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The responsibility of accounting is based on the recognition of individual areas or responsibility a specified in a firm’s organisation structure. These areas of responsibility are known as responsibility centres. A responsibility centre may be defined as a segment of the organisation where an individual manager is held accountable for the segment’s performance. There are three types of responsibility centre:

• A cost centre – where managers are accountable for the expenses under their control.

• A profit centre – where managers are accountable for sales revenue and expenses.

  
  

• An investment centre – where managers are normally accountable for sales revenue and expenses, but in addition are responsible for capital investment decisions and are thus able to influence the size of the investment.

  Other costs that affect decision making are:

  Sunk Cost: Any expenditure which has already taken place in the past and which will not be affected by a particular decision under consideration can be ignored – past costs are sunk costs.

  Incremental Cost: If a cost will be incurred if a particular course of action is taken, but avoided if the action is not taken, the cost is said to be incremental. Specific fixed costs appropriate to the decision may also be incremental if as a result of not taking the action contemplated, they can be avoided. These are sometimes called differential costs.

  Committed Cost: This is a cost which has its origin in a previous decision.

  Discretionary Cost: Such a cost doe not have to be made immediately such as the re-decorating of the firm’s offices. Management can choose the best time to do the work and when to spend the money. Sometimes referred to as the programmed or managed costs.

  Opportunity Cost: If a firms’ resources can be put to alternative use, then the opportunity cost is the opportunity forgone.

• 1. Standard cost systems are costly to implement and operate.

  2. Standards must be updated frequently.

  1. performance measurement;

  1. determination of reimbursement and fee or price setting;

  2. program authorisation, modification, and discontinuation decisions; and

  Absorption Method

  Absorption costing charges the fixed and variable costs involved in the making of products or the provision of a service, which is why it can also be called full costing. It does not under-estimate the importance of a fixed costs and ensures that these costs are covered, but only if the actual sales volume is equal or above the estimated sales volume. In the instance of failing to meet the estimated volume, the fixed costs would not be met. This could have diverse effects on the cashflow, the ability of a company to pay the fixed costs, the profitability and the future of the organisation.

  Key issues:

  • In spite of criticisms, absorption-costing systems are still prevalent.

  • Recognising the problems in absorption costing systems provides greater appreciation of how to implement such systems.

  • The average cost includes both fixed and variable costs divided by total units produced.

  • Below capacity average costs decrease as more units are produced because fixed costs are “spread” over more units.

  • Therefore, managers evaluated on average cost can lower average costs by producing more.

  • Greater production is a problem if excess units can not be sold.

  • Short-term income can be increased and the company can be harmed at the same time.

  • This is an example of a trade-off between planning and control.

  • The opportunity cost of capital and inventory handling costs should be recognised.

  • Also a policy of no excess inventory can be implemented.

  • Other performance measures can be chosen such as stock price changes.

  • The allocation of overhead costs simulates a tax on the allocation base.

  • If tax is greater than the opportunity cost of using the allocation base because of fixed costs, the allocation base will be underused.

  • If fixed costs are allocated to products, they will not generally represent the opportunity cost of using the indirect resource.

  • The allocation of costs to products greater than the opportunity cost can lead to the inappropriate dropping of products.

  • The reallocation of unavoidable costs can lead to a downward spiral.

  • Because of these problems, alternatives have been suggested and are becoming more popular.

    Criticisms of absorption cost systems

    Absorption costing transfers, as part of stock value some of the overheads incurred from a period previous into a future period, there is also a danger that stocks built up maybe not be saleable later and therefore the overheads absorbed will increase the future loss. Stocks may be increased as a deliberate policy to meet actual or expected orders, as a means of keeping the factory going to avoid laying off production workers or even to absorb overheads.

    It is tempting to keep production at normal levels when sales demand falls in order to avoid heavy under-absorptions reducing the already depressed profits. This can prove costly to the business because it not only risks having to sell such goods off cheaply later but it also incurs the costs of storing the goods and paying interest on the money borrowed to pay for the materials “tied up” in such stocks.

    Evaluation of other Different Methods

    Marginal/Variable Costing

    Marginal costing separates the fixed costs and only makes calculations to determine the profit using the variable costs of production or providing a service and subtracting this from the selling price to discover the contribution. Marginal costing provides valid information for internal decision making, although the appropriateness for external reporting is more debatable. Its real importance is in providing contribution and profit figures and identifying the possible profits available in different circumstances and these in turn could then help pay for the fixed costs.

