University of Dar es Salaam

Department of Mechanical and Industrial

Engineering

IE 445: Entrepreneurship for Engineers

 Production/Operation & Technology
Analysis

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 The Theory of Production

• Production involves transformation of

inputs such as capital, equipment, labor, and
land into output - goods and services

• In this production process, the manager is

concerned with efficiency in the use of the
inputs
- technical vs. economical efficiency

3
 Two Concepts of Efficiency

• Economic efficiency:
– occurs when the cost of producing a given output
is as low as possible

• Technological efficiency:
– occurs when it is not possible to increase output
without increasing inputs

4
You will see that basic production theory is simply
an application of constrained optimization:

the firm attempts either to minimize

the cost of producing a given level of
output
or
to maximize the output attainable
with a given level of cost.

Both optimization problems lead to

same rule for the allocation of inputs
and choice of technology
5
 Production Function
• A production function is purely technical
relation which connects factor inputs &
outputs. It describes the transformation of
factor inputs into outputs at any particular
time period.
Q = f(L,K,R,Ld,T,t)
where
Q = output R= Raw Material
L= Labour Ld = Land
K= Capital T = Technology
t = time

For our current analysis, let’s reduce the

inputs to two, capital (K) and labor (L):

Q = f(L, K) 6
 Short-Run and Long-Run
Production

• In the short run some inputs are fixed and

some variable
– e.g. the firm may be able to vary the amount of
labor, but cannot change the amount of capital

– in the short run we can talk about factor

productivity / law of variable proportion/law
of diminishing returns

7
• In the long run all inputs become variable
– e.g. the long run is the period in which a
firm can adjust all inputs to changed
conditions
– in the long run we can talk about returns to
scale

8
 Relationship Between Total, Average, and
Marginal Product: Short-Run Analysis

• Total Product (TP) = total quantity of output

• Average Product (AP) = total product per total

input

• Marginal Product (MP) = change in quantity

when one additional unit of input used

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 The Marginal Product of Labor
• The marginal product of labor is the increase in
output obtained by adding 1 unit of labor but
holding constant the inputs of all other factors

Marginal Product of L:
MPL= Q/L (holding K constant)
= Q/L

Average Product of L:
APL= Q/L (holding K constant)

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 Law of Diminishing Returns
(Diminishing Marginal Product)
• The law of diminishing returns states that when more
and more units of a variable input are applied to a
given quantity of fixed inputs, the total output may
initially increase at an increasing rate and then at a
constant rate but it will eventually increases at
diminishing rates.
• Assumptions. The law of diminishing returns is based
on the following assumptions:
(i) the state of technology is given
(ii) labour is homogenous and
(iii) input prices are given. 11
 Short-Run Analysis of Total,
Average, and Marginal Product

• If MP > AP then
AP is rising
• If MP < AP then
AP is falling
• MP = AP when AP
is maximized
• TP maximized
when MP = 0

12
 Three Stages of Production in Short
Run
AP,MP
Stage I Stage II Stage III

APX

•TPL Increases at MPX X

•TPL Increases at
Diminshing rate. • TPL begins to
increasing rate.
•MPL Begins to decline. decline
•MP Increases at
decreasing rate. •TP reaches maximum •MP becomes
level at the end of stage II, negative
•AP is increasing MP = 0.
and reaches its •APL declines
•AP continues to
maximum at the decline
13
end of stage I
Application of Law of Diminishing Returns:

• It helps in identifying the rational and irrational

stages of operations.

• It gives answers to question –

a) How much to produce?
b) What number of workers to apply to a
given fixed inputs so that the output is
maximum?

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 Production/Operation & Technology
Analysis
• The Business Location
• The Manufacturing Process
• Buildings and Other Structures
• Machinery and Equipment
• Raw Materials
• Direct labour
• Factory Overhead
• Final Thoughts on Production

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 The Business Location
• After determining the nature of the product or service,
plant location is perhaps one of the most important
one-time production decision.
• It significantly affects the cost of moving your product
from your business to the doors of the potential buyers.
• You have several options in locating your business.
a) Your house.
b) A partner's property.
c) A rented space.
d) Or even an idle land that you owned.
• Whatever your choice will be, select the one closest to
your buyers (proximity to market).

