have seen that wealth can only be created by operations that are productive in relation to a
known market, with the required financing and human resources. This means that all of the
functions of the firm must be well coordinated to earn revenue and have a competitive advantage.
The cross functional coordination of decision making is facilitated by an operations strategy that is
developed by a team of managers from across the entire business.
Learning Objectives:
After studying this unit you will be able to:
„h Define productivity and its importance.
„h Explain about the global environment of business and competition.
„h Analyse why some companies are more successful at competing than others.
„h Discuss how effective strategies can lead to competitive organisations.
„h Explain how organisations can improve productivity.
3.2 Productivity
.Productivity., in business, is a measure of performance of a company, in terms of how effectively
and efficiently it is using its resources. Productivity is related to Operations Management as it
focuses on maximising its resources. utilisation. In the larger context of the organisation, strategy
can either be to differentiate its products without specific focus on the cost, or to focus on being a
low-cost producer without a particular emphasis on differentiated product. In either case, the cost
of operations are key to
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.winning. in the market, because even for a highly differentiated product, the demand will be
under threat if the costs of operations are so high as to push the product prices beyond the
customers. value perception.
Productivity directly influences the cost of operations. Productivity can be simply defined as the
ratio of outputs to Inputs. In general, the output is referred to in terms of the value of the products
or services produced by the company, while the input can be a number of factors invested in: raw
materials, capital, labour, energy, etc, or a combination of them. Thus,
Labour Productivity = Output of Products / Labour Input
On the other hand, 2
Overall Productivity = Output of products / All Resources used
Hence, a company in order to optimise its cost levels, and effectively create a competitive
advantage should improve its productivity levels.
3.2.1 Different Types of Productivity
Productivity can be divided into three types. They are:
1. Technological Productivity
2. Employee Productivity
3. Managerial Productivity
Technological Productivity is the level of output received after using any technology or device
within a certain period of time. Adopting new technological advancements, for example, CAD
(Computer-aided Design) and CAM (Computer-aided Manufacturing), can enhance the
Technological Productivity.
Employee Productivity is the level of output received from the employees within a certain period
of time. Good training to the employees, encouraging multi-skilled labours, introducing new tools,
encouraging participation in Managerial decisions in the company can achieve good Employee
2 For more information on different kinds of Productivity please visit
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Managerial Productivity is the level of output received from Managers within a certain period of
time. Managerial productivity can be achieved if the Managers crave for quality rather than
quantity. They should also encourage employees to participate in the decision-making issues
related to the company. Managers should also cultivate the habit to reward the employees for
their performance and should adopt some managerial techniques to improve the Productivity.
Thus the Productivity of any company or organisation depends on both people and operations
variable which in turn improves business competitiveness.
Self Assessment Questions
1. Operations strategies and decisions should fulfil the needs of the business and should add
______________ to the firm.
2. Productivity is related to Operations Management as it focuses on ___________ its resources..
3. Productivity can be simply defined as the ratio of ________________.
Activity 1:
Visit the branch of Britannia foods in your area and create a report on how productivity influences
the cost of operations.
3.3 Competitiveness
Competitiveness of a firm is simply its propensity and ability to compete with other firms in the
industry. An average company tries to survive in the market whereas a highly competitive
company fights the competition and tries even to change the .rules of the game.. Competition has
become the major challenge as more and more companies are entering in contest, and trying to
corner larger market shares for themselves in their product markets. The size of the .market.
remains more or less the same, but the number of firms competing for their individual shares are
increasing rapidly. In countries like India and China, where the markets for many products /
services are still growing, the markets offer hope and scope for the firms to succeed and operate
profitably, provided they plan properly and execute them effectively.
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Today, the importance of competitive advantage for a firm could be greater. All well-run firms are
constantly striving for and working towards attaining competitive advantage and sustaining it in
the long run. This is important in order to run their organisation profitably in a highly competitive
and fast-changing market. These are done through formulation of well thought-out competitive
strategies and implementing them effectively.
3.3.1 Competitive Dimensions of Operations
Some of the factors that influence the competitive position of a firm can be listed under the
following categories:
„h Cost / Price: Large segments of most markets, especially in less developed countries like India
¡V buy solely on the basis of price. Hence, manufacturers or service providers need to focus on
being low-cost producers. Typically, such products are like commodities.
„h Quality: Many people prefer products that are superior in quality, in terms of reliability or
performance or durability. For manufacturers, quality can be introduced either through product
design or through superior process. However, too much emphasis on quality or attributes of a
product would render the product over-priced.
„h Delivery speed: Ability of a company to deliver a product quickly could give the company an
edge in the market.
„h Reliable delivery: This refers to the ability of a company to deliver its product or offering as per
commitment made to the customer. Often, this aspect becomes more important than the .speed
of delivery..
„h Flexibility in supply: The ability of a company to adjust or respond to sudden changes in
demand would give it considerable advantage in the market, since market demands are
unpredictable and companies experience sudden surges or fall in demand. Hence, a company
with the flexibility in operations can either leverage the situation of excess demand or effectively
cope with the sudden fall in demand such that it maintains its inventory or capacity costs at low
„h Flexibility in new product introduction: Another important aspect of .flexibility. that company
should have is to introduce new products or in offering a variety of products. A company which is
able to switch to new products, or from one existing product to another, enjoys market advantage.
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Activity 2:
Visit any supermarket and note the competitive strategy they use to compete with the other
supermarkets in the area.
Self Assessment Questions
4. Competitiveness of a firm is simply its propensity and ability to __________ with other firms in
the industry.
5. _________,______,_____,______,____,___ are the factors that influence the competitive
position of a firm.
3.4 Strategy
Essentially, developing a competitive strategy means - developing a broad formula for how a
business is going to compete, what its goals should be, and what policies are needed to carry out
these goals.
Competitive Strategy can be defined as a combination of the goals which the organisation works
towards achieving and the policies it needs to implement to attain these goals. Different
terminologies may be used by different firms, such as: ¡§mission¡¨ or ¡§objectives¡¨ or ¡§goals¡¨;
¡§tactics¡¨ or ¡§operating policies¡¨ or ¡§functional policies¡¨. The figure shown below (Figure 3.1),
which can be called the Wheel of Competitive Strategy3, is a method that can be clearly used to
articulate the key aspects of a firm.s competitive strategy.
3 Reference:
Operations Management Unit 3
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Definition of how
the business is
Objectives for
growth, market
Product Line
Target Markets
Figure 3.1: The Wheel of Competitive Strategy
The inner circle of the wheel, also called the .hub., broadly identifies the
organisation.s goals, i.e., it defines how the organisation intends to compete
in the marketplace, and also outlines its specific economic and noneconomic
objectives. The spokes of the wheel indicate the key operating
policies, with which the firm desires to achieve these objectives. Depending
on the nature of the business, management specifies or articulates these
objectives. Once they are defined clearly, the concept of strategy can be
used to guide the overall behaviour of the firm. At the broadest level,
formulating a competitive strategy involves considering four key factors that
define what a company can successfully accomplish. This is depicted in
Figure 3.2.
The firm.s strengths and weaknesses are its profile of assets and skills
relative to competitors, including aspects such as financial resources,
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technological posture and brand identification. The personal values of an organisation are the
motivations and needs of the key executives and other personnel who must implement the
chosen strategy. The strengths and weaknesses of the organisation, together with its values,
determine the internal limits of the industry.s opportunities.
Figure 3.2: Key Factors of Competitive Strategy
The threats to the organisation, together with its inherent risks and potential rewards, determine
the competitive environment the organisation forms a part of. Societal expectations reflect the
impact on the company of such things as government policy, social concerns, evolving mores,
and many others.
How effective an organisation.s competitive strategy is, can be identified by checking its proposed
goals and policies for consistency with the below mentioned points:
„h Organisation.s goals are achievable.
„h Key operating policies address these goals.
„h Key operating policies complement one another.
„h Goals and policies are in sync with industry opportunities.
„h Goals and policies can be accomplished with available resources.
„h Goals and policies relate to societal concerns.
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„h Goals and policies match the availability of resources to the company with respect to its
„h Timing of the goals and policies reflect the organisation.s ability to be flexible.
„h Goals are well defined by the key implementers.
„h There is a link between the goals, policies, and values of the key implementers to ensure
„h There is sufficient managerial capability to allow for effective implementation.
Self Assessment Questions
6. Competitive Strategy is a combination of the ________for which the firm is striving, and the
_________through which it is seeking to get there.
7. Industry opportunities and threats with its attendant risks and potential rewards define
3.5 Corporate/Business and Operations Strategy
The Corporate strategy defines the long term vision of a company. The business strategy of an
individual business of a corporate entity follows from the corporate strategy. Most large
corporations pursue several businesses representing different industries and operating in
different markets. Each business has to find its own way of competing in its markets. Three
different types of .Generic. strategies can be pursued by businesses. They are:
„h Low Cost strategy.
„h Differentiation Strategy.
„h Niche strategy which can be either low cost or differentiation in approach.
Operations strategy specifies how the firm employs its production capabilities to support its
corporate strategy.
3.5.1 Operations Strategy Model
.Mission., .Distinctive Competencies., .Objectives. and .Policies. form the heart of operations
strategy. Figure 3.3 depicts:
„h The Inputs and Outputs of the operations strategy.
„h The hierarchy of strategies in a typical multi-business firm.
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Corporate & Business
Operations Strategy
(cost, quality, flexibility &
(process, quality
systems, capacity, &
Consistent pattern
of decisions
Functional strategies in
marketing, finance,
engineering, human
resources, and
information systems
Figure 3.3: Operation Strategy Model
Decisions in the four parts of operations ¡V process, quality, capacity and
inventory ¡V are outcomes of the strategy formulation, and are connected
with other functions in the business ¡V such as marketing and finance.
The role of Operations Strategy in relation to other functional strategies in
any of the businesses of the firm is given below:
Operations mission
Every business operations should have an articulated .Mission. along with
other functional strategies that is connected to the business strategy as well.
For example, if the business strategy is product leadership, the operations
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mission should focus on new product introduction and develop the needed flexibility to adapt
product to the changing needs of the market. If the company chooses to follow other strategies ¡V
such as market or price leadership ¡V the corresponding operations missions would be different.
Thus, the operations mission is derived from the business strategy adopted.
Distinctive competence
Distinctive competence refers to the company.s ability to carry out a (business) process better
than the competitors. The competence could be derived either from .unique. resources (capital or
human) or from .unique. capabilities (sometimes leading to a patent).
The distinctive competence of the company should be commensurate with the .mission. of
operations. Developing the distinctive competence refers to developing a business process in an
area (for example, in quality assurance) which is different from the mission of the operations (say,
excelling in new-product innovation). Similarly, the distinctive competence must be valued by
other functional areas such as marketing, finance, etc., so that it gets all-round support from the
entire cross-section of the business, as a basis for obtaining competitive advantage.
Sometimes, a business strategy may be derived from a company.s distinctive competence
(existing or planned) and the company may work towards matching the market to it. A company,
in order to compete effectively ¡V would need not only a suitable market segment but also a
unique capability to service the market segment. Thus, it is seen that .distinctive competence. is
an essential pre-requisite for working on a successful business strategy.
Operations objectives
The third element of Operations Strategy is operations objectives. There are four common
objectives, they are:
„h Cost
„h Quality
„h Delivery
„h Flexibility
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The company.s .Mission. is logically converted into objectives in the above mentioned areas. To
be strategic in nature, these objectives should be long-term (5 to 10 years).
Operations policies
This relates is the fourth element of the Operations Strategy. Policies are normally broad
guidelines that the company develops in keeping with their strategies and value systems. These
policies assist decision-makers (including the senior most management levels) in arriving at
decisions. Operations policies should generally be developed for each decision categories
(process, quality systems, capacity, and inventory), and should be integrated with other functional
decisions and policies.
Linking strategies
Operations Strategy should also be linked with other parts of the whole business, such as
marketing and financial strategies. Table 3.1 shows how two diametrically opposite business
strategies give rise to different functional strategies4:
Table 3.1: Comparison of Business Strategies
Strategy A
Strategy B
Business Strategy
Product Imitator
Product Innovator
Market Conditions
Price sensitive
Mature Market
High Volume
Standardised product
Product-features sensitive
Emerging Market
Low Volume
Customised Product
Operations Mission
Emphasise low-cost for mature products
Emphasise flexibility to introduce new products
Distinctive Competence Operations
Low cost through superior process technology and vertical integration
Fast and reliable new-product introduction through product teams and flexible automation
4 Refer book on ¡§Contemporary Concepts and Cases: OPERATIONS MANAGEMENT¡¨ ¡V
International Edition - by author Roger G. Shroeder ¡V page 28
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Operations Policies
Superior process
Dedicated automation
Slow reaction to changes
Economy of scale
Workforce involvement
Superior products
Flexible automation
Fast reaction to changes
Economies of scope
Use product development teams
Marketing Strategies
Mass distribution
Repeat sales
Maximising of sales opportunities
National sales force
Selective distribution
New-market development
Product design
Sales made through agents
Finance Strategies
Low risk
Low profit margins
Higher risks
Higher profit margins
Thus, it is seen that not only the Operations Strategy gets dictated by the overall business
strategy of a company, but also that the other functional strategies need to be in line with the
Operations Strategy.
Focused operations
Whichever type of strategy the company follows, it has to ensure that the operations function is
carried out in a .focused. manner through a coordinated set of policies.
Self Assessment Questions
8. The Corporate Strategy defines the _________vision of a company.
9. _______________________.form the heart of operations strategy.
10. ____, ____, _____, and _____ are the .four common objectives of Operations..
Activity 3:
Visit two supermarkets and compare their business strategies.
3.6 Global Environment of Competition
A company should be very effective in its operational performance and should have good
strategy, to perform well. It is very difficult for a company to outperform others merely on the
strength of its operational effectiveness.
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For example, Japanese companies had developed substantial competitive advantage mainly due
to their far superior manufacturing techniques and practices. In course of time, American
companies caught up with the Japanese in respect of manufacturing expertise, and overhauled
them in performance with the help of superior strategies.
Business Strategy is a company.s plan as to how it will compete in the market place. However,
the competitive environment is constantly changing. This could be largely attributed to the
emergence of new technologies in almost all industries. Therefore, a company needs to be alert
and have the ability to adjust to the changing environment in order to remain competitive.
Future business conditions across the world can be estimated by understanding the present
conditions. Some of the business conditions that affect the current business scenario are as
„h Global competition as prevailing today.
„h Customers. increasing demand for quality, customer service and low price.
„h Rapid onset of new and advanced technologies.
„h Rapidly growing service sector.
„h Depleting resources.
„h Increasing concern for social issues.
3.6.1 Global Competition
Due to rapid globalisation, industries in most countries are facing intense competition. Developed
countries look for new markets for their products in new countries as their own home markets are
maturing, while the emerging economies churn out superior products offered at lower prices since
the industries in their countries look for larger markets.
Tremendous growth in transportation and communication has made accessing the modern and
distant market easier. The entire world can be perceived today as a .Global Village.5, wherein
economic events in one country promptly affect other countries.
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China and India, with their very large populations, have emerged as the biggest markets for the
future. On the other hand, the same high population, coupled with improved education levels and
experience in many industries, are also posing fresh competition to west-based industries.The
above dynamics are giving birth to new international companies whose domain of operations
spans several countries. Consequently, operations managers have to coordinate with
geographically dispersed operations. On the other hand, several countries have broken trade
barriers and are actively cooperating with other countries. For example, the European Union is
one such example; even though the countries are separated geographically by thousands of
miles they have set up bi-lateral agreements. These have given rise to more .strategic alliances.
amongst individual companies.
Fluctuating international stock markets, currency volatility, fluctuating interest rates, inflation and
very high levels of trade imbalances have created turbulence in financial markets, thus affecting
international business.
3.6.2 Quality, Customer Service and Cost Challenges
Spiralling competition and great strides in innovation have literally made (prospective) customers
to behave like .kings.. Due to the awareness of the choices available for them, customers
demand for quality of products. Consequently, many companies today are no more satisfied with
delivering ¡¥acceptable quality. but strive for ¡¥perfect product and service quality¡¦.
Companies are now striving to meet the customers. needs and meet the ideal of perfect quality
that is the concept of .Total Quality Management. (TQM). TQM also focuses on .continuous
improvement of quality. which, in turn, calls for empowering all those who are involved in making
and delivering the products.
Another area of pressure on companies is that of costs and prices. Industry has found ways to
reduce cost and to increase scope of fixing prices in the market. Automakers concentrate
productivity and retailers try to leverage such aspects as economies of scale, huge discounts on
large scale purchases and other Supply Chain practices to reduce costs dramatically and thus,
effectively compete in the market place. Other measures such as restructuring, downsizing,
outsourcing, have become popular among
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companies in their attempts to keep costs low. Labour-intensive industries have resorted to off-
shoring their activities.
3.6.3 Advanced Technologies
Both Manufacturing, as well as service industries has experienced far-reaching impact on their
operations because of .automation.. The initial disadvantages of high investments in automation
are outweighed by not only lower manpower costs, but also by improved productivity, improved
quality, reduced wastage and scrap, quicker response to customers and more frequent
introduction of new products and services.
One of the examples of automation is Computer and Software Technology. Computer
applications and software have helped companies replace labour-intensive processes such as
payroll, billing, sales order processing, inventory control, etc. with computerised software.
Integrated ERP software systems facilitate real-time data and information to support decision
However, competitive advantage resulting out of a company.s automation does not last long
since competitors invariably duplicate such innovations. At the same time, companies cannot
avoid innovating since doing so renders them at a competitive disadvantage.
Continuous growth of service sector
In more recent times, there has been a sudden growth in service industries. It has far outstripped
the growth of the manufacturing sector. This fact is no indication of any appreciable decline in the
manufacturing sector. Rather, the steep growth in number of service industries reflects the fact
that more and more service products are in demand, and much of this increased demand is
generated by the manufacturing sector. Hence, a strong and steady manufacturing sector is
necessary for the growth of service sector.
Self Assessment Questions
11. Due to rapid globalisation, industries in most countries are facing _______.
12. Consequently, many companies today are no more satisfied with delivering .acceptable
quality. but strive for ____ & _____.
13. Both Manufacturing, as well as, service industries has experienced far-reaching impact on
their operations because of___________.
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14. _________, _______, _____________ have become popular among companies in their
attempts to keep costs low.
15. A strong and steady ______________ is necessary for the growth of service sector.
Activity 4:
Compare any big mall and a small retail shop and list down the points how the latter is facing
tough competition from the former due to rapid growth in globalisation.
3.7 Summary
Firms competing in their industries need to have a .competitive strategy., since it has been
practically established that there are significant benefits through an explicit process of formulating
strategies, and implementing them effectively.
Firms are also increasingly aware that they cannot be satisfied by just being a place to make their
products and services, but their operations should contribute to the company.s competitive
posture. Therefore, every company also needs an Operations Strategy. Operations Strategy
should be fully connected to the company.s business strategy, and should contribute to the
company establishing a .competitive advantage. over its competitors.
Competitiveness of a firm is its willingness to compete effectively with other firms in their industry.
Competitive advantage is the ability of the company to generate superior profits as compared to
the average profitability of other firms in the industry.
Strategy development generally means developing a road map or a broad formula as to how the
business is going to compete in the market place. Competitive Strategy is, therefore, both the
formulation of long-term Plans, as well as, their effective implementation. Formulating strategy
involves consideration of four factors which define the boundary of what the company will be able
to accomplish, and these factors are:
„h Company.s strengths & weaknesses
„h Industry opportunities & threats
„h Personal values of key implementers of the strategies
„h Broader societal expectations
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Strategy formulation in the area of operations generally involve major decisions in the areas of
process, quality, capacity and inventory, which emphatically determine the two major elements of
delivering value to the customer ¡V benefits through product and service, and the cost that the
customer has to incur to experience the benefits.
A company has to develop Distinctive Competencies in the relevant areas to achieve either of the
two attributes mentioned above.
The key operations objectives fall in the areas of cost, quality, delivery and flexibility. Companies
always need to formulate policies which provide guidelines to the operating managers to take
effective and timely decisions to accomplish objectives & goals.
Lastly, it is important to note that while Operations Strategy should be linked to and drawn from
the company.s business strategy, it should be in line with other functional strategies ¡V Marketing,
HR, Finance, etc. ¡V of the company.
3.8 Terminal Questions
1. What is meant by .competitiveness. of a firm? What are the factors affecting the competitive
position of a firm?
2. Describe the link of Operations Strategy with other strategies of the company.
3. Explain the terms: Operations Mission, Distinctive Competence, Operation Objectives and
Operation Policies.
4. What are the effects of Global Competition on the industries in India?
3.9 Answers
Answers to Self Assessment Questions
1. Competitive advantage
2. Maximising
3. Outputs to Inputs
4. Compete
5. Cost \price, quality, delivery speed, reliable delivery, flexibility in supply, flexibility in new
product introduction
6. Goals, Policies
7. Competitive environment
8. The long-term vision
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9. Mission, Distinctive Competencies, Objectives and Policies
10. Cost, Quality, Delivery and Flexibility
11. Intense competition
12. Perfect product; Service quality
13. Automation
14. Restructuring, Downsizing, Outsourcing
15. Manufacturing sector
Answers to Terminal Questions
1. Refer section 3.3
2. Refer section 3.5
3. Refer section 3.5
4. Refer section 3.6
3.10 Case Study
SP Banking Corporation was found in 1960. It is a well established bank with 35 locations
throughout India with Delhi as its main operating branch. The bank has different kinds of service
for different kinds of customers. The Bank started facing problems with the amount of ATM
centres. Customers were getting frustrated due to long hours of waiting. Not only that but also the
centres were not sufficient for the customers during peak time. Other Banks were offering lower
interest rates on loans with higher interests on savings accounts and fixed deposits. These
problems posed a great threat to the reputation of the Bank and soon it began losing its old
A board was appointed to develop the strategy of the Bank. This board decided to start 24 hours
customer service centre so that the Bank would concentrate more on customer service to
withstand the competition. The Board also solved problem related to customer-service such as
staffing and facilities. It also introduced on-line banking..
1. Create a list of changes that the Bank should have considered for the operations function
before appointing a board.
2. According to you in which other way can SP Bank solve its problems?
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3.11 Glossary
Agreement, harmony, or correspondence, the quality of agreeing, being suitable and appropriate.
To decrease, use up or empty out, a state that continues for a limited time.
Fully and clearly defined or formulated, a concise explanation of the meaning of a word or phrase
or symbol.
An underlying meaning, understood though not directly expressed.
A natural tendency or disposition, a tending towards or natural liking.
To rise or fall with steady acceleration, a continuously accelerating increase or decrease:
To achieve a steady, effective pace, to attain a maximum level of competence. It signifies
progress or development.
3. .Operations Management : Theory and Practice. by B. Mahadevan

Unit 4 Profitability of Business Operations

4.1 Introduction
4.2 Pay-back Period Analysis
4.3 Stakeholder Requirements
4.4 Opportunity and Ownership Costs
Opportunity Cost
Ownership Cost
4.5 Discounted Cash Flow Analysis
4.6 Cost ¡V Benefit Ratios
Undiscounted Cost-Benefit Ratio
Discounted Cost-Benefit Ratio
4.7 Sensitivity Analysis
4.8 Break ¡V Even Analysis
4.9 Summary
4.10 Terminal Questions
4.11 Answers
4.12 Case Study
4.13 Glossary

4.1 Introduction
By now you must be familiar with the concept of Operations Management and the competitive
strategies of any organisation. This unit covers pay-back period analysis, stakeholder
requirements, opportunity and ownership costs, discounted cash flow analysis, cost ¡V benefit
ratios, sensitivity analysis, and break ¡V even analysis.
Businesses are economic entities. One of their main objectives is to make sustained profits.
Basically, a business involves investing in:
„h Assets ¡V capital
„h Material
„h Human resource
Businesses use these assets to effectively undertake the .conversion processes of raw materials
and components into finished products that are marketable at profit, thus yielding a desirable
.return. on the investments made.
Investment on plant and equipment is one of the most significant decisions taken by the promoter
/ top-level-management. These decisions have a very high and long-standing impact on the
profitability of a business. To preserve and maintain the wealth-producing assets of the business,
the .returns. on equity must not only be competitive with other investment options available to
stockholders and investors, but also be adequate to upgrade and update the assets to meet the
emerging requirements of the market. The expected rate of return is also based on the investor.s
perceived risk associated with the investment opportunity.
Accepting a strategy of any company.s management depends on the estimated rate of return on
equity obtainable, from among different options of strategies. It also depends on the perceived
risk and the acceptability of the option by the stakeholders.
For a decision on investment in plant and equipment, any criteria that are adopted must provide a
means of distinguishing between acceptable and unacceptable options; a rating of the options in
order of their desirability; and solve the problem of choosing techniques. The criteria must,
however, respect two fundamental principles:
„h ¡§The bigger the better¡¨ principle: Investments and equipments being equal, bigger benefits
are preferable to smaller benefits.
„h ¡§The bird in hand¡¨ principle: Investments and equipments being equal, early benefits are
preferable to later benefits.
Finally, the criteria must have the capability to be applied to any conceivable investment.
Besides the parameter of Return on Investment (ROI)1, which is the most popular criterion for an
investment decision, there are other metrics which are important. The key stakeholders of the
company are focused on different parameters such as:
„h Return on assets
„h Cash flow
„h Economic value added
1 For more information on ROI please visit

Another very popular parameter used while making investment decisions is the .Pay-back
Period., which is derived from ROI. The discounted cash flow. is another very important concept
while evaluating various investment options.
In addition to the above parameters, even short-range decisions are made on similar basis. Aptly
termed as the Cost-Benefit Ratio, any option should weigh the ratio of the expected benefit
arising out of a decision to the cost incurred due to the decision.
An important technique used in selecting an investment option is the .Sensitivity Analysis., which
assesses the dependency of success of a decision on the key assumptions made while taking the
Learning Objectives:
After studying this unit, you will be able to:
„h Define profitability and its importance.
„h Explain the various types of costs.
„h Analyse accountability of the management of the company towards the company.s
„h Explain the concepts of Cash Flows.
„h Define the basic concept of financial decision making ¡V Cost-benefit ratios.
4.2 Pay-back Period Analysis
Pay-back period analysis tells us how long it will take to earn back the money we spent on the
asset. Pay-back period analysis has been used when new assets have been purchased with a
large capital amount. Pay-back Period Analysis is a simple way to decide whether one should
analyse the acquisition as a viable investment decision. The formula to calculate the pay-back
period is:
Cost of Asset / Annual Cash Inflow = Payback Period
Thus, if an asset costs Rs. 150 million and is expected to generate a return of Rs. 30 million
annually, the pay-back period would be 150 / 30 = 5 years. However, it is possible that the annual
return varies from year to year. In such a case, the annual returns need to be added up till a point
that it reaches the cost of the asset ¡V this would indicate the pay-back period.
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An asset with a shorter back period would rank higher than one with longer paybacks. The theory
is that assets with shorter paybacks are more liquid, and thus less risky ¡V they allow us to
recoup our investments sooner, so that the money can be re-invested elsewhere. Moreover, with
any asset, the risk increases as we look further ahead. With shorter payback period, there is less
of a chance that market conditions, obsolescence, interest rates, the economy, or other factors
affecting the asset will drastically change.
Obviously, the period for both capital recovery and return has to be lower than the economic life
of the asset. After the payback period, the asset contributes to profits because the invested
amount has been recovered.
Is pay-back period analysis a measure of the investment.s profitability? The answer, in general, is
.NO. since it ignores benefits that occur after the payback period. The major criticism with this
analysis is that it ignores the time value of money.
Importance of Pay-back Analysis
It is the most popular method used in industry for making decisions on investments. It is a means
of establishing an upper bound on the acceptable degree of risk where one can appraise the near
future with some confidence. Payback period is an appealing unit of measurement because it is
easily understood when interpreted. The Pay-back Period analysis is very important for new
companies with poor economic resources. This method can also be used in firms where the
products are not used for a longer period of time, for example, consumer electronics.

Self Assessment Questions

1. Pay-back Analysis tells us how long it will take to _________ ________ the money we spend
on the __________.
2. An asset with a _________ back period would rank higher than one with _______ paybacks.
3. Is pay-back period analysis a measure of the investment.s profitability? Answer .Yes. or .No..

Activity 1:
Calculate the Payback Period of a company when the assets cost
Rs. 350 million and is expected to generate a return of Rs. 30 million
4.3 Stakeholder Requirements
Who are an organisation.s stakeholders? ¡V All individuals, groups, other
organisations and entities that either influence the working of the
organisation or are directly influenced by it. Some of the main stakeholders
of any particular company are:
„h Shareholders
„h Employees
„h Management
„h Customers
„h Suppliers
„h Regulatory agencies
„h Government
„h The community.
It is the job of operations managers to convince the stakeholders that the
investment in plant and equipment is going to enhance the value of the
investments already held by them in the organisation. Some of the concepts
that can be considered in analysing the investment are discussed in the
following sub sections.
Return on Investment (ROI)
The ROI is a fundamental measure of efficiency with which a firm manages
its assets. It answers the question: ¡§How much profit is the firm generating
from the use of its assets?¡¨ Return on investment is a very popular unit of
measurement because it is simple and versatile. Another advantage of ROI
is that it can be modified to suit the situation according to what you have
included as costs and returns. The return on investment formula:
Cost of Investment
(Gain fromInvestment ƒ{Cost of Investment )
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Earnings Before Interest and Tax (E.B.I.T)2
The EBIT is the revenue earned by the company without regard to how it is
financed. If it is the rate of corporate tax, then EBIT (1 ¡V t) gives the Income
after Tax deduction.
ROI is defined as the ratio of Income after tax to the value of assets,
indicated as a percentage. That is.
ROI = EBIT (1-t) / Assets X 100
Where, t = Tax rate on ordinary income
Return on Assets (ROA)3
The RAO indicates profitability of a company relative to its own total assets.
It tells how efficiently a management is using its assets to generate
earnings. It is the ration of any company's annual incomes by its total
assets, ROA can be displayed as a percentage. Sometimes this is also
called as "return on investment". The formula for return on assets is:
Total Assets
Net Income
Cash Flow
The Operating Cash Flow (cash flow provided by the operations) is a central
and crucial concept for financial management. It measures the ability of the
company to generate a flow of cash, through its day-to-day operations and
thus evaluates its capacity for survival and for long-term growth.
The Operating Cash Flow (OCF) is the basic and fundamental source of
cash for the investment and financing policies of the company. It is better if it
is higher as it gives more flexibility to a company to build a long-term
strategy without constraint and interference from economy.
OCF = Profit after Taxes, Interest, Dividend payments + Depreciation
Economic Value Added (EVA)
According to the concept of EVA, a company or division creates value for
owners only when its operating income exceeds the cost of capital
employed. EVA is generally calculated as the net operating after taxes profit
For more information on EBIT please go to
For more information on ROA please go to
minus ¡V a charge for the opportunity cost of the capital invested. EVA can be calculated as:
NOAT = The net operating after taxes profit
COCC = A charge for the opportunity cost of the capital invested.
It is an estimate of the amount through which earnings exceed or fall short of the required
minimum rate of return for shareholders or lenders at comparable risk.
EVA measures the difference between the pre-investment and post-investment value for the
Self Assessment Questions
4. An organisation.s stakeholders include all individuals, groups, and other entities that either
________ the working of the organisation or are directly _________ by it.
5. Return on Investment (ROI) is a fundamental measure of the _______ with which a firm
manages its _______.
6. Operating Cash Flow measures the ability of the company to generate, through its ________, a
flow of _________.
7. EVA measures the difference between the ___________ and ____________ value for the

4.4 Opportunity and Ownership Costs

We have seen in the previous section that one of the major decisions in business which
especially concerns operations is pertaining to investments in plant and equipment. While making
such decisions, the costs of such investments have to be calculated precisely, so that decisions
are made on sound and rational basis.
The cost of an investment is not merely the cost of acquiring the assets, which could be equated
to the landed price of the assets plus the installation and running in costs. The cost of an
investment forms one of the elements of the overall ownership costs. The concept of .ownership.
cost adequately addresses the need to look at the costs more comprehensively.

4.4.1 Opportunity Cost

Opportunity Cost can be defined as the profits foregone by investing funds or efforts in one
project instead of in another project.
Let us understand this concept through a more individual-based example of a person owning a
motor car whose value in the market is Rs. 2 lakhs, which becomes the economic value of the
car. The person can either sell the car for its value or retain the car. In case he sells the car, the
Rs. 2 lakhs can earn interest over a period of one year. By retaining the car, the person foregoes
the interest, which is the opportunity cost of ownership. Besides, by retaining the car for one year,
the sale value of the car gets diminished. This loss in the resale value is the second opportunity
cost. So, the total opportunity cost is the loss of interest earnings plus the loss in sale value.

4.4.2 Ownership Cost

Ownership Cost is the total cost of owning and maintaining an asset over a period of time
including the opportunity cost.
In the above example, in order to keep the car running for one more year, some
capital/maintenance expenses would need to be incurred on the car. So the cost of continued
ownership is the opportunity cost, plus the capital additions or renewals to keep the car running.
The above logic applies to any asset whether belonging to an individual or an organisation. Thus,
an asset may indicate reducing opportunity cost over the years, but the cost of running and
maintenance will progressively increase
Self Assessment Questions
8. The Cost of an investment is not merely the cost of ________ the _________.
9. Ownership Cost is the total cost of ______ and __________ an asset over a period of time
including the opportunity cost.

4.5 Discounted Cash Flow Analysis

Discounted Cash Flow analysis is the most widely used investment appraisal technique, and it
essentially extends the payback period analysis. Once the net cash flows have been assessed for
each of the years they are discounted progressively at a pre-determined rate, usually at the cost
of capital. The Net Present Value of the venture is then calculated by adding all the discounted
annual cash flows over the anticipated life of the project.
In brief, a Discounted Cash Flow view of the cash flow stream should probably appear with a
business case summary when:
„h The business case deals with any kind of .investment. scenario where different uses for money
are being compared.
„h The business case covers two or more years.
„h Change in inflow and outflow differs over
„h Different cases are compared and differ in cash flow timing within the analysis period.

For example, ¡§Would a thousand rupees earned today be the same as a thousand rupees
earned 5 years later? ¡§NO¡¨, because, even if the thousand rupees earned today is deposited in
a bank, it would earn a compound interest over the next 5 years and become, say, more than Rs.
1800/- in that time. Money loses value due to time. It also loses value due to risk and many other
factors. To get around the problem of value of time, Pay-back analysis should be used in
conjunction with Discounted Cash Flow analysis.

Discounted Cash Flow makes use of the Present Value concept, that is, an amount available
today is worth more than the same amount available later. Besides, money which is not available
today but available only later cannot be used now. Therefore, the future value of money is
discounted in financial evaluation, to reflect its lesser value. The worth of future money today is
called the Present Value.
The total of the stream of Present Value calculations is called the Net Present Value. The present
value of an anticipated future earning is decided by two things:
„h The amount of time between now and the future payment.
„h The interest rate.
The Rate of Return is that rate, for which the present value of net monetary operating advantage
equals the cost of the initial investment. Discounted Cash Flow analysis is particularly useful for
comparing the financial merits of assets which have very different patterns of expenditure and

Self Assessment Questions

10. Discounted Cash Flow makes use of the _________ Value concept.
11. What the ________ money is worth _________ is called the Present
12. ________, ________, _________ analysis is the most widely used
investment appraisal technique.

4.6 Cost ¡V Benefit Ratios

As the name suggests, this is a ratio between the anticipated Benefits of a
decision, and the Costs likely to be generated by that decision. An
investment can be treated as one such decision area. There are two
versions of the Cost-Benefit Ratio analysis:
„h Discounted cost-benefit ratio analysis.
„h Undiscounted cost-benefit ratio analysis.

4.6.1 Undiscounted Cost-Benefit Ratio

Undiscounted cost-benefit ratio analysis can be of two types, .Gross. and
In .Gross. undiscounted benefit, cost-benefit ratios are calculated without
deducting depreciation and the other benefits are then added. The sum is
then divided by the investment cost.
Gross =
Investment Cost
Sum of all benefits
In the net version, depreciation is deducted in computing the benefits. In the
undiscounted version, the benefits are taken at face value, while in the
discounted versions calculations are based on a discount factor.
4.6.2 Discounted Cost-Benefit Ratio
This is a more sophisticated tool when compared to Undiscounted Cost-
Benefit Ratio. It is the ratio of the present value of the future benefits, at a
specified rate of discount, to the present value of the present and future
investment outlays and other costs, at the same rate of discount.
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Features of Discounted Cost-Benefit Ratio
The features of Discounted Cost-Benefit Ratio are:
„h The discounted Cost-Benefit ratio takes into account all income, whenever received, and all
investments/expenditures, whenever incurred. The use of compound interest in the calculations
effectively gives more weight to early receipts than to later ones.
„h This is the first criterion which gives effect to both principles. It can be used to solve problems
of choosing techniques by calculating the incremental cost-benefit ratio on the incremental
investment required for the more expensive project.
„h The cost of capital is of crucial importance in this technique, since rankings depend on the
value of cost of capital chosen.
Table 4.1 depicts comparison between two different projects, that is, Project A and Project B. The
respective costs and returns of the project have been mentioned. The results of the two projects
are given when calculated using discounted cost-benefit ratios at 5%, 6% and 7 % respectively.
The result of profitability if required rate is 5%, 6% and 7% respectively is also given. The
principle to which both projects apply is mentioned.
Table 4.1: Comparison between Project A and Project B
Project A
Project B
100 Rs
100 Rs
106.00 in a year
112.36 in two years
Discounted cost-benefit ratios at 5% (DCBR)
Discounted cost-benefit ratios at 6%
Equally acceptable
Equally acceptable
Discounted cost-benefit ratios at 7%
Profitability if Required rate of return is 5%
Profitability if required rate of return is 6%
Equally acceptable
Equally acceptable
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Profitability if required rate of return is 7%
The bigger the better
The bigger the better
Self Assessment Questions
13. Cost ¡V Benefit Ratio is a ratio between the ___________, ___________ of a decision, and
the Costs likely to be generated by that decision.
14. Two versions of the Cost-Benefit Ratio analysis are _________cost-benefit ratio analysis, and
__________ cost-benefit ratio analysis.

4.7 Sensitivity Analysis

Uncertainty threatens all decisions taken about the future. The investment selection process has
to look into the future and predict outcomes. There is no certainty on the quality and impact of the
environment on the investment. Sensitivity analysis is a useful technique for assessing the extent
to which the success of a preferred investment is dependent on the key assumptions. This
analysis allows each of the important assumptions underlying a particular investment to be
questioned and changed. In particular, it tests how sensitive it is to predict performance or
outcome is to each of these assumptions. For example, the key assumptions underlying an
investment might be that market demand will grows by 7% p.a, or that the inflation rate will be
limited to 3%. Sensitivity analysis, typically, asks the following questions:
„h What would be the effect on performance if the market growth is only 5%?
„h How would this impact the decision?
„h How important is the market growth in the decision process?
A similar process might be repeated for the other key assumptions. This process helps
management to develop a clearer picture of the risks of making particular decisions and the level
of confidence it can have in a given decision.
Sensitivity Analysis is sometimes referred to as .what-if. analysis. It is a mathematical technique
that is defined by a series of equations, input factors, parameters, and variables aimed to
characterise the strategy being investigated. Its use grew with the incorporation of the
equations in the form of computer spreadsheet packages, which are ideally suited to this
analysis. These tools characterise the uncertainty associated with an investment and are used to
„h The quality of investment definition.
„h Factors that mostly contribute to the variability of the results.
„h The maximum range of variation in results.
„h Interactions between the different environmental factors.
The choice of which sensitivity analysis method to adopt is difficult to specify, as each technique
has strengths and weaknesses. Such a choice depends on the problem the organisation is trying
to address, on the characteristics of the investment under study, and also on the computational
cost that the organisation can afford. Sensitivity Analysis models depend upon the information fed
into them, upon their structure and upon the framing assumptions made to build them.

Self Assessment Questions

15. Sensitivity analysis is a technique for assessing the extent to which the success of a preferred
investment is dependent on the _________, __________.
16. Sensitivity Analysis is sometimes referred to as _________, _______analysis.
Activity 2:
Visit a nearby manufacturing company and enquire how performance of a company is affected if
the market growth is slow. How would this impact the decision and how important is the market
growth in the decision process.
4.8 Break-Even Analysis
This is also known as the cost ¡Vvolume ¡V profit analysis, and is typically based on the following
„h Cost can be divided into two broad categories: Fixed Costs and Variable Costs.
„h Unit Selling Price is constant over the entire sales volume. This means that total revenue vary
linearly with the volume of sales.
„h Inventory changes are Nil. In other words, whatever is produced during a particular period is
sold during the same period
„h The firm either produces a single product, or, if it produces more than one product, it maintains
the same product mix.
The cost-volume-profit analysis examines alternate levels of profit or loss for different levels (or
numbers) of products sold/produced. The choice of the number of products sold/produced
obviously depends on the anticipated demand. The point (of level of production/sales) where the
total Costs equals the total Revenues is called the .break-even. point.
As cost is an important component in selecting processes and plant and equipment, some of the
basics of costs should be examined. The total cost of a product can be seen to have two
components if viewed from the perspective of manufacturing:
„h Manufacturing Costs: Traditionally, costs classified as manufacturing costs include direct
materials, direct labour and manufacturing overhead.
„h Non-Production Costs: In addition to the manufacturing costs, there are non-manufacturing
costs that constitute overhead, marketing and overhead costs.
Costs can be classified on the basis of their relation to the volume of production. They are:
„h Fixed Costs: These are costs that remain constant irrespective of the volume of production.
They represent items of costs such as depreciation, insurance, taxes ¡V that are linked to the
hiring/owning of the factory premises, plus other costs such as salaries of fixed personnel,
interest on long-term debt, etc. Fixed costs arise as a result of capacity creation, and do not vary
with the variations of activity (capacity utilisation). They are function (of essentially) of time.
„h Variable Costs: Several important components of cost vary directly with output. For instance,
the costs of materials that directly go into the product ,that is, costs of labour hours that are
directly utilised for production, costs of power and other utilities that are incurred only during
production but do not happen when production is not taking place. All such costs would vary
directly with every additional unit produced, and are called Variable Costs.
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To examine investment proposals in respect of plant and equipment and other fixed assets
required for manufacturing, the cost-volume-profit analysis is significant since it indicates the level
of capacity utilisation that is required in order to break-even and thereafter to contribute to the
firm.s profits.
As mentioned earlier, any manufacturing (whether of products or services) involves the
application of human, capital and material resources. Some extent of use of these resources
need to be made even before the commencement of production, and persisted within order to
carry out production on an on-going basis. Hence, these costs become .fixed., and have to be
incurred month after month, or year after year, irrespective of the level of production. Apparently,
these costs have to be recovered fully through revenue generation which takes place due to
production and selling of the company.s products and realisation of the money from customers.
On the other hand, the revenue generation leads to profits only if the unit price at which the
product is sold is (in most cases) greater than the total of the unit-related costs incurred to
produce the product ¡V otherwise referred to the .contribution margin.. In other words, each unit
produced and sold generates a surplus for the company, and higher the number of units of the
product produced / sold, the larger is the total surplus. As a company is able to enlarge market
demand for its products and sell more (by producing more), the surplus keeps increasing, and at
some point equals the .fixed. costs incurred by the company month after month. This point (as
related to the level of production/sales) is called the .break-even. point, since at this level of
production, the company neither incurs a loss nor gains profit, that is, it breaks even.
The significance of this analysis for decision making regarding investments on plant and
equipment is that the investment should (preferably) be such that the break-even point is low as
far as possible. Which means that the investment should be such that not only the ensuing .fixed.
costs are as low as possible, but also the investment enables to keep the variable costs low on
one side and to create larger value (through the resultant product or service) for the customer and
thus realise a higher price.
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Self Assessment Questions
17. Break-even Analysis is also known as the_______¡V________ ¡V ________ analysis.
18. The point (of level of production/sales) where the _______, _________ equals the _______,
_________ is called the .break-even. point.
19. Fixed Costs (in Production) are costs that remain constant irrespective of the ___________ of
_________ .
20. Investment should be such that the break-even point is as ________as possible.

