PRODUCTIONS & OPERATIONS MANAGEMENT (UNIT-5)

 Cost-Benefit Analysis:
Jules Dupuit, a French engineer and economist, introduced the concepts behind CBA in the
1840s. It became popular in the 1950s as a simple way of weighing up project costs and benefits, to determine
whether to go ahead with a project.
As its name suggests, Cost-Benefit Analysis involves adding up the benefits of a course of
action, and then comparing these with the costs associated with it. The results of the analysis are often
expressed as a payback period – this is the time it takes for benefits to repay costs. Many people who use it
look for payback in less than a specific period – for example, three years.
A cost-benefit analysis is done to determine how well, or how poorly, a planned action will turn
out. Although a cost-benefit analysis can be used for almost anything, it is most commonly done on financial
questions. Since the cost-benefit analysis relies on the addition of positive factors and the subtraction of
negative ones to determine a net result, it is also known as running the numbers. A cost-benefit analysis finds,
quantifies, and adds all the positive factors. These are the benefits. Then it identifies, quantifies, and subtracts
all the negatives, the costs. The difference between the two indicates whether the planned action is advisable.
The real trick to doing a cost-benefit analysis well is making sure you include all the costs and all the benefits
and properly quantify them.
Should we hire an additional sales person or assign overtime? Is it a good idea to purchase the
new stamping machine? Will we be better off putting our free cash flow into securities rather than investing in
additional capital equipment? Each of these questions can be answered by doing a proper cost-benefit
analysis.

You can use the technique in a wide variety of situations. For example, when you are:
 Deciding whether to hire new team members.
 Evaluating a new project or change initiative.
 Determining the feasibility of a capital purchase.
However, bear in mind that it is best for making quick and simple financial decisions. More robust approaches
are commonly used for more complex, business-critical or high cost decisions.

 How to Use the Tool: Follow these steps to do a Cost-Benefit Analysis.

1) Step One: Brainstorm Costs and Benefits:
First, take time to brainstorm all of the costs associated with the project, and make a list of
these. Then, do the same for all of the benefits of the project. Can you think of any unexpected costs? And
are there benefits that you may not initially have anticipated? When you come up with the costs and
benefits, think about the lifetime of the project. What are the costs and benefits likely to be over time?
2) Step Two: Assign a Monetary Value to the Costs
Costs include the costs of physical resources needed, as well as the cost of the human effort
involved in all phases of a project. Costs are often relatively easy to estimate (compared with revenues).
It's important that you think about as many related costs as you can. For example, what will any
training cost? Will there be a decrease in productivity while people are learning a new system or
technology, and how much will this cost? Remember to think about costs that will continue to be incurred
once the project is finished. For example, consider whether you will need additional staff, if your team
will need ongoing training, or if you'll have increased overheads.
3) Step Three: Assign a Monetary Value to the Benefits
This step is less straightforward than step two! Firstly, it's often very difficult to predict
revenues accurately, especially for new products. Secondly, along with the financial benefits that you
anticipate, there are often intangible, or soft, benefits that are important outcomes of the project.
For instance, what is the impact on the environment, employee satisfaction, or health and
safety? What is the monetary value of that impact? As an example, is preserving an ancient monument
worth $500,000, or is it worth $5,000,000 because of its historical importance? Or, what is the value of
 stress-free travel to work in the morning? Here, it's important to consult with other stakeholders and
decide how you'll value these intangible items.
4) Step Four: Compare Costs and Benefits
Finally, compare the value of your costs to the value of your benefits, and use this analysis to
decide your course of action. To do this, calculate your total costs and your total benefits, and compare the
two values to determine whether your benefits outweigh your costs. At this stage it's important to consider
the payback time, to find out how long it will take for you to reach the break-even point – the point in time
at which the benefits have just repaid the costs.
For simple examples, where the same benefits are received each period, you can calculate the
payback period by dividing the projected total cost of the project by the projected total revenues:

Total cost / total revenue (or benefits) = length of time (payback period).

 Input-Output (I-O) Analysis:

