rganizations constantly endeavour to maximize their

value-creation opportuni-
C ties and benefit from the same. The
protit-making potential of an organization is
directly related to the competitive advantage that it enjoys in the market over its
competitors. Therefore, it is very important for every organization to seek an answer to the
Operations strategy
the process of
making key operations
decisions that are
auestion:"What should the organization do to create
competitive advantage for itself and consistent with the
sustain it forlonger
a time? The strategy-making process addresses this critical
vital information that helps the question a overall strategic
provides some
organization to create advan- objectives of thee
tage. A strategic planning exercise enables an organization to respond competitive
to market needs in organzation
24 Operations Management
-
the most effective manner by aligning the various resources and activities in the organization to deliver products and
services that are
likely to succeed in the marketplace. At the end of this exercise, the
organization willtypically be able
to
spell out its
strategic intents and develop an overall corporate strategy.Through the strategy-making process, the
A good strategy often brings in rewards for the
organization cquips itself with the required systems and procedures,
organization in the fornm of profits, a higher market share, and a dominant position in its sector in several aspects of
businesSs.
Every organization, whether in services or manufacturing, has a strategic intent. The strategic intent could be to
provide goods and services at a low cost, or to provide a highly customized product or service. For example, the stra-
tegic intent a law cost air line is to provide affordable air travel. The strategic intent influences the overall corpo-
of
rate strategy an organization, which, in turn, shapes its operations strategy. Operations strategy is the
of of process
making key decisions regarding the operations function of an organization on the basis of inputs from its overall cor
porate strategy. In this manner, it links the overall strategic intents and the corporate strategy to specific aspects of
the operations system. Strategic decisions include, for example, the extent of
capacity to be built into the system, the
type of process and technology to be used, the nature of products and services to be offered, and the type of sup-
ply chain to be configured. In the process of making these decisions, it is important to identify key measures of oper
ational excellence. In this chapter, we shall look at all these aspects of operations
strategy in detail. Betore we discuss
the
strategy-formulation process, it would help to understand the context and relevance of operations strategy in any
organization.
 2.2 THE STRATEGY-FORMULATION PROCESS
of
The process formulating an appropriate operations strategy involves a sequential and structured set of activities.
Figure 2.1 depicts the various steps in the process. These can be grouped into three broad
steps. The first step is to identify
the strategic options tor
sustaining competitive advantage. Once these options have beenidentified, the overall corporate
strategy can be devised on the basis of firm-level
strengths and weaknesses. The corporate strategy provides the basis for
arriving at the appropriate operations strategy for the organization.
As shown in the figure, the
strategy-formulation process can also be understood in terms of a series of detailed steps,
which include:
1. understanding the competitive dynamics at the marketplace,
2. identifying order-winning and order-qualifying attributes,
3. deciding on strategic options for sustaining competitive advantage,
4.
matching the strategic options with the resources, constraints, values, and objectives of the organization to arrive at
the overall corporate strategy.
5. developing the operations strategy on the basis of the corporate strategy, and;
6. using the operations strategy to select appropriate options for configuring an operations system and establishing rel-
evant measures for operational excellence.
 26 Operations Management

Competitive dynamics at Order winners

the marketplace Order qualifiers

Generic competitive priorities

Strategic options for Quality
sustaining competitive Cost
advantage Delivery
Flexibility

