Cambridge Notes Unit 4 Business Studies IGCSE
- 2. Managing resources effectively to produce goods and services PRODUCTION is the provision of a product or a service to satisfy consumer wants and needs. • The process involves firms adding value to a product. • Value added is the difference between the cost of inputs (raw materials or components) and the final selling price of the product or service. • The production process applies to manufacturing as well as service industries. • In adding value, businesses combine the 'inputs’ of a business (factors of production, such as land, labour, capital and enterprise) to produce more valuable 'outputs' (the final good or service) to satisfy consumer wants or needs. • However, these factors of production, also called economic resources, can be combined in different proportions — as inputs — to the production process.
- 4. Managing resources effectively to produce goods and services For a business to be competitive it should combine these inputs of resources efficiently so that the business makes the best use of resources at its disposal to keep costs low and increase profits. In a developing country, where wages are low, it may be more efficient to use many workers and few machines to produce goods — the production process is called 'labour-intensive’. However, in developed countries where labour costs are high, then production is often 'capital-intensive', where businesses use machines/robots and employ few workers.
- 5. OPERATIONS DEPARTMENT • The Operations department's role in a business is to take inputs and change them into outputs for customer use. • Inputs can be physical goods or services. • The Operations Manager is responsible for making sure that raw materials are provided and made into finished goods or services.
- 6. Difference between production and productivity • The level of production is the output of the business. • Productivity is the output measured against the inputs used to create it. • Productivity is how a business can measure its efficiency. • The productivity of a business can be measured by: Productivity = Quantity of output Quantity of inputs
- 7. Difference between production & productivity • Businesses often want to measure the productivity of one of the factors of production or inputs, usually labour. • This is measured by dividing the output over a given period of time by the number of employees: Labour productivity = Output (over a given period of time) Number of employees • Productivity can either mean using fewer inputs to produce the same output or using the same inputs to produce a much greater output. • As employees become more efficient, the amount of output produced per employee will rise and therefore the costs of producing the product will fall. • Businesses strive to increase productivity in order to become more competitive. • Different levels of success at being productively efficient account for the difference between a firm's ability to be competitive, remain trading and being able to generate profits.
- 8. Ways to increase efficiency/ productivity Introducing Introducing automation (use machines instead of people to do jobs) Improving Improving labour skills by training staff so that they have more techniques of working. Improving Improving the layout of the machines in a factory to reduce wasted time and therefore increase efficiency.
- 9. Benefits of increasing efficiency/ productivity Increased output relative to the inputs required. Lower costs per unit (average cost). Fewer workers may be needed, possibly leading to lower wage costs. Higher wages for workers increases motivation
- 10. Why businesses hold inventories (stock) • Have you ever gone into a shop and found they have run out of what you wanted? • If so, then the shop might have had higher sales than usual or else their delivery of stock might have been late. • TO ENSURE THAT THERE IS ALWAYS ENOUGH INVENTORY TO SATISFY DEMAND, INVENTORY LEVELS MUST BE CAREFULLY CONTROLLED. • Inventories can take various forms, including raw materials, components, partly finished goods, or finished products ready for delivery. • It can even include inventory of spare parts for machinery in case of breakdowns.
- 11. Why businesses hold inventories • When inventories get to a certain point (reorder point), they will be reordered to bring inventories back up to the maximum level again. • The business must reorder before inventories get too low to allow time for the goods to be delivered. • If inventory levels get too low, they might actually run out if there is an unexpectedly high demand for the goods. • If too high a level of inventory is held then this costs a lot of money; the business has bought the goods but they are not being used and the money could be put to better use.
- 12. Why businesses hold inventories (stock) The following graph demonstrates how inventory levels can be managed.
- 13. Why businesses hold inventories (stock) • The buffer inventory level is the inventory held to deal with uncertainty in customer demand and deliveries of supplies. • Effectively managing inventory levels is very important to all types of businesses, specially manufacturing and retail businesses.
- 14. Lean production Lean production refers to techniques used by businesses to cut down on waste and therefore increase efficiency. It tries to reduce the time it takes for a product to be developed and become available in the shops for sale, so that it is as quick as possible. Lean production cuts out any activities which do not add value for the customer and this can apply to services as well.
- 15. Seven types of waste that can occur in production • overproduction — producing goods before they have been ordered by customers. This results in high storage costs and possible damage to goods whilst in storage. • waiting — when goods are not moving or being processed in any way then waste is occurring • transportation — moving goods around unnecessarily causes waste and is not adding value to the product. Goods may also be damaged when they are being moved around • unnecessary inventory – if there is too much inventory then this takes up space, may get in the way of production and costs money • motion — any actions, including bending or stretching movements of the body of the employee wastes time. It may also be a health and safety risk for the employees. This also applies to the movement of machines which may not be necessary • over-processing – if complex machinery is being used to perform simple tasks, then this is wasteful. Some activities in producing the goods may not be necessary if the design of the product is poor. • defects -- any faults require the goods being fixed and time can be wasted inspecting the products.
- 17. BENEFITS OF LEAN PRODUCTION Costs are saved through: • less storage of raw materials or components • quicker production of goods or services • no need to repair defects or provide a replacement service for a dissatisfied customer • better use of equipment • cutting out some processes which speeds up production • less money tied up in inventories • improved health and safety leading to less time off work due to injury. Reduced costs can lead to lower prices for customers, businesses being more competitive and possibly also increased profits.
- 18. Lean production can be achieved through:- • Kaizen • just-in-time inventory control • cell production.