    Marginal costing emphasises the contribution margin. This emphasis aids management in selecting product lines, in determining the optimal sales mix for pricing purposes, and in solving other problems involving choices. The data are especially important to companies that face make-or-buy decisions because variable costing facilitates comparing company costs with costs of buying from outsiders. In addition, the cost-volume-profit relationship provides a valuable tool for other short-run planning activities.

    The key points are:

  • With variable costing only the variable overhead is allocated to the product.

  • All fixed costs are treated as period costs.

  • One advantage is that the variable cost per unit approximates the opportunity cost of making another unit if the organisation is operating below capacity.

  • Variable costing also reduces the incentive to overproduce.

  • A variable costing system will also not have fluctuating product costs as the output volume changes. Variable costing will not approximate the opportunity cost if there is an opportunity cost of using fixed resources.

  • Fixed overhead resources may be overused if not allocated.

  • In spite of advantages, most companies still use absorption costing.

  • Cost object: identify the object to be costed, such as a product, customer, or service.

  • Activity cost pools: identify the major activities and break out the costs for each.

  • Driver: choose an appropriate cost driver for each activity cost pool.

  • Rate: compute the activity cost rate for each activity (equals pool divided total base).

  • Assign: assign costs to objects based on the activity cost rate.

    Using ABC, overhead costs are traced to products and services by identifying the resources, activities, and their costs and quantities to produce output. A unit of output (a driver) is used to calculate the cost of each activity. Cost is traced to the product or service by determining how many units of output each activity consumed during any given period of time. ABC does not only apply to manufacturing organisations: it is also appropriate for service organisations such as financial institutions, medical care providers, and government units. In fact, some banking organisations have been applying the concept for years under a different name – unit costing. Unit costing is used to calculate the cost of banking services by determining the cost and consumption of each unit of output of functions required to deliver the service.

    
    

    Key points

  • Activity-based costing (ABC) recognises different levels of overhead costs and generates more accurate product costs for planning purposes.

  • Activity-based management (ABM) recognises both planning and control implications of the activity costing system.

  • As organisations become more complex, they become more difficult to manage because interdependencies become less obvious.

  • ABM allows managers to have a better understanding of the relationship among different activities. • Process management identifies activities and designs the organisational structure around these activities.

  • Activities are also identified as either value-added or non-value-added depending on whether they are on the value chain.

  • To discourage non-value-added activities, large application rates can be used for the cost drivers related to those activities.

  • The choice of cost drivers is one way to turn ABM into a control mechanism.

  • An organisation may intentionally choose application rates different than the opportunity cost of using the cost driver to influence behaviour that discourages use of the cost driver.

  • If there is a fixed cost component between the activity cost and the usage of the cost driver, then there is still an incentive for overproduction.

  • ABC is most useful with product diversity, complex overhead structures, and in industries that are very competitive and require accurate product costs.

Avoidable and controllable costs (or relevant and irrelevant costs)

Avoidable costs are those costs that may be saved by not adopting a given alternative, whereas unavoidable cannot be saved.


A controllable cost is a cost that is reasonably subject to regulation by the manager with whose responsibility that cost is being identified. If a manager can control the quantity and price paid for a service, then the manager is responsible for all the expenditure incurred for the service. If a manager can control the quantity of the service but not the price paid for the service, then only that amount of difference between actual and budgeted expenditure that is due to usage should be identified with the manager. Finally if he cannot identify quantity or price paid, then the expenditure is uncontrollable and should not be identified with the manager.

Dangers of Variable Costing

The simplicity of variable costing allows management to easily understand the resulting figures. However, managers may misapply the principal of variable costing. A change to a different accounting method that gives a completely different picture under similar labels may confuse them. Although the purpose of the change in costing methods is to bring about better understanding, it may cause more confusion instead.

Another danger is that the financial manager may assign variable costing income a broader significance than it deserves. When sales substantially exceed current production, for instance, variable costing profits are higher than those under absorption costing, and management may take improper action based on these increased profits. These profits may mislead marketing executives to ask for lower prices. Managers may also demand higher employee benefits to sales bonuses when, in fact, there is no justification for such actions. At the other extreme, variable costing results may mislead management during a business recession because, when sales lag behind production during early stages, the variable costing profit will be minimised and the variable costing loss maximised. Management may miss future profit opportunities by thus misreading the severity of the recession.

