1. 5.5 Production Planning

2. The supply chain process (or logistics)
Refers to the sequence of activities from the production of a good or service to it being delivered to the end customer.
Supply chain management (SCM) is the art of managing and controlling these logistics, which must be efficient and cost effective for a business to be profitable.
Key functions:
Stock control
Quality control
Supplier networks
Transportations

3. Reasons for using SCM:
Long supply chains increase the chances of things going wrong. Hence, effective SCM can prevent mistakes that would otherwise adversely affect the business.
SCM helps to ensure that an appropriate supply of stocks is used to meet the level of demand.
SCM is a tool for achieving lean production (a system based on minimal input for maximum output) by helping an organization to identify areas of wastage and inefficiency.

4. Problems with SCM:
With increased globalization, international sourcing becomes more complex. There are more partners in the supply chain to deal with, perhaps from various parts of the world, dealing in different languages and time zones. Time lags and potential cultural conflicts can delay getting the right products to the right customers in a cost-effective way.

5. Problems with SCM:
Greater interdependence also means that a single problem in the supply chain can cause major disruptions. The greater need for partners to share information and to collaborate also requires building trust among the partners. This will necessitate sufficient time and resources.

6. Key functions of SCM

7. 1. Stock control

8. Stockpiling vs. stock-outs
Businesses have to decide on the optimal level of stock because there are costs and drawbacks to poor stock control.
Stockpiling – holding too much stock
Stock-outs – holding insufficient stocks

9. Categories of stock
Raw materials – natural resources used for production
Work-in-progress - goods that are not yet complete (semi-finished)
Finished goods – units of output that are ready to be sold

10. Stock Control Costs of holding stock:
The cost of the materials themselves.
The cost of the warehouse
The costs of the storage and security staff
The cost of wasted materials, including theft
The cost of insurance for the warehouses and their contents
Now consider....
Storage costs – warehousing, etc.
Depreciation costs – wear and tear, perishability, shelf-life, etc.
Opportunity cost – zero revenue earned on stocks sitting around!
Administration costs – monitoring stock levels, ordering and processing, etc.

11. Benefits of holding sufficient stock:
Stock Control
Benefits of holding sufficient stock:
Availability of stocks to meet customer needs – no damage to reputation or halts to production
Buffer stocks help to cope with unplanned changes in demand
Smoothes out the volatility of lead times (measures the time lag between placing an order and receiving the stocks)

12. Costs of holding insufficient stock: Lost sales
Stock Control
Costs of holding insufficient stock:
Lost sales
Production comes to a halt
Damaged reputation / image
Higher administration costs if small orders are placed often

13. Stock Control Chart Stock Level Time
Maximum Stock Level
Re-order triggered
Re-order level
Minimum Stock Level
Lead Time
Time
Maximum stock levels achieved after stock delivery. Stock levels decline during production.
When the stock level reaches the re-order level, it triggers a new order. The difference between the time of re-order and delivery is the ‘lead time’.
The Traditional Stock Control Model

14. Types of stock control methods: JIT vs. JIC
Just-in-time vs. Just-in-case

15. Just-in-time stock control (JIT)
Stocks are delivered as and when they are needed in the production process
This allows only absolute minimum levels of stock to be held at any time
Finished goods are dispatched as soon as they have been produced, thus eliminating the need for storage

16. Case study example:
The BMW Mini is assembled using a JIT system. Customers place specific orders before the cars are made. Each component is ordered to be available when needed for production. The use of bar codes for these components ensures the right parts are supplied at the right time. JIT allows a series of Minis, all of different colors and engine sizes, to be made on the same production line.

17. Advantages of JIT Reduced storage costs
Money not tied up in stock can be used elsewhere – better cash flow
Can be flexible to seasonal changes in demand
Improved motivation as teamwork is promoted
Less wastage due to stock getting damaged or perishing
See page 522 for more advantages

18. Limitations of JIT
System will not work without reliable suppliers – huge reliance on them as there are short LEAD TIMES {time taken from order placement to delivery}
No room for mistakes as stock levels are minimal
Small stock orders more frequently can increase administration costs
Reliance on computer ordering systems – any error could halt production
The JIT system requires the total commitment of the entire workforce – unrealistic?
See page 522 for more disadvantages

19. Just-in-case stock control (JIC)
Traditional stock system whereby large amounts of stock are stored in case there are demand and supply fluctuations
Buffer {reserve} stocks are kept in case of late deliveries or sudden increase in demand