- 19. KAIZEN • Japanese Kaizen means 'continuous improvement' and its focus is on elimination of waste. • The improvement does not come from investing in new 'continuous technology or equipment but through the ideas of the workers themselves. • Small improvement' groups of workers meet regularly to discuss problems and possible solutions. • This has proved effective because no one knows the problems that exist better than the workers who work with them all the time, so they are often the best ones to think of ways to overcome them.
- 20. KAIZEN • Kaizen eliminates waste, for example, by getting rid of piles of inventory or reducing the amount of time taken for workers to walk between jobs so that they eliminate unnecessary movements. • When Kaizen is introduced, the factory floor is re-organised by repositioning machines tightly together in cells, in order to improve the flow of production through the factory. • The floor will be open and marked with colour-coded lines which map out the flow of materials through the production process.
- 22. Advantages of KAIZEN increased productivity reduced amount of space needed for production work in progress is reduced improved factory layout may allow some jobs to be combined, so freeing up employees to do other jobs in the factory
- 23. Just-in-Time inventory control Just-in –time is a production method whose focus is on reducing or virtually eliminating the need to hold inventories of raw materials or components and on reducing work in progress and inventories of the finished product. The raw materials or components are delivered just in time to be used in the production process. The making of any parts is done just in time to be used in the next stage of production and finished goods are made just in time they are needed for delivery to the customer/shop.
- 24. Just in time inventory control Advantages • All this reduces the costs of holding inventory, as no raw materials and components are ordered to keep in the warehouse just in case it is needed. • Warehouse space is not needed, again reducing costs. • The finished product is sold quickly and so money will come back to the business more quickly, helping its cash flow. To operate just-in-time, inventories of raw materials, work-in- progress and finished products are run down, and no extra inventory is kept. The business will therefore need very reliable suppliers and an efficient system of ordering raw materials or components.
- 25. CELL PRODUCTION Cell production is where the production line is divided into separate, self- contained units (cells), each making an identifiable part of the finished product, instead of having a flow or mass production line. This method of production improves the morale of the employees and makes them work harder, so they become more efficient. The employees feel more valued and are less likely to strike or cause disruption.
- 26. METHODS OF PRODUCTION Three main methods of production: • job production • batch production • flow production.
- 27. JOB PRODUCTION • Job production is where a single product is made at a time. • This is where products are made specifically to order, for example, a customer would order a particular cake. • Each order is different and may or may not be repeated. • Other examples include: specialist machinery manufacturers who will manufacture a machine for another business to meet a particular specification, bridges, ships, made-to-measure suits, cinema films, or individual computer programs that perform specialised tasks.
- 28. Advantages of job production It is most suitable for personal services or 'one-off' products. The product meets the exact requirements of the customer. The workers often have more varied jobs (they don't carry out just one task). More varied work increases employee motivation — giving them greater job satisfaction. It is flexible and often used for high-quality goods and services meaning that a higher price can be charged.
- 29. Disadvantages of job production • Skilled labour is often used. • The costs are higher because it is often labour intensive. • Production often takes a long time. • Products are specially made to order and so any errors can be expensive to correct. • Materials may have to be specially purchased leading to higher costs.
- 30. BATCH PRODUCTION • This is where similar products are made in blocks or batches. • A certain number of one product is made, then a certain number of another product is made, and so on. • Examples include: a small bakery making batches of bread, several houses built together using the same design, furniture production (a certain number of tables are made, then a certain number then a certain number of chairs),or clothing (a batch of a particular size of jeans is produced and then a batch of another size).
- 31. Advantages of batch production • It is a flexible way of working and production can easily be changed from one product to another. • It still gives some variety to workers' jobs. • It allows more variety to products which would otherwise be identical. This gives more consumer choice (for example, different flavours of drinks) • Production may not be affected to any great extent if machinery breaks down.
- 32. Disadvantages of batch production It can be expensive as semi-finished or finished products will need moving about. Machines have to be reset between production batches which means there is a delay in production and output is lost. Warehouse space will be needed for stocks of raw materials and components. This is costly.
- 33. Flow Production • This is when large quantities of a product are produced in a continuous process. It is sometimes referred to as mass production because of the large quantity of a standardised product that is produced. It is called flow production because products look as if they are flowing down the production line (they move continuously along a production line). • The basic ingredients are put together at one end of the production line and then the product moves down, and more parts are added, and so on, until the product is finished and packaged ready for sale. • Large numbers of identical products are made, and the costs of production are low (the business will gain from economies of scale). Examples of products produced in this way include: cars, cameras, televisions, packaged foods and drinks; in fact any mass produced, standardised product which is sold to a mass market will be produced in this way.
- 34. Advantages of flow production • There is a high output of a standardised product. • Costs are kept low and therefore prices are also lower. • It is easy for capital-intensive production methods to be used — reducing labour costs and increasing efficiency. • Capital intensive methods allow workers to specialise in specific, repeated tasks and therefore the business may only need relatively unskilled workers — little training may be needed.
- 35. Advantages of flow production • It may benefit from economies of scale in purchasing. • Low average costs and therefore low prices usually mean high sales. • Automated production lines can operate 24 hours a day. • Goods are produced quickly and cheaply. • There is no need to move goods from one part of the factory to another as with batch production, so time is saved.
- 36. Disadvantages of flow production It is a very boring system for the workers, so there is little job satisfaction, leading to a lack of motivation for employees. There are significant storage requirements — costs of inventories of raw materials/ components and finished products can be very high. The capital costs of setting up the production line can be very high. If one machine breaks down the whole production line will have to be halted.