4.9 Summary
Being economic entities, one of the main objectives of businesses is to make sustained profits.
The expectation of profits would depend on the investments made for starting and running the
business. This relates to the concept of Return on Investment (ROI). Logically, the ROI on any
investment should be estimated to be better than the corresponding ROI on any other alternate
investment opportunity. This will be the basis for any entrepreneur to select an appropriate
investment option.
The ROI of any business would be directly proportional to the .profit. generated by operating the
business. And profits gained are equal to .revenues from the business. less the .costs incurred. in
not only running the business, but also in setting up the business. Included in the costs of setting
up a business are the Opportunity Costs and Ownership Costs.
Major investments take place for plant and machinery, and operations managers have to
convince the stakeholders that the investments in plant and machinery shall yield adequate
returns. Apart from ROI, other measures such as EBIT, ROA, Cash Flow, EVA, etc are also used
to analyse and judge the appropriateness of investments.
One of the most common analysis used is the Pay-Back analysis, which determines the time
period within the entire investment can be recovered through profits. It is natural that most
investors look for the lowest pay-back period. Cash flow analysis is another way to determine
whether the business can be operated smoothly, since profits most get accrued and are not
realised immediately. However, in order to keep the business in operation, cash is required. The
Discounted Cash Flow analysis further gives weight age to the fact that money earned today is
worth more than the same money earned in the future.
Decisions, whether of long-term nature such as a large investment, or shorter-term decisions,
always involve money outflow. In order to assist decision making, cost-benefit analysis and cost-
benefit ratios are used.
Parallel to the investment decisions the company also studies the consequences if the actual
happenings are different than the assumptions made while making the investments.
Another way to analyse while making major decisions regarding operations is the Break-even
Analysis, which basically determines the level of production/sales at which the entire costs are
recovered, that is, the business starts making profits.
4.10 Terminal Questions
1. What are Opportunity Costs and Ownership Costs, and how are they relevant to investment
2. What do the stakeholders of an organisation seek in terms of results of a business? What are
the parameters used by managements to satisfy the stake holders?
3. Describe the concept of Pay-back period analysis.
4. What is Cash Flow analysis, and how is Discounted Cash Flow analysis different?
5. What are Cost-Benefit Ratios, and how are they used in analysing investments?
6. Describe Sensitivity analysis.
7. How is Break-even Analysis significant to investment, as well as, operational decisions?
4.11 Answers
Answers to Self Assessment Questions
1. Earn, assets
2. Return on investment
3. Owning, maintaining
4. Influence, influenced
5. Efficiency, assets
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6. Operations, cash
7. Pre-investment, post-investment
8. Acquiring, assets
9. Owning and Maintaining
10. Present
11. Future, today
12. Discounted, cash, flow
13. Anticipated Benefits
14. Discounted, undiscounted
15. Key, assumptions
16. What, if
17. Cost, volume, profit
18. Total, costs, total , revenues
19. Volume, production
20. Low
Answers to Terminal Questions
1. Refer to section 4.4
2. Refer to section 4.3
3. Refer to section 4.2
4. Refer to section 4.4
5. Refer to section 4.5
6. Refer to section 4.6
7. Refer to section 4.7
4.12 Case study
SP is one of the largest travelling agency in India, with headquarters at Delhi. With it.s 100 years
of history it has 150 branches throughout the world. It stands as synonym for excellent service
and commitment. High cost base of a new ownership challenged the commitment of the
company. The team at Delhi started working on reducing costs and optimising revenues. SP
decided to collaborate with SK Software solutions to restructure its business process and IT. SP
wanted a partner who can share the profit and loss evenly which ever was re-invested. SK
accepted the offer to partner with SP. SK did not follow the traditional way of working but came up
with innovative thoughts. It suggested
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partnership in delivering services and common service centres to reduce the back-office functions
costs. This method worked well and more benefits with less risk were delivered. This enabled SP
to have rapid profitability and made to re-invest the profits for new business. SK appointed a team
to take care of the shared service centres, financial matters, human resource, project delivery
administration and IT. The result was a common language base and three units of business:
Service distribution, SP Airlines and Tour Operations.
In one year SP became a strategic sourcing model. The new business reduced the risk of
creating structure and funding additional business.
In one year, SP changed its business model altogether and moved to a strategic sourcing model.
The company improved operations, reduced its cost base by 75 million pounds, and increased
profitability. The new business model delivered the benefits and value of the Shared Services
Centre program faster and at significantly reduced risk while creating the structure and the
funding to drive additional business transformation. SK not only helped SP but also became a
partner in its outcomes. During the 15 years of partnership SP was very comfortable in handling
with the common service centres and controlled all critical operational activities.
Co- sourcing has transformed SP entirely into a very successful company
1. Do you advise SP for out-sourcing rather than co-sourcing? Explain.
2. What made the two organisations to build a good working relation or environment?
4.13 Glossary
A valuation by an authorised person, document criteria used to allocate organisational rewards.
A decrease in price or value, the loss, over time, in the value of an asset such as plant,
equipment, and vehicles.
To acquire or come into, cause to experience or suffer or make liable or vulnerable to.
Relating to or involving money, a unit of money unit, unit of measurement ¡V any division of
quantity accepted as a standard of measurement or exchange.
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Being in the process of passing out of use or usefulness; i.e. process or condition of going out of
date or being no longer in use.
To hold firmly and steadfastly to a purpose, continue to exist in the process of manufacturing
1. Production and Operations Management, by R. Panneerselvam.
2. Discounted Cash Flow ¡V A theory of the Valuation of Firms, by Lutz Kruschwitz, Andreas
4. http: //

Operations Management Unit 5

Unit 5 Break-Even Analysis and Operations Cost Management

5.1 Introduction
5.2 Operation Costs
Influencing Factors
5.3 Economics of Operations – Economies of Scale
Break-Even Point Analysis
5.4 Economics of Operations – Economies of Scope
Methods of Achieving Economies of Scope
5.5 Summary
5.6 Terminal Questions
5.7 Answers
5.8 Case Study
5.9 Glossary

5.1 Introduction

By now you must be familiar with some of the tools and techniques used for making investment
decisions, related mainly to plant and equipment. Such decisions are more strategic in nature
since they have long-term impact on the profitability of the firm.
The next level of consideration after plant and equipment, and implementing those creating
capacities of manufacturing, is that of actual operations.
In the current prevailing scenario of intense competition, in almost every industry and for any type
of product or service – the market mechanism is the predominant driver of individual operations.
Most of the firms today are compelled to be „market driven., since obtaining sustained business
for company.s products has become one of the most challenging tasks of an organisation. This
effectively means that there is restricted choice for companies to set the price for their products or
services. This does not convey that all firms in the same industry need to offer the same price or
very similar prices. Nevertheless, different firms offering similar products or similar „value. levels
to the customer have to restrict their price within a very narrow band, common for all such

The transformation process within any business adds both „value. and „cost. to the goods or
services output from the system. In a manufacturing system, the cost of physical conversion,
example materials processing and assembly, often represents a major part of the total cost of the
products produced. In transport, the cost of moving the customer, comprising the cost of
equipment used (vehicles and service equipment) and the cost of labour employed, as well as
any overheads, is often be a major ingredient determining the total cost of the transport to the
customer. Similarly, in supply and service systems, the operations function adds significant cost
to total cost of the items or service provided for the eventual customer. Thus, the most important
aspect of Operations Management turns out to be Cost Management, and the operations
manager must be familiar with the factors contributing to the cost of operations, the factors
influencing these costs, and means available for the measurement and control of the cost of
Learning Objectives:
After studying this unit, you will be able to:
. Define Operations Costs.
. Define the factors that influence Operations Costs.
. Define economics of scale and economics of scope.
. Explain the concept of a „Break-Even. point.
. Analyse Cost Control.

5.2 Operations Costs

In the previous unit, you have learnt about manufacturing costs and non-manufacturing costs.
These are commonly referred to as Direct Costs and Indirect Costs.
Direct Costs comprise those which may be identified separately for each goods or service
produced, for example the cost of the direct materials consumed or incorporated and the cost of
direct labour involved in the provision of output items or services.
Indirect Costs or Operations Overheads are those expenses which cannot be charged specifically
to particular output items, services or transports. Indirect Costs include the cost of:
. Indirect materials
. Indirect labour
. All other charges involved in operating the system where such charges cannot be allocated
accurately to particular goods or services, example administration costs.
Together, these costs build up to the total Operations Cost along with the general and
administrative costs and the profit, to the total cost to the customer, i.e. the selling or purchase
price, as given below:
Direct Materials + Direct Labour = Direct Cost
Operations Overheads + [General Overhead and Admin Cost] = Total Operations Cost
Total Cost + Profit = PRICE
Operations Cost Management involves planning and controlling all costs that add up to the Total
Operations Cost. These would include both Manufacturing Costs and Distribution Costs that are
incurred within the factory premises. Operations Cost Management would exclude costs related
to marketing and selling, but would include logistics costs that are directly related to the process
of reaching the product to the customer. The responsibility of the operations manager would be to
plan and control the above costs in such a way that the further activities of marketing, distributing
and selling can be done profitably considering the price that the products can command in the
The final unit cost of a finished product at the factory premises can be depicted by the following
Final Cost = Direct Material Cost + Direct Labour Cost + Factory Overheads (suitably allocated to
each product)
In case, the product has to be delivered to the customer at the door-step, then the final unit cost
would be:
Final Landed Cost at Customer.s end = Direct Material Cost + Direct Labour Cost + Operations
In the latter case, the Direct Labour Cost could also include the direct labour involved in handling,
loading and transporting each product to the customer. Similarly, the overheads would now be
termed as Operations Overheads since it would also include additional overheads that are linked
in ensuring that the products are made available to the customer at their premises.
It may also be observed from above that the Direct Cost comprises only (direct) materials and
labour costs, and does not include machinery cost, which is the third type of resource used in
operations. The reason for this is that machinery is used for many products and other purposes,
and hence it is very difficult to allocate the related costs directly to any product. Hence, costs
associated with machinery are treated as Operations Overheads. Machinery Costs would include:
. Running costs of the machinery.
. Maintenance and repair costs of the machinery.
. The depreciation, which is treated as an „expense..
However, the Operations Overheads can be sub-divided into:
. Indirect materials
. Indirect labour
. Other expenses
Indirect materials could include costs of lubricating oil, other consumables, etc.
Indirect labour could include costs of people involved in supervision, technical support,
inspection, etc.
Other expenses could include expenses such as depreciation, rent, welfare costs, etc.
Total Operations Cost can be divided into:
. Fixed Costs
. Variable Costs
As mentioned in the previous unit, Fixed Costs consists of those elements of cost that are not
dependent on, or do not vary with, the level of production. These would include items like rent,
staff salaries, power consumption that takes place even when production is not on, etc.
Variable costs include those costs that are directly dependent on the number of units produced.
Each element of variable cost, such as material, labour, power, etc., would be directly attributable
to an additional unit produced.
Control of Operation Costs
Most organisations work with a budgeted costing format. This format lists all the items of cost,
and combines them into Direct and Indirect Costs.
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Attempts are made to distinguish costs that can be related to production of individual unit.
Allocation and measurement of individual items. cost is a key to effective Cost Management.
Sophisticated accounting techniques such as Activity Based Costing, help managements to
assign costs to individual units of production to a very high degree. Such costs which cannot be
assigned directly, or received irrespective of production, are included in overheads. While control
of Direct Costs is easier, Overheads Costs always pose a major challenge in analysing them and
setting norms or standards.
Direct Material Cost can be controlled by:
. Using only the required amount of different raw materials and components for each unit of a
. Controlling the wastage generated in the process of manufacture.
. Ensuring a high level of quality control during production.
. Recovering and reusing of materials/components rejected during the manufacture.
Direct Labour Cost can be controlled by improving productivity i.e., getting more output per unit
Other Direct Costs such as direct power, direct other materials, can be controlled in a similar
manner by ensuring minimum downtime of machines and minimising the rejections out of
In order to control Fixed Costs, the planning should be clear and operations should be flexible.
Some of the ways to use the fixed resource to maximum in achieving maximum output are:
. Employment of temporary labour force.
. Multi-skilled workmen.
. Quick change-over time of machine settings, etc.
In most cases, the items of expenditure which generate fixed costs are a function of time.
5.2.1 Influencing Factors
Certain strategic decisions affect the cost of manufactured products. Some of these factors are
discussed below:
. Quality: The level of quality determines the costs, as it determines the extent of quality
inspections, the quality (hence the cost) of materials used and the technology used.
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. Features of the product: If the product has more features the price is high because more efforts
are required in designing and developing it.
. Quantity of production: Due to the phenomenon of „economies of scale. and „learning curve.,
large amount of products can be produced with very low investment.
. Productivity: Higher levels of efficiency due to higher throughput, lesser wastage or rework, etc.,
reduces the unit cost of production as the fixed cost (generally proportional to the time elapsed)
gets distributed over larger numbers of products.
Self Assessment Questions
1. __________, _________ comprise those costs which may be identified separately for each
good or service produced.
2. Operations Cost Management involves ____ and _____ all costs that add up to the Total
Operations Cost.
3. Final Cost a product is given by the equation _________ .
4. Operations Overheads can be sub-divided into Indirect_______, Indirect ______ and other
5. Another division of total Operations Cost would be the _________ Costs and ____________
5.3 Economics of Operations – Economies of Scale
The concept of „Economies of Scale. can be explained by considering a situation where a
manufacturing facility has been just set up, and the necessary raw materials, power connections,
work force, etc. have all been organised, and the company is all set to commence manufacture.
It should be appreciated that even before the first unit is produced, the company is incurring
certain costs such as rent for the premises, the fixed portion of salaries, usage of electricity and
power for general lighting, air-conditioning and running of equipments such as compressors,
filters, etc. These generate the fixed costs of operations. Let us say that such an expenditure of
fixed nature is Rs. „F. per day.
Now, consider the situation when the plant reaches a stage of producing 10 units of product per
day. If the variable cost (cost of material + cost of direct labour + cost of power + others) per unit
of production is „v., then the total cost of producing 10 units (on any particular day) works out to
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Total Cost = (F + 10 x v) / 10 = F/10 + „v.
If after some time, the plant manufactures 40 units of product in a day, then the total cost of
producing those 40 units would be:
Total Cost = F/40 + „v.
Thus, we see that as the production level increases during a particular time period, the Unit Cost
of producing a product reduces. In other words, if the scale of operations increases, then the unit
cost of manufacture comes down. This aspect is referred to as the „Economies of Scale.. This
phenomenon is contributed by more than one factor:
. The Fixed Costs get distributed over a larger number of products produced, thus bringing down
the unit cost of production.
. With higher scale of operations, the workmen would become more adept at manufacturing - thus
increasing productivity, which in turn, reduces the unit cost further.
. In view of high level of operations, the volumes of purchases of both products and services will
be high, and consequently procurement costs will come down.
5.3.1 Break-Even Point Analysis
The break-even point1 is the point where total income is equal to the total costs associated with
the sale of the product. It is mostly used by the production management. It categorises the
production cost between the variable cost and the fixed cost.
The graph below in Figure 5.1 shows a simple case of behaviour of Revenue, Total Operations
Costs, Variable Operations Costs and Fixed Cost at various levels of output / throughput.
The X-axis represents the production volume or the production throughput, while the Y-axis
represents the value (in rupees) of Costs/Revenue/Profit. The horizontal line parallel to the X-axis
represents the Fixed Costs, which is constant over the entire range of Volume or Throughput.
The variable Operations Cost is represented by a slightly slant line as shown, and the Total
Operations Cost (which is the total of Fixed cost and Variable cost) is
1For more information on Break-Even point please visit
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accordingly shown by a different line with a different slope.
Revenue = PQ
Total Operations
Cost = F +VQ
Fixed Operations
Break Even
Analysis X
Variable Operations
QBE Production / Production Rate
Figure 5.1: Break Even Analysis
To understand the concept of Break-even Analysis, let us assume the
Q = The Quantity of Production / Sales
P = The Unit Price of the Product
V = The Unit Variable Operations Cost
F = The Fixed Operations Cost
Therefore, Revenue = P x Q = PQ
Total Cost of Production = F + VQ
The Break-Even quantity is the quantity (sold/produced) at which the
Revenue equals the Total Operations Cost. If „QBE. represents the Break-
Even quantity, it is determined by the equation:
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Therefore, (P – V) QBE = F or,
QBE = F / (P – V), that is, Fixed Cost, divided by, Unit Profit Margin.
The Profit, at any given quantity Q, is equal to:
PQ – (F + VQ)
The Quantity (Q.) for a given level of Profit (Pr) is given by the equation:
Q. = (Pr + F) / (P – V)
The Operations Management personnel, especially at senior level have different choices to
select, regarding the plant and equipment and the other two input variables of material and
labour. To illustrate the behaviour of costs and profits as related to the choice of the three
variables, let us take an example where two scenarios are considered.
The graph in Figure 5.2 compares two „Break-Even. points – I and II. In the set of costs
represented by I, the Fixed Cost is at a lower level, but the Variable Operations Cost is a steeper
line representing higher variable costs. In case of II, the Variable Costs line is less steep, thus
reflecting lesser variable costs (per unit), but a high Fixed Cost element. This can happen,
typically, in case of large investments in technology, where initial cost of plant and equipment is
high, but the running costs are low.
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Break Even
Point I
Break Even
Point II
Production /Production
Fixed Operations Cost I
Fixed Operations
Cost II
s cost I
s cost II
Total Revenue
Figure 5.2: Break Even Point I & II
Thus, the Break-Even Point for I is lower than that for II, since the fixed
costs are appreciably lower in case of I. However, beyond the Break-Even
point, the profit margin (that is the gap between revenue and total cost) is
greater for II than for I.
This analysis is very significant for operations managers, to make decisions
on the investments in plant and equipment.
In practice, the Revenue and Costs are variable not always in a linear
fashion as shown in the above graph (figure 5.2). The following graph in
Figure 5.3 depicts these values in a more realistic fashion. For example, as
the output is increased, the variable Operations Cost, which increases
linearly initially, becomes more flat as the operations stabilise. Again,
beyond a particular level of output, perhaps beyond the normal capacity of
the plant, the variable Operations Cost becomes steeper.
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X Axis
Y Axis
Figure 5.3: Depicting Values in a More Realistic Manner
It can be seen that the total variable Operations Cost varies linearly initially,
and then stabilises as the output reaches optimum levels. But at some point
again it increases assuming that the capacity limits are reached, and the
firm has to work overtime for production or has to be sub-contracted.
Similarly, the revenue also increases linearly till the demand for the
company.s product reaches maturity, and thereafter, the company may need
to scale down prices to retain volumes, because the curve starts dipping.
The „Profit. therefore, starts with a negative level (as revenue is zero, but the
firm is incurring fixed costs) and gradually curves upwards to touch the
X-axis (the point of intersection reflecting the Break-Even point) when the
total revenue equals total Operations Costs. Thereafter, the profit continues
to increase till the revenue starts dipping or till the total Operations Costs
again shows steeper increase.
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The graph in Figure 5.3 is applicable for an analysis over a short „time-frame. since the
operations manager can play around only with volume of production by varying the input of
materials or labour. Over a longer „time-frame., the operations manager is in a position to vary
the third variable, that is the machinery (capacity) also, which impacts not only the fixed costs, but
the manager is also in a position to achieve a continued reduction in the total Operations Costs
over a longer time-frame.
In real business situations, if a company is into manufacture of only one type of product or
service, the operations manager has limited flexibility over reducing the cost. They can leverage
what we call the „Economies of Scale. by changing the Volume to reduce Costs. The market has
a limit on such leveraging since the demand for one single type of product tends to level off,
beyond some numbers.
Self Assessment Questions
6. If the scale of operations increases, then the unit cost of manufacture comes down. This theory
is called as ______________„.
7. “At Break-Even point, the operations neither registers a profit not incurs a loss.” (True / False)
8. The Break-Even quantity of production / sale is obtained by dividing the total ____ cost by the
unit ____ _____.
9. In real business situations, if a company is into manufacture of only one type of product or
service, the operations manager has ______________ over reducing the cost.
10. The market has a limit on such __________ since the demand for one single type of product
tends to level off, beyond some numbers.
Activity 1:
Visit any manufacturing company which is all set to start production of goods. List the costs that
the company incurs even before it starts its first unit of production.
5.4 Economics of Operations – Economies of Scope
Many businesses, due to the competitive market, are forced to broaden into manufacture of
different types of products, and achieve higher volumes only
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through the variety of products. Efficient and flexible operations systems can develop this
process. This approach is called the „Economies of Scope.2.
Developing very efficient machine settings, and re-arranging the availability and issue of
materials, and the workmen.s ability to adjust to change of products and multi-skill can make the
operations more flexible.
To illustrate the advantages of leveraging the economies of scope, let us consider an automobile
company manufacturing only one type of automobile. Even if this particular model is selling
successfully, the manufacturer would find it extremely difficult to compete effectively in a market
where many leading automobile companies manufacture and offer to the customers a wide
variety of automobiles. Typically, taking up manufacture of another model of automobile would
involve large investments in alternate plant and machinery. The manufacturer would need to
recruit and train another set of workmen to undertake efficient manufacture of a second model. All
this would considerably add to the cost of the second model. However, if the company employs
„flexible manufacturing systems. consisting of machinery and equipments which can take up
processing different type of components, and also a set of workmen who can efficiently operate in
both cases and are also proficient of effecting the change-over in short time – it is possible for
them to manufacture both models, wherein the production of the second model would involve
mainly the Direct Costs of material, labour and power, and only a marginal additional fixed cost.
This would bring down the manufacturing costs of both models, and the company will be at an
advantage over the competitors in successfully marketing the products.
David Kass 3wrote, in his 1998 article, "Economies of Scope and Home Healthcare,"that
economies of scope will be present if a firm can produce many, different product lines at a given
output level with a lower price than a combination of separate firms, each producing a single
product with the similar output level. Economies of scope and economies of scale differ from each
other. The difference is that, if an organisation or firm receives a cost
2 For more information on Economy of Scope please visit
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advantage by producing a complementary variety of products with a concentration on a core
competency. However, economies of scope and scale are often interdependent and positively
correlated. Frankly speaking if the benefits from scope have little to do with the size of output.
For example, if you take any paper products in the industry, it is common for large firms to
produce the primary ingredient in paper and their own pulp. This is done before manufacturing
the paper goods themselves. Smaller firms will have to buy pulp at higher costs from others,
higher than what the large companies pay. For the large producers, an economy of scope would
be the savings from producing both pulp and paper, although the large companies will probably
have economies of scale that make it possible to invest in pulping operations in the first place.
In another example, many banks have economies of scope when they offer a different variety of
related financial services, such as investment services and retail banking, with a single service
infrastructure, that is, ATMs, Internet site and their branches. Clearly, the costs of using a single
infrastructure to provide multiple services would be less than the costs of providing each service
separately would be much greater.
5.4.1 Methods of Achieving Economies of Scope
There are four different kinds of methods to achieve Economies of Scope, they are:
. Flexible Manufacturing
. Related Diversification
. Mergers
. Linked Supply Chains
Flexible Manufacturing.
Economies of Scope is the result of the use of flexible processes and flexible manufacturing
systems. This is because; these systems allow fast and low-cost switching of one product line to
another. The producer can add different varieties of new products to their present line. It is
possible if a producer can produce many products with the same equipment and if the equipment
permits the comfort and ease to change as market demands change. This increases the scope of
products, acting as a barrier for new organisations from entering a competitive synergy.
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Related Diversification.
A related diversification strategy results in Economies of scope and often termed as “economies
of diversification”. When a firm extends its existing capabilities, resources, or areas of expertise
for greater competitiveness, this strategy can be operated. According to Hill, Ireland, and
Hoskisson.s strategic management book, organisations choose related diversification according
to their corporate-level strategy. It is an attempt to exploit economies of scope among their
various business units. Cost-savings in a business can be achieved by transferring transferring
expertise in one business to a new business. The businesses can share operational skills or even
share plant facilities, know-how in manufacturing and equipments, or other existing assets. They
may also share intangible assets like corporate core competence or an expertise. With such
sharing of activities you can maximise limited constraints.
For example, Kleenex Corporation is a paper products manufacturing company. It provides paper
for a variety of end users, including products targeted specifically for health care providers and
hospitals, children, families, infants, and women. They produced different kinds of products from
facial tissues to paper towels, from Huggies diapers to wipes, and a number of products for
surgical use. The companies uses similar raw material inputs and manufacturing processes as
well as distribution and logistics channels.
In the United States today, the Merger Wave is in part, an attempt to create Economies of Scope.
Pharmaceutical companies sometimes combine forces to share the expenses of development
and research to bring new products in to market. Henderson and Cockburn conducted a research
in 1996 which explains that organisations involved in drug discovery realise economies of scope
by sustaining different portfolios of research projects that catch both internal and external
knowledge spillovers.
Linked Supply Chains
Economies of scope can be brought out with the help of today's linked supply chains among
manufacturers, raw material suppliers, wholesalers, distributors, retailers, other vendors and
consumers. Productivity gains, waste reduction, and cost improvements can be achieved with the
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integrating of a vertical supply chain. These improvements that arise from the ability to reduce or
cut costs by operating two or more businesses under same corporate shelter exist whenever it is
less costly for two or more businesses to operate under one centralized management than to
function independently.
Cost savings opportunities can branch out from interrelationships anywhere along with the
businesses' value chain. As organisations become linked in supply chains, especially as part of
the new E-economy, there is a growing potential for economies of scope. Scope economies have
the capacity to increase a firm's value and can increase the performance and higher returns to
shareholders. The scope economies can also help a firm to reduce risks.
Self Assessment Questions
11. „Economies of Scope. is an approach by which higher volumes are sought to be achieved
through manufacturing a ________ of __________.
12. Manufacture of a variety of products is done by developing operations systems which are
_________ and still _____________.
13. Many businesses, due to the _________, are forced to __________ into manufacture of
different types of products, and achieve _______ volumes only through the variety of products.
Activity 2:
A leading company manufactures refrigerators and is not satisfied with the competition it gives to
its competitors. The company decides to manufacture different types of products to withstand the
competition. What are the challenges it faces to withstand the competition given by other
companies manufacturing multiple products?
5.5 Summary
For most products, Operations Cost constitutes a major part of the total cost of a product.
Operations strategy – in line with business strategy – either aims for „low cost. manufacturing, or,
for excellent quality and differentiation. It is therefore the responsibility of the operations
managers to control and manage costs, so that they can deliver value to the customer either by
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means of very competitive prices, or through superior, „differentiated. products.
Operations Costs can be classified either into „direct. or ‘Indirect’ costs, or as, Fixed and Variable
costs. It is necessary for operations managers to understand the factors that contribute to either
of these two varieties of costs. Beginning with the design of the product, the selection of the type
of machinery and the manufacturing process to be used, managers would need to guide and
operate every aspect of operations in order to manage the costs.
Break-Even Point, Economies of Scale and Economies of Scope are important techniques based
on which both planning and execution of operational processes are conducted. While economy of
scale seeks to reduce costs by scaling up operational levels, economy of scope is based on the
fact that a company can optimise costs even by enlarging the basket of its products, so that
certain „fixed. nature of costs are shared between the products.
5.6 Terminal Questions
14. What are the types of Operations Costs? What kinds of factors influence them?
15. What is Break-Even Point and how is this concept used in deciding the operational issues?
16. What is „Economies of Scale.? Illustrate with an example.
17. How is „Economies of Scope different from Economies of Scale?
5.7 Answers
Answers to Self Assessment Questions
1. Direct, costs
2. Planning, controlling
3. Final Cost = Direct Material Cost + Direct Labour Cost + Factory Overheads Materials, labour
4. Fixed, variable
5. Economy of Scale refers to the reduction in costs achieved in manufacture due to high levels of
6. True
7. Fixed, profit, margin
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8. Limited flexibility
9. Leveraging
10. Variety, products.
11. Flexible, efficient.
12. Competitive market, broaden, higher
Answers to Terminal Questions
1. Refer to Section 5.2
2. Refer to Section 5.3
3. Refer to Section 5.3
4. Refer to Section 5.4
5.8 Case Study
RT Steel Company (RT) was established in 1909 by RT Rao at Vijayawada in Andhra Pradesh,
India. RT produced a good range of products and services. RT produced every steel product
irrespective of the quantity, shape and usage. RT initiated a modernisation programme in 1980s
for the cause of modernisation. The management could find its own drawbacks in the process of
RT tried to reduce costs by adopting creative strategies and other cost cutting techniques. It
reduced the use of expensive metal which is generally used to give strength and flexibility to the
steel. The company planned to reduce the time of product delivery from four weeks to one week
and reduce man power. With a lot of communication with employees the company reduced its
workforce by 15000 employees. Rather than promoting people on seniority basis RT started to
promote young workers based on their performance. This performance encouraging programme
proposed not only a new structure for the organisation but introduced flexibility in making
decisions and encouraging teamwork among all levels of employees.
The modernisation programme by RT was recognised as a very successful step towards
In spite of the depressed market RT achieved a good amount profit tax in the year 2000. RT
emerged as a very powerful steel company which produced the lowest cost steel. By the end of
the financial year of 2001
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the operating cost of RT at the hot metal stage was Rs. 3750 per tonne and the company.s cost
per tonne of finished steel was Rs. 7600 per tonne.
1. According to you what might be the reason for RT becoming one of the few companies in India
with such a standing?
2. Do you agree that the performance encouraging programme and cost cutting technique helped
RT in gaining a good position in the steel industry? How did these two programmes help RT?
5.9 Glossary
A highly skilled worker or employee in any company who can adopt the working culture.
Fixed cost
A periodic charge that does not vary with business volume. Costs that do not vary over time.
To improve the manufacturing capacity and increase the rate of return from an investment, as in
buying securities on margin.
Variable cost
Expenses that vary in direct proportion to the quantity of output of any company.
1. „How To Do A Break Even Analysis. by Tom Egelhoff.

