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Copyright © Amity University1
PAN African eNetwork
ProjectMASTER OF FINANCE & CONTROL
STRATEGIC FINANCIAL MANAGEMENT
Semester - III
Mr. SURAJ PRAKASH
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FINANCIAL ASPECT OF
SUPPLY CHAIN MANAGEMENT
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A supply chain is a network of facilities and distribution options that
performs the functions of
1. Procurement of materials,
2. Transformation of these materials into intermediate and finished
products, and
3. The distribution of these finished products to customers.
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Supply chain management is typically viewed to lie between
fully vertically integrated firms, where a single firm, and those
own the entire material flow where each channel member
operates independently.
Therefore coordination between the various players in the
chain is key in its effective management.
Cooper and Ellram [1993] compare supply chain management
to a well-balanced and well-practiced relay team. Such a team
is more competitive when each player knows how to be
positioned for the hand-off.
The relationships are the strongest between players who
directly pass the baton, but the entire team needs to make a
coordinated effort to win the race
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SUPPLY CHAIN DECISION
6
We classify the decisions for supply chain management into twobroad categories ±
strategic and operational.
As the term implies, strategic decisions are made typically over alonger time horizon. These are closely linked to the corporate
strategy (they sometimes {\it are} the corporate strategy), and
guide supply chain policies from a design perspective.
On the other hand, operational decisions are short term,and focus on activities over a day-to-day basis. The effort in
these type of decisions is to effectively and efficiently
manage the product flow in the "strategically" planned
supply chain.
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S upply Chain Decisions
There are four major decision areas insupply chain management:
1) Location,
2) Production,
3) Inventory, and
4) Transportation (distribution),
and there are both strategic and operationalelements in each of these decisionareas.
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Location DecisionsThe geographic placement of production facilities, stocking points,
and sourcing points is the natural first step in creating a supplychain.
The location of facilities involves a commitment of resources to along-term plan.
Once the size, number, and location of these are determined, so arethe possible paths by which the product flows through to the finalcustomer.
These decisions are of great significance to a firm since theyrepresent the basic strategy for accessing customer markets, andwill have a considerable impact on revenue, cost, and level of
service.
These decisions should be determined by an optimization routinethat considers production costs, taxes, duties and dutydrawback, tariffs, local content, distribution costs, productionlimitations, etc.
Although location decisions are primarily strategic, they alsohave implications on an operational level.
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Production Decisions
The strategic decisions include what products toproduce, and which plants to produce them in, allocationof suppliers to plants, plants to DC's, and DC's tocustomer markets.
As before, these decisions have a big impact on therevenues, costs and customer service levels of the firm.
These decisions assume the existence of the facilities,but determine the exact path¶s through which a productflows to and from these facilities.
Another critical issue is the capacity of the manufacturingfacilities--and this largely depends the degree of verticalintegration within the firm.
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Operational decisions focus on detailedproduction scheduling. These decisions include theconstruction of the master production schedules,scheduling production on machines, and equipment
maintenance.
Other considerations include workload balancing,and quality control measures at a production facility.
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Inventory DecisionsThese refer to means by which inventories are managed.
Inventories exist at every stage of the supply chain as either rawmaterials, semi-finished or finished goods.
They can also be in-process between locations.
Their primary purpose to buffer against any uncertainty that might existin the supply chain. Since holding of inventories can cost anywherebetween 20 to 40 percent of their value, their efficient managementis critical in supply chain operations.
It is strategic in the sense that top management sets goals. However,most researchers have approached the management of inventoryfrom an operational perspective.
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These include deployment strategies (push versus pull),control policies --- the determination of the optimal levels of order quantities and reorder points, and setting safetystock levels, at each stocking location. These levels are
critical, since they are primary determinants of customer service levels.
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Transportation Decisions
The mode choice aspect of these decisions are the more strategicones. These are closely linked to the inventory decisions, since thebest choice of mode is often found by trading-off the cost of usingthe particular mode of transport with the indirect cost of inventoryassociated with that mode.
