Department of Management

OM=CHAPTER ONE

Nature of Operations Management

1.1. Introduction

Today companies are competing in a very different environment than they were only a few years
ago. To survive they must focus on quality, time-based competition, efficiency, international
perspectives, and customer relationships. Global competition, e-business, the internet, and
advances in technology require flexibility and responsiveness. This new focus has placed
operations management in the limelight of business, because it is the function through which
companies can achieve this type of competitiveness. Consider some of today’s most successful
companies, such as Wal-Mart, Southwest Airlines, General Electric, Starbucks, Toyota, FedEx,
and Procter & Gamble. These companies have achieved world-class status in large part due to a
strong focus on operations management. In this course we will learn specific tools and
techniques of operations management that have helped these, and other companies, achieve their
success.

The purpose of this course is to help prepare you to be successful in this new business
environment. Operations management will give you an understanding of how to help your
organization gain a competitive advantage in the marketplace. Regardless of whether your area
of expertise is marketing, finance, MIS, or operations, the techniques and concepts, this
coursewill help you in your business Career. This material will teach you how your company can
offer products and services cheaper, better, and faster.

What is Operations Management?

Every business is managed through three major functions: finance, marketing, and operations
management. Figure 1-1 illustrates this by showing that the vice presidents of each of these
functions reports directly to the president or CEO of the company. Other business functions –
such as accounting, purchasing, human resources, and engineering etc. support these three major
functions. Finance is the function responsible for managing cash flow, current assets, and capital
investments. Marketing is responsible for sales, customer demand, and understanding customer

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wants and needs. Most of us have some idea of what finance and marketing are about, but what
does operations management do?

President or CEO

Marketing Operations Finance

V.P. of Marketing V.P. of Operations V.P. of Finance
Managers; Customer Managers; People, Managers; Cash flow,
demands Equipment, Current assets
Generates; sales for Technology, and
goods and Materials, and Capital
services Information investments
Generates; good and/or
services

Figure 1-1:Organizational chart showing the three major business functions.

Operation management (OM) deals with the production of goods and services that people buy
and use every day. Operations Management is the business function that plans, organizes,
coordinates, and controls the resources needed to produce a company’s goods and services.
Operations management is a management function .It involves managing people, equipment,
technology, information, and many other resources. Operations management is the central core
function of every company. This is true whether the company is large or small, provides a
physical good or a service, and is for profit or not for profit. Every company has an operations
management function. Actually, all the other organizational functions are there primarily to
support the operations functions. Without operations, there would be no goods or services to sell.
Consider a retailer such as Gap that sells casual apparel. The marketing function provides
promotions for the merchandise, and the finance function provides the needed capital. It is the
operations function, however, that plans and coordinates all the resources needed to design,
produce, and deliver the merchandise to the various retail locations. Without operations, there
would be no goods or services to sell to customers.

The role of operations management is to transform a company’s inputs into the finished goods or
services. Inputs include human resources (such as workers and managers), facilities and

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processes (such as buildings and equipment), as well as materials, technology, and information.
Outputs are the goods and services a company produces. Figure 1-2 shows this transformation
process. At a factory the transformation is the physical change of raw materials into products,
such as transforming leather and rubber into sneakers, denim in to jeans, or plastic into toys. At
an airline it is the efficient movement of passengers and their luggage from one location to
another. At a hospital it is organizing resources such as doctors, medical procedures, and
medications to transform sick people into healthy ones.

Customer Feedback

Inputs
Inputs The Transformation Process
The Transformation Outputs Outputs
Human Resources
 Human
Process Goods
 Goods
Facilities & Processes
 Resources Services
 Services
Technologies
 Facilities
Materials &
Performance Information
Processes
 Technolog
ies

Figure 1-2 The transformation process

Operations management is responsible for orchestrating all the resources needed to produce the
final product. This includes designing the product; deciding what resources are needed;
arranging schedules, equipment, and facilities; managing inventory; controlling quality;
designing the jobs to make the product; and designing work methods. Basically, operations
management is responsible for all aspects of the process of transforming inputs into outputs.
Customer feedback and performance information are used to continually adjust the inputs, the
transformation process, and characteristics of the outputs. As shown in Figure 1-2, this
transformation process is dynamic in order to adapt to changes in the environment.
Proper management of the operations function has led to success for many companies. For
example, in 1994 Dell Inc. was a second higher computer maker that managed its operations
similar to others in the industry. Then Dell implemented a new business model that completely
changed the role of its operations function. Dell developed new and innovative ways of

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managing the operations functions that have become one of today’s best practices. These
changes enabled Dell to provide rapid product delivery of customized products to customers at a
lower cost, and thus become an industry leader.