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Unit 6 Facilities Location Planning
6.1 Introduction
6.2 Role of Globalisation in Location Decisions
6.3 Location Decisions
General Procedure for Location Decisions
Regional Factors that Affect Location Decisions
Community Considerations
Site-Related Factors
6.4 Multiple-Plant Strategies
6.5 Service and Retail Locations
6.6 Global Locations
6.7 Evaluating Location Alternatives
Location Cost ¡V Profit ¡V Volume Analysis
The Transportation Model
Factor Rating
The Centre of Gravity Method
6.8 Summary
6.9 Terminal Questions
6.10 Answers
6.11 Case study
6.12 Glossary
6.1 Introduction
By now you must be familiar with the concept of operations cost and the factors that influence it.
You must also be familiar with the Economics of Operations - Scale and Scope. This unit deals
with location planning and decisions.
Location decisions need to be made both by organisations that are being set up, and by existing
organisations. Some existing organisations may look for locations to expand their market or as a
part of their marketing strategy, which would generally mean looking for additional locations.
Some other firms may look for locations because they experience increasing demand for their
products which cannot be fulfilled by mere expansion of existing facilities.
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Other firms could face deficiency of resources ¡V such as raw material, or even skilled labour.
Some companies may experience shift in their markets, and consider either changing their
location or adding new facilities to better cater to their customers. Sometimes, the cost of
continuing business at existing locations may have become more expensive as compared to
other locations that can be considered.
Facilities planning are closely linked to an organisation¡¦s business strategies. A cost-leadership
strategy may warrant locating operational facilities either close to their customers to optimise their
distribution costs or closer to their suppliers in order to reduce the landed-costs of key inputs. On
the other hand, a differentiating strategy may call for a judicious selection of location of facilities in
order to provide greater value to their customers through extending better service to them.
Learning Objectives:
After studying this unit, you will be able to:
„h Evaluate the role of globalisation for location planning.
„h Explain the importance of location decisions.
„h Explain the various options available while making location decisions.
„h Explain the decision-making process for making location decisions.
6.2 Role of Globalisation in Location Decisions
Rapid pace of economic reforms in most countries have led to globalisation of markets. These
have made location decisions more significant in more recent times. Globalisation has opened up
new opportunities for multi-national companies as far as location decisions are concerned.
For instance, ABB1, a Swiss-Swedish multinational corporation with headquarters in Zurich,
Switzerland, operates mainly in the power and automation technology areas, sought to set up
plants capable of producing world-class products at internationally competitive prices. Such
factories also required high levels of technical capability and domain expertise. This approach led
them to identify Nasik and Vadodara as perfect locations for setting up plants for manufacturing
circuit-breakers. ABB also set up a plant
1 For more information on ABB please visit
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at Faridabad in Haryana (the only plant located east of Suez Canal2 to manufacture variable
drive motors for global markets).
The above example reflects the close relationship between globalising operations and location
decisions. Some of the chief factors which cause globalisation of operations are discussed below,
along with how each of these factors affects the location decisions:
„h Regulatory issues: This is the most significant factor. In the early 90¡¦s, India initiated a number
of regulatory changes that has rendered India as a very attractive destination for locating
manufacturing facilities. Removal of entry barriers and reduction in manufacturing costs due to
tariff reductions are two important reasons. Another reason is the emergence of regional trading
„h Factor advantages: Certain specific locations offer organisations factor advantages which
promote globalisation. For example, for developed countries in the west, cheaper labour or
manpower costs attract them to locate facilities in developing countries. Sometimes, availability of
skilled labour in certain locations also is a factor advantage. Some of the other advantages that
companies may experience could be in the form of availability of cheaper water or power
resources, or availability of better technical infrastructure in the form of ancillary industries.
„h Expanding markets: Certain markets in developing or under developed countries are
registering very high growth rate. Such countries offer new opportunities for multi-national
companies for expanding into new markets.
Activity 1:
List out the reasons why International companies come to developing countries and locate their
Self Assessment Questions
1. Rapid pace of economic reforms in most countries have led to _____ of markets.
2. Globalisation has opened up new opportunities for multi-national companies as far as _____
_____ are concerned.
2 The Suez Canal is located in Egypt. It is an artificial sea-level waterway. It connects the
Mediterranean Sea and the Red Sea.
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3. Removal of _____ and _____ in _____ costs are two important reasons why India became
attractive for locating manufacturing facilities.
4. Certain specific locations offer organisations _____ advantages which promote globalisation.
5. Certain markets in developing or under developed countries are registering very high _____.
6.3 Location Decisions
Location decisions3 are also strategically important due to many reasons. They generally involve
long-term commitment and are difficult or expensive to change. Location decisions also tend to
have significant impact on subsequent investment requirements, operating costs and revenues
and on operations themselves. A poor choice of location may add to transportation costs or result
in difficulty in obtaining required skilled levels in people, or they may make access to raw
materials more difficult. In short, for both manufacturing and services operations, the decision on
location is bound to have impact on the company¡¦s competitive advantage.
Objectives of Location Decisions
Profit-based organisations make most of their decisions on the resultant profit potential, while
non-profit organisations generally tend to seek a balance between their ability to serve their
customers and the costs they incur. However, it can be said that there is no ¡¥ideal¡¦ location for
any company. There may be many acceptable locations for a company. Sometimes, the options
may be so many as to make it very difficult to make a choice. Thus, practically, most companies
identify only the acceptable locations from which to make the final choice.
Choice of a location can often depend on the position of a company in its ¡¥supply chain¡¦.
Considering the extreme ends of a typical chain, a retailer may focus on accessibility to a
customer and seek to locate the business nearer the market, while at the beginning of a supply-
chain; a supplier of raw materials may attempt to locate the main facility near the source of raw
3 For more information on Location Planning please visit
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Four possible options exist in case of decision on location. They are:
„h To expand an existing facility: This pre-supposes that there is scope for expansion in the
existing facility. Such an option is considered if there are sufficient advantages in the existing
location that are not available in other options. This option generally entails less cost than other
„h Add more locations to existing ones: Generally, this happens in retail operations. The basic
concept would be to weigh the resultant impact of the total system ¡V in other words, the
company should examine whether addition of locations would result in a net improvement in
business, which would also be cost-beneficial. Sometimes, this option is resorted to pre-empt
competitors from entering the market.
„h Move from existing location to a new one: In this option also, a cost-benefit analysis of moving
to a new location should be assessed carefully before taking a decision. Shift in the market,
running out of raw material supplies or required manpower, etc. are some of the typical reasons
for considering this alternative.
„h Status Quo: This option may be forced on a company if the latter is unable to identify any
better potential location.
6.3.1 General Procedure for Location Decision
The approach to location decisions by different companies depends on the company¡¦s size and
geographical scope of its operations. Small companies adopt an informal approach. New and
small firms may locate their facility at a certain place just because the owner lives there or close-
by, and look for only local alternatives in case of expansion or adding new facilities. Large
companies, on the other hand, use a more formal approach, considering a wider range of options,
and subjecting the process to a detailed and rational analysis.
The procedure of making a decision on location in case of a formal approach may be described
as follows:
1. Decide on the criteria to be used for evaluating different location alternatives. For example,
increased revenue, or cost saving, or community service.
2. Identify important factors that influence the calculations ¡V for example location of markets or of
raw materials.
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3. Develop location alternatives:
a. Identify a general location.
b. Identify a small number of area alternatives.
c. Identify site alternatives within the area chosen.
d. Evaluate the alternatives and make the selection.
Step ¡¥a¡¦, is a matter of managerial decision.
Step ¡¥b¡¦, factors affecting Location decisions.
Amongst the many factors that may influence the location decision, a few may be more
significant. For example, for a nuclear power plant, proximity to abundant water supply for cooling
is very important, while for a steel plant, proximity to iron ore mines and to coal pits would be top
priority. A company would need to identify such important factors and narrow the search for
suitable options in a particular geographical area.
6.3.2 Regional Factors that Affect Location Decisions
There are several regional factors that affect Location Decision. Some of them are:
„h Market location
„h The location of Raw Materials
„h Labour issues like ( wage rates in that particular area, labour productivity and commitment
towards work)
„h Taxes and climate also affect the Location Decision in any particular region.
Location of raw materials
The logic for locating a facility near the source of raw materials may be either ¡¥necessity¡¦ or
¡¥perish ability¡¦ or ¡¥transportation costs¡¦. For example, mining operations, has to be located
near the mines. Facilities for food processing or canning of fruits may warrant proximity to raw
material because of ¡¥perish ability¡¦. In case of certain products such as finished steel, there is a
considerable reduction in the weight / volume during the process of conversion from raw material
to finished goods, making transportation of raw materials a key element in production costs, and
hence the facility location may be closer to the supply of iron ore due to ¡¥transportation costs¡¦.
Location of markets
Location of markets influence location decisions since in many cases, profit-oriented companies
tend to locate their facilities near the market as a part of
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their competitive strategy. Retail sales and service organisations, typically, are found in the centre
of the markets they serve; example ¡V fast-food restaurants, supermarkets, dry-cleaners, etc.
Since in most cases, the products of different competitors are not much differentiated,
¡¥convenience¡¦ to the customer becomes a key attribute. This is so even in case of banks,
drugstores, etc.
Some firms need to locate their facilities near their markets in view of the perish ability of their
products such as bakery products, flowers, fresh food stores. For some other firms, physical
distribution costs may become the key criterion. In some other cases, proximity to customers is
sought because of the need for close customer contacts.
Labour factors
In arriving at a decision on the location of a facility, labour factors also play a key part. This is
particularly so for labour-intensive organisations. Some of the factors considered are labour cost,
labour productivity, tendency to form unions and generally, workers¡¦ attitude towards work.
Climate and taxes
In some cases, extreme climatic conditions may be avoided by some companies since it may
affect worker attendance or create road blocks thus hampering delivery schedules.
Taxes are also a major consideration, especially if different states / regions have a totally different
tax regime.
6.3.3 Community Considerations
Communities tend to attract businesses due to creation of employment, or because tax
collections can be better. However, certain communities may be sensitive to disturbance of
ecology, and may go out of the way to discourage certain types of businesses from setting shop
in their area.
In some cases, while the community as a whole may hold a favourable view about location of a
business, individual families or residents may have serious objections to certain businesses
locating or expanding their facility in the sites next to theirs, due to objection to possible increase
in noise levels, traffic or pollution. Examples of such businesses are: airports, nuclear facilities,
high-way construction, etc.
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From a company¡¦s view-point, a community can be attractive as a place for its workers and
managers to live in view of superior facilities of education, health-care, shopping, transportation
and religious worship.
6.3.4 Site-Related Factors
The other important factor which has to be considered in Location Decision is Site-Related
Factors. These are important because only if the site and soil condition is good, the construction
will be strong enough. Even the cost of the land and its future accessibility also matters a lot.
The main considerations in case of site-related factors are:
„h Land
„h Transportation
„h Access and zoning or other restrictions
In certain cases, sites may need to be evaluated with the help of engineers or technical experts in
case of heavy manufacturing units, erection of large buildings or facilities with special
requirements. Soil conditions, load bearing capacity and drainage rates can be critical and may
need careful and expert evaluation.
In view of the fact that decisions on site are long-term, factors such as scope for future
expansions, current utility such as sewer connections, sufficient parking space, access to main
roads, etc. have predominance over land cost. From this point of view, Industrial Parks could be
ideal locations, but on the flip side would be restrictions on certain types of industries inside an
industrial park.
Self Assessment Questions
6. It can be said that there is no _____ location for any company.
7. Most companies identify only the _____ locations from which to make the final choice.
8. Choice of a location can often depend on the position of a company in its _____.
9. The approach to location decisions by a company depends on the company¡¦s _____ and
_____ scope of its operations.
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Activity 2:
Assume that you are planning to open an automobile shop. List out the main site related factors
that you will take into consideration.
6.4 Multiple-Plant Strategies
Multi-Plant Strategies are the different types of strategies used in production plants, marketing
plants and processing plants. There are a few alternatives available for companies that are
contemplating more than one manufacturing facility. One alternative could be to take up
manufacture of one product line in each plant. Another approach could be to service a particular
market area from one plant manufacturing different products/product lines. Another option could
be to assign to each plant a particular manufacturing process.
Product plant strategy
Under this strategic approach, different facilities produce different product lines, each serving the
entire domestic market. Such an arrangement reflects a specialisation approach towards labour,
materials and equipment along product lines. This often contributes to Economies of Scale, and
hence lower operating costs. The different plant locations can either be widely spread or gathered
within a small area.
Market area plant strategy
With this strategy, plants are designed to serve a particular geographic segment of the market.
Individual companies produce either most or all of the product lines, but supply to a limited
geographical area. Significant savings on distribution / transportation costs of finished products
often out-weigh other factors such as larger incoming logistics costs. This arrangement is
particularly recommended when finished products are heavy in nature. Another advantage could
be a faster responsiveness to customers in terms of delivery and service. This approach calls for
a ¡¥centralised¡¦ plant.
Process plant strategy
Here, the strategy is to focus different aspects of a process in different plants. Automobile
industries often resort to this arrangement where the engines, transmissions, radiators, body
forgings, etc. are manufactured in different plants. This approach is suitable where a product has
a number of
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components, and especially if some of the components are sub-assemblies. In this arrangement,
coordination of production throughout the system becomes highly complex, and a well informed,
centralised administration is required to achieve the same. However, a key advantage is that
each plant is highly specialised and generates large volumes, resulting in Economies of Scale.
In Multiple plants, the strategies of work implemented in one plant can be shared by others and
improvement in products and processes in all plants can be achieved effectively.
Self Assessment Questions
10. Under product plant strategic approach, different facilities produce different _____ lines, each
serving the entire _____ market.
11. Under market area plant strategy, plants are designed to serve a particular _____ segment of
the market.
12. The process plant strategy is to focus on _____ aspects of a _____ in different respective
Activity 3:
Visit any supermarket in your area and enquire about the various issues which were taken in to
consideration before opening it in your area. Make a list of the alternate choices that the
supermarket owner could have thought of before opening it.
6.5 Service and Retail Locations
The process of making location decisions in case of service and retail operations involve different
considerations as compared to manufacturing locations. While manufacturers tend to be cost-
focused, service and retail businesses tend to be focused on revenue. For service providers and
retailers, traffic volume and convenience are high on their priority lists.
Retailers tend to locate themselves near other retailers (not necessarily their own competitors) in
order to take advantage of traffic volume and to offer more convenience to the customers. For
example, automobile component dealers tend to gather together, restaurants tend to be near
hotels and specialty stores tend to be near malls, in order to take advantage of heavy traffic.
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For retail establishments, parking and transportation facilities can be vital. Thus, malls attract lot
more people than downtown establishments since the former offer free parking facilities. In urban
areas customer safety and security also are considered very important.
In many cases, competitors¡¦ locations play significant part. Some businesses tend to locate near
competitors in order to take advantage of concentration of potential customers. In other cases,
such as franchisee operations, it is unlikely that businesses will locate near other franchisees.
A comparative picture of selection criteria between manufacturing/ distribution businesses and
retail/service businesses is presented in the following Table 6.1:
Table 6.1: Comparison between Manufacturing and Service
Manufacturing / Distribution
Service / Retail
Manufacturing is Cost focussed.
Service is more Revenue focussed.
In manufacturing the organisation has to bear the transportation costs.
Demographics: age, income, educa-tion are taken into considera-on in service.
Manufacturing depends on the availability and costs of energy.
Service oriented business depends on population and the area it is situated in.
Manufacturing depends on the cost, availability and skills of the labour.
Competition drives service sector.
In manufacturing the organisation has to bear the building and the leasing costs
Traffic volume also plays a crucial role in Service Business.
Customer access /and parking is more important in Service.
Self Assessment Questions
13. For making location decisions, while manufacturers tend to be _____-focused, service and
retail businesses tend to be focused on _____.
14. For retail establishments, _____ and _____ facilities can be vital.
Activity 4:
We generally find many shopping malls, retail shops, automobile shops and supermarkets
together in a particular area. So, create a list of reasons why these kind of shops which sell the
same product, flock together in one area.
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6.6 Global Locations
As more and more companies have ventured out of their national borders, and as globalisation
has been catching on, recent trend in locating manufacturing facilities indicate a distinct
preference for foreign locations. Certain countries like India and China offer tremendously large
potential markets for various products. Companies prefer to locate their manufacturing facilities in
such countries to reduce delivery costs and also to be closer to the customers.
The year 1994 was a watershed year when General Agreement on Tariffs and Trade (GATT)
passed a resolution reducing/eliminating various import tariffs. Consequently, the tendency to
locate facilities within a country to escape tariffs became a non-issue.
Another trend has been the practice of Just in Time (JIT) manufacturing, due to which suppliers
prefer to locate their facilities near to the customers to reduce the lead time. In addition, in light
manufacturing industries, such as electronics, proximity to markets is gaining precedence to low-
cost labour.
Development in Information Technology (IT) has also made communication faster and more
efficient. Even distant places are connected within minutes due to advancement in IT and
Another factor that promotes companies to locate their manufacturing facilities in developing
countries is that some local markets¡¦ customers do not buy products that are not made in their
own country. Currency fluctuations and devaluations can also make a major impact on the prices
of products, thus making imports much more expensive. Changes in currency values alter the
price of foreign goods, but not the price of domestically produced goods.
The growth in multi-national operations over the past few decades reflects the importance of
foreign locations. Some firms could be attracted to foreign locations because of proximity to
sources of basic raw materials and natural resources, while others have ventured beyond their
country¡¦s boundaries in order to expand their markets. Some other organisations may be
attracted to outside locations because of availability of labour ¡V abundant resources.
Some countries offer financial incentives to companies to create jobs for their people. Some
countries may adopt import tariffs in order to discourage foreign companies from setting up units
in their own country. This would
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result in limiting competition in the country, which in turn, may attract more competent companies
to set up their facilities in the country.
An organisation which is considering locating its operations / facilities in a foreign country must
judiciously weigh the benefits of such a move against the potential problems they are likely to
face. Amongst the latter, a major source of problem would be the stability of the host country¡¦s
government, and its attitude towards foreign firms.
Problems to a company in a different country can also be caused by language and cultural
differences. Many organisations have taken initiatives to moderate this problem by providing
facilities of housing, education and medical service with special efforts. Companies also select
such personnel who are a little familiar with the host country¡¦s language and culture.
Self Assessment Questions
15. The year _____ was a watershed year when GATT passed a resolution reducing / eliminating
of various import tariffs.
16. Another trend has been the practice of _____ manufacturing, due to which suppliers prefer to
locate their facilities nearer the customers.
17. Currency _____ and _____ can also make a major impact on the prices of products.
18. Problems to a company in a different country can also be caused by _____ and _____
6.7 Evaluating Location Alternatives
A number of alternatives are available that help in evaluating location alternatives. Some of the
alternatives are explained in the following paragraphs.
6.7.1 Location Cost ¡V Profit ¡V Volume Analysis
Location Cost-Profit Analysis means deciding whether a particular location is suitable for further
operations and transactions. It considers the cost of the land and determines the lowest cost of
the same, to commence operations.
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In this procedure4:
First, the Fixed Cost and Variable Cost for each location is determined:
Total Cost = Fixed Cost + ¡¥v¡¦ x Q
Where, ¡¥v¡¦ is the Variable Cost per unit
Q is the Output level being considered.
The two coordinates (output on one axis and Total Cost on the other axis)
are plotted independently for all the locations on the same graph
For a given (expected) level of output, the most economical location can
easily be determined by reading the graph (alternately, the profit value can
be determined for different levels of output at each location).
0 2 4 6 8 10 12 14 16
Annual Output (000 units)
B superior C superior A superior
Total Annual Cost (Rs)
Figure 6.1: Total Cost of Manufacturing at Different Levels
The above graph shows four different graphs ¡V ¡¥A¡¦, ¡¥B¡¦, ¡¥C¡¦ and ¡¥D¡¦ ¡V each
shows the total cost of manufacturing at different levels of output. The four
different graphs refer to different location alternatives.
For more information please refer
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It is observed from the above graph that between output levels of:
„h 0 and 400 of total annual cost, the location alternative ¡¥B¡¦ is more economical in terms of
total cost of production.
„h 400 and 1400 of total annual cost, the alternative ¡¥C¡¦ offers the lowest total cost.
„h Beyond 1400 units of output, the alternative location of ¡¥A¡¦ offers the lowest total production
Thus, the above analysis provides guidance to managers who make decisions on locating their
manufacturing facility, depending on the visualised output level/levels.
6.7.2 The Transportation Model
Either because of heavy anticipated movement of raw materials or of the finished products,
transportation costs sometimes influences the location decision.
If the source or destination for raw materials or finished goods is single, it is a simple case of
factoring in the cost of transportation in the ¡¥variable cost.¡¦ However, in case of multiple
locations of raw materials and/or finished products, then the resultant total cost of
¡¥transportation¡¦ for any given location of a facility will need to be worked out with the help of a
transportation model of ¡¥Linear Programming¡¦. The same logic holds good even if a company is
considering addition of a number of, new facilities.
6.7.3 Factor Rating
Factor rating is a general approach to evaluate alternates and compare them. A composite value
for each alternative is worked out by summarising all related factors. Both ¡¥quantitative
information¡¦ and ¡¥personal information¡¦ can be factored in working out the composite value for
each alternative. The procedure involved is as follows:
1. The relevant Factors (location of market; infrastructure requirements like water supply, parking
facilities, etc ) are identified and determined.
2. Each Factor is assigned a ¡¥weight¡¦ based on its relative importance as compared to other
factors (the sum of ¡¥weights¡¦ for all factors would be 1.0).
3. A common ¡¥scale¡¦ is identified for all factors.
4. For each location alternative, the score is calculated.
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5. The ¡¥factor weight¡¦ is multiplied by the score for the respective factor, and the resultant value
for each factor is added up together.
6. The particular alternative having the highest composite score is selected.
A photo-processing shop intends to open a new branch store. The following table has information
on two different potential locations.
Table 6.2: Example for Factor Rating
(out of 100)
Weighted Scores
Alt. 1
Alt. 2
Alternative 1
Alternative 2
Proximity to
Existing store
.10(100) = 10.0
.10(60) = 6.0
Traffic Volume
.05(80) = 4.0
.05(80) = 4.0
Rental Costs
.40(70) = 28.0
.40(90) = 36.0
.10(86) = 8.6
.10(92) = 9.2
.20(40) = 8.0
.20(70) = 14.0
Operating Costs
.15(80) = 12.0
.15 (90) = 13.5
In the above Table 6.2 the two alternatives locations 1 and 2 are discussed. Alternative 1 scores
better than Alternative 2 in proximity to existing store. Both have equal advantages when it comes
to traffic volume. Alternate 2 has good chances in all the other factors. So when all the factors are
calculated, Alternative ¡¥2¡¦ is superior since its Composite Score is higher.
Hence under certain circumstances, a minimum threshold is established for the composite score,
and any factor for which the composite score is below the ¡¥threshold¡¦ is rejected outright. In an
extreme case, if each considered factor has a ¡¥less-than-threshold¡¦ composite score (and
hence gets rejected), then the company looks for additional factors or can review the threshold
level established.
6.7.4 The Centre of Gravity Method
This technique is particularly used for decision on location of a distribution centre. The concept is
to determine such a location for which the distribution cost is the minimum.
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The basis for the cost calculation is to treat the distribution cost as a linear
function of the ¡¥distance¡¦ and ¡¥quantity¡¦ shipped.
The simpler model is to consider that the weight to be shipped to each
destination is fixed. In a variation of the simpler model, of centre of gravity
the weights can be made to vary, but within the same proportion (for
example: seasonal variations).
As the initial step, the destination locations are plotted on a set of coordinates
in such a way that the relative positions of the destinations are
accurately positioned. The next step is to determine the ¡¥centre of gravity¡¦.
2 4 6 8 10
Centre of
Figure 6.2: Determining Centre of Gravity
In the above Figure 6.2, the X axis and Y axis represent the distance and
the ¡¥D¡¦ represents the destination. Assuming that the quantity to be shipped
to each destination is equal, the co-ordinates of the Centre of Gravity that
can be determined by calculating the ¡¥average¡¦ of the X-coordinates of all
destinations and the average of all the Y-coordinates, respectively, that is,
by using the following formulae:
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x = £Uxi . n
y = £Uyi . n
xi = ¡¥x¡¦ coordinate of destination ¡¥i¡¦
yi = ¡¥y¡¦ coordinate of destination ¡¥i'
n = The number of destinations
i= 0-10 (x)
i= 0-6 (Y)
In case, the number of units to be shipped to each destination is different from the others, then a
¡¥weighted average¡¦ is used to determine the Centre of Gravity that coordinates, using the
following formulae:
x = £UQi xi . £UQi
y = £UQi yi . £UQi
xi = ¡¥x¡¦ coordinate of destination ¡¥i¡¦
yi = ¡¥y¡¦ coordinate of destination ¡¥i'
Qi= Quantity to be shipped to destination ¡¥i¡¦
Self Assessment Questions
19. Factor Rating is a general approach for evaluating _____ and comparing them.
20. The Centre of Gravity method is a technique particularly used for decision on location of a
_____ centre.
6.8 Summary
Decisions on location of facilities are of strategic importance to most organisations. Such
decisions involve high initial costs, and cannot be reversed easily. Whether an organisation is
being newly set up or whether an organisation already exists, location decisions have to be well
thought out. Companies initiate such decisions on additional locations due to many other reasons
such as fresh access to depleting resources or to deliver better ¡¥service¡¦ to customers.
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The planning of facilities is directly drawn from a company¡¦s business strategy. In turn, location
decisions, when implemented, have significant impact on subsequent investments, operational
parameters and revenues.
Generally, a company comes up with many suitable locations to suit their strategy and different
requirements. The final selection of the location is done based on several criteria, - including
whether a firm wishes to expand its existing facility, add more locations to existing ones, or shift
its facility.
While the criteria for selection of a location is a management decision, several factors ¡V such as
regional factors, proximity to markets, labour availability, climate, tax regime, etc can influence
the calculations. Besides, there are the aspects of community and the infrastructure availability at
the site.
Companies can adopt different strategies focused on either the product or the market or the
In case of choosing location for service type of business or a retail business, the focus is
generally on the traffic volume and service deliverables.
More companies are venturing into global operations and hence they need to make location
decisions not only within the national borders, but in other countries also. A number of techniques
are available to evaluate the suitability of alternate locations. Whatever the technique, the main
logic in such calculations is to understand the Cost ¡V Benefit equation.
6.9 Terminal Questions
1. Why should a company give importance to location decisions?
2. What are the objectives of making location decisions, and what options are available for
making a choice of locations?
3. What are the different types of strategies followed while selecting a location, and discuss their
relative characteristics?
4. Explain the peculiarity of location selection in case of service operations.
5. What are the new challenges faced by any company regarding location decisions in a global
6. What are the methods of evaluating alternate locations?
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6.10 Answers
Answers to Self Assessment Questions
1. Globalisation
2. Location decisions
3. Entry barriers, reduction, manufacturing
4. Factor
5. Growth, rate.
6. Ideal
7. Acceptable
8. Supply Chain
9. Size, geographical
10. Product, domestic
11. Geographic
12. Different, process
13. Cost, revenue.
14. Parking, transportation
15. 1994
16. JIT
17. Fluctuations, devaluations
18. Language, culture
19. Alternatives
20. Distribution
Answers to Terminal Questions
1. Refer to Section 6.1
2. Refer to Section 6.3
3. Refer to Section 6.4
4. Refer to Section 6.5
5. Refer to Section 6.6
6. Refer to Section 6.7
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6.11 Case Study
Soha Limited, which is one of the foremost manufacturers of textile handicrafts in North India,
realised the growing demand for its products in South India. It planned to set a new production
facility at a suitable location. It started considering many suitable locations for this purpose. The
management started collecting relevant data about the major cities and states where they can set
up their company. They also considered factors like location, cost and potential. Finally, Factor
rating method was used to find a suitable state and Centre of gravity method was used to find a
suitable location for their planned business operations. The analysis had a wide variety of factors
based on the information and experience in the field. Considerable weightage was given for every
factor in the analysis. After considering the result of the analysis, ¡¥Munnar¡¦ in Kerala was
selected for their business operation in South India. Kerela had abundant raw material and the
cost of the land was also affordable. Kerela was also at a very favourable distance for their
operations. These all factors made Kerela the most favourable place for manufacturing the textile
1. What according to you might have been the factors that the company considered before
deciding Kerela as its centre for business operations?
2. In which way would the productivity be affected if the location decision was taken in haste?
6.12 Glossary
Subordinate or subsidiary company which helps in better productivity.
To lessen the value of currency so that it will affect price of products.
To have precedence from allowing the companies to get into com- petition.
To proceed despite possible risk in establishing a company abroad.
Classifying or dividing any area into different zones for better administration or operations.
General Agreement on Tariffs andTrade (GATT)
This is a multinational treaty designed to provide an international forum that encouraged free
trade between member states by regulating and reducing tariffs on traded goods and by providing
a common mechanism for resolving trade disputes. It is a United Nations agency.
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3. Manufacturing Facilities: Location, Planning, and Design by Dileep R. Sule