When management decides to expand or eliminate activities connected with specific product lines or other specific business units, it may need to adjust income figures determined using variable costing. For example, most businesses produce or sell several products differing in ratios of variable costs to sales revenue and contribution rates. They can improve the total profit picture by eliminating the products contributing the smallest amount and by continuing to carry the products making large contributions to profit. On the other hand, this approach, too, can be misleading. If companies drop items contributing small amounts of profits, the fixed unit cost that other products must cover will increase. As a result, profits will likely decrease if the company fails to add other products to its line. A company also must consider intangible factors because a product with a low contribution margin ratio may be necessary for convenience of customers. The loss in customer goodwill that might result from dropping this item could easily offset any gain from products with higher contribution margins.

Standard costs

Standard costs are predetermined costs that are usually expressed on a per-unit basis; they are target costs, costs that should be attained. Standard costs help to build budgets gauge performance, obtain product costs and save book-keeping costs. Standard costs are the building blocks of a flexible budgeting and feedback system. It estimates the costs of production and then are compared to the actual costs. They are used for planning decisions such as pricing and outsourcing as it represents the expected future cost of a product, service, process or subcomponent and serve as a benchmark.  The difference between the actual and standard cost is called a variance. Standard costs are used for control as a form of contract among managers.

Costs and benefits of using standard costing systems:

3. Standard cost systems also create incentive problems and are not particularly timely. 4. The benefits of control and planning, however, seem outweigh the costs because many organisations are using standard costs.

ABC – Activity Based Costing

The basic distinction between traditional cost accounting and ABC is as follows: Traditional cost-accounting techniques allocate costs to products based on attributes of a single unit. Typical attributes include the number of direct labour hours required to manufacture a unit, purchase cost of merchandise resold, or number of days occupied. Allocations, therefore, vary directly with the volume of units produced, cost of merchandise sold, or days occupied by the customer. In contrast, ABC systems focus on activities required to produce each product or provide each service based on each product’s or service’s consumption of the activities.

Activity-based costing focuses on activities, or processes, rather than products or departments. Instead of categorising overhead costs by department or in total, costs are organised into pools for related activities. By using time sheets or other means, the time and resources spent for each activity accumulate into a cost pool for each activity. The next step is to choose a driver that represents how much the end product-the chip-uses each activity. The process of implementing activity-based costing can be described as follows:

The criticisms against ABC is that the analysing of the cost drivers is very time consuming, and due to the high expense incurred, the potential gain does not justify the cost. It is also criticised (as is Full Costing) that it isn’t very relevant for decision making.

How these might improve the quality of information

Managerial cost accounting is the process of accumulating, measuring, analysing, interpreting, and reporting cost information useful to both internal and external groups concerned with the way in which the organisation uses, accounts for, safeguards, and controls its resources to meet its objectives. Cost information is used for many different purposes that can be generally classified into five types:

2) cost reduction and control;

decisions to contract out work or make other changes in the methods of production or delivery of services.

Combining Variable Costing and Absorption

While reporting for external purposes must conform to generally accepted accounting principles, financial data prepared for internal uses need not. The unacceptability of variable costing for external reporting does not affect its importance and special usefulness as an analysis tool. The basic objective of costing should be to meet internal requirements. Variable costing can contribute to this objective because it overcomes many of the weaknesses in reporting with conventional absorption costing. Many companies have converted to variable costing to obtain certain advantages and have found many others not thought of initially. Variable costing need not replace absorption costing. A well-informed management needs both contribution margin analysis and full cost data in budgeting and decision making.

Using a combined approach suggests that arranging the income statement to show both an income under variable costing and the net income required for external reporting. To variable costing income, the business can add or deduct an increment measuring the effect of the change in the fixed cost components of inventory variation to arrive at conventional profits. This can distinguish income resulting only from sales that arise due to those inventory changes. One advantage of this approach is the income statement separates variable costs from fixed costs.

Having both sets of profit figures enables the executive to form judgements with much greater facility than if only profit figure were available; it also facilitates responsibility accounting by making it possible to have information by organisational level. This dual approach provides the additional information that management needs for making decisions and still follows generally accepted accounting principles. A system combining variable costing and absorption costing with standard costs and flexible budgets provides more effective cost control.

ABC

ABC is crucial because it tells managers which products or services make or lose money – they sometimes don’t know. Traditional cost allocations often depict an unrealistic, inadequate view of profitability, sometimes distorted by hundreds of percent. In most cases, ABC is designed to provide profitability information for each segment of their product/service market matrix. After learning about the specific products, services or customers that make or lose money, managers can choose an effective course of action, such as changes to price, product mix, distribution and sources of supply.

