capacity utilization and outsourcing chapter 25 Flashcards
capacity utilization
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.
outsourcing
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.
maximum (full) capacity
the highest level of Sustained output that can be achieved.
capital utilization formula
rate of capacity utilization=current output level/maximum output level * 100
capacity utilization: the impact on average fixed costs
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.
drawback to working at full capacity for a considerable period of time
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.
operating at over maximum capacity
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.
operating at under maximum capacity
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.
excess capacity
this exists when the current levels of output are less than the full-capacity output of a business; also known as spare capacity.
ways to improve capacity utilization in the short term
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.
Rationalisation
reducing capacity by closing factories/production units
long term excess capacity
This might be caused by an economic recession or technological changes which reduce demand for a business’s existing products.
advantages of rationalization
reduces overheads
results in higher capacity utilization form the remaining production units
disadvantages of rationalization
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.
advantages of researching and developing new products
New products will replace existing products and make the business more competitive.
If introduced quickly enough, new products might prevent rationalization and associated problems.
disadvantages of researching and developing new products
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.
capacity shortage
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.
advantages if using subcontractors or outsourcing of supplies, components or even finished goods to reduce long term capacity shortages
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.
disadvantages if using subcontractors or outsourcing of supplies, components or even finished goods to reduce long term capacity shortages
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.
advantages invest capital in the expansion of production facilities
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.
disadvantages invest capital in the expansion of production facilities
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.
reasons for outsourcing
reduction and control of operating costs
increased flexibility
improved company focus
access to quality service or resources
freeing internal resources
reasons for outsourcing: 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.
reasons for outsourcing: 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 rationalization of existing production units owned by the business.
