Making Operational Decisions

ManagingCapacity

What is Capacity?

The maximum output that a business can

produce in a given period with the available

resources

More on Capacity

• Usually measured in production units (e.g. 1,000 cars per month)

• Productive capacity can change:– E.g. when a machine is having maintenance, capacity is reduced– Capacity is linked to labour: e.g. by working more production

shifts, capacity can be increased• Capacity needs to take account of seasonal or

unexpected changes in demand– E.g. Chocolate factories need capacity to make Easter Eggs in

November and December before shipping them to shops after Christmas

– E.g. Ice-cream factories in the UK needed to quickly increase capacity during a heat wave

What is Capacity Utilisation?

The percentage of total capacity that is actually

being achieved in a given period

Capacity Utilisation Formula

Capacity utilisation (expressed as a percentage) is calculated using this formula:

Actual level of output

Maximum possible output

X 100

Capacity Utilisation Example

Capacity utilisation in January 2009 =

Actual output (3,200)

Maximum possible output (4,000)X 100

Stephenson Audio manufacturer hand-held microphones. The factor in Sandbach has a maximum output of 4,000 units per

month. In Jan 2009, actual output was 3,200 microphones

= 80.0%

Why Capacity Utilisation Matters

• Often used as a measure of productive efficiency

• Average production costs tend to fall as output rises

• So firms usually aim to produce as