The key point with the strengths and weaknesses of all these methods is to find the most realistic method of costing, which is truly representative of the business at the present time and has the ability to be forward looking. The problem with historical data is that it does not always represent the future direction of the business and this can prove costly with dramatic effects on the company. The object of these costings is to give an indication of firstly which costs are spent where and secondly the most effective measure of allocating them to products or departments in order to establish a cost price in which to work from. The differing systems use a variety of ways of allocation with Marginal only using the Variable costs, Absorption using fixed and variable costs and Activity Based using these but allocating them by activity. The best option provided it is cost effective would be to establish the costs under each of these headings and then compare the differences with the Standard Costing (the estimated not actual costs).

With more accurate information, decisions will be more representative of the actual environment and costs likely to be incurred, thus giving a clearer more accurate image of the actual finances and budgetary control required as well as how much the running of the business and the provision of the service is in reality.

Supply and Demand

The task of managing businesses and ensuring a good balance between supply and demand is usually very much more complex for services than for goods, since goods manufacturers are able to separate production from consumption, they have the ability to hold stocks of goods that can be moved to even out regional imbalances in supply and demand. Stocks can also be built up to cater for any peaks in demand. Many of the strategies for managing supply and demand which are open to goods manufacturers are not available to services producers. Services cannot be stored which indicates an inability to match supply and demand consistently as an excess capacity in one time period cannot be transferred to another period when there is a shortage, nor can excess demand in one area normally be met be excess supply located in another.

This does not generally cause a problem where demand levels are stable and predictable. However, most services experience demand which shows significant variation:

• Daily variation (commuter train services in the morning and evening peaks, leisure centres during evenings)

• Weekly variation (night clubs on Saturday nights, InterCity trains on Friday evenings)

• Seasonal variation (air services to the Mediterranean in summer, department stores in the run-up to Christmas)

• Cyclical variation (the demand for mortgages an architectural services Unpredictable variation (the demand for building repairs following storm damage)

Success for organisations in competitive markets facing uneven demand comes from being able to match supply with demand at a cost that is lower than that of its competitors, with a standard of service which is higher, or both. Quality of service may suffer when a service organisation expands its output beyond optimal levels. For example, a bank offering a stockbroking service may suffer harm if it stimulates demand for its service at a time of peak demand, such as a flotation of a nationalised industry.

Demand is frequently stimulated during the off-peak periods using all elements of the marketing mix. Prices are often reduced during slack periods in a number of tactical forms (for example, “off-peak” train tickets, the “happy hour” in pubs and money-off vouchers) valid only during slack periods. Similarly, demand is suppressed during peak periods using a reformulation of the marketing mix. prices are often increased tactically, either directly (for example, surcharges for rail ravel on Friday evenings, higher package holiday prices in August) or indirectly (removing discounting during peak periods.

Controlling supply and demand within manufacturing means keeping production under close watch by watching output, within the timeframe and economic zone under consideration and matching supply to demand in terms of quantity and quality. The latter should be understood as the price/quality ratio and adequate technological response making it possible to answer the needs, attitudes and expectations of the consumer. There are many more elements of a manufacturing operation, other than workstation ability, impacting the ability to meet demand. These include:

• Material availability

• Tool, fixture and NC tape availability

• Waiting for a busy workstation

• Routings, especially alternatives

• Processing time standards

• Efficiency

• Waiting for transfer lot to complete

• Waiting for a process batch to complete (heat treat, autoclave, etc.)

• Maintenance

• Product mix

• Variability in set up time based on sequence material handling

• Cleanup time

• Double set up due to expediting

• Waiting for physical space

All these elements will have impact on the achievable output of a manufacturing organisation, and hence will dictate supply.

Factors Influencing Supply include the availability of raw materials and resources, efficient  management and effective production processes, competitive pressure in the market to meet consumer demands, the time-frame for changing production schedule between products and reacting to changing demands and current technology or physical capacity level of the producer.

Ways to modify the supply:

• Hiring/ firing workers: entails certain costs, both tangible and intangible.

• Overtime/Slack time: It is much less severe than hiring/ firing and is quicker and easier to implement.

• Part-time/Temporary labour: Is attractive because of flexibility it affords, and because companies can pay part-time or temporary workers less and not provide them with fringe benefits.