- 37. Factors affecting which method of production to use • THE NATURE OF THE PRODUCT. If a fairly unique product or an individual service is required (in fact many services are individual to the customer and will be specifically tailored to their requirements), job production will be used. If the product can be mass produced using an automated production line, then flow production will be used. • THE SIZE OF THE MARKET. If demand is higher and more products can be sold but not in very large quantities, batch production will be used. The product will be produced in a certain quantity to meet the particular order. Small local markets or niche markets will be served by businesses using job or batch production. International markets are served by businesses using flow production.
- 38. Factors affecting which method of production to use • THE NATURE OF DEMAND. If there is a large and fairly steady demand for the product, such as soap powder, it becomes economic to set up a production line and continuously produce the product (flow production). If demand is less frequent, such as for furniture, then production may be more likely to be job or batch production. • THE SIZE OF THE BUSINESS. If the business is small and does not have the access to large amounts of capital, then it will not produce on a large scale using automated production lines. Only large businesses can operate on this scale. Small businesses are more likely to use job or batch production methods.
- 39. How technology has changed production methods • Technological advances have allowed the mechanisation and automation of production methods in many industries. For example, the car industry is almost entirely automated. • The use of automation, robotics and CAD/CAM keeps businesses ahead of the competition, keeps costs falling, reduces prices and improves the products manufactured.
- 40. How technology has changed production methods • Automation is where the equipment used in the factory is controlled by a computer to carry out mechanical processes, such as paint spraying on a car assembly line. The production line will consist mainly of machines and only a few people will be needed to ensure that everything proceeds smoothly. • Mechanisation is where the production is done by machines but operated by people, for example, a printing press. Robots are machines that are programmed to do tasks, and are particularly useful for unpleasant, dangerous and difficult jobs. They are quick, very accurate and work non-stop 24 hours a day. • CAD (computer aided design) is computer software that draws items being designed more quickly and allows them to be rotated to see the item from all sides instead of having to draw it several times. It is used to design new products or to re-style existing products. It is particularly useful for detailed technical drawings
- 41. How technology has changed production methods • CAM (computer aided manufacture) is where computers monitor the production process and control machines or robots on the factory floor. For example, on the production line of a car plant computers will control the robots that spot-weld the car body together or the robots that spray paint the car. • CIM (computer integrated manufacturing) is the total integration of computer aided design (CAD) and computer aided manufacturing (CAM). The computers that design the products are linked directly to the computers that aid the manufacturing process.
- 42. Technology has also improved productivity in shops • Technology has also improved productivity in shops with electronic payment methods and scanners at the tills. • EPOS (electronic point of sale). This is used at checkouts where the operator scans the bar code of each item individually. The price and description of the item is displayed on the checkout monitor and printed on the till receipt. The inventory record is automatically changed to show one item has been sold and if inventory is low (at the reorder point) then more inventory can be automatically ordered.
- 43. EFTPOS (electronic funds transfer at point of sale) • This is where the electronic cash register is connected to the retailer's main computer and also to banks over a wide area computer network. • The shopper's card will be swiped at the till and the bank information will automatically be read from the card. • The money will be directly debited from the customer's account after they have signed for the debit to be made or have entered their PIN (personal identification number). • A receipt will be printed as confirmation that the payment has gone out of the customer's account.
- 44. Advantages of new technology • Productivity is greater as new production methods are used. • Greater job satisfaction stimulates workers, as routine and boring jobs are now done by machines. • The types of jobs have changed as more skilled workers are needed to use the new technology. Businesses must offer training to existing workers in the use of new technology. The workers are more motivated and therefore improve the quality of their work. • Better quality products are produced owing to better production methods and better-quality control. • More accurate consumer demand results from computers being used to monitor inventory levels. • Quicker communication and reduced paperwork, owing to computers, lead to increased profitability. • The information that is available to managers is much greater and this results in better and quicker decision making. • New products are introduced as new methods of production are introduced. The market and tastes of the consumer have changed.
- 45. Disadvantages of new technology Unemployment rises as machines/computers replace people on the factory floor and in offices. It is expensive to invest in, which also increases the risks as large quantities of products need to be sold to cover the cost of purchasing the equipment. Employees are unhappy with the changes in their work practices when new technology is introduced. New technology is changing all the time and will often become outdated quite quickly and need to be replaced if the business is to remain competitive.
- 46. Costs, scale of production and break-even analysis
- 47. Business costs All business activities involve costs of some sort. These costs cannot be ignored. For example, the manager of a business is planning to open a new factory making sports shoes. Why does the manager need to think about costs? Some of the reasons are explained below. • The costs of operating the factory can be compared with the revenue from the sale of the sports shoes to calculate whether or not the business will make a profit or loss. This calculation is one of the most important made in any business. • The costs of two different locations for the new factory can be compared. This would help the owner make the best decision. • To help the manager decide what price should be charged for a pair of sports shoes. Accurate cost information is therefore very important for managers.
- 48. Fixed costs and variable costs • The main types of costs are fixed costs and variable costs. • Fixed costs are costs which do not vary with the number of items sold or produced in the short run. They have to be paid whether the business is making any sales or not. They are also known as overhead costs. Examples of fixed costs include management salaries and rent paid for property. Even if output was zero, these costs would still have to be paid. • Variable costs are costs which vary directly with the number of items sold or produced. Examples of variable costs include material costs and piece- rate labour costs. The more units that are produced, the higher these variable costs will be.