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 The Business Location
• The proposed business will be located in
__________________.
• The map shown below is a guide on how to go to the
site:
• Figure: The Location Map
Draw the map and describe the Business Location
proposed site.

Why did you select this location?

NOTE : Do you own this land?  If so, how much does it cost
today? Tshs. ________
NOTE : If no, how much will you rent the space per month?
Tshs._______

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 The Business Location
BUYING THE LAND. If you need to buy the land for the
business, consider the following costs (if applicable) in
addition to the basic land cost.
i. Registration of land titles
ii. Unpaid real estate taxes
iii. Commissions to sales agents

iv. Cost of evicting tenants

v. Physical improvements and land clearing

vi. Landscaping and pavements installation

vii. Right of ways for additional access roads

viii. Access road construction

ix. Flood control systems

x. Drainage systems installation

xi. Waste disposal systems and fees
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 The Manufacturing Process
• Here, you should convince the readers (the banker
for example) that you know how to manufacture
the product (or deliver the service)--in the most
economical and in fact, much better--way.

• You should describe the process systematically,

highlighting the:
– materials,
– machinery or tools,
– time, and
– other special considerations in each step of the way.
• Use as much drawings as you can.
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 The Manufacturing Process
⚫ Describe how you will manufacture your Manufacturing Process
product?
You can either use: textual or symbolic.
Textual is a written step-by-step process
description.
Symbolic uses:
 - operation
 - inspection
D - delay
→ - transport
- inspection

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 Buildings and Other Structures
• Do you need additional space to produce the product(s)
or offer service(s)? A separate room if the business is
in your house. A street linking to the main road. A small
bicycle parking area, etc.

• They all require time and costs. You have to carefully

decide what you really need.

• After deciding, check if the following costs apply to

you:
– Building permits and licenses
– Architectural or engineering (civil, mechanical, electrical,
chemical, construction management, etc.) design fees
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 Buildings and Other Structures
• Systems installation:
• Electrical (to include 3-phase power connection, step-
down transformers, power-factor correction, wiring
networks, lighting systems, "stand-by" power systems, etc.
Please check with TANESCO).
• Water and sewage (to include water pumps, piping and
plumbing systems, sewage systems, etc. Please check with
Water Department).

• Provisions for yard, parking space, storage and warehousing,

cafeteria, workers lockers, toilets and bath, meditation room.

• Provisions for the installation of pollution system, whenever

applicable.
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 Buildings and Other Structures
⚫The proposed business will need buildings and
structures as outlined below:
Describe the building that you need. Building
Specify the shape, layout, construction
materials, how long to build it, how
much it will cost, etc.
Describe the other structures (car Other Structures
parks, access to roads, etc.) you
require.
NOTE: How much does the building and other structures cost in
total? Tshs. _____

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 Machinery and Equipment
• Now, let us consider the production engine--the machinery and
equipment.

• These consists of machinery (those that are directly used in

production of the product) and equipment (while indirectly
used, they are needed for efficient operation).

• Equipment includes transport, office equipment, materials

handling, etc.

• Don't buy them for the sake of buying.

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 Machinery and Equipment CONT’D…
• They add cost to your product. Finally, check whether any or
all of the following apply to you:

• Ordering costs (i.e., tenders, canvassing, vendor selection,

etc.)

• Procurement cost (ex-Business of the supplier)

• Freight, shipment and other transport (land, air, and sea) costs

• Brokerage and warehousing costs

• Import duties

• Insurance costs
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 Machinery and Equipment CONT’D…
They add cost to your product. Finally, check
whether any or all of the following apply to you:
• Foundation costs
• Installation costs
• Warranty costs
• Testing and adaptation costs
• Spare parts supplies costs
• Tools and other auxiliary components costs
• Formulations (e.g., chemical formula), patents,
and other technology acquisition cost
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 Machinery and Equipment CONT’D…
• If you are buying the equipment in Dar, chances are,
your supplier have already paid for most of the above
costs and have included them on your price. They are
however presented here for you not to underestimate
your machinery and equipment costs.