Input-output is a novel technique invented by Professor Wassily W. Leontief in 1951. It is used
to analyze inter-industry relationship in order to understand the inter-dependencies and complexities of the
economy and thus the conditions for maintaining equilibrium between supply and demand. Thus it is a
technique to explain the general equilibrium of the economy. It is also known as “inter-industry analysis”.
Before analyzing the input-output method, let us understand the meaning of the terms, “input” and “output”.
According to Professor J.R. Hicks, an input is “something which is bought for the enterprise” while an output
is “something which is sold by it.”
An input is obtained but an output is produced. Thus input represents the expenditure of the
firm, and output its receipts. The sum of the money values of inputs is the total cost of a firm and the sum of
the money values of the output is its total revenue. The input-output analysis tells us that there are industrial
interrelationships and inter-dependencies in the economic system as a whole. The inputs of one industry are
the outputs of another industry and vice versa, so that ultimately their mutual relationships lead to equilibrium
between supply and demand in the economy as a whole.
Coal is an input for steel industry and steel is an input for coal industry, though both are the
outputs of their respective industries. A major part of economic activity consists in producing intermediate
goods (inputs) for further use in producing final goods (outputs).
There are flows of goods in “whirlpools and cross currents” between different industries. The
supply side consists of large inter-industry flows of intermediate products and the demand side of the final
goods. In essence, the input-output analysis implies that in equilibrium, the money value of aggregate output
of the whole economy must equal the sum of the money values of inter-industry inputs and the sum of the
money values of inter-industry outputs.

 Three Types of Economic Impact of I-O Analysis:

I-O models estimate three types of impacts: direct, indirect and induced. These terms are
another way of saying initial, secondary and tertiary impacts that ripple throughout the economy. By using I-
O models, economists can estimate the change in inputs across industries due to a change in output in one or
more specific industries. The direct impacts of an economic shock are the initial change in expenditures. For
example, building a bridge would require spending on cement, steel, construction equipment, labor and other
inputs. The indirect, or secondary, impacts are due to the suppliers of the inputs hiring workers to meet
demand. The induced, or tertiary, impacts result from the workers of suppliers purchasing more goods and
services.
Here's an example of how I-O analysis works: A local government wants to build a new bridge
and needs to justify the cost of the investment. To do so, it hires an economist to conduct an I-O study. The
economist talks to engineers and construction companies to estimate how much the bridge will cost, the
supplies needed, and how many workers will be hired by the construction company. The economist converts
this information into dollar figures and runs numbers through an I-O model, which produces the three levels
of impacts. The direct impacts are simply the original numbers put into the model, so for example, the value
of the raw inputs (cement, steel, etc.). The indirect impacts are the jobs created by the supplying companies,
 so cement and steel companies. The induced impacts are the due to the amount of money that the new workers
spend on goods and services.

 VALUE ANALYSIS:
Value engineering or value analysis had its birth during the World War II Lawrence D. Miles
was responsible for developing the technique and naming it. Value analysis is defined as “an organized
creative approach which has its objective, the efficient identification of unnecessary cost-cost which provides
neither quality nor use nor life nor appearance nor customer features.” Value analysis focuses engineering,
manufacturing and purchasing attention to one objective- equivalent performance at a lower cost.
Value analysis is concerned with the costs added due to inefficient or unnecessary specifications
and features. It makes its contribution in the last stage of product cycle, namely, the maturity stage. At this
stage, research and development no longer make positive contributions in terms of improving the efficiency of
the functions of the product or adding new functions to it.
Value is not inherent in a product, it is a relative term, and value can change with time and
place. It can be measured only by comparison with other products which perform the same function. Value is
the relationship between what someone wants and what he is willing to pay for it. In fact, the heart of value
analysis technique is the functional approach. It relates to cost of function whereas others relate cost to
product. It is denoted by the ratio between function and cost.
Function
Value = Cost

 Value Analysis Framework: The basic framework for value analysis approach is formed by the
following questions, as given by Lawrence D. Miles:
 What is the item?
 What does it do?
 What does it cost?
 What else would do the job?
 What would the alternative cost be?
Value analysis requires these questions to be answered for the successful implementation of the technique.