- 49. Business Costs: Summary • Needed to calculate profit and loss. • Help managers to make decisions. • Can be either fixed or variable with output. TOTAL COSTS = FIXED COSTS + VARIABLE COSTS
- 50. Fixed costs and variable costs • The total costs of a business, during a period of time, are all fixed costs added to all variable costs of production. This total figure can then be compared with the sales revenue for the period to calculate the profit or loss made. • Average cost is the total cost of production divided by total output (sometimes referred to as ‘unit cost’. Total cost = average cost per unit x output
- 51. Using cost data to make cost-based decisions Use of cost data Example Explanation Setting prices Avearge cost of making a pizza=$3. If the business wants to make $1 profit on each pizza sold, it will charge a prize of $4. If the average cost per unit was not known, the business could charge a price that leads to a loss being made on each item sold. Deciding whether to stop production If the total annual cost of producing a product is $25 000 but the total revenue is only $23 000, then the business is making a loss and could decide to stop making the product. No business will willingly continue to make a loss but the decision to stop making a product will also depend on whether: • The product has just been launched on the market-sales revenue might increase in future. • The fixed costs will still have to be paid e.g. if the factory being used for the product is not sold Deciding on the best location Location A for a new shop has total annual costs of $34 000. Location B for a new shop has total annual costs of $50 000. On this data alone, Location A should be chosen. Costs are not the only factor to consider – there might not be any point in choosing a low-cost location for a new shop if it is in the worst part of town.
- 52. ECONOMIES OF SCALE AND DISECONOMIES OF SCALE ECONOMIES OF SCALE are the factors that lead to a reduction in average costs as a business increases in size. There are five economies of scale. Purchasing economies When businesses buy large numbers of components, for example materials or spare parts, they are able to gain discounts for buying in bulk. This reduces the unit cost of each item bought and gives the firm an advantage over smaller businesses which buy in small quantities. Marketing economies There are several advantages for a large business when marketing its products. It might be able to afford to purchase its own vehicles to distribute goods rather than depend on other firms. Advertising rates in papers and on television do not go up in the same proportion as the size of an advertisement ordered by the business. The business will not need twice as many sales staff to sell ten product lines as a smaller firm needs to sell five.
- 53. ECONOMIES OF SCALE Financial economies Larger businesses are often able to raise capital more cheaply than smaller ones. Bank managers often consider that lending to large organisations is less risky than lending to small ones. A lower rate of interest is therefore often charged. Managerial economies Small businesses cannot usually afford to pay for specialist managers, for example marketing managers and qualified accountants. This tends to reduce their efficiency. Larger companies can afford specialists, and this increases their efficiency and helps to reduce their average costs.
- 54. ECONOMIES OF SCALE Technical economies • There are many of these, but a few examples will help to show how important they can be. Large manufacturing firms often use flow production methods. These apply the principle of the division of labour. Specialist machines are used to produce items in a continuous flow with workers responsible for just one stage of production. Small firms cannot usually afford this expensive equipment. It could be that they sell their products in small quantities and flow production could not be justified. The use of flow production and the latest equipment will reduce the average costs of large manufacturing businesses. • In addition, some machinery is only made with a certain high output capacity. For example, an automatic welding machine can do 100 welds a minute. A small firm, if it bought such a machine, could not keep the machine working all day and the average cost of using it would be high. This is because the machinery is not 'divisible' into smaller capacity machines.
- 55. ECONOMIES OF SCALE Economies of scale can result in lower average (or unit) costs not lower total costs. A large business is likely to have higher total costs than a small one — but lower average costs.
- 56. Diseconomies of scale • Diseconomies of scale are the factors that lead to an increase in average costs as a business grows beyond a certain size. • Some research suggests that very large businesses may become less efficient than the smaller ones and this could lead to higher average costs for big firms. Poor communication The larger the organisation the more difficult it becomes to send and receive accurate messages. If there is slow or inaccurate communication, then serious mistakes can occur which lead to lower efficiency and higher average costs.
- 57. Diseconomies of scale Low morale Large businesses can employ thousands of workers. It is possible that one worker will never see the top managers of the business. Workers may feel that they are unimportant and not valued by the management. In small firms it is possible to establish close relationships between workers and top managers. The lack of these relationships in a big firm can lead to low morale and low efficiency amongst the workers. This will tend to push up average costs. Slow decision making It often takes longer for decisions made by managers to reach all groups of workers, and this could mean that it will take a long time for workers to respond and act upon managers' decisions. The top managers will be so busy directing the affairs of the business that they may have no contact at all with the customers of the firm and they could become too removed from the products and markets the firm operates in.
- 58. Breakeven Level of Output Break-even level of output is the quantity that must be produced/sold for total revenue to equal total costs (also known as break-even point).
- 59. Break Even Charts: comparing costs with revenue • Break even is a very important idea for any business-especially a newly set up business. • The break-even level of output or sales indicates to the owner or manager of a business the minimum level of output that must be sold so that total costs are covered. • At this break-even level of output, it is important to note that a profit is not being made-but neither is a loss! • The ‘quicker’ a newly set up business can reach break even point the more likely it is to survive-and go on to make a profit. • If a business never reaches break even point, then it will always make a loss. • The breakeven level of output can be worked out in two ways:- 1. By drawing a break-even chart or graph 2. By calculation.
- 60. Drawing a break-even chart • Break-even charts are graphs which show how costs and revenues of a business change with sales. They show the level of sales the business must make in order to break-even. • The revenue of a business is the income during a period of time from the sale of goods or services. TOTAL REVENUE = QUANTITY SOLD X PRICE. In order to draw a break-even chart, we need information about the fixed costs, variable costs and revenue of a business. For example, in a sports shoe business we will assume that: • fixed costs are $5 000 per year • the variable costs of each pair of shoes are $3 • each pair of shoes is sold for a price $8 • the factory can produce a maximum output of 2000 pairs of shoes per year.
