the contribution of operations to added value

4.1 The Nature of Operations – The Transformational Process

Objective

To understand how operations convert inputs into outputs, how this creates added value, and how the performance of the process is measured.

Key Concepts

• Operations: activities that transform inputs (resources) into outputs (goods or services).
• Transformational process: the series of steps that add value to the inputs.
• Added value: market value of the output – total cost of the inputs.
• Productivity: ratio of output to input.
  Formula: Productivity = Output ÷ Input

1. The Transformational Process

1. Inputs – labour, materials, capital, information, energy, etc.
2. Transformation activities – manufacturing, assembling, cooking, service delivery, etc.
3. Outputs – finished goods or services supplied to customers.

2. Measuring Performance

• Efficiency: achieving the same output with fewer inputs (cost reduction).
• Effectiveness: achieving the required level of output (meeting customer requirements).
• Productivity (numeric example):
  A bakery produces 5 000 loaves of bread in a week using 2 500 labour‑hours.
  Productivity = 5 000 ÷ 2 500 = 2 loaves per labour‑hour.
• Sustainability: operating without depleting resources or harming the environment. Typical indicators include waste per unit, energy consumption per unit and carbon emissions.

3. Capital‑Intensive vs Labour‑Intensive Operations

Aspect	Capital‑Intensive	Labour‑Intensive
Cost structure	High **fixed** costs (machinery, plant, depreciation). Low **variable** costs.	Low fixed costs. High **variable** costs (wages, overtime).
Risk	High investment risk if demand falls.	More flexible to demand changes.
Flexibility	Low – difficult to change product mix quickly.	High – easy to switch tasks or products.
Examples	Automobile assembly plant, semiconductor fab.	Boutique tailoring, hand‑crafted furniture.

4. Operations Methods

Method	Characteristics	Advantages	Disadvantages	Typical Example
Job production	One‑off items; high customisation; skilled labour.	Very flexible; high quality.	High unit cost; low volume.	Custom wedding dresses.
Batch production	Groups of identical items; set‑up between batches.	Economies of scale within a batch; moderate flexibility.	Set‑up costs; inventory between batches.	Bakery producing loaves of different breads.
Flow (mass) production	Continuous, high‑volume, low‑variety; specialised equipment.	Very low unit cost; high output.	Very low flexibility; high capital investment.	Car manufacturing assembly line.
Mass‑customisation	Standardised base product with options for individual choice; flexible technology.	Combines low cost with high variety.	Complex coordination; requires advanced IT.	Nike ID shoes, Dell computers.

4.2 Inventory Management

Purpose of Holding Inventory

• Buffer against uncertainties in demand or supply.
• Maintain smooth production flow.
• Take advantage of bulk‑buying discounts.
• Allow time for quality checks, maintenance and set‑up.

Types of Inventory

• Raw materials – inputs not yet processed.
• Work‑in‑progress (WIP) – partially finished goods.
• Finished goods – ready for sale.
• MRO stock – items needed to keep equipment running (maintenance, repair & operating).

Key Costs

• Holding (carrying) cost – capital cost, storage, insurance, obsolescence.
• Ordering (set‑up) cost – paperwork, transport, handling.
• Stock‑out (shortage) cost – lost sales, customer dissatisfaction, possible penalties.

Measurement of Productivity (Inventory)

Productivity of inventory management can be expressed as the ratio of inventory turns to the average inventory level.

Formula: Inventory Turnover = Cost of Goods Sold ÷ Average Inventory

Example: If COGS = £500 000 and average inventory = £50 000, then Inventory Turnover = 10 times per year.

Safety Stock & Re‑order Level

Safety stock protects against demand or supply variability.
Re‑order level = (Average demand per period × Lead time) + Safety stock.

Economic Order Quantity (EOQ) Model

Provides the order size that minimises total holding + ordering costs.

Formula: EOQ = √[(2 × D × S) / H]

• D = Annual demand (units)
• S = Ordering cost per order (£)
• H = Holding cost per unit per year (£)

Just‑In‑Time (JIT) vs Just‑In‑Case (JIC)

Aspect	JIT	JIC
Philosophy	Produce/receive only what is needed, when it is needed.	Maintain extra stock “just in case” of disruptions.
Inventory level	Very low – often < 1 day of stock.	Higher – typically several weeks of safety stock.
Limitations	High exposure to supply‑chain shocks; requires reliable suppliers and accurate demand forecasts.	Higher holding costs; risk of obsolescence.
Typical example	Toyota Production System – parts arrive on the line exactly when needed.	Retailer keeping a few weeks of finished‑goods stock.