Firm-level strengths
and weaknesses
Corporate strategy

Strategic options for Measures for operational

operations
Operations strategy excellence

FIGURE 2.1 The strategy-formulation process

Step 1: Understand the Competitive Market Dynamics

Any strategy-making exercise begins with scanning the marketplace and understanding its dynamics. Market dynamics
direct the organization toward the issues it should consider while formulating its operations strategy. It provides useful
information on competitors, the nature of offerings that they make to the customer, customer expectations, missing links
between expectations and current offerings, and the intensity of competition. An analysis of this information will enable
an organization to identify which aspects of its products and services can provide it a unique positioning and a competi-
tive advantage over its competitors. Tata Motors' positioning of the Nano in the R100,000 range is an illustration of how
organizations use such information to arrive at their operations strategy. A similar example in the services sector is the
positioning of Café Coffee Day. Their outlets are positioned as cafes that provide "affordable" luxury, and seek to satisfy the
needs of a demographic segment that comprises young employees and college-goers.
In the previous section, we discussed the liberalization process and saw how the current level of expectations has
changed in several industry sectors. Under normal circumstances, customers may have several expectations besides price,
Such as performance, quality, ease of use, delivery commitments, technological superiority of products, and critical post-
Sales support. Customer expectations keep changing with time. Technological improvements and evolution of markets
and infrastructure may cause a shift in customer expectations about a product or a service. The demographic profile of
the customer base may also shift over the years. Moreover, customers may be exposed to newer choices either by a smart
competitor or due to the entry of foreign firms into the market. Therefore, it is important for organizations to prioritize
their alternatives and understand what is likely to have a greater impact in the market. Customer expectations and the
competitive priorities that an organization needs to pursue could be better understood using the notion of order-winning
and order-qualifying attributes.

Step 2: ldentify Order-qualifying and Order-winning Attributes

Order-qualifying attributes are the set of attributes that customers expect in the product or service they consider for pur-
chase. The absence of any of these attributes will result in the customer removing the product or service from his or her list
ofitems under consideration. The mere presence of these attributes, however, does not guarantee that the customer will buy
 Operations Strategy 27

the product. It only indicates the minimum or threshold level of requirements for considering the
product. Order-qualifying
attributes are
There other attributes that have the
are
potential to sufficiently motivate the customer to buy the attributes that
the product. Such attributes are knowm as order-winning attributes. The perception ot the Customers expect in the
customer is that the presence of these attributes indicates to him or her that the product/ser-
product or service they
vice underconsideration surpasses the basic requirements and, therefore, hasthe potential to consider for buying
provide bettervalue for money. The presence oforder-winning attributes in a product/service
helps the customer differentiate it from the competitors' offerings. It also favourably influences
Order-winning
the customersbuying decision with respect to the product/service. The more the number of attributes are
such attributesthat a customer perceives in a product/service, the greater is the chance that the attributes that have the
customer may buy the product/service. potential to suficiently
What constitutes order-winning and order-qualifying attributes might change from time motivate the customer
to time. During the early and mid-1980s, superior quality was an order-winning attribute for to buy the product
several multinational organizations. Therefore, they invested much of their strategic planning
and implementation efforts towards developing quality-management systems. However, in the 1990s, quality became an
order-qualifying attribute as customers began to expect high levels of quality in products/services. Moreover, several com-
petitors were able to nmatch customer expectations with respect to quality. The next order-winning attribute was high
delivery reliability. Organizations developed just-in-time practices to addresses the issue of delivery. Other order-winning
attributes that have evolved over time include efficient consumer response, speed, variety, and convenience.

Step 3: Identify Strategic Options for Sustaining Competitive Advantage

After an analysis of the competitive dynamics, an organization will be in a position to identify the order-winning and
order-qualifying attributes for the products/services that it offers. At the end of the exercise, the order-winning and order-
qualifying attributes provide the organization with a set of options for sustaining competitive advantage. Competition
analysis may indicate that the organization will do better by providing high-quality goods, or that a wider variety of
options will bring success. It could also indicate convenience in usage in some cases. Such an exercise often points to more
than one possible attribute for order winning. These attributes also help an organization develop appropriate operational
measures of excellence.

