5.6 Production Planning (HL)

Greater control, less risk. It is easier to monitor logistics, quality management and ethical practices locally than globally. These issues are increasingly important to consumers, who may demand products with transparent and ethical supply chains.

Lower transport costs. Increasing trade tariffs, rising fuel prices and taxes on carbon emissions make long distance transport more costly; shorter journeys will save money.

Local–social and global–ecological benefits. Purchasing from nearby suppliers supports stronger local communities and networks. You learned about generative businesses in Section 1.5.6; these are easier to develop in a local setting.

Higher production costs. Local suppliers may not be able produce large quantities, reducing economies of scale. These higher costs can lead to higher prices for consumers.

Less choice. There may be fewer suitable suppliers offering the needed resources or products, especially for businesses in remote locations.

Greater choice. Global markets have more potential suppliers with a wider variety of materials. Some materials, such as rare earth metals, may only be available in a limited number of places.

Lower costs of production. Global suppliers may offer resources or products at lower cost, because they pay workers less, have to comply with fewer regulations, or because they have technologies to produce more efficiently. 

Greater risk. Complex global supply chains may have greater risks due to exposure to multiple geopolitical tensions. Trade barriers, armed conflict, disrupted shipping routes, rising fuel prices, natural disasters and changing regulations are all issues.

Lack of transparency and control. It is more difficult to monitor logistics, quality management, and ethical labour and environmental practices globally than locally. These issues are increasingly important to consumers, who may avoid products with supply chains that are unethical or not transparent. 

Kognity: The organisation of resources to establish what, when, how and where something can be produced.

InThinking: This is the management process of ensuring a business has the right resources at the right time to produce goods and supply services to meet the demands of its customers.

Improved cash flow and reduces costs. Businesses can reduce costs by reducing the stock (inventory) they hold. They can then use the money saved for other operations (Subtopic 3.7).

• minimized storage costs

• less waste from inventory (inventory doesn't go bad, no damaged inventory, doesn't become obsolete)

• liquidity position improves because less money spent on inventory

Improved operations. Employees know they need to be careful in operations, because there is no spare stock (inventory) to rely on.

Increased capacity. With less storage space needed for stock (inventory), more space can be allocated to production.

Reduced economies of scale. Businesses will make smaller orders, possibly reducing purchasing economies of scale (Section 1.5.2).

High risk. Production may halt if a small part of the supply chain breaks down. Any delay in delivery becomes critical for production.

Reduced resilience. Businesses may be unable to adapt to changes in the internal or external environment (related to risk). JIT may not be suitable for businesses with seasonal demand.

Expensive technology. JIT system may rely on technology to ensure efficient stock control and movement, which can be expensive and vulnerable to technical faults and breakdowns

Depends on third-party suppliers. Effectiveness relies on the efficiency and reliability of third-party suppliers

Inflexible. Cannot meet unexpected changes in demand

Resilience. Production can continue for a time, even with disruptions to supply chains. Unexpected orders can be filled.

Economies of scale. The business can order larger quantities of supplies, resulting in lower costs through purchasing economies of scale.

Less risk. The business is less exposed to changes in the external environment, such as increases in resource costs.

Increased customer satisfaction as stock is available when they want it

Less working capital. Purchasing large quantities of stock reduces liquidity (Subtopic 3.5); less cash is available for operations.

Higher storage costs. Holding large quantities of stock is costly due to space needs.

Waste. A business may not be able to use all of the large quantities of stock it purchased, resulting in wasted resources, particularly with perishable goods.

• productivity rate

• labour productivity

• capital productivity

• defect rate

• operating leverage

• capacity utilisation rate

OL > 1 → profits increase faster than sales (high leverage, high risk)

OL < 1 → profits increase slower than sales (low leverage, lower risk)

What does operating leverage tell us?

Operating leverage can be used to measure of the impact of an increase in sales revenue on the profit of the business, as this will depend on the firm's fixed and variable costs.

Operating leverage measures how a firm's operating income is affected by its fixed costs, variable costs, and sales volume. The ratio helps managers to determine whether the firms has too many fixed costs (such as rent or mortgage payments) or too many variable costs (cost of sales related to making and/or selling the products). 

A business with a lot of fixed costs will tend to face more risks. This is because a fall in sales, perhaps caused by an economic recession, will still mean those expenses have to be paid. By contrast, if there is an increase in sales revenues, the firm's fixed costs stay the same, so the business stands to gain a lot more profit.

However, if the business has a lot of variable costs, this is not so much of a risk. This is because if sales revenues fall, so will the firm's cost of sales as variable costs are directly linked to the level of production or output. Hence, operating leverage signifies the importance of controlling fixed costs. Hence, the operating leverage ratio allows a business to see how different types of expenses impact its operating income.

The DOL ratio shows how well a business is using its fixed-cost items (such as rent paid on its premises as well as the machinery and equipment used in the production process) to generate profits. The more profit that a business can squeeze out of its fixed assets (or non-current assets), the higher its degree of operating leverage will be.

• High fixed costs 

  • Eg. R&D, physical capital, marketing

    • Eg. Pharmaceutical Company

• High fixed costs compared to variable costs are more risky (not as flexible) (sad =( )

• Each sale gives you a larger amount of profit (happy =D)

More sensitive to sales fluctuations — they can gain a lot when sales rise but can lose heavily if sales drop.

Examples:

Airlines → high fixed costs (planes, maintenance, salaries); extra passengers mostly add profit

Hotels → fixed costs for property, staff; extra guests = profit once break-even is hit

Software companies (like Microsoft) → huge R&D and development costs, but selling more copies costs almost nothing

Movie theaters → rent, salaries, utilities; each extra ticket sold is almost pure profit

Car manufacturers → high investment in factories and equipment

• Means higher variable costs 

  • Eg. materials, piece rate labour, shipping, etc

    • Eg. Grocery store

• High variable costs compared to fixed costs are less risky (more flexible) (happy =D)

• Each sale gives you only a small amount of extra profit

Examples:

Grocery stores → lots of variable costs (inventory); slim margins

Restaurants with revenue-share leases → variable rent and ingredient costs

Consulting firms → mainly labor-based; costs increase with each project

Freelancers or gig workers → no fixed office, only paid per job

Retail drop-shippers → only buy goods after receiving customer orders

In-house production (make) 

• Quality and cost control through vertical integration. 

• Protecting intellectual property

  • Production secrets and patents do not need to be shared with a third party. This is important because outsourcing increases the risk of copycat brands or fakes occurring, potentially damaging the sales and/or the brand image.

• Corporate Social Responsibility / Brand image:

  • Can ensure healthy and fair working conditions for employees and robust environmental protection.

  • Example: Nike controlling production of clothes, can control labour conditions, no sweat shop production, improve ethics and brand name

Third party suppliers (subcontractors) (buy)  

• can create flexibility and capacity for the business, such as dealing with unexpected fluctuations in the level of demand. 

• Subcontractors may be more productive and cost-effective. 

• Specialisation and expertise. Sometimes a business simply does not have the expertise to make the product it wants to sell. 

• Low costs due to economies of scale. subcontractor can combine the work with other products in order to achieve economies of scale, thereby lowering costs of production.

• Lower fixed costs. The business may not want to invest in the large-scale capital, such as a factory, needed to produce the product, especially if it is unsure about its success. Outsourcing to a producer who already has production facilities makes more sense in this case.