CHAPTER ONE

FUNDEMENTALS OF OPERATIONS
MANAGEMENT

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 Learning Objectives

• Define Operations Management (OM)

• Explain the role of OM in business
• Describe the decisions that operations managers make
• Describe the differences between service and manufacturing
operations
• Identify major historical developments in OM
• Identify current trends in OM
• Describer the flow of information between OM and other
business functions

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 Production, operation, management and OM
What is production?
• Production is defined as “the step-by-step conversion of one form of
material into another form through chemical or mechanical process.

What is operation?
 Operation is a process by which goods and services are created’.

What is management?
• Management is the function of planning, oganizing, directing and
controlling the business activities.

What is operations management?

 OM refers to the application of management function in the conversion
of inputs in to outputs(creation of goods and/or services)
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 What is operations management?.......
Cont’d
 More specifically, OM is the business function responsible for
planning, coordinating, and controlling the resources needed to
produce a company’s products and services
• Operations Management (OM) is concerned with the
management of resources and activities that produce and deliver
goods and services for customers

• In a nut shell, all definitions consider OM as the management of

transformation process that converts input into output

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 Cont’d

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 Why conversion is needed?

• To add values i.e. to create or enhance the utility of the

product to the user.”

• Since every business exists to create value to the

customers, OM is common function.

• Thus, operations function is the heart of and indeed the

very reason for an organization to come in to being

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 Types of conversion to create value

a) Alter: refers to change in the form or state of the inputs.

This change may be:
i) physical as in manufacturing such as car assembly
ii) psychological (sensual) such as satisfaction after enjoining
recreational center
iii) Physiological such as feeling of comfort after getting cured from
an illness

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 Cont’d

• Transport: - the entity (input) gets value added through transport

because it may have more value if located somewhere other than
where it currently is.
• Store: - the value is enhanced if the entity is kept in a protected
environment for some period of time, such as potatoes in a cold
storage
• Inspect: - the value of an entity may be enriched through an
inspection as we better understand its properties and can there
for take more informed decisions regarding their purchase, use,
repair etc.
• Exchange: Banks create value to the customers trough exchange
• Knowledge change: institution create value by imparting
knowledge in the mined of the learner

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 Cont’d

• Thus, we see that the value may be added to an entity through a

number of different means. It may directly change in space, in
time, in form, or even just in our mental image of it.
• All these processes can be called operations

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 1.3. System concepts in operations management

• A system may be defined as “a purpose full collection of people,

objects and procedures for operating within an environment”.

• Thus every organization can be represented as a system consisting

of interacting sub systems.

• The basic process of the system converts (transforms) the resource

inputs (such as people, plant, part processes, planning and controlling
systems) in to some useful form of outputs.

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 KEY TERMS IN OPERATIONS SYSTEM

 Inputs: inputs to the system may be labor, material, machine,

facilities, energy, information, technology etc. Other inputs to
operating system can be: customer in a bank, patient in a hospital,
commuters to public transport system, files and papers to an
office situations and program to be run in a computer centers
 Components: are machines, persons, tools, in the system.

 Outputs: similarly output from the system may be in terms of

finished products, transported goods, delivered massages, cured
patients, serviced customers etc.

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 Cont’d

• Transformation:-all operation functions are essentially a part of

the conversion process which transforms entities in shape, size,
form, location, space, time, and state to have higher value than
the original value.

• Hence, every organization can be considered essentially as a

conversion system which converts inputs in to outputs through the
conversion/transformation processes.

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 Cont’d

System Inputs Components Transformations Output

Hospital Patients Doctors ,Nurses, Cured person
Staff, Equipment, Physiological
Facility, Energy,
etc
Bank Clients Teller, Staff, Exchange Loan/deposit etc.
Facility etc
College High school Teacher, Class Imparting Educated person
graduate room, Books etc
knowledge
Automobile Steel, Sheet, Tools, Equipments, Physical Automobile
factory Engine Power etc
Restaurant Hungry Waiter, Physical Satisfied
Customer Environment, customers
Energy etc

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 Why study Operations Management?

a) OM is one of organization’s core function

• Operations management (OM) is one of the three major
functions of any organizations, and it is integrally related to all
the other business functions. All organizations finance
(account), Produce (operate) and market (sell)

• As operation is one of the key area of any organization it is

important to know how the operations management segment
the activity.