While air shipments may be fast, reliable, and warrant lesser safetystocks, they are expensive. Meanwhile shipping by sea or rail maybe much cheaper, but they necessitate holding relatively largeamounts of inventory to buffer against the inherent uncertaintyassociated with them. Therefore customer service levels, andgeographic location play vital roles in such decisions. Sincetransportation is more than 30 percent of the logistics costs,
operating efficiently makes good economic sense.
Shipment sizes (consolidated bulk shipments versus Lot-for-Lot),routing and scheduling of equipment are key in effectivemanagement of the firm's transport strategy.
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Supply-Chain Management (SCM)
Another aspect of Advanced Planning and
Scheduling.
It administers the flow of supplies, logistics,
services and information through the supply-
chain, from suppliers, manufacturers, sub-
contractors, stores and distributors to customers
and end-users. It involves business strategy,
information flow and systems compatibility.
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Benefits
Improved visibility of information betweensuppliers and customers: quicker responseto changes in demand.
Shared knowledge: reducing waste andinventories, improving product quality andservices throughout the chain.
Development of a longer term ³learningnetwork´ for the benefit of customers,suppliers and individuals.
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Physical v/s Financial Supply
Chains Physical Supply Chain
± Information andprocesses related to thestatus and movement of
the physical goods in transitor storage
E.g. Procurement,supply, logistics,Customs, qualityinspection and
regulatory aspects of thephysical movement
Financial Supply Chain
± Information andprocesses related to thestatus and compliance
stages of the financial aspects of Supply ChainManagement
E.g. Supplier and Buyer Finance process progressstatus, DC and Open
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Financial Aspects of the
Supply Chain Aim to give companies a real insight on the role the
supply chain plays to reduce costs in the wider companybusiness model.
It focuses on how one can reduce costsand create valuewithout resorting to lowering supplier rates. To methods inhow through greater internalcollaboration between financeand logistics departments, cash flow and working capitalimprovements can berealized. And in how greater
collaboration with partners within your supply chain willresult in lower totalsupply chain costs.
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Supply Chain Financing Solution
Vendor (Supplier) Financing
± Post Shipment Financing ± Pre Shipment Financing
± Inventory Financing
Distributor Financing Receivables Financing and Risk
Management
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TURBULANT BUSINESS ENVIRONMENT FINANCIAL
DIMENSIONOF DECISION MAKING
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SUPPLY CHAIN DESIGN
PROBLEM- FINANCIAL ISSUE Process data
a set of products
a set of markets. a set of potential geographical sites.
a set of potential equipment
lower and upper bounds for capacityincrement
product recipes
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Financial data
product prices
Direct costs
relationship indirect expenses/ capacity.
relationship investment/capacity coefficients for marketable securities
discount factors (Qty., prompt payment)
pledging costs.
tax rate and depreciation data. Interest rates
salvage value
premium risk (shareholders)
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Improved collaboration between finance and other business and supply chain functions is necessary tofacilitate the process to develop activity based costing.
This collaboration should help to overcome the
seemingly widespread inability of supply chainmanagers to articulate the cost and benefit of supplychain activities.
Capitalizing on these opportunities requires the ability toplan for and measure supply chain performance and toeffectively communicate performance implication infinancial terms. The supply chain manager¶s ability toarticulate the financial implications of exchangebetween firms will become more important in future.
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Activity Based Costing
What?
Why?
How?
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Requirement of Cost Systems Valuation of inventory and measurement of
the cost of goods sold for financial reporting.
Estimation of the costs of activities, products,services, and customers.
Providing economic feedback to managers
and operators about process efficiency.
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Today¶s businesses are working in an
increasingly complex environment.
Use of Advanced Technology
Product Life Cycle
Product Complexity
Channels of Distribution
Quality Requirements
Product Diversity
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0
100
1 2 3 4
Composition of Cost
Direct Material Labour Overheads
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Conventional Costing Total Cost = Material + Labour+ Overheads
Overheads are allocated to the products on
volume based measures e.g. labour hours,machine hours, units produced
Will this not distort the costing in the
new environment?
ABC provides an Alternative.