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Unit 7 Forecasting
7.1 Introduction
7.2 Introduction to Forecasting
Common Characteristics of Forecasting
7.3 Elements of a Forecast
7.4 The Process of Forecasting
7.5 Approaches to Forecasting
7.6 Qualitative Forecast
Executive Opinions
The Delphi Method
Sales Force Opinions
Consumer Surveys
7.7 Times-Series Approach
Approaches to Time Series Data
7.8 Associative Forecasting Techniques
Simple Linear Regression
7.9 Forecast Accuracy & Forecast Management
Managing or Controlling the Forecast
7.10 Summary
7.11 Terminal Questions
7.12 Answers
7.13 Case Study
7.14 Glossary
7.1 Introduction
By now you must be familiar with the concept of Operations Management. One of the primary
tasks in Operations Management is that of planning of everything that is related to production.
At corporate levels, planning is more strategic and qualitative, at business levels and further
down, at functional and managerial levels, the planning activity takes a very specific form. The
outcome of planning ¡V a PLAN ¡V is expressed in a specific quantitative form.
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Pre-requisite for any planning exercise is a FORECAST.
This unit covers common characteristics of forecasting, elements of a forecast, the process of
forecasting, approaches to forecasting, qualitative approaches, time-series approach associative
forecasting techniques, forecast accuracy & forecast management.
Learning Objectives:
After studying this unit you will be able to:
„h Define the elements of a good forecast.
„h Explain the steps involved in the forecasting process
„h Describe different qualitative techniques of forecasting, listing the advantages and
disadvantages of each.
„h Compare qualitative and quantitative techniques of forecasting.
Discuss measures of forecast accuracy.
7.2 Introduction to Forecasting
Forecasting can be defined as the estimation as to when, and to what extent future events will
take place, for the purpose of planning. In spite of advanced development in computers and
mathematical models, forecasting has not become an exact .science.. It can be more of an .art. at
individual level, at organisational level, various techniques have been developed using scientific
reasoning, and many good companies rigorously use some of these techniques, combined with
a .gut-feel. of certain key responsible employees.
Thus, effective forecasting often demands a skilful combination of .art. and .science.. Experience
and judgment also play a crucial role in forecasting apart from technical expertise. In addition,
forecasters are well advised to hope for some .luck. and exhibit humility since many a times, the
best forecasters produce awful forecasts, and the worst ones develop very effective forecasts. To
make forecasts, two kinds of information are generally taken into account. They are:
„h Information pertaining to present conditions.
„h Information regarding past experience.
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In business, many formal methods and techniques have been developed not only to develop
forecasts but also to assess forecast accuracy. A Forecasting method has to be carefully chosen
depending on the use to which the forecasted figures are put. No single existing universal method
of forecasting can be used for several situations.
The aim in any organisation would be to develop forecasts that will turn out to be as close to the
actual unfolding of events as possible, so that the plans developed based on forecasts are most
appropriate to the company.s objectives and to the environment in which it operates.
Another reflection of good forecasts and good forecasting would be the ability of the organisation
or its planning team to make timely mid-course corrections to its plans based on external events.
Forecasts impact decisions throughout an organisation in finance, marketing, human resource
management, accounting, systems management, operations management, etc.
Some typical applications of forecasts are as follows:
„h Profit projections, cash-flow estimates, costing estimates, etc.
„h Equipment needs, financing requirements, etc.
„h Hiring plans, lay-off plans and counselling, etc.
„h Product development planning, pricing, promotional plans, inventory planning, capacity
planning, etc.
Invariably, use of forecast in one area has impact on other areas, thus making it necessary for
managers in different functional areas to coordinate while making decisions. The applications of
forecasts include:
„h Planning the system.
„h Planning the use of the system.
The former involves long-term plans (strategic) while the latter generally deals with medium and
short-term plans. Business forecasting does not confine itself to predicting demand. Future
revenues, costs, profits, prices, availability of resources, interest rates, and stock prices are also
estimated by forecasting. In order to understand the subject better, we focus on Demand
Forecasting and techniques; principles are also equally relevant to other variables. The task and
responsibility of preparing .Demand Forecasts. generally rests with the marketing function in a
business entity,
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notwithstanding the fact that the forecasts developed have far-reaching and high level of
influence over operations. However, the operations function itself would need to develop
forecasts regarding capacity and time requirements, material needs, and labour deployment.
7.2.1 Common Characteristics of Forecasting
Even though there are different kinds of techniques and methodologies used in forecasting
certain common features span the entire variety of forecasting techniques. Some of the common
characteristics of forecasting are as follow:
„h The different techniques make a common assumption that what happened in the past will
continue to happen in future.
„h Forecasts are never absolutely precise. The actual events or results generally deviate from the
estimates made. It is very difficult to predict accurately how a large number of related factors will
influence one particular variable under study. Further, the aspect of random occurrences
contributes additionally to a forecast being different from the actual. Therefore, inaccuracies
should be factored in while making decisions.
„h It is possible to get a more accurate forecast for a set of variables than for a single variable,
since the errors during the process of forecasting tend to avoid each other to some extent. Such
opportunities are available in certain cases, when a product is demanded by a number of
independent customers, or the same raw material is required in different products.
„h Accuracy of forecasts is inversely proportional to the .time horizon. of the forecast. Short-term
forecasts need to contend with lesser uncertainties than longer-term estimates. Hence they tend
to be more accurate.
It is not enough to depend solely on models or computers for developing forecasts. Unforeseen
events such as weather-specific factors, new tariffs or taxes and competitors. moves are likely to
have major impact on demand. Therefore, it is necessary for a manager to be very alert and
modify forecasts as and when such incidents occur.
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Self Assessment Questions
1. What assumptions do different techniques of forecast make?
2. Forecasts are never absolutely ____.
3. Accuracy of forecasts is inversely proportional to the _______________ of the forecast.
7.3 Elements of a Forecast
We have already discussed the meaning of forecast and its common characteristics in the
previous section. Now let us discuss about the elements of forecast. Elements of forecast mean
basic assumptions or principles which make a good forecast.
A well-prepared forecast should fulfil certain conditions:
„h The forecast should be prepared at the appropriate time for it to be used effectively. Many
decisions have a longer lead time, such as putting up new facilities. Therefore, the time horizon of
the forecast should be sufficient to act on the forecast and implement necessary changes.
„h The forecast should be accurate, and the degree of accuracy should be specified. This will
facilitate users to factor in likely errors, and also make comparisons of alternative forecasts
„h A forecast should be reliable. Forecasts developed with the help of a particular technique
should work consistently. This will provide confidence to users when they consider using new
„h The forecast should be expressed in relevant units ¡V whether they are units, rupees,
equipment capacities, man-hours, etc. so that the concerned persons can use it easily.
„h The forecast should be expressed in writing. This will reduce the chances of different people
using different information. Written forecasts will also help in subsequently comparing actual
results with the forecast made.
„h The forecasting technique should be easy to understand and use. The users of forecasts often
get confused with forecasts made through sophisticated techniques and hence loose confidence.
This may result in misuse of techniques. Simple forecasting techniques are generally more
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„h The forecasts should give rise to benefits which are more than the costs incurred. The
forecasting should be cost effective.
Self Assessment Questions
4. The forecast should be prepared at the ____ or ____ time for it to be used effectively.
5. The forecast should be ____, and the degree of ____ should be specified.
Activity 1:
Prepare a list of elements which makes a forecast good.
7.4 The Forecasting Process
Forecasting process is the mechanism for approaching for participation from people who are
experienced and have the capability to predict the future events and arrange them in a sequence
to develop a format. It generally defines on how to gather and arrange the information in a logical
The forecasting process consists of six basic steps:
1. Understand and specify the purpose of the forecast: It is necessary to express for what
purpose and when the forecast is to be used so that the level of detail and accuracy required, and
the resources that can be justified can be examined. For example, if the firm is interested in
introducing a new product within the next six months, or if the production department want to plan
next month.s production to meet the market demand, or, if the top management looking at
diversifying into new areas of business. Each of the above situations would call for a different
type of forecast- in terms of time-horizon, or accuracy level of the forecast ¡V and the forecast
results would also be used differently in each case.
2. Establish a time-horizon of the forecast: The longer the time-horizon of forecast, the less is its
accuracy likely to be. At the same time, the kind of decision to be made would decide the time
horizon for which the forecast is required. The time horizon identified would also determine
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the type of data required ¡V in terms of variety and source of data and the detail to which the data
is required.
3. Select the suitable forecasting technique: The next step after identifying the purpose, time-
horizon, and the nature of data is to choose an appropriate model. To help do this, a sample set
of data relating to earlier period can be picked up and a quick analysis can be done to examine
the presence of .seasonal. or .cyclical. effect. Information about existence of such patterns helps
in selecting the appropriate model for consideration.
Each model will involve certain parameters that are to be determined. For example, if a .moving
average. technique is to be used to predict future demand, then the parameter would be the
number of periods for which the average will be calculated. Based on the sample data, the
parameters of the selected model have to be established, after which the logic could be used for
However, before using the logic, it is advisable to .test. its appropriateness by choosing a small
.early. period and working out the forecast for subsequent periods. Such forecasts could be
compared with the .actual. figures that have happened during the subsequent period to see the
extent of deviation between the forecast and the actual. If the deviation is nominal then the logic
can be used. However, if the deviation is abnormal, then there is a need to re-examine the logic,
and some of the parameters selected may need change.
4. Mobilise relevant data and analyse the same: The quality and quantity of data that a firm can
mobilise for forecasting purposes will limit the accuracy in forecasting. Therefore, it is vital to
know the type of data required and the normal sources through which data can be obtained.
Sales force estimates can provide data about:
„a Actual consumption
„a Changing profile of consumption
„a Competitors. corresponding performances
„a Movement in market shares amongst competitors
„a Market growth figures
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Since sales force normally spans the entire geographical range of the firm.s market, data
obtained through the sales force can be particularly significant in short-term forecasting, and for
mid-course corrections to sales and production planning.
5. Prepare the forecast: While preparing a forecast you should follow few things which are very
crucial. They are:
„a Be very practical in estimating the forecast.
„a You should choose the right technique for forecasting.
6. Monitor the accuracy of the forecast: A forecast has to be monitored to determine whether it is
giving required results. Monitoring a forecast includes:
„a Checking the forecast regularly against actual data that is present or against the historical
„a Monitoring the operations for getting better results.
„a Adjusting the forecast as the information flows, in case of absence of historical data.
Self Assessment Questions
6. The forecasting process consist of ____ basic ____.
7. The longer the ________ of a forecast, the ____ is its accuracy likely to be.
7.5 Approaches to Forecasting
There are two general approaches for forecasting, They are:
„h Qualitative approach.
„h Quantitative approach.
Qualitative approaches mainly involve subjective inputs which cannot be generally expressed in
numerical terms. Quantitative methods, on the other hand, are either based on historical data or
involve .causal. (explanatory) relationships.
The forecasting processes in .qualitative. approach make use of human judgment and opinion,
based on knowledge, experience and hunches. Since these are very difficult (sometimes
impossible) to quantify, the .quantitative. approach do not resort to such .soft. inputs. The latter
steer clear of personal
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biases that often influence qualitative methods. In practice, either of the above approaches, or
both, is used to develop forecasts.
Based on the two approaches, the forecasting techniques can be broadly classified under three
headings, they are:
„h Judgmental forecasts
„h Time-series forecasts
„h Associative model
Judgmental forecasts are based on analysing subjective inputs obtained through different
possible sources such as ¡V consumer surveys, sales staff, managerial staff, and panel of
experts. These sources often provide insights that are not otherwise available.
Time-series forecasts, in simple terms, seek to project patterns identified in past data into future
probabilities. The basic assumption in this approach is that ¡§the future will be like the past¡¨.
Associative models use co-relation equations that consist of one or more explanatory variables
that can be used to predict future demand. For examples, demand for a product and money
spend on advertising for the product, demand and birth rate, or demand and a particular
demographic profile.
These techniques are discussed in detail in the coming sections.
Self Assessment Questions
8. The two general approaches for forecasting are____ and ____.
9. The forecasting processes in .qualitative. approach make use of____ ____ and ____.
10. How are forecasting techniques classified based on qualitative and quantitative approaches?
7.6 Qualitative Forecasting
Qualitative forecasts are based on judgment and opinion. Under some circumstances, forecasters
either choose or are compelled to rely on judgment and opinion to make forecasts. The reasons
can be varied. It could be non-availability of enough time to gather relevant data; or, if a
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product type is new, past data may not be available at all; in other cases, due to drastic change in
the environment, and past data available may not be applicable. These forecasts are called
judgemental forecasts. Some of these judgemental forecasts are discussed below.
7.6.1 Executive Opinions
The forecast is drawn on the basis of opinions or judgments of a small group of senior level
managers (in marketing, sales or any other functional area) whose knowledge, skills and
experience are leveraged. This method is generally used for long-term planning or new product
development. The risk involved in this technique is that one of the personnel in the group would
develop a leadership role and their opinion may prevail. It becomes difficult to spread the
responsibility of producing a forecast uniformly over all the members of the group.
7.6.2 The Delphi Method
The use of this method is not confined to forecasting. The Delphi method concept involves
circulating a series of questionnaires among individuals who have the knowledge and ability to
contribute meaningfully. The responses are kept anonymous, this promotes receiving honest
responses and chances of bias and of one of the opinions prevailing gets minimised. This
process is repeated in several rounds, depending on the need for accuracy. The responses
received in any round may either be circulated (anonymously) to all respondents before seeking
their second round of opinions. This not only expands the scope of information on which
responses can be based, but gives them the opportunity to fine tune the opinion based on others.
opinions. The goal is to achieve a consensus forecast. In the area of forecasting, Delphi method
is generally used for technological forecasting ¡V predicting changes in technology and its impact
on the organisation. Often, the aim is to forecast, when an anticipated event will occur. Such
forecasts are generally long term and single-time forecasts for which very little hard data is
available to analyse. Due to this the judgment or opinions of experts or knowledgeable people is
7.6.3 Sales Force Opinions
The field sales or the customer service personnel are often a very good source to forecast
product demand since they are in direct contact with customers. As the field sales people have
updated customer feedback
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about the existing products and are even aware of the customers. future plans, they are in a
position to give precise opinion about the future demand. Certain drawbacks with this approach
include the inability of the sales force to make considered judgment, that is, to distinguish
between what the customers are likely to do and what they actually will do. Simultaneously, it has
also seen that the sales force.s judgment is biased due to self-interest, especially if the forecast
thus produced should become the basis for the performance .targets. set for them. On the other
hand, the sales people (perhaps due to limited all round experience) tend to be unduly influenced
by the recent trend.
7.6.4 Consumer Surveys
This is a very popular approach since demand is ultimately generated by consumers, their
opinions would be most authentic. But, invariably the population of prospective customers is very
large, and it is not easy to identify the potential customers amongst them. Thus, instead of
contacting all of them individually, firms resort to .surveys., where a ¡§representative¡¨ of the
population is approached for their responses. While this has the potential to obtain inputs .straight
from horses mouths., it requires considerable skill to design and administer a survey, and equally
so to interpret the data/information obtained from such surveys. Surveys can be expensive and
time consuming, the respondents often exhibit irrational behaviour patterns, and often the
response rates are low. Firms resorting to this method need to have the expertise to overcome
these pitfalls.
Self Assessment Questions
11. The Delphi method concept involves circulating a ____ of ____ among individuals.
12. Surveys can be ____ and ____ ____.
Activity 2:
Visit a soap manufacturing company and learn how they come to know the requirement of their
customers without contacting them directly. List the various techniques that the manufacturers
use to forecast the requirements in order to satisfy the customer.
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7.7 Time-Series Forecast
Time series is a sequence of observations taken at regular time intervals ¡Vmaybe daily, weekly,
monthly, quarterly, yearly or periodically. The observations or data may pertain to demand, or
they may be of earnings, profits, shipments, output, rejections, etc.
Forecasting techniques based on time-series data are made on the assumption that future values
of the variables can be estimated from past values.
Even though, no attempt is made to analyse the factors influencing the pattern of the time-series,
this method has been very popular and is known to deliver acceptable results. The analysis of the
past data consists of plotting the data against time, and visually examining the chart. Some of the
patterns that can be recognised are:
„h Trend
„h Seasonal variation
„h Cyclical variation
„h Variations around an average
„h Irregular variations or random variations.
Trend refers to a long-term upward or downward movement of data. Some examples include
population changes, changes in income, etc.
Seasonal variation refers to short-term, regular variations generally linked to the time of the
calendar year or time of the day. Restaurant occupancy, foot-falls in supermarkets and bookings
in theatres experience such variations.
Cyclic variations reflect wavelike variations of more than a year.s duration. These are related to
influence of economic, political or agricultural factors.
Irregular variations happen because of unusual conditions such as severe weather conditions,
strikes or a major change in technology or product. They do not reflect typical behaviour and can
distort the analysis of a time-series. Wherever possible, data pertaining to such reasons should
be identified and removed from the overall data of time-series, before analysing.
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Random variations just happen without any referable reasons. They can
be seen as residual variations after all other types of variations are
accounted for.
A point to remember is that a .demand forecast. should be based on past
data of .demand. and not of sales, in order to take into account the aspect of
market share of the concerned firm and also that of .stock outs., if they have
taken place.
The charts shown in Figure 7.1 depict some of the variations described
0 Time
Year 1
Year 2
Year 3
Jan Feb March April May June July Aug Sep Oct Nov Dec
Figure 7.1: Variations in Forecasting
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7.7.1 Approaches to Time series Data
Various approaches to the analysis of the time-series data1 are discussed as under:
1. Naive Methods
This is so called because of the use of a naive approach. A naive forecast uses a single value of
a time series as the basis of forecast. This method of forecast can be used with a stable series
(variations around an average), with seasonal variations, or with trend. For example, the forecast
for demand for turkeys during the next Christmas is the same as the actual demand for turkeys
during the last Christmas.
Although, the naive approach may appear too simplistic, it is a legitimate forecasting tool. The
advantages of this tool are that:
„h It has virtually no cost.
„h It is quick and easy to prepare because the data need not be analysed.
„h It is easily understandable.
The main objection to this method is its inability to provide accurate forecasts. However, if the
accuracy level provided by this type of forecast is acceptable, this approach should be seriously
considered. Other forecasting techniques offering better accuracy would cost more. One of the
applications of the naive Forecast is to use it sometimes as a standard for comparison against
which the cost and accuracy of other techniques can be judged.
2. Techniques for averaging
Historical data typically contains a certain amount of random variations that may hide the
systematic movements in the data. The randomness is mostly due to the combined influence of
many factors ¡V each relatively unimportant ¡V and hence cannot be reliably predicted. Averaging
techniques smooth such variations. It would be ideal to remove all randomness and leave only
the .real. variations, but this is not possible. Maybe, this can be rationalised by hoping that the
small variations are .random. and that the large variations are .real..
1 For more information on Time Series Data please visit
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These techniques smooth fluctuations in a time series because the
individual highs and lows in the data offset each other when they are
combined into an average. A forecast based on an average, tends to show
less variability than the original data, as shown in Figure 7.2.
Figure 7.2: Ideal and Gradual Variability
Since many of the movements (variability) exhibited by the data may be
random in nature, and not reflect a .true. change, averaging might be
advantageous, since it avoids need for the firm to respond to mostly random
changes and thus save a lot of avoidable cost.
Averaging techniques generate forecasts that reflect recent values of a time
series (example, the average value over a recent period). These techniques
are most appropriate when a time series data tend to vary around an
average; although they can work equally well in the case of a gradual or a
step change.
There are three techniques for averaging as mentioned below:
„h The Moving Average
„h The Weighted Moving Average
„h Exponential Smoothing
Moving Average: The Moving Average technique is one in which a number
of recent data values get averaged to determine a forecast, and the set of
data values get updated with most recent values with the passing of each
additional time period.
The disadvantage with the .naive method. is that it is based on just one
single corresponding data to predict a forecast, and no smoothing is
affected. This can be overcome by increasing the number of data
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considered, which is achieved by the Moving Average technique which uses
a number of recent data values and averages them, in order to project a
The Moving Average can be computed using the following equation:
F MA A n
t n „¸ tƒ{ ƒ ƒ 1
i = An index that corresponds to a time period
n = The number of time periods considered in the moving average
At-i = The actual value of the data in period t ¡V i
MA = The Moving Average
Ft = The forecast for the time period .t.
Assume that the following table shows figures of monthly demand for a
certain brand of shoes in a particular locality, in the past six months. The
forecast for the demand for this brand of shoes in that locality in the seventh
month, based on a four-month moving average would be calculated as
Period Demand
1 82
2 70
3 97
4 73
5 74
F7 = (100 + 74 + 73 + 97) / 4 = 344/4 = 86 pairs
If actual demand in the seventh month turns out to be 93 pairs (say), then
the forecast for the eighth month would be based on the new Moving
Average for the just previous four months, i.e.,
F8 = (93 + 100 + 74 + 73 )/ 4 = 340/4 = 85 pairs
Note: In the moving average, as the value for each new period become
available, the latest period-value replaces the oldest period-value
considered for calculating the average, and thus the moving average gets
updated. Thus, the forecast changes for each successive period reflect only
the most recent period-value.
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The moving average incorporates as many data points as desired. The
larger the number of data points, the larger is the weightage given to older
data and the sensitivity to the latest data value gets reduced. For better
responsiveness, it would be advisable to have fewer data points.
The advantage of Moving Average forecast is that it is easy to compute and
easy to understand. A potential disadvantage is that all values considered in
an average are weighted equally.
Weighted Moving Average: In a weighted average technique, while
computing a forecast, more recent values are given more weightage as
compared to earlier values.
For example, the most recent value of a variable may be given a weightage
of 0.30, followed by weights of 0.25, 0.20, 0.15 and 0.10 for the previous
successive four years. Note that the total weight for the values of these five
years is 1.0, but individual years get different weightage.
If we consider the previous cited example of demand for shoes that we
considered for the previous years, the forecast for the seventh year based
on the weighted moving average of five years would be calculated as:
„¸ ƒ
ƒ ƒ ƒ{
t n i i t F WMA W A i
(0.3 X 100 + 0.25 X 74 +0.2 X 73 + 0.15 X 97 + 0.1 X 70) / 5
i.e. (30 + 18.5 + 14.6 + 14.55 + 7) / 5 = 84.65 / 5 = 16. 93 pairs
The weighted average.s advantage over a simple moving average is that it
reflects the most recent occurrences. However, the choices of weights
should not be random, but have sufficient rationale behind it.
Exponential Smoothing: It is a more sophisticated weighted averaging
method that is relatively easy to understand and use. Every new forecast
will be based on the previous forecast along with a percentage of the
deviation between the actual and forecast for the previous period. In other
Next period forecast = Previous period forecast + £á (Actual ¡V Forecast for
the pervious period)
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(Actual ¡V Forecast for the previous period) represents the Forecast error,
£á is the percentage of the error
Putting it down as an equation,
( ) ƒ{1 ƒ{1 ƒ{1 ƒ ƒy„¡ ƒ{ t t t t F F A F
Ft = The Forecast for period .t.
Ft-1 = The Forecast for the previous period
£á = The smoothing constant
At-1 = The Actual demand or sales for the previous period
The smoothing constant .£á. represents the forecast error percentage. Each
new forecast will be same as the previous forecast plus a percentage of the
previous error.
Techniques for Trend
If a .trend. is present in a set of data values, then the necessary analysis
involves developing an equation for it. The trend profile may be linear, or
may not be so. Some common non-linear trend types are shown in Figure
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Parabolic Trend
Growth Curve
Figure 7.3: Non Linear Trend Types
However, we will focus exclusively on linear trends because they are very
common. Two major techniques that are used to develop forecasts when
.trend. is present are:
„h Using a trend equation
„h An extension of exponential smoothing
A linear Trend Equation typically reads as follows:
F a bt t ƒ ƒy
Ft = The value of the variable at any point of time.t.
a = The value of the variable at time t=0
b = The slope of the trend line
t = The time period
Trend-Adjusted Exponential Smoothing
Trend-adjusted Exponential Smoothing, also known as Double Smoothing.
This technique can be used when a time-series shows a linear trend. This
technique is appropriate only when data varies around an average or has
step or gradual changes. If a series exhibits trend, and simple smoothing is
used on it, the forecast will all lag the trend; if the data is increasing, each
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forecast will be too low; if the data is decreasing, the forecast will be too
The Trend-Adjusted Forecast (TAF) is composed of two elements: a
smoothed error and a trend factor.
t t t TAF ƒ S ƒyT ƒy1
St = The Previous Forecast plus Smoother Error
Tt = The Current Trend Estimate
( ) t t t t S ƒTAF ƒy x A ƒ{TAF
( ) ƒ{1 ƒ{1 ƒ{1 ƒ ƒy ƒ{ ƒ{ t t t t t T T y TAF TAF T
.x. and .y. are smoothing constants.
Usually, values of .x. and .y. are selected through trial and error, after which
a starting forecast and estimation of trend is made.
Techniques for Seasonality
Seasonality refers to increase or decrease in data values at regular intervals
that can be linked to recurring events. The variations are periodic ¡V whether
annual and quarterly. Examples of seasonality are winter/summer clothing,
holiday trips of families linked to school vacations, traffic density on city
roads linked to time of the day.
Seasonality in a time series is expressed in terms of the amount of deviation
of the actual value from the average value of the series. If the series has no
trend, the seasonality gets expressed in terms of the average. In case a
trend is present, seasonality is expressed in terms of the trend value.
Two different types of seasonality can be present. One is the .additive. type,
where the variation from the average is almost uniform over time, i.e, the
series value at any point in time is the ¡§average value¡¨ at that point,
plus/minus, a .fixed quantity.. In the other type of seasonality, called the
.multiplicative., the deviation of the series value keeps increasing at a
compound rate, that is, the series value at any point in time is a percentage
of the ¡§average value¡¨ at that point. Organisations predominantly use the
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multiplicative model in practice, and the percentage factor is called the
.Seasonal Relative. or the .Seasonal Index..
Additive Mode
Multiplicative Mode
Figure 7.4: Additive and Multiplicative Seasonality
The above Figure 7.4 depicts the additive and multiplicative seasonality.
You can see the variations almost similar in additive seasonality but in the
multiplicative seasonality the variations are increasing.
Seasonal indices are used in two ways in forecasting:
„h To de-seasonalise data.
„h To incorporate seasonality in a forecast.
The idea behind de-seasonalising is to remove the seasonal component
from the data to identify the non-seasonal (trend) component. This is done
by dividing each data point by the seasonal index.
To incorporate seasonality, first the trend estimates for the desired period is
obtained using a trend equation. Then the trend estimates at each point of
time period is multiplied (assuming the use of multiplicative model) with the
seasonal index.
Techniques for Cycles
Cycles are upward/downward movements of data similar to that of
seasonality, but the time duration is usually longer ¡V say, 2 to 6 years.
Usually, cycles occur irregularly, that is, the time period between two
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successive peaks or troughs may not be the same. This makes it difficulty
and sometimes impossible to project past data into future.
Self Assessment Questions
13. Time Series is a sequence of observations taken at ____ .
14. Cycles reflect ________ variations of more than a year.s duration.
15. A naive Forecast, for any period, equals the previous period.s
16. In a weighted average technique, more ________ are given more
weight as compared to ____ while computing a forecast.
17. Seasonality refers to increase or decrease in data values at regular
intervals that can be linked to ________.
Activity 3:
Illustrate how a mobile company owner can forecast the rates, sales
and demands for his product in the market. List out the various ups
and downs his forecasting can face in the current telecommunication
7.8 Associative Forecasting Techniques
In the Associative Forecasting techniques, the objective is to identify
variables that can be used to forecast the value of our interest. For example,
the variable of .demand. for a product may be linked to the variable of .price.
of the product, or, to the variable of .price. of a substitute product. The basic
method used in this approach is called Regression.
7.8.1 Simple Linear Regression
This is the simplest and most widely used form of regression, involving a
linear relationship between two variables.
The objective in Linear Regression is to obtain .an equation of a straight line
that minimises the sum of the squares of vertical deviations of data points
from the least squares line. It is referred to as the least square criterion. The
equation of the least squares line is given by:
Y a bx c ƒ ƒy
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Yc = The predicted (dependent) variable
a = The value of y when x = 0 (i.e. the height of intercept of the least
squares line on y-axis)
b = The slope of the least squares line
x = The predictor (independent) variable
The Figure 7.5 shows the predictor variable. The straight line is the objective
as discussed above. The horizontal line shows the predictor variable.
Predictor Variable
Figure 7.5: Predictor Variable
7.9 Forecast Accuracy and Forecast Management
In the area of forecasting2, the accuracy of forecasts is very vital. Besides,
there has to be adequate control over the process of forecasting. The
variables in real life are complex in nature, making accurate future
predictions is virtually impossible. Therefore, it is important, while making a
forecast, to indicate the likely deviation of the forecast figure from the actual
figure that will emerge. This will provide an idea to the forecaster as to how
far a forecast might be.
2 For more information please refer Armstrong, J. Scott (ed.) (2001) (in English). Principles of
a handbook for researchers and practitioners. Norwell, Massachusetts: Kluwer Academic
ISBN 0-7923-7930-6
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The aspect of .accuracy. is also significant while deciding on which
technique to use for forecasting ¡V based on accuracy expected and the
corresponding .cost.. Accurate forecasts are needed especially for day-today
planning and scheduling of manufacture. If forecasts are not accurate, it
may result in allocating either .too little. or .too much. resources to the jobs
leading to additional costs, or dissatisfied customers, etc. Major decisions
such as those of substantial investments, also depend on forecasts, where
the decision makers need to know the likely error of forecast, so as to know
whether their decision is not out of bounds.
Forecast error is the difference between the value that eventually occurs
and the value that was predicted for a certain time period. Hence,
Error of Forecast = Actual - Forecast
Forecast accuracy is very important for the selection of forecasting method.
The .accuracy. is expressed on the basis of historical error performance of a
forecast. Three commonly used methods for expressing forecast accuracy
„h Mean Standard Deviation (MSD)
„h Mean Squared Error (MSE)
„h Mean Absolute Percent Error (MAPE)
Expressed as formulae, they are:
MSD ƒ„¸ [Actual ƒ{ Forecast]/ n
MSE ƒ„¸ [Actual ƒ{ Forecat ]2/(n ƒ{1)
MAPE [Actual Forecast]/ActualX100
n ƒ„¸ ƒ{
7.9.1 Managing or Controlling the Forecast
Many forecasts are made at regular intervals ¡V annual, monthly and weekly.
Forecast errors happen more often, and hence a series of forecasts would
generate a number of errors. In order to monitor whether forecasts are
performing properly, these forecast errors are tracked and analysed.
The likely sources of forecast errors are as follows:
„h The model may be inadequate due to (a) the omission of an important
variable; (b) a change or shift in the variable that the model cannot deal
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with (example, sudden appearance of a trend or cycle), or (c) the appearance of a new variable
(example, new competitor)
„h Irregular variations may occur due to severe weather or other natural phenomena, temporary
shortages or breakdowns. Catastrophes or similar events.
„h The forecasting technique may be used incorrectly or the results misinterpreted.
„h There are always random variations in the data. Randomness is the inherent variation that
remains in the data after all causes of variation have been accounted for.
A forecast is considered to be performing well if the errors indicate only random variations. If they
are not random, there is a case for investigating the reasons and how to correct the problem.
Self Assessment Questions
18. Forecast error is the difference between the value that _______and the value that was
________ for a certain time period.
19. ________is the inherent variation that remains in the data after all causes of variation have
been accounted for.
20. _________happen more often, and hence a series of forecasts would generate a number of
7.10 Summary
Even though a number of forecasting techniques are available, no single technique works well in
every situation. Hence, there is a need to take into consideration a number of factors ¡V
especially cost and accuracy. Cost would include the cost of generating the forecast, the cost of
forecasting errors, etc. The higher the accuracy level required, the higher tends to be the cost.
Hence, a trade-off between the two becomes inevitable.
Other factors to be considered would include the availability of historical data, computer software,
time for collection of data and its analysis, and the expertise to forecast.
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In a particular situation, more than one forecasting technique may be used to obtain independent
results. If the different forecasts produce common results, then the confidence level on the
forecast remains high.
Forecasts can be used for a reactive or a pro-active approach. Reactive approach would be for
an application such as determining the future demand, while a pro-active approach would be to
use the Forecast to influence demand.
Computers play an important role in preparing Quantitative forecasts. A wide range of software
packages are available ¡V such as templates for moving average, for exponential smoothing, for
linear-trend equation, etc.
Forecasts are basis for many decisions in business. The better the quality of forecasts is the
greater will be the ability for the company to leverage future opportunities. A good strategy would
be to obtain improved short-term forecasts, so that the company can benefit through better
profits, reduced inventory levels, better customer service. This will also give justification for
company managers to rely more on longer-term forecasts.
7.11 Terminal Questions
1. What are the common characteristics amongst the various forecasting techniques /
2. What are the essential conditions that a well-prepared forecast should satisfy?
3. List and explain the six basic steps involved in preparing a forecast.
4. What is meant by .Qualitative. approach to forecasting? How does it differ from a .Quantitative.
5. Describe the .Delphi method. of forecasting.
6. What are the averaging techniques available in .Quantitative. forecasting techniques?
7. Why are .accuracy. and .control. of forecasts important?
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8. Following table shows figures of weekly demand for a certain brand of toilet soap at a retail
store, in the past eight months.
Period Demand
1 32
2 20
3 47
4 31
5 24
6 50
7 38
8 42
a) Determine the forecast for the demand of that brand of toilet soap in the 9th week by the 5-
month moving average method.
b) If the actual demand for the soap in the 9th week turns out to be 56 nos, what would be the
Forecast for the 10th week, calculated on the same basis?
7.12 Answers
Answers to Self Assessment Questions
1. A common assumption of what happened in the Past continues to happen in the future.
2. Precise.
3. Time horizon
4. Appropriate, suitable
5. Accurate, accuracy.
6. Six steps.
7. Time horizon, less.
8. Qualitative, quantitative.
9. Human, judgment, opinion
10. Judgmental; Time-series; Associative
11. Series, questionnaires.
12. Expensive, time, consuming
13. Regular time intervals
14. Wave like.
15. Actual value
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16. Recent values, earlier values.
17. Recurring events.
18. Eventually occurs, predicted
19. Randomness
20. Forecast errors
Answers to Terminal Questions:
1. Refer to section 7.2
2. Refer to section 7.3
3. Refer to section 7.4
4. Refer to section 7.5
5. Refer to section 7.6
6. Refer to section 7.7
7. Refer section 7.9
(a) Demand Forecast for the 9th week is given by the average of the respective demands for the
previous 5 weeks; i.e.,
F9 = (42 +38 + 50 + 24 + 31) / 5 = 185 /5 = 37 nos.
(b) Since the actual demand in the ninth month is 56 nos., then the Forecast for the tenth month
would be based on the new Moving Average for the just previous five months, i.e.,
F10 = ( 56 +42 + 38 +50 + 24 ) / 5 = 210/5 = 42 nos.
7.13 Case Study
ABC is a big automobile company established in 1960. It planned to introduce a low cost car in
the market. It started forecasting on the investments and requirements for that particular project.
The company.s board planned to manufacture a rear engine and wheels. The engine was
expected to have two cylinder petrol engines and the mileage was expected to be around 21
km/litre. The project started in the year 2000. Since the beginning of the project the team
members were instructed to avoid wastage and concentrate on low cost target of the car.
The forecasting team thought that they will outsource the engine. But later they studied all the
engines which would probably suit the car and decided to manufacture it. They started working on
the engine in the year 2003. To reduce the weight of the car they replaced the steering and
driveshaft with a steel tube. Similarly, the team suggested many cost cutting ideas but due to
various reasons they were not followed.
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While ABC launched the car at the promised price of Rs 80,000 many forecasters opined that the
car would come across many challenges in the future. They explained that the decline in cost of
the raw material January 2003 and March 2004 had helped ABC maintain the price target of the
car. Forecasters opined that the car will create a new segment in the car market.
But they were also concerned about the company's low capacity to fulfil high demand. They
argued that if the low margins of the company are considered then it would it take a longer time
for the project to complete.
But in spite of all these predictions made by experts, ABC introduced the car as scheduled. It was
one of the low costing cars with exceptional servicing quality.
1. What do you understand about the forecasting done in this case study?
2. Do you agree that forecasting sometimes can fail? Explain.
7.14 Glossary
To keep within bounds of its rules or regulations or restricting itself in a particular limit.
An impression that something might be the case, an intuitive guess or feeling about the ups and
downs in any business management process.
Some things or elements that can be expressed as a number or measure or quantity.
To measure associations between variables, the relation between selected values of x and
observed values of y.
4. Armstrong, J. Scott (ed.) (2001) (in English). Principles of forecasting: a handbook for
researchers and practitioners. Norwell, Massachusetts: Kluwer Academic Publishers. ISBN 0-
5. Geisser, Seymour (1 June 1993) (in English). Predictive Inference: An Introduction. Chapman
& Hall, CRC Press. ISBN 0-412-03471-9.
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Unit 8 Workforce Planning and Productivity
8.1 Introduction
8.2 Performance Management
History of Performance Management
Importance of Performance Management
Types of Performance Management
8.3 Perspective of Performance Management
Exploring Organisational Effectiveness
Suggested Capacities for Organisational Effectiveness
8.4 Workforce Management
Work Practices
Work Study
Work Measurement
8.5 Methods Study
Machine Worker Interaction
Work Environment
8.6 Workforce Productivity
Learning Curve
Incentive Schemes
8.7 Difference between Performance Management and Performance Appraisal
8.8 Summary
8.9 Terminal Questions
8.10 Answers
8.11 Case Study
8.12 Glossary
8.1 Introduction
By now you must be familiar with the concept of Forecasting and the impact it has on Operations
Management. You must also be familiar with the elements, process and approaches of
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You must have also analysed the importance of decision making in Operations Management.
Whenever we have to make decisions in Management, we have two approaches to arrive at a
decision that is:
„h One is to consider the available facts, various options for action, and its likely consequences.
Then evaluate all these based on one¡¦s experience.
„h The gut feeling as to what might happen and take a decision based on that.
The quality of the decision depends on the individual¡¦s knowledge, analytical capability, and
judgment. When the matter concerned is small or personal in nature, this process may be
sufficient as the consequences are not very serious. However, the decision involves complex
issues and the data is varied ,that is, factors are different fields having different impacts on the
result; we try to quantify the data, devise some models for predicting the likely consequences and
some techniques to arrive at decisions.
Historical data guides us to formulate the relationships between the variables. Uncertainties about
the activities and results can be anticipated based on probabilities and choices made. The
models we choose depend on the type of situations. In the operations field, we need to schedule
various activities for completion of a job or project.
The time for each activity is known approximately. At a particular stage, a number of activities
have to be completed for further progress. Delay in one of the activities creates inventory of
materials, which have arrived from another stream. Some materials or machines or men or all,
will be idling as they have not received the materials scheduled to have at that place. Rate of
production, absenteeism, breakdown of equipment, delayed arrival of material, and uncertain lead
time causes imbalance in the production system. But planning will have to be done with respect
to resources allocated and products promised. We prepare models, apply quantitative
techniques, and attempt to conduct activities so that minimum disturbances take place. The
workforce that conducts activities has to allocate work, train, and motivate to improve
performance. This unit will give the details about the various aspects that have to be considered
while planning for the workplace and productivity.
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Learning Objectives:
After studying this unit, you will be able to:
„h Explain the key elements of workforce performance.
„h Define the concept of systems of productivity and performance measurement.
„h Analyse the workforce motivation and management.
„h Explain the process of managing workforce and effecting improvement in various functioning of
8.2 Performance Management
Performance management includes activities to make sure that goals are being met in an
effective and efficient manner. Typically, when we think of performance in organisations, we think
on the performance of employees. The performance Management should focus on:
„h The Organisation.
„h Departments like computer support, administration, sales, etc.
„h Processes like billing, budgeting, product development, financial Management, and so on.
„h Programs like implementing new policies and procedures, to ensure a safe workplace; or, for a
non-profit organisation, the ongoing delivery of services to a community.
„h Products or services to internal or external customers.
„h Projects for example, automating the billing process, moving to a new building.
„h Teams or groups organised to accomplish the results for internal or external customers.
Performance management looks different in different places, but effective organisations share
some common characteristics1. These are:
„h Real-time and regular performance data
„h Ready to work culture inspired by strong leadership
„h Agreed lines of individual accountability
„h Performance management review should be clear, combining challenge and support
„h Transparent set of performance rewards and sanctions
1 For more information on Performance Management please visit
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The Figure 8.1 shown below can best illustrate the characteristics in
performance management.
Transparent set of
performance rewards
and sanctions
Real-time and regular
performance data
Ready to work
culture inspired by
strong leadership
management review
should be clear,
combining challenge
and support
Agreed lines of
Figure 8.1: Performance Management
Effective performance management requires:
„h Systematic decision making and communicating what needs to be done.
That is, making decision about the aims, objectives, priorities, and
targets of an organisation and communicating the same.
„h A plan to rely on so that it meets the requirements. These plans include
improvement, action or service plans.
„h Performance measures. If the aims/objectives have been achieved, then
some means of assessing them should be present.
„h Performance reporting using the obtained information. This information
must be precise and must reach the right people at the right time, so that
decisions are made on time and relative actions are taken.
8.2.1 History of Performance Management
You can trace back the history of Performance Management to 1940¡¦s.The
Managers in different Organisations used this technique to assess the
performance of employees. Based on this assessment, the salary given to
any employee was justified. Since then, this technique has become more
sophisticated and has been used not only for assessments but also
appraisals, feedbacks, and development planning.
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It was impossible for many businesses to properly gather and analyse data earlier to the 20th
century. Decision support systems were introduced in business in 1970. These support systems
can analyse one department at a time. Executive information systems were introduced in 1980.
These information systems can efficiently and effectively summarise ongoing transaction in an
organisation. By 1990, business intelligence had improved with the introduction of computers and
technologies. Customer relationship management was also improved. Advanced management
techniques combined with novel technology improved the analysis, reporting and planning in
business. These new advancements gave rise to an integrated methodology, that is, corporate
performance management. This business management is a complete approach in strategic
In 2001 by Gartner research the concept of Corporate performance management (CPM) was
introduced. This management is also called as business performance management. This explains
the metrics, methodologies, process and systems which are required to control the performance
of an organisation. The main feature of corporate performance management includes complete
integration, support of collaboration, analytical insight, automating data processing, and focusing
on exceptions.
There are three levels of corporate management performance. Those levels are:
„h Client
„h Application
„h Data
The essential steps in corporate performance management are:
1) Strategic planning
2) Score carding
3) Budgeting
4) Forecasting
5) Consolidation
6) Business Intelligence
Strategic planning is the basic requirement of any business. The objective of score carding is to
test the performance relevant to strategic planning. Corporate performance management utilises
metrics to judge the present position of the business. Data related to metric is consistent and
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Corporate performance management accelerates the budget and forecasting process, rising and
improving the accuracy, and providing auditable budgets. The forecasting ability assists the
business to take appropriate action in keeping with the occasion. Consolidation is an important
component in CPM. Financials depend upon the consolidation process. Business intelligence
refers to transforming data into information. This information is used while making decision.
8.2.2 Importance of Performance Management2
Performance Management is very important for an organisation and for its employees. From the
employer¡¦s point of view it is important because, it gives him an idea on how his subordinates
are working to achieve the goals of the Organisations. It also allows the organisation to know,
which employee is performing well and is best in contributing towards their goals. From the
employee¡¦s point of view performance management gives an idea about his career growth.
Performance Management is necessary for:
„h Striving towards common goals.
„h Clear understanding of what the job requires or expects.
„h Regular performance feedbacks.
„h Steps and advices on improving performance of any individual or organisation.
„h Rewarding the performances.
With the help of performance management, you can make sure those employees who not only
fulfil their responsibilities, but to do so or to be the best of their abilities meet your expectations.
With the help of Performance management you can also tap the full potential of your employees
or staff. In nutshell, it can be explained as a comprehensive process, which starts from monitoring
and developing the aspired traits to rating, their progress. It also involves rewarding them for their
involvement and achievements.
8.2.3 Types of Performance Management3
The performance management in general scenario can have two separate types of
managements. They are:
2 For more information please visit
3 For more information on Types of Performance Management please visit
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Organisational Performance Management: it is used to analyse the
performance of the company towards its goals
Employee performance management: it is used to analyse the
performance of the employees towards the company¡¦s goals. This includes:
„h Planning work and setting expectations.
„h Monitoring performance.
„h Developing the capacity to perform.
„h Rating performance periodically.
„h Rewarding good performance.
The Figure 8.2 shown below depicts Employee¡¦s Performance
Figure 8.2: Employee Performance Management
Self Assessment Questions
1. Performance management includes activities to make sure that goals
are being met in an _________ and ________ manner.
2. You can trace back the history of _____________ to 1940¡¦s.
3. Performance Management is very important for an _________ and for
its ____________.
4. Typically, when we think of performance in Organisations, we think on
the _____________.
5. The performance management in general scenario can have
___________ separate types of managements.
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Activity 1
Imagine that you are a Manager in an Organisation and you have been given a task of judging
the performance of few employees. Make a list of all elements you would consider in an
8.3 Perspectives of Performance Management
Despite the recent attention to achieve maximum performance, there is no standard interpretation
of meaning or its approach. You should be aware of the different views and be able to choose
your own. The information in the next paragraphs will explain the people¡¦s suggestions on what it
takes for an organisation to achieve maximum performance.
8.3.1 Exploring Organisational Effectiveness
The phrase, ¢wOrganisational effectiveness,¡ü is commonly referred when; discussing
organisations have achieved maximum performance. Probably one of the best overviews of the
concept of organisational effectiveness is provided by Herman and Renz (2002). The authors
identified nine fundamental propositions about organisational effectiveness. Their propositions
were written about non-profit organisations. However, they also apply to organisations in general.
In general, to apply to any organisations the description of the nine fundamental propositions are
modified as follows:
1. Organisational effectiveness is always a matter of comparison
When determining the effectiveness of an organisation, one has to analyse to what are you
comparing the Organisation, to conclude whether it is effective or not? For example, are you
comparing to a certain set of best practices or to another highly respected Organisation?
2. Organisational effectiveness is multi-dimensional
Organisational effectiveness cannot be measured by one indicator. For example, a budget
surplus or a strong product outcome does not guarantee that, the organisation has achieved
overall maximum organisational effectiveness.
3. Boards make a difference in Organisational effectiveness, but how is not clear
There is a correlation between effective boards and effective organisations. However, it is not
clear that one necessarily causes the other.
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4. Organisational effectiveness is a social construction
This concept lies ¢win the eyes of the beholder.¡ü One person might have a completely different
interpretation than another person.
5. More effective Organisations are more likely to use correct Management practices
The authors are very keen to point out that the reverse is not necessarily true. That is, ¢wthose
Organisations that use correct management practices will be judged as being effective.¡ü
6. Claims about ¡§best practices¡¨ warrant critical evaluation
The authors explained the results of their study, which did not agree with the wide assertion that
certain practices, for example, automatically produce the best Boards.
7. Measures of responsiveness offer solutions to differing judgments
This proposition reframes the concept of effectiveness for an Organisation to how well that
organisation is doing in responding to whatever is currently important.
8. It can be important to distinguish different types of Organisations
This is true to progress in understanding the practices and strategies that lead to organisational
9. Network effectiveness is as important to study as Organisational effectiveness
This proposition recognises that, the effectiveness of an organisation might depend to a great
extent on the effectiveness of the wide network of organisations in which it operates.
8.3.2 Suggested Capacities for Organisational Effectiveness
Letts, Ryan and Grossman (1998) suggested four key capacities for organisational effectiveness.
These capacities were suggested for non-profit organisations. However, they also apply to
organisations in general. Hence their descriptions are modified as follows to apply to
organisations in general:
„h Adaptive capacity means the ability to focus on the external environment of any organisation,
especially in meeting the requirements of the customers and simultaneously adjusting itself to
give response to such
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needs and requirements. Attention to assessments, collaboration and networking, planning, and
assessing promote the adaptive capacity.
„h Leadership capacity means, the ability to guide the organisation in a particular direction
successfully. Establishing goals, directing, motivating everyone, decision making, helping
everyone in solving problems, and having an eye for vision promotes leadership capacity.
„h Management capacity means, the ability to utilise the resources in an organisation effectively
and efficiently. Developing and co-ordinating the resource available in an organisation
accomplishes management capacity. This includes people, money, and facilities.
„h Technical capacity means, the ability to efficiently create, design, operate, and deliver the
products and services to the customer. The type of products and services provided by the
organisation decides the nature of the technical capacity.
One more key capacity has been added later that is:
„h Generative capacity means, the ability of an organisation to change the environment positively.
Activities like informing, educating, and persuading policy makers, community leaders, and share
holders, promote this capacity.
Self Assessment Questions
6. The phrase, ______________ is commonly referred to when discussing organisations that
have achieved maximum performance.
7. __________ identified nine fundamental propositions about organisational effectiveness.
8. Letts, Ryan and Grossman (1998) suggested _______________ for organisational
9. ______________ means the ability to focus on the external environment of any organisation
especially in meeting the requirements of the ________ and simultaneously adjusting itself to
give response to such needs and requirements.
10. ____________ means the ability to guide the organisation in a particular direction
11. __________ means the ability of an organisation to change the environment positively.
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12. ___________ means the ability to utilise the resources in an organisation effectively and
Activity 2
Visit an organisation in your city and list out the various activities that it takes, to track the
performance of employee¡¦s who contribute more to achieve the goal of the organisation.
8.4 Workforce Management
Workforce management4 is about assigning the right jobs to the right employees with the right
skills at the right time. In this section we will consider the various concepts of workers¡¦
contribution for productivity. You will also study the way work is measured, and how the workers
get the benefit for superior performance and how productivity is influenced by the environment in
the organisation.
Workforce management includes:
„h Benefits and Payments
„h Time and Punctuality
„h Career Planning and success
„h Human Resource Administration
„h Encouraging Talent and tracking applicant
„h Performance
„h Forecasting
„h Workforce tracking
Productivity is achieved by creating an environment, which is helpful for efficient working. By
adopting good practices that instil a sense of purpose, cooperative behaviours and openness,
workers become willing partners in the process of manufacturing. This gives them life and pride.
Reward is important for recognising good work done by the employee. For the same purpose,
work measurement and determining efficiency levels are important.
8.4.1 Work Practices
Work practices are ways of doing any work that has been in vogue and
4 For more information on workforce management please visit
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found to be useful. Work practices are determined by motion and time study conducted over
years and found to be efficient and practiced. Any method improvement that will be conducted
may change the practice. But this is evident only after trials have shown that they increase the
comfort of the worker and get the job done faster.
8.4.2 Work Study
When analysing work methods and performing a job on a machine or equipment, we say that
work study is being conducted. The study helps in designing the optimum work method and
standardisation of the work method. This study enables the method¡¦s engineer to search for
better methods, higher utilisation of man and machine, and accomplishment of higher
productivity. The study gives an opportunity to the workmen to learn the process of study and will
be able to offer suggestions to improve methods. This encourages workmen participation, permits
them to make changes, and report the advantages that can be derived from those. This course is
in line with the principle of constant improvement and helps the organisation in the long run.
Reward systems may be implemented for recognising contributions from the workmen. Work
study comprises of work measurement and method study. Work measurement focuses on the
time element of work, while method study focuses on the methods deployed and development of
better methods.
8.4.3 Work Measurement
Work measurement can be defined as a systematic application of various techniques. These are
designed to establish the content of work involved in performing a specific task. The task is
performed by a qualified worker. International Labour Organisation¡¦s (ILO)s definition for a
qualified worker is ¢wone who is accepted as having the necessary physical attributes,
possessing the required intelligence and education, and having acquired the necessary skill and
knowledge to carry out the work in hand to satisfactory standards of safety, quantity and quality¡ü.
With this, we arrive at the standard time for a task. This will be used to fix performance grading of
other workers. It forms the basis of incentives, promotion, and training for workmen and
assessment of capacity for the plant.
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8.5 Methods Study
Here the focus is on studying the method currently being used and developing a new method for
performing the task in a better way. Operation Flow Charts, Motion Charts, Flow Process Charts
are studied to find the purpose of each activity that is an element of the task, the sequence in
which they are done, and the effect of these on the work. The study may help in changing some
of them and even eliminate some of them to effect improvements. The new method must result in
saving time, reduce motions and simplify activities.
8.5.1 Machine Worker Interaction
This method studies the amount of time an operator spends on the machine, before it is activated
and the time he has nothing to do. In many modern manufacturing centres, where we have
automated systems of manufacturing, the role of the worker is limited to observing various
screens, dials, and indicator lamps to see that the process is going on smoothly. In some cases,
his job may be to load the jobs on the machines and check the settings. What is of concern to us
is, to see whether the operations permit an operator to look after two or three machines, without
affecting the performance of the machine or man.
8.5.2 Ergonomics
Ergonomics is the study of physical human factors for his functioning. We study the movements,
the amount of energy that is available for certain activities, and the coordination among them. In
operations management we use these factors at two places as follows:
„h The first is to design machines that are operated and the way, the operator does the tasks on
the machine using different controls. Levers, wheels, switches, pedals and so on have to be
positioned so that, he has maximum comfort for working long hours.

„h The other is the consideration given for the type of loads the body can take at various
positions. When lifting jobs, clamping them, moving them, and holding them, energy is expended
by different organs. Racks, tables, and pallets, are positioned and designed to suit workers¡¦
physical features.
8.5.3 Work Environment
The work environments in which tasks are performed will definitely affect the
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productivity greatly. The combination of temperature, humidity, and air movements produce a
level of comfort or discomfort considering whether they are within a range. All these factors
depend on the conditions to which employees are accustomed. A temperature range of 24 to 32
degrees Celsius would be suitable. Good illumination at the workplace helps productivity. Using
pleasing colours for the walls and surroundings may also help productivity. Noise levels, when
they are continuous and high, affects the concentration of the employees and affects their work.
They even become irritable and their interaction with other people produces confusion and
conflict. If noise of the machines is inevitable, ear plugs must be supplied to the workmen.
8.6 Workforce Productivity
Workforce Productivity is the ratio of the number of pieces produced to the number of hours spent
on them. This figure takes into consideration a number of things like machine capability, worker¡¦s
skill, his motivation, and the environment. There are various methods by which productivity is
sought to be improved. Some of them are:
„h Measure all aspects across all functions of the organisation, so that all personnel are spared
and nobody is favoured. To ensure performance, uniformity, and fairness are guaranteed.
„h Establish reasonable goals of production. They must be either too low for letting satisfaction or
too high to be attempted.
„h Complaints about the working conditions are treated as opportunities to make corrections and
seek higher productivity.
8.6.1 Learning Curve
The principle is that people take less time to do the same job subsequently, as the effort and skill
expended in earlier activities has resulted in learning. Learning improves performance. But the
rate of improvement declines as the repetitive acts increase.
For example, if a job takes 15 minutes for the first piece, it takes 13 for the second, 12 for the
third and so on. But this improvement is not continuous. If the 100th piece takes 6 minutes, the
101st piece will not take any less time. Training helps to achieve that 6-minute performance. It is
also necessary to improve productivity.
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8.6.2 Incentive Schemes
These are monetary and non-monetary benefits that the management gives in recognition of
superior performance. They can be calculated on individual, team, group, department or the plant
basis. Most of the times, these are negotiated with labour unions. There are many ways the
incentives are calculated wherein; the basis will be a standard level of production. A proportion of
the additional production is distributed as incentives. This is a motivational factor for increasing
Self Assessment Questions
13. ______________ is about assigning the right jobs to the right employees with the right skills
at the right time.
14. Performance of workforce can be achieved by establishing __________ __________ of
15. The range of temperature which is considered to make it comfortable for workmen is between
________ and ______ degrees Celsius.
16. ___________ are determined by motion and time study conducted over years and found to
be efficient and practiced.
17. ____________ can be defined as a systematic application of various techniques that are
designed to establish the content of work involved in performing a specific task
18. _______, _____________, ______________ are studied to find the purpose of each activity,
(an element of the task), the sequence in which they are done and the effect of these on the
19. ____________ method studies the amount of time an operator spends on the machine before
it is activated and the time he has nothing to do.
20. _____________ is the study of physical human factors for his functioning. We study the
__________________; _________ that is available for certain activities and the coordination
among them.
21. The combination __________________ produce a level of comfort or discomfort considering
whether they are within a range.
Activity 3
Make a list of measurements that an organisation can do to promote productivity and encourage
active participation of an employee. Suggest some measures for improving good relations
between the management and employees.
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8.7 Difference between Performance Management and Performance Appraisal
Performance management incorporates performance appraisal, promotions, and career paths
and so on. Performance management is when we look at every possible aspect of managing an
employee's performance in the organisation.
However, performance appraisal is one of the ways, or better to say "tools" through which
performance management is done. The differences between the both are explained in a table
Table 8.1 Differences between Performance management & Performance appraisal
Performance management
Performance Appraisal
Types of objectives
Emphasise on integrating organisational, team, and individual objectives.
Emphasise on individual objectives.
Types of performance measures
Emphasise on competency requirements measures as well as quantified measures
Emphasise on qualitative and quantitative measures
Continuous review with one or more formal reviews in a year.
Performs annual appraisal.
Rating system
Follows joint or participative process, rating less common.
Follows top-down systems with ratings.
Rewarding linkage
Do not have direct link to rewards.
Often linked to pay.
Owned by line management.
Owned by human resource department.
Corporate alignment
Integrated business driven system aimed at organisational and people development.
Isolated system not linked to organisational goals.
Focus of Performance Reviews
Focuses on future performance.
Focus on past performance
Questions Asked
What can be done to help employees perform as effectively as possible?
How well was the work done?
On ratings and evaluations.
On performance planning, analysis, review, developments and improvements.
Monitoring and Designing
By the organisational department.
Designed by the HR department but could be monitored by the respective departments
Identification of Developing Needs
At the end of the year.
At the beginning of the year.
8.8 Summary
The Models depict a physical system in a mathematical form so that by changing the variables,
depending on the factors under consideration, we can predict the effect on the outcomes. These
are used to take decisions for deployment of resources so that optimisation is achieved. We have
seen a few popular and useful models that help us to understand the business process. We have
also discussed the concept of Learning Curve and the utility of the same in understanding
workforce productivity.
We have also seen the different types of operations management like, organisational and
employee management. The unit also discussed Letts, Ryan and Grossman¡¦s (1998) four key
capacities for organisational effectiveness. Adaptive capacity, Leadership capacity, Management
capacity, Technical capacity and Generative capacity were also explained in brief.
You have learnt how workforce management influences productivity. Productivity is achieved by
creating an environment, which is helpful for efficient working. You also learnt the difference
between performance management & performance appraisal.
8.9 Terminal Questions
1. Can you list out the differences between performance Management and performance
2. What do you understand by Ergonomics? How does it help the production manager?
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3. How is the study of Learning Curve helpful in Work Study methods?
4. Can you explain the nine fundamental propositions about Organisational effectiveness?
5. Briefly discuss the Suggested Capacities for Organisational Effectiveness.
6. What is Workforce Management?
8.10 Answers
Answers to Self Assessment Questions
1. Effective, efficient
2. Performance Management
3. Organisation, employees
4. performance of employees
5. Two
6. ¢wOrganisational effectiveness,¡ü
7. Herman and Renz
8. four key capacities
9. Adaptive capacity, customers
10. Leadership capacity
11. Generative capacity
12. Management capacity
13. Workforce management
14. Reasonable goals
15. 24 and 32
16. Work practices
17. Work measurement
18. Operation Flow Charts, Motion Charts, Flow Process Charts
19. Machine Worker Interaction
20. Ergonomics, movements, the amount of energy
21. Temperature, humidity and air movements
Answers to Terminal Questions
1. Refer to section 8.7
2. Refer to section 8.5
3. Refer to section 8.6
4. Refer to section 8.3
5. Refer to section 8.3
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8.11 Case study
XYZ is one of the leading electric utilities company. It has 16,000 employees. It has transmission
and generation business units and nuclear and fossil generation plants. XYZ wanted to manage
IT workforce capabilities in a way that required competencies were available and inventory of
capabilities could be aligned with business needs. XYZ named its objective ¡X creating an Agile
IT Organization. The challenge for XYZ was that it had recently centralised its organisation.
Earlier its structure was decentralised. Due to this centralisation all roles and functions of the
organisation as well as the employee¡¦s were in a state of confusion. XYZ then approached SP
solutions for a remedy. SP recommended the use of role based organisation to meet the
requirements of clients. This paved way for a workforce capabilities program for achieving the
goal of an Agile IT Organization. To look at different dimensions like people processes, metrics,
systems, career framework and competency alignment a multi-year program was formulated. SP
defined Career framework for all roles in infrastructure and in application services. Each role¡¦s
competencies were planned and depicted in alignment with enterprise-wide HR directives. To
track the effectiveness of the program metrics was defined.
In result of this solution XYZ was able to plan and see the future business requirements clearly.
Competencies are mapped to roles and this enabled XYZ in identifying any shortfall in workforce
1. Can you give an alternate solution for XYZ?
2. Instead of going to SP Solutions, what steps XYZ should have taken to mould its relations with
the employees?
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8.12 Glossary
The grouping or positioning of teams
Any of various tools with opposing, often adjustable sides or parts for bracing objects or holding
them together.
to introduce gradually; implant or infuse to some thing
A wooden, shovel like potter's tool used for mixing and shaping clay.
A metal tool used for printing on book bindings.
A period of general or popular usage or favour
3. Performance Management ¡V A Briefcase Book by Robert Bacal

Unit 9 Capacity Planning and Material Handling

9.1 Introduction
9.2 Material handling
Scope of Material Handling
Importance of Material Handling
Objectives of Material Handlings
9.3 Balancing for Material Flow
Johnson.s Algorithm of Sequencing
CDS Algorithm for n jobs on m machines
9.4 Principles, Practices and Advanced Analysis for Order Picking
Design Considerations
Considerations when planning and implementing integrated
Material Handling Systems
9.5 Ergonomics and Material Handling: A task oriented Assessment of
Needs and Solutions
9.6 Approaches for Shop Floor Sequencing of Material Handling Jobs
9.7 Capacity Planning
9.8 Different kinds of Capacity Planning
9.9 Measuring capacity
Constraints on capacity
Production Scheduling
9.10 Summary
9.11 Terminal Questions
912 Answers
9.13 Case Study
9.14 Glossary
9.1 Introduction
By now you must be familiar with the concept of Performance Management and its types. You
have also learnt about Workforce Management and how it affects the work productivity. The
differences between Performance Management and Performance Appraisal were also discussed.
Material handling has become one of the important functions of Operations Management, owing
to the necessity of making them efficient and economical. This necessity is the outcome of
worldwide outsourcing and meeting the demands of a global market. Variety and volumes have
compelled companies to seek specialised suppliers from various countries. Assemblies take
place at different locations and distribution is across the world. Many companies do not have
.main stores. at their manufacturing facilities. Suppliers deliver the required quantities to the
places where they are required for further processing or assembly. To reduce inventory, only
required quantities have to be made and delivered at appropriate times. This necessitates that
flow lines are smooth. Balancing flow lines, different equipments achieving the same and
preparing layouts to achieve these is the subject matter of this unit.
Learning Objectives:
After studying this unit you will be able to:
. Explain the importance of a good layout in enabling efficient material handling;
. Explain the principles involved in designing Integrated Material Handling Systems;
. Assess how material flow is regulated so that balancing of work loads becomes efficient.
9.2 Material handling
Material Handling1 means providing, the right amount of material, at the right time and place, in
the right position, and the right sequence for the right cost. Material Handling also refers to
activities, equipment, and procedures related to the moving, storing, protecting and controlling of
materials in a system.
1 For more information please visit

9.2.1 Scope of material handling

The scope of material handling within any organisation depends on the size of the organisation,
the product that it manufactures, and the value of the product. It also depends upon the value of
the activity being performed and the importance of material handling in the organisation. Material
Handling has three different points of view, they are:
. Traditional point of view
. Plant wide
. System point of view
Traditional point of view
The Traditional point of view emphasises on the movement of materials from one place to
another, within the boundaries of an organisation. The main motive is to move the materials from
one place to another in the best way.
Plant wide
The plant wide emphasises on the entire flow of materials in a plant. The main motive is the inter-
relation between all problems and possibility of establishing an overall materials handling.
System point of view
The system point of view visualises the problems related to material handling and other closely
related issues, as one. This point of view consists broader considerations of material handlings
issues. These issues involve the movement or transportation of materials from all places and
sources of supply within a particular plant.
9.2.2 Importance of Material Handling
Handling materials that are effective is important to manufacturing operations. Materials delivered
by vendors must be unloaded, must be moved through production operations to stores and
inspections, and then ultimately to shipping departments. This movement adds to the cost of the
product, but not to the value of the product.
One of the subsets to plant layout is analysis of material handling. It is a part of design of
production facility and can hardly be separated. A good layout plan helps an operation to use the
most effective handling method. Efficient use of appropriate materials handling methods reduces
costs and helps maximum capabilities to be extracted from a given production facility.
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9.2.3 Objectives of Material Handlings
The main objective of Material Handlings is to reduce the distance through which the materials
are handled and the number of handling equipments.
Other objectives are listed below:
. Lowering the cost for handling unit materials.
. Decreasing the time of manufacturing cycle through faster movements of materials.
. Providing greater safety in the movement of materials.
. Providing good working conditions.
. Providing good quality by not damaging the products with inefficiency in handling.
. Utilising the storage areas to increase the storage capacity.
. Achieving higher productivity by lowering the manufacturing cost.
9.3 Balancing for Material Flow
Production lines have a number of work centres in a particular sequence so that, the material that
gets processed has to move further without encountering any bottlenecks. The quantities
produced, the rate of production at each centre, the number of operations, and the total
production required are factors taken into account. The reason and use of balancing is to check
that no shortages occur between work centres and fewer inventories get created. This can be
achieved by using the principles of JIT and Lean Manufacturing. Dynamic programming, Linear
Programming, and other mathematical models are used to study these problems. Some
computer-efficient approximate algorithms have been developed to help the process.
The Line Balancing Problem
Assembly lines are best suited for the study and analysis of the Line Balancing Problem, called
Assembly Line Balancing (ALB). All ALB are categorised by Ghosh and Gagnon2 into four
SMD . Single Model Deterministic: This model assumes that the one product that passes through
the dedicated line has all tasks times known. This model is useful when automatic machines or
where operations have their times predictable with certainty.
SMS . Single Model Stochastic: This model allows the task times to be variable. This is applicable
when a single product goes through machines where, manual content is more and the operations
do not have definite periods. Determining locations and sizes of buffers require to keep the
throughput is the purpose of this algorithm.
MMD . Multi/Mixed Model Deterministic: In this case task times are known, but we have many
products that go through the line. The products are assembled in batches.
MMS . Multi/Mixed Model Stochastic: The task times are variable and we have many products
that go through the production line. The problems of balancing such lines are more.
Decomposition of the assembly into sub-assemblies and having advanced handling equipment
may help to make inventories small and keeping the flow line smooth.
Generally the criteria for all the above cases are technical and economical. The technical criterion
seeks to maximise the line efficiency, that is, throughput. Minimising the number of workstations,
number of operators and reducing the quantum of buffers are the economic criteria. Many times a
trade off may be necessary. It is for the operations manager to balance between two competing
9.3.1 Johnson’s Algorithm of Sequencing
This algorithm is used for sequencing of n jobs through two work centres. The purpose is to
minimise idle time on machines and reduce the total time taken for completing all the jobs. There
are no priority rules since all jobs have equal priority. The order of the operations will be
machine1 first and machine 2 next.

