4.2 - Analysing Operational Performance
The meaning of capacity and capacity utilisation
Capacity refers to the maximum output a business can produce in a given period using its existing resources, without investing in additional fixed assets such as machinery or factory space.
The factors that affect capacity
- Number and skills of employees - More staff or highly skilled workers can increase overall output.
- Available technology - Modern machinery, well-maintained equipment, and efficient computer systems enhance production potential.
- Type of production process - Different methods, such as assembly lines or custom manufacturing, influence how much can be produced.
- Level of investment - Greater funding for resources and infrastructure expands capacity limits.
Calculating capacity utilisation
Capacity utilisation measures the percentage of a business's total capacity that is currently being used.
Where:
- Actual output = The amount produced in a given period
- Maximum capacity = The highest possible output with current resources
Worked example - Calculating capacity utilisation
A bakery can produce up to 6,000 loaves per day but currently produces 3,900 loaves. Calculate the capacity utilisation.
Step 1: Identify the values
- Actual output = 3,900 loaves
- Maximum capacity = 6,000 loaves
Step 2: Apply the formula
Step 3: Perform the calculation
The advantages and disadvantages of high and low capacity utilisation
Operating at different levels of capacity utilisation has implications for efficiency, costs, and business performance. Businesses often aim for around 90% utilisation, as this balances benefits while avoiding the pitfalls of running at full capacity.
The drawbacks of operating at 100% capacity utilisation
- Quality issues - Maintaining high standards may become difficult when pushing resources to their limits.
- Inability to handle extra demand - Potential customers might be turned away, or seasonal peaks and one-off orders cannot be accommodated.
- Lack of downtime - Constant operation leaves no time for maintenance, shortening equipment lifespan and risking breakdowns that cause delays.
- Increased stress and errors - Managers and staff may face higher pressure, leading to mistakes and reduced morale.
- No flexibility - Surplus stock could build up if production outpaces demand, tying up working capital.
The disadvantages of low capacity utilisation (under-utilisation)
Low capacity utilisation means resources are not being used efficiently, leading to higher costs per unit:
- Inefficient use of resources - Fixed assets like machines and facilities are paid for but not fully utilised.
- Higher unit costs - Fixed costs are spread over fewer units, increasing the average cost per item.
Where:
- Total costs = Fixed costs + variable costs (£)
- Units of output = Number of items produced
Worked example - Calculating unit cost at different output levels
A toy factory has monthly costs of £12,000. It produces 2,000 toys in one month and 1,500 in another. Calculate the unit cost for each month.
Step 1: Identify the values
- Total costs = £12,000 (per month)
- Output in first month = 2,000 toys
- Output in second month = 1,500 toys
Step 2: Calculate unit cost for first month
Step 3: Calculate unit cost for second month
Step 4: Interpretation
Lower output increases unit cost from £6.00 to £8.00, showing the impact of under-utilisation.
Ways to increase or decrease capacity utilisation
Businesses can adjust capacity utilisation to match demand, either by expanding output or reducing it when necessary. Methods vary between short-term and long-term approaches.
Methods to increase capacity utilisation
- Extend operating hours - Run multiple shifts, including weekends or holidays, to use facilities more fully.
- Invest in resources - Buy extra machinery and hire staff to operate it.
- Boost workforce - Recruit permanent employees for long-term growth, or use temporary staff and overtime for short-term needs.
- Enhance productivity - Reorganise workflows and motivate employees to work more efficiently.
- Subcontract or outsource - Hire external firms to handle overflow work during peak periods, avoiding the need for year-round extra capacity. For example, a clothing brand might outsource sewing to another factory during high-demand seasons.
Methods to address under-utilisation and decrease capacity
- Stimulate demand - Adjust the marketing mix, such as through promotions, price reductions, or improved distribution.
- Utilise spare capacity - Take on subcontracting work for other firms or produce goods for competitors to keep machinery running.
- Rationalise operations - Reduce capacity if demand remains low:
- Short-term options: Cut overtime, shorten the working week, reallocate staff, or let temporary contracts expire.
- Long-term options: Allow natural wastage (not replacing staff who leave), make redundancies, or sell off factories and equipment.
Managing capacity over time
Effective capacity management involves planning for both current and future demand to ensure long-term efficiency and adaptability.
Strategies for long-term capacity planning
- Forecast future demand - Use market research to predict changes, though this involves uncertainty and risk.
- Align with demand trends - Adjust capacity to match expected long-term shifts, providing lower unit costs if predictions are accurate.
- Incorporate flexibility - Use short-term methods for seasonal products or special orders, while long-term solutions handle sustained changes.