- 61. Drawing a break-even chart To draw a break-even chart, it will help if a table is completed. Take note of variable costs and revenue when no output is being produced. Clearly, there will be no variable costs as no shoes are being made and, as no shoes are being sold, there will be no revenue. • When output is 2000 units, variable costs will be: 2000 x 6 = $6 000 • Assuming all output is sold, total revenue will be: 2000 x 8 =$16 000 Sales ($)=0 Sales ($)=500 Sales ($)=2000 units Fixed costs 5000 5000 5000 Variable costs 0 1500 6000 Total costs 5000 6500 11000 Revenue 0 4000 16000
- 63. Break-even chart • the 'y' axis (the vertical axis) measures money amounts — costs and revenue • the ‘x’ axis (the horizontal axis) shows the number of units produced and sold • the fixed costs do not change at any level of output • the total cost line is the addition of variable costs and fixed costs. What does the graph show? The break-even point of production is where total costs and total revenue cross. The business must therefore sell 1000 pairs of shoes in order to avoid making a loss. At production below the break-even point, the business is making a loss. At production above the break-even point, the firm makes a profit. Maximum profit is made when maximum output is reached, and this is a profit level of $ 5000.
- 64. Class-work Activity 18.6 Page 229 in the textbook
- 65. Uses of break- even charts Apart from identifying the break-even point of production and calculating maximum profit — there are other benefits of break-even charts. Advantages of break-even charts Managers are able to read off from the graph the expected profit or loss to be made at any level of output. Impact on profit or loss of certain business decisions can also be shown by redrawing the graph. Consider again the sports shoe business. What would happen to break-even point and maximum output level if the manager decided to increase the selling price to $9 per pair? This new situation can be shown on another break-even chart.
- 67. Advantages of break-even charts Maximum revenue now rises to $18 000. The break-even point of production falls to 833 units and maximum profit rises to $7000. Seems like a wise decision! However, the manager needs to consider competitors' prices too and he may not be able to sell all 2000 pairs at $9 each. • The break-even chart can also be used to show the safety margin — the amount by which sales exceed the break-even point. In the graph above, if the firm is producing 1000 units, the safety margin is 167 units (1000 - 833).
- 68. Limitations of break-even charts • Break-even charts are constructed assuming that all goods produced by the firm are actually sold — the graph does not show the possibility that inventories may build up if not all goods are sold. • Fixed costs only remain constant if the scale of production does not change. For example, a decision to double output is almost certainly going to increase fixed costs. In the case of the sports shoe business, an increase in output above 2000 will need a larger factory and more machinery. • Break-even charts concentrate on the break-even point of production, but there are many other aspects of the operations of a business which need to be analysed by managers, for example how to reduce wastage or how to increase sales. • The simple charts used in this section have assumed that costs and revenues can be drawn with straight lines. This will not often be the case; for example, increasing output to the capacity of a factory may involve paying overtime wage rates to production workers. This will make the variable cost line slope more steeply upwards as output expands. Also, in order to increase sales a business may need to offer discounts for large orders, and this will cause the slope of the revenue line to be less steep
- 69. Homework Activity 18.7 Textbook page 231 Questions a) to d)
- 70. Break-even point: the calculation method It is not always necessary to draw a break-even chart in order to show the break-even point of production. It is possible to calculate this. The CONTRIBUTION of a product is its selling price less its variable cost.
- 71. Case study example • Cape Designs Ltd make wooden desks. The selling price of each desk is $50. The variable costs of materials and production labour are $20. The weekly fixed costs are $6000. • What is the break-even level of production? It is necessary to calculate the contribution of each desk. This is the selling price less the variable cost. The calculation for the contribution of each desk is: Selling price — Variable cost = Contribution $50 - $20 = $30 • Each desk gives a contribution to fixed costs and profit of $30. In order to break even each week, the business must make sufficient desks, contributing $30 each, to cover the fixed costs of $6000. Break-even level of production = Total fixed costs Contribution per unit = $6000 = 200 units per week $30
- 72. Achieving quality production • Quality means to produce a good or a service which meets customer expectations. • Imagine you went to the shops and bought a pair of jeans, took them home and found that they had a hole in them — you would not be a very happy customer! • The business would get a bad reputation if this happened very often and would lose sales. • You would probably take the jeans back to the shop and expect a replacement. • If the shop refused to replace the jeans, you would feel this was unfair which is why in some countries there are laws to protect consumers so that shops have to replace faulty products or refund the price.
- 73. What quality means and why it is important for all businesses A business needs to try to ensure that all the products or services it sells are free of faults or defects. This will ensure that the business: • establishes a brand image • builds brand loyalty • will maintain a good reputation • will help to increase sales • attracts new customers.
- 74. BUT IF QUALITY IS NOT MAINTAINED THE BUSINESS WILL: • lose customers to other brands • have to replace faulty products or repeat poor service which raises costs for the business • have customers who tell other people about their experiences, and this may give the business a bad reputation leading to lower sales and profits.
- 75. What does quality mean? • Quality does not just mean producing a high-quality product or service. • Ask yourself this question — if you buy a low-priced remote- controlled toy car would you expect it to work as well as an expensive toy car? • The answer will probably be no. But you do expect the low-priced product to be perfect and not have any faults. • A manufacturing business needs a product with a good design, then it needs to ensure that it is manufactured without any faults and the product needs to satisfy the wishes of the customer. • A service providing business needs to match customer expectations with its level of customer service, delivery times and convenience. • Therefore, quality is a very important part of any business in both the manufacturing and service sectors. • There are several ways businesses can ensure that they produce a good quality product or provide a good service.
