Production Manager must decide on using the most appropriate production system.
A production system is the combination of factors of production (mix of labor and machinery used in operations) that business uses in the process of transforming inputs into finished products that are supplied to customers.
In general, businesses can be described as either being labor intensive, capital intensive or using automation. These are three main types of production systems:
- Labor intensive. Where mainly people are used to produce products.
- Capital intensive. Where mostly machines are used to produce products.
- Automation. Where production of products is controlled by a computer.
While some methods of production are labor-intensive some other ones are heavily capital-intensive or use automation.
Capital intensive
This is a production system in which production operations are mainly done by machinery and equipment. A larger proportion of capital input is used in the production process compared with labor and any other factor input (in terms of their costs). The cost of capital accounts for the largest proportion of firm’s overall production costs. Hence, the business heavily relies on capital because it is relatively cheaper.
It is important to note that other businesses may choose to be capital intensive even though labor-intensive production is still possible.
Examples of capital intensive production
Goods and services that are being made both using simple and inexpensive capital tools such as ovens for baking of bread as well as using very expensive capital-intensive plants for e.g. electricity generation or aluminum smelting.
Here are some examples of capital intensive industries: aerospace manufacturing, chemical manufacturing, energy production, healthcare, mining, oil and gas, and telecommunications.
Advantages of capital intensive production
- High productivity. Capital intensive production can lead to high productivity, as machines can produce goods and services much faster than humans can. Additionally, machinery can run 24 hours a day without any breaks or financial compensation.
- Low labor costs. Capital intensive production can reduce labor costs, as fewer workers are needed to operate machines.
- Standardized quality. Capital intensive production can help to ensure standardized quality, as machines can produce goods and services consistently.
- Economies of scale. Capital intensive production can lead to economies of scale, as businesses can produce goods and services at a lower cost per unit when they produce in large quantities. This can benefit the business in the medium to long term as Fixed Costs (FC) are spread over a larger volume of output.
- Increased profits. Capital intensive production can help businesses to increase their profits, as they can produce goods and services at a lower cost and sell them at a higher price. By becoming more capital-intensive by increasing capital investment expenditure, the business can improve levels of output, leading to increased productivity, hence lower cost per unit.
Disadvantages of capital intensive production
- High initial investment cost. Capital intensive production requires a high initial investment cost, as businesses need to purchase and maintain expensive machinery and equipment. Hence, capital-intensive businesses tend to have high Fixed Costs (FC) of production because the costs of machinery and equipment can be very extremely high.
- High risk. Capital intensive production is high-risk, as businesses can lose a lot of money, if their machinery and equipment break down or become obsolete.
- Job displacement. Capital intensive production can lead to job displacement, as machines can replace human workers. Therefore, the firm will need to bear the cost of making workers redundant.
- Environmental impact. Capital intensive production can have a negative impact on the environment, as it often requires the use of large amounts of energy and resources.
- Technological dependence. Capital intensive production makes businesses dependent on technology, which can lead to problems if the technology fails or becomes outdated. Additionally, there will be recurring training costs as more skilled workers are required.
How to choose between different types of production systems?
The most appropriate production system for a business depends on several factors including:
- Aims and objectives of the organization. More capital-intensive technologies will be used by businesses where the main objective is maximizing profit as operating in mass markets will allow for minimizing unit cost of production. On another hand, more labor-intensive production allows for possible cost reductions during a recession when some of the workforce might be laid off to better control costs.
- Business size. Smaller businesses may not be able to afford expensive capital equipment due to limited sources of finance. On another hand, large businesses will most likely use automated production lines in order to fulfill huge market demand.
- Relative cost of labor and capital. When the relative prices of these two inputs are much different from one another, the business will choose the production system that is cheaper. Assuming that substitution resources are feasible. If labor costs are high and rising, then using more capital equipment might be preferred. Consequently, when costs of purchasing capital are high, then the firm will choose more labor-intensive production methods.
- Product. The nature of the product will determine whether it should be produced using labor intensive methods, capital intensive methods or whether the process should be fully automated. Additionally, the product image that the firm wishes to establish will play a role in choosing the type of production system.
- Size of the market. Larger markets will require more capital-intensive technologies such as using automation with mass production (flow production methods). Whereas businesses that serve smaller markets are more likely to use more labor-intensive types of production.
The main factors to consider in choosing the right production system includes the cost of labor and capital (whichever is lower) as well as the size of the market (the larger the market the more capital-intensive production).