Step 4: Devise the Overall Corporate Strategy

Organizations may not be in a position to make use of all the strategic options available to them. This is because they face
constraints in operating with the resources available to them. For instance, the top management may have certain prefer
ences and views on how desirable the options are from an internal perspective. Moreover, the organization's culture and
values may not permit it to exploit the available options fully. Therefore, the next critical step is to match the strategic
with the available and constraints and to develop an
options available for sustaining the competitive advantage resources

into consideration its strengths and weaknesses.

appropriate strategic plan thatfulfils the organization's objectives, taking
The outcome of this exercise is the overall corporate strategy.

Step 5: Arrive at the Operations Strategy

Once the corporate strategy is arrived at, it serves as the basis for the operations strategy. For instance, if the overall strat-
egy of an organizationis to provide low-cost goods, then the choices made in operations will be consistent this
with
Overall strategy. For example, large capacities will be built to exploit scale economies. Procurement and supply-chain func-
tions will develop appropriate methods for locating low-cost, high-quality suppliers and devise systems for continuous
cost reduction of input material. Planning and control will emphasize on continuous cost improvement, productivity
maximization, and cost control and management. Product portfolio decisions will de-emphasize variety and instead
design systems with fewer variations. The organization will benefit from large-volume. Process design will reflect choices
such as continuous flow, mass production system and self service so that operations can be delivered at lower fixed costs.
Simultaneously, appropriate control systems and performance measures for operational excellence will be developed so
that these are consistent with the strategy of cost minimization.
28 Operations Management

of measures for opera-

The outcome of operations strategy formulation process is Step 6, the development
the
as illustrated in Figure 2.1.
tional excellence and the selection of specific options for conhguring the operations system,
alternatives available for operations systems and
In order to configure an effective operations system, knowledge of the
easures of excellence is imperative. Some of these
alternatives are described in the following sections.

2.3 MEASURES FOR OPERATIONAL EXCELLENCE

Operational-
excellence measures
provide the critical
inkage between order-
Winning and order-
qualitying attributes
identified through
the strategic planning
exercise and the choices
made in the operations.
The operations-strategy exercise is inextricably linked to developing measures for opera-
tional excellence. Such measures serve several purposes in the operations-strategy process
Operational-excellence measures provide the critical linkage between order-winning and
order-qualifying attributes identified through the strategic planning exercise and the choices
made in the operations. Developing a set of measures pertaining to each attribute helps organi
zations to evaluate how well the operations system is responding to the requirements of the
marketplace. Based on this evaluation, necessary changes can be made to the operations system
to align the activities with the strategic goals, should there be a mismatch or underpertormance
of the operations system.
 2.4 0PTIONS FOR STRATEGIC DECISIONS IN OPERATIONS
Translating the corporate strategy into the operations strategy essentially involves making choices in the design andopera
tional control of the operations system. The choices are made in such a fashion that the options are consistent with the
overall strategic objectives ofthe organization. Figure 2.2 depicts the options available for strategic decisions in operations
management. The product portfolio addresses the core issues of the type of products to offer through the operating system
as well as the breadth of each offering. Similarly, technology, capacity, supplychain, and process options enable anorgani-
zation to make appropriate choices in the respective domains.

Product Portfolio
One of the strategic choices that an organization can make is with respect to its product portfolio. By product portfo
lio, we mean decisions regarding the products that the organization wants to produce, the number of variations in each
product line, and the extent of customization that it can offer to its customers. In reality, organizations operating in the
 Operations Strategy 31