The steps to be taken are:

i) Choose the job which has the shortest processing time in any of the two work centres.
ii) If it happens to be on machine 1, then load it first; if it is on machine 2, allot it for loading last.
iii) Eliminate this job. Continue this till all jobs have been allotted.

Example: Time on
M/c 1
M/c 2
Time 1 Hr. is on M/c1 load it first. Cancel the row which contains 1 and 3.25. The job is C.
Next, time 1.25 is on M/c1. Load job F next.
The next is 1.5 which is on M/c. 2. Load it last. The job is E, continue¡¦
The loading sequence is given in the box below
In case the period on two machines for any of the jobs is the same, you may choose either of
them for applying the above rule.

9.3.2 CDS Algorithm for n jobs on m machines

This algorithm given by Campbell, Dudek and Smith, gives m-1 solutions and we can choose the
most optimal between them. We will use the Johnson.s rule by converting the number of
machines from m to 2, by considering differing combinations . like 1 and m, then1+2, then M-1
and M, then 1+2+3 and a M-2, M-1 and M, and so on. This process is useful, when the numbers
of machines is small. We will work out a problem where we have 4 machines.

Perform the following steps:

i) Take column M1 and M4, ignoring M2 and M3. Get the sequence by applying Johnson.s rule.
ii) Next Combine M1 and M2 . Make it as one machine MX and combine M3 and M4 and call it
MY. Get the sequence.
iii) Next Combine M1 and M2 and M3 . and call it MC. Similarly combine M2 and M3 and M4. Call
it MD. Find the sequence.
iv) Calculate the total time taken to process all jobs A, B C, D and E. Choose whichever given the
total time.

The first table will be

Calculate the total time taken when this sequence is followed. Remember, that except for M1,
other machines may have to wait to start their operations, until the previous operation is over.
You have to include idle times at the beginning, middle or the end.

Self Assessment Questions

1. _____________________means providing, the right amount of material, at the right time and
place, in the right position, and the right sequence for the right cost.
2. The Traditional point of view emphasises on the movement of materials from one place to
another within the ____________of an organisation.
3. _________________point of view consists broader considerations of material handlings issues
which involves the movement or transportation of materials from all places and sources of supply
within a particular plant and.
4. __________ algorithm is used for sequencing of n jobs through two work centres.

9.4 Principles, Practices and Advanced Analysis for Order Picking

Order Picking is a process through which items or products have to be supplied and regained
from specific storage location. It is found to take 60% of the activities of the labour in the
warehouse. As it is crucial for the business to meet customer demand efficiently and accurately,
lot of attention is being given to these criteria of operations. In the manufacturing area, we expect
to move towards small t sizes, point-of-use-delivery and cycle time reductions. These are
mandatory to meet the so called targets of JIT, which have economic implications. Efficient order
picking is a must for surviving in the competition. In the supply chain process, retrieval, storage,
and delivery do not add value to the product, but they are necessary.

9.4.1 Equipments
First you will learn about the types of equipments that help us in bringing efficiency to the
a) Horizontal Travel . These can be in the aisle, picker to divide systems. The worker rides a
vehicle and picks the item or product and puts them into the cart. He may also pick and place the
item on a conveyor. The storage system can also be pallet racks, shelves, storage drawers or
gravity flow racks. The pallet racks can have only one or two levels.
b) Person Aboard . In this system, the picker is on a platform of the vehicle; he can move up and
also horizontally along the aisle.
c) Part to Picker . These are mechanised systems. Here a storage device carries the trays or bins
to the person picking. These complete the tasks other instructions received through a remote
control device with the picker. Many pickers generally can also access the system.
d) Special equipment . to increase throughput and space efficiency, special equipments are
manufactured, which is in the form of mobile shuttles, rotary racks, and moveable shelves that
travel in lanes or even an automatic item picker which can eject items on a conveyor belt.
e) Workplace Equipment . Items can be kept on a work bench and be picked up. The carts also
are used to keep items for being picked up.
It should be noted that any of the systems described above are to suit the purpose and
economies that can be derived. Before implementing any of these a detailed study of alternatives,
a plan for expansion or reduction in the requirement of a particular product or a probable shifting
of the location etc. will have to be undertaken. Some of these factors are listed below:
. Material Properties
o size, weight and nest ability
o carton counts, pallet counts
o fragility,
o value
o fragility
o environment . temperature, humidity
. System Requirements for the Product
o Volume per product
o Number of order to be shipped
o Response time
o Supporting processes . labelling, pricing,
o Growth factors
. Economic Factors
o Investment Required
o Project life
o Rate of return
9.4.2 Design Considerations
Some of the factors mentioned above also are relevant for the purpose of design. Design
considerations arise, mainly out of the following:
. Total number of products that are to be stored.
. Number of products received per shift.
. Total numbers retrieved per shift.
. Variability in the above . These determine the dimensions of the building required for the
purpose. Sizes of bins, racks, pallets are also fixed on the basis of above. Choice between carts,
carousals, vehicles, conveyors, automatic item pickers can be made as also the space for
locating and moving them.
. Labour force
. Management Information System.
9.4.3 Considerations while planning and implementing Integrated Material Handling Systems
Material handling systems need to be made efficient so that resources used help in maintaining
the flow of material with minimum bottlenecks and maximum throughput. Integration is between
various equipments, processes, information and a system of control. Inevitably, we use computer
systems and some amount of automation to bring in efficiencies, which otherwise would be lost.
Activity 1
Visit any manufacturing company and list the different types, size, weight, fragility and efficiency
in productivity of the machines they use.
9.5 Ergonomics and Material Handling: A task Determined Assessment of Needs and Solutions
In Ergonomics, the body is studied as if it were a machine . the way the limbs move, the knees
bend, the hands reach or grip, and weights are be lifted at different positions of the back. The
dynamic motions that the body and the organs are subjected to are studied with a view to design
the systems. Dr. Bill Marris developed, what is popularly known as, LMM . Lumbar Motion Monitor
in a study of low back injury. It allows measurement of the forces at work in bending and twisting.
This helps us to make improved decisions regarding job improvements. This is especially helpful
in material handling stations, where workmen have to lift weights, raise them to awkward
positions to find a place, move them, hold them, and push them. When the same movements are
to be repeated a number of times, knowing the problems the movements can cause, we can
design equipments to reduce difficulties faced by the workers. You will remember that the same
considerations were discussed, while working on machines. It is worth mentioned a word of
caution. Machine shop operations or material handling, we have to assess the need for
implementing any methodology. This is because these would have been worked out by the
operators and supervisors over years in different job situations as it affects them on a personal
basis, best practices would have set in. Material handling systems are mostly outsourced and the
expertise of the contractor will be of great help. However, the particular needs for the products
which are handled by us, the shapes, volumes and the type of handling like lifting, storage,
retrieval and loading can be formulated and projected data will be useful. Solutions that are
required should be considered, for a long term usage and as also possible changes that can be
Self Assessment Question:
5. Efficient ___________ is a must for surviving in the competitive.
6. Before implementing any of these detailed studies of alternatives, a plan for
__________________ is the requirement of a particular product or a probable shifting of the
location etc. will have to be undertaken.
7. ______________________ determine the dimensions of the building required for the purpose.
8. In the supply chain, storage, retrieval and delivery do not add value to the product, but are
necessary. (True / False)
9. In ___________________, the body is studied as if it were a machine . the way the limbs
move, the knees bend, the hands reach or grip, weights are be lifted at different positions of the
9.6 Approaches for Shop Floor Arrangement of Material Handling Jobs
Arranging takes decisions on the order in which jobs are loaded on different machines. The main
criteria is to take the job through the technological steps in which, the processing requires to be
done for the change that is to be effected on the processed material. The major concerns are
regarding the quantities that need to be processed and the time that the different operations
require. In case the product has to enter assembly, along with other parts that are being
manufactured then, all the required parts arrive at that point at the same time. Some components
may be outsourced. To handle different varieties of parts, we possess material handling
equipments such as cranes, lifting forks, trucks etc. The problem for the managers is the limited
supply of these equipments and the need to optimise utilisation of the equipment to see that the
manufacturing line has smooth flow. Our major concern should be to minimum movement, reduce
inventory, and timely availability. This requires an integration of information regarding all the
factors and take decisions that can accommodate and optimise utilisation of resources.
Activity 2
List out the factors that you consider when you design equipments to reduce difficulties faced by
the workers.
9.7 Capacity planning
Capacity planning3 is the analysis of what can be produced and what the expected demand will
be. Capacity planning4 must take place at many levels. To increase capacity, you must purchase
new equipments. This can be a lengthy process. In result, capacity planning requires long term
analysis. During business planning sessions, Capacity must be analysed first. The company must
know well about their current capacity and the right percentage at what they are operating. This
number can be confusing, if you are operating close to full-capacity. It is acceptable if most of the
product goes to inventory. The capacity must be measured against the actual demand but not
against actual production.
Many factors can affect capacity such as the number of workers, their ability to work, number of
machines, wastage, scrap, defects, mistakes, productivity, suppliers, government regulations,
and preventive maintenance. Capacity planning can be related to both the long term and the
short term. There are different issues at stake for each.
Long-Term Capacity Planning
In the Long-Term, Capacity Planning focus is on the strategic issues related to the organisation.s
main production facilities. The technology and the transferability of the process to different
products are also interlaced with this capacity planning (long term capacity planning). When
short-term changes in capacity are insufficient, Long-term capacity planning may evolve.
For example, if the organisation.s additions of a third shift plan does not
3 For more information on Capacity Planning please visit
4 For more information on Capacity Planning please refer .The Art of Capacity Planning. by John
Allspaw produce enough output, and if subcontracting arrangements cannot be made. The
possible alternative is to add capital equipment and optimise the layout of the plant (long-term
actions). It might be more desirable to include some more additional plant space or to construct a
new facility (long-term alternatives).
Short-Term Capacity Planning
In the short term, capacity planning focus is on issues which are related to scheduling, labour
shifts, and balancing resource capacities. The main aim of this capacity planning (short-term
capacity planning) is to handle unpredicted shifts in demand, in an efficient economic manner.
The time frame for short-term planning generally involves a few days, but may run as long as six
There are many alternatives for making short-term changes in capacity. One of them involves
failure in meeting the demands. Working overtime is the easiest and the most commonly used
way to increase capacity in short term. It is also a flexible and low cost alternative. While, the firm
has to pay one and a half times more than the normal labour rate. It exceeds the expenses of
training, hiring, and paying extra benefits. Other resource-increasing alternatives are available, if
overtime does not provide enough short-term capacity. These include employing casual or part-
time workers, adding shifts, getting workers on lease, and facilities subcontracting.
Medium-term Capacity Planning
In the medium-term, capacity planning is focus is on analysis during monthly meetings. It may be
necessary to take short-term measures, if the capacity is consistently less than what is
demanded. Financial data and comparisons need to be completed, when making the decision to
increase capacity in the medium-term. The decision to subcontract or hire more people or use
overtime are all over expensive and are required to be analysed properly.
Capacity must be analysed in the short-term on a weekly basis, when the production schedule is
being released. The decision to increase capacity can be extremely costly and is not easy.
Ensure that you have checked and analysed all your options and supported them with financial
Capacity is calculated: (number of machines or workers) ¡¿ (number of shifts) ¡¿ (utilisation)
¡¿ (efficiency).
Capacity planning can be related to both the long term and the short term. However, there are
different issues at stake for each.
Activity 3
Assume that you are going to open a retail shop. List out the factors as well as issues which you
think will affect the Capacity Planning.
9.8 Different kinds of Capacity Plannings
Any particular production unit.s capacity (e.g. machine, factory) is its ability to produce or do what
the customer requires. Production and operations management consists of three different kinds of
capacity, they are:
. Potential capacity
. Immediate capacity
. Effective capacity
Potential capacity is the capacity available to influence the planning of senior management. For
example, assisting them to take decisions on overall business growth and investment. This is
important for a long-term decision that does not influence the daily production management.
Immediate capacity planning is the capacity made available in the short-term. It is the highest
potential capacity taking it as used productively. Effective capacity is a very simple concept. This
is essential for production managers to know what capacity is actually receivable.
9.9 Measuring capacity
Capacity must be measured in the unit of work, as it is the ability to work.
For example, assume that a factory has a capacity of 10,000 "machine hours" in each 40 hour
week. Then this factory must possess the capacity to produce 10,000 "standard hours of work"
during a 40-hour week. The actual volume of product that the particular factory produces will
depend on:
. The quantity of work involved in production (for example. does a product require 1, 5, 10
standard hours?).
. Any extra time required in production (for example. machine set-up, maintenance).
. The effectiveness or productivity of the factory.

9.9.1 Constraints on capacity

In capacity management there are two general potential constraints. They are . TIME and
Time is a limitation where a customer has a particular demand for delivery date. In such
situations, capacity managers generally "plan backwards". In other words, they assign the final
stage (operation) of the production to the period where delivery is required. This process assists
in identifying whether, there is sufficient time to meet the production demands and whether there
is any need to increase the capacity, although temporarily.
9.9.2 Production Scheduling
A Production Schedule represents the time that is very essential or necessary to carry out a
particular assigned task. A job schedule generally shows the plan for the manufacture of a
particular task or a job. It can be created through "work / study" reviews which will determine the
time and method required.
Many different varieties of businesses carry out several production tasks at one time that impose
to blend several job schedules. This process is generally called as "scheduling". The result is
called as the production schedule or factory schedule for the factory/plant as a whole.
In preparing a production schedule, attention needs to be paid to:
. Dates on which delivery of product is planned (when are finished products due?).
. Job schedules related to each and every production task.
. Capacities of departments involved or production sections.
. Efficiency of these production sections or departments.
. Planned Holidays.
. Expected sickness / absenteeism / training.
. Availability of components, raw materials, and packaging
There are two important problems with production scheduling:
. Performance Measurement. Tells if financial performance is most important, minimises the
amount of stock. It also tells if the objectives in marketing more important . for example, always
produce sufficient product to meet customer demand.
. The large number of probable schedules - likely caused by too much complexity or variety in the
production needs of the business.
Self Assessment Questions
10. Material handling systems are mostly _______________ and the ___________ of the
contractor will be of great help.
11. A job schedule can be created through ___________ reviews which will determine the times
and method required.
9.10 Summary
In this unit we have considered various factors that affect the layout of the manufacturing place to
provide for efficient utilisation of the floor space vis a vis workflow. For sequencing of jobs
Johnson.s Algorithm is a useful starting point and more advanced methodologies are also
available. Balancing the production is a very important aspect of achieving maximum throughput
and reducing inventory. Material handling systems are also discussed.
We have also discussed the meaning of the Capacity Planning and how can it be related to both
the long term and the short term. Three different kinds of Capacity Planning; Potential capacity,
Immediate capacity, Effective capacity; were discussed. Measuring Capacity and Constraints on
Capacity are covered. The two general potential constraints of Capacity Planning are TIME and
CAPACITY. The unit ends with the discussion on Production Scheduling and focussing on the
issues which are to be taken in consideration while scheduling the production.

9.11 Terminal Questions

1. What do you understand by Line Balancing?
2. What is the importance of Order Picking in material handling?
3. Material movement in a manufacturing plan considers economics important. Why? How are its
principles applied?
4. What are the different kinds of Capacity Planning?
5. Explain Johnson.s rule for sequencing and how it is different from CDS algorithm.
6. What are Short-Term, Long-Term and Medium-Term Capacity Planning?

9.12 Answers
Answers to Self Assessment Questions
1. Material Handling
2. Boundaries
3. System point of view
4. Johnson.s Algorithm of Sequencing
5. Order picking
6. Expansion or reduction
7. Variability in the above
8. True
9. Ergonomics
10. Outsourced, Expertise
11. "Work / study"
Answers to Terminal Questions
1. Refer section 9.3
2. Refer section 9.4
3. Refer section 9.4
4. Refer section 9.9
5. Refer section 9.3
6. Refer section 9.8

9.13 Case Study

Bhadravathi is a paper manufacturing company that manufactures papers and supplies them
through out India. The company had an issue with one of its driers. A goo was being formed on
one of their driers. No one could come to a conclusion precisely why the mysterious goo was
forming on their dryer but the operators at CCC Solutions, Gurgoan, India, had had enough of
trying to clean the sticky sap-like goo that was making its screens blind and CEO Rama Krishna.
A was growing increasingly concerned about its effect on productivity. Drying up to 70% moisture
has recovered fibres from the waste stream of the paper mill; Mr. Rama Krishna targeted the
production rates of 3,000 lbs. /hr. but the design of the dryer damaged his efforts. ¡°This .goo.
was a horrendous problem according to the employees working there. They had to shut down the
entire line once in a month to clean the dryer. This cost about $5,000.00 every month, in labour
costs and lost production alone. The problem prevented efficient airflow and caused hindrance in
the productivity. Then the paper product manufacturing company tried replacing this troublesome
dryer with a another new kind of vibrating fluid bed dryer from The RV & Co., Belgaum, India.
This company has the history of designing and manufacturing the new vibrating fluid bed dryers,
screeners, de-waterers, coolers, and many other process equipment for companies for many
famous companies since a decade. ¡°Identifying the core problem was the first step in the
process, which lay in the formed screen design of the round dryer. According to many workers
the gooey formed was a sign of inefficient airflow. Instead of using formed screens with fine holes
that attracts clogs, RV used a proprietary wedge-wire deck with 0.010 inches wide tapered slots
with 1/8¡± thick triangular wires. This wedge-wire ensured opening for air flow and plug flow also.
After installing the RV dryer in June 2000, Mr. Ramakrishna has been able to increase the
production to a very effective and impressive 4,000 lbs. /hr., exceeding the target by 50%. RV.s
approach is based on designing a system that meets a target production and quality rate. But if
the operators of CCC solutions ever want to clean the system, RV engineers have made their job
very easy. It is cleanable by design, the 40¡± wide x 16. long dryer is manufactured with a davit
lifting system that makes one person to lift the entire cover off of the fluid bed with one single
hand, providing access instantly to the deck at the chest level. As the previous dryer operated
eight feet above the floor, the frequent cleanings required personal visits over a platform which is
very tall and carried a basic risk for safety. The RV dryer, were being operated at floor level,
which in return completely eliminated the safety risk and also enabled the CEO of CCC solutions
to bring the entire processing line down to the floor level. ¡°Reorienting the line onto a single level
also cuts down a second source of frustration: a belt conveyor was being used to lift the fibrous
sludge nine feet high to the dryer.s in feed. The material used to frequently stick to the belt and
required manual removal, slowing production. RV.s machines in contrast, stand only 2-1/2. off the
floor, allowing the use of an ultra-short in feed conveyor. The RV
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machine regularly meets the targeted 8% moisture content, it is easily adjusted when a 12%-14%
specification is desired and product integrity is exceptional.
1. What were the problems faced by the paper manufacturing company?
2. What were the solutions given to CCC Solutions by RV&Co?
9.14 Glossary
a long narrow passage which helps in dividing the machine
A point or an area of traffic congestion which creates problem for the machine in functioning
a power tool used to buff surfaces as a polisher
buffing wheel - a wheel that is covered with soft mater
A problem that causes fear or dread or terror among everyone
A quantity or amount or Something that can be counted or measured
3. The Art of Capacity Planning by John Allspaw

Unit 10 Lean Operations and Time-based

10.1 Introduction
10.2 Lean Operations: Planning for Flow
10.3 Lean Operations and Waste Elimination
The Seven Forms of Waste
The 5S.s
10.4 Lean Operations in Service Industry
10.5 Development of Time Based Competitiveness
10.6 Design for Manufacture and Simultaneous Engineering
10.7 Time Charting and Analysis
10.8 Business Process Reengineering (BPR)
Principles of BPR
Criticism of BPR
10.9 EDI, EPOS, and Bar Coding
10.10 Summary
10.11 Terminal Questions
10.12 Answers
10.13 Case Study
10.14 Glossary
10.1 Introduction
By now you must be familiar with capacity planning and material handling techniques. This unit
familiarises you with lean operation method and time-based competitiveness. In the first part, this
unit deals with the lean operations method, concept of waste and application of lean operations in
service industry. In the second part, it deals with the development of time- based
competitiveness, design for manufacture and simultaneous engineering, time charting and
analysis, Business Process Reengineering (BRP) and EDI, EPOS, and bar coding.
Learning Objectives:
After studying this unit you will be able to:
. Define lean operations
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. Explain lean operations and waste elimination
. Describe the role of lean operations in the service industry
. Elucidate the development of time-based competitiveness
. Explain the design for manufacture and simultaneous engineering
. Describe time charting and analysis
. Describe business process reengineering
. Explain EDI, EPOS, and bar coding
10.2 Lean Operations: Planning for Flow
Lean operations are a series of numerical and visual tools to streamline material and information
flow. It includes continual waste reduction and looks at all processes from the perspective of the
Lean manufacturing was first launched to the world through the Just In Time (JIT) concepts and
the Kanban1 techniques established as part of the Toyota Production System. But as a
philosophy of operations, lean is much more than that and is of much broader interest. Lean
manufacturing and lean operations in common have presented a persuasive case for organising
production, and production control tools, by forcing product to flow rapidly. Naturally, flowing
product rapidly through a supply chain makes economic sense. It is proven in practice also.
Parts of the lean philosophy have little to do openly with flow planning concepts, such as visual
control, poka-yoke error reduction, or continuous development. They can be used in non-lean
environments as well. But by reducing error and variability, these non planning elements of lean
are a big part of producing the environment where flow can occur.
In a typical lean environment, for example, the Toyota Production System, production levels are
very cautiously planned and modulated. Production is pulled through the plant with Kanbans.
Hence, lean is often equated with ¡°pull¡± operations.
Flow-oriented planning is basically a high-performance method. It involves using neither much
inventory nor much excess capacity to stabilise supply and demand, but rather finding ways to
stabilise them directly. Performing
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this delicate operation is at the centre of lean operations and of product flow planning in a lean
For example, consider a typical main appliances firm which manufactures washers, dryers,
dishwashers and refrigerators. They have some seasonal sales variation due to seasonal home
completion and a few other factors, which are minor. They have redesigned the supply chain for
flow so that the dealers keep small stock in their stores or warehouses. Instead, dealers should
rely on the firm for replacement within a few days. So the firm keep completing inventory in their
regional distribution centres. However, the firm has figured out how to keep it very modest. The
firm moved as much of their product segregation into accessory kits in part. Then, the firm either
supplied those kits to dealers when they order a dryer or installed the kit at the distribution centre
after they received the dealer order. This way, the firm has learnt how to re-supply their
distribution centres from tiny flow-through inventories at their plants and also how to manage
production to meet dealers. demand.
10.3 Lean Operations and Waste Elimination
The lean approach to supervising operations is founded on doing the simple things well, on
regularly doing them better, and on squeezing out waste in every step of the way. Often seen as
the important practitioner of the lean approach in Japan, the Toyota Motor Company has
developed a set of practices which has shaped what we now call lean or JIT. Some argue that the
beginning of JIT lies within Toyota.s reaction to the .oil shock. of rising oil prices in the early
1970s. The need for enhanced manufacturing efficiencies that the lean operations provoked has
encouraged Toyota to speed up its JIT ideas which were already formed. These developments by
Toyota, and other Japanese manufacturers, were also encouraged by the national cultural and
economic conditions. Japan.s attitude towards waste (.make every grain of rice count.), together
with its position as a crowded and virtually a country with less natural resources produced ideal
conditions. With these conditions, they devised an approach that emphasizes low waste and high
added value.
Possibly, the most important part of the lean philosophy is its focus on the elimination of all forms
of waste. Waste can be defined as any action which
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does not add value. Two simple devices are generally used in lean improvement. First is .the
seven forms of waste.. This is concerned with identifying waste as the first step towards
eliminating it. Second is .the 5S.s.. This is a simple set of principles for reducing waste.
10.3.1 The Seven Forms of Waste
Toyota has recognised seven types of waste, which have been found to be applicable in many
different types of operations . both service and production . and which form the core of lean
. Over-production: According to Toyota, producing more than what is immediately needed by the
next process in the operation is the greatest cause of waste.
. Waiting time: Waiting time is the pause between two inter-related processes (i.e. waiting for the
inputs from the previous process to get started with the next process). Equipment effectiveness
and labour effectiveness are two popular measures which are widely used to measure equipment
and labour waiting time, respectively.
. Transport: Moving items around the operation does not add value. Layout changes which bring
processes closer together such as improvements in transport methods and workplace
organisation can all reduce waste.
. Process: The process itself may be a source of waste. Several operations may exist only
because of poor component design or poor maintenance. As such, these processes can be
. Inventory: All inventories should become an objective for elimination. However, it can be
reduced only by tackling the causes of inventory.
. Motion: Simplification of work is a rich source of reduction in the waste of motion. An operator
may look busy but sometimes no value is being added by the work.
. Defectives: Quality waste is often very significant in operations. Total costs of quality are much
greater than that has traditionally been considered. It is, therefore, more important to address the
causes of such costs.
10.3.2 The 5S¡¯s
The 5-S terminology originated in Japan and even though the translation into
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English is approximate, they are generally taken to represent the following:
1. Sort: Remove what is not needed and keep what is needed
2. Straighten: Position things in such a way that they can be easily reached whenever they are
3. Shine: Keep things clean and tidy; no refuse or dirt in the work area
4. Standardise: Maintain cleanliness and order. Ensure perpetual neatness
5. Sustain: Develop a commitment and pride in keeping to standards.
Self Assessment Questions
1. Lean is often equated with ______________ operations.
2. ____________ has developed a set of practices which has shaped what we now call lean or
3. Toyota has recognised _______ types of waste.
4. __________ is the pause between two inter-related processes.
5. Removing what is not needed and keeping what is needed is called ___________.
6. __________ itself may be a source of waste.
10.4 Lean Operations in Service Industry
In this section, we consider the wider application of JIT. The idea of flow and waste is not
restricted to manufacturing. JIT, of course, has its ancestry in manufacturing. But, gradually, JIT
and lean principles are found in the service industry even though they may not be accepted as
such by service industry managers. Many of them have only an unclear notion of JIT and lean
principles. It no longer matters what it is that is being done is called; what matters is how effective
it all is. In this section, we will discuss the use of a few JIT and lean concepts in the service
The JIT scheduling idea of stability has wide potential in service operations. In banking, it is
general to have regular slots for work: for example, cheques are sorted at regular intervals. The
similar principles apply widely in magazine publishing where there are regular deadlines that must
be met at the same time each month. The proofs must arrive at the editor.s desk by a certain time
each month, so that editor is ready to receive them, the printer
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is ready to perform various tasks, and the supplier knows that paper must be delivered by a
certain date. All this establishes a routine. This brings order without having to make a new plan
each month.
The lean operations idea of waste reduction, and its converse, continuous improvement, is
broadly appropriate. Toyota uses the seven wastes in all areas, not just in manufacturing. In
service, continuous improvement is more closely associated with total quality in general, than with
JIT or lean operations.
Several lean techniques are directly applicable in service. The following are a few techniques
used by lean operations in the service industry:
. Cellular design: It can have dramatic results unlike a departmental design. One example is a
local authority who sanctions the building plans approval, formerly taking weeks as the plans
move around between departments such as the building inspectors, structural engineers, town
planners, health department and sometimes traffic engineering, is now routinely done within
hours as some representatives from all these departments have relocated themselves into a cell.
. Variety as late as possible: The lean design idea has broad application in insurance where
standard policies are made up and necessary special clauses added as necessary.
. Changeover reduction principle: This principle of making the highest possible preparation before
the changeover is not only applicable to a Grand Prix pit stop, but also to other service domains.
These domains can include restaurants, hotel reception desks, university registration and for all
meetings to ensure good customer service.
10.5 Development of Time Based Competitiveness
Time-based competitiveness has developed out of JIT manufacturing to have a big impact on
manufacturing, service and distribution. In the seminal work Competing Against Time2, the
authors mentions many examples of companies that have benefited through time-based
strategies. For example:
. Wal-mart: The American discount store has customer delivery times of about 80% less than
those of competitors and as a result enjoys an
2 George Stalk and Thomas Hout, 1990.
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income advantage of 36% against the industry norm of 12%.
. Atlas Door: A manufacturer of industrial doors has lead times of about 66% less than those of
competitors and as a result enjoys a income advantage of 15% against norm of 5%.
Often there is a straight association between time taken and quality levels, but in the opposite
way to what many people think. Normally, quality improves as time is reduced. Reducing the time
to make a product leads to less work in process and quicker detection of any problems that may
have arisen. Defective processes can be stopped sooner and the amount of rework is reduced.
The same effect is found in services: reducing the time often improves the feedback and leads to
improvement before what has taken place is forgotten. But overhead also reduces.
Think of a project having to support a head office administration, with ongoing costs per month. If
the project is completed sooner and another one begun, less overhead is accumulated. Then,
there is inventory. The longer it lies idle, the more it costs. A sensational example occurred when
Britain worked a three-day week as a result of power cuts, and output actually increased although
this probably could not be sustained.
As a result of their research, Stalk and Hout (1990) have proposed a number of rules of
. The 0.05 to 5 rule: It states the fact that on an average the amount of time that value is being
added to a product or service is among 0.05% and 5% of the total time used up in the system.
. The 3/3 rule: It states that the 95% to 99.95% of time that a product or service is inactive, is
divided into three components each accounting for one third of the time. The three components
are: conclusion of the batch that the product or service is part of; physical and intellectual rework
and management decision time.
. The ¨ù - 2- 20 rule: It states that for every quartering of the time required to produce a product or
service, efficiency will be double and there could be a 20% rate reduction.
. The 3 * 2 rule: It states the advantage of time-based competitors, a development rate of three
times the average with twice the profit margin.
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Activity 1:
We know that customers are ready to pay for improved quality, but how about for reduced time?
Try to certify Stalk and Hout.s findings locally. Find some comparable shops, selling, say,
furniture or domestic appliances, or insurance companies. Ask about their delivery times, or claim
settlement times, and prices. Then, if they are quoted companies, try to find out about their
Alternatively, think of a few examples where reduced time attracts a premium price.
10.6 Design for Manufacture and Simultaneous Engineering
Design needs individuals to declare in the lean and time-based operations circumstance. Design
is potentially one of the most influential tools for lean manufacturing. The organisation of design is
also vital for time competitiveness as it brings new products to the marketplace quicker.
Lean design demands close co-operation among number of departments: design, engineering,
quality, marketing, and manufacturing. The best JIT or lean companies find ways to bring these
groups together to solve what should be a mutual problem. The whole process is known as
simultaneous engineering.
Design for manufacture plans to design in quality and manufacturability. Simultaneous
engineering involves a .rugby scrum. method putting together a team from design, manufacture,
development, quality, suppliers and others such as marketing, to decrease the .over the wall.
mentality. This means that every department .throws. their finished work over the wall not caring
what the next department does to it, since the first department is no longer concerned with what
happens to the process next. The process of developing the product is then seen as more vital
than functional departments. Going further, some companies, for example Honda, needs
designers to work as operators for a week or so each year. Others, such as Hewlett Packard,
attempt to locate the design team close to the shop floor, and to have common refreshment
areas. The aim is to reduce time and cost.
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Computer Aided Design (CAD) is critical today for both better design and for time compression.
Superior CAD systems can permit simulation, where a mathematical model of the product can be
tested, before prototyping or manufacture. Another method is .early prototyping., to test products
with customers, which may be better than waiting for .design perfection..
Supplier involvement in design recognises that with established suppliers, where there is an
atmosphere of trust and perhaps .co-destiny.. The suppliers should be used as specialists in their
own areas of competency or process speciality. Early discussion about sharing certain feature
product information with trustworthy suppliers is necessary. A particular method is .open specs.
where the designer only gives the broad prerequisite and allows the supplier to innovate,
decrease costs and use the latest technology. Increasingly, some suppliers are being asked to
design and supply entire product .corners., not just component parts. This means that first-tier
suppliers increasingly have the responsibility to work with second-tier into the final product.
10.7 Time Charting and Analysis
Time charting and analysis can be used in decreasing manufacturing lead times, in decreasing
product development times, or in enhancing the turnaround in most service industries.
The Critical Path Analysis (CPA) technique has been used for over 30 years for project
management, basically to organise the time co-ordination of a variety of activities. Versions of
CPA allow for .crashing.; that is, the purposeful reduction of project time by using extra resources.
This is a trade-off; less time for more price. But in the time charting and analysis, the plan is to
decrease time without an additional cost punishment or in fact to reduce both time and cost. Time
charting and analysis starts by assembling a process chart or a critical path diagram which details
all the steps involved in producing the product or service. Often in manufacturing, and also in
services, there is an official process chart (what should happen) and a real process chart (what
actually happens). Also process charts, where they are kept are often out of date. In any case,
the aim is to get the real time process chart. This can often be achieved by following through a
product or service and detailing all the steps and times, including delays and storage, and
distance covered.
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The aim is to reduce time and waste. It is essentially a creative process.
Preferably the people involved in the process should be used in its analysis
and improvement. The basic step is to examine the process flow chart and
to split the activities into those that add immediate value for the customer
and those that do not. Figure 10.1 depicts such a flow chart.
Necessary to
Contribute to
requirements? Contribute to
Real value
Business value
No value
Activities that must be
performed to meet customer
Activities that do not contribute to meeting
customer requirements. These activities could be
eliminated without deterioration in product/
service functionality
Record order
Type policy
Research data
Record claim
Record data received
Order forms
Update personnel records
Prepare financial reports
Review and approval
Figure 10.1: Value Added Assessment
The plan, of course, is to accomplish the added value of the product or
service in as little time as possible. Therefore, try to make every valueadding
step continue from the previous value-adding step. The continuation
should be without disturbances for waiting, queuing or for procedures which
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assist the company but not the customer. This is Stalk and Hout.s main sequence. They have
provided several guidelines. Some of the questions that must be answered include:
. Can the non value-adding steps be removed, simplified, or condensed?
. Can some activity that delays a value-adding activity be simplified or carried over?
. Are there are any activities, mostly non value-adding activities, that can be done in analogous
with the sequence of value-adding activities?
. Can activities that have to be approved from department to department (and back) be
acknowledged into a team activity? Better still, can one person do it? If so, what training and
backup would be required?
. Where are the bottlenecks? Can the capability of the bottleneck be extended? Do bottleneck
operations keep working or are they postponed for minor reasons? Are bottleneck operations
delayed by non-bottleneck operations and whether they are value-adding or not?
. What arrangements can be made before the major sequence of value-adding steps is initiated
so as to avoid delays such as preparing the paperwork and getting the machines ready)?
. Can the necessary customer variety or requirements be added at a later stage, for instance,
making a fundamental product or service but adding the colour and sunroof as late as possible?
. If jobs are done in batches, can the batches be divided so as to move on to a second activity
before the whole batch is complete at the first activity?
. Can staff flexibility be enhanced so as to allow several tasks to be done by one person, thus
cutting handing on delays?
. What is the decision making preparation? Can decision-making power be handed over to the
point of use? Can the routine decisions be accepted so that they can be dealt with on the spot?
For example, using a computer based expert systems.
. Where is the finest place, from a time point of view, to carry out every activity? Can the activity
be carried out at the point of use or contact, or must it really be referred somewhere else?
. Do clients like a .one-step. process? If not, why they do not like?
. If problems do extend, what will be the delays and how can these delays be decreased?
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. Is it probable to move assessment points so that they take place earlier?
. What availability of information will make the value-adding series smoother
or more continuous? Is there more than one resource of information, and if
so can this be brought to one place such as a general database?
. Can the time taken for value-adding activities be reduced? This action
enables breaking down a value-adding action into more detailed
activities, some of which would be non value-adding. For example,
preparing a meal can be considered to be a value-adding activity, but
this activity itself may involve wastes such as moving around the kitchen.
A more detailed analysis is advantageous for repetitive activities
10.8 Business Process Reengineering (BPR)
BPR became a management prospect in 1990 with a typical article in
Harvard Business Review3: ¡°don.t automate . obliterate¡±. Hammer states
that BPR is as crucial a view of management, but many disagree. In fact,
BPR can be seen as a natural improvement from ideas such as JIT, System
Analysis, Time based Competitiveness and Total Profit.
Reengineering is a basic rethinking and radical redesign of business
processes to accomplish dramatic improvements in cost, quality, speed and
service. BPR joins a strategy of promoting business innovation with a
strategy of making major improvements to business processes so that a
company can become a much stronger and more flourishing competitor in
the marketplace. Figure 10.2 depicts the BPR cycle.
Design To-Be
Test & Implement
Identify Processes
Review, Update
Analyse As-Is
Figure 10.2: Business Process Reengineering Cycle
3 By Michael Hammer entitled .Reengineering
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10.8.1 Principles of BPR
According to Michael Hammer (1990), the principles of BPR are:
. Organise in the region of outcomes, not tasks: This principle implies that instead of organising a
job around departments or persons, each job should be organised with a department and also
fixing the department to own the responsibility for the job assigned. You should think about what
the objective of the process is.
. Have those who use the output of the process perform the process: Here Hammer suggests
that, with the aid of suitable information technology, it is no longer essential to have, for example,
centralised purchasing, accounting, personnel and so on. One consequence is delayed as
different functions have different priorities. These tasks can be done by the users of each service
. Subsume information processing work into the real work that produces the information: People
who create the information should also process it. So, again with the help of computers, functions
who produce, sell or order should process the information themselves rather than handing it on to
accounting, marketing or purchasing.
. Link parallel activities instead of integrating their results: In taking a new product to market the
conventional way is for each function to work in sequence. These functions include marketing,
design, engineering, manufacturing and so on.
. Put the decision point where the work is performed, and construct control into the process:
According to Hammer, the distinction between those that do and those that control is increasingly
outdated. This principle is not only about suitable empowerment, but also creative management
and once again computer systems.
. Capture information once and at the source: According to Hammer, the finances of information
have altered. Once when information was hard to transmit and store, it made sense to collect it
several times. With modern IT this is no longer the case.
10.8.2 Criticism of BPR
Reengineering has received a bad reputation because such projects have often resulted in
massive layoffs. The main reasons are,
. BPR presumes that the factor that limits organisation.s performance is
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the incompetence of its process. This may or may not always be true. Also BPR suggests no
means to authorise this assumption.
. BPR presumes the need to start the process of performance improvement with a ¡°clean state¡±.
. BPR does not provide an efficient way to focus the improvement efforts on the organisation.s
. Sometimes, or maybe quite often, a gradual and incremental change may be an improved
. BPR culturally influenced towards the US way of thinking.
Activity 2:
Contrast Hammer.s principles we have outlined with the principles developed from Stalk and Hout
and Harrington (1991). Recognise similarities. Make up a .master list.. Also, compare Hammer.s
principles with what you have learned about JIT and TQM.
10.9 EDI, EPOS and Bar Code
Electronic Data Interchange (EDI) allows straight computer-to-computer communication. This can
be extended where a bank is connected to the value added network to permit automated
payment. This term is used where there is a complete network of companies using EDI. On one
level, this paperless trading decreases time and increases accuracy by avoiding re-keying.
Clerical staff may be saved, and transactions are less expensive than by mail, telephone or fax.
Cash flow also improves.
But on another more strategic level, EDI opens up other opportunities such as capacity to link
intra-company communications with external companies, to search for prices and suppliers more
easily, to improve forecasts where EDI is linked to Electronic Point Of Sale (EPOS) and to other
information systems. It is probable, for example, for manufacturers to write the master production
schedules of their suppliers directly. EDI has until recently exclusively involved word processing,
but now interchange of graphical design data is possible.
One of the problems with EDI has been standards. A supplier may discover himself having to
work through numerous EDI networks with different message standards. In Britain, Tradanet is a
VAN (Value Added Network) used by numerous retailers. The German car industry uses one
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and the British another (Odette). Several networks operate in the USA. Attempts have been made
to create a universal standard.
EPOS terminals which examine bar codes to generate itemised receipts are a recognisable
feature in most supermarkets. Once again, they can be used far away from their obvious
advantage of improved data accuracy and customer service. They enable maintaining an up-to-
date record of product usage . a tremendous marketing advantage. The implications are a shift in
balance of power away from suppliers, who used to have most of the information about product
popularity and the success of promotions, towards the retailers. In Britain and the USA, some
supermarket chains are now encouraging customers to use personal cards, which have the
potential to link detailed transactions to particular customers and so to target promotions to
specific customers.
A bar code is a visual machine-readable depiction of data, which shows certain data on certain
products. Initially, bar codes symbolised data in the widths (lines) and the spacing of parallel
lines, and may be referred to as linear or 1D (1 dimensional) bar codes or symbologies. They also
come in patterns of squares, dots, hexagons, and other geometric patterns within images termed
2D (2 dimensional) matrix codes or symbologies. Even though 2D systems use symbols other
than bars, they are usually referred to as bar codes as well. Bar codes can be read by visual
scanners called bar code readers, or examined from an image by special software.
The initial use of bar codes was to tag railroad cars, but they were not financially successful until
they were used to mechanise supermarket checkout systems, a task in which they have become
roughly universal. Their use has spread to many other roles as well, tasks that are generically
referred to as Auto ID Data Capture (AIDC). Other systems are attempting to make inroads in the
AIDC market, but the simplicity, universality and low cost of barcodes has limited the role of these
other systems.
The real potential is realised when all three technologies are linked. Over the last decade, Tesco
has been able to approximately half the number of distribution centres, while the number of
suppliers and turnover has more than doubled. The vast majority of their suppliers now deliver to
the nearest distribution centre rather than direct to the supermarkets as previously.
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Self Assessment Questions
State whether True or False:
7. The JIT scheduling idea of stability has wide potential in service operations.
8. 4 * 8 is one of the rules of response.
9. Design does not need individual declare in the lean and time-based operations circumstance.
10. Electronic Data Interchange (EDI) allows straight computer-to-computer communication.
11. A bar code is a visual machine-unreadable depiction of data.
10.10 Summary
Lean operations are a series of numerical and visual tools to streamline material and information
flow. It includes continual waste reduction and looks at all processes from the perspective of the
customer. Lean operations plan the flow of the processes in an organisation. One of the important
parts of lean philosophy is the elimination of wastes from an organisation. Also lean operations
can be used in service industries effectively to increase the profit.
Time-based competitiveness has developed out of JIT manufacturing to have a big impact on
manufacturing, service and distribution. Time-based competitiveness can be used in designing,
manufacturing and simultaneous engineering industries. Reengineering is a basic rethinking and
radical redesign of business processes to accomplish dramatic improvements in cost, quality,
speed and service. EDI, EPOS and bar code are the techniques that are essential for the
industries to maintain time-based competitiveness.
10.11 Terminal Questions
1. Explain how lean operations can be used for planning the flow with example.
2. List out the seven forms of waste. Explain how 5S.s are used to eliminate them.
3. Elucidate lean operations in service industry.
4. Explain in detail the development of time-based competitiveness.
5. Describe design for manufacture and simultaneous engineering.
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6. Explain time charting and analysis.
7. What is Business Process Reengineering? List out its principles? What are them criticisms it
8. Differentiate between EDI, EPOS and Bar code.
10.12 Answers
Answers for Self Assessment Questions
1. Pull
2. Toyota Motor Company
3. Seven
4. Waiting time
5. Sort
6. Process
7. True
8. False
9. False
10. True
11. False
Answers for Terminal Questions
1. Refer section 10.2
2. Refer section 10.3
3. Refer section 10.4
4. Refer section 10.5
5. Refer section 10.6
6. Refer section 10.7
7. Refer section 10.8
8. Refer section 10.9
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10.13 Case Study
Business Process Reengineering for the Commissions Process
The Client
An Australian corporation, which is amongst the top ten banking institutions and top five universal
insurers, has one of the maximum cross-sell rates in the financial sector. The insurance activities
of the company cover personal insurance, corporate coverage and workers' compensation.
Business Need
Alliances and intermediaries were key development drivers in the long-term approach of the
client. In order to better manage the channel behaviour and meet the organisation's objectives,
the capability to pay accurate and timely commissions was an important element. This was
considered a critical competitive edge and a weak link in client's back office capabilities.
This organisation paid a huge amount every year in commissions which was roughly 20% of its
profits before goodwill and taxes. At the same time, it lost significant amount on overpayments
and commission leakage.
Challenges and Requirements
The following challenges were faced during implementation:
The existing operations comprised of manual processes using band aid systems which were high
cost and presented serious risk
This organisation paid a huge amount every year in commissions, which was approximately 20%
of its profits before goodwill and taxes. At the same time, it lost significant amount on
overpayments and commission leakage
1. Map the different stages of BPR cycle with this case study.
2. What role an organisation should perform which benefit the client?
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10.14 Glossary
Poka-yoke error reduction
The idea is to prevent mistakes as opposed to relying on operator vigilance.
Visual control
The principle of increasing efficiency and effectiveness simply by deliberately making things
The process of deciding how to commit resources between varieties of possible tasks.
Auto ID Data Capture
It is the methods of automatically identifying objects, collecting data about them, and entering that
data directly into computer systems, without human involvement.
Electronic data interchange
It is the structured transmission of data between organisations by electronic means. It is used to
transfer electronic documents from one computer system to another.
Kanban is a signaling system to trigger action. As the name itself suggests, Kanban historically
uses cards to signal the need for an item.
1. Lean Production for Competitive Advantage . A Comprehensive Guide to Lean Methodologies
and Management Practices, by John Nicholas.
2. Business process change: reengineering concepts, methods, and technologies, by Varun
Grover, William J. Kettinger.
3. Benchmarking for people managers, by John Bramham, Institute of Personnel and
4. Reengineering, by Michael Hammer.
5. Competition.html