• Although very rarely, some suppliers already include

the training cost of one of your workers in starting,
operating, and maintaining the machinery and
equipment.

• Check whether you need additional skills training and

how much it will cost.
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 Machinery and Equipment CONT’D
• The proposed business will need the machinery and
equipment that are listed in the Table below:
Machinery/ Quantity Sources Estimated Cost
Specification Needed (in Tshs)

What
machinery
and
equipment
do you need.

` Total
• NOTE: Do you need skills training for your workers, how much will it
cost? Tshs _____
• NOTE: Do you need to try out the machine and produce some trial
production, how much will it cost? Tshs _____
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 Office Equipment
Costing the office equipment will also include
some or all of the following:
• Office furniture (tables, chairs, display
counters, file cabinets, racks, dust bins, etc.)

• Office equipment (telephone, fax, computers,

photocopiers, calculators, cash registers, cash
box, in- and out-trays, stamp pads, staplers,
coffee and tea pots, drawing boards, white
boards, etc.)

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 Office Equipment
• The proposed business will need the office
equipment that are listed in the Table below:
What office Office Quantity Sources Estimated Cost
equipment Equipment Needed (in Tshs)
do you
need?

Total
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 Transport Equipment.
• These includes carts, bicycle, motorbikes, cars, transport trucks,
delivery vans, wheel borrows, materials handling, etc.

• Consider also the costs for spare parts and add-on facilities, break-in
costs, insurance, registration and license costs, as well as duties and
taxes.

• The proposed business will need the transport equipment that are listed
in the Table below:

What Transport Quantity Sources Estimated Cost

transport Needed (in Tshs)
equipment
do you need?

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 Other Equipment
• The proposed business will need other
equipment listed in the Table below:
Other Quantity Sources Estimated
Equipment Needed Cost
Needed (in Tshs)

What other
equipment
do you
need?

Total

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 Direct Operating Costs
• Unlike the above items which are all one-time
decisions, the direct operating costs are recurrent.

• You will incur these costs every time you produce the
product.

• Thus, a simple mistake in calculating these costs can be

multiplied as many times as your production volume.

• The direct operating costs include the costs of materials

used in producing the product, the direct labour cost
and the Business overhead costs
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 Direct materials, Labour & Business overhead
• At this point in preparing your business plan, try to
imagine the costing structure of your product.

• It consists of the direct operating costs (materials,

labour and Business overhead) plus selling and
administrative costs plus your profit margin.

• You should be able to have a fairly good idea of the

percentages that these items have on your overall cost
structure.

• Let us begin with raw materials.

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 Raw Materials
• This item does not only include the direct materials that go
with the product but also indirect ones such as packaging
materials, labels, indirect materials, wastes and other defects,
repairs and reruns, ordering costs, and other storage costs.
• The proposed business will need the raw materials that are
listed in the Table below:
What raw Raw Quantity Needed Sources Price per Unit
materials do Material per Product (in Tshs)
you need for
production?

Total
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 Raw Materials
• NOTE: Estimate the percent of materials to
the overall price of the product? ______ %

• NOTE: Considering the production volume in

your sales forecasts, estimate your total
annual raw materials cost. Tshs _______

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 Direct Labour
• In this part, you need to estimate the total number of direct workers
(usually those that touch the raw materials and convert them to finish
products). In estimating the costs of direct labour, consider the following:
– Wages

– Parastatal Pension Fund

– Medical Insurance

– Non compulsory Insurance

– Sick Leave (e.g., 30 days per year, if worked more than 90 days)

– Annual Leave (15 days if worked for more than one year)

– Cost of holidays

– 13 Month Pay

– Maternity Leaves (90 days before and after at normal pay)

– Emergency Medical allowances

– Transport Allowances

– Food Allowances

• NOTE: In Tanzania, minimum wage is Ts 150,000 per month

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 Direct Labour
• The proposed business will need the direct
production workers listed in the Table below:

What workers Position Skill Level Sources Annual Wages

will you need
to maintain
production?

