<5.6 PRODUCTION PLANNING (HL)>

--LOCAL/GLOBAL SUPPLY CHAINS--

⚠️SUPPLY CHAINS ≠ DISTRIBUTION CHANNELS⚠️

--"WHAT IS A SUPPLY CHAIN?"--

A SUPPLY CHAIN refers to a SYSTEM/PROCESS of organising people, activities, information and resources TO MOVE A PRODUCT/SERVICE FROM SUPPLIER TO THE CUSTOMER/END USER (RAW MATERIAL->FINAL DELIVERY).

--LOCAL vs GLOBAL CHAINS--

--LOCAL--

LOCAL SUPPLY CHAINS refer to a supply chain where sourcing, production, and distribution ALL OCCUR WITHIN THE SAME COUNTRY/REGION.

--GLOBAL--

GLOBAL SUPPLY CHAIN refers to a supply chain where raw materials, manufacturing, and distribution OCCURS ACROSS MULTIPLE COUNTRIES..

-WHY LOCAL?-

SHORTER LOCAL LEAD TIMES.
LESS MISCOMMUNICATION.
SUPPORTS LOCAL ECONOMY.
CREATES LOCAL JOBS.
LOCAL GOV'T ASSISTANCE?
LOWER CARBON FOOTPRINT.
LESS RISK FROM GEOPOLITICAL ISSUES, EG TARIFFS, COVID...
SUITABLE FOR SMALL FIRMS
NOTE: IF WE REVERSE THESE PROS FOR LOCAL, WE GET THE CONS FOR GLOBAL

-WHY GLOBAL?-

LOWER PRODUCTION COSTS INCLUDING LABOUR.
LOWER CUSTOMER PRICES.
MORE CUSTOMER VARIETY.
ACCESS TO WIDER RANGE OF RESOURCES (MAYBE NOT AVAILABLE LOCA;LLY) AND SUPPLIERS.
CAN SCALE UP MORE EASILY.
NOTE: IF WE REVERSE THESE PROS FOR GLOBAL, WE GET THE CONS FOR LOCAL

--WHEN GLOBAL FEELS LOCAL--

Both definitions above are from the same perspective, in that the end-user is based in the same country as the suppliers, however If your customer base is located overseas—especially near your overseas production or distribution sites, it can function almost like a local market, giving all the PROS of LOCAL (reduced shipping costs, lead times, etc...) So it is ⚠️VITALLY IMPORTANT THAT YOU MAKE THIS PERSPECTIVE CLEAR⚠️ when evaluating both types of chain.

--JUST IN TIME/JUST IN CASE--

--JUST IN TIME--

JUST IN TIME is a type of INENTORY CONTROL TOOL used to MANAGE RISK, and is used in PRODUCTION PLANNING. It's key features are as follows:
- - ✅ONLY STOCK NEEDED ARRIVES, SO NO WASTE.
  - ✅MINIMAL STORAGE COSTS.
  - ⚠️VERY ACCURATE FORECAST OF DEMAND TRENDS IS REQUIRED.
  - ⚠️VULNERABLE TO ANY SUPPLY CHAIN DISRUPTIONS.
  - ⚠️SUPPLIERS MAY DISLIKE SMALL FREQUENT DELIVERIES
  - ⚠️NO ROOM FOR PRODUCTION ERRORS, AS NO EXTRA STOCK.

--JUST IN CASE--

JUST IN CASE is a type of INVENTORY CONTROL TOOL used to MANAGE RISK, and is used in PRODUCTION PLANNING. It's key features are as follows:
- - - ✅KEEPS A BUFFER STOCK., 'IN-CASE' OF UNEXPECTED SPIKES IN DEMAND. SO LESS RISK OF 'STOCKOUTS'.
    - ✅SUPPLIERS PREFER LARGER ORDERS & LESS DELIVERIES.
    - ✅GOOD IF DEMAND IS UNPREDICTABLE.
    - ⚠️IF EXTRA STOCK IS NOT SOLD WILL LEAD TO WASTE IF UNUSED.
    - ⚠️INCURS STORAGE COSTS.
    - ⚠️STILL SMALL ROOM FOR ERRORS.

--TASK--

Create a Venn Diagram comparing both types.

--STOCK CONTROL CHARTS--

--WHAT DO THEY SHOW?--

STOCK CONTROL CHARTS, (also called an 'inventory control' charts) are a VISUAL TOOL used by businesses TO MONITOR AND MANAGE STOCK LEVELS OVER TIME. It helps ensure that inventory is available when needed while AVOIDING 'OVERSTOCKING' or 'STOCKOUTS'. In essence they provide a visual answer to the following questions:
Q. "What's the maximum stocks you want/can hold?" (Max level)
- - - - e.g. "Ideally, 60 bags of coffee beans is the max we want to store"
Q. "How many units do we sell on average each day?" (Usage rate)
- - - - e.g. "We use ≈5 bags of coffee beans per day"
Q. "At what level of stock remaining do we re-order?" (Re-order level)
- - - - e.g. "When we are down to 35 bags in stock we reorder", "Why?"
Q. "How many days after placing an order will it arrive?" (Lead-time)
- - - - e.g. “Well it takes 5 days for the new stock to arrive, and...”
Q. "Do we include a 'buffer-stock' into this level?" (Buffer level)
- - - - e.g. "...we want to keep a 10 bag buffer stock just in case"
Q. "When we re-order what quantity should we get?" (Re-order quantity)
- - - - e.g. "So, we reorder 50 bags when we're down to 35 bags"

"Does this make sense?" "Sort of", "Nah!"

"Ok!, let’s plot it so it makes it's crystal clear"

--TASK--

Copy the final slide, annotate and try to derive a formula to work out the Reorder level? Ask yourself "What impacts the rate at which stock reaches the buffer level, and how long before the rate reaches the buffer level after an order?

--TASK--

With reference to the formula can you answer the question above?
Reorder Level = (Daily Usage Rate × Lead Time) + Buffer Stock

"We can see that as the lead time falls (rises), the reorder level falls (rises), as the supplier is now quicker"

--TASK--

With reference to the formula can you answer the question above?
Reorder Level = (Daily Usage Rate × Lead Time) + Buffer Stock
"We can see that as the usage rate falls (rises), the reorder level rises (falls), as the firm needs supplier is now quicker"

--WHY ARE SHORTER LEAD TIMES BETTER?--

Why shorter lead times are preferred?

✅ Benefits of Shorter Lead Times

Faster Response to Demand

You can restock or adjust production quickly when customer needs change.

Lower Inventory Costs

You don’t need to store as much stock “just in case,” which saves money on storage and reduces waste.

Reduced Risk of Stockouts

Products arrive faster, so you're less likely to run out even if demand spikes.

Better Cash Flow

You buy what you need when you need it — less money tied up in stock sitting on shelves.

Supports JIT (Just-in-Time) Systems

Essential for lean production methods that aim to reduce waste.

Improved Customer Satisfaction

Faster delivery times lead to happier, more loyal customers.

📦 Example:

A clothing shop with a 2-day lead time can reorder popular shirts and get them on the shelves quickly — while a shop with a 3-week lead time might miss the trend altogether.

--CAPITAL UTILISATION RATE--

--DEFINITION & FORMULA--

CAPITAL UTILISATION RATE, measures HOW MUCH OF A FIRM'S PRODUCTIVE CAPACITY (The maximum amount of goods and services that a firm can produce given its available capital resources and technology) IS BEING USED. Here is the formula:
CAPITAL UTILISATION RATE (%) =
ACTUAL OUTPUT / MAXIMUM POSSIBLE OUTPUT × 100
We acknowledge FOUR POSSIBLE STATES of CAPACITY as follows

--EXCESS--

"We have the appropriate amount of capital to meet all demand, but at the moment demand is temporarily insufficient/reduced!"

EXCESS CAPACITY is a term often used when describing an individual FIRM/INDUSTRY that 'TEMPORARILY' has unused capital, due to a recession or some event that results in consumers holding back their usual spending.
DEMAND < SUPPLY

--FULL--

"We already have the appropriate amount of capital to meet all current demand, though we can't produce anymore!"

FULL CAPACITY is a term often used when describing an individual FIRM/INDUSTRY that is using all its capital efficiently to meet current demand, without waste or shortages. However, this means any further demand will result in higher prices.
DEMAND = SUPPLY

--BELOW--

""We haven't built enough capital to meet the nation's demand!"

BELOW CAPACITY is a term often used when describing an individual FIRM/INDUSTRY that is PERMANENTLY unable to invest in enough capital to satisfy the demand from consumers.
DEMAND > SUPPLY

--OVER--

"We have built far more capital than we will ever need!"

OVER CAPACITY s a term often used when describing an individual FIRM/INDUSTRY that HAS PERMANENTLY invested in too much capital and as a result the supply base is too large for realistic demand.
SUPPLY > DEMAND

--PAST PAPER TASK 1--

Calculate the capacity utilization rate at the break-even quantity for DD for the first year of operation (show all your working).

STEP 1- Work out the B/E quantity using Fixed cost / Contribution per unit
STEP 2- Work out the utilisation rate using B/E quantity / Total capacity

--PAST PAPER TASK 2--

Calculate the increase in capacity at RDM if the company builds a new production facility (show all your working).

STEP 1- Work out current utilisation rate Current output / Total capacity
STEP 2- If after expansion the utilisation-rate is 50% and current output is still 20,000, then fit these into the formula to work out the new total capacity.
STEP 3- Now, with the new total capacity, minus the original capacity to determine the increase in capacity.

--DEFECT RATE--

--DEFINITION-

THE DEFECT RATE (%) measures the percentage of products that are faulty or below quality standards out of the total produced.

= Number of defective units/Total units produced x 100

✅ Why It Matters:

A LOW DEFECT RATE means high product quality and customer satisfaction.
A HIGH DEFECT RATE leads to waste, rework costs, returns, and damage to reputation.

--PRODUCTIVITY--

--PRODUCTIVITY RATE (%)--

THE PRODUCTIVITY RATE is a general measure that shows how effectively inputs such as labour and machinery (capital) are converted into output (inputs to output ratio)
The formula: TOTAL OUTPUT / TOTAL INPUTS

--LABOUR PRODUCTIVITY RATE (%)--

LABOUR PRODUCTIVITY is the most common productivity statistic measured, and shows the average output per worker (in a given time period. The formula is...
TOTAL OUTPUT / TOTAL WORKERS EMPLOYED x 100
"HOW TO IMPROVE?"

IMPROVE THROUGH TRAINING: If the firm can train its workers better then as their skill level rises, so too should productivity however, training can be expensive and time-consuming, and highly qualified staff could leave to join another, perhaps rival, business. EEK!
IMPROVE EMPLOYEE MOTIVATION: There are many different views on the most appropriate ways to do this. Increasing pay is unlikely to have a permanent impact on productivity (as identified by Herzberg). There may be little point in increasing pay by 10% if labour productivity only rises by 5%. After all, it is unit costs that firms want to drive down. Most businesses now put the emphasis on non-financial methods of motivation. These include involvement in decision-making, kaizen groups, delegation an quality circles. If these increase productivity without an increase in labour pay, unit costs will fall.
PURCHASE MORE ADVANCED EQUIPMENT: from office computers to robot-controlled production machines – should allow increased output with fewer staff. But such expensive investment will only be worthwhile if high output levels can be maintained. In addition to the capital cost, staff may need to be retrained and there may be genuine fear amongst the workers about lost jobs and reduced security of employment.
MORE EFFECTIVE MANAGEMENT: There are many ways in which ineffective management can reduce the overall productivity of a business. Failure to purchase the correct materials, poor maintenance schedules for machines or heavy-handed management of staff are just some of these. More efficient operations and people management could go a long way to improveproductivity levels.

--CAPITAL PRODUCTIVITY RATE (%)--

CAPITAL PRODUCTIVITY is a measure of output per unit of capital used (e.g., machines, equipment) in a given time period. The formula is...
TOTAL OUTPUT / TOTAL CAPITAL USED x 100

--OPERATING LEVERAGE--

--DEFINITION--

OPERATING LEVERAGE is best understood as a 'MULTIPLIER' or a 'RATE OF CHANGE' that answers one critical managerial question:

"If we increase sales by x%, how much % does our profit increase?"

--KEY IDEAS/ASSUMPTIONS--

In order to answer this question we must make a number of key points:

1) It is based on all key assumptions of the B/E model....

2) ...Total Revenue (TR) and Total Cost (TC) curves are linear.

3) ...All fixed costs remain constant regardless of output.

4) We only focus on profitable output levels (beyond breakeven).

This is is only applicable when we consider output levels beyond B/E

This diagram visually shows the concept of Operating Leverage in relation to the Break-even Model:

TR (Total Revenue) increases linearly with sales.

TC (Total Cost) starts at the fixed cost level and increases with variable costs.

The Break-even Point is where TR = TC.

Beyond this point, the gap between TR and TC widens, representing increasing profit—this widening is where operating leverage kicks in.

The steeper the divergence, the greater the profit gains for each extra unit sold, especially in high fixed-cost firms.

--WHY IS IT A MULTIPLIER?--

Once a firm passes its breakeven output, each additional unit sold contributes to profit, therefore the rate at which TR diverges from TC (i.e., how steep the gap grows) determines how fast profits grow.
"What Determines the Size of the Operating Leverage Multiplier?"
The higher the fixed costs relative to variable costs (the ratio of fixed costs to variable cost), the greater the degree of operating leverage. This is because, after covering fixed costs, a larger portion of each sale contributes directly to profit. Thus, small increases in sales lead to disproportionately large increases in profit.
We can see below that at when the ratio of VC to FC is greater the B/E output level is LOWER, but the DIVERGENCE is also LOWER and vice versa.
We can see this clearly in the diagram below....

-HIGH LEVERAGE-

If the ratio of fixed to variable costs is HIGH, then the firm is said to have HIGH operating leverage.
This means that a GREATER proportion of the firm’s total costs are fixed, and do not change with output. As a result:

"The firm needs high sales to reach its break-even point, because those fixed costs must be covered before making any profit"

"However, once the break-even point is passed, most of the additional revenue contributes to profit, since variable costs are relatively low"

"On the downside, if sales fall, the firm still has to pay those large fixed costs, which means it faces a high risk of losses even with small drops in revenue"

In short: high operating leverage = high risk, high reward.

-LOW LEVERAGE-

If the ratio of fixed to variable costs is LOW, then the firm is said to have LOW operating leverage.
This means that a SMALLER proportion of the firm’s total costs are fixed, and do not change with output. As a result:
"The firm can reach its break-even point more quickly, because it has fewer fixed costs to cover"
"However, after breaking even, a significant portion of additional revenue goes toward variable costs, so profit grows more slowly"
"Though, if sales fall, the firm is less exposed, because most of its costs are variable and will decrease with lower output — giving it more flexibility and lower risk.
In short: low operating leverage = low risk, lower reward.

-EXAMPLE-

--POOL HALL--

Fixed Costs per month
- - Rent for the venue: $4,000
  - Staff salaries: $3,000
  - Utilities, insurance, etc..: $2,000
  - Total fixed costs: $9,000

Variable Costs:
- - Cue chalk, wear & tear on tables, electricity per hour of use. Let’s say: $1 per hour of pool play per customer
Revenue of $10/hour
- - B/E is the number of hours it takes to cover its fixed and variable cost, which in this case is 1000 hours as this will make a revenue of $10k as well as cost the firm $10k (9k + 1000*$1)

Implication are that the fixed costs are very high ($9,000), and variable costs are low ($1 per customer). So If only a few people show up, the pool hall loses money because those fixed costs are still due. However once enough customers come in to break even then each extra $10 earned per hour mostly goes toward profit, since the cost per extra player is just $1.
- In summary:
- High Fixed Costs + Low Variable Costs = High Operating Leverage
- The pool hall needs high usage to survive, but once it gets busy, it becomes very profitable quickly.
- This also means it’s risky: If fewer people play than expected, the hall still owes rent and wages.

-EXAMPLE-

🎱 Example: Low Operating Leverage at a Pool Hall (Outsourced/Flexible Model)

🔧 Fixed Costs (low):

Small venue rented by the hour: $1,000/month

Part-time staff paid only when working: $500/month average

Minimal insurance/licensing fees: $500/month

Total fixed costs: $2,000/month

⚙️ Variable Costs (high):

Staff wages per hour, rental costs per table per game, pay-per-use lighting and utilities

Let's say: $6 in variable cost per hour of pool play (including labor and overhead)

💡 Implication of Low Operating Leverage:

The fixed costs are low, so the pool hall doesn’t lose much if business is slow.

However, since variable costs are high, each extra game played adds a significant cost.

Suppose the hall charges $10/hour:

$6 goes to costs, leaving only $4 profit per hour.

So, even after breaking even, profit grows slowly because each sale still incurs high costs.

📉 Summary:

Low Fixed Costs + High Variable Costs = Low Operating Leverage

The pool hall breaks even more easily, but profits grow slowly with each additional customer.

It’s less risky, but also less rewarding in high-demand periods.

--TASK--

With reference to the diagram above complete these sentences!
- - A firm with a lot of fixed costs relative to variable costs will naturally B/E at an output level GREATER/LOWER THAN a firm with relatively fewer fixed costs relative to variable costs.
  - However, a firm with very few variable costs relative to fixed costs will make MORE/LESS PROFIT per sale beyond their B/E level of output.

--FORMULA--

How many times will a 1% increase in sales increase profits?
Well that depends on the gap between: TR - VC / TR - VC - FC
Because the denominator (operating profit) grows faster than the numerator (contribution margin) after breakeven, the DOL decreases as output rises.

--FORMULA--

So we can say that: "As sales rise, revenue increases faster than total variable costs as such the lower the rate of variable costs relative to revenue the greater the profit right!!!"
Operating leverage can be used to assess the degree to which a business can increase operating profit by increasing revenue. A business that generates sales with a high gross margin and low variable costs is described as having high operating leverage. Businesses with high operating leverage must cover a larger amount of fixed costs during each time period whether they sell any products or not. The business may make a large gross profit on each extra item sold, but it must reach enough sales volume to cover its substantial fixed costs. If it can do this, then the business will earn a significant profit on all sales after it has paid for its fixed costs. However, profit will be more sensitive to changes in sales volume.
Businesses with low operating leverage have high variable costs per unit that vary directly with the number of units sold, but they have relatively low fixed costs to pay each time period. In a business with low operating leverage, a large proportion of total costs are variable costs. In this case, the business makes a relatively small profit on each extra unit sold, but it does not have to achieve a high sales volume in order to cover its relatively low fixed costs. It is easier for this type of business to earn a profit at low sales levels, but it will not earn very high profits if it generates additional sales.

To calculate operating leverage, the following formula is used:

We have already seen that firm's that are profitable with relatively high fixed costs and low variable costs will make more profit every time they make a sale and vice versa, right! We can use a formula to find a multiplier which shows how much a 1% in sales will increase profits as follows. We start by picking a level of output.
Clearly any firm that is in profit must be covering both its fixed and variable costs at that output level however with all fixed costs covered only variable costs will reduce the profit from each additional sale right? But by how much? Equally we can say that well that simply depends on the ratio of variable costs to fixed costs.
cha

after B/E when you sell a unit the gap between the money in and money out is revenue - AVC / if we divide this by

How many times will a 1% increase in sales increase profits? Well that depends on the gap between TR and TVC

--''WHICH IS BEST?"--

Whether high or low operating leverage is better depends on the business model, market conditions, and risk appetite. Here's a breakdown to help you decide:

🔺 High Operating Leverage:

✅ Pros:

High profit potential once break-even is reached.

Scalability: Adding more customers doesn’t add much extra cost.

Ideal for tech, media, or education (like international schools).

❌ Cons:

High risk: If sales fall, you still have to pay high fixed costs.

Less flexible during downturns (e.g., can’t easily reduce teacher salaries or shut a factory quickly).

Takes longer to become profitable (requires more upfront investment).

🔻 Low Operating Leverage:

✅ Pros:

Lower risk: Costs rise and fall with sales — easier to scale up/down.

Better for new businesses, seasonal firms, or service providers.

Easier to adapt in uncertain markets.

❌ Cons:

Lower profit margins — profits grow slowly as costs rise with each sale.

Hard to scale big without hiring more people or buying more materials.

🧠 So which is better?

Condition Best Choice

Stable, growing market High leverage

Volatile or uncertain market Low leverage

Startup with limited funds Low leverage

Established business with capital High leverage

Focus on flexibility and control Low leverage

Goal: Big profits from scaling fast High leverage

--TASK--

Explain why you would consider your school high leverage

--CASE STUDY: YOUR SCHOOL--

ARE international schools high leverage?

Yes, international schools are generally high operating leverage businesses, and here’s why:

High Fixed Costs Facilities, teacher salaries, admin staff, IT systems, and marketing are ongoing regardless of student numbers.

Low Variable Costs Adding an extra student often involves minimal additional cost (e.g., a few materials or lunch), especially if class sizes don’t need to grow.

Revenue Scaling Each new student adds tuition revenue with little added expense — profits rise quickly once break-even is passed.

Break-Even Point Requires a certain number of enrolled students to cover fixed costs. Below that, losses occur quickly.

📘 Example:

A school might spend millions annually on buildings, staff, and curriculum. Whether 500 or 550 students attend, those costs are mostly the same. But those extra 50 students generate pure profit after the break-even point.

⚠️ Risk:

If enrolment drops, schools can’t cut costs quickly — teacher contracts, rent, and utilities are fixed. So they are financially sensitive to enrolment fluctuations — a key trait of high operating leverage.

NOTE:👩‍🏫 Are teacher salaries fixed or variable costs?

✅ In most schools (especially international schools):

Teacher salaries are treated as fixed costs in the short to medium term.

That’s because:

Teachers are hired on annual contracts, regardless of how many students are in the class. Whether you have 18 or 22 students, the teacher gets paid the same.

Schools usually can’t reduce staff easily without affecting operations or quality.

⚖️ So they are:

Fixed in the short run: Can't easily adjust if student numbers fluctuate.

Variable in the long run: If enrolment stays lower over years, schools might reduce staff.

📊 Summary:

Cost Type Is it Fixed or Variable? Why?

Teacher salaries Fixed (short/medium term) Contracts and staffing needs don’t change easily.

Textbooks/supplies Variable Costs increase per student.

Utilities/rent Fixed Paid no matter how many students attend.

So while it might feel like salaries could vary, in financial planning for international schools, they are treated as a fixed cost — making the business high in operating leverage.

Let me know if you'd like this turned into a teacher-focused example or visual!

--COST TO BUY vs COST TO MAKE--

--"Would it be cheaper to make in-house or order it in?"--

--DEFINITION--

COST TO BUY refers to the costs to purchase the item or service FROM A THIRD-PARTY supplier, rather make it yourself:
Example: Buying readymade T-shirts from a manufacturer for $5 each.

--DEFINITION--

COST TO MAKE refers to the costs to make the item yourself (IN-HOUSE), rather than get a 3rd party to do it.

--EXAMPLE--

COST TO BUY refers to the costs to purchase the item or service FROM A THIRD-PARTY supplier, rather make it yourself:
Example: Buying readymade T-shirts from a manufacturer for $5 each.

--EXAMPLE--

COST TO MAKE refers to the costs to make the item yourself (IN-HOUSE), rather than get a 3rd party to do it.

Calculate cost to make and the cost to buy IBAT lenses.

--GANTT CHART--

--CONTRIBUTION (HL)--

--CRITICAL PATH ANALYSIS (HL)--

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