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Unit 11 Quality Systems in Operations
11.1 Introduction
11.2 Quality Control as a system
Dimensions of Quality
Systems View of Quality
11.3 Quality Control Techniques
Quality at the source
Quality Control Tools
11.4 Quality Based Strategy
11.5 Total Quality Management (TQM)
Approaches to TQM
11.6 Towards TQM - ISO 9000 as a platform . working with intranet
Total Productive Maintenance
11.8 Summary
11.9 Terminal Questions
11.10 Answer
11.11 Case Study
11.12 Glossary
11.1 Introduction
By now you must be familiar with the concept of operations management and its scope. Quality is
a very essential part of operations management. Since its introduction, it has been realised that
production of items in required quantities, at the right time is not enough. Customers demand a
product with excellent quality, as well as good service. You will notice that there is no relevance in
offering good service when, the product is not of a good quality. Thus, quality is the policy to
survive in the contemporary markets, which are expanding. It is a marketing strategy that helps
an organisation to enter a market or to compete with existing manufacturers. It is the foundation
for achieving customer.s satisfaction that is, the purpose for which the organisation exists. Brands
get created as a result of offering quality products. The quality components must be built into the
processes, design, and operations that help in manufacturing the product or delivering it (service)
either independently or as a part of the product. Statistical tools are
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used to identify sources of defects in such processes. Since cost has become an important
dimension of customer satisfaction, efficiencies have to be built in all operations like production,
material handling, maintenance, marketing, packaging, and supply chain.
Learning Objectives:
After studying this unit you will be able to:
. Define Quality.
. Explain various methods through which Quality can be achieved.
. Analyse the TQM concepts.
. Explain how quality is achieved by design and robust manufacturing systems.
11.2 Quality Control as a System
Quality is a procedure for ensuring the maintenance of proper standards in manufactured goods,
especially by occasional random inspection of the product. In the following sub sections the
dimensions of quality and systems view of quality are discussed in detail.
11.2.1 Dimensions of Quality
Before we consider quality control, let us see what quality means. Generally quality is built-in in
the product or service that is rendered to the customer. Since we are attempting to measure the
same, we will look into those aspects of quality called Dimensions of quality:
Quality of design . The meaning of design is the specifications of materials, characteristics,
finishes and other features that are incorporated in the product, of which the manufacturer is
aware and expects them to meet the customers. needs. A service provider has to set, them in the
product. After deciding upon these factors, quality is introduced by designing these parameters.
Thus, quality of the design of the dimensions, materials and processes of producing, and
inspection is very important to check performance quality.
Conformance to design . The point to which the finished product or service that is delivered meets
the parameters that have been incorporated in the design. It verifies that the variability in the
process is within acceptable limits so as not to compromise the functionalities that the designer
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Utilisation conditions . These refer to the necessity of the customer being informed/trained, so
that the purpose for which the product was made is realised by the customer in, thus enhancing
his satisfaction. Instructions, manuals, help lines; onsite training by the manufacturers. personnel
improves the perception of quality.
After sales service . There are so many reasons why products do not function to the expected
levels. It may be improper use, unexpected /additional demands, improper assembly or even
manufacturing defects. There is a need to rectify these and make products or services perform up
to the expected standard. The firm must put in place a system, by which these possibilities are
anticipated and attended to give customer satisfaction. This is an important, but often neglected
dimension of quality.
11.2.2 Systems View of Quality
A system consists of a number of elements that have specific functions of their own. These give
support and receive support from one another to deliver outputs, as though they come from a
single unit. Structure, organisation, hierarchies, and integration of elements within a system make
it effective. Design ensures that information flow, feed back and monitoring take place to make
the system efficient. Quality control is exercised mainly by two methods. The first is by designing
the equipments, processes, manufacturing methods, and technologies to ensure that quality
parameters are obtained without fail. Robustness is built into all aspects of the system to ensure
that its quality characteristics do not get affected by providing inputs or during extreme working
conditions. Variability is inherent in any process. All processes have equipments, tools,
methodologies, movements, facilitating goods, and people who have their behaviours exhibited
depending on their knowledge, skills, and abilities. The mechanism for assuring quality is to
anticipate and plan for the proper, designed performance of the process within the permissible
deviations so that, they do not affect quality. Procedures have to be set up, data have to be
gathered, and evaluations have to be made available at all nodal points. This is necessary for
dissemination of information, implementing actions necessary to monitor the variables, and
bringing them to acceptable levels. This is the quality control system.
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Self Assessment Questions
1. TQM is management and control of _________.
2. Customer.s perception of adequacy, if not excellence, goes a long way in establishing
3. Variability is inherent ________.
4. __________________verifies that the variability in the process is within acceptable limits so as
not to compromise the functionalities that the designer wanted.
5. Quality control is exercised mainly by _______methods.
Activity 1
Visit any retail shop and list the elements which they consider to ensure Quality in their goods
and service.
11.3 Quality Control Techniques
Techniques are certain procedures and activities adopted using data for deciding a particular
aspect of quality and arriving at decisions that are conclusive. Even though every technique was
developed and tested by senior personnel or consultants, it will be simple enough to be
interpreted, understood, and implemented by the personnel for their immediate use. The
techniques, the criteria to be used and adopted, and the ways of interpreting data must be
handed over to them for use. We will consider some of them here.
11.3.1 Quality at the source
This concept helps the production worker to be more responsible for inspection of his own work
and take right action. Since inspection is done immediately after a job is done, this helps to
identify the cause of the error, with clarity and aids in faster rectification. Many times some
fundamental processing mistakes get identified and their analysis improves the quality in the long
run. Every worker has the authority to stop production, if he finds some serious defect. This gives
workers pride in their work and assigns responsibility for quality in work. Help must always be
available from the Quality Control personnel, to help workers understand the implications of the
above actions. All these factors bring in understanding between employees, cooperation, and
improve the achievement of quality. The information generated may be used to effect
improvements at the suppliers. end also. The entire process brings in openness, commitment and
participation, and helps in achieving quality.

11.3.2 Quality Control Tools

Quality Control (QC) is a procedure which intends to ensure that, a manufactured product or
performed service adheres to a defined set of quality principles or meets the demands of the
customer. The QC tools are used to achieve quality.
The following are considered as the basic tools for achieving quality control:
Flow Chart
Check sheet
Pareto Analysis
Scatter Diagram
Control Chart
Cause and Effect Diagram
Now let us consider each tool listed above and analyse how it helps to improve the quality of a
Flow Chart: It is a visual representation of process, showing the various steps. It helps in locating
the points at which a problem exists or an improvement is possible. Detailed data can be
collected, analysed, and methods for correction can be developed. A sample is shown below.
1. List the various steps or activities in a particular job.
2. Classify them as a procedure or a decision.
3. Each decision point generates alternatives.
4. Criteria and Consequences that go with decision are amenable to evaluation for purposes of
assessing quality.
The flow chart helps in pin-pointing the exact point at which errors have crept in. A simple chart is
shown below.
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Opn Insp Opn Insp Pack
Rej Rej
Figure 11.1: Process Flow Chart 1
Check Sheet: These are used to record the number of defects, types of
defects, locations at which they occur, times at which they occur, and the
workmen responsible for its occurrence. These sheets make a record of the
frequencies of occurrence with reference to possible defect causing
parameter. It helps to implement a corrective procedure at the point where
the frequencies are more, so that the benefit of correction will be maximum.
A sample sheet is shown below.
Table 11.1: Check Sheet
DEFECT DAY 1 2 3 4 5
1 // /// /// ///// //
2 / //// /// //// ///
3 // ////// //// // //
4 // //// /// // //
5 /// ////// /// / ///
6 // //// /// /// //
The above table depicts that the number of defects in 1 and 5 are not many
as compared to defect no 2, which increased over the days and appears to
be stabilising at the higher side. Therefore these defects in 2 have to be
attended immediately. The column representing days can be changed to
represent observed by the hour, if required.
Histogram . Histograms are pictorial representations of distribution of data.
They are used to record big volumes of data about a process. They reveal
whether the pattern of distribution has a single peak or many peaks and also
the extent of variation around the peak value. This helps in identifying
whether the problem is serious. When used in conjunction with parameters
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that are comparable, the visual patterns help us to identify the problem
which must be attended to.
Figure 11.2: Histogram
The values shown in the above figure are the number of observations made
regarding a parameter. Sometimes, percentages are shown to demonstrate
the relative contribution of each of the parameters.
Pareto Analysis . Pareto Analysis is a tool for dividing problem areas
according to the degree of importance and attending to the most important.
Pareto principle, also called 80-20 rule, states that 80 percent of the
problems that we encounter arise out of 20 percent of items. If you find that,
in a day, you have as many as 184 assemblies having problems and there
are 11 possible causes. It is observed that 80 per cent of them, that is, 147
of them have been caused by just two or three of them. It will be easy to
focus on these two or three and reduce the number of defects to a great
extent. When the cause of these defects has been attended, we will observe
that some other defect becomes predominantly observed. It is observed that
if the process is continued, we will march towards zero defects.
Scatter Diagram . These are used when we have two variables and want
to know the degree of relationship between them. We can determine if there
is any cause and effect relationship existing between and its extent over a
range of values. Sometimes, we assume that there is no relationship, in
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which we can change one parameter making sure that it does not affect the
Figure 11.3: Scatter Diagram
We can see that the change in Variable 2 does not have much effect on
Variable1. The other interpretation can be that for a small change in
Variable 1, the effect on Variable 2 is more.
Control Charts . These are used to verify whether a process is under
control. When variables remain within a range, they will render the product
and maintain the specifications. This is the quality of conformance. The
design parameters determine the range of permitted deviations. Samples
are taken and the mean and range of the variable of each sample
(subgroup) is recorded. The mean of the means, of the samples gives the
control lines. Assuming normal distribution, we expect 99.97 per cent of all
values to lie within the Upper Control Limit (UCL) and Lower Control Limit
(LCL). Corresponding to + 3.. The graphical representation of data helps in
changing settings to bring back the process closer to the target.
Consider The Following Data:
A shaft is to be made with a diameter of 25mm. They area required to be
ground to be between +0.01 and -0.02mm, by a process of centre less
grinding. A sample of five nos. is taken every hour and the observations are
recorded as shown below:
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9 A.M
24.98 24.99 25.0
25.04 25.01
10 A.M.
25.01 25.02 25.0
25.01 25.0
11 A.M.
24.99 24.98 25.02
25.02 24.97
12 Noon
24.97 24.99 25.01
25.04 25.03
2 P.M.
25.01 25.02 25.0
25.03 25.01
3 P.M.
24.99 24.98 25.02
24.97 25.00
4 P.M.
24.97 24.99 25.01
25.04 25.03
5 P.M.
25.01 25.02 25.0
25.03 25.01
1. Draw A Line Diagram Taking The Means Of Every Hour
2. Draw The R Chart And X Charts And
Determine Whether The Process Is Under Control.
The steps to be followed to find the range for the sample readings of each
hour are:
Find the mean of the readings of each hour that is, x
Add all the means calculated above and take the mean of the means . you
will get the mean for all samples.
The UCL is x . 3. where . is the standard deviation of the means of
dimensions obtained on the dimensions of samples obtained every hour.
However, in drawing the control charts, it is customary to range a constant
that depends on the size of the sample, to calculate the UCL and LCL. The
formulas are as under.
d2 - values depend on the sample size.
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On a graph sheet, y axis represents the dimension. The mean value is drawn as a horizontal line,
near the middle of the y-axis while the horizontal axis represents the serial number, of the
samples. Variations of the dimensions get marked on both sides of the mean line.
Cause and Effect Diagram: In this diagram all possible causes are classified on quality
characteristics that lead to a defect. These are arranged in such a way that, different branches
representing causes connect the stem, in the direction of the discovery of the problem. When
each of them is investigated thoroughly, we will be able to pinpoint some factors that cause the
problem. We will also observe that a few of them will have cumulative effect or even a cascading
Figure 11.4: Cause and Effect Diagram
When we observe that we have excessive defects from a machine, we try to identify all possible
sources of the causes of defects. We make a study of each of them and try to correct it.
Acceptance Sampling . In this method of quality control, the supplier and customer agree upon
accepting a lot, by inspecting a small number taken randomly from the bulk supply. Out of the
sample, if a small number is determined and accepted by both parties are defective, the lot is
accepted. If the number of defectives is more than the agreed size, the entire lot is rejected.
Obviously, risks for the producer and buyer exist. As the sample
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size increases and the number of acceptable defectives decreases, the risk for the buyer
decreases. And the converse is also true. That is the reason these numbers cannot be fixed, as
they depend on the customer.s requirements. Sometimes parties go for a doubling sampling plan.
In this case, a range of defectives is fixed. If defectives are less, the lot is accepted. If it is more
than the higher number, the lot is rejected. If the no of defectives falls between the above two
numbers, another sample of a higher size is taken for inspection. If the total number of defectives
is less than another determined number, the lot is accepted.
11.4 Quality Based Strategy
Strategy means planning and supplementing a series of activities based on the evaluation of both
internal and external environment, so as to maximise the yield. Essentially short term and long
term objectives are in the horizon. The available resources, both present and future are
evaluated. Within the restraints they place on the system, the most beneficial activities are
planned. Most importantly, an assessment of the competitors in all these aspects is made to
either confront it or bypass it, for reaching the goals. Unless these are not based on the quality of
the product or service, the effort is meaningless. Quality in design, manufacture, packing,
delivery, pricing, and after sales service acts as an advantage and plays an important role is
ensuring customer satisfaction. So the foundation of any strategy should be quality. Nowadays
price is also a component of quality. To achieve quality at low prices, efficiencies in all processes
have to be realised. This is where we have Lean Manufacturing, Just in time, Flexible
Manufacturing Systems, and so on that play a vital role in controlling costs. Working for quality
awards like Deming, Malcolm Baldrige Awards increases efficiencies in the organisation and
builds customer confidence.
11.5 Total Quality Management (TQM)
TQM is viewed from many angles . as a philosophy, as an approach and journey towards
excellence. The main motive is to satisfy customer by involving everybody in the organisation, in
various functions with constant improvement driving all activities. TQM systems are designed to
prevent poor quality in products/services. The steps listed below have to be implemented to
achieve Total Quality:
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1. Take all measures to know what the customer wants that is, voice of the customer. Develop
methods that generate facts, which can be used for decision making. Do not ignore the internal
customer that is, the next person in the process.
2. Transform the demands into design specifications that meet or exceed customer expectations.
3. Processes are to be designed, so that they facilitate doing the job right from the first time.
Include elements that make it impossible to commit mistakes. It is known as fail-saving or fool
proofing. The Japanese call it Pokayoke.
4. Maintain record of all procedures followed, occurrences, and consequences. They help in
formulising the processes, so that constant improvement becomes possible. More particularly,
any gaps can be seen and corrected immediately.
One of the basic tenets of TQM is ¡°just because something is working well, improvement is not
necessary¡±. The search must be continuous, to find ways and means to improve every aspect of
the business process like finance, operations, and management. Complacency must never be
allowed to creep in at any time. In this aspect, culture plays an important role. All these require
top management commitment
11.5.1 Approaches to TQM
Being practiced worldwide by different organisations, TQM has different approaches towards its
achievement. The basic thrust of each of these is realising excellence. All the approaches have
many features in common, but the emphasis shifts from one to the other. Needless to say, each
organisation will use any of these or even a combination to suit its structure, culture, and need.
Some emphasise on the philosophy of TQM and the role of management and employees in being
aware, committed and act. Some expect us to use statistics more intensely. Some give us an
.integrated approach.. The following are some of the approaches used to determine the quality of
Deming Wheel
Juran.s Quality Triology
Crosby.s Absolutes of Quality
Taguchi.s Quality Loss Function
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Deming Wheel
Deming wheel or PDSA Cycle, as it is called is a constant quality enhancing model; it consists of
a logical sequence of four repetitive steps for constant enhancement and learning
Deming¡¯s approach is summarised in his 14 points.
Constancy of purpose for continuous improvement.
Adopt the TQM philosophy for economic purposes.
Do not depend on inspection to deliver quality.
Do not award any business based on price alone.
Improve the system of production and service constantly.
Conduct meaningful training on the job.
Adopt modern methods of supervision and leadership.
Eliminate fear from the minds of every individual, connected with the organisation.
Remove barriers between departments and people.
Do not exhort, repeat slogans, and put up posters.
Do not set up numerical quotas and work standards.
Give pride of workmanship to the workmen.
Education and training to be given vigorously.
State and show top management.s commitment, for better quality and productivity.
Deming with the help of the above principles gave a four step approach to ensure a purposeful
journey of TQM. The slope illustrated in figure 11.5 is used to indicate that, if efforts are let up, the
programme will roll back.
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Act Plan
Check Do
Deming Cycle -Plan -Do -Check- Act
Figure 11.5: Deming Wheel
The explanation for every quarter of the Deming Wheel, shown in the above
figure is as follows:
Plan . means that a problem is detected, processes are stated and relevant
theories are checked out.
Do . means that the plan is implemented on a trial basis. All inputs are
correctly measured and recorded.
Check . means that the trials taken according to the plan are in accordance
with the expected results.
Act . means that regular production is started, so that quality outcomes are
assured when the above steps are satisfying.
Juran¡¯s Quality Triology
Juran utilised his well-known Universal Breakthrough Sequence to
implement quality programmes. He suggested the following quality
Proof of need: This means that there should be a compelling need to make
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Project Identification: in this, what is to be changed is defined and determined. Projects with
certain time frames and the resource allocation are determined.
Organisation with top management.s commitment is made by assigning people and fixing their
Diagnostic journey: Every team will determine the systematically or randomly or deliberately
arising problems. Root causes are ascertained with utmost certainty.
Remedial Action: This is the stage when changes are introduced. Validation, testing, and
inspection, are also included at this point.
Holding on to the gains: The above steps result in beneficiary results. Maintaining records of all
actions and consequences assists in further improvements. The actions that resulted in the
benefits derived must be the norm for establishing standards.
Juran has classified cost of quality into four categories, they are:
Failure costs . Internal: These are costs of rejections, repairs, and so on in terms of materials,
labour, machine time, and loss of morale.
Failure costs . External: These are costs of replacement, on-site rework including spare parts,
and expenses of the personnel, warranty costs, and loss of goodwill.
Appraisal Costs: This consists of costs of inspection, including maintenance of records,
certification, segregation costs, and so on.
Prevention costs: This consists of the sequence of three sets of activities that is, Quality Planning,
Quality Control, and Quality Improvement from the trio logy, to achieve Total Quality
Juran argues that:
Good planning considering the needs of both internal and external customers and developing
processes to meet them, results in good quality. The processes are also planned to meet them.
Quality is built into the system of manufacture, inputs, and processes that are on stream like raw
material, spare parts, labour, machine maintenance, training, warehousing, inspection
procedures, packaging, and so on. They
Operations Management Unit 11
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should be prepared to follow certain standards and control exercised, to make sure that mistakes
do not repeat often and if they occur they are corrected at the source.
Quality Improvement measures are very important to preserve the quality culture. Newer methods
will be found, some operations can be eliminated, and improved technology will be available. In
short, as experience is gained, things can always be done better. It is for the management to take
the responsibility and encourage the employees to be on the look out for opportunities for
Crosby¡¯s Absolutes of Quality
Like Deming, Crosby also lays emphasis on top management commitment and responsibility for
designing the system so that, defects are not inevitable. He requested that there should be no
restriction on spending for achieving the best quality. In the long run, maintaining quality is easier
and cheaper or economical rather than compromising on its achievement.
Crosby.s absolutes are listed below:
Quality is conformance to requirements, not .goodness..
Prevention, not appraisal, is the path to quality.
Quality is measured as the price paid for non-conformance and as indexes.
Quality originates in all factions. There are no quality problems. It is the people, design, and
process who create problems.
Crosby has also given 14 points similar to those of Deming. His approach stresses on, increasing
awareness, measurement of quality, error cause removal, corrective action, and continuously
reinforcing the system, so that advantages derived are not lost over time. He intends that the
quality management regimen must improve the overall health of the firm or organisation and
prescribed a vaccine.The ingredients of the vaccine are:
Commitment . Integrity and honesty to produce everything right first time and every time.
Communication . Flow of information between suppliers, departments, customers helps in
recognising opportunities.
Systems and operations . These must bring in a quality environment so that
everybody is uncomfortable with anything less than the best.
Taguchi¡¯s Quality Loss Function
His contention is that quality comes from design. He propagated a wide use
of Design of Experiments, for experimentation on variables and obtains
specifications those results in the highest quality of the product. It assists in
bringing price effective improvements in quality. He beliefs that designers
must prepare effective designs, so that product can withstand the
variability.s that tend to be consistent and give quality for longer periods. His
objective in transferring the loss function is, to make producers realise that it
is the target value of the specification that must be achieved and not the
permissible deviations. The loss caused is the double of the deviation
multiplied by a cost constant that is represented as shown below:
2 L . C(X .T)
Where L = Total Loss
C = Cost constant
X = average value of the quality characteristic
T = target value of the characteristic.
Taguchi also explains about losses to society because of a dent in quality.
That is, both the manufacturers and users in society, who will have to
endure the consequences of, reduced performance, as long as the product
is used.

Self Assessment Questions

6. The flow chart helps in _________ the ___________at which errors
have crept in.
7. _____________ measures are essential to keep the quality culture
8. Quality is measured as the price paid for _____________ and as
9. _________-had the belief that designers must prepare effective
designs so that product can withstand the variability.s which tend to be
consistent and give quality for longer periods.
10. Crosby also has given __________ points similar to those of Deming
Activity 2
Assume that you have opened an automobile manufacturing company. List out all the processes
which you consider will be essential in delivering the product with best quality.
11.6 Towards TQM - ISO 9000 as a Platform . Working with Intranet
In this Unit so far, we saw a number of methods of achieving quality and also the prescriptions of
the quality gurus. No particular model or methodology might be completely useful to any
organisation. However, with the knowledge gained by becoming aware of the various tools, we
must be in a position to implement the steps that will be suitable for us. In this direction, ISO 9000
set of standards details out the requirements to be adhered to, for certification. The certification
helps the organisation to be on track, in the journey towards TQM. International Standards
Organisation in Geneva brought out a set of standards to the practice of methods which assure
quality. The objectives of the standard are:
. To maintain product quality in relationship to requirements and reinforce improvement in the
organisational systems.
. To give confidence to the management and other stakeholders, especially the customers, that
the organisation is run on quality lines.
. To instill a sense of pride in the employees that motivates them to perform better.
The key elements of ISO 9000 that are required for certification, details many functions of the
organisation and procedures that needs to be adhered to. Documents that they are being
followed have to be formulated and the personnel must be trained to use them. Documentation is
a very important requirement. It means, write what has to be done, and do what you have
promised to do. Certification is done by accredited agencies, who are specially trained to do the
various inspections required before an organisation is certified. During the process of
implementation, a number of opportunities open up for improving quality. Since documentation is
done for all activities, the records act as a guide for analysing problems for which solutions can
be sought. The team work that is required results in better
communication. ISO 9000 acts as a starting point towards higher efforts for achieving TQM. Six
sigma1 projects can be taken up for a more rigorous implementation of quality standards. The
benefits of better communication with intranet cannot be overlooked. Capturing data, analysis of
them and distribution of relevant data to users is an important facilitation process which intranet
provides. Verification, guidance, and monitoring become easy. All processes whether design,
manufacture or dispatch, can be conducted efficiently with proper authorisations sought and got
instantly. With video-conferencing, the inconvenience of putting people at one place for
discussion and decision making is avoided. Documents can be transferred, and edited
instantaneously. The time, energy, and money saved can be utilised for other activities thus,
enhancing efficiency of all the people concerned. All these enhance the quality of work of all
Self Assessment Questions
11. _____________acts as a starting point towards higher efforts for achieving TQM.
12. _________is done by accredited agencies who are specially trained to do the various
inspections required before an organisation is certified.
13. _____________projects can be taken up for a more rigorous implementation of quality
11.7 Total Productive Maintenance (TPM)
Maintenance is a function in any operations system that has the responsibility of keeping the
equipments in good condition. Generally, equipments deteriorate because usage makes the parts
wear, introducing inaccuracies on the products made on them. When the deterioration produces
components that exceed the permitted deviations, rendering them unacceptable, maintenance is
undertaken to bring back the machine to produce acceptable components. Sometimes the failure
is sudden and serious that the equipment stops working. Disruption of production and emergency
repair work are costly and schedules are missed causing delays in supplies and consequent
losses. These breakdowns occur because the equipment was carrying hidden defects, which
were not apparent during
1 For more information please visit
conditions that could permit functioning, despite the latent defect. All these are attended to by the
maintenance department. Historical records indicate the probability of failures over different
periods that help us to plan and attend them. With progress in automation, we have costly
equipments. We have flow lines and any one machine breaking down causes a series of
machines to be idle. So, we have to move towards zero breakdowns like, we want to move
towards zero defects by implementing TQM tools. TPM2 puts the responsibility of maintenance
where it belongs to and the operator, who uses the equipment. It is a companywide activity that
involves all the people. The main thrust is eliminating all break downs. The focus is on the
operating personnel because they would know about malfunctioning earlier and more than
anybody else. They work on the machine and will be aware of the slightest variations that occur.
They will also be able to plan for removing the cause before it becomes serious. So, every
planned maintenance activity reduces the probability of a breakdown. Ownership of the operation
and machine increases the commitment of the workmen. Autonomy is the starting point for
learning and excellence. The worker can suggest better ways of improving quality, productivity,
and design. This helps in continuous improvement. Team work and participation improves the
quality culture. The principles of 5S that is, the housekeeping activities that improve efficiency at
workplace is considered a measurable standard, to aid the implementation of TPM even in the
office rooms.
Self Assessment Questions
14. TPM puts the responsibility of ________ where it belongs to the operator who uses the
15. __________ and machine increases the commitment of the workmen
11.8 Summary
Importance of quality cannot be overemphasised. Achievement of quality is not limited to the
production department or the quality control department. Modern concepts of quality go beyond
maintaining dimensions and making the products work well. Quality is to be incorporated into all
functions of
2 For more information please refer to TPM: a route to world-class performance by Peter
Willmott, Dennis McCarthy
management along with transport, accounting, and packaging. Total quality envisages where
suppliers and customers are treated as partners to achieve total quality. Concepts of Six Sigma
and their implementation assure enhanced customer satisfaction.
The various Quality Control Techniques have been discussed with the help of diagrams. The
different approaches, that is, Deming Wheel, Crosby.s Absolutes of Quality, Juran.s Quality
Trilogy, have been discussed in detail.
Taguchi.s Quality Loss Function. You have also learnt about the concept of TQM. You have also
learnt that maintenance is a function in any operations system that has the responsibility of
keeping the equipment in good condition.

11.9 Terminal Questions

1. What are the dimensions of Quality?
2. Explain the concept of Quality at Source.
3. Which are the Q C Tools?
4. Why Acceptance sampling is done?
5. Explain how cause and effect diagram helps in finding the root cause of a problem?
6. What does Deming Wheel represent?
7. How does Crosby.s absolute of quality differ from Deming.s principles?

11.10 Answers
Answers to Self Assessment Questions
1. Quality-related activities
2. Long term relationships
3. In any process
4. Conformance to design
5. Two
6. Pin-pointing, exact place
7. Quality improvement
8. Non-conformance
9. Taguchi
10. 14
11. ISO 9000
12. Certification
13. Six sigma
14. Maintenance, equipment
15. Ownership of the operation

Answers to Terminal Questions

1. Refer section 11.2
2. Refer section 11.3
3. Refer section 11.3
4. Refer section 11.3
5. Refer section 11.3
6. Refer section 11.5
7. Refer section11.5

11.11 Case Study

In June 1995 AS, an Indian-based aerospace company announced its merger with ABC, another
Indian-based aerospace and industrial controls major. The merger, valued at Rs1500 Crores in
stock and assumed debt, created a Fortune 50 company, with Rs 2000 Crores in revenues and
more than Rs 3500 Crores in market capitalisation. Both companies decided to work under the
name of ASB International Company which was in real a global company with true global
technology. Besides cost savings yearly, the merger was expected to offer many business
synergies to the two companies. The combined technological, cultural, managerial, financial, and
operational strengths of both the companies were expected to drive the growth of the new
To get more benefits out of the merger, ASB planned to integrate the quality management
initiatives of the two companies. Thus, in December 1995, it came up with plans to build on ASB.s
existing efforts in order to implement a world-renowned quality initiative, known as Six Sigma.
The decision to create a broad Six Sigma which was not just bound to processes, but to different
functional areas, as well resulted in the creation of the Six Sigma System.
This unique system was formed with the help of both the company.s quality systems namely Six
Sigma and ASB Quality Value (AQV), respectively.
According to industry professionals, AS growth owed much to the top management's focus on
improving efficient operational. Foremost among such initiatives was the Six Sigma initiative
introduced 1994. AS implemented the Six Sigma Breakthrough Strategy, which aimed at rising
productivity by 7% every year in its industrial sectors.
While the company began recognising the benefits of Six Sigma implementation in manufacturing
processes, it also decided to broad-base the Six Sigma implementation exercise by implementing
it to other processes such as innovation and product development.
According to the company sources, the most important benefit of the Six Sigma Plus initiative was
that it enabled the company to understand the requirements and needs of its customers. For
example, a tool named 'Voice of Customer' assisted to gain feedback from customers, which in
turn assisted the company design a novel customer relationship management system in 1996.
ASB focused on five areas . people, cash, growth, productivity, and enablers. In these areas, the
company importantly focused on cost cutting (through lay-offs and closing unprofitable
businesses), increasing productivity, growth, effective cash flow management, new product/
service development, and healthy customer and employee relationships.
By early 2000, the company integrated Six Sigma Plus into the way its employees imagined and
implemented - thus making Six Sigma Plus an integral part of the organisation's culture. In real,
Six Sigma Plus became more of a mindset. By now, about 70% of the company.s management
was trained in Six Sigma Plus basics (that is. in DMAIC). The company.s objective was to have
100% of its management trained in Six Sigma Plus by the end of the year. Apart from this, it also
aimed at having 100% of its engineers trained in the Design for Six Sigma (DFSS) program by
that time.
According to Krishna Mohan), AS's Chief Growth Officer, Six Sigma greatly increased the
efficiency of the product development process. The application of Six Sigma tools boosted the
company in identifying probable risks and their impact, evaluate the independent variables, define
the probability of occurrence, reduce variability and maximise results. Thus, the initiative forced
the company to make more accurate product development decisions
1. What did ASB planned to get more benefits out of the merger?
2. What were the areas primarily focussed by ASB?
11.12 Glossary
the introduction of a subject to widespread audience for discussion and debate
A significant, usually diminishing effect or impression
One place where different lines, systems, or paths meet
Six Sigma
Six Sigma seeks to improve the quality of process outputs by identifying and removing the causes
of defects (errors) and minimizing variability in manufacturing and business processes It uses a
set of quality management methods, including statistical methods, and creates a special
infrastructure of people within the organisation like "Black Belts", "Green Belts", and so on, who
are experts in these methods.
5 S.s
5 S.s method is the process of creating workplace cleanliness and organisation, including visual
1. TPM: a route to world-class performance by Peter Willmott, Dennis McCarthy

Operations Management Unit 12

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Unit 12 Independent Demand Inventory Systems
12.1 Introduction
12.2 Inventory Items
12.3 Inventory Decisions
Reorder Point (or Perpetual) Model
Periodic Review Model
12.4 Economic Order Quantity
Limitations of EOQ
Variations in the EOQ
12.5 The EOQ and the JIT Philosophy
Safety Stock
Inventory Control
ABC Classification
Cycle counting
Measuring Inventory Performance
12.6 Summary
12.7 Terminal Questions
12.8 Answers
12.9 Case Study
12.10 Glossary

12.1 Introduction
Inventory is the stock of any item or resource used in an organisation. An inventory system is a
set of policies and controls, which monitors the levels of inventory and determines what levels
must be maintained, when the stock should be replenished, and how large the orders should be.
By convention, manufacturing inventory generally refers to material entities that contribute to or
become part of a firm's product output. Manufacturing inventory is generally classified into raw
materials, finished products, component parts, supplies, and work in process. In services,
inventory generally refers to the goods to be sold and the supplies necessary to deal with the
A common classification of inventory items in manufacturing companies is as follows:
„h Raw materials: Purchased items or extracted materials that are transformed into components
or products.
„h Components: Parts or sub-assemblies used in building the final product.
„h Work-in-process (WIP): Any item that is in some stage of completion in the manufacturing
„h Finished goods: Completed products that are delivered to customers.
„h Distribution inventory: Finished goods and spare parts that are at various points in the
distribution system.
„h Maintenance, repair and operational (MRO) inventory (often called supplies): Items that are
used in manufacturing but do not become part of the finished product.
Inventory serves many purposes, such as:
„h Ensuring on time delivery of completed products to customers
„h Providing a buffer against supply chain uncertainty and unpredictability
„h Detaching manufacturing operations
„h Assuring an uninterrupted supply of seasonal products
„h Taking advantage of volume discounts.
Inventory items are divided into two main types:
„h Independent demand
„h Dependent demand items
Learning Objectives
After studying this unit, you will be able to:
„h Explain the different types and uses of inventory.
„h Analyse the importance of Inventory in manufacturing, using a material requirements planning
(MRP) system.
„h Explain Inventory Management Techniques.
„h Calculate appropriate safety stock inventory policies and perform ABC inventory control and
„h Analyse the role of cycle counting in inventory record accuracy.

12.2 Inventory Items

Some inventory items can be classified as independent demand items, and some can be
classified as dependent demand items. While we need to make the timing and sizing decisions
for all inventory items, we must be careful in the manner in which we make those decisions for
these two types of items.
Dependent demand inventory item consists of items whose demand is related to (or dependent
upon) some higher level item. Demand for such items is usually considered as derived demand.
Dependent demand inventory items are usually the materials, parts, components, and assemblies
that are part of the finished product.
Independent demand inventory consists of items for which demand is influenced by market
conditions and is not related to production decisions for any other item held in stock. Hence
independent demand inventory is concerned with .end items. rather than its components, parts,
or ingredients. In contrast to this is the dependent demand inventory that consists of items
required as components or inputs to a product or service. Material Requirements Planning (MRP)
is used for dependent demand.

