Operations management

Table of Contents

1. Topic pack - Operations management - introduction
2. Operations Management (OM) - Introduction
3. 5.1 Production methods notes
4. 5.1 Production methods - questions
5. 5.2 Costs and revenues - notes
   1. Costs and revenues
   2. Types of costs
   3. Costs and revenue - shape of cost curves
   4. Costs - fixed and variable - examples
   5. Revenue
   6. Mattel 1Q Profit Falls On Higher Expenses
   7. Costs and decisions
   8. Contribution to fixed costs
   9. Contribution analysis for multi-product firms
   10. Special orders
   11. Cost centres and profit centres
   12. Why have cost and profit centres?
   13. Apportioning costs to profit and cost centres
   14. Full Costing
   15. Absorption costing
6. 5.2 Costs and revenues - questions
7. 5.3 Break-even analysis - notes
8. 5.3 Break-even analysis - questions
9. 5.3 Break-even analysis - simulations and activities
10. 5.4 Quality assurance - notes
11. 5.4 Quality assurance - questions and activities
12. 5.5 Location - notes
13. Innovation - notes (HL only)
14. 5.6 Innovation - questions
15. 5.7 Production planning - notes
16. 5.7 Production planning - questions
17. 5.8 Project management - notes (HL only)
18. 5.8 Project management - questions (HL only)
19. Print View

Types of costs

To be able to control costs, it is necessary to understand more about them and from where they arise. In this section we examine the nature and classification of costs.

Costs are usually classified according to their relationship with the level of output of the firm. The following costs are therefore defined in relation to how they change in value as the level of output varies.

Fixed costs

Examples of fixed costs

• Rent
• Office salaries
• Advertising
• Insurance
• Depreciation

Fixed costs can be represented on a graph and this would appear as follows:

Figure 1 Fixed costs

A common mistake made by candidates in examinations is to state that fixed costs will always remain constant. This is not the case, as these costs are fixed with respect to short-term changes in the level of output only. In the long-term, a firm may rent a second factory or take out more insurance cover, so fixed costs are likely to change.

Variable costs

Common examples of variable costs are as follows:

Example of variable costs

• Direct labour
• Raw materials and components
• Packaging costs
• Royalties

Variable costs can be represented on a graph and this would appear as follows:

Figure 2 Variable costs

Semi-variable costs

In reality, nearly all costs cannot easily be classified into either fixed or variable. Most costs will fall somewhere between the two classifications. In this case, we classify these as semi-variable costs.

For example, although the wages of the production staff may appear to be variable costs, in reality, they will vary with the level of output, but not in a direct manner. The direct relationship is unlikely to hold over a long period of time. Similarly, many costs will have a fixed element, but also a variable element (for example, most bills for gas and electricity will consist of a standing charge, which is fixed and a variable element, which will depend on the usage). Telephone bills often contain a fixed line rental, but call charges vary with the number made, the distance of the call and the time elapsed. A telephone bill will aggregate these different charges.

What would the graph of a semi-variable cost look like?

As there is a link between the cost and the level of output, we would expect the semi-variable cost curve to be upward sloping. However, there is no accurate 'textbook' appearance for this curve. It will normally slope upwards in a non-linear manner, although this may be stepped or curved.

Total costs

In nearly all cases, total costs will be the addition of total fixed costs and total variable costs (where total variable cost is the variable cost per unit multiplied by the level of output).

Total costs can be represented on a graph and this would appear as follows:

Figure 3 Total, fixed and variable costs

Direct costs

For example, assume a firm is producing both chairs and tables. The chairs produced use a certain type of wood, but the tables use another type of wood. Then both types of wood would be direct costs, because they are directly related to the level of output of a particular product, not to the level of output in general.

Indirect costs

For example, the cost of powering machinery will be related to the level of output, but not to a particular product.

Generally, the terms indirect and direct costs are more likely to be used when the firm produces a range of products. In break-even analysis, the firm will only be producing a certain product type. This means that the terms fixed and variable costs are more likely to be used.

A final question; what type of cost is labour?

The answer here starts with a phrase that is very common within business and management. The answer starts with - 'It all depends'. It all depends on how the labour is paid. Make a list of as many payment schemes (different ways people are paid) as you can think of, then click on Remuneration. Look up the term in the glossary as well.

This means that for much of the time labour is a fixed cost, fixed for the period of the employment contract. Relatively few people are paid solely on the basis of what they produce. Most employees have elements of both fixed and variable payments in their remuneration.

You will often be asked to give examples of fixed and variable costs. When answering this type of question, it may be best NOT to use labour as an example.