same sector and offering similar

products/services differ widely with
respect to the range ot choices in their offerings to customers. This isa Product
reflection of their Overall
strategic objective. A few examples will help
us understand this concept better.
portfolio
Let us consider air travel from
Bangalore to Delhi. IndiGo and Jet
Airways offer similar services for passengers, but differ vastly in terms Supply
of the services offered. Jet Airways is a full-service airline that chain Process
provides
business- and economy-class travel facilities. In addition, it offers free
Strategic
options for
air miles accrued through a frequent-flier scheme. operations
IndiGo, on the other
hand, offers just economy-class tickets. There are wide differences in
the in-flight services offered by the two airlines. While
Jet Airways
begins a journey by serving a glass of soft drink to its customers and fol-
Tech Capacity
lows it with appetizers, a meal, coffee, tea, and mineral water nology
(in unlim-
ited quantities), in the case of IndiGo,
nothing is available free of cost.
A limited choice of snacks and meals is available
against payment. At FIGURE 2.2 Options for strategic decisions
the outset, it may appear as though Jet
Airways' offer is more attractive. in operations
However, a closer analysis will show that the two airlines
pursue differ-
ent strategic objectives and, therefore, have different competitive priorities and customer segments to cater to. IndiGo's
priority 1S one of low operational costs while that of Jet Airways is of high-quality service.
A similar example of how the product portfolio varies with the overall strategicobjective can
be seen in the varied range of restaurants in metropolitan cities such as Mumbai. Restaurants
ranging from small self-service eating joints to multi-cuisine restaurants with a host of well- The product
portfolio of an
trained waiters and huge dining spaces span the entire
range of product/service port-folio organization refers
options. These options are related to the overall strategic intent of each organization. to decisions on
Several such examples exist in the manufacturing industry as well. Consider Dell and Lenovo, what products the
two well-known computer manufacturers. The overall strategic objective of Dell appears to be organization wants
one of providing highly differentiated products, whereas Lenovo appears to emphasize robust to produce, the
and reliable computing power. Therefore, the product portfolio choices for these two manufac- number of variations
turers are different. in each product line
These examples demonstrate the role of a product portfolio in fulfilling the desired strategic and the extent of

objectives of an organization. If the overall strategic objective is to provide a highly differenti- Customization it can
offer to ts custormners.
ated set of products and services to the customer, it is possible to achieve this by offering prod-
uct/service customization. On the other hand, if the overall objective is one of cost leadership
then the product portfolio tends to be narrow.
For an organization desiring to provide a wide product portfolio to its customers, flexibility will be the most
important competitive priority. Several aspects of operations management will be configured to meet this objective.
Operational control systems and pertormance measures will be chosen in such a manner that they enmphasize flex-
ibility over other criteria such as cost and delivery. The organization should develop an efficient and responsive new-
product development process that can respond to the changing requirements at the marketplace with newer versions of
the product.

Process Design
Appropriate choice of processes is another option through which an organization can trans- Process choices lead
late its strategic objectives to operations. Process design refers to the overall configuration of to three types of
the operations system in such a way that the various activities are consistent with the process flows: continuous
streamlined flow
choice. Viewed alternatively, process choices influence the nature of material and information
intermittent or batch
low in an organization. At a broad level, three types of flow happen on account of process
flow, and jumbled
choices: continuous streamlinedflow, interimittent or batchflow, and jumbled flow. The choice of process flow.
technology will be consistent with that of the product portfolio decisions that an organization
makes.
 32 Operations Management

Consider a volume manufacturer such Hero Motor orp. Ltd. (HML) and a variety manufacturer such
as
as Bharat Heavy Electricals Limited
(BHEL). The process choices of these tw0 manufacturers are vastly differ
ent and are in linc
with their overall objectives. The overall objective of HMI. can be stated as
providing a var-
ety of high-performance motorbikes at reasonable prices. BHEL'S Overall objective is to fulfil complex and
hug
ckey engineering contracts in the power sector on time. A manufacturer emphasizing high production volune
Iewer varieties, and low (HML in
cost our cxample) will make process choices that
appropriate for this require.
are
hent. In operations management, a mass or a batch production system is appropriate for such manufacturers. In the
case of BHEL, on the other
hand, the process choice will be influenced by the need to have a wide varicty and a large
production volume of a single or a few units. Project shops and functional layouts are some appropriate processes for
BHEL. Similar cxamples could be found in services as well. A banking service for a high networth individual (Such as SB
Kohinoor Barjara Branch) will have a process design which is different from the regular branches of State Bank of India
An
organization working towards the objective of providing a wide range of products to its customers will have to make
a process choice that is more of thebatch/ intermittent flow type. The production planning and control systems, schedul.
ing, and the procurement practices will all be influenced by the flow system an organization chooses to adopt. Some of
these issues are discussed in greater detail in Chapter 4.