Self Assessment Questions

1. Inventory items are divided into ___________ and ________________.
2. ______________ consists of items for which demand is influenced by market conditions and is
not related to production decisions for any other item held in stock.
3. MRP is _______________________.
4. __________________ are nothing but the parts or sub-assemblies used in building the final

12.3 Inventory Decisions

Managing independent demand inventory involves answering two questions:
„h How much to order?
„h When to order?
There are other questions as well, such as who to buy from and where it is to be stored, but these
are rare issues. However, the questions .when to order. and .how much to order. involves regular
reassessment, and these questions interact with each other.
Inventory Management Techniques
Inventory management is primarily about specifying the size and placement of stocked goods. It
might be required at different locations within a facility or within multiple locations of a supply
network to protect the regular and planned course of production against the random disturbance
of running out of materials or goods. The scope of inventory management also concerns the fine
lines between replenishment lead time, carrying costs of inventory, asset management, inventory
forecasting, inventory valuation, inventory visibility, future inventory price forecasting, physical
inventory, available physical space for inventory, quality management, replenishment, returns and
defective goods, and demand forecasting.
Independent demand item techniques are subdivided into:
„h Reorder point (or Perpetual) Model
„h Periodic review models
12.3.1 Reorder Point (or Perpetual) Model
The Reorder Point (ROP) or Perpetual model formula allows determining the Safety Stock (SS)
required to achieve a certain cycle service level. In general, the longer the lead times and greater
the variability of demand and lead times, more is the need for safety stock.
Assume that an inventory holding is continually depleted. The ROP is that level of inventory which
is just sufficient to help during the period that it takes for your supplier to deliver. More precisely, it
is the forecasted demand expected during the lead time.
Of course the demand during the lead time may not materialise as we expect, if:
„h Demand is lower than expected. You experience excess of stock when the new shipment is
„h Demand is higher than expected. You experience a shortage or stock-out before the shipment
is delivered.
To allow this possibility, SS is maintained. As a result, the formula for the reorder point is:
DLT = forecast demand during the lead time
= expected average demand per period x number of periods for lead time
SS = Safety Stock
A well-used variation of the ROP inventory model is called the .two bin. system. Here each
inventory item is literally kept in two bins, side by side. Inventory is drawn out from the first bin
until it is empty. This is the ROP. There is sufficient inventory in the second bin to cover expected
demand during the delivery lead time. It is a simple, visual system that is commonly used for low-
cost C type items. Figure 12.1 illustrates the .sawtooth. pattern.
Figure 12.1: ROP Inventory Model
12.3.2 Periodic Review Model
In many cases, it is more practical to order several items at the same time, in case if there is a
common supplier. So it makes sense to review all items from the common supplier periodically
and order just what is needed. Normally inventory is topped to a target level, and for this reason
this model is also known as the mm/max model.
Operations Management Unit 12
.: 239
This inventory model is still widely used because of the following common situations:
„h Where individual transactions are difficult to record
„h Where shelf life is a problem
„h Where joint orders are placed with a supplier
The first of these situations is rapidly disappearing in supermarkets, where there is increased use
of point of sale terminals.
The question with a periodic system is how often we must make the review. Usually, this is a
practical consideration, perhaps coinciding with a scheduled order delivery cycle.
Figure 12.2 graphically depicts the situation where L is the lead time, R is the review period and
Q is the order quantity.
Note that an order quantity determined at A must be sufficient to last through the review period
and the next lead time. And also note that the quantities are different for each review period.
Figure 12.2: The Periodic Review Model
Operations Management Unit 12
.: 240
The relevant formulas are:
M = Target inventory level
DL = Forecast demand during the lead time
DR= Forecast demand during the review period
SS = Safety stock
Q = M ¡V I-O
= D (R+L) + SS ¡V (I+O)
Q = Order quantity
M = Target Inventory level
I = quantity on hand
O = quantity on order
Activity 1:
Calculate the target inventory level and order quantity, where:
„h The review period is 7 days
„h The delivery lead time is 5 days
„h Demand averages 2 units per day
„h The safety stock is 4 units
„h The on-hand inventory is 15 units
„h The quantity on order is 6 units.
12.4 Economic Order Quantity
Economic Order Quantity is defined as, the optimal quantity of orders that minimises total variable
costs required to order and hold inventory.
The EOQ is the classic formula in inventory management. It represents the optimal trade-off
between the costs of ordering and the costs of holding inventory.
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Following are the assumptions of EOQ formula:
„h New inventory is delivered in batches
„h There are no stock- outs
„h Demand is constant and continuous
„h Delivery lead time is constant and known.
Over the time, inventory levels decline, but are replenished just in time to avoid stock-out. Figure
12.3 illustrates the EOQ graphically.
Figure 12.3: Economic Order Quantity
We can see that the average level of inventory being held is very different in the two cases:
The unit carrying cost rate, expressed as percentage, comprises the sum of the cost of the capital
tied up and the costs of holding inventory.
The former includes the opportunity cost of the cash tied up, and the latter the costs of storage
and control, the costs of insurance and the costs of risk including obsolescence and possible
pilferage. There are also less obvious costs including the cost of inspection, data processing and
record keeping,
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inventory handling equipment such as racks and fork lift trucks, and the
training of inventory control staff.
The monetary value of the carrying cost is equal to the average inventory held,
multiplied by the carrying cost rate and the unit cost. If we assume that demand
is constant, then the average quantity held is equal to half the order quantity.
Order cost is the cost of placing a single order and comprises of factors
such as selecting the supplier, preparing the order, receiving and inspecting,
paying the invoice when order is received. EOQ method assumes this
cost to be constant irrespective of the number of orders placed.
We can now write down the formulas for each cost as:
Carrying cost = (Q/2) C I
Order cost = (D/Q) S
There is also the basic cost of the items which is constant irrespective of
order size:
Item cost = D C
and so, Total cost = Carrying cost + Order cost + Item Cost
= (Q/2) C I + (D/Q) S + D C
Q = Order quantity
C = Item cost
I = Annual carrying cost interest rate
D = Annual demand
S = Order cost per order.
EOQ can be derived by equating the Holding cost and the Order cost, or by
calculus, as shown below.
Deriving Holding cost using Order cost:
2DS = Q2CI
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By calculus:
2 Q2
( cos )
ƒ ƒ{ ƒ
d Total t
2 Q2
Some of the advantages of EOQ are:
„h It provides a baseline for getting the best deal.
„h It helps you purchase only necessary items, keeping away from over
12.4.1 Limitations of the EOQ
Though EOQ is one of the best known formulae in operations management,
there are advantages and disadvantages with EOQ.
Some of the disadvantages of EOQ are:
„h Applicable only to non-perishable products with staple demand
„h Ignores delivery quantities and discounts
„h Assumes storage space is unlimited
„h Assumes retailer controls delivery scheduling
„h Cost structures have changed, e.g. ordering costs reduced by ecommerce;
stock is seen as a liability not asset.
The disadvantages are very obvious if you've got a high periodicity or
seasonality to your consumption, or if your usage is very minimal. EOQ
should only be applied to higher volume items that are worth inventorying.
12.4.2 Variations in the EOQ
There are many variations in the basic EOQ model. Some of the useful
variations are listed below:
„h Quantity discount logic is programmed to work in conjunction with the
EOQ formula to determine optimum order quantities. Most systems
require this additional programming.
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„h Additional logic is programmed to determine the maximum quantity of items subject to spoilage
or to prevent obsolescence on items reaching the end of their product life cycle.
„h When used in manufacturing to determine lot sizes, where production runs are very long
(weeks or months) and finished product is released to stock and consumed/sold throughout the
production run, then you may need to take into account the ratio of production to consumption to
more accurately represent the average inventory level.
„h Safety Stock calculation may take into account the order cycle time that is driven by the EOQ.
If so, you may need to include the cost of the change in safety stock levels into the formula.
Self Assessment Questions
5. ______________ is defined as, the optimal quantity of orders that minimizes total variable
costs required to order and hold inventory.
6. Periodic review model is also known as __________.
7. _________ pattern represents Reorder Point (or Perpetual) Model.
12.5 The EOQ and the JIT Philosophy
In this section, the Just-In-Time (JIT) view of the holding costs of inventory is discussed. When
firms are purchasing to meet high and consistent levels of demand, they can take the advantage
of JIT in inventory physical plant space reduction.
Two new concepts are developed to underpin the idea that, even if the JIT approach can induce
inventory physical plant space reduction, it is possible for EOQ to be more cost effective, as the
inventory demand approaches the break-even point between the function of the annual holding
capacity of an inventory facility and the function of the EOQ-JIT cost indifference point.
JIT has recognised that there are several additional costs of inventory. They are:
„h Lead time and responsiveness: In factories, large batches contribute directly to longer queues.
Longer the queue, longer is the lead time before another batch can be worked on and hence
slower the responsiveness. A large batch, either made or ordered from a supplier, may have to
cover requirements (or a longer period of time). Near the
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end of the period, we would find that either we have been too optimistic leading to unsold
products, or too pessimistic leading to shortages. It would be better to make or order small
batches more frequently which simultaneously reduces the inventory costs and decreases the
forecast horizon. Of course, the key to this is to reduce order or set-up costs.
„h Quality: Larger the batch size, lesser the frequency of inspections. Also, there is an increased
risk of spoilage with some categories of inventory. This means that there are likely to be more
„h Space: Inventory occupies space in the warehouse on the factory floor. Not only this, there is a
possibility that the space could be used for other purpose. A large accumulation of inventory often
creates physical barriers, thereby lengthening transportation distances, preventing visual controls
and inhibiting communication. These may have an impact on quality and lead time.
„h Control: More inventories mean more controls in the form of counting and checking to ensure
„h Material handling: With JIT, it is ideal to have human-movable containers to move inventory
between closely spaced operations, rather than using expensive forklift trucks to move large
batches over longer distances.
These points are mutually supportive. They may be hard to quantify, but for certain the JIT
attitude leads to a conclusion that the true costs of holding inventory arc much higher than we
thought they would be.
12.5.1 Safety Stock
Safety Stock (SS) is defined as extra units of inventory, carried as protection against possible
stock outs (shortfall in raw material or packaging). It is the level of extra stock that is maintained
below the cycle stock to buffer against stock outs.
12.5.2 Inventory Control
Inventory control is the supervision of the supply, storage and accessibility of items in order to
ensure an adequate supply without excessive supply. It is also referred as internal control, an
accounting procedure or a system designed to promote efficiency or assure the implementation of
a policy or safeguard assets or avoid fraud and error and so on.
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12.5.3 ABC Classification
In inventory management, ABC classification is a method of categorising the products.
There are a different methods to set up an ABC Ranking, such as Annual Sales Volume ranking,
Velocity (times sold), Quantity sold/Consumed or by Margin. But the most commonly used
method is the Annual Sales Volume ranking. This method allows identifying small amount of
products that usually account for most of the sales.
Here is the method for determining ABC ranking based on Annual Sales Volume:
1. Calculate the 12 month dollar usage for all of the products (Volume X Cost).
2. Rank the items in descending order by the dollar usage.
3. The ¡§A¡¨ items are the top 80% of the total annual usage dollars.
4. The ¡§B¡¨ items make up the next 15% of total annual usage.
5. The ¡§C¡¨ items are the remaining items are the remaining 5% with >0 usage in the past 12
6. Label zero-usage items as ¡§D¡¨.
12.5.4 Cycle counting
A cycle count is an inventory management procedure where a small subset of inventory is
counted on any given day.
Cycle counts are less disruptive to daily operations, provide an ongoing measure of inventory
accuracy and procedure execution, and can be tailored to focus on items with higher value,
higher movement volume or those that are critical to business processes.
A special case of inventory control is record accuracy. The importance of inventory control is no
less with independent demand inventory control.
The most universally agreed best practice in inventory management procedure is cycle counting.
However, cycle counts can introduce inventory errors if the cycle count process is poorly
executed. Multiple locations per item, work in process, and lag in paperwork processing can
contribute to these errors.
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12.5.5 Measuring Inventory Performance
A common method of measuring inventory performance is by inventory turns. It is the number of
times the inventory is turned around per year. It is measured by taking total sales and dividing by
the value of the inventory.
Another measure is to divide days of inventory on-hand (this could be the number of days or
working days) by the number of turns and average age of inventory.
12.6 Summary
Inventory management is a huge subject and the essentials are discussed in this section.
Inventory is a vital part of any business. Control of inventory offers tremendous opportunity for a
business which has given low priority to this aspect in the past.
In this unit, the basic inventory decisions as how much to order and when to order were
We considered the classic economic order quantity method, which can be used to calculate how
much to order, provided the assumptions underlying the formula are valid.
And also, two basic inventory control philosophies are introduced. The perpetual system and the
periodic system and a set of inventory management techniques, time phased order point, which is
well-suited for non-uniform demand and for high-value items. It is noted that all inventory
management systems should incorporate ABC analysis and cycle counting. Finally, Inventory
turns, a common way of measuring inventory performance is also discussed.
Self Assessment Questions
8. Inventory Control is also referred to as _________.
9. Define cycle counting.
10. Explain Safety Stock.
12.7 Terminal Questions
1. Name and explain the different types of inventory.
2. Explain two different Independent demand item techniques.
3. Explain Economic Order Quality.
4. What are the limitations of EOQ?
5. Explain measuring Inventory Performance.
12.8 Answers
Answers to Self Assessment Questions
1. Independent demand and Dependent demand items
2. Independent demand inventory
3. Material requirements planning
4. Components
5. Economic Order Quantity
6. mm/max model
7. Sawtooth
8. internal control
9. Refer Section 12.5.4
10. Refer Section 12.5.1
Answers to Terminal Questions
1. Refer section 12.1
2. Refer section 12.3.1
3. Refer section 12.4
4. Refer section 12.4.1
5. Refer section 12.5.5
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12.9 Case Study
Zhou Bicycle Case Study
Zhou Bicycle Company, located in Seattle, is a wholesale distributor of bicycles and bicycle parts.
These retail outlets receive the order from ZBC with 2 days after notifying the distribution centre,
provided that the stock is available. However, if an order is not fulfilled by the company, no
backorder is placed. The retailers arrange to get their shipment from other distributors, and ZBC
loses that amount of business. The company distributes a wide variety of bicycle. The most
popular model, and the major source of revenue to the company, is the AirWing. ZBC receives all
the models from a single manufacturer in China, and shipment takes as long as 4 weeks from the
times an order is place. With the cost of communication, paperwork, and customs clearance
included, ABC estimates that each time an order is in place. It incurs a cost of $65. The purchase
price paid by ZBC, per bicycle, is roughly 60% of the suggested retail price for all the styles
available, and the inventory carrying cost is 1% per month (12% per year) of the purchase price
paid by ZBC. The retail price (paid by the customers) for the AirWing is $170 per bicycle. ZBC is
in interested in making an inventory plan for 2006. The firm wants to maintain a 9.5% service
level with is customers to minimize the losses on the lost orders. The data collected for the past 2
years are summarized in the following table. A forecast for AirWing model sales in 2006 has been
developed and will be used to make an inventory plan for ZBC.
Develop an inventory plan to help ZBC.
Discuss ROP's and total costs.
12.10 Glossary
It is a list for goods and materials available in stock by a business. It is also used for a list of the
contents of a household and for a list for testamentary purposes. It is the stock of any item or
resource used in an organisation.
Economic Order Quantity
It is the optimal quantity of orders that minimises total variable costs required to order and hold
ABC classification
It is a business term used to define an inventory categorisation technique often used in materials
management. It is also known as Selective Inventory Control. It is a way to categorise/group the
Cycle count
It is an inventory management procedure where a small subset of inventory is counted on any
given day.
Safety stock
It is a level of extra stock that is maintained below the cycle stock to buffer against stock outs.
1. Logistics of production and inventory, by S. C. Graves, A. H. G. Rinnooy
Kan, Paul Herbert Zipkin.
2. Inventory Record Accuracy: Unleashing the Power of Cycle Counting,
2nd Edition, by Roger B. Brooks, Larry W. Wilson.
Unit 13 Statistical Quality Control
13.1 Introduction
13.2 Statistical Quality Control
13.3 Descriptive Statistics
Descriptiveness Measures
13.4 The Stem-and-Leaf plot
13.5 The Frequency Distribution and Histogram
13.6 Probability Distribution
Types of Probability Distribution
13.7 Summary
13.8 Terminal Questions
13.9 Answers
13.10 Case Study
13.11 Glossary
13.1 Introduction
By now you must be familiar with the concepts of Independent demand inventory control. This
unit familiarises you with the concepts of Statistical Quality Control.
Statistical Quality Control (SQC) monitors the production samples of determining the quantities
statistically. Thus, a process is said to be in a state of statistical control if the variations of the
sample stay within the limits. However, when a process is out of control it is necessary to locate
the specific causes for the variation and take a corrective action.
The information facilitates controlling and improving the process of manufacturing. Furthermore,
statistics is that language that facilitates engineers, manufacturing, procurement, management,
and other functional components of the business communicate effectively about quality.
Learning Objectives:
After studying this unit you will be able to:
„h Define Statistical Quality Control and various methods associated with it
„h Explain descriptive statistics
„h Define probability distribution
„h Explain various types of Probability Distribution.
13.2 Statistical Quality Control
Statistical Quality Control (SQC) is a method that uses various statistical sampling of units that
are produced by a production process. These are further checked and verified for defectives
called as variances. It determines whether the process is in control or not.
If the process is not in control, then necessary and corrective actions are taken. Thus, the
Statistical Quality Control (SQC) chart is used as a basic tool that formally distinguishes between
the normal, as well the abnormal variances. These control charts further helps in distinguishing
the random variances from the variances that need managerial investigation.
Thus, the final analysis helps in obtaining the improvements in the products and the processes.
Thus, this identification of the chance variances avoids unwanted and unnecessary investigations
of variances and there by eliminating frequent changes.
Some of the various tools and methods associated with the Statistical Quality Control (SQC) are:
„h Descriptive Statistics
„h Stem and leaf Plot
„h Frequency Distribution and Histogram
Now let us discuss these tools and methods in detail.
13.3 Descriptive Statistics
Descriptive statistics is a process that is used to describe the features of data in terms of quantity.
It is generally represented with formal analyses. For example, in a study involving human
subjects, there appears a table that provides information such as the overall size of the sample,
subgroup sample sizes, and information about the demographic or the clinical characteristics,
such as the average age, the proportion of subjects with each gender. However, most statistics
can be used either as a statistic that is descriptive or in an inductive analysis.
For example, the average reading test score for the students in each classroom in a school can
be reported. This could give a descriptive sense of typical scores and their variation. However,
when a formal hypothesis test on scores is performed, we are doing inductive rather than the
descriptive analysis. Some of the common examples of the descriptive statistical analysis include
measures of central tendency, measures of dispersion and measures of association, cross
tabulation, contingency table, and histogram. Thus, descriptive statistics provides various
numerical and graphic procedures. This facilitates to summarise a collection of data in a clear and
understandable way.
13.3.1 Descriptiveness Measures
Descriptive statistics provides various numerical and graphic procedures. There are various
measures of the descriptiveness statistics. They are as follows:
„h Central Tendency Measures: They are computed in such a way that, a ¡§center¡¨ is achieved
around which; the measurements in the data are distributed. However, there are various
measures under central tendency measures such as:
o Mean: It computes the sum of all the measurements and divides by the number of
measurements. For example Consider the quantities as mentioned in Table 13.11
Table 13.1: Example of Mean
1 -
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Therefore, the sum of all the quantities .X. is obtained and the mean is calculates as:
MEAN= 40/10 = 4
The mean of all quantities is 4, and the sum of deviations is 0.
o Median: It is computed in such a way that half of the measurements are below it and half of the
measurements are above it. It is illustrated in the table 13.2.
Table 13.2: Example of Median
Measurements Ranked
Therefore, Median is (4+5)/2 = 4.5
Thus, only two central values are used in the computation. The median is not sensible to extreme
Mode: It computes the most frequent measurement in the data.
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Table 13.3: Example of Mode
In this case, the data has two modes: 5 and 7 because both the
measurements are repeated twice.
„h Variation or Variability measure: They are performed to compute how far
away the measurements are from the center.
For example, consider that a population has four observations {1, 3, 5, 7}.
What is the variance??
Solution: First, we need to compute the mean of the population.
It is calculated as:
Then, all the values are plugged in the formula for the variance of a
2 2 ƒã ƒ„¡( ƒ{ƒÝ)
[(1 4) (3 4) (5 4) (7 4) ] 4 2 2 2 2 2 ƒã ƒ ƒ{ ƒy ƒ{ ƒy ƒ{ ƒy ƒ{
[9 1 1 9] 4 20 4 5 2 ƒã ƒ ƒy ƒy ƒy ƒ ƒ
Thus a variance value .5. is obtained for the population.
„h Relative Standing Measures: They are computed to describe the relative
positions of specific measurements in the data.
ƒÝ ƒ (1ƒy 3ƒy 5 ƒy 7) 4 ƒ 4
x ƒ{ƒÝ ƒã ƒ 78 ƒ{ 69.0 2.8 ƒ 3.21
x ƒ{ƒÝ ƒã ƒ 76 ƒ{ 63.6 2.5 ƒ 4.96
For Example: Consider a scenario where, the heights of two superstars
are compared. NBA superstar Michael Jordan is 78 inch tall and WNBA
basketball player Rebecca Lobo is 76 inch tall. By this observation, it is
obvious that Jordan is taller by 2inches than Rebecca. But which player is
considered taller relatively? Does Jordan.s height among men exceed
Lobo.s height among women? Consider Men have heights with a mean of
69.0 inches and a standard deviation of 2.8 inches. Consider women have
heights with a mean of 63.6 inches and a standard deviation of 2.5 inches.
Solution: In order to compare the heights of Michael Jordan and Rebecca
Lobo that are relative to the populations of men and woman, we need to
standardise the heights by converting them to z scores
Jordan: z=
Lobo: z=
Thus, Michael Jordan.s height is 3.21 standard deviation above the mean.
However, Rebecca Lobo.s height is 4.96 standard deviations above the
mean. This means that Rebecca Lobo.s height among woman is relatively
greater than Michaels Jordan.s height among men.
Self Assessment Questions
1. _________ is a measure to calculate a measurement from the center.
2. _________ computes the most frequent measurement in the data.
3. How do we calculate median?
4. Define Descriptive statistics
5. Statistics can be used either as a statistic that is descriptive or in an
inductive analysis.(True/False)
Activity 1
Analyse how the central tendency measures are calculated. List out the
differences between mean, median and mode.
13.4 The Stem-and-Leaf plot
Statistics is the science of analysing data and drawing conclusions, taking variation in the data
into account. However, no two units of a product that is produced by a manufacturing process are
identical. Some variation is inevitable. For example, the net content of a soft drink can vary
slightly from, can to can and the output voltage of a power supply is not exactly the same from,
one unit to another.2
There are several graphical methods that are very useful for summarising and presenting data.
One of the most useful graphical techniques is the stem-and-leaf display.
Suppose that, the data are represented by u1, u2 . . . , un and that each number u1 consists of at
least two digits. To construct a stem-and-leaf plot, each number ui is divided into two parts i.e.
A Stem: It consists of one or more of the leading digits
A Leaf: It consists of the remaining digits.
For example: Consider the data that consists of percent defective information ranging between 0
and 100 on various semiconductor wafers. The value 76 can then be divided into the stem 7 and
the leaf 6.
Once a set of stems has been selected, then they are listed along the left hand margin side of the
display. The leaves that correspond to the observed data values are listed in order, beside each
stem in the order in which, they are encountered in the data set.
For example, the construction of a stem and leaf plot can is illustrated in the table 13.4. The table
represents the weekly yield data from a semiconductor fabrication facility.
2 -
Table 13.4: Weekly yields
In order to construct a stem and leaf plot, the values 4, 5, 6, 7, 8 and 9 are selected as stems.
Thus, the resulting stem and the display of leaf are as shown in the Table 13.5.
Table 13.5: Stem-and-leaf display for the data in 13.3
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By inspecting the plots, it is clear that the yield distribution has a symmetric shape, approximately
with a single peak.
Variation of the Stem-and-Leaf Display:
An ordered stem-and-leaf display has the leaves arranged by magnitude, as shown in the table
Table 13.6: Variation of the stem and leaf
The display facilitates the process of finding the percentiles of the data. The percentile is a
number such that at most p% of the various measurements is below it and at most 100 - 9 % (100
minus 9) of the data are above it. For example, in a certain data the 85th percentile is 340. It
means that 15% of the measurements in the data are above 340 and the remaining 85% of the
measurement are below 340.
However, the fiftieth percentile of the data distribution is called the sample median .. The median
is computed in such a way that, half of the measurements are below it and half of the
measurements are above it. Suppose the number of observations is n and is an odd number. The
median can be calculated, by sorting the observations in the ascending order or descending
order. Thus, the median will be in the rank position [(n-1)/2 + 1] on the list.
On the other hand, if n is even, then the median is calculated by taking the average of the (n/2)
and (n/2 +1) ranked observations. For example, consider the value of n to be 40 that is an even
number, the median is calculated by taking the average of the two observations. The tenth
percentile is computed by observing the rank (0.1) (40) +0.5 =4.5, or (49+49)/2 = 49.The first
quartile is the observation with rank (0.25)(40) + 0.5
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= 10.5 (halfway between the tenth and eleventh observation) or (53+54)/2 = 53.5, and the third
quartile is the observation with rank (0.75)(40) + 0.5 = 30.5 (halfway between the thirtieth and
thirty-first observation), or (79+81)/2 = 80. The first and third quartiles are occasionally denoted
by the symbols Q1 and Q3, respectively and the inter-quartile range IQR = Q3 ¡V Q1 is
occasionally used as a measure of variability. For the semiconductor yield data, the inter-quartile
range is IQR = Q3 ¡V Q1 = 80 ¡V 53.5 = 26.5
In some stem-and-leaf displays, it may be desired to provide more classes or stems. One way is
modifying the original stems and follows: Divide the stem 5 (say) into two new stems, 5* and 5#.
The stem 5* has leaves 0,1,2,3, and 4, and the stem 5# has leaves 5,6,7,8, and 9. These will
double the number of original stems. We could increase the number of original stems by five by
defining five new stems: 5* with leaves 0 and 1, 5t (for twos and threes) with leaves 2 and 3, 5f
(for fours and fives) with leaves 4 and 5, 5s (for sixes and sevens) with leaves 6 and 7, and 5#
with leaves 8 and 9.
Finally, although the stem-and-leaf display is an excellent way to visually show the variability in
data, it does not take the time order of the observations into account. Time is often a very
important factor that contributes to variability in quality improvement problems. We could, of
course, simply plot the data values versus time; such a graph is called a time series graph or a
run chart. However, a useful; approach is to combine the time series graph with the stem-and-leaf
display to produce a dig dot plot.
Figure 13.1 shows the dig dot plot for the semiconductor yield data. This display clearly indicates
that time is an important source of variability in this production process. More specifically, yields
in the first 20 weeks of production are substantially below the yields reported in the last 20 weeks.
Something may have changed in the process (or have deliberately changed by operation
personnel or the process engineers) that is responsible for the yield improvement.
Leaf Stem Time Series plot (run chart) Frequency
Figure 13.1: A dig dot plot of the data
Self Assessment Questions
6. What do we understand by the term ¡§percentile¡¨?
7. What does a stem contain?
8. Stem and leaf display is a graphical technique. State (True/False)
13.5 The Frequency Distribution and Histogram
A frequency distribution is an arrangement of the data by magnitude. It is a
more compact summary of data, than a stem-and-leaf display. Table 13.6
represents 125 observations on the inside diameter of forged piston rings
used in an automobile engine. The data were collected in 25 samples of five
observations each. Note that there is some variability in piston-ring
diameter. However, it is very difficult to see any pattern in the variability or
structure in the data, with the observations arranged as they are in Table
13.7.For example, a frequency distribution of the piston-ring data is shown
in Table 13.8. From this table, we note that there was one ring that had a
diameter between 73.965 mm and 73.970 mm, eight rings having diameters
between 73.980 mm and 73.985 mm, and so forth.
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Table 13.7: Forged Piston-Ring inside Diameter (mm)
Sample Number
Table 13.8: Frequency Distribution for Piston-Ring Diameter
Ring Diameter, u (mm)
Cumulative Frequency
Relative Frequency
Cumulative Relative Frequency
73.965 „T u < 73.970
73.970 „T u < 73.975
73.975 „T u < 73.980
73.980 „T u < 73.985
73.985 „T u < 73.990
73.990 „T u < 73.995
73.995 „T u < 74.000
74.000 „T u < 74.005
74.005 „T u < 74.010
74.010 „T u < 74.015
74.015 „T u < 74.020
74.020 „T u < 74.025
74.025 „T u < 74.030
A graph of the observed frequencies versus the ring diameter is shown in Figure 13.2. This
display is called a histogram. The height of each bar in Figure 13.2 is equal to the frequency of
occurrence of ring diameter. The histogram represents a visual display of the data in which one
may more easily see three properties. They are as follows:
„h Shape
„h Location or central tendency
„h Scatter or spread
Figure 13.2: Histogram for Piston-ring Diameter Data
In the piston-ring diameter data, we see that the distribution of ring diameter
is roughly symmetric with the central tendency very close to 74mm. Thus;
the variability in ring diameter is apparently relatively high, as some rings
are as small as 73.967 mm, while others are as large as 74.030 mm.
However, there are many factors that have to be considered while
constructing histograms such as when the data is large, it is very essential
to group data into bins or cells as in the piston ring. The various factors that
needs to be considered while constructing histogram is as follows:
„h Use between 4 and 20 bins ¡V often choosing the number of bins
approximately equal to the square root of the sample size works well.
„h Make the bins of uniform width.
„h Start the lower limit for the first bin just slightly below the smallest data
Thus, grouping the data into bins condenses the original data. This results in
loss of details of some data. Thus, when the number of observations is
relatively small, or when the observations only take a few values, the
histogram may be constructed from a frequency distribution of the
ungrouped data. Alternatively, a stem-an-leaf display could be used. A
primary advantage of the stem-an-leaf display is that, the individual
observations are preserved, whereas they are lost in a histogram.
13.6 Probability Distribution
The histogram or stem-and-leaf plot is used to describe sample data. A sample is a collection of
measurements selected from some larger source or population. For example, the 125 piston-ring
diameters in Table 13.7 are a sample of piston-ring diameters, selected from the manufacturing
process. The population in this example is the collection of all piston rings produced by that
process. By using statistical methods, we may be able to analyse the sample piston-ring diameter
data and draw certain conclusions about the process that manufactures the rings.
Thus, a probability distribution is a mathematical model that relates the value of the variable, with
the probability of occurrence of that value in the population. In other words, we might visualise
piston-ring diameter as a random variable. This is because it takes on different values in the
population according to some random mechanism. Then, the probability distribution of ring
diameter describes the probability of occurrence, of any value of ring diameter, in the population.
13.6.1 Types of Probability Distribution
Generally, a probability distribution is called discrete, if it is characterised by a probability mass
function. Thus, the distribution of a random variable X is discrete. X is called a discrete random
variable if:
As .u. runs through the set of all possible values of X.
There are two types of Probability Distribution:
„h Discrete Distribution
„h Continuous Distribution
1. Discrete Distribution: When the parameter being measured can only take on certain values,
such as the integers 0, 1, 2, the probability distribution is called a discrete distribution. For
example, the distribution of the number of nonconformities or defects in printed circuit boards
would be a discrete distribution. A discrete probability can take on only a limited number of
values, which can be listed.
The function pi=P(X=Xi) or p(x), is called the probability function or more precisely probability
mass function (p.m.f) of the random variable X. The set of all possible ordered pairs {x, p(x)}, is
called the probability distribution of the random variable X. To summarise the set of ordered pairs,
[x, f(x)] is a probability function, probability mass function or probability distribution of the discrete
random variable X, for each possible outcome x. if f(x) . 0, then £U f(x) = 1 and P(X=x) = f(x).
There are two types of Discrete Probability Distributions. They are as follows:
„h Binomial (Bernoulli) Distribution
„h Poisson Distribution
„h Binomial (Bernoulli) Distribution: An experiment often consists of repeated trials, each with two
possible outcomes that may be labelled success or failure. The most obvious application deals
with the testing of items as they come off an assemble line, where each test or trial may indicate
a defective or a non defective item. We may choose to define either outcome as a success. The
process is referred to as Bernoulli process. Each trial is called a Bernoulli trial. The process of
Bernoulli distribution can be used under the following conditions, if:
„h The random experiment is performed repeatedly a finite and fixed number of times. In other
words n, the no. of trials is finite & fixed.
„h The outcome of the random experiment (trial) results in the dichotomous classification of
events. In other words, the outcome of each trial may be classified into two mutually disjoint
categories, called success (the occurrence of the event) and failure (the non-occurrence of the
„h All the trials are independent, i.e., the result of any trial, is not affected in any way, by the
preceding trials and doesn.t affect the result of succeeding trials.
The probability of success (happening of an event) in any trial is p, and is constant for each trial.
q=1-p, is termed as the probability of failure. That is non-occurrence of the event and is constant
for each trial. The distribution is useful in such an experiment where there are only two outcomes,
success or failure, good or defective, hit or miss, yes or no, and so on.
The assumptions of Bernoulli distribution are:
„h Each trial has mutually exclusive possible outcomes, that is, success or failure.
„h Each trial is independent of other trials.
„h The probability of a success (say p) remains constant from trial to trial.
„h The number of trials is fixed.
If the probability of success in any trial is p, and that of failure in any trial is q, then the probability
of r successes in n independent trials is given by:
P(r) = P(X=r) = nCr. Pr. q n-r
Where, p = probability of success
q = probability of failure
r = no. of successes desired
n = no. of trials undertaken
X = random number
The binomial distribution is completely determined, that is, all the probabilities can be obtained, if
n & p are known. Obviously, q is known when p is given because q=1-p.
Since the random variable X takes only integral values, Binomial distribution is a discrete
probability distribution.
Constants of binomial distribution include:
ƒÝ = np
ċ2 = npq
ƒã = „©(npq)
A manufacturing process produces thousands of diodes per day. On the average, 1% of these
diodes do not conform to specifications. Every hour, an inspector selects a random sample of 50
diodes and classifies each diode in the sample as conforming or nonconforming, if we let x be the
random variable representing the number of nonconforming parts in the sample, then the
probability distribution of x is,
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P(x) = 50Cx. (0.01) x. (0.99) 50-x
Where, x = 0, 1, 2¡K 50
Since this is a binomial distribution of having nonconformity, we may compute the probability of
finding one or fewer nonconforming parts in the sample as:
P(x „T 1) = P(x = 0) + P(x = 1)
= p (0) + p (1)
= 0.6050 + 0.3056 = 0.9106
„h Poisson Distribution: The number of outcomes occurring during a given time interval or in a
specified region, are called Poisson experiments. Thus, the given time interval can be of any
length, such as a minute, a day, a week, a month, or even a year. Hence, a Poisson experiment
can generate observations for the random variable X, representing the number of telephone calls
per hour received by an executive in a service centre, the no. of day.s school is closed due to
heavy rain or the no. of postponed games due to rain during a cricket tournament. The specified
region could be a line segment, an area, a volume, or perhaps a piece of material. In such
instances X might represent the number of field mice per acre, the number of bacteria in a given
culture, or the no. of typing errors per page.
The Poisson process includes the following:
„h The number of outcomes that occur in one time interval or specified region is independent, of
the number that occurs in any other disjoint time interval or region.
„h The possibility or the probability that a single outcome will occur during a very short time
interval or in a small region, is proportional to the length of the time interval or the size of the
region. It doesn.t depend on the number of outcomes occurring outside this time interval or
„h The possibility that more than one outcome that will occur in a short time interval or fall in such
a small region is considered negligible. Thus, the number of X of outcomes occurring during a
Poisson experiment is called Poisson random variable, and its probability distribution is called the
Poisson distribution.
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The assumptions of Poisson distribution are:
„h The occurrences of events are independent that is, the occurrence of an event in an interval of
time or space does not affect the probability of a second occurrence of the event in the same (or
any other) interval.
„h The probability of a single occurrence of the event in a given interval is proportional to the
length of the interval.
„h The probability of occurrence of more than one event in a very small interval is negligible.
Poisson distribution may be obtained as a limiting case of Binomial probability distribution, under
the following conditions:
„h n, the no. of trials is independently large i.e., n„_„V
„h p, the constant probability of success for each trial is independently small i.e., p„_0
„h Np=m, (say), is finite.
Thus, under the above three conditions the Binomial probability function tends to the probability
function of the Poisson distribution given below:
P(r) = P (X=x) = e-m. mr
Where, r is no. of success (occurrence of the event)
m = np, mean no. of occurrences per interval of time
e = 2.71823 (aprox.)
& r! = r (r-1) (r-2) ¡K¡K 3. 2. 1
Constants of Poisson distribution include:
1. ƒÝ = np = £f
2. ƒã2 = £f
3. ƒã = „© £f
2. Continuous distributions: When the variable being measured is expressed on a continuous
scale, its probability distribution is called a continuous distribution. The probability distribution of
piston-ring diameter is
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continuous. A frequency polygon gets smoother & smoother as the sample size gets larger, and
the class intervals becomes more numerous and narrower. Ultimately, the density polygon
becomes a smooth curve called, the density curve. The function that defines the curve is called
the probability density function.
Thus, in a continuous probability distribution, the variable under consideration is allowed to take
on any value within a given range, so we cannot list all the possible values.
A function p(x) is said to be the probability density function of the continuous random variable X, if
it satisfies the following properties:
„h p(x) . 0, for all x in the interval [a,b]
„h For 2 distinct numbers c & d in the interval [a, b]
„h P (c . X . d) = [Area under the probability curve between the ordinates
„h (vertical lines) at x=c & x=d]
„h Total area under the probability curve is 1, i.e., P (a . X . b) = 1
For a continuous random variable, the probability at a point is always zero, that is, P(X=c) =0, for
all single point values of c. Hence, in case of continuous random variable, we always talk of
probabilities in an interval & not at a point that is always zero.
Since in the case of continuous random variable, the probability at a point is always zero, using
addition theorem of probability, we get:
P(c . X . d) = P(c < X . d) = P(c . X < d) = P(c < X < d)
Hence, in case of continuous random variable, it does not matter if one or both the end points of
the interval (c , d) are included or not.
Suppose that x is a random variable that represents the actual contents in ounces of a can of
coffee. The probability distribution of x is assumed to be:
f(x) = 1/1.5, 15.5 „T x „T 17.0
Since the range is assumed to be normally distributed, the probability of a can containing less
than 16.0 oz is:
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P (x „T 16.0 )
P (x „T 16.0)
= (16.0 ¡V 15.5) / 1.5 = 0.333
There are various types of Continuous Probability Distributions. They are as follows:
„h Normal Distribution
„h Exponential Distribution
„h Poisson Distribution
„h Normal Distribution: Normal probability distribution or commonly called the normal distribution
is a continuous probability distribution in which, the relative frequencies of a continuous variable
are distributed according to the normal probability law. In other words, it is a symmetrical
distribution in which, the frequencies are distributed evenly about the mean of the distribution. It is
an approximation to binomial distribution when n is large & p or q is not very small. The limiting
frequency curve obtained as n becomes large is called, the normal frequency curve or simply
normal curve. Normal distribution is a limiting case of Poisson.s distribution when, the mean m is
large. There are two basic reasons why the normal distribution occupies such a prominent place
in statistics, they are:
„h It has some properties that make it applicable to many situations in which, it is necessary to
make inferences by taking samples.
„h The normal distribution comes close to fitting the actual observed frequency distributions of
many phenomena. This includes human characteristics like weights, heights, and IQs, output
from physical process like dimensions and yields, and other measures of interest to managers, in
both the public and private sectors.
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Consider a continuous random variable X. It is said to have a normal distribution with parameter
m & standard deviationċ, if it has the probability density function represented by the equation,
[¡V1/(2ƒã2)] (x-ƒÝ)2
ƒã „©(2ƒà)
Where, ċ = standard deviation of the given normal distribution
ƒÝ = mean of the random variable x
Ĉ = 3.1416
e = 2.7183
When ƒÝ = o, i.e., mean is zero
ƒã „©(2ƒà)
Probability density can be converted into frequency density by multiplying the former equation
with N, that is., the total number of items in the distribution.
Standard Normal Distribution:
If X is a random variable following normal distribution with mean ƒÝ and standard deviationƒã,
then the random variable Z defined as follows is called the standard normal variety.
Z = X - ƒÝ
For standard normal variety, ƒÝ = 0 & ƒã = 1, hence the probability density function of standard
normal variety is given by,
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Exponential Distribution: Consider a continuous random variable X is said to have an exponential
distribution with parameter £\ if its probability density function is given by:
P (x)
£\ e-£\x,
for 0 < x < „V
Where, £\ is a positive constant
e = 2.7187
This distribution is also referred to as negative exponential distribution. There is a relationship
between the Poisson distribution and exponential distribution. If the Poisson distribution describes
the number of failures per unit time, then the exponential distribution will represent the time
between two successive failures.
The cumulative density function of the exponential distribution is,
P (x)
£\ e-£\x. dx
- e-£\x
Constants of exponential distribution are:
„h Mean = 1/£\
„h Variance = 1/£\2
Self Assessment Questions
9. List the types of Continuous Probability Distributions.
10. The constant value of e is _________________
11. The probability distribution of piston-ring diameter is ________________
12. Binominal Distribution is also called as _________________
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13. The number of outcomes occurring during a given time interval or in a
specified region, are called as _________________
14. Define a discrete distribution
15. Expand P.M.F
Activity 2:
Consider that the electricity power failures occur according to a Poisson
distribution with an average of 3 failures every twenty weeks. Calculate the
probability that there will not be more than one failure during a particular
The average number of failures per week is:
ƒÝ ƒ 3 20 ƒ 0.15
Not more than one failure means, we need to include the probabilities for ¡§0
failures¡¨ plus ¡§1 failure¡¨.
( ) ( ) 0.15 0! 0.150.15 0 0.15 1
0 1 ƒy ƒ ƒy ƒ ƒ{ p X P X e e
Thus there is 98.91% probability that, there will not be more than one failure
during a particular week.
13.7 Summary
We have understood how the descriptive statistics such as histograms and
frequency distribution, can be used to express variation. Instead of going for
testing whole of the population, the tools can be used to select a sample
and test it. Further the data can be used for probability approximation.
Thus, the process of Statistical control is an effective method of monitoring a
process through the use of control charts. Thus, it ensures that any given
sample is determined in terms of quantity.
13.8 Terminal Questions
1. How do we calculate mean of given quantities?
2. Explain the procedure of constructing the stem and the leaf plot of the
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3. Explain the process of Bernoulli distribution.
4. Analyse the various types of Probability distribution.
5. Explain the various measures of the descriptive statistics.
13.9 Answers
Answers to Self Assessment Questions
1. Variability measure.
2. Mode.
3. It is computed in such a way that half of the measurements are below it and half of the
measurements are above it
4. Descriptive statistics is a process that is used to describe the features of data in terms of
5. True.
6. The percentile is a number such that at most p% of the various measurements is below it and
at most 100-9 % of the data are above it.
7. A Stem consists of one or more of the leading digits.
8. True.
9. Normal Distribution, Exponential Distribution, Poisson Distribution.
10. 2.7187.
11. Continuous.
12. Bernoulli Distribution.
13. Poisson experiments.
14. When the parameter being measured can only take on certain values, such as the integers 0,
1, 2, the probability distribution is called a discrete distribution.
15. Probability Mass Function.
Answers to Terminal Questions
1. Refer section 13.3
2. Refer section 13.4
3. Refer section 13.6
4. Refer section 13.6
5. Refer section 13.3
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13.10 Case Study
Imagine a busy road in Bangalore. Consider that vehicles are passing
through a junction on a busy road at an average rate of 300 per hour. We
know that the Poisson random variable satisfies the following conditions:
The number of success in two disjoint time intervals is independent
The probability of success during a time interval that is small is
proportional to the entire length of the time interval.
P(X ) e X! X ƒÝ ƒ{ƒÝ ƒ
Where, X= 0, 1, 2, 3¡K¡K
e = 2.718
£g = mean number of successes in the given time interval or region of
1. Find the probability that none passes in a given minute.
2. What is the expected number passing in two minutes?
3. Find the probability that this expected number actually pass through in a
given two-minute period.
The average number of cars per minute is:ƒÝ ƒ 300 60 ƒ 5
(a) 5 0 3
0 ( ) 5 0! 6.7379 10ƒ{ ƒ{ P x ƒ e ƒ „e
(b) E(X) = 5 ¡Ñ 2 = 10 E(x) ƒ 5„e2 ƒ10
(c) Now, withƒÝ ƒ10,we have, ( ) 10 10! 0.12511 10 10
10 ƒ ƒ ƒ{ p x e
Based on the function: 10 ! 10 e x
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We can plot a histogram of the probabilities for the number of cars per minute:
13.11 Glossary
The percentile is a number such that at most p% of the various measurements is below it and at
most 100-9 % of the data are above it. It is also called as centile and is the value of a variable
below which a certain percent of observations fall.
Statistics is a collection of techniques for making decisions about a process or population based
on an analysis of the information contained in a sample from that population. It is that language
that facilitates engineers, manufacturing, procurement, management and other functional
components of the business communicate effectively about quality.
Descriptive statistics
Descriptive statistics is a process that is used to describe the features of data in terms of quantity.
It is generally represented with formal analyses. Thus, descriptive statistics provides various
numerical and graphic procedures. This facilitates to summarise a collection of data in a clear and
understandable way.
A histogram is a graphical representation of a frequency distribution. The range of the variable is
divided into class intervals for which the frequency of occurrence is represented by a rectangular
column; the height of the column is proportional to the frequency of observations within the
interval. It is a visual graph that shows the frequency of a range of variables.