20. Sudden changes in demand and supply can be met
Advantages of JIC
Sudden changes in demand and supply can be met
Purchasing economies of scale can be taken advantage of
Reduces downtime caused by stock- outs since there is no need to wait for suppliers to deliver – stock can be taken out of storage

21. Risks of theft, perishability
Disadvantages of JIC
High storage costs
Risks of theft, perishability
Can cause cash flow problems due to large amounts of money tied up in stock

22. The optimum level of stock depends on:
The type of product being produced – fast moving consumer goods need to be held in large quantities; durables such as vehicles can be held in smaller quantities
Demand forecasts – higher levels of stock will be kept during peak season periods
Lead times – larger volumes of stock need to be kept if lead times are long periods
Opportunity cost - The higher the opportunity cost of holding stock then the lower the levels need to be eg luxury brands are expensive to hold in stock

23. Capacity Utilization

24. Capacity Utilization
This is a measure of the existing level of output of a firm as a proportion of its total potential output. It’s a measure of firm’s efficiency.
Capacity utilization = Actual Output x 100
Productive capacity
High capacity utilization means that the level of output is close to its maximum (known as productive capacity).

25. Capacity utilization
Capacity utilization is important to firms that have:
High fixed costs – remember that fixed costs per unit decrease as the level of output increases
Low profit margins – large quantities need to be produced and sold in order to make a satisfactory overall profit
High levels of break-even – could be due to high production costs and low profit margin
Low marginal costs – the cost of producing one extra good!

26. Methods to increase capacity utilization (page 528 box 5.5 a)
Improved marketing strategies – increased sales automatically lead to higher capacity utilization
Subcontract work – using external firms to help supply the firm’s products
Reduce capacity – spare capacity might exist because of excess capacity

27. Capacity utilization Drawbacks of high capacity utilization:
Equipment and machinery are used for longer periods of time – break-downs may result
Stress placed on workers – may affect productivity and motivation
May lead to over-crowding, longer waiting times and lower standards of customer service in businesses such as theme parks, restaurants, hair salons, etc.
Stretching resources may lead to higher costs (diminishing returns)

28. EXAM TIP!
There is little the firm can do when the cause of low capacity utilization is an economic recession. When the economy recovers, capacity utilization should automatically increase to meet the increasing level of consumer demand.

29. EXAM TIP!
Do not confuse the drawbacks of higher capacity utilization with diseconomies of scale. Diseconomies of scale can only happen if the business operates on a larger scale, i.e. if its productive capacity has increased.

30. EXAM TIP!
It is important to consider the context of the business when deciding whether it should increase or decrease its capacity utilization. For example, a product in its launch phase of the product life cycle is likely to have low capacity utilization. Only if demand for the product surges will the firm increase its capacity utilization.

31. Productivity

32. Productivity Rate
Measures how well resources are used in the production process.
Labor productivity – is a measure of the efficiency of the workers by calculating the output per worker. The higher the labor productivity rate, the more productive (or efficient) the workers are.
LP = Total output x 100
Number of workers

33. Importance of Higher Productivity Rate:
Economies of scale – higher levels of output help to reduce the average cost of production.
Earnings (higher profits and wages) – higher productivity rates are a source of cost savings and higher profits for businesses. Higher profitability enables firms to pay higher wages to their workers who are more productive.
Efficiency (improved competitiveness) – highly productive businesses can gain advantages beyond economies of scale. As they are more productive, they can compete more effectively on an international scale.
Evolution (growth) – higher productivity rate is a source of growth for businesses because it increases their productive capacity.

34. Determinants of productivity rates (TRIES):
Technology – investment in the latest technologies helps workers to be more productive
Rivalry – competition creates an incentive for businesses to be more productive in order to remain competitive
Innovation – this is the commercialization of new ideas and products
Entrepreneurship – productivity rate is largely dependent on the leadership and personal motivation of entrepreneurs
Skills and Experience – education, training and development can increase a firm’s human capital

35. EXAM TIP!
Higher levels of production and higher productivity rates are often confused concepts. The former increases the output of goods and services. However, increasing the number of workers or any other resource does not necessarily increase output unless they are used productively (efficiently). Firms that operate on a larger scale can suffer from diseconomies of scale, resulting in a lower productivity rate.

36. EXAM TIP!
Remember that Business Management is an interrelated discipline. For example, non-financial rewards, such as recognition of worker’s achievements, can have a positive effect on the productivity rate. Consider how genuine praise from your teachers or parents can influence your attitude to learning.

