IB Business and Management

5.7 Production Planning

Learning Objectives

• To understand the different types of stock

• To understand the COSTS of holding stock

• To be aware of some problems & consequences of poor stock management

Types of Stock

Stocks are also known as inventories. There are 3 categories of stock:

•Raw Materials & Components•Work-in-Progress•Finished Goods

Stock Control

• Businesses have to find out and keep the optimum level of stock.

• There can be BIG problems associated with keeping too much or too little stock

WHAT STOCK LOOKS LIKE…

www.scalemodels.co.uk

Amazon

Ocado

What type of stock…ready?

Task – 5 mins

• In groups discuss and create a list of:

1.Costs/problems of keeping large amounts of stock

2.Costs/problems of keeping low amounts of stock

Write idea on post it – pin on board

Costs of keeping stock

• Storage Costs– Rent– Insurance– Staff

• Chance of Fire, Theft, Damage• Wastage due to stock being– Perishable– Obsolete– Outdated

• Ties up working capital• Old stock may need to be heavily

discounted

Costs of keeping low levels of stock

• Higher chance of a stock-out resulting in:– Lost Sales– Damaged Reputation– Down-time– Lower productivity/efficiency

• Higher administration costs due to more orders being made

• No bulk buying discounts

JUST-IN-TIME VS JUST-IN-CASE

Just-in-case

• This is the traditional method of stock control

• Large amounts of stock are kept in case of fluctuations in demand

• Reserve/buffer stock is kept incase of problems such as a delayed delivery

What are the benefits of a JIC system?

Benefits of JIC

• Sudden increases in demand can be met• Reduced lead-time for customers• Purchasing economies can be taken

advantage of• Reduced down-time

However…. Costs of stock storage will be highLiquidity will be affected

Just –In -Time

• A stock management system where the minimum stock is kept

• First made famous by Toyota’s Taiichi Ohno as part of the ‘Toyota Production System’

Task - Video

• Watch the video “Toyota Production System in the News”

• What are the key features of JIT?

Key Features of JIT

• A ‘pull’ system of production• Stocks of raw materials arrive ‘Just In

Time’ for them to be used in production• Finished goods are dispatched as soon as

they are completed• Barcode systems ensure that stock levels

are managed accurately• Kanban Systems used

Video

• Watch the video ‘Kanban system explained’

Task – In Pairs

• Write a list of:

• The advantages of JIT• The disadvantages of JIT• The conditions needed for JIT to be

successful

Advantages

• Reduced Stock holding costs• Improved liquidity• Reduced breakeven point• Improves motivation?• Reduces waste• Strengthened relations with suppliers

Limitations

• Reliance on suppliers• No room for mistakes• Lack of flexibility• Lack of purchasing economies• Admin costs of ordering high• Reliance on sophisticated technology

Conditions needed for JIT to be successful

• Excellent relationships with suppliers• Suppliers to be located nearby• Commitment from management and

workforce• Embedded into the culture• Excellent quality stock• Steady demand?/Customers accept

long lead-times

STOCK CONTROL GRAPHS (HL)

The role of the purchasing department

• Ensure quality of raw materials• Buy at competitive prices• Ensure right quantity of stock is

ordered• Ensure timely delivery• Develop relationships with suppliers

Stock Control Graph

Stock Level

Time

Maximum Stock Level

Minimum Stock Level

Re-order level

The Traditional Stock Control Model 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’.

Lead Time

Re-order triggered

Buffer Stock

Re-order Quantity

Stock Control Graph

Answer the following questions1. Identify and label;

i) Maximum Stock Levelii) Re-order Leveliii) Minimum Stock Level

2. What is the re-order quantity?3. What amount of buffer stock is held? 4. Mark on your diagram the lead time?5. With reference to the diagram, why do firms hold buffer

stock? What may have happened on days 11 and 12?6. Why do firms want to keep the amount of stock they hold

to a minimum?