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Unit 14 Failure Prevention and Recovery
14.1 Introduction
14.2 System Failure
Why Do Things Fail?
14.3 Measuring Failure
Failure Rate
Failure over Time the =Bath-Tub‘ Curve
14.4 Failure Detection and Analysis
Mechanisms to Detect Failure
14.5 Failure Analysis
14.6 Improving the Operation‘s Reliability
14.7 Recovery in Service Operations
Failure planning
14.8 Summary
14.9 Terminal Questions
14.10 Answers
14.11 Case Study
14.12 Glossary

14.1 Introduction
Although no operation must be indifferent to failure, in some operations it is vital that the products
and services do not fail. For example, electricity supplies to the hospitals. Other products and
services must be available when needed, such as car seat belts, the police service and other
emergency services. In these situations dependability is not just desirable, it is essential. In less
critical situations, having dependable products and services is a way for organisations to gain a
competitive advantage. For example, Japanese companies made great gains in share market
(automobiles and electrical goods) through their reputation for high product reliability.
Operations managers are always concerned with improving the dependability of operations, the
products and services that they produce,
and trying to have strategies in place to minimise the likelihood of failure. However, the failures do
occur, in spite of all the attempts to prevent them. What is important is that, they have plans in
place to help them recover from the failures. Figure 14.1 explains how this unit fits into the
operation‘s improvement activities.
Figure 14.1: Model of Operations Improvement
Failure is when something does not work as it should do. For example, if the shop assistant who
sells you an item of clothing =fails‘ to inform you the fact that it should be dry cleaned, it is
technically a failure. Yet, frequently in operation management, we use the term failure to denote a
more dramatic event.
There is a clear spectrum of failure which goes from regular minor failures to very serious and/or
catastrophic. Usually, the minor =failures‘ are addressed in =quality management‘.
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In this unit on failure prevention and recovery we mainly deal with less frequent but more serious
Learning Objectives:
After studying this unit, you will be able to:
. Identify why failure occurs in operations.
. Explain the various ways of measuring failure.
. Describe the means of detecting and analysing failure.
. Describe the different approaches to maintenance.
. Discuss the importance of failure recovery.
14.2 System Failure
There is always a chance that in developing a product or providing a service, things might go
wrong. Mistakes are inevitable and are an intrinsic part of life. Nothing is perfect.
Accepting that failure occurs is not equivalent to ignoring it, and this does not imply that
operations cannot or should not attempt to minimise failure. Not all failures are equally serious.
Some failures are incidental and may not be noticed. In the finale of a concert performance a
violinist may play a wrong note and the effect is unlikely to have any great impact. If he or she is
giving a solo performance, however, then the error may sour the whole performance. The concert
like all systems may be more tolerant to some types and some levels of failure than others.
For example, if the cigarette lighter in a car or the pen used by a police officer to write a
statement fails, the effect may be irritating but not necessarily serious. Conversely, the failure of
one component of a system may threaten the whole system. For example, leaking hydraulics in a
car or a prisoner not informed of his or her rights can put the whole process at risk.
Failure is perceived differently from the viewpoints of the evaluators. For a person who is only
interested in the final result of an activity would consider it to be an Outcome Failure if the core
issue has not been resolved or a core need is not met.
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A failure can also be a process failure, wherein the activity is completed successfully but a person
may still feel dissatisfied if the underlying process is perceived to be below expected standard or
14.2.1 Why Do Things Fail?
Failure in an operation can occur because of many different reasons. Machines can break down,
customers might make unexpected demands which the operation fails to meet, staff may make
simple errors in their jobs which prevent normal working, materials from suppliers could be faulty
and so on. The three main causes for failures are:
. Those which have their source inside the operation because its overall design was faulty, or
because its facilities (machines, equipment and buildings) or staff fail to operate as they should
. Those caused by faults in the material or information inputs to the operation
. Those caused by the actions of customers
Types of failures that occur in operations are:
. Design failures
. Facilities failures
. Staff failures
. Supplier failures
Design failures
The overall design of an operation can be the root cause of failure. In its design stage an
operation might look fine on paper, only when it has to cope with real circumstances does
inadequacies become evident. Some design failures occur because a characteristic of demand
was overlooked or miscalculated.
A production line might have been installed in a factory which in practice cannot cope with the
demands placed upon it or a theatre front-of-house layout might cause confused and jumbled
customer flow at peak times. In both the examples, there is no unexpected demand placed on the
operations. It is just the straightforward errors in translating the requirements of demand into an
adequate design that causes the problems.
Other design-related failures occur because the circumstances under which an operation has to
work are not as expected. Consider the following
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examples, a biscuit production line might have been installed assuming a certain pack size but
then the market demands a larger pack size which causes the machine to jam occasionally. A
theatre‘s lighting controls might have been designed for simple lighting sequences, but because it
now takes bookings for shows with complex lighting needs, the control system overloads and
In both cases the demands placed on the operation were unexpected at the point of design and
this led to some kind of failure. But they are still considered as design failures. Adequate design
includes identifying the range of circumstances under which the operation has to work and
designing accordingly.
Facilities failures
All the facilities (i.e, the machines, equipment, buildings and fittings) of an operation are liable o
break down. The =breakdown‘ may only be partial, for example a worn or marked carpet in a
hotel or a machine that can only work at half its normal rate. Alternatively, this can be regarded as
a =failure‘ - a total and sudden cessation of operation. Either way, it is the effects of a breakdown
that should be considered.
Some breakdowns can cause a large part of the operation to halt. For example, a computer
failure in a chain of supermarket could paralyse several large stores until it is repaired. Other
failures might have a significant impact only if they occur at the same time as other failures.
Staff failures
Staff failures occur due to errors and violations. Errors are mistakes in judgement with hindsight.
A person must have done something different that might result in significant deviation from
normal operation.
For example, if the manager of a sports shop fails to anticipate an increased demand for footballs
during the World Cup, the shop runs out of stock and fail to supply its potential customers. This is
an error of judgment.
Violations are acts that are clearly contrary to defined operating procedure. For example, if a
machine operator fails to clean and lubricate the machine in the prescribed manner, it is
eventually likely to fail. This indicates that the operator has violated a set procedure.
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Supplier failures
Any failure in the delivery or quality of goods and services into an operation can cause failure
within the operation. The failure of the band to turn up at a concert causes the whole event to
=fail‘. Similarly, if the band does show up but proves to be of dubious talent, the concert could
also be regarded as a failure. The more an operation relies on suppliers of materials or services,
the more it is liable to failure, which is caused by missing or sub-standard inputs.
Customer failures
Not all failures are (directly) caused by the operation or its suppliers. Customers can misuse the
products and services which the operation has created.
For example, a washing machine might have been manufactured in an efficient and fail-free
manner, yet the customer who buys it could overload it or misuse it in some way which causes it
to fail. The customer is not =always right‘. Customers‘ inattention, incompetence or lack of
common sense can be the cause of failure. However, merely complaining about customers is
unlikely to reduce the chances of this type of failure. Most organisations accept that they have a
responsibility to educate and train their customers and to design their products and services, so
as to minimise the chances of failure. For example, the sequence of questions at automatic teller
machines (ATM) is designed by banks to make their operation as =fail-free‘ as much as possible.
14.3 Measuring Failure
There are three main ways of measuring failure. They are:
. Failure rates — how often a failure occurs
. Reliability — the chances of a failure occurring
. Availability — the amount of available useful operating time
=Failure rate‘ and =reliability‘ are different ways of measuring the same thing – the tendency of an
operation, or part of an operation, to fail. =Availability‘ is a measure of the consequences of
failure in the operation.
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14.3.1 Failure Rate
Failure rate is calculated as the number of failures over a period of time. For
example, the failure rate of security at an airport can be measured by the
number of security breaches per year.
The failure rate of an engine can be measured in terms of the number of
failures divided by its operating time. Failure Rate (FR) is usually calculated
from examining actual operating or test data. It can be measured either as a
percentage of the total number of products tested or as the number of
failures over time:
FR =
FR =
14.3.2 Failure over Time - The ‘Bath-Tub’ Curve
Failure, for most parts of an operation, is a function of time. At different
stages during the production life cycle the probability of it failing is different.
For example, the probability of an electric lamp failing is relatively high when
it is first plugged in. Any small defect in the filament material or in the way
the lamp is assembled could cause the lamp to fail. If the lamp survives
these initial stages, it could still fail at any point, but the longer it survives,
the more likely its failure becomes. Most physical parts of an operation
behave in a similar manner.
The curve which describes failure probability of this type is called the bathtub
curve. Figure 14.2 does not depict the failure rate of a single item, but
describes the relative failure rate of an entire population of products over
total number of products tested
number of failures
operating time
number of failures
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Figure 14.2: The Bathtub Curve
Some individual units fails relatively early (infant mortality failures), others lasts until wear-out,
and some fails during the relatively long period typically called normal life.
Failures during infant mortality are undesirable and are always caused by defects and blunders
like material defects, design blunders, errors in assembly, etc. Normal life failures are considered
to be random cases of "stress exceeding strength." However, many failures often considered as
normal life failures are actually infant mortality failures. Wear-out is due to fatigue or depletion of
materials (such as lubrication depletion in bearings). A product's life is usually limited by its
shortest-lived component. A product manufacturer must check that all specified materials are
adequate to function through the intended product life.
The bathtub curve is generally used as a visual model to illustrate the three key periods of a
product failure and not calibrated to depict a graph of the expected behaviour for a particular
product family. It is uncommon to have enough short-term and long-term failure information to
actually model a
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population of products with a calibrated bathtub curve. Also, the actual time periods for these
three characteristic failure distributions can vary greatly. Infant mortality does not mean that
"products fail within 90 days" or any other defined time period. Infant mortality is the time when
the failure rate of a product decreases, and may last for years. Conversely, wear-out does not
always happen long after the expected product life. It is a period when the failure rate increases,
and is observed in products after just a few months of use. This, of course, is a disaster from a
warranty standpoint.
The infant mortality period is the time over which the failure rate drops, but is undesirable
because a significant number of failures occur in a short time, causing early customer
dissatisfaction and warranty expense. Theoretically, failures during normal life occur at random
but with a relatively constant rate when measured over a long period of time. Because these
failures are liable to warranty expense or create service support costs, the bottom of the bathtub
should be as low as possible. And no wear-out failures should occur during the expected useful
lifetime of the product.
Self Assessment Questions
1. _______ is when something does not work as it should do.
2. Three main ways of measuring failure MRP are _______, ________ and _________.
3. __________ is calculated as the number of failures over a period of time.
Activity 1:
A deceptively simple activity. Deceptive because the processes that universities use to detect
=failures‘ are subtle and often deeply flawed!
List out the different kinds of failure that occur at a university. These may include some of the
. Failure of students to take advantage of the learning opportunities they are presented with.
. Failure of staff to carry out their contracted functions.
. Failure of equipment.
. Failure of outside suppliers.
. Failure to follow an appropriate strategic direction.
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14.4 Failure Detection and Analysis
When failure occurs, operations managers must have:
. Mechanisms in place, to ensure that a failure has occurred.
. Procedures in place, to analyse the root cause for this failure.
14.4.1 Mechanisms to Detect Failure
Organisations sometimes may not be aware that the system has failed and thereby lose the
opportunity both to put things right for the customer and to learn from the experience. There are
many methods available to actively look for failure. They are:
. In-process checks: Employees check if the service is acceptable during the process itself.
Although in some situations this form of failure detection can detract from the service itself.
. Machine diagnostic checks: A machine is tested through a prescribed sequence of activities
designed to expose any failures or potential failures. Computer servicing procedures often include
this type of check.
. Point-of-departure interviews: At the end of a service, staff may formally or informally check if
the service has been satisfactory and try to solicit problems as well as compliments.
. Phone surveys: These can be used to solicit opinions about products or services. Television
rental companies, for example, may check on the installation and servicing of equipment in this
. Focus groups: These are groups of customers who are requested to focus on some aspects of a
product or service. These can be used to discover either specific problems or more general
attitudes towards the product or service.
. Complaint cards or feedback sheets: These are used by many organisations to solicit views
about the products and services. The problem with this method is that very few people tend to
complete them. It may possible, however, to identify the respondents and so follow up on any
individual problem.
. Questionnaires: These may generate a slightly higher response than complaint cards. However,
they may only generate general information from which it is difficult to identify specific individual
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14.5 Failure Analysis
One of the critical activities for an organisation when failure has occurred is to understand why
the failure occurred. This activity is called failure analysis. There are different techniques and
approaches used to uncover the root cause of failures. Some of these approaches are briefly
described in this section.
Accident investigation
Large-scale national disasters like oil tanker spillages and aeroplane accidents are usually
investigated by accident investigators specifically trained in analysis of the causes of the
accident. Although the techniques they use have usually been developed to be appropriate for
the particular type of accident being investigated, the common role of accident investigators is to
make recommendations to minimise or even eradicate the likelihood of any such failures
occurring again.
Product liability
Many organisations (either by choice or more often because of a legal requirement) adopt
product liability. This ensures that all their products are traceable. Any failures can be traced back
to the process which produced them, the components from which they were produced or the
suppliers who provided them. This means that any fault can be rectified and also that, if
necessary, all other similar products can be recalled for checking. This is sometimes seen when
car and electrical components or food items are recalled.
Complaint analysis
Just like errors, complaints always arise. They are increasingly seen to be a cheap and easily
available source of information about errors. Complaints and indeed compliments need to be
taken seriously as they are likely to represent only the =tip of the iceberg‘ of customer attitudes.
The prime function of complaint analysis involves analysing the content of the complaints to
understand better the nature of the problem as it is perceived by the customer.
Critical incident analysis
Critical incident analysis requires customers to identify the elements of products or services that
they find either particularly satisfying or not satisfying. They are asked to write down incidents that
led dissatisfaction or
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satisfaction. It is a popular way of collecting information, especially in service operations. The
Critical Incident Technique (CIT) was originally developed during the Second World War by
psychologist John Flanagan and was used to determine the reasons for the high rate of pilot
failure during training.
Fault tree analysis
Fault tree analysis is a logical procedure that starts with a failure or a potential failure and works
backwards to identify all the possible causes and therefore the origins of that failure. The fault
tree is made up of branches connected by two types of nodes: AND nodes and OR nodes. All the
events at the branches below an AND node need to occur for the event above the node to occur.
Only one of the events at the branches below an OR node needs to occur for the event above the
node to occur.
Figure 14.3 shows a simple tree identifying the possible reasons for a hot dish being served cold
in a restaurant.
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Figure 14.3: Fault-Tree Analysis - Example
14.6 Improving the Operation’s Reliability
Once a thorough understanding of the causes and effects of failure have been established, the
next responsibility of operations managers is to try to prevent the failures occurring. It is achieved
. Designing out the fail points in the operation
. Building redundancy into the operation
. =Fail-safing‘ some of the activities in the operation
. Maintaining the physical facilities in the operation
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The maintenance of physical facilities (equipment, machines and buildings) is an important
activity in all operations.
14.7 Recovery in Service Operations
Recovery has been developed particularly in operating services. The word =Recovery‘ has
originated from British Airways =Putting the Customer First‘ campaign. Service recovery does not
just mean .return to a normal state. but to a state of enhanced perception.
Service operations managers need to recognise that all customers have recovery expectations
that they want organisations to meet. Recovery should be a planned process. Organisations need
to design appropriate responses to failure. Responses are always linked to cost and
inconvenience caused by the failure. It should meet the needs and expectations of the customer.
14.7.1 Failure planning
Identifying how organisations can recover from failure is of particular interest to service
operations because they can turn failures around to minimise the effect on customers or even
turn failure into a positive experience.
However, it is also of interest to other, especially those where the consequences of failure are
particularly severe. Bulk chemical manufacturers and nuclear processors, for example, spend
considerable resources in deciding how to cope with failures. The activity of devising the
procedures that allow the operation to recover from failure is called failure planning. There are
four stages in failure planning. They are:
1. Discover
2. Act
3. Learn
4. Plan
Discover: The first thing any manager needs to do when faced with a failure is to discover its
exact nature. Three important pieces of information are needed: first of all, what exactly has
happened; second, who will be affected by the failure; and third, why did the failure occur? The
last point is not intended to be a detailed inquest into the causes of failure (that comes later) but it
is often necessary to know the causes of failure to determine further action.
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Act: The discover stage could take only minutes or even seconds, depending on the severity of
the failure. If the failure is severe, with important consequences, we need to do something about
it quickly. This means carrying out three actions, the first two of which could be carried out in
reverse order, depending on the urgency of the situation.
First, inform the people involved, what you propose to do about the failure. In service operations
this is especially important where customers need to be informed, both for their peace of mind
and to demonstrate that something is being done. In all operations, however, it is important to
communicate what action is going to happen so that everyone can set their own recovery plans in
motion. Second, the effects of failure need to be contained in order to stop the consequences
spreading and causing further failures. The precise containment action depends on the nature of
the failure. Third, there needs to be some kind of follow-up to make sure that the containment
action has really contained the failure.
Learn: As discussed earlier in this unit, the benefits of failure in providing learning opportunities
should not be underestimated. In failure planning, learning involves revisiting failure to find out its
root cause and then engineering out the causes of the failure so that it does not happen again.
This is the key stage for failure planning.
Plan: Learning lessons from a failure is not the end of the procedure. Operations managers need
to formally incorporate these lessons into their future reactions to failures. This is often done by
working through =in theory‘ how they would react to failures in the future. Specifically, this
involves identifying all possible failures that might occur and then, formally defining the
procedures that the organisation should follow in the case of each type of identified failure.
14.8 Summary
Failure problems and mistakes are inevitable and intrinsic part of operations life. Things are
always going wrong. This is why operations managers need to be concerned with the causes and
effects of failure, as well as being active in attempting to minimise failure. Not all failures are
equally serious and attention is usually directed at those that have adverse impact on the
operation or its customers.
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Failures occur in operations for several reasons. Some are a direct result of goods or services
which are supplied to the operation. Others happen within the operation, either because there is
an overall failure in its design, because one or more of its physical facilities break down, or
because there is a human error. Customers can also cause failures through their incompetence in
handling goods and services.
In practical terms, operations managers have three sets of activities which relate to failure. The
first is concerned with understanding what failures are occurring in the operation and why they
are occurring. Once the nature of the failure is understood, an operations manager‘s second task
is to examine ways of either reducing the chances of failure or minimising the consequences of
failure. The third task is to devise plans and procedures that help the operation to recover from
failures when they do occur. The first of these tasks is, in fact, a prerequisite for the other two.
This chapter deals with these three tasks.
Self Assessment Questions
4. When the failure occurs, operations managers must have __________ and __________ in
5. _______ is one of the ways to analyse failure.
6. ________ is one of the ways to improve operations reliablity.
7. The word =Recovery‘ has originated from _________.
8. The ________is typically used as a visual model to illustrate the three key periods of product
9. The phenomenon of understanding the reason for failure is called ___.
10. The ___________ period is a time when the failure rate is dropping.
Activity 2:
A 24-hour ATM machine outside a bank was closed down between the following times during a
seven-day period:
11.00 am Monday – 2.00 pm Monday 1.00 am Tuesday – 10.30 am Tuesday 4.00 pm Tuesday –
10.00 am Wednesday 3.00 pm Friday – 10.00 am Saturday
Calculate the ATM‘s failure rate (in time), the mean time between failures and its availability.
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14.9 Terminal Questions
1. What is Failure? Explain with an example.
2. What are the three main causes for failures?
3. What are the types of failures?
4. What are the three main ways of measuring failures?
5. Name the mechanisms to detect failure.
14.10 Answers
Answers to Self Assessment Questions
1. Failure
2. failure rates, reliability, availability
3. Failure rate
4. mechanisms, procedures
5. Accident investigation
6. Fail-safing
7. British Airways
8. bathtub curve
9. Failure Analysis
10. infant mortality
Answers to Terminal Questions
1. Refer section 14.1
2. Refer section 14.2.1
3. Refer section 14.2.1
4. Refer section 14.3
5. Refer section 14.4.1
14.11 Case Study
Better late and happy than just late
Fiona Rennie sat and enjoyed her coffee as she waited at Warsaw airport. Returning home to the
UK after a week of energetic academic research, she was pondering her latest project – how
service businesses have to be more aware of their customers‘ needs and, in order to compete
must be able to offer a high level of customer service.
Warsaw airport was busy with passengers, waiting to board the afternoon
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British Airways flight to London Heathrow, the anticipation growing as they passed through the
scanners and walked down the aisle onto the aircraft. Safely in their seats, the 200 passengers
were soon depressed to hear from the captain that there was a slight mechanical problem and
that their take-off would be delayed by approximately half an hour. This delay did not merit having
to disembark and complimentary drinks were soon on the way round.
Inevitably, the half-hour delay soon unfolded into a bigger problem and an apologetic captain
announced that he felt that passengers would be better placed in the departure lounge rather
than waiting for the repair to be completed. A few grumbles and mutters about connections at
Heathrow and other missed appointments could be heard – but generally the mood was fairly
genial and the airline staff went out of their way to try to accommodate passenger queries. After
an hour in the departure lounge and with no definitive answer available on the estimated take-off
time, the airline moved into the next stage of its =customer-placating programme‘ by providing
meal vouchers for everyone and directing them to the airport restaurant. As the mood quietened
and passengers began to question further just how long they were going to have to wait, the
airline announced the departure time – some four hours behind schedule.
The flight itself went according to plan and the cabin crew walked up and down the aisles
answering, where possible, queries on connecting flights and subsequent travel arrangements.
On arrival (finally) at Heathrow, the captain, who had been very apologetic throughout the whole
process, bade the passengers‘ farewell, expressing his concerns at the late arrival and hoping
that it had not inconvenienced them too greatly. For some, though, the four-hour delay meant
considerable problems in trying to reach their onward destinations that evening and the airline
sales desk was soon busy with anxious passengers looking for help. Several were to be put up in
a local hotel, courtesy of the airline, leaving them to recommence their travels, fresh, the next
morning. Others did not have so far to go and to stay overnight in the UK‘s capital city actually
meant more inconvenience the following day. Unperturbed, the airline‘s Customer Service
Manager quickly took it upon himself to arrange chauffeur-driven transport for these people,
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ensuring that the inconvenience caused by the delay was effectively minimised. The priority was
not necessarily to deal with each customer as quickly as possible, but to ensure that each person
was given a solution that suited his or her needs.
Airlines are known to have well-developed recovery procedures. In the case of failure, the airline
could activate various levels of preconceived and ad hoc customer care.
Fiona was certainly impressed, and although very late, glad to be safely home as planned.
1. Draw up a =failure plan‘ for delays of this type. How could it help the airline to improve its
recovery procedures further?
2. When are failure and recovery particularly important to an operation?
14.12 Glossary
Is when something does not work as it should.
Mistakes in judgement.
Failure rate
A way to calculate the number of failures over a period of time.
The infant mortality period
The time when the failure rate starts dropping.
Failure Analysis
The phenomenon of understanding the reasons for failure.
1. Operations management, by Mike Pycraft.
2. Operations management, by Nigel Slack, Stuart Chambers, Robert Johnston.

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Unit 15 Challenges in Operations
15.1 Introduction
15.2 The Strategy Challenge
All Operations Should Have a Strategy
Difficulties in Formulating Operations Strategy
15.3 Generic Operations Strategies
15.4 Formulation Procedures
The Hill Methodology
The Platt.s.Gregory procedure
15.5 Strategies must be Ethical
15.6 Transferring Operations Practices
15.7 Strategies Must be Creative
15.8 Strategies Must be Implemented
15.9 System Failure
Failure Analysis
Improving the Operation.s Reliability
15.10 Summary
15.11 Terminal Questions
15.12 Answers
15.13 Case Study
15.14 Glossary
15.1 Introduction
By now you must be familiar with the purpose and decisions of Operations management. Now we
are in a position to discuss some of the issues related to Operations challenge, in two ways. First,
we will discuss about the strategic view of operations and the process of operations strategy, that
is, the way in which operations strategies are formulated. Second, we will identify some of the
challenges that all operations managers face in an attempt to cut through the complexity which
characterises most operations and develop their own operations strategies appropriate for the
modern world.
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Of course, this list of strategic ¡°challenges¡± could be very long, but there are four important
challenges to discuss:
. The moral imperative to develop ethical operations strategies
. The necessity to consider the international dimension of operations strategies.
. The need for creativity in devising operations strategies.
. The ultimate challenge of implementing the chosen strategies.
Figure 15.1 illustrates these issues:
Figure 15.1: Important Operations Challenges
Learning Objectives:
By now you must be familiar with the concept of Operations management. After studying this unit,
you will be able to:
. Explain why and how operations strategies are put together.
. Explain the way in which the decisions resulting from operations strategies have an ethical
. Describe how operations managers need to consider their operations strategies from an
international perspective.
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. Explain why achieving creative operations strategies involve challenging the trade-off paradigm
of operations.
. Describe how operations managers need to set an .implementation agenda. to put their
strategies into practice.
. Discuss the importance of failure recovery.
15.2 The Strategy Challenge
A strategy is the pattern of decisions and actions, which helps an organisation to achieve the
intended long term goals.
The company.s strategies are the means to achieve the company.s vision. The statement of
strategy does not appear in any particular order of priority. It must be read as a co-ordinated and
coherent whole, when taken as a group, it enables to achieve company.s vision.
The important test for operations managers is not only to understand and command the detailed
complexity of all the operations decisions, but also to see whether they can make enough sense
of the operation to fit it into a strategic context, reshape and improve it, and then make sure that
its contribution to the competitiveness is both clear and ongoing.
15.2.1 All Operations Should Have a Strategy
Why should operations bother around for putting a strategy together since it requires
considerable effort and time? The obvious answer is that an effective operations strategy helps
the organisation to compete more effectively. There is some empirical evidence to support this.
For example, an organisation.s technology strategy, among other things, shapes the integration
between different parts of its processes. It.s planning and control strategy has to work within the
constraints imposed by the technology. A shared strategy allows not only these areas to measure
their own decisions against the common purpose, but also allows the implications of each other.s
strategy areas to be explored. In this way a formally constructed operations strategy gives the
basic structure which ensures that the many individual decisions taken around the organisation,
all point in the same direction.
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15.2.2 Difficulties in Formulating Operations Strategy
Operations management is a complex business, so trying to make strategic sense of any
operation is always a difficult task. The major difficulties that affect the formulation process are:
. Operations managers are central to the strategy formulation process, yet they are likely to be
geographically dispersed among the company.s sites.
. Operations managers operate in .real time.. They can only allow their attention to drift from the
running of the operation for relatively short periods. This responsibility for the day-to-day running
of the operation means, that they operate under a .need to deliver. from which, only the most
important strategic pressures can divert them.
. The inertia of operational resources imposes a certain amount of conservatism (an orientation,
advocating the preservation of the best in society and opposing radical changes).
15.3 Generic Operations Strategies
Generic operations strategies are common approaches to organise the operational functions,
adopted by different types of organisation. So, if the operations strategies of many different
organisations are reviewed, it becomes evident that the strategies of the individual organisations
are clustered into groups within which the strategies are similar, or possess common elements.
Some organisations take a traditional approach in designing their processes which do not
included many of the innovations in technology, layout, job design, organisation, and so on.
The four way classification results in generic operations strategies which are termed as:
. Caretaker strategy
. Marketeer strategy
. Reorganiser strategy
. Innovator strategy
Figure 15.2 depicts the four way classification in generic operations strategies.
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Figure 15.2: Generic Operations Strategies
The Caretaker strategy
This strategy is often employed when an organisation believes that there is little competitive
advantage to be gained by differentiating itself from its competitors. The operations function is
expected to provide as efficient and reliable service to the rest of the organisation as possible
without much investment, change or disruption. Operations managers are expected to make sure
things do not go wrong, rather than provide much in the way of innovation or creativity.
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The Marketeer strategy
Marketeer strategies are used by organisations which experience increased competition. They
respond to this competition by enhancing or extending their level of customer service. This might
include things such as broadening the range of their products or services, increasing quality
levels or giving delivery guarantees. No fundamental change is made to the physical design and
organisation of the operation itself, but it is expected to respond to marketing-led changes in
competitive stance. The operations function tries to do this by developing its infrastructural
resources such as planning and control systems, working practices, or quality management
The Reorganiser strategy
This strategy implies a change in the way an organisation designs and manages its processes.
This means investment in new technology and (more significantly) a different way of organising
its methods of producing goods and services. Companies adopting Just In Time (JIT) and cellular
manufacturing principles are typical organisations adopting this strategy. The new processes
often give enhanced flexibility that allows the operation to respond quickly and effectively to
changes in marketing strategy.
The Innovator strategy
The innovator strategy is a combination of the marketeer and the reorganiser strategies. Not only
does the organisation adopt an enhanced approach to design its operations, it also expects
enhanced customer service from its operations function. In other words, it has enhanced not only
to be flexible in the short term in response to competitive pressure, but also to introduce new
products and services faster and more effectively than competitors.
Organisations adopting either a caretaker or a marketeer strategy are recommended first to
enhance their operations structure to achieve a reorganiser strategy, after which they can
undertake the more difficult infrastructural changes towards an innovator strategy.
Self Assessment Questions
1. A __________ is the total pattern of the decisions and actions which position the organisation
in its environment and are intended to achieve its long term goals. _________.
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2. _________ is the output from operations strategy, _____________ is the act of creating the
3. There are ___________ in almost every decision area.
15.4 Formulation Procedures
Most organisations, even if they adopt one of the generic strategies described above, would want
to formulate their own operations strategy to cope with their individual competitive circumstances.
There are several alternative procedures which have been suggested as providing the outline
framework for developing an operations strategy. Most consultants have developed their own
frameworks, as have several academics.
Following are the two important procedures that explain how operations strategies are formulated
in practice:
. The Hill Methodology
. The Platt.s-Gregory Procedure
15.4.1 The Hill Methodology
One of the first, and certainly most influential, approaches to operations strategy formulation is
devised by Professor Terry Hill of London Business School1. The .Hill Methodology. is illustrated
in Table 1, it follows the well-tried approach of providing a connection between different levels of
strategy making. It is a five step procedure. These steps are as follows:
. Identify the corporate goals: This step helps in understanding the long-term corporate objectives
of the organisation so that the eventual operations strategy can be seen in terms of its
contribution to these corporate objectives.
. Identify the product market: This step helps in understanding how the marketing strategy of the
organisation is developed to achieve corporate objectives. This step identifies the
products/service markets which the operations strategy must satisfy, as well as identifying the
product or service characteristics such as range, mix and volume which the operation is required
to provide.
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. Translate marketing strategy into competitive factors: This step helps in converting the operating
strategies identified in the previous step into competitive advantage. This is in terms of winning
business or satisfying customers.
. Define the characteristics of operations: This step helps in setting structural characteristics of
the operation which are consistent with each other and appropriate for the way the company
wishes to compete. This step is called process choice. This is similar to the volume-variety
. Involve infrastructural features. This step involves the .non-process. infrastructural features of
the operation.
Table 15.1 gives an illustration of the Hill methodology.
Table 15.1: Illustration of Hill Methodology
Step 1
Step 2
Step 3
Step 4
Step 5
Operations Strategy
Corporate Objectives
Marketing Strategy
How do products or services win orders
Process Choice
Other .financial. measures
Product / service markets and segments
Standardisation or customisation
Leader or follower
Delivery Speed
Delivery dependability
Product/service design
Brand image
Technical service
Process technology
Trade-offs embodied in products
Role of inventory
Capacity, size, timing, location
Functional support
Operations planning and control systems
Work structuring
Payment systems
Organisational structure
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15.4.2 The Platt¡¯s . Gregory Procedure
Platt.s and Gregory (1990)2 developed a procedure to help formulate an operations strategy, it
has three stages. They are:
. Stage 1: It starts with an analysis of the market position of the organisation. This stage looks at
the external environment that includes opportunities and threats in the competitive marketplace.
In particular, it identifies the elements that are required by the market and then compares these
with the achieved performance, so it enables an organisation to chart how the operation performs
with in the market perspective. Recording performance in this way shows the gaps, which are
then be addressed by the operations strategy.
. Stage 2: In this stage the capabilities of the operation are assessed. This stage assesses the
current operations practices and how important are these achieved performance levels identified
in Stage 1.
. Stage 3: Reviewing the options open to the organisation takes place at this stage and results in
the selection of options that best satisfy the criteria identified in the earlier stages.
This procedure identifies the gaps between operations performance and the market
requirements. Also, this model is regarded as being over-simplistic by authorities in the strategy
area. It does provide a framework for asking some important questions though.
Activity 1:
Consider that you are an operations manager, in a manufacture industry. Formulate an
operations plan/strategy using Hill methodology as given in the table.
15.5 Strategies Must be Ethical
The concept of ethical decision making permeates operations management. Nearly all the
decisions made by operations managers have some kind of ethical considerations that affect one
or more of the following groups:
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. The operation.s customers
. The operation.s staff
. The operation.s suppliers
. The community in which the operation exists
. The operation.s shareholders and owners
There are ethical implications in almost every decision area. Table 15.2 identifies some of these
ethical considerations:
Table 15.2: Ethical Considerations in Operations Management
Decision area
Some Ethical issues
Product/service design
. Customer safety
. Recyclability of materials
. Energy consumption
Network design
. Employment implications of location
. Employment implications of plant closure
. Employment implications of vertical integration
. Environmental impact of location
Layout of facilities
. Staff safety
. Disabled customer access
. Energy efficiency
Process Technology
. Staff safety
. Waste and product disposal
. Noise pollution
. Fume and emission pollution
. Repetitive/alienating work
. Energy efficiency
Job design
. Staff safety
. Workplace stress
. Repetitive/alienating work
. Unsocial working hours
. Customer safety(in high contact operations)
Planning and control (including MRP, JIT and project planning and control)
. What priority to give customers waiting to be served
. Materials utilisation and wastage
. Unsocial staff working hours
. Workplace stress
. Restrictive organisational cultures
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Capacity planning and control
. ¡°Hire and fire¡± employment policies
. Working hours fluctuations
. Unsocial working hours
. Service cover in emergencies
. Relationships with sub-contractors
. ¡°Dumping¡± of products below cost
Supply chain planning and control
. Honesty in supplier relationships
. Transparency of cost data
. Non-exploitation of developing country suppliers
. Prompt payment to suppliers
. Minimising energy consumption in distribution
. Using recycled materials
Quality planning and control and TQM
. Customer safety
. Staff safety
. Workplace stress
. Scrap and wastage of materials
Failure prevention and recovery
. Environmental impact of process failures
. Customer safety
. Staff safety
Ethics are considered as the framework of moral behaviour which determines whether we judge a
particular decision as either being right or wrong. In operations management, as in other areas of
management, ethical judgements are not straightforward. Such decisions have to be weighed
against cost, profitability and sustainability of the organisation.
15.6 Strategies Must be International
Different parts of the world have differing cultures, economic conditions, history, market needs,
demography, and so on, and are likely to develop different operations practices. The most
obvious example is the way Just-in-Time (JIT) and lean manufacturing practice grew up in Japan
in the aftermath of the Second World War.
Linking this back to the discussion of ethics in the earlier part of this unit, should an organisation
which originates in a culture where any kind of gift or bribe is highly unethical, prevent its
operations from giving small gifts to potential suppliers or customers in a country where this is
culturally acceptable? Similarly, should an organisation which has built up a strong
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world-wide brand image allow this to be adapted in different regions? For example, McDonald.s
the fast-food chain, developed a rigorous and highly standardised way of organising its
operations, which was one of the main reasons for its world-wide success.

When locating operations internationally organisations can adopt four configurations. These are:
. Home country configuration
. Regional configuration
. Global coordinated configuration
. Combined regional and global coordinated configuration
Transferring operations practices
Companies all over the world differ in their conditions and culture and hence develop their own
approach to operations management, so can the practices which grew up under one set of
conditions transfer successfully to parts of the world where conditions might be very different?
Sometimes, an operational practice that is extremely successful in one part of the world does not
transfer easily. For example, the Federal Express Corporation in America invented the overnight
express deliver service. Its .hub-and-spoke. operations in the United States guarantees overnight
delivery from any part of the country to any other part by routing all packages through a single
hub in Memphis, Tennessee. Influenced by the moves towards greater European integration,
Federal express attempted to duplicate its US operation in Europe. However, Europe is far from
being a single integrated economic entity as is the US. Differences in culture, language, currency,
tax rates and so on, posed problems which were not experienced in the US. After a few years of
struggling to develop the overnight express business it gave up the struggle and closed this part
of its business.
Long-term transfers of operations practice
In the long term operations, one can trace the movement and development of operations
management practice as it responds to conditions in one part of the world and then is adopted by
other parts.
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15.7 Strategies Must be Creative
The operations strategy formulation procedures which are described earlier in this unit provide a
structure and logical process that help operation managers to move in a sensible direction.
However, these procedures do not provide the single best strategic solution. They help
operations managers to go about developing a strategy, they do not instruct them what to do.
When different sets of operations managers, face exactly the same set of circumstances, they
come up with very different strategic solutions. Some operations managers might follow the
conventional and traditional routes (which may well provide adequate solutions), while others
might be more innovative and creative in coming up with an original strategic solutions, or at least
develop ones which embody some original idea. Many successful operations are successful
because of the innovative way of creating their products and services. Federal Express, the
parcel delivery company described earlier in this unit, is a good example of this.
15.8 Strategies Must be Implemented
Implementation is the structure and the condition which connects strategic initiatives to
measurable results. It is only half of the success to develop a good strategy. The execution is an
important step, which can easily make or break the best strategy. Many businesses fail to achieve
the objectives, since they do not connect operations with goals.
Implementing strategy is challenging for many organisations. Learning from emotional responses
in the early stages of implementation process, reveals the presence of unexpected emotional
triggers, can allow timely adjustments. In other words, emotions serve as feedback signals in
strategy implementation.
15.9 System Failure
System Failure is one of the major challenges in operations. There is always a chance that in
developing a product or providing a service, things might go wrong. Mistakes are inevitable and
are an intrinsic part of life. Nothing is perfect. Accepting that failure occurs is not equivalent to
ignoring it and this does not imply that operations cannot or should not attempt to minimise
failure. Not all failures are equally serious. Some failures are incidental and may not be noticed.
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Failure in an operation can occur because of many different reasons. Machines can break down,
customers might make unexpected demands which the operation fails to meet, staff may make
simple errors in their jobs which prevent normal working, and materials from suppliers could be
faulty and so on. When failure occurs, operations managers must have:
. Mechanisms in place, to ensure that a failure has occurred
. Procedures in place, to analyse the root cause for this failure.
Mechanisms to Detect Failure
Organisations sometimes may not be aware that the system has failed and thereby lose the
opportunity both to put things right for the customer and to learn from the experience. There are
many methods available to actively look for failure. In-process checks, Machine diagnostic
checks, Phone surveys and Questionnaires are mechanisms to detect failure.
15.9.1 Failure Analysis
One of the critical activities for an organisation when failure has occurred is to understand why
the failure occurred. This activity is called failure analysis. There are different techniques and
approaches used to uncover the root cause of failures. Some of these approaches are briefly
described in this section.
. Accident investigation
. Product liability
. Complaint analysis
. Critical incident analysis
Fault tree analysis
Fault tree analysis is a logical procedure that starts with a failure or a potential failure and works
backwards to identify all the possible causes and therefore the origins of that failure.
15.9.2 Improving the Operation¡¯s Reliability
Once a thorough understanding of the causes and effects of failure have been established, the
next responsibility of operations managers is to try to prevent the failures occurring. It is achieved
. Designing out the fail points in the operation.
. Building redundancy into the operation.
. .Fail-safing. some of the activities in the operation.
. Maintaining the physical facilities in the operation.
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The maintenance of physical facilities (equipment, machines and buildings) is an important
activity in all operations.
Self Assessment Questions
4. ____ and _________ are the two important formulating procedures.
5. ____________ is often employed when an organisation believes that there is little competitive
advantage to be gained by differentiating itself from its competitors.
6. Name the four way classification of generic operations strategies.
7. The innovator strategy is a combination of the ______________and the strategies.
8. _________ is one of the major challenges in operations.
9. ______________is a logical procedure that starts with a failure or a potential failure and works
10. __________ of physical facilities (equipment, machines and buildings) is an important activity
in all operations.
Activity 2:
A leading American cosmetic company, planning to open a branch in India. What do you think are
the ethical and cultural challenges that the company would face, while implementing its operation
15.10 Summary
The process of operations strategy is concerned with the act of creating the strategy, whereas the
content of operations strategy is concerned with the output from the operations strategy
formulation process. Although not all operations have operation strategy, there is some evidence
to suggest that those who do are more likely to be successful, and those operations managers
who take part in the strategy, formulation process should have obtained a better understanding of
the organisation.s overall strategy.
Operations strategies can be classified into categories of generic strategies. One of such
classification distinguishes between caretaker strategies, marketeer strategies, reorganiser
strategies, and innovator strategies.
The Hill methodology uses a five step procedure which progressively establishes a strategic logic
between the long corporate objectives of the organisation, the marketing strategy of the
organisation, and its competitive
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factors for each product or service group, the structural process choice decisions of operations
and the infrastructural decisions of operations.
The Platt.s-Gregory procedure places a greater emphasis on comparing the needs on comparing
the needs of markets with the achieved performance of operations. It uses profiling methods to
determine the gaps between the importance of competitive factors and the operation.s
performance at delivering them. Some companies make their ethical stance explicit through a
statement of mission and values.
System Failure is one of the major challenges in operations. One of the critical activities for an
organisation when failure has occurred is to understand why the failure occurred. This activity is
called failure analysis.
15.11 Terminal Questions
1. What are the three main difficulties faced in formulating operation strategy?
2. Explain strategy challenge.
3. Explain the five steps involved in Hill methodology.
4. What is Failure? Explain with an example.
5. Mention the four ways to improve the operations reliability.
15.12 Answers
Answers to Self Assessment Questions
1. 'strategy'
2. Content, process
3. Ethical implications
4. The Hill methodology, The Platt.s-Gregory procedure
5. The Caretaker strategy
6. The four way classification of generic operations strategies are:
¨¬ Caretaker strategy
¨¬ Marketeer strategy
¨¬ Reorganiser strategy
¨¬ Innovator strategy
7. Marketeer, reorganiser
8. System Failure
9. Fault tree analysis
10. The maintenance
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Answers to Terminal Questions
1. Refer section 15.2.2
2. Refer section 15.2
3. Refer section 15.4.1
4. Refer section 15.8
5. Refer section 15.10
15.13 Case Study
Short Case
Recycled St Regis
The trend towards materials recycling in many countries can have a significant impact on the way
in which some products are manufactured. Perhaps the industry which has had to adjust the most
is paper-making. St Regis Paper is one of the largest manufacturers of recycled paper in Europe,
producing almost a million tonnes of finished product a year. Its mill in Kemsley, in the UK, is one
of the most modern, efficient and environmentally friendly plants in Europe. Two paper machines
running at speeds of up to 900 metres per minute each make 250 000 tonnes a year of high-
quality brown .liner grades. (used to make corrugated boxes).
The raw material is 100% cent recycled paper, which is treated on a state-of-the-art stock
preparation plant. This process cleans and sorts the individual paper fibres. When this material is
used on the paper machines, it produces a product which is practically indistinguishable from
conventional paper made from wood pulp.
1. What production problems would you anticipate from using waste papers in the stock
preparation plant and in the paper-making process?
2. In what ways would you expect recycled products to differ from their conventional
counterparts? What steps could you take in the production process to minimise these
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15.14 Glossary
Generic Operations strategies
Are common approaches to organise the operational functions, which are adopted by different
types of organisation.
Formulation Procedures
Are the two important procedures which explain how operations strategies are formulated in
Fault tree analysis
Is a logical procedure that starts with a failure or a potential failure and works backwards to
identify all the possible causes and therefore the origins of that failure.
Failure Analysis
The phenomenon of understanding the reasons for failure.
1. Operations management: an active learning approach, by John Bicheno, Brian Elliot.
2. Operations management: an international perspective, by David Barnes.
3. Challenges posed to operations management by the "new economy".;col1