 Steps in Value Analysis: In order to answer the above questions, three basic steps are necessary:
1) Identifying the function: Any useful product has some primary function which must be identified a bulb
to give light, a refrigerator to preserve food, etc. In addition it may have secondary functions such as
withstanding shock, etc. These two must be identified.
2) Evaluation of the function by comparison: Value being a relative term, the comparison approach must be
used to evaluate functions. The basic question is, ‘Does the function accomplish reliability at the best cost’
and can be answered only comparison.
3) Develop alternatives: Realistic situations must be faced, objections should overcome and effective
engineering manufacturing and other alternatives must be developed. In order to develop effective
alternatives and identify unnecessary cost the following thirteen value analysis principles must be used:
 Avoid generalities.
 Get all available costs.
 Use information only from the best source.
 Brain-storming sessions.
 Blast, create and refine: In the blast stage, alternative productive products, materials, processes or ideas
are generated. In the ‘create’ stage the ideas generated in the blast stage are used to generate
alternatives which accomplish the function almost totally. In the refining stage the alternatives
generated are sifted and refined so as to arrive at the final alternative to be implemented.
 Identify and overcome road blocks.
 Use industry specialists to extend specialized knowledge.
 Key tolerance not to be too light.
 Utilize the pay for vendors’ skills techniques.
  Utilize vendors’ available functional products.
 Utilize specialty processes.
 Utilize applicable standards.
 Use the criterion ‘Would I spend my money this way?’
 VERTICAL INTEGRATION:
Vertical integration is a strategy where a company expands its business operations into
different steps on the same production path, such as when a manufacturer owns its supplier and/or distributor.
Vertical integration can help companies reduce costs and improve efficiencies by decreasing transportation
expenses and reducing turnaround time, among other advantages. However, sometimes it is more effective for
a company to rely on the established expertise and economies of scale of other vendors rather than trying to
become vertically integrated. Specifically, vertical integration occurs when a company assumes control over
several production or distribution steps involved in the creation of its product or service. Vertical integration
can be carried out in two ways: backward integration and forward integration. A company that expands
backward on the production path into manufacturing is assuming backward integration, while a company that
expands forward on the production path into distribution is conducting forward integration.
Companies from many different industries and sectors choose to vertically integrate. A
mortgage company that originates and services mortgages is a vertically integrated loan-servicing firm. The
company lends money to homebuyers and collects their monthly payments, rather than specializing in one
service or the other. A solar power company that produces photovoltaic products and also manufactures the
cells used to create those products is another example of a vertically integrated business. In this case, the
company moved along the supply chain to assume the manufacturing duties, conducting a backward
integration.
Vertical Integration is an integration method in which a company includes/expands to different
stages of production/business especially in the areas of distribution and supply chain so as to gain more
control over the market it operates in. Vertical Integration ensures that the systematic growth of company's
operations giving end to end solution to the customer. It helps streamlining business process as per the
company, lesser dependency of third party service providers and gives more control to the company.

 When is vertical integration attractive for a business?

Several factors affect the decision-making that goes into backward and forward integration. A
company may go in for these strategies in the following scenarios:
 The current suppliers of the company’s raw materials or components, or the distributors of its end
products, are unreliable.
 The prices of raw materials are unstable or the distributors charge high fees.
 The suppliers or distributors earn big margins.
 The company has the resources to manage the new business that is currently being taken care of by the
suppliers or distributors.
  The industry is expected to grow significantly.

Advantages:
Any of the advantages of vertical integration gives the company a competitive advantage over
non-integrated companies. Consumers are more likely to choose its goods or services. Either the costs are
lower, the quality is better, or the product is tailored directly to them.

1) The first advantage is that the company doesn't have to rely on suppliers: They are less likely to face
disruptions from those that aren't well-run. They can avoid frequent strikes and labor disputes from
companies that are in socialist countries.
2) Second, companies benefit from vertical integration when its suppliers have a lot of market power, and
can dictate terms: That is critical if one of the suppliers is a monopoly. If the company can go around
these providers, it reaps many benefits. It can lower internal costs and have better delivery of needed
items. It's less likely to be short of critical elements.
3) Third, vertical integration gives a company economies of scale: That's when the size of the business
allows it to cut costs. For example, it can lower the per unit cost by buying in bulk. Another way is to
make the manufacturing process itself more efficient. Vertically integrated companies eliminate overhead
by consolidating management.
4) Fourth, a retailer with vertical integration knows what is selling well: It can then "knock off" the most
popular brand-name products. That's when it copies the ingredients or manufacturing process. It creates
similar, but store-branded, marketing messages and packaging. Only powerful retailers can do this. That's
because the brand-name manufacturers can't afford to sue for copyright infringement. They are unwilling
to risk losing distribution through the retailer.
5) The fifth advantage is the one that's most obvious to consumers: That's low prices. A company that's
vertically integrated can lower costs. It can transfer those savings to the consumer as lower prices.
Examples include Best Buy, Walmart, and most national grocery store brands.

 Disadvantages:
 The biggest disadvantage of vertical integration is the expense. Companies must invest a great deal of
capital to set up or buy factories. They must then keep the plant running to maintain efficiency and
profit margins. That reduces flexibility.
 Vertically integrated companies can't follow consumer trends that take them away from their factories.
They also can't change factories to countries with lower exchange rates.
 A third problem is a loss of focus. Running a successful retail business, for example, requires a
different set of skills than a profitable factory. It's difficult to find a CEO that's good at both.
  It's also not likely that any company will have a culture that supports both retail stores and factories. A
successful retailer attracts marketing and sales types. That culture isn't responsive to the needs of
factories. The clash of cultures can lead to misunderstandings, conflict and lost productivity. A non-
integrated company can even use cultural diversity in the workplace to compete against the vertically
integrated one.