Supply Chain
The supply chain A manufacturer of goods relies on other business organizations for raw materials and com-
the network of entities ponents required in the manufacturing process. It also depends on other business entities to
supplying Components, supply its finished goods to the end customers through a market. The supply chain is the net-
raw materials, andda work of entities supplying components, raw materials, and a host of services to the organization
host of services to an aswell as those distributing the finished
organization as weil
goods and services to customers through alternative
channels. Organizations need to make
as those distributing appropriate supply-chain choices consistent with their
the finished goods
strategic objectives.
Recent studies have shown that
and servIces of the
ured-an efficient supply chain and a
fundamentally two types of supply chains can be confhg-
organization to its responsive supply chain. As the name suggests, an eff-
cient supply chain is designed with the main
CUstomers through objective of pursuing efficiency goals with respect
alternative channels
to
supply-chain operations. Essentially, this translates into cost
optimization and maximum
utilization of the resources employed in
supply-chain operations. In the case of a
responsive sup-
ply chain, the key objective is to develop a capability to respond fast to market
design appropriate supply chain, it is imperative to have a good
an requirements. To
ply chain is configured. The product profile is the result of the understanding of the product profile for which the
sup-
strategy.
product-portfolio decisions made as part of the operations
Let us consider the
design of a supply chain for the distribution of Annapurna atta (flour) and salt. Salt and
functional products. Functional flour are
products are characterized
by stable demand little
predictability of demand. Moreover, customers are not likely change
tion patterns, and a reasonable level of patterns, or no in consump-
higher price because of some special aspect in the distribution of the to pay a
significantly
fad clemcnts in these products, based on which a product or the service. There are no fashion and
price premium could be extracted from customers. Under these
tions, cost minimization and effciency
goals will be the strategic requirement, and the supply chain should be condi
accordingly. configured
The strategic
requirements for some
products are in sharp contrast to those for functional products. For instance, con-
sider products such as Tanishq watches and
to fashion fads. There is also a need for
jewellery offered by Titan. These products are trendy, expensive, and sensitive
creating greater variety and more designs to satisfy diverse tastes and
As the demand for such goods is difficult to preferences.
predict, the organization has very little lead time to react to changing
and customer preferences in the market. This patterns
category of products is known as innovative products. The supply chain for
such products should be designed with the basic objective of
providing a high level of responsiveness.
discussed here demonstrate the need for conhguring the outbound supply chain (dcalers,
The two
distributors, retailers,exanmples
etc.). in
the case of consumer goods, in tandem with the choice of the product portfolio and the overall strategic objectives of the
irm.
 Operations Strategy 33

In the case of industrial

goods, too, the design of supply chains should be consistent with the strategic objectives of the
organization. This is true for the design of inbound supply chains (raw material and component suppliers) as well. We shall now
look two more examples to understand the
at
of raw materials such as steel
design of supply chains in the case of industrial goods. The first is the requirement
plates and rods for the manufacture of components by a manufacturer of geartboxes tor automo-
biles. In this case, the product falls
neatly into the description of a functional product. Therefore, the organization needs to con-
figure its supply chain for the raw materials on the basis of efficiency. Let us consider another
for remotely monitoring various producta digital control system
parameters and thereby controlling the operations of a steel-making machine. Due to several
new developments in electronics and
processor speed and capabilities, the product is likely to be subjected to frequent changes
in design and enhancements. It should have a
supply chain that is able to bring in new enhancements in the control system ass
and when they happen in the market and
help in making product upgrades more frequently. In this case, the organizationis
handling an innovative product and should be able to configure a responsive
Effcient supply chains are designed with the central supply chain for the control system.
minimization and better asset utilization.
objective overall supply-chain cost
of