- 76. Quality control • QUALITY CONTROL IS THE CHECKING FOR QUALITY AT THE END OF THE PRODUCTION PROCESS, WHETHER IT IS THE PRODUCTION OF A PRODUCT OR SERVICE. • A traditional way to make sure that products went out of factories with no defects was to have Quality Control departments whose job it was to take samples at regular intervals to check for errors. • If errors or faults were found, then a whole batch of production might have to be scrapped or reworked. • The Quality Control department would check that quality was being maintained during the production of goods, try to eliminate errors before they occurred, and find any defective products before they went out of the factory to customers. • A business may also use a 'mystery customer' to test out the service to check if the quality is as expected.
- 77. Quality Control Advantages • Tries to eliminate faults or errors before the customer receives the product or • Less training required for the workers. Disadvantages/drawbacks: • Expensive as employees need to be paid to check the product or service • Identifies the fault but doesn't find why the fault has occurred and therefore is difficult to remove the problem • increased costs if products have to be scrapped or reworked or service repeated.
- 78. Quality assurance • Quality assurance is the checking for the quality standards throughout the production process, whether it is the production of a product or service. • This takes a slightly different approach to quality. The business will make sure quality standards are set and then it will apply these quality standards throughout the business. • The purpose of quality assurance is to make sure that the customer is satisfied, with the aim of achieving greater sales, increased added value and increased profits. • To implement a quality assurance system, several aspects of production must be included. • Attention must be paid to the design of the product, the components and materials used, delivery schedules, after-sales service and quality control procedures. • The workforce must support the use of this system, or it will not be effective.
- 79. Quality assurance Advantages: • tries to eliminate faults or errors before the customer receives the product or service • fewer customer complaints • reduced costs if products do not have to be scrapped or reworked or service repeated. Drawbacks: • expensive to train employees to check the product or service • relies on employees following instructions of standards set.
- 80. Total Quality Management (TQM) Total Quality Management (TQM) is one approach to implementing a quality assurance system.Again, it is the influence of the Japanese that has changed the way quality is ensured in many businesses today. • TQM is the continuous improvement of products and processes by focusing on quality at each stage of production. It tries to get it right first time and not have any defects. • There is an emphasis on ensuring that the customer is always satisfied, and the customer can be other people/departments in the same business that you are completing tasks for, not just the final customer. • This should mean that quality is maintained throughout the business and no faults should occur, as all employees are concerned with ensuring that a quality good or service is delivered. • TQM should mean that costs will fall. It is closely linked with Kaizen and the use of quality circles. Quality circles are where groups of workers meet regularly and discuss problems and possible solutions. Workers are encouraged to suggest new ideas to reduce waste and ensure zero defects.
- 81. Total Quality Management Advantages: • quality is built into every part of the production of a product or service and becomes central to the ethos of all employees • eliminates all faults or errors before the customer receives the product or service as it has a 'right first time' approach • no customer complaints and so brand image is improved — leading to higher sales • reduced costs as products do not have to be scrapped or reworked or service repeated • waste is removed and efficiency increases. Drawbacks: • expensive to train employees to check the product or service • relies on employees following TQM ideology.
- 83. HOW CAN A CUSTOMER BE ASSURED OF A QUALITY PRODUCT OR SERVICE? • Ifa customer wants to be sure that a product or service will meet particular standards, then they can look for a quality mark associated with the product or service. The business can apply to have this quality mark on their goods or services, and they will have to follow certain rules to be able to keep this quality mark. An example is the ISO (International Organisation for Standardization) which grants a business the right to use an ISO number in its literature and advertising. • Ensuring a good customer service is also important to service sector businesses. They may not usually use a quality mark to show they provide a good service, but by having a good reputation and recommendations by satisfied customers they will keep repeat customers as well as gain new ones. Internet sites, such as TripAdvisor, are useful ways for businesses to gain a good reputation if satisfied customers put positive reviews on the site. Of course, bad reviews will give the business the opposite effect and they will lose many potential customers as well as the dissatisfied customer who posted the review.
- 84. LOCATION DECISIONS • The location of a business is usually considered either when the business is first setting up or when its present location proves unsatisfactory for some reason. The business environment is constantly changing and a business's objectives, for example expanding or increasing profits, may result in a location no longer being suitable. The business may decide to look for an alternative site or may decide to set up additional factories/shops either in the home country or abroad. • Many businesses operate on a large scale and look at location on a world level, not just on a national or continental level. This is often termed globalisation because firms plan many aspects of their business, such as location decisions, marketing and sales, on a global scale. • Factors affecting where a manufacturing business chooses to locate will usually be different from those factors affecting where a service sector business will set up, even though some factors will be common to both.
- 85. FACTORS AFFECTING THE LOCATION OF A MANUFACTURING BUSINESS 1.Production methods and location decisions • The type of production methods used in a manufacturing business is going to have a significant influence on the location of that business. • If job production is used, the business is likely to be on a small scale and so the influence of the nearness of components, for example, will be of less importance to the business than if flow production is used. • If production is on a large scale, the location of component suppliers might be of greater importance because a large number of components will need to be transported and the cost will be high.
- 86. FACTORS AFFECTING THE LOCATION OF A MANUFACTURING BUSINESS 2. Market • Locating a factory near to the market for its products used to be thought important when the product gained weight — when it became heavier and more expensive to transport than the raw materials/components. An example might be a drinks manufacturer, where the bottles and ingredients are lighter than the filled bottles and so the factory may have to be located near to the main markets for the product. • Today, because transport is much improved, being near to markets is of less importance, even for weight-gaining or bulk-increasing products. If the product perishes quickly and needs to be fresh when delivered to the market, such as milk, bread or cakes, the factory might be located close to its retail outlets. However, ways of preserving food for longer have reduced the importance of this factor.
