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IB BUsiness MAnagement:
5.5 Production Planning HL

On of the key aims of production planning is to minimise the costs of holding stocks while ensuring that there are sufficient resources for production to be able to meet customer demand in a timely manner. This topic looks at the different types of stock control methods and their relative merits, and examines the need for businesses to recognise and establish their optimum stock levels in order to remain competitive.

Key Learning Outcomes:

  • Explain the supply chain process
  • Compare just-in-case (JIC) and just-in-time (JIT) stock management systems
  • Prepare and interpret stock control charts
  • Determine an organisation's capacity utilisation rate
  • Determine an organisation's productivity rate
  • Determine the cost to buy (CTB) and cost to make (CTM) a product for any organisation.
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The cost of holding stock is 4-10% of the stock's value

The Supply Chain Process

A supply chain is a system of organisations, people, activities, information, and resources involved in moving a product or service from supplier to customer. Supply chain activities transform natural resources, raw materials, and components into a finished product that is delivered to the end customer.

Think back to your last visit to a Best Buy. Remember the large range of HD TVs, how did they all get there? The answer is the supply chain. Supply chains include all of the companies that participate in the design, assembly, and delivery of products for buyers like you. Retailers, manufacturers, transportation companies, and distributors are some of the key players.

Managing supply chains

Buy it

Move it

Make it

Sell it

Stock Control 

Stock (inventory) materials and goods required to allow for the production of and supply of products to the customer.

Stock has three forms:

  1. Raw materials and components. These will have been purchased from outside suppliers. They will be held in stock until they are used in the production process.
  2. Work in progress. At any one time the production process will be converting raw materials and components into finished goods and these are ‘work in progress’. For some firms, such as construction businesses, this will be the main form of stocks held. Batch production tends to have high work-in-progress levels.
  3. Finished goods. Having been through the complete production process goods may then be held in stock until sold and dispatched to the customer.

 costs of stock holding:

  1. Opportunity cost. Working capital tied up in stocks could be put to another best alternative use. The capital might be used to pay off loans, buy new equipment or pay off suppliers, or could be left in the bank to earn interest.
  2. Storage costs. Stocks have to be held in secure warehouses. They often require special conditions, such as refrigeration. Staff will be needed to guard and transport the stocks which should be insured against fire or theft.
  3. Risk of wastage and obsolescence. If stocks are not used or sold as rapidly as expected, then there is an increasing danger of goods deteriorating or becoming outdated. This will lower the value of such stocks. Goods often become damaged while held in storage – they can then only be sold for a much lower price.

not holding enough stock

  1. Lost sales. If a firm is unable to supply customers ‘from stock’, then sales could be lost to firms that hold higher stock levels and are perceived as being more reliable as a result. This might lead to future lost orders too. In purchasing contracts between businesses, it is common for there to be a penalty payment clause requiring the supplier to pay compensation if delivery dates cannot be met on time.
  2. Idle production resources. If stocks of raw materials and components run out, then production will have to stop. This will leave expensive equipment idle and labour with nothing to do. The costs of lost output and wasted resources could be considerable.
  3. Special orders could be expensive. If an urgent order is given to a supplier to deliver additional stock due to shortages, then extra costs are quite likely to be incurred in the administration and processing of the order and in special delivery charges.
  4. Small order quantities. Keeping low stock levels may mean only ordering goods and supplies in small quantities. The larger the size of each delivery, the higher will be the average stock level held. By ordering in small quantities, the firm may lose out on an important economy of scale such as discounts for large orders.

Key Terms

Economic order quantity (EOQ): The optimum or least-cost quantity of stock to re-order taking into account delivery costs and stock-holding costs

Buffer stocks: The minimum stocks that should be held to ensure that production could still take place should a delay in delivery occur or production rates increase.

Re-order quantity: The number of units or quantity (e.g. tonnes) ordered each time.

Lead time: The normal time taken between ordering new stocks and their delivery.

Re-order stock level: The level of stocks that will trigger a new order to be sent to the supplier.

Just in case (JIC): Holding high stock levels ‘just in case’ there is a production problem or an unexpected upsurge in demand.

Just in time (JIT): A stock control method that aims to avoid holding stocks by requiring supplies to arrive just as they are needed in production and completed products are produced to order.

Just In Time stock control

Just In Time (JIT) requires that no buffer stocks are held, components arrive just as they are needed on the production line and finished goods are delivered to customers as soon as they are completed.

JIT - Conditions for success:
Summary notes

Advantages and disadvantages of just-in-time stock management

JIT may not be suitable for all firms at all times:
  • There may be limits to the application of JIT if the costs resulting from production being halted when supplies do not arrive far exceed the costs of holding buffer stocks of key components.
  • Small firms could argue that the expensive IT systems needed to operate JIT effectively cannot be justified by the potential cost savings.
  • In addition, rising global inflation makes holding stocks of raw materials more beneficial as it may be cheaper to buy a large quantity now than smaller quantities in the future when prices have risen.
  • Similarly, higher oil prices will make frequent and small deliveries of materials and components more expensive.