Question A clothes manufacturer wants you to help them

determine when they need to re-order the zips that they use in their manufacturing process.

They have provided the following information:Maximum stock level: 800Minimum stock level: 200Stock used per week: 100Lead time: 1 weekTask• On your own draw a stock control graph. Then answer

the following questions.• At what stock level must an order be placed for more

zips? Label this on the diagram• If the company wants stock levels to rise to the

maximum level when the new stock arrives how many zips must be ordered? Label this on your diagram

• Why do the company set a minimum stock level?

IB Business and Management

5.7 Capacity Utilisation (HL)

Capacity Utilisation

• A firm’s productive capacity is the total level of output or production that it could produce in a given time period.

• Capacity utilisation is the percentage of the firm’s total possible production capacity that is actually being used.

• Capacity utilisation is calculated as follows:

actual output per period x 100maximum possible output per period

Example

• If a firm could produce 1200 units per month, but is actually producing 600 per month, its capacity utilisation is as follows:

• Capacity utilisation % = 600 units per month x 100% 1200 units per month= 50%

Questions:

• A restaurant has the capacity to serve 90 covers per evening......

• What would their capacity utilisation be if they had bookings for:

a.10 customersb.42 customersc.85 customers

11.1%

46.7%

94.4%

Financial Implications

• A firm’s level of capacity utilisation determines how much fixed costs should be allocated per unit

• As a firm’s capacity utilisation increases, the fixed costs per unit will decrease.

• For example, a firm had a capacity of 1,200 units and had fixed costs of £12,000 per month, the fixed costs per unit would be £20 per unit at 50% capacity utilisation, but only £10 per unit at 100% capacity utilisation.

Questions:

• A restaurant has the capacity to serve 90 covers per evening...... The average variable cost per customer is £5. Their fixed costs are £200 per day

• What would the average total cost per customer be if they had bookings for:

a.10 customersb.42 customersc.85 customers

£25

£9.76

£7.35

Working at Full Capacity

• A firm should be working at its most efficient if it is running at full capacity

Can you think of any drawbacks to a firm Of working at full capacity?

Drawbacks of working at full capacity

• There may not be enough time for routine maintenance, so machine breakdowns may occur more frequently and orders will be delayed

• It may not be possible to meet new or unexpected orders so the business cannot grow without expanding its scale of production

• Staff may feel under excessive pressure, leading to increased mistakes, absenteeism and labour turnover

• If the work space is overcrowded, work may become less efficient due to the untidy working conditions

• It may be necessary to spend more on staff overtime to satisfy orders, increasing labour costs

What could a firm do if it had reached full capacity?

Dealing with High Capacity Utilisation

• Extra shifts or longer opening hours

• Seasonal workers• Outsourcing or subcontracting• Expansion

What might cause low capacity utilisation?

Causes of Low Capacity Utilisation

• New competitors taking market share or causing over-supply in the market

• Fall in market demand due to changes in consumer tastes or fashion or the economy

• Unsuccessful marketing – one or more aspect of the marketing mix may simply mean that the firm is not successful

• Seasonal demand – this is especially apparent in the tourist industry where firms like hotels and leisure parks are full in the summer but see much lower utilisation at other times of the year

Problems of Low Capacity Utilisation

• Higher fixed costs per unit mean reduced profitability; if prices were raised to cover these costs, this would probably lead to reduced sales unless the product was price inelastic

• Spare capacity can portray a negative image, particularly in a business where it can be seen that it is no longer busy – such as a shop or a health club - signifying loss of popularity

• Staff can become bored and demoralised if they don’t have as much to do, especially if they fear losing their jobs

Benefits of Low Capacity Utilisation

Low capacity utilisation is unlikely to be desirable in the long term as the higher unit costs will make it difficult to compete. However it is not all bad news and possible short term benefits include:

• A firm may have more time for maintenance and repairs and for staff training, to prepare for an upturn in trade

• There may be less stress for employees than if they were working at full capacity

• The firm can cope with new orders; firms in expanding markets may expect to have low utilisation whilst they build their sales

What could a firm do to deal with low capacity utilisation

Dealing with Low Capacity Utilisation

• New business – Changing elements of the marketing mix in order to generate more sales

• Rationalisation – or ‘downsizing’• Short-time working• Laying off workers

Case Study

• In February 2008, American car manufacturer Chrysler suffered a 22% drop in demand for Lorries. At the same time costs were soaring due to rising petrol prices.

