3.4.3 Making operational decisions to improve performance: How to Utilise Capacity Efficiently. Flashcards
Define under-utilisation of capacity.
When a firm’s output is below the maximum possible output.
Aka excess capacity or spare capacity. Represents a waste of resources and means that the organisation is spending unnecessarily on its fixed assets.
Define capacity shortage.
When a firm capacity is not large enough to deal with the level of demand for its products.
What are the possible reasons a firm may be operating below its maximum output?
New competitors or products entering the market - some markets the growth of competition has been so high - excess capacity in the market - average turnover for each outlet has begun to fall.
Fall in demand for the product due to changes in taste or fashion.
Unsuccessful marketing.
Seasonal demand.
Over-investment in fixed assets.
A merger or takeover leading to duplication of many resources and sites.
What is the impact of spare capacity?
Can help a firm cope with unexpected problems or increases in demand - increase costs.
What are the disadvantages of spare capacity?
Higher proportion of fixed costs per unit - if utilisation falls, the fixed costs must be spread over fewer units of output leading to higher unit costs.
Higher unit costs - lead to either lower profit levels or the need to increase price to maintain the same profit levels - lower sales volume.
Can portray a negative image of a firm - unsuccessful - discourage customers - lead to lower sales.
Less work to do - bored and demoralised employees - lower motivation and efficiency - if the problem persists, employees may fear loosing their jobs.
What are the advantages of spare capacity?
More time for maintenance and repairs - training and improving existing systems.
Less pressure and stress for employees - overworked at full capacity.
Can cope with sudden increases in demand.
What is the formula for calculating the maximum possible sales that a business can achieve before it needs to expand capacity?
Maximum capacity / current capacity level = maximum sales revenue / current sales revenue.
Example of calculating the maximum possible sales that a business can achieve before it needs to expand capacity:
If a business earns sales revenue of £12 million and operates at 80% capacity level, it can calculate that its maximum possible sales revenue is £15 million, without increasing its capacity.
Maximum capacity / current capacity level = maximum sales revenue / current sales revenue.
100% £X
——- = ——-
80% £12m
If 80% = £12m, then 100% - 100/80 x £12m = £15m.
Define rationalisation.
A process by which a firm improves its efficiency by cutting the scale of its operations.
Outline rationalisation.
If a business has spare capacity - follow rationalisation policy to reduce capacity and save unnecessary expenditure.
What does rationalisation lead to?
Leads to a cut in the capacity of a firm and thus to a reduction in its maximum output.
Example of rationalisation:
If a firm is capable of producing 200 units but actually produces only 96 units, its capacity utilisation is only 48%. If it rationalises and halves its capacity to 100 units, it will have a much more efficient level of capacity utilisation of 96%.
Outline the different ways which capacity can be reduced.
Selling off all or a part of its production area.
Changing to a shorter working week or shorter day.
Laying of workers.
How can selling off all or a part of the production area reduce capacity?
Will cut fixed costs - suitable if low capacity is long term, not short term - production will be difficult to increase again if the factory has been sold.
How can changing to a shorter working week or day reduce capacity?
Save costs and cut production - may lead to lower motivation and higher staff turnover.