- 87. FACTORS AFFECTING THE LOCATION OF A MANUFACTURING BUSINESS 3. Raw materials/components • The raw materials may be considerably heavier or more expensive to transport than the finished product. Where a mineral is processed from the ore, there will usually be considerable waste produced in this process. It is often cheaper to process the ore near to the mining site than to transport it elsewhere • If a particular process uses many different components, a business might look very carefully at its location. If many of these component suppliers are located near to one another, it might be preferable to locate near to these suppliers. This was often a factor in car manufacturing, where many different components are used to assemble a car, but again improved transport has lessened this influence. • If the raw material needs to be processed quickly whilst still fresh, locating near to the raw material source is still important. An example is frozen vegetables or tinned fruits, which need to be processed quickly. There will also be a lot of waste generated which does not go into the packaging.
- 88. FACTORS AFFECTING THE LOCATION OF A MANUFACTURING BUSINESS 4. External economies of scale • External economies of scale are cost benefits to a business resulting from locating in a region with other businesses operating in the same industry. • Firms which support the business in other ways might need to be located nearby. Support businesses which install and maintain equipment may be better if nearby so that they can respond quickly to breakdowns. • The local education establishments, such as universities, might have research departments who work with the business on developing new products — being in close contact may help the business to be more effective. 5. Availability of labour To be able to manufacture products at least some labour will be necessary, even if it is not a great number. If particular skilled labour is needed, it may be easier and cheaper to recruit these employees if the business sets up in an area where people with the relevant skills live. If the manufacturing process requires a large number of unskilled workers, an area where there is high unemployment may be more suitable. Also, the wage rates paid to employees might vary and an area where wages are lower might be preferable.
- 89. FACTORS AFFECTING THE LOCATION OF A MANUFACTURING BUSINESS 6. Government influence • When a government wants to encourage businesses to locate in a particular area it will offer state-funded grants to encourage firms to move there. • If an area has high unemployment, the government might give money to businesses who locate in that area. • However, the government influence might be negative in that there might be regulations or restrictions on what businesses can do. • In fact, a government can refuse to allow a business to set up altogether. An example might be where the business produces a harmful waste product during the manufacturing process and the government will not want the waste product, for example nuclear waste, to poison the surrounding area.
- 90. FACTORS AFFECTING THE LOCATION OF A MANUFACTURING BUSINESS 7. Transport and communications Businesses usually need to be near to a transport system, be it road, rail, inland waterway, port or airport. Where the product is for export then the ability to easily get to a port will be important. A nearby motorway can reduce costs by speeding up the time spent delivering the products to market even when the market is quite a distance away. 8. Power and water supply Today electricity is available in most places and therefore the availability of power is not so important. But to some industries having a reliable source of power, and therefore no regular power cuts, may be essential.The same could be said of water as for power — a reliable supply will be needed. If large supplies of water are needed as part of the manufacturing process, for example, for cooling purposes with a power station, then being near to a water supply, such as the sea or a river, will be important. 9. Climate This will not influence most manufacturing businesses but occasionally climate might be important. For instance, Silicon Valley in the US has a very dry climate which aids the production of silicon chips.
- 91. Factors affecting location of a service sector business
- 92. 1. Customers • Locating a service sector business near its customers will be very important for certain types of services. These are usually services where direct contact between the business and the customer is required. If a quick response time is needed to serve the customers, then the business needs to be located nearby. This would be true for plumbers and electricians who serve the local area in which they live. Other examples of personal services that need to be convenient for customers to use are hairdressers, beauticians, caterers, restaurants, cafés, gardeners, builders, post offices. • Some services do not need to be near to customers. Direct personal contact is not necessary as these services can be contacted by telephone, post or the internet. These businesses can therefore be located in different parts of the country or in different countries to where their customers live. With the increasing use of IT and the internet more and more firms are becoming free from the need to locate near to their customers.
- 93. 3. Technology Technology has allowed some services to locate away from their customers. Some services are now conducted by telephone or via the internet and therefore the business itself does not need to be near to customers, for example website designers. These service businesses can locate anywhere and can therefore choose to locate on the outskirts of cities or even in remote areas (dependent on how many employees are required), so that they can take advantage of cheaper rent. 4. Personal preference of the owners The owners of businesses can influence where particular services choose to locate. They often locate their business near to where they live. 5.Availability of labour If a service business requires a large number of employees, then it cannot locate in remote areas. It will need to locate near to a large town or city. Ifa particular type of skilled labour is required then it may also have to locate near to where this labour is found. However, it is more likely that the particular skilled labour will move near to the business for work rather than the other way round.
- 94. 6. Climate Climate will affect some businesses particularly if they are linked to tourism in some way. Hotels often need to locate themselves where the climate is good and near to a beach. 7. Near to other businesses Some services serve the needs of large businesses, such as firms that service equipment found in big companies. They will need to be nearby to respond quickly to a call to repair equipment. Services such as banks need to be near busy areas for the convenience of customers. However, internet banking has made this less important today. 8. Rent/taxes • If the service does not need to be on the main streets in a town or city centre, for example doctors, dentists or lawyers then the business will locate on the outskirts of town to benefit from lower rents and taxes.