• Subcontracting: can have disadvantages, including higher costs and lack of control of product quality.

• Co-operative arrangements: many companies have arrangements to share facilities.

• Inventories: companies can use inventories as a buffer between supply and demand during the time period. Inventories are more useful in manufacturing than in service organisations.

Demand planning involves aggregate and item-level forecasts, inventory plans, and replenishment requirements for each node in the supply chain. Forecasting, inventory, and replenishment planning is carried out for each “demand unit”- item level units analysed by service territory or, increasingly, by customer or even individual customer facilities. Manufacturing planning and scheduling involves translating replenishment requirements into a manufacturing plan and a daily schedule for each manufacturing line or piece of equipment. Factors Influencing Demand include whether the good/service a necessity or a luxury, the availability of substitutes and the time frame for making the decisions regarding demand.

Ways to modify the demand

• Price incentives: are useful for reducing peak demand and stimulating off-peak demand.

• Reservations: requiring customers to reserve capacity in advance can influence demand

• Backlogs: companies can modify demand asking customers to wait for orders. • Complementary products or services: companies that have highly seasonal demand use complementary products and services to smooth out their demand. • Advertising/ promotion: can stimulate demand from peak periods to slack periods.

Forecasting

Forecasts help a company anticipate changes in customer demand so the company can be responsive to the needs and benefits of the customer. The are linked to plans and budgets, having a “look into the future” to show the logical consequence of the continuation with the existing plans – trends, fashions, peaks and troughs must all be taken into consideration. The identification of problem areas and then pursuing a different route or preventative measures are excellent planning tools. Forecasts provide an estimate of future levels of demand so that companies can have the necessary capacity and materials available to quickly and reliably respond to customers. In manufacturing the forecast helps prevent underproduction that would cause poor customer service, it also helps estimate periods of over-production that would lead to excessive costs and stock which could cause financial problems for the company. Businesses may use forecasts in several areas including:

Technological forecasts

- to estimate the rate of technological progress. Technological change will provide businesses with new products and materials to offer for sale, creating new competition and markets. This also includes the introduction of new processes for making regular products to reduce costs using the economies of scale.

Economic forecasts

- government agencies publish economic forecasts or a statement of expected future business conditions. These are of interest in regard to taxes, levels of employment and the needs of the economy for money (borrowing and lending). Businesses can obtain ideas about long and medium term growth from these forecasts.

Demand forecasts

- This gives the expected level of demand for the company’s goods or services throughout some future period and is usually an instrument in the company’s planning and control decisions. The portion of total demand that actually flows to a particular company is a result of many forces in the market.

In the management of service operations the aim is to maintain the same level of service at all times and this can provide difficulties for the operations manager when there are widely varying demands on the service. The more accurate a forecast can be made of demand patterns the more there exists the opportunity to arrange the resources of the operation to meet the demand. In the majority of service operations the capacity cannot be changed very greatly in the short term and there will be periods when there is the risk of losing customers because of their unwillingness to wait for the service.

In the current climate there is a need for effective, automated and computerised procedures where statistical forecasting techniques are particularly useful. These include time series data (showing product demands for past few weeks, average demand, trends etc) in order to produce a forecast of such details for future predictions. Error checking systems must be implemented however and the forecasts updated frequently to take into account new information. Forecasting models can be used to help with predictions and an example of such is shown below:

The general other 2 types of forecasting techniques used for demand forecasting are: time series analysis which are useful if the trend shows and fairly consistent pattern which is expected to continue, causal methods which use independent variables in addition to time in order to show a consistent relationship in the past and quantitative techniques.

The following table shows types and characteristics of forecasts:

Capacity

Capacity is the Ability to Meet Demand. If bottlenecks in the system can be eliminated it increased the opportunity to deal with peak demands. The provision of extra capacity must be linked to a costing exercise and the best arrangement of the two main capacity management strategies for a particular service operation selected with this in mind.

Capacity within a Service Context

The extent to which an organisation is able to adjust its output to meet changes in demand is a reflection of the elasticity of these factor inputs. Capacity is said to be inelastic over the short term when is it impossible to produce additional capacity but is elastic where supply can be adjusted in response to demand. The output of a service organisation is determined by the productive capacity of their equipment and its personnel. It is measured in units of output per time period. Some examples would include, patients treated per month or customers served per day. The variability of the demand for the service may be large over relatively short periods of time, this is typically experienced in retail outlets and restaurants in the course of a day. The time taken to perform the service may itself vary from customer to customer.