Just as proper management of operations can lead to company success, improper management of
operations can lead to failure. This is illustrated by Kozmo.com, a Web-based home delivery
company founded in 1997. Kozmo’s mission was to deliver products to customers- everything
from the latest video to ice cream – in less than an hour. Kozmo was technology enabled and
rapidly became a huge success. However, the initial success gave rise to overly fast expansion.
The company found it difficult to manage the operations needed in order to deliver the promises
made on its Web site. The consequences were too much inventory, poor deliveries, and losses in
profits. The company rapidly tried to change its operations, but it was too late. It had to cease
operations in April 2001.

The Web-based age has created a highly competitive world of online shopping that poses special
challenge for operations management. The Web can be used for on-line purchasing of everything
from CDs, books, and groceries to prescription medications and automobiles. Whereas the
Internet has given consumers flexibility, it has also created one of the biggest challenges for
companies: delivering exactly what the customer ordered at the time promised. As we saw with
the example of Kozmo.com, making promises on a Web site is one thing; delivering on those
promises is yet another. Ensuring that orders are delivered from “mouse to house’ is the job of
operations and is much more complicated than it might seem. In the 1990s many dot-com
companies discovered just how difficult this is. They were not able to generate a profit and went
out of business. To ensure meeting promises companies must forecast what customers want and
maintain adequate inventories of goods, manage distribution centers and warehouses, operate
fleets of trucks, and schedule deliveries while keeping costs low and customers satisfied. Many
companies like Amazon.com manage almost all aspects of their operation. Other companies hire
outside firms for certain functions, such as outsourcing the management of inventories and
deliveries to UPS. Competition among e-trailers has become intense as customers demand
increasingly shorter delivery times and highly customized products. A same-day service has
become common in metropolitan areas. For example, Barnesandnoble.com provides same-day

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delivery in Manhattan, Los Angeles, and San Francisco. Understanding and managing the
operations function of an on line business has become essential in order to remain competitive.

For operations management to be successful, it must add value during the transformation
process. We use the term value added to describe the net increase between the final value of a
product and the value of all the inputs. The greater the value added, the more productive a
business is. An obvious way to add value is to reduce the cost of activities in the transformation
process. Activities that do not add value are considered a waste; these include certain jobs,
equipment, and processes. In addition to value added, operations must be efficient. Efficiency
means being able to perform activities well, and at the lowest possible cost. An important role of
operations is to analyze all activities, eliminate those that do not add value, and restructure
processes and jobs to achieve greater efficiency. Today’s business environment is more
competitive than ever, and the role of operations management has become the focal point of
efforts to increase competitiveness, by improving value added and efficiency.

1.2. Differences between Manufacturing and Service Organizations

Organizations can be divided into two broad categories: manufacturing organizations and service
organizations, each posing unique challenges for the operations function. There are two primary
distinctions between these categories. First, manufacturing organizations produce physical,
tangible goods that can be stored in inventory before they are needed. By contrast, service
organizations produce intangible products that cannot be produced ahead of time. Second, in
manufacturing organizations most customers have no direct contact with the operation. Customer
contact is made through distributors and retailers. For example, a customer buying a car at a car
dealership never comes into contact with the automobile factory. However, in service
organizations the customers are typically present during the creation of the service. Hospitals,
colleges, theaters, and barber shops are examples of service organizations in which the customer
is present during the creation of the service.

The differences between manufacturing and service organizations are not as clear-cut as they
might appear, and there is much overlaps between them. Most manufacturers provide services as
part of their offering, and many service firms manufacture physical goods that they deliver to
their customers or consume during service delivery. For example, a manufacturer of furniture

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may also provide shipment of goods and assembly of furniture. On the other hand, a barber shop
may sell its own line of hair care products. You might not know that General Motors’ greatest
return on capital does not come from selling cars but rather from post sales parts and service. The
differences between manufacturing and services are shown in figure 1-3, which focuses on the
dimensions of product tangibility and the degree of customer contact. Pure manufacturing and
pure service extremes are shown, as well as the overlap between them.

Figure 1-3. Characteristics of manufacturing and service organizations

DEGREE OF CUSTOMER CONTACT
Low High

Manufacturing Organization
Physical product
Product can be inventoried
Low customer contact
Capital intensive
Long response time

Intangible product
Product cannot be inventoried
High customer contact
Labor intensive
Short response time

Service Organization

Even in pure service companies some segments of the operation may have low customer contact
while others have high customer contact. The former can be thought of as “back room” or
“behind the scenes” segments. Think of a fast-food operation such as Wendy’s, for which
customer service and customer contact are important parts of the business. However, the kitchen
segment of Wendy’s operation has no direct customer contact and can be managed like a
manufacturing operation. Similarly, a hospital is a high-contact service operation, but the patient
is not present in certain segments, such as the lab where specimen analysis is done. In addition to

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pure manufacturing and pure service, there are companies that have some characteristics of each
type of organization. For these companies it is difficult to tell whether they are actually
manufacturing or service organizations. Think of a post office, an automated warehouse, or a
mail-order catalog business. These companies have low customer contact and are capital
intensive, yet they provide a service. We call these companies quasi-manufacturing
organizations.