 LEARNING CURVES:
In any environment if a person is assigned to do the same task, then after a period of time, there
is an improvement in his performance. If data points are collected over a period of time, the curve constructed
on the graph will show a decrease in effort per unit for repetitive operations. This curve is very important in
cost analysis, cost estimation and efficiency studies. This curve is called the learning curve. The learning
curve shows that if a task is performed over and over than less time will be required at each iteration.
Historically, it has been reported that whenever there has been instanced of double production, the required
labor time has decreased by 10 or 15 percent or more.
Learning curves graphically portray the costs and benefits of experience when performing
routine or repetitive tasks. Also known as experience curves, cost curves, efficiency curves, and productivity
curves, they illustrate how the cost per unit of output decreases over time as the result of accumulated
workforce learning and experience. That is, as cumulative output increases, learning and experience cause the
cost per unit to decrease. Experience and learning curves are used by businesses in production planning, cost
forecasting, and setting delivery schedules, among other applications. One can explain the shape of learning
curves another way. When a new task or production operation begins, a person or system learns quickly, and
the learning curve is steep. With each additional repetition, less learning occurs and the curve flattens out. At
the beginning of production or learning, individuals or systems are said to be "high" on the learning curve.
That means that costs per unit are high, and cumulative output is low. Individuals and systems "move down"
the experience or learning curve by learning to complete repetitive tasks more efficiently, eliminating
hesitation and mistakes, automating certain tasks, and making adjustments to procedures or systems.
Some theorists believe that
learning curves are not actually curves, but more
like jagged lines that follow a curving pattern.
They assert that learning occurs in brief spurts
of progress, followed by small fallbacks to
previous levels, rather than in a smooth
progressive curve. Such a model of learning,
however, does not affect the usefulness of
learning curves in business and production
applications. The phrase, of course, has spread
from management science to business and other
activities generally. In the broader frame
"learning curve" has come to mean that every
new activity requires the acquisition of
knowledge and skill. It takes time (and therefore
money) to master new jobs and new fields, but
later knowledge provides efficiency and
leverage.
Learning curves are also known as experience curve, cost curves, efficiency curves and
productivity curves. These curves help demonstrate the cost per unit of output decreases over time with the
increase in experience of the workforce. Learning curves and experience curves is extensively used by
organization in production planning, cost forecasting and setting delivery schedules. Learning curve is
relevant in taking following decision:
 Pricing decision based on estimation of future costs.
 Workforce schedule based on future requirements.
 Capital requirement projections.
 Set-up of incentive structure.
 JUST-IN-TIME (JIT) MANUFACTURING:
Just-In-Time (JIT) Manufacturing is a philosophy rather than a technique. By eliminating all
waste and seeking continuous improvement, it aims at creating manufacturing system that is response to the
market needs.
The phrase just in time is used to because this system operates with low WIP (Work-In-Process)
inventory and often with very low finished goods inventory. Products are assembled just before they are sold,
subassemblies are made just before they are assembled and components are made and fabricated just before
subassemblies are made. This leads to lower WIP and reduced lead times. To achieve this organizations have
to be excellent in other areas e.g. quality.
According to Voss, JIT is viewed as a “Production methodology which aims to improve overall
productivity through elimination of waste and which leads to improved quality”.
JIT provides an efficient production in an organization and delivery of only the necessary parts
in the right quantity, at the right time and place while using the minimum facilities”.

 Seven Wastes:
Shiego Shingo, a Japanese JIT authority and engineer at the Toyota Motor Company identifies
seven wastes as being the targets of continuous improvement in production process. By attending to these
wastes, the improvement is achieved.
1) Waste of over production: Eliminate by reducing set-up times, synchronizing quantities and timing
between processes, layout problems. Make only what is needed now.
2) Waste of waiting: Eliminate bottlenecks and balance uneven loads by flexible work force and equipment.
3) Waste of transportation: Establishes layouts and locations to make handling and transport unnecessary if
possible. Minimize transportation and handling if not possible to eliminate.
4) Waste of processing itself: Question regarding the reasons for existence of the product and then why each
process is necessary.
5) Waste of stocks: Reducing all other wastes reduces stocks.
6) Waste of motion study for economy and consistency: Economy improves productivity and consistency
improves quality. First improve the motions, then mechanize or automate otherwise. There is danger of
automating the waste.
7) Waste of making defective products: Develop the production process to prevent defects from being
produced, so as to eliminate inspection. At each process, do not accept defects and makes no defects.
Make the process fail-safe. A quantify process always yield quality product.

 Benefits of JIT:
The most significant benefit is to improve the responsiveness of the firm to the changes in the
market place thus providing an advantage in competition. Following are the benefits of JIT:
 Product cost—is greatly reduced due to reduction of manufacturing cycle time, reduction of waste and
inventories and elimination of non-value added operation.
 Quality —is improved because of continuous quality improvement programs.
 Design—Due to fast response to engineering change, alternative designs can be quickly brought on the
shop floor.
 Productivity improvement.
 Higher production system flexibility.
 Administrative and ease and simplicity.