In some cases the use of a service is characterised by the random arrivals of the customers, when the determination of capacity may be dealt with by the application of queuing theory. If the demand for the service follows a pattern, or is expected to follow a pattern, historical data or marketing research may be used in mathematical models to establish an estimate for demand in the future. The resulting trends in demand will be either constant, rising or falling. Choices relating to capacity may be thought of as managing the gap between the required and the available capacity.

Capacity within a Manufacturing Context

Capacity is a measure of a manufacturing enterprise’s ability to provide products to its customers when needed, or a manufacturer’s ability to meet demand and is a major expense in most manufacturing companies. It is the highest sustainable output rate of a unit, given a particular product mix, a specified level of equipment, labour, and a normal work schedule. If too much capacity is available, the company has heavy capital and operating expenses. If too little productive capacity is available, or if the proper amount is available but poorly utilised, a company cannot meet the level of demand that could be possible and in either case profitability will suffer. Capacity is a Manufacturer’s Primary Asset – the facilities, equipment and people used to make product and the ways those facilities, equipment and people are used. Effectively managing manufacturing capacity can make the difference between loss and profit.

The availability of the individual capacities is entered into calendars. This allows the company to use multiple work shifts, calculating transport time during the production. Breaks, holidays and vacations can also be entered into the calendars either on a standard profile level or individually for each capacity. The capacity workload can be settled on single capacities, groups or departments for any period (days, weeks, months, and so on). This is used to see which capacities have the heaviest workload and to determine the most optimal use of capacities on all levels.

Very important in production capacity planning is the acknowledgement of constraints. Productions capacity can be constrained by number of machines or number of workers and the manufacturer must focus on managing all the limiting elements of the production capacity, not just a few- exposing the interactions and variability of materials, tools, operating strategy, product mix and other elements which determine their “ability to meet demand.” Then everyone in the organisation who makes decisions which impact capacity must have this new, more accurate information. The increasing or decreasing of production capacity costs money.

Capacity Management

Capacity management is concerned with the matching of the capacity of the operating systems and the demand placed on that system. In manufacturing it is a commitment to base all manufacturing planning on the real productive capabilities of the plant by those making the decisions based on the present and future ability to meet demand, including production planning, material planning, engineering, customer service, production support and business management, should have access to information about production capabilities and forecast operational performance.

Achieved through six capacity-specific functions, each of these functions is performed to support a distinct set of decisions in a manufacturing enterprise. The capacity-specific functions are shown below:

• Capacity Design is used to design new, expanded or modified manufacturing facilities to ensure that the production strategy, the capital equipment specifications, and the labour strategy meet long-range production objectives.

• Continuous Capacity Improvement is performed to enhance the processes and methods of an existing operation. “Should equipment be upgraded?” and “Should job sequencing methods be changed?” are addressed with this capacity function.

• Capacity Scheduling is used to plan capacity availability and loading to meet current demand and near-term expected demand. “How much overtime, if any, should be worked, and when?” and “Can an order be accepted without making other orders late?” are points addressed.

• Logistics Scheduling determines the dates at which materials, tools, fixtures and other production support are required. “When are the tools needed for this order’s broach operation?” and “When is the best time to do preventative maintenance on these workstations?” are answered during Logistics Scheduling.

• Production Scheduling is performed to develop accurate, achievable work plans for the short term by assigning jobs to workstations in a specific sequence. “Which grinder should be used to run this job in order to minimise set-up?” and “Should this order be given priority because its due date is approaching?” are addressed by Production Scheduling.

• Schedule Adjustment is used to make modifications to the near-term production schedule to reflect updates based on the most recent information available. “How should today’s jobs be reassigned since one mill went down?” are shown on the production schedule using Schedule Adjustment.

Adopting a Capacity Management orientation gives a manufacturer the opportunity to use their understanding of production capacity as a competitive advantage. Exposing elements, including both value-adding and non-value-adding components, which impact a manufacturer’s ability to produce provides insight used to make cost-effective decisions.

Capacity Management allows manufacturing management to achieve these business objectives:

• Meet customer delivery requirements and more confidently set expectations.

• Shorten production cycle time by identifying and reducing non-value-added time.

• Improve the quality of product by reducing disruptions caused by overly reactive planning and reducing the time product spends on the shop floor.

• Reduce cost by better managing inventories and the use of premium-priced production methods (overtime, expediters, premium freight).