Supply‑Chain Management (SCM)

• Definition: Coordination of activities from raw‑material suppliers through manufacturers to the end‑customer.
• Key activities:
  • Procurement and supplier relationship management.
  • Production planning and scheduling.
  • Logistics (transport, warehousing, distribution).
  • Information flow (forecasting, order tracking, ERP systems).
• Link to inventory: Effective SCM reduces the need for large safety stocks by improving forecast accuracy, lead‑time reliability and visibility across the chain.

4.3 Capacity Utilisation & Outsourcing

Capacity Utilisation

Measures the extent to which a firm uses its available productive capacity.

Formula: Capacity Utilisation % = (Actual Output ÷ Design Capacity) × 100

• Design capacity – maximum output under ideal conditions (no downtime).
• Effective capacity – realistic maximum after accounting for planned maintenance, breaks, and unavoidable losses.

Worked example:

A coffee‑bean roaster can theoretically roast 1 200 kg per month (design capacity). Because of routine maintenance and staff breaks, the effective capacity is 1 000 kg. In a particular month the plant actually roasts 800 kg.

Capacity utilisation (based on design capacity) = (800 ÷ 1 200) × 100 = 66.7 %.
Capacity utilisation (based on effective capacity) = (800 ÷ 1 000) × 100 = 80 %.

High utilisation improves efficiency but may reduce flexibility and increase wear‑and‑tear.

Outsourcing

Contracting an external organisation to perform activities that could be done in‑house.

Reasons for Outsourcing

• Cost reduction (lower labour rates, economies of scale).
• Access to specialised expertise or technology.
• Focus on core activities.
• Flexibility to adjust capacity quickly.

Benefits & Risks

Benefits	Risks / Disadvantages
Lower production costs, faster time‑to‑market, reduced capital investment.	Loss of control over quality, dependence on supplier reliability, possible confidentiality breaches.
Ability to use world‑class facilities (e.g., Apple’s contract manufacturers).	Potential negative impact on employee morale and brand perception.

Impact on Added Value

• Outsourcing can increase added value when cost savings exceed any loss in perceived quality or brand equity.
• Poor supplier performance can erode added value through higher defect rates, delayed deliveries or reputational damage.

Added Value – Calculation & Illustration

Definition

Added value = Market value of the output – Total cost of the inputs used to produce it.

Formulae

• Overall added value: Added Value = Value of Output – Cost of Inputs
• Per‑unit added value: Added Value per unit = Selling Price per unit – Variable Cost per unit

Worked Example – Smartphone Manufacturer

Item	Cost (£)
Materials (screen, battery, etc.)	120
Labour	30
Allocated overheads	20
Total Input Cost	170
Selling price per unit	250
Added Value per unit	80

Ways to Enhance the Contribution of Operations to Added Value

1. Adopt lean manufacturing (Kaizen, 5S) to eliminate waste and improve flow.
2. Invest in technology – automation, ERP, AI‑driven scheduling – to raise productivity.
3. Implement quality management systems (e.g., ISO 9001) to reduce defects and increase perceived value.
4. Develop flexible production lines capable of rapid change‑over or mass‑customisation.
5. Foster a culture of continuous improvement and employee involvement.

Summary

• Operations transform inputs into outputs; this transformation is the core of value creation.
• Efficiency, effectiveness, productivity and sustainability each influence how much value is added.
• Understanding capital‑ vs labour‑intensive operations and selecting the appropriate production method (job, batch, flow, mass‑customisation) aligns capacity with market demand.
• Effective inventory management (purpose, types, costs, EOQ, safety stock, reorder level, JIT/JIC) balances holding costs against the risk of stock‑outs.
• Supply‑chain management links inventory decisions to the wider network of suppliers and customers.
• Capacity utilisation (design vs effective) and strategic outsourcing affect both cost structures and the ability to meet customer expectations.
• Added value is realised when the market price of the output exceeds the total cost of the inputs; improving operational performance directly raises this margin.