• Action had to be taken• What would you recommend that

Chrysler should do in order to deal with the problem?

Application of Capacity Utilisation

• In general, businesses would feel most comfortable at something between 80 to 90% capacity utilisation

• Fixed costs per unit are relatively low and there is some scope to meet new orders or carry out maintenance and training.

• A firm that has just invested in major new facilities in anticipation of major growth could take some time before reaching a good level of utilisation, so it is important to consider sales trends when discussing capacity utilisation.

IB Business Management

5.7 Outsourcing, Off shoring and Make or Buy Decisions

(HL)

Outsourcing/Subcontracting

• The act of finding an external party to carry out internal (and often non core) activities of the firm.

• What sort of activities might these be?

Commonly outsourced activities

Cleaning Accounting ICT maintenance Catering Recruitment and Selection Manufacturing of components Customer service call centres Security Training Market Research Events Management

How does outsourcing reduce costs/efficiency?

• Job is being done by specialists who are more efficient

• Reduces the need for capital expenditure• Different companies may bid for the contract

meaning that competitive prices are gained• Increases flexibility• Reduces labour costs• The business focuses on it’s core operations

Potential problems of outsourcing?

• Can initially cause redundancies• Quality needs monitoring• Will the third party follow the same

standards?

Why do businesses choose to outsource?

• So that they can focus on their core operations

• Reduce costs• If the business lacks expertise• If the business is working at full

capacity

Off Shoring

• Relocating business functions and processes overseas. This can be:

• Production offshoring (e.g. manufacturing)

• Service offshoring (e.g. call centres)• Why would a firm do this?• Where are popular offshoring

destinations?

Benefits of offshoring to host countries

• Job creation• Economic growth• Tax revenue• Development of skilled workforce• Investment in infrastructure

Issues with offshoring:

• Is offshoring exploitation?• Difficult to monitor ethical standards• Communication difficulties• Exchange rate fluctuations

Make or Buy Decisions

• Businesses will often have to make a choice as to whether to make a component itself or to buy from a supplier

• These decisions are also made by people on a regular basis

Example……..

If a person wants to give their friend a birthday cake, they could make one or buy one.

Write a list of reasons why someone might choose to buy one.Write a list of reasons why someone might choose to make one

Reasons for making…….

• If making is cheaper• If there are no suitable suppliers• If delivery times can’t be met by the supplier• Quality of products made by the suppliers is

not good enough• There is spare capacity• To maintain secrecy• To ensure continuity of supply• To retain labour during a slack period of

trading

Reasons for buying

• If buying is cheaper• To increase specialisation• If the amount needed is a one off or

too small to be economical• Lack of expertise• Avoid investment in equipment

Is making or buying cheaper?

It depends…… often it is cheaper to buy small quantities but it may become cheaper to make as quantities needed increase

What information would a firm need to know if it wanted to calculate whether making or buying would be cheaper?

Information needed:

• The unit price of the supplier• A forecasted quantity needed• The average variable cost of

producing each unit• If any additional fixed costs that

would be incurred

Cost Calculations

Cost to Buy =Quantity needed x Suppliers priceCost to Make = Additional Fixed Cost + (AVC x Quantity needed)

However

• As we saw before, cost is only one factor. A firm must also take into account:

• Reliability• Speed• Quality• Whether there is spare capacity• How reversible the decision is• Effect on the work force