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Conventional Costing
Expenses
Cost Objects
AB Costing
Resources
Activities
Cost Objects
Economic
Element
Work
Performed
Product or
service
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Basics of A B C Cost of a product is the sum of the costs
of all activities required to manufacture
and deliver the product.
Products do not consume costs directly
Money is spent on activities
Activities are consumed by
product/services
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Basics of A B C (contd.) ABC assigns Costs to Products by tracing
expenses to ³activities´. Each Product is
charged based on the extent to which it usedan activity
The primary objective of ABC is to assign
costs that reflect/mirror the physical dynamics
of the business
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Basics of A B C (contd.) Provides ways of assigning the costs of
indirect support resources to activities,
business processes, customers, products. It recognises that many organisational
resources are required not for physical
production of units of product but to provide a
broad array of support activities.
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ABC systems addresses
the following Questions:
What activities are being performed by the
organizational resources?
How much does it cost to perform activities? Why does the organization need to perform
those activities?
How much of each activity is required for the
organization's products, services, and
customers?
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Basics of A B C : How?Steps:
1. Form c ost pools
2 . Identify activiti es
3. M ap resour c e c osts t o activiti es
4. De
fine
activity c o
st dr
iv er
s5 . C alculat e c ost
Cost pools are groups or
categories of individual
expense items
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Identify Activities
In developing an ABC system, the
organisation identifies the activities
being performed:
Move material
Schedule
productionPurchase material
Inspect items
Respond to
customers
Improve productsIntroduce new
products
Explore new markets
Activity Dictionary
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Map resource costs to activities
Financial accounting categorizes expenses
by spending code; salaries, fringe benefits,
utilities, travel, communication, computing,depreciation etc.
ABC collects expenses from this financial
system and drive them to the activities
performed.
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Salaries 313,000
Depreciation 155,000
Electricity 132,000
Supplies 25,000
Travel 100,000
Total 725,000
Accounting RecordsActivities Salaries Depreciati Electricity Supplies Travel Total
Business Development 20,000 25000 5000 5000 55,000
Maintianing Present Business 80,000 60000 50000 5000 10000 205,000
Purhcasing Material 125,000 50000 20000 20000 60000 275,000
Set upMachines 25,000 10000 2000 37,000
Running Machines 50,000 10000 50000 110,000
ResolveQuality Problems 13,000 5000 25000 43,000
Total 313,000 155000 132000 25000 100000 725,000
ABC Records
Mappin g
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Activities: Types
Unit level:Performed each time a unit isproduced.
Batch level:Performed each time a batch is
produced Product level:Performed to support production
of different type of product
Customer Level: Performed to support servicing
customers
Facility level: Residuary head
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Define activity drivers
The linkage between activities and costobjects, such as products, customers,, isaccomplished by using activity drivers.
An activity driver is a quantitative measureof the output of an activity.
The selection of an activity driver reflects a
subjective trade-off between accuracy andcost of measurement.
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Activities Drivers
Unit Level
Acquire and Use material for containers No. of Containers
Acquire and Use material for baby-care p No. of products
Batch Level
Set up manually controlled machines No. of batches of con
Set up computer controlled machines No. of batches of B.