Manufacturing vs Service
Characteristic Manufacturing Service
 Out put Tangible Intangible
 Customer contact Low High

 Uniformity of input High Low

 Labor content Low High

High Low
 Uniformity of output
Easy difficult
 Measurement of productivity
High Low
 Opportunity to correct quality
problems

It is important to understand how to manage both service and manufacturing operations.

However, managing service operations is of especially high importance. The reason is that the
service sector constitutes a dominant segment of the world economy.

1.3. Operations Management Decisions

In this section we look at some of the specific decisions that operations managers have to
make.we need to make decisions for the whole companies that are long term in nature. Long-
term decisions that set the direction for the entire organization are called strategic decisions.
They are broad in scope and set the tone for other, more specific decisions. They address
questions such as: What are the unique features of our product? What market do we plan to
compete in? What do we believe will be the demand for our product? Short term decisions that
focus on specific departments and tasks are called tactical decisions. Tactical decisions focus on
more specific day-to-day issues, such as the quantities and timing of specific resources. Strategic
decisions are made first and determine the direction of tactical decisions, which are made more

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frequently and routinely. Therefore, we have to start with strategic decisions and then move on to
tactical decisions. This relationship is shown in figure 1-5.

Tactical decision must be aligned with strategic decisions, because they are the key to the
company’s effectiveness in the long run. Tactical decisions provide feedback to strategic
decisions which can be modified accordingly. OM decisions are critical to all types of
companies, large and small. In large companies these decisions are more complex because of the
size and scope of the organization.

Large companies typically produce a greater variety of products, have multiple location sites,
and often use domestic and international suppliers. Managing OM decisions and coordinating
efforts can be a complicated task, yet the OM function is critical to the company’s success.

STRATEGIC DECISIONS TACTICAL DECISIONS

Broad in scope Narrow in scope
Long-term in nature Short term in nature
All encompassing Concerning a small group of issues

Eg. What are the unique features of our product that make us competitive?
Eg. Who will work the 2nd shift tomorrow?

Fig 1-5 Strategic Vs tactical decisions

1.4. PRODUCTIVITY

What is Productivity?

Productivity is the value of outputs (goods and services) produced divided by the values of the
input resources (wages, cost of equipment and the like) used or the ratio of outputs (goods and
services) to inputs (e.g. labor and materials). In other words, productivity is a measure of how
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efficiently inputs are being converted into outputs. It measures how well resources are used. The
more efficiently a company uses its resources, the more productive it is:

output
Productivity =
input

We can use this equation to measure the productivity of one worker or many, as well as the
productivity of a machine, a department, the whole firm, or even a nation. The possibilities are
shown in the following table.

Table 1-3: Productivity measures

Productivity measures
outputproduced
Total productivity measure =
allinputsused
output output output output
partial productivity measure = ∨ ∨ ∨
labor machines materials capital
Multifactor productivity measures =
output output output
∨ ∨
labor+mac h ines labor+ materials labor+ captial+ energy

When we compute productivity for all inputs, such as labor, machines, and capital, we are
measuring total productivity. Total productivity describes the productivity of an entire
organization. For example, let’s say that the weekly dollar value of a company’s outputs, such as
finished goods and work in progress is $10,200 and that the value of its inputs such as labor,
materials, and capital is $8,600. The company’s total productivity would be computed as
follows:

output $ 10,200
Total productivity = = =1.186
input $ 8,600

Often it is much more useful to measure the total productivity of one input variable at a time in
order to identify how efficiently each is being used.

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When we compute productivity as the ratio of output relative to a single input, we obtain a
measure of partial productivity also called single factor productivity. Following are two
examples of the calculation of partial productivity:

1. A bakery oven produces 346 pastries in 4 hours. What is its productivity?

numberofpastires 346 pastires
Machine productivity = = =86.5 pastries/hour
time 4 hours
2. Two workers paint tables in a furniture shop. If the workers paint 22 tables in 8 hours,
what is their productivity?
22tables
Labor productivity = =1.375tables /hour
2 workersx 8 hours

Sometimes we need to compute productivity as the ratio of output relative to a group of inputs,
such as labor and materials. This is a measure of multifactor productivity. For example, let’s say
that output is worth $382 and labor and materials costs are $168 and $98, respectively. A
multifactor productivity measure of our use of labor and materials would be

output $ 382
Multifactor productivity = = =1.436
labor+materials $ 168+ $ 98

Interpreting Productivity Measures

To interpret the meaning of a productivity measure, it must be compared with a similar

productivity measure. For example, if one worker at a pizza shop produces 17 pizzas in 2 hours,
the productivity of that worker is 8.5 pizzas per hour. This number by itself does not tell us very
much. However, if we compare it to the productivity of two other workers, one who produces 7.2
pizzas per hour and another 6.8 pizzas per hour, it is much more meaningful. We can see that the
first worker is much more productive than the other two workers. But how do we know whether
the productivity of all three workers is reasonable? Standard needs to be developed in order to go
through such cases.

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