• Provide a better quality of life for employees by reducing the frustration levels caused by constant interruptions and lack of visibility into the plan.

Accurate and achievable plans introduced through better capacity management result in increased confidence. Capacity is the principal asset of a manufacturing enterprise.

There are two basic capacity management strategies for service operations which can be used independently or in combination: Varying capacity in which the capacity is changed to follow changes in demand (referred to as the “chase” strategy by Sasser, Olsen and Wyckoff, 1978), which may be accomplished by:

• changing the number of service people

• changing the hours worked

• using subcontractors

• utilising the customers

• sharing capacity with other service operations

• transferring resources from one part of the operation to another

Manage demand by influencing demand to minimise the need to make changes in capacity. This may be accomplished by:

• price changes

• advertising and promotion

• developing non-peak demand

• developing complimentary services

• using reservation or appointment systems

• making the customer wait or queue

Aggregate Planning

Aggregate Planning is  a medium-term capacity planning that typically encompasses a time period of two to eighteen months. It involves determining the best quantity to produce and selecting the lowest-cost  method that will provide flexibility in capacity while meeting production requirements.  Aggregation is done according to:

• Products:  a product family is a group of products that are manufactured similar and have common labour and materials requirements

• Labour:  a company can aggregate work force  by product family

• Time:  the time period is usually about 1 year.

Aggregate production planning involves managing work force levels – the number of workers required for production, production rate – the number of units produced per time period and inventory levels – the balance of unused units carried forward from the previous period. It takes place in a complex environment that has a number of external and internal factors. Among the common objectives are:

1. Minimise costs

2. Maximise profits

3. Minimise inventory levels

4. Minimise changes in work force levels

5. Minimise use of overtime

6. Minimise use of subcontracting

7. Minimise changes in production rates

8. Minimise number of machine set-ups

9. Minimise idle time for plant and personnel

10. Maximise customer service

Most of the time organisations that sell products or services estimate the demand to this product time-unit (day, week, month). All these demands per time-unit are added together to get an aggregate demand for all products per time-unit. When this amount is calculated, the production capacity must be upgraded, or downgraded to meet this demand. When these organisations sell several product or services, this calculation becomes more difficult because it is not likely that two different products require the same amount of labour and raw material. Here the production is not per month (time-unit), but per unit. The amount of labour necessary to produce one unit can then be the standard to make the aggregate planning for these products.

Service industry sectors suffer similar problems to the manufacturing environment and use similar techniques. The service sector can be perceived as simpler since issues of stock are avoided (except in retail), but even then, replenishment stock is expected to be sent generally within 2 – 3 working days with stock either being ordered through the fixed quantity procedure or the fixed interval procedure.

A strategy is a plan of action in order to give the company a sense of purpose and begins by asking what the activities and goals of the business are, relating both to the present position of the company and the likely future resources and opportunities available to the organisation. These strategic decisions encompass a very wide range of data and is inevitably decided upon by the top end of the hierarchy.

It begins with the Mission Statement determining the organisations’ fundamental purpose for existence and the way it perceives itself. They are broad in purpose whilst reflecting the views and the philosophy of top management. It should clearly identify the customers, the needs it is satisfying and the key products as well providing employees and other stakeholders with a vision they can believe and want to adopt as their own. The vision is the long term view and aspiration of the owner and is a perception of what the firm could achieve. The mission and vision are in interchangeable and this provides the framework for the objectives of the company which in turn should support the mission, these are however expected to change in time.

Companies will have multiple objectives which can be both long and short term, should be SMART and are likely to include: market share, shareholder payments, and social responsibility. These may conflict and priorities will be established and some form of measure to quantify and define the objective. Objectives indicate the distinctive competences or strengths whilst providing guidelines for measuring internal performance in the company and are the cornerstone of any management activity. The ultimate objective is to gain a superior position over the competition (using Porter’s Generic Strategy) but is dependent on market conditions.

Analysing the External (Micro) Environment is the next stage using a Stakeholder Analysis. This determines the group of people with influence and power internally and will benefit from its success (i.e. Directors, Government, etc). The monitoring of the environment is imperative in order to recognise trends, price cuts from competitors, market place analysis and the power of the customer etc. The Macro Environment includes a PEST Analysis, examining the global environment where the company operates, considering each of the aspects which could have a direct impact upon the company and its strategic plan. Products decline for a number of reasons but can include technological advancement to the products, supply and demand, social changes (culture or fashion), saturation of the market, legislation and Health and Safety.