in their supply chain to achieve this

Organizations need to incorporate several features An efficient suppily
objective. The design of a responsive supply chain, on chain is designed with
the other hand, begins with the basic
premise that uncertainty in demand and large forecast the main objective of
errors are often the reality. Therefore, the
supply chain requires certain strategies to address overall supply-chain
these issues. Further, developing systems to
improve responsiveness is another objective of the Cost minimization and
design. Our intention here is to merely show how the design of the supply chain will be influ- better a5set utilization.
enced by the overall strategic objectives of the
organization. In
Chapter 5, we shall return to the
question of supply-chain design and provide some more details on the different methods
organizations adopt to design
efficient and responsive supply chains.

Technology
Technological advancements in recent years have offered new opportunities for creating competitive advantage. Recall how
Asian Paints first utilized technological advancements for mixing basic pigments to distribute paints in a large variety of
colours and a large assortment of sizes. Organizations making a strategic choice to
operate in the mid-volume, mid-variety
products and services could utilize new technology such as flexible manutacturing systems and
computer-integrated man-
ufacturing to improve productivity and to respond faster to the market. Technology can provide unique advantages to
organizations in providing better products and services to customers. Prominent among these are the following:
)Increased resource utilization: Computer-based operation of systems has enabled
high resource utilization in systems.
Scheduling flexibility: Technology often enhances flexibility in scheduling various customer orders as it enables
zations to react to changes swiftly. Theretore, organizations can use organi-
technology to provide better customer service.
)Ease of changes: Changes in design and process plans can be easily accommodated
ther, complex operations can be handled without much difficulty and the desired
through the use of technology. Fur-
)Ease of expansion: Technology also provides volume flexibility to the
quality levels can be achieved.
in response to a growing market.
organization and makes it much easier to
expand
)Reduced lead time: Advanced technological features make it possible to cut down lead time.
Lower in-process inventory: Several of the benefits discussed here
and reduced cost.
directly translate to lower work-in-process inventoryy
34 Operations Management

react 1aster to customer heeds, man-

new technologv options for Drocesses,
organizations can nage
Cvident that
by using
levels of productivity. Theretore, process technology iscone
nsid
maintain high
"wiue pOrtlolio of product offerings, and yetstrategy in organizations. In some cases, the use of radically new technolo
CTc to De a potential enabler of operationscosts. However, ifthe strategic intent is to provide high levels of responsiven.enesy
euts i
high depreciation and operating them on to the c u s t o m e r by way
of a
premium forr the
these costs by passing
ustomers, it may be possible to recover
additional value provided in comparison to the competition.

Capacity be produced per unit.