Total
NOTE : Estimate the percent of direct labour to the overall price of the product? ______ %

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 Factory Overhead
• In this part, you need to estimate the factory
overhead of the proposed enterprise.

• These includes the following cost items:

– Machinery repair and maintenance costs
– Telephone
– Electricity
– Water
– Kerosene, gas, etc.
– Oil, grease and lubricants
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 Factory Overhead cont….
• Fire equipment and insurance
• First aid medicine kit
• Pollution control measures
• Garbage disposal
• Security systems
• Contributions to village and community development
• Although rent is an important factory overhead item,
it will be included as plant location.

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 Factory Overhead cont`d
• The proposed business will spend on the
factory overheads listed in the Table below:
What are Factory Quantity Monthly Annual Costs
the factory Overhead Needed Costs (Tshs)
overheads (Ts)
that you
incur?

Total
NOTE: Estimate the percent of Factory Overhead to the overall price of the
product? ______ %
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 Technology risk assessment or
management
• In this section, you must define the major risks
facing the proposed technology.

• In addition to regular business risks such as

downward industry trends, cost overruns, and
unexpected entry of competitors, also include
risks specific to the technology.

• For example, be sure to address issues such as

software bugs, computer viruses, and
unfavorable new policies or legislation.
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 Technology risk assessment or
management
• A risk can be defined as an event or circumstance that has a
negative effect on your business, e.g., the risk of having equipment
or money stolen as a result of poor security procedures.

• Types of risk vary from business to business.

• You must decide on how much risk you are prepared to take in your
business.

• Some risks may be critical to your success; however, exposing your

business to the wrong types of risk may be harmful.

• Risk management is a process in which businesses identify, assess

and treat risks that could potentially affect their business
operations.
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 What is a risk?
• The most common business risk categories are:

1. Strategic – decisions concerning your business’ objectives

2. Compliance – the need to comply with laws, regulations, standards and

codes of practice

3. Financial – financial transactions, systems and structure of your business

4. Operational – your operational and administrative procedures

5. Environmental – external events that the business has little control over
such unfavourable weather or economic conditions

6. Reputational – the character or goodwill of the business.

7. Others include health and safety, project, equipment, security, technology,

stakeholder management and service delivery.

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 Preparing a risk management plan
• STEP 1: Identify the risk
• STEP 2: Assess the risk
• STEP 3: Manage the risk
• STEP 4: Monitor and review

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 Risk Response Mechanism
Escalate
Avoid

Transfer

Mitigation

Accept

A. Avoidance (Terminating the risk)

B. Transfer (Transferring the risk)
C. Mitigation (Treating the risk)
D. Acceptance (Tolerating the risk)
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 Risk management summary

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 Final Thoughts on Production
• Wonderful, you're great! You're now half-way through.
You have also realized that there are really more costs in
production that you did not anticipate you needed.
• Please don't rush. Spend an hour or so to reflect on the
decisions you made earlier.
• Review what you have done. As a whole, do they make
sense?
• Can you still eliminate some unnecessary one-time
production costs? How about the items in the direct
operating costs that are all recurrent ones, can you still
reduce on some them?
• Remember, it is better to check and re-check your estimates
and figures before spending the first Tshs/$/£ on your
proposed business.

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 Final Thoughts on Production
• How long does it take to produce one Final Thoughts on
product? Production
• How many can you produce in one
eight-hour day?
• Can you actually produce this much?
• Are there other factors that can prevent
you from producing this much?

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 Final Thoughts on Production Cont`d…
• On the space provided, write some of your Final Thoughts
thoughts on the following: on Production
• Operating under a 200-day year, how many
can you actually produce?
• Check again your costs; how much percent
of the selling price is: raw materials, direct
labour, and factory overhead.
• Finally, multiply the total annual
production volume by your price per unit
under the marketing section, does it
approximately reach your target sales
forecast for Year 1?
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