25. Capacity utilisation and outsourcing Flashcards
Significance of capacity utilisation
Capacity utilisation is a major factor in determining the operational efficiency of a business. Maximum capacity for a hotel will be the number of room nights available uring a period. If a business is working at full capacity, it is achieving 100% capacity utilisation. There is no spare capacity. Capacity utilisation rates are used by analysts to compare how one business or factory is performing compared to the average, or how capacity utilisation differs from previous periods.
Impacts of full capacity utilisation
When capacity utilisation is at a high rate, the fixed costs of rent and machinery depreciation are spread over a large number of units. Average or unit fixed costs will be relatively low. Unit fixed costs will be at their lowest possible level and this should help to increase profits. The business will be able to claim how successful it is, as it has no spare capacity. For example, hotels will put up ‘No vacancy’ signs and airlines will have no unsold seats. Employees feel their jobs are secure and may have a sense of pride that the products they produce are so popular.
Drawbacks
* Employees may feel under pressure due to the workload and this could raise stress levels. Operations managers cannot afford to make any production scheduling mistakes, as there is no slack time to make up for lost output.
* Regular customers who wish to increase their orders will have to be turned away or kept waiting for long periods. This could encourage them to use other suppliers, with the danger that they might be lost as long-term clients.
* Machinery will be working continuously and there may be insufficient time for maintenance and repairs. This lack of servicing may store up trouble in the form of increased unreliability in the future.
Improving short term excess capacity
This might be caused by low seasonal demand. Options for improving capacity utilisation in the short term include:
* Maintaining high output levels. This strategy adds to inventories and could be expensive and risky if sales do not recover.
* Adopting a more flexible production system, allowing other products to be made that could be sold at other times of the year. This needs a flexible workforce and production resources.
* Insisting on flexible employment contracts so that, during periods of low demand and excess capacity, workers work fewer hours to reduce capacity and costs. This may have a negative impact on employee morale and motivation.
Improving long term excess capacity
* Rationalisation
Advantages:
* This reduces overheads.
* It results in higher capacity utilisation from the remaining production units.
Disadvantages:
* Redundancy payments might have to be paid.
* Workers may worry about job security.
* Industrial action may be a risk.
* Capacity may be needed later if the economy picks up or if the business develops new products.
* The business may be criticised for not fulfilling its social responsibilities.
Improving long term excess capacity
* Research and development new produts
Advantages:
* New products will replace existing products and make the business more competitive.
* If introduced quickly enough, new products might prevent rationalisation and associated problems.
Disadvantages:
* This may be expensive.
* It may take too long to prevent cutbacks in capacity and rationalisation.
* Without long-term planning, new products are introduced too quickly, without a clear market strategy, and may be unsuccessful.
Factors influencing decision on solving shortage capacity
To consider the management options it is essential to analyse the cause of the excess demand and the time period it is likely to last. For instance, if excess demand results from a reduction in output caused by a faulty machine that will be repaired next month, then action to raise capacity is unnecessary. The final decision will depend on many factors, not least the cost of expanding the scale of operations. The time factor is again important. It may prove to be quicker to place work contracts with outside firms, which could produce components that used to be made within the factory, than to build a new factory. These are important decisions because the success or failure of a business expansion could determine the future profitability of a business.
solving shortage capacity
* Use subcontractors or outsourcing of supplies
Advantage:
* No major capital investment is required.
* It should be quite quick to arrange.
* It offers much greater flexibility than expansion of facilities – if demand falls back, then contracts with other firms can be ended.
Disadvantage
* It gives less control over the quality of output.
* It may add to administration and transport costs.
* There may be uncertainty over delivery times and reliability of delivery.
* Unit cost may be higher than inhouse production due to the supplier’s profit margin.
solving shortage capacity
* Invest capital in the expansion of production facilities
Advantage:
* It increases capacity for the long term.
* The business is in control of quality and final delivery times.
* The new facilities should be able to use the latest equipment and methods.
* Other economies of scale should be possible too.
Disadvantage:
* The capital cost may be high.
* There may be problems with raising capital.
* It increases total capacity, but problems could occur if demand should fall for a long period.
* It takes time to build and equip a new facility and customers may not wait.
Outsoucring
* Advantages
- Reduction and control of operating costs:
Instead of employing expensive specialists who might not be required at all times, it could be cheaper to buy in specialist services as and when they are needed. These specialist service providers may be cheaper because they benefit from economies of scale, as they provide similar services to other businesses as well. Much outsourcing involves offshoring, i.e. buying in services, components or completed products from low-wage economies.
- Increased flexibility:
By removing departments altogether and buying in services when needed, the fixed costs of office and factory space and salaried employees are converted into variable costs. Additional capacity can be obtained from outsourcing just when needed. It demand falls, contracts can be cancelled much more quickly than the rationalisation of existing production units owned by the business.
- Improved company focus:
By outsourcing peripheral activities, the management can concentrate on the main objectives and tasks of the business. These are called the core parts of the business. So, a small hotel might use management time to improve customer service and outsource the accounting function completely.
- Access to quality service or resources that are not available internally.
Many outsourcing firms employ quality specialists that small to medium-sized businesses could not afford to employ directly.
- Freeing up internal resources for use in other areas.
For example, HR functions are bought in, then the office space and computer facilities previously used by HR could be made available to improve customer service.
Outsoucring
* Disadvantages
- Loss of jobs within the business:
This can have a negative impact on employee motivation. Workers who remain directly employed may experience a loss of job security. Bad publicity may result from redundancies too, especially if the business is accused of employing very low-wage employees in other countries in place of the jobs lost. This could lead to the firm’s ethical standards
being questioned.
- Quality issues:
The quality levels of the goods or services being outsourced will be difficult to check on. A clear contract with minimum service level agreements or product quality standards will be needed. The company outsourcing the functions may have to send the employees responsible for
quality control to the business used for outsourcing, in order to ensure that product quality and customer service standards will be met.
- Customer resistance:
This could take several forms. Overseas telephone call centres have led to criticism from customers about their inability to understand foreign operators. Customers may object to dealing with overseas outsourced operations. Bought-in components and functions may raise doubts in customers’ minds about quality and reliability.
- Security:
Using outside businesses to perform important IT functions may be a security risk. If important data were lost by the business, who would take responsibility for this?
- Corporate social responsibility (CSR):
Using outsourced contracts, especially in low-wage economies, means that the business is less able to ensure that its CSR policy towards workers or the environment is being upheld.
Evaluation of outsourcing
If you are asked to evaluate outsourcing decisions, remember that the more important an activity is to the overall reputation of the business, the less likely it is that outsourcing will be appropriate.
The global trend towards outsourcing will continue as businesses look for further ways of improving operational efficiency, and as more opportunities arise due to globalisation. The process is not without its risks, however. Before any stage of the production process is outsourced, the company must undertake a substantial cost–benefit analysis of the decision. Having closed or run down a whole department to outsource its functions, it would be time-consuming and expensive to reopen and re-establish the department if the outsourcing fails to deliver.
One of the key factors in any business decision on outsourcing is to identify the core activities that must be kept within direct control of the business.
