5.7 - Productivity
The meaning and calculation of capacity utilisation
Capacity utilisation measures how much of a firm's maximum potential output is being achieved at a given time. It shows the percentage of full production capacity that is actually in use.
Formula for capacity utilisation
Where:
- Actual output per period = The amount produced in a specific timeframe (e.g., units per month)
- Full capacity output per period = The maximum possible production in the same timeframe if all resources are fully used
A rate of 100% means the firm is operating at full capacity, with no unused resources. High-growth firms or those at full capacity might improve utilisation by subcontracting some work to external providers.
Mass production becomes cost-effective only when firms maintain high capacity utilisation levels.
Worked example - Calculating capacity utilisation
A factory's full capacity is 1,500 units per week, but it produces 1,200 units in a given week. Calculate the capacity utilisation rate.
Step 1: Identify the values
- Actual output per period = 1,200 units
- Full capacity output per period = 1,500 units
Step 2: Apply the formula
Step 3: Calculate the result
Advantages and disadvantages of full capacity utilisation
Operating at full capacity (100% utilisation) means all resources are in use, which can boost efficiency but also create challenges.
Advantages of full capacity utilisation
- Lowest average costs - Production costs per unit fall due to economies of scale, as fixed costs are spread over maximum output.
- Higher profits - Reduced unit costs often lead to increased profitability.
Disadvantages of full capacity utilisation
- Staff stress - Workers may become overworked, leading to higher stress levels.
- Equipment wear - Machinery deteriorates faster, raising maintenance and replacement expenses over time.
The meaning and calculation of productivity rates
Productivity measures how efficiently inputs are turned into outputs. A high productivity rate indicates efficient operations, which positively correlates with a firm's profitability and ability to compete.
While productivity is key, it can be hard to measure in service-based roles, such as teachers or nurses, where quality of output matters more than quantity.
Labour productivity
Labour productivity assesses worker efficiency, often in labour-intensive firms. It is commonly calculated as output per worker.
Other measures include sales revenue per worker or units produced per labour hour. High labour productivity is vital because labour costs form a large part of total expenses.
Capital productivity
Capital productivity evaluates how well fixed assets, like machinery, generate output. It is preferred by capital-intensive firms to track asset efficiency.
Worked example - Calculating labour productivity
A clothing manufacturer produces 5,400 garments in a month with 25 employees. Calculate the labour productivity per employee.
Step 1: Identify the values
- Total output per period = 5,400 units
- Number of employees at work = 25
Step 2: Apply the formula
Step 3: Calculate the result
Make or buy decisions using cost to buy and cost to make
A make or buy decision involves choosing whether to produce an item in-house (insource) or purchase it from an external supplier (outsource). Managers compare the cost to make (CTM) with the cost to buy (CTB) to decide.
If CTM exceeds CTB, buying is usually more cost-effective, and vice versa. Quantitative tools like break-even analysis and investment appraisal help inform these choices.
Non-quantitative factors also matter, though they are harder to measure:
- Quality control standards
- Supplier reliability
- Impact on employees
- Internal expertise and experience
Formula for cost to buy (CTB)
Where:
- Price = Cost per unit from the supplier (£)
- Quantity = Number of units needed
Formula for cost to make (CTM)
Where:
- Fixed costs = Expenses that do not change with output (e.g., rent, £)
- Variable costs = Expenses that vary with output (e.g., materials, £)
Worked example - Comparing cost to buy and cost to make
A firm needs 600 components. Buying them costs £7 each. Making them in-house involves £1,800 in fixed costs and £2.50 per unit in variable costs. Calculate CTB and CTM, and decide whether to make or buy.
Step 1: Identify the values
- Quantity = 600 units
- Price per unit (for buying) = £7
- Fixed costs (for making) = £1,800
- Variable costs per unit (for making) = £2.50
Step 2: Calculate CTB
Step 3: Calculate CTM
Variable costs total = £2.50 × 600 = £1,500
Step 4: Interpretation
CTM (£3,300) is less than CTB (£4,200), so it is cheaper to make the components in-house.