Just in time in practice

Technology in managing stocks

JUst-in-Case Stock control

Just In Case: The traditional view of holding stock was to hold high stock levels, especially of raw materials and finished goods, to meet unexpected situations such as:
  • failure of supplying firm to deliver on time
  • production problems halting output
  • increased consumer demand.
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Traditional just-in-case stock-control chart
The stock level does not necessarily follow regular and consistent patterns. The strength of sales is shown in the slope of the line. Strong sales lead to stocks being quickly depleted - steeply sloping lines. Weak sales lead to stocks being slowly depleted and  less steeply sloping lines. A run of unexpected sales or supply chain interruptions can lead to stock outs.

Stock control CHARTS:
​worked example

 buffer stocks protect against supply chain interuptions

The Japanese earthquake interrupted the efficient  just-in-time supply chains of major manufacturers such as Toyota and Apple.

Pros and Cons of just-in-case stock management

Stock-control and small IT systems

Stock-control and massive IT systems

Case Study: Production Planning 

Case Study: Production Planning 

Capacity Utilisation

Capacity utilisation: the proportion of maximum output capacity currently being achieved.

There are potential drawbacks to operating at full capacity for a long period of time:
  • Staff may feel under pressure due to the workload and this could raise stress levels. Operations managers cannot afford to make any production scheduling mistakes, as there is no slack time to make up for lost output.
  • Regular customers who wish to increase their orders will have to be turned away or kept waiting for long periods. This could encourage them to use other suppliers with the danger that they might be lost as long-term clients.
  • Machinery will be working flat out and there may be insufficient time for maintenance and preventative repairs and this could lead to increased unreliability in the future.
So many firms attempt to maintain a very high level of capacity utilisation, but to keep some spare capacity for unforeseen eventualities.
  • Excess capacity: exists when the current levels of demand are less than the full capacity output of a business – also known as spare capacity.
  • Full capacity: when a business produces at maximum output.
  • Capacity shortage: when the demand for a business’s products exceeds production capacity.

Capacity UTILIsATION - Notes

Calculating Capacity Utilisation

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How to calculate capacity utilisation
For example, if a t-shirt manufacturer can produce a maximum of 10,000 t-shirts a month in her factory using current equipment and staffing, and  is currently producing 7,000 t-shirts a month then it's capacity utilisation rate is 70 per cent.

overcoming capacity shortage:


Productivity

How well a firm is using its resources in the process of producing its goods or services is measured by its productivity rates. For example, the productivity of labour and the productivity of capital are commonly used metrics a firm would be interested in. The higher the labour productivity, the more efficient a business's use of its labour is. Staff can produce more product, or less staff can be used to produce the same amount of product.  Either way, the labour cost per unit of output is reduced enabling the firm to reduce its costs of production. Higher productivity rates increase the efficiency of firms and economies of scale are achieved (increased output at reduced cost), thus enabling higher profits to be made. Increased productivity enables firms to grow.

Labour Productivity

COst to buy and cost to make

The potential cost advantages of outsourcing are an important part of the make-or-buy decision. The cost to buy a component or service can be obtained from estimates given by potential suppliers. The cost to make should use contribution costing, that is only the additional costs of making a product or component or providing a service should be considered. Overheads that would still have to be paid if the outsourcing option was used should not be included in the calculation. An example can be used to demonstrate this. An operations manager of a computer assembly firm has obtained an estimate from a specialist supplier of keyboards: ‘To supply 1000 keyboards each month at $3 each = total cost of $3000’.

The manager has estimated the internal variable and direct costs of making keyboards in-house at $3.50 each. Obtaining 1000 keyboards from an outsourcing company would save the computer business $500 per month. The cost to buy is less than the cost to make.

Make-or-buy? Worked Example

Make or Buy decisions

The Make-or-Buy Decision (also called the outsourcing decision) is a judgment made by management whether to make a component internally or buy it from the market. While making the decision, both qualitative and quantitative factors must be considered.

Examples of the qualitative factors in make-or-buy decision are: control over quality of the component, reliability of suppliers, impact of the decision on suppliers and customers, etc.

The quantitative factors are actually the incremental costs resulting from making or buying the component. For example: incremental production cost per unit, purchase cost per unit, production capacity available to manufacture the component, etc.

Make or Buy Decisions - Make

Make or Buy Decisions - Buy

5.5 Production Planning: 
PowerPoint summary notes

5.5 Production Planning: 
Mr Burton explains 

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