of units of goods that can it of
Capacity refers to the maximum number
reters to the maximum number ofe
In a manufacturing
time in a manufacturing system.
In a service system, it Ser
when a two-wheeler manufac
system, capacity is
vice offerings that can be
made per of unit time. For example,
the maxImum number
an installed capacity
of 20,000 vehicles per day, it merely indicates th
turer reports that it has
of units of goods that
it can produce in a day. Similarly, if
an inter-city bus oper
maximum number of two-wheelers
can be produced it to the limit of its service. Capaci
is 500 passengers per day, points
per unit of time. In says that its capacity
tor
dimension as they directly and significanti
a service system, the decisions in operations have an important strategic
an accrued cos
offered in three ways. First, there is
term capacity refers to influence the cost of goods and services
that illustrates
scale. Economy of scale is an economic principle
the maximum number advantage due to economies of and the aPpropriate levels
the relationship between the cost of the goods produced by system
a
of service offerings that
to this principle, as a firm grows and production
ofcapacity built into the system. According
can be made per unit
decrease its costs. A fhrm can thus benefitfrom
of time. units increase, it will have a better chance to
level.
lower total costs by operating at a predetermined
costs and contribu
cost accounting principles pertaining to marginal
The second aspect of cost advantage c o m e s from
function of the fixed and variable costs of the operating system. Every
tion. The cost of goods and services produced isa
out of investment in
investments in fixed costs. They are: (1) asset costs arising
organization has three major types of
of the supervisory and managerial workforce; and (3) facilities maintenance
machinery and buildings; (2) manpower costs
costs to sustain several support facilities. By increasing
the productive capacity (and consequently the sales), it is possible
to spread these fixed costs over a larger base of
activities and thereby achieve lower costs and greater contribution.
The third benefit arising from large capacity investments is that it provides additional cost advantages in procuring
base and large amounts of procurement of key raw
other factors of production. Large capacity implies a large production
in the market. Furthermore, the firm will be in a
materials and other resources. Large volume provides bargaining power
channelize the development efforts of its suppliers and collabora-
position to influence key trends in the industry and to
to understand how this is possible. Reliance Industries
tors to its overall benefit in the long run. Let us consider an example
finished products of Reliance, such as
Limited is one of the largest petrochenmical manufacturers in the world. Many of the
various distribution points. A large number of tank
petrol and LPG, are stored in tanks and transported through tankers to
ers is required at the Jamnagar facility and the Hazira facility near Surat. Typically, the daily requirements are in the range
of 3000 trucks. The large scale of operation enables Reliance to negotiate better rates for trucking services.

2.5 BREAK-EVEN ANALYSIS

Break-even analysis is a related concept that links capacity to costs. It explains the significance of having greater produc
capacity to lower costs and maximize profits or contribution. Let us use the following notations to understand the concep
of break-even:

F= Fixed costs of production

V= Variable cost of production of one unit
p=Selling price of one unit of the product
c= Contribution of one unit of product towards fixed costs
S=Sales volume (in terms of number of
units)
BEP Sales volume required to achieve break even
 Operations Strategy 35

It is obvious that as every individual unit sells at a price p and has incurred a variable cost of v, the difference between the
rwo is the excess over the variable cost that could cover the fixed costs. This quantity is known as the contribution margin (c).
and can be represented by the following equation:
C-p-v

The break-even point is the point at which the contribution margin is able to cover the
fixed costs. Therefore, at the break-even point, the organization will have a no-proht, no-loss
tota The break-even
point is the point at
situation, but would have covered all the fixed costs invested in the system. Break-even sales refers which the contribution
to the number of units to be sold at the break-even point. The break-even point and break-even margin is able to cover

sales can be expressed as follows: the total fixed costs.

F
BEPales

It is clear from the discussion on break-even analysis that as an organization's cumulative production excecds the break-
even point, it will provide significant cost benefits to the organization as after that, the fixed costs need not be covered any
more. Larger capacity utilization will invariably provide cost advantages to the organization.

EXAMPLE 2.1
A company manufactures ball-point pens that it is able Therefore, contribution of one unit of the pen towards
to sell at 15 per piece. The variable cost of the pen is the fixed costs (¢) can be calculated as follows:

10 per unit. If the company has made a total invest-

ment in fixed costs to the tune of R30,000, what is the Cp-V=R15- F10= 75
break-even sales for the pen? Graphically represent the F
cost structure and the break-even point. BEPSales 30,000=6000
5
units
Solution As seen in Figure 2.3, the point of intersection of
F= Fixed costs of production = 730,000
the total cost and the revenue curve is the break-even
V= Variable cost of production of one unit of the pen
point, and the corresponding sales are the break-even
= T10
sales.
F15
Selling price of one unit of the pen
=
p=

-Fixed cost Variable costTotal cost Revenue

160,000

140,000
120,000
100,000

80,000
60,000
40,000

20,000

0 1000 2000 3000 4000 5000 6000 7000 8000 9000 10,000 11,000
Sales (units)
FIGURE2.3 Graphical representation of the break-even point