capacity utilization and outsourcing chapter 25

Question 1

capacity utilization

Answer 1

the proportion of maximum output capacity currently being achieved. major factor in determining the operational efficiency of a business. Capacity utilization rates are used by analysts to compare how one business or factory is performing compared to the average, or how capacity utilization differs from previous periods.

Question 2

outsourcing

Answer 2

using another business (a third party) to undertake a part of the production process rather than doing it within the business using the firm’s own employees.

Question 3

maximum (full) capacity

Answer 3

the highest level of Sustained output that can be achieved.

Question 4

capital utilization formula

Answer 4

rate of capacity utilization=current output level/maximum output level * 100

Question 5

capacity utilization: the impact on average fixed costs

Answer 5

When capacity utilization 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. When capacity utilization is low, fixed costs will have to be borne by fewer units and average fixed costs will rise. when firms aim to produce at 100% capacity the 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 also employees feel their jobs are secure and may have a sense of pride that the products they produce are so popular.

Question 6

drawback to working at full capacity for a considerable period of time

Answer 6

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.

Question 7

operating at over maximum capacity

Answer 7

the highest output level that can be maintained over a reasonable period of time. It might be possible, during emergency situations, to achieve higher output levels for very short time periods. This could be done by using machines beyond their safe working limits and by asking labour to work longer than the contractually permitted hours. Obviously, this situation is not sustainable or recommended. It could result both in machines breaking down, and in workers being too stressed to sustain high levels of output in future.

Question 8

operating at under maximum capacity

Answer 8

When a business is operating at less than full capacity it means that there is excess capacity. Low levels of capacity utilization lead to high unit fixed costs. Options for improving capacity utilization depend on whether the excess capacity is a short-term or long-term problem.

Question 9

excess capacity

Answer 9

this exists when the current levels of output are less than the full-capacity output of a business; also known as spare capacity.

Question 10

ways to improve capacity utilization in the short term

Answer 10

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.

Question 11

Rationalisation

Answer 11

reducing capacity by closing factories/production units

Question 12

long term excess capacity

Answer 12

This might be caused by an economic recession or technological changes which reduce demand for a business’s existing products.

Question 13

advantages of rationalization

Answer 13

reduces overheads
results in higher capacity utilization form the remaining production units

Question 14

disadvantages of rationalization

Answer 14

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 criticized for not fulfilling its social responsibilities.

Question 15

advantages of researching and developing new products

Answer 15

New products will replace existing products and make the business more competitive.

If introduced quickly enough, new products might prevent rationalization and associated problems.

Question 16

disadvantages of researching and developing new products

Answer 16

This may be expensive.

It may take too long to prevent cutbacks in capacity and rationalization.

Without long-term planning, new products are introduced too quickly, without a clear market strategy, and may be unsuccessful.

Question 17

capacity shortage

Answer 17

when demand for a business’s products exceeds production 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. the final decision on reducing long term capacity shortage will depend on many factors. These are important decisions because the success or failure of a business expansion could determine the future profitability of a business. Failure to expand capacity in a growing market could leave the business with a shrinking market share or becoming increasingly dependent on external contractors. Rapid expansion that takes place before demand trends are clear could lead to excess capacity problems if demand trends change.

Question 18

advantages if using subcontractors or outsourcing of supplies, components or even finished goods to reduce long term capacity shortages

Answer 18

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.

Question 19

disadvantages if using subcontractors or outsourcing of supplies, components or even finished goods to reduce long term capacity shortages

Answer 19

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 in-house production due to the supplier’s profit margin.

Question 20

advantages invest capital in the expansion of production facilities

Answer 20

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.

Question 21

disadvantages invest capital in the expansion of production facilities

Answer 21

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.

Question 22

reasons for outsourcing

Answer 22

reduction and control of operating costs
increased flexibility
improved company focus
access to quality service or resources
freeing internal resources

Question 23

reasons for outsourcing: reduction and control of operating costs

Answer 23

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.

Question 24

reasons for outsourcing: increased flexibility

Answer 24

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 rationalization of existing production units owned by the business.

Question 25

reasons for outsourcing: improved company focus

Answer 25

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.

Question 26

reasons for outsourcing: access to quality service or resources

Answer 26

that are not available internally. Many outsourcing firms employ quality specialists that small to medium-sized businesses could not afford to employ directly

Question 27

reasons for outsourcing: freeing up internal resources for use in other areas

Answer 27

the extra office space and computer facilities of the space that was previously used by the closed department can be used by another department

Question 28

potential drawbacks to outsourcing

Answer 28

loss of jobs within the business
quality issues
customer resistance
security
corporate social responsibility

Question 29

potential drawbacks to outsourcing: loss of jobs within the business

Answer 29

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.

Question 30

potential drawbacks to outsourcing: quality issues

Answer 30

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.

Question 31

potential drawbacks to outsourcing: customer resistance

Answer 31

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.

Question 32

potential drawbacks to outsourcing: security

Answer 32

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?

Question 33

potential drawbacks to outsourcing: corporate social responsibility

Answer 33

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.

Question 34

Business process outsourcing (BPO)

Answer 34

a form of outsourcing that uses specialist contractors to take responsibility for certain business functions, such as human resources and finance. Before any substantial BPO of complete functions is undertaken or 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.

Question 35

outsourcing evaluation

Answer 35

The global trend towards outsourcing will continue as businesses look for further ways of improving operational efficiency, and as more opportunities arise due to globalization. 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. The nature of these core activities will vary from business to business.