The Analytical Tools include McKinsey’s 7 S Model. It is a powerful framework for internal analysis considering the interaction of 7 sub systems, when one is changed, the other 6 may also require modifying in order to obtain optimum efficiency and effectiveness. These comprise of the structure which shows how to co-ordinate tasks, the strategy – planned responses to environmental changes to achieve organisational objectives, the systems in place to ensure the company gets things done effectively, the style – management techniques, the staff – human resources including morale, recruitment and promotions, the skills – what it does or needs to do best in order to be successful and finally superordinate goals and shared values – these are the guiding principles which include the aspirations, mission, values and ethos of the business.

Porter’s 5 Forces is a model of competitive analysis within a particular market, helping the business understand the market it’s located in by illustrating how the competitive forces shape a business and the relationship between market structure and market behaviour. It identifies new entrants, suppliers, substitutes, buyers and industry competitors determining the level of competition, capacity and identifies the 5 major influences on the profitability of a market which incorporates Competitive rivalry, Ease of Entry and Barrier to Entry, Determinants of Supplier Power and Price sensitivity/bargaining Leverage. These forces of competition are the motivating factors which moves an industry forward towards a sufficient profit and is crucial to establish the importance of each force and scrutinise the most relevant, assessing their strength in a situation in order to create a plan to obtain strategic advantage.

Ansoff’s Product/Market Matrix indicates the direction a business is likely to pursue with a product strategy as it relates environmental factors to internal ones. It is designed to transform the firm from the present position to one described by the objectives, subject to constraints of the capabilities and the overall potential of the organisation. This model specifically illustrates two concepts, gap analysis which is designed to evaluate the difference (gap) between the current position of the firm and its objectives. The organisation chooses the strategy that “substantially closes the gap.” Synergy refers to the idea that firms must seek “product-market posture with a combined performance that is greater than the sum of its parts,” more commonly known as “2+2=5″ formula.

BCG Matrix analyses the portfolio of a company by identifying where a product is within its life cycle (i.e. Cash Cow) and is determined by two variables, the rate of growth and the relative market share. It offers an understanding of a variety of markets by identifying the probable direction to be taken. The vertical axis represents external factors and identifies the rate of industry growth when all being equal the prospects are favourable whereas the horizontal axis shows internal characteristics like the relative market share or competitive strength of the largest competitor. Assumptions are made concerning profit and market share being related, no barriers to entry/exit and the market is still growing whilst the maturity of the industry can be recognised. The balanced portfolio has Stars, Cash cows and problem children – dogs are not necessary as they indicate failure.

Porter’s Generic Strategy is an industry analysis providing information on which competitive strategies may be based in order to obtain the most advantageous position within the market place. It identifies the 3 strategies as cost leadership, differentiation and focus with the need for every business to adopt one of the strategies in order to succeed enabling competitive advantage.

A SWOT Analysis is used to carry out a systematic and searching appraisal of the company through the identification of its strengths and weaknesses whilst also identifying potential assets and opportunities still to be exploited. It can identify policy changes required in order to meet long term objectives, can prove beneficial in the more effective use of resources which can in turn improve profitability and finally help prepare defence strategies to combat external threats on the company.  These, along with considerations of societal and company values, lead to creation, evaluation, and choice of strategy. SWOT’s objective is to recommend strategies that ensure the best alignment between the external environment and internal situation by analysing factors that may affect desired future outcomes of the organisation.

Strategy Review

An Internal Audit considers the financial performance which would ideally cover the past few years if the figures are available in order to identify trends (comparing to the norm for the industry and then against the performance of competitors), and thus hopefully identifying improvement and danger areas. There is usually the standard list of parameters used in this analysis which include financial ratios. The functioning of every individual department should also be considered (i.e. R & D, marketing etc) with close scrutiny being paid towards its effectiveness and efficiency as well as its individual strengths and weaknesses. The organisational structure needs to be reviewed also since this encompasses the framework which holds the departments together, and finally the intangibles – this indicates organisational effectiveness and covers the culture and style of management, the motivating elements and other factors which are not clearly visible but nevertheless still exist.

The Marketing Audit bases its assumptions on the business recognising the environment where it exists and having knowledge and experience of the market forces in order to be successful in the promotion of its products. By fulfilling the needs of the customer and being perceived as “different” or “better” than the competition becomes highly important in order to become a market leader since “branding” and product profile can be the cause of success or failure.