- 95. Factors affecting the location of a retailing business
- 96. Retail businesses are in the service sector, but some special location factors often apply to these types of business. 1. Shoppers Most retailers will want an area which is popular, such as a shopping mall/centre. The type of shopper an area attracts will also influence the attractiveness of the area to particular types of retailers. If the retailer sells expensive goods, it needs to be in an area where people on high incomes might visit; if the goods are small gift-type products, the retailer might want to be in an area visited by tourists. 2. Nearby shops Being able to locate near to shops/businesses which are visited regularly, such as a post office or popular fast-food outlet, will mean that a lot of people pass your shop on the way to other shops and businesses and may go in to make a purchase. There may be many competitors nearby. You may think that this is bad for business, but it can also be a positive situation. If the business sells clothes, then being located near to many other clothes shops encourages people to visit the area as there is a lot of choice, therefore increasing business. If the clothes shop is in a position where there are no other similar shops nearby, it may not attract people to visit the shop as there will be limited choice.
- 97. 3. Customer Parking available/nearby Where parking is convenient and near to the shops, this will encourage shoppers to that area and therefore possibly increase your sales. Lack of parking may put people off visiting the area and sales will be lower. 4. Availability of suitable vacant premises If a suitable vacant shop or premises is not available for purchase or rent, the business may not be able to locate in the area it wishes. 5. Rent/taxes The more central the site of the premises, the higher the rent and taxes will usually be. If a retail area is popular, there will be a high demand for sites in this area and therefore the cost of renting these sites will be higher. If the area is less popular, such as on the edge of town, the demand and therefore the rents will be lower.
- 98. Security, Legislation and access for delivery vehicles 6. Access for delivery vehicles Access for delivery vehicles might be a consideration if it is very difficult for them to gain access to the premises. 7. Security High rates of crimes such as theft and vandalism may deter a business from locating in a particular area. Insurance companies may not want to insure the business if it is in an area of high crime. A shopping area which is patrolled by guards, even though it will be more expensive to rent the premises, might prove preferable. 8. Legislation In some countries there may be laws restricting the trading or marketing of goods in particular areas.
- 99. Locating in different countries • Multinational (transnational) companies have offices, factories, service operations or shops in many different countries. • However, the rapid growth of newly industrialising countries, increasing international trade, improved global communications and improvements in transport have meant that many businesses can now consider where in the world to operate rather than just considering a single country; often called globalisation. • Therefore, this means that many more businesses, other than multinationals, are considering moving to another country, either to expand their operations or sometimes to relocate entirely, many from developed countries to rapidly growing economies. • A number of factors will affect whether a business decides to relocate to another country and which country to choose where to locate.
- 100. 1. New markets overseas • When a business sees a steady increase in its sales overseas it may decide to relocate nearer to these markets rather than transport its products from the existing manufacturing base as it may be more cost effective. • An example is JCB construction equipment which has built additional factories in Brazil and China as well as keeping its existing factory in the UK. • If the business is in the service sector, then locating near to its customers may be essential (for example Starbucks). The better the forecasts for growth in these markets then the more attractive the location for business.
- 101. 2. Cheaper or new sources of materials If the raw material source runs out, a business must either bring in alternative supplies from elsewhere or move to a new site in a country where it can more easily obtain these supplies. This is particularly true of mineral sources such as oil wells — these need to be in the country where the oil is found. Also, it might be cheaper to use the raw materials at their source rather than transport them to another country to process. 3. Difficulties with the labour force and wage costs If the business is located in a country where wage costs keep on rising, there may come a point when the business decides it is more profitable to relocate overseas, particularly labour-intensive businesses, to reduce wage costs. This has been true of many Western businesses moving their manufacturing plants to developing countries where the wages paid are much lower (for example, Vietnam for textile products). If particular types of skilled labour are needed by the business, the business might need to relocate to a different country where it can recruit the right type of labour. This has been true for businesses which employ staff with IT skills being attracted to locate in India which has a large number of graduates from university with IT-related degrees.
- 102. Rent, Grants and trade barriers 4. Rents/taxes considerations If other costs such as rent or taxes (on profits or personal incomes) keep increasing this might cause the business to relocate to countries where these rents or taxes are lower. 5. Availability of government grants and other incentives Governments may want to encourage foreign businesses to locate in their country to bring in investment and job opportunities. They may be willing to give grants, lower taxes or other incentives to businesses to induce them to come to their country rather than go elsewhere. Governments do this because the businesses will provide jobs and possibly teach new skills and import their technology into the economy. 6. Trade and tariff barriers If there are trade barriers, such as tariffs (tax on imported goods) or quotas (where a limit is placed on the quantity of imports of a particular good), then by locating in that country there will be no restrictions. An example of this is the investment by Japanese car companies in Europe in order to get around the European Union's strict quotas for the import of cars.
- 103. The role of legal controls on location decisions The decisions by firms about where to locate their business can have a very important effect on the firm's profitability. Managers will want to locate their businesses in the best possible area, taking into account factors such as cost of land, proximity to transport links and customers, availability of workers, and so on. Why do governments try to influence these location decisions? Usually for TWO MAIN REASONS: 1. To encourage businesses to set up and expand in areas of high unemployment — in some countries these are called development areas 2. To discourage firms from locating in overcrowded areas or on sites which are noted for their natural beauty.
- 104. Measures used by government to influence where firms locate. Planning regulations will legally restrict the business activities that can be undertaken in certain areas. For example, a business planning to open a factory in an area of residential housing might be refused planning permission. It would then be against the law for the firm to build the factory on this site. In certain parts of many countries, especially in particularly beautiful areas, it is not possible to establish any kind of business other than farming. Many governments provide grants or subsidies to businesses to encourage them to locate in undeveloped parts of the country. This assistance could be in the form of financial grants, such as a non-repayable amount of money paid to the business to locate in a particular area or subsidies paid to businesses (for example, low-rental factories). These development areas which receive government assistance usually have a very high unemployment rate and there is a great need for new jobs.