Product Level
Design and manufacture moulds No.of moulds require
Use manually controlled machines Product type (contain
Use conputer controlled machines Product type (B.Prod
Customer Level
Consult customers No. of consultations
Provide warehousing for customers No. of cubit feet
Faciltiy Level
Manage workers Salaries
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Activities Drivers Activity Cost Activity Volum Activity RUnit Level
Acquire and Use material for containers No. of Containers 40,000 1,000,000 0.04
cquire and Use material for baby-care products No. of products 80,000 8,000 10
Batch Level
Set up manually controlled machines No. of batches of containers 3,000 10 300
Set up computer controlled machines No. of batches of B. Produst 12,000 20 600
Product Level
Design and manufacture moulds No.of moulds required 5,000 5 1000
Use manually controlled machines Product type (containers) 15,000 1 15000
Use conputer controlled machines Product type (B.Products) 40,000 1 40000
Customer LevelConsult customers No. of consultations 4,000 40 100
Provide warehousing for customers No. of cubit feet 2,000 10,000 0.2
Faciltiy Level
Manage workers Salaries 3,000 15,000 0.2
Use main building Square feet 48,000 16,000 3
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Ascertaining Cost
A c t i i t i e s A Ra te A.Volume Containers Baby Product
n i t e e
Acquire and Use material for containers 0.04 1,200,000 48,000
cquire and Use material for baby-care products 10 7,000 70000
a tc e e
Set up manually controlled machines 300 12 3,600
Set up computer controlled machines 600 16 9600
r o c t e e
Design and manufacture moulds 1000
1 1,0004 4000
Use manually controlled machines 15000 1 15,000
Use conputer controlled machines 40000 1 40000
C sto e r e e
Consult customers 100
Containers 2 200
B.products 40 4000
Provide warehousing for customers 0.2
Containers 8,000 1,600B.products 2,000 400
a c i t i e e
Manage workers 0.2
Containers 4,000 800
B.products 10,000 2000
Use main building 3
Containers 5,000 15,000
B.products 7,000 21000
o ta C o st 85,200 151,000
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Building an ABC Model
Identify
esources
Identify
Activities
Identify
Cost Objects
Define
esource
Drivers
Define
Activity
Drivers
Enter
esource
Costs
Enter
esource
Driver Qty.
Enter
Activity
Driver Qty.
Calculate
Costs
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ABC: Where to Use?
High Overheads
Product Diversity or Multiple Products
Customer Diversity Service Diversity
Stiff Competition
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TARGET COSTING
45
Target costing is a pricing method used by firms.
It is defined as "a cost management tool for reducing
the overall cost of a product over its entire life-cycle
with the help of production, engineering, research and
design".
A target cost is the maximum amount of cost that can
be incurred on a product and with it the firm can still
earn the required profit margin from that product at a
particular selling price.
In the traditional cost-plus pricing method materials,
labor and overhead costs are measured and a desired
profit is added to determine the selling price.
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Target costing involves setting a target cost by subtracting a desired profit marginfrom a competitive market price.
A lengthy but complete definition is
"Target Costing is a disciplined process for determining and achieving a full-
stream cost at which a proposed product with specified functionality,performance, and quality must be produced in order to generate the desired
profitability at the product¶s anticipated selling price over a specified period
of time in the future."
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This definition encompasses the principal concepts:
products should be based on an accurate assessment of the wants and
needs of customers in different market segments, and cost targets
should be what result after a sustainable profit margin is subtracted from
what customers are willing to pay at the time of product introduction andafterwards.
These concepts are supported by the four basic steps of Target Costing:
(1) Define the Product
(2) Set the Price and Cost Targets(3) Achieve the Targets
(4) Maintain Competitive Costs.
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To compete effectively, organizations must continually redesign their products ( or services) in order to shorten product life cycles.
The planning, development and design stage of a product is therefore critical to an
organization's cost management process. Considering possible cost reduction at
this stage of a product's life cycle (rather than during the production process) is
now one of the most important issues facing management accountants in industry.
Here are some examples of decisions made at the design stage which impact on
the cost of a product.
The number of different components Whether the components are standard or not
The ease of changing over too Japanese companies have developed target
costing as a response to the problem of controlling and reducing costs over the
product life cycle.
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What is Operations Management?
The business function responsible for
planning, coordinating, and controlling
the resources needed to produce a
company¶s products and services
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What is Operations Management?
It is a management function.
Organization¶s core function.