37. Case study:
Kodak was once the world’s largest supplier of photographic camera film, but was too slow to switch to digital technology in the late 1990s. Founded in 1888, Kodak dominated throughout most of the twentieth century, with its market share peaking at 90% in However, Kodak’s inability to make profit for 5 consecutive years meant the company stopped production of digital cameras and filed for bankruptcy in 2012.

38. Cost to buy (CTB) Cost to make (CTM)

39. Make or buy decisions
Should the firm produce the product itself, or should it buy the product from a supplier and then re-sell it?
A cost-benefit analysis is usually done to answer the question – if the cost of producing the product is lower than the suppliers price then it makes sense to manufacture the product.
The cost – benefit analysis must consider:
Expected sales volume (Q)
Fixed costs to make the product (machinery etc) (FC)
Average variable costs to make the product (AVC)
Price of the supplier (P)

40. Qualitative factors to consider: The quality of the product
Make or buy
Qualitative factors to consider:
The quality of the product
The reliability of subcontractors
If there is spare capacity to make the product
The terms and conditions of any contracts – how easy is it to change your mind?

41. Formulas: The cost-to-buy: CTB = P x Q
The cost-to-make: CTM = FC + (AVC x Q)
If CTM > CTB, then it is more financially desirable to ‘buy’.
If CTM < CTB, then it makes financial sense to ‘make’.

42. Case Study:
Foxconn is the global market leader in the electronics contract industry. The Taiwanese company makes some of the world’s best-known electronic products for its clients, including Apple (iPod, iPad and iPhone), Amazon (Kindle) and Nintendo (Wii U). Other clients include Acer, Cisco, Dell, Google, HP, Microsoft, Nokia, Sony and Toshiba. Foxconn has factories in China, Brazil, Mexico, India, Japan, Malaysia, Hungary, Slovakia and the Czech Republic.

43. Questions – 5.5.9
Business & Management

44. CUEGIS page 535
Business & Management

45. Key Terms
Business & Management

46. Buffer Stock
Refers to the minimum stock level held by a business in case there are unexpected events, ie. late deliveries of components or a sudden increase in demand for the firm’s product.

47. Capacity Utilization
Measures a firm’s existing level of output as a proportion of its potential output. High capacity utilization means that the firm is producing close to its productive capacity.

48. Just-In-Case (JIC)
Is the traditional stock management system that maintains buffer stocks in case there are unexpected fluctuations in supply (such as delayed delivery of stocks) or sudden change in demand.

49. Just-In-Time (JIT)
Is a stock control system whereby materials and components are scheduled to arrive precisely when they are needed in the production process.

50. Labor Productivity
Is a measure of the efficiency of a firm’s workers by calculating the output per worker. It is an indicator of the current level of skills and motivation of the workforce.

51. Lead Time
Measures the duration between placing an order and receiving it. The longer the lead time, the higher buffer stocks tend to be.

52. Make-or-buy decisions
Refer to situations where a firm has to decide between manufacturing a product and purchasing it from a supplier, based on comparing the cost to make (CTM) with the cost to buy (CTB).

53. Maximum Stock Level
Refers to the upper limit of inventories that a firm wishes to hold at any point in time.

54. Minimum Stock Level
Refers to the smallest amount of inventories that a business wishes to hold. For many businesses, this minimum is above zero as a precautionary measure.

55. The optimum stock level (or the economic order quantity)
Refers to the best inventory level for a firm, which ensures that there are sufficient stocks for production while incurring minimal costs.

56. Productive Capacity
Refers to a firm’s maximum (potential) output if all its resources are used fully and efficiently.

57. The Productivity Rate
Measures the degree of efficiency in the use of resources in the production process. It uses an average measure, e.g. output per worker, revenue per sales person or output per machine hour.

58. Re-order level
Refers to the level of stock when a new order is placed. Lead times mean that the re-order level helps to prevent production problems arising from a lack of stock.

59. Re-order Quantity
Refers to the amount of new stock ordered. It can be seen from a stock control chart by calculating the difference between the maximum and minimum stock levels.

60. Stock-out
Occurs if a business does not hold enough stocks to meet orders for production.

61. Stockpiling
Occurs when a business over-produces so holds too much stock. This is detrimental to the firm’s cash flow position.

62. Stocks or Inventories
Are the materials, components and products used in the production process, ie. raw materials, semi-finished goods and finished goods.

63. The supply chain
Is the sequence of activities from the production of a good or service to it being delivered to the end customer.

64. The Usage Rate
Refers to the speed at which stocks are depleted. The higher the usage rate, the more frequent re-ordering of stocks needs to be.