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 Typical Organization Chart

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 Cont’d

• ii. We study operations management because we want to know

how goods and services are produced. The production function is
the segment of our society that creates the products we use.

• iii. We study OM to understand what operations managers do. By

understanding what these messages do, you can develops the
skills necessary to become such a manager.

• iv. We study OM because it is such a costly part of an

organization. A large percentage of revenue of most firms is spent
in the operations management functions

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 Manufacturing operation Vs Service operation

Similarities between Service & Manufacturers

• All use technology
• Both have quality, productivity, & response issues
• All must forecast demand
• Each will have capacity, layout, and location issues
• All have customers, suppliers, scheduling and staffing issues

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 Differences between manufacturing & services

• Services: • Manufacturers:
• Intangible product • Tangible product
• Product cannot be inventoried • Product can be inventoried
• High customer contact • Low customer contact
• Short response time • Longer response time
• Labor intensive • Capital intensive
• quality and productivity is difficult to • Quality and productivity easy to
measure measure
• High degree of variety of input • High degree of uniformity of
• Difficult to automate input& output
• Easy to automate

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 Cont’d

Characteristic Manufacturing Service

Output Tangible Intangible
Customer contact Low High
Uniformity of input High Low
Labor content Low High
Uniformity of output High Low
Measurement of productivity Easy Difficult
Opportunity to correct High Low
quality problems
High

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 Current trends influencing the field of OM

• There are significant trends outside of the field of operations that

will influence the evolution of OM in the coming decades

a) Growth and dominance of services: - At one time, the primary

employment sector in the world economy was agriculture; with
the industrial revolution that changed, and manufacturing was
the primary employment sector. Today it is services

For example, the percentage of employment in service sector jobs in 1993 for a
sampling of nations was: Canada 75%, USA 74%, Belgium 71%, Israel 68%,
France 66%, Italy 60%, and Japan 60%. Today for most of these countries, the
percentage of workers employed by service business is even higher.

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 Service Economy

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 Cont’d
b) Internationalization: Business competition is now global.
Improvement in logistic systems, communication technologies
along with greater opportunities for international trade have
created new opportunities and challenges in the design of value
adding system

Internationalization:
• demands for global competitiveness
• demands for higher quality
• Results in huge technology changes
• demands for time based competition
• Results in Work force diversity

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 Cont’d

c) Environmental quality
• Environmental concerns have traditionally not been the focus of
operation managers.

• Increased regulation, public scrutiny, customer expectations, and

the concern of employees for their community are beginning to
change OM activities

• Recent regulations in the USA and other countries have forced

industry to find less polluting ways to satisfy their customers

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 Operation Management Decisions
Strategic (long term) decisions:
• Strategic Decisions – set the direction for the entire company;
they are broad in scope and long-term in nature
• Product selection and design: what product or services are to offer constitute
crucial decisions.
• Process selection and planning: choosing optimal processes of conversion
systems is an important decision concerning choices of technology, equipment
and machines
• Facilities location: - is a long term decision which concerns decision regarding
location of production system or its facilities
• Facilities lay out and materials handling
• Capacity planning:-is a long term decisions which concerns the acquisition of
productive resources

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 Cont’d

Operational (tactical/short term) decisions

• Operational level decisions deal with short term specific day to
day planning and control problems.
E.g.
• Resource needs & quantities to produce
• Production planning, scheduling and control
• Inventory planning and control
• Quality assurance
• Work and job design
• Maintenance and replacement
• Cost reduction and control

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 OM Decisions
-Tactical decisions are very frequent
-Strategic decisions less frequent
-Tactical decisions must align with strategic decisions

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 Plan of Book-Chapters link to Types of OM Decisions

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 Scope of Operations Management
.. important decision areas in Operations Management
Ten critical/
includes:
1. Design of goods and services
2. Managing quality
3. Process and capacity design
4. Location strategy
5. Layout strategy
6. Human resources and job design
7. Supply chain management
8. Inventory, MRP, JIT
9. Scheduling
10. Maintenance
The operations function Consists of all activities directly related to
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producing goods or providing services.
 Historical Development of OM

• Industrial revolution Late 1700s

• Scientific management Early 1900s
• Human relations movement 1930s-1960s
• Management science Mid-1900s
• Computer age 1970s
• Environmental Issues 1970s
• Just-in-Time Systems (JIT) 1980s
• Total quality management (TQM) 1980s
• Reengineering 1990s
• Global competition 1980s
• Flexibility 1990s
• Time-Based Competition 1990s
• Supply chain Management 1990s
• Electronic Commerce 2000s
• Outsourcing flattening of the world 2000s

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 Productivity Measurement
• Productivity is the relationship between the
Outputs generated from a system and the Inputs
that are used to create those outputs.
– A measure of the effective use of resources,
usually expressed as the ratio of output to input
• Productivity ratios are used for
– Planning workforce requirements
– Scheduling equipment
– Financial analysis
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 Productivity-----cont’d
Units produced
Productivity =
Input used

 Productivity is a measure of how efficiently inputs are converted to outputs

 It is a measure of process improvement
 It represents output relative to input
 Only through productivity increases can our standard of living improved

Measures of Productivity
Single-factor (Partial) productivity
Multi-factor productivity
Total factors productivity
 Productivity Calculations

One resource input  single(partial)-factor productivity

The productivity of labor, material, energy, space, capital etc will be
measured separately

See the following labor productivity as an example of partial productivity

Labour Productivity
Productivity = Units produced
Labor-hours used

Example 1
If 1000 units of output produced by
250 labor hour, then calculate labor = 1,000/250= 4 units/labor hour
productivity per hour
 Some examples of partial productivity measures
• Labor productivity
– Units of output per labor hour
– Units of output per shift
– Value-added per labor hour
– Birr value of output per labor hour
• Machine productivity
– Units of output per machine hour
– Birr value of output per machine hour
• Capital productivity
– Units of output per birr input
– Birr value of output per birr input
• Energy productivity
– Units of output per kilowatt hour
– Birr value of output per kilowatt hour
 Example 2 Collins Title Productivity

Old System:

Staff of 4 works 8 hrs/day 8 titles/day

Payroll cost = $640/day Overhead = $400/day

8 titles/day
Old labor
productivity = 32 labor-hrs

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 Collins Title Productivity----cont’d
Old System:

Staff of 4 works 8 hrs/day 8 titles/day

Payroll cost = $640/day Overhead = $400/day

Old labor 8 titles/day

productivity = 32 labor-hrs = .25 titles/labor-hr

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 Collins Title Productivity------cont’d
Old System:

Staff of 4 works 8 hrs/day 8 titles/day

Payroll cost = $640/day Overhead = $400/day

New System:

14 titles/day Overhead = $800/day

8 titles/day
Old labor
productivity = 32 labor-hrs = .25 titles/labor-hr

New labor 14 titles/day

productivity = 32 labor-hrs

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 Collins Title Productivity----cont’d
Old System:

Staff of 4 works 8 hrs/day 8 titles/day

Payroll cost = $640/day Overhead = $400/day

New System:

14 titles/day Overhead = $800/day

Old labor 8 titles/day

productivity = 32 labor-hrs = .25 titles/labor-hr

New labor 14 titles/day

productivity = 32 labor-hrs = .4375 titles/labor-hr

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 Collins Title Productivity----cont’d
Old System:

Staff of 4 works 8 hrs/day 8 titles/day

Payroll cost = $640/day Overhead = $400/day

New System:

14 titles/day Overhead = $800/day

Old multifactor 8 titles/day

productivity = $640 + 400

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 Collins Title Productivity----cont’d
Old System:

Staff of 4 works 8 hrs/day 8 titles/day

Payroll cost = $640/day Overhead = $400/day

New System:

14 titles/day Overhead = $800/day

Old multifactor 8 titles/day

productivity = $640 + 400 = .0077 titles/dollar

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 Collins Title Productivity---cont’d
Old System:

Staff of 4 works 8 hrs/day 8 titles/day

Payroll cost = $640/day Overhead = $400/day

New System:

14 titles/day Overhead = $800/day

8 titles/day
Old multifactor
productivity = $640 + 400 = .0077 titles/dollar

New multifactor 14 titles/day

productivity = $640 + 800

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 Collins Title Productivity----cont’d
Old System:

Staff of 4 works 8 hrs/day 8 titles/day

Payroll cost = $640/day Overhead = $400/day

New System:

14 titles/day Overhead = $800/day

Old multifactor 8 titles/day

productivity = $640 + 400 = .0077 titles/dollar

New multifactor 14 titles/day

productivity = $640 + 800 = .0097 titles/dollar

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 Example 3
Three employees process 600 insurance policies
in a week. They work 8 hrs per day, 5 days a
week.

Required calculate labor productivity?

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 Cont’d
Solutions
Labor productivity=output/inputs.
Where, output is number of insurance policies
processed(600 policies) and input is hours
worker(3workers X 8hrs/day X 5days)
3workers X40 hrs=120 hrs

= 5 polices/hours
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 Multi-Factor Productivity

Multiple resource inputs  multi-factor productivity

Output
Productivity =
Labor + Material + Energy +
Capital + Miscellaneous
 Also known as total factor productivity if all total inputs are
considered
 In multi-factor productivity outputs and inputs are
often expressed in dollars
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 Example
..

7040 Units Produced

Sold for $1.10/unit

Cost of labor : $1,000 What is the

multifactor
Cost of materials: $520 productivity?

Cost of overhead: $2000 And Explain your result.

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 Solution:
..

MFP = Output
Labor + Materials + Overhead

MFP = (7040 units)*($1.10)

$1000 + $520 + $2000

MFP =7744/3520=2.20 This means that using input

that has 1 $ value we can produce output which will have 2.20$ value

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 Total-Factor Productivity

All resource inputs  Total -factor productivity

Relate the total output of goods produced or services delivered
with all inputs used to produce them

Output
Productivity = All inputs

TFP = Output
Labor + Materials +capital +Energy +miscellaneous

NB: In total factor productivity, all inputs are considered

 Exercise

• Consider the following data and answer the accompanying questions

– Units Produced: ……..100,000
– Labor hours used: ….…10,000
– Machine hours: ………..5,000
– Cost of materials: ….…..Birr 35,000
– Cost of energy: ………...Birr 15,000
– Cost of labor per hour: ..Birr 20
– Cost per machine hour: .Birr 10
– Selling price per unit: ….Birr 100

From the data above, calculate:

A. Single factor or partial productivity of Labor and Machine
B. The multifactor productivity of labor, machine, and materials
C. The total factor productivity

NB:
-You can calculate output in terms of units (100,000)or value of output(100,000 X100)
-Total labor cost=10,000 X 20
-Total machine cost=5000 X 10
Summary
 Productivity Growth Rate

• Can be used to compare a process’

productivity at a given time (P2) to the same
process’ productivity at an earlier time (P1)

P2  P1
Growth Rate 
P1
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 Productivity Growth Rate------cond
Example:
– Last week a company produced 150 units using 200
hours of labor. This week, the same company
produced 180 units using 250 hours of labor.
– Determine its productivity growth rate.
150 units
P1   0.75 units / hour
200 hours
180 units
P2   0.72 units / hour
250 hours
P2  P1 0.72  0.75
Growth Rate    0.04
P1 0.75
or a negative 4% growth rate
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 Productivity Improvement(PI)

Productivity Improvement (PI) is the result of

managing and intervening in key transformation
or work processes.
PI will occur if:

O O O O O
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I I I I I