Every organization has OM function
± Service or Manufacturing
± For profit or Not for profit
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Typical Organization Chart
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© Wiley 2007 54
What is Operations Management
Role? OM Transforms inputs to outputs
± Inputs are resources such as
People, Material, and Money
± Outputs are goods and services
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© Wiley 2007 55
OM¶s Transformation Process
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© Wiley 2007 56
OM¶s Transformation Role
To add value
± Increase product value at each stage
± Value added is the net increase between output product value
and input material value
Provide an efficient transformation
± Efficiency ± perform activities well at lowest possible cost
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© Wiley 2007 57
Goods & Services
Services Intangible product
Product cannot beinventoried
High customer contact
Short response time
Labor intensive
Manufacturing Tangible product
Product can beinventoried
Low customer contact
Longer response time
Capital intensive
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© Wiley 2007 58
On the other hand«
Both use technology
Both have quality, productivity, & response issues
Both must forecast demand Both will have capacity, layout, and location issues
Both have customers, suppliers, scheduling and
staffing issues
Manufacturing often provides services Services often provides tangible goods
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© Wiley 2007 59
Hybrid organizations
Some organizations are a blend of service/manufacturing/quasi-
manufacturing Quasi-Manufacturing(QM) organizations
QM characteristics include
± Low customer contact & Capital Intensive
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© Wiley 2007 60
Improving Products
http://www.npr.org/templates/story/story.php?sto
ryId=89070760
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aqXPK8X2MaL8
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© Wiley 2007 61
Improving Services
http://www.npr.org/templates/story/story.p
hp?storyId=88196545
http://www.npr.org/templates/story/story.p
hp?storyId=7000908
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© Wiley 2007
62
Trends in OM
Service sector growing
to 50-80% of non-farm
jobs- See Figure 1-4
Global competitiveness
Demands for higher
quality
Huge technology
changes
Time based competition
Work force diversity
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OM Decisions
All organizations are based on decisions
Decisions follow a similar path
± First decisions very broad ± Strategic
decisions Strategic Decisions ± set the direction for the entire
company; they are broad in scope and long-term innature
± Following decisions focus on specifics -Tactical decision
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OM Decisions
Tactical decisions focus on
± Specific day-to-day issues
Resource needs, schedules, & quantities to
produce
± Tactical decisions are very frequent
± Strategic decisions less frequent
± Tactical decisions must align with strategicdecisions
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OM Decisions
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Plan of Book-Chapters link to Types of
OM Decisions
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Why OM?
For long-run success companies must placemuch important on their operations ± The 1950-1960 era was the U.S. golden era where
primary opportunities were marketing
± The 1970-1980 U.S. companies experienced a largedecline in productivity growth ± international firmsbegan to challenge in many markets
± The 1970-1980 era saw U. S. firms lagging behind in
methods and processes ± The resurgence of American business in the 1990¶scapitalized on improved operations
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Historical Development of OM
Industrial revolution Late 1700s
Scientific management Early 1900s
Human relations/Human Resources1930s -
Management science Mid-1900s
Computer age 1970s
Environmental Issues 1970s
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Historical Development of OM Just-in-Time Systems (JIT) 1980s
Total quality management (TQM) 1980s
Reengineering 1990s
Global competition 1980s
Flexibility 1990s
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Historical Development of OM
Time-Based Competition 1990s
Supply chain Management 1990s
Electronic Commerce2000s
Outsourcing and
flattening of the world 2000s
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OM in Practice
OM has the most diverse organizational function
Manages the transformation process
OM has many faces and names such as;
± V. P. operations, Director of supply chains,Manufacturing manager
± Plant manger, Quality specialists, etc.
All business functions need information from OM
in order to perform their tasks
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Business Information Flow
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OM Across the Organization Most businesses are supported by the
functions of operations, marketing, and
finance
The major functional areas must interact to
achieve the organization goals
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OM Across the Organization -
continued Marketing is not fully capable of meeting customer needsif they do not understand what operations can produce
Finance cannot judge the need for capital investments if they do not understand operations concepts and needs
Information systems enables the information flowthroughout the organization
Human resources must understand job requirementsand worker skills
Accounting needs to consider inventory management,capacity information, and labor standards
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Highlights
OM is the business function that is responsible for managing and coordinating the resources needed toproduce a company¶s products and services.
Its role of OM is to transform organizational inputs into
company¶s products or services outputs OM is responsible for a wide range of decisions, ranging
from strategic to tactical.
Organizations can be divided into manufacturing andservice organizations, which differ in the tangibility of the
product or service
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STRATEGIC COST
MANAGMENT
PRODUCT LIFE CYCLE
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P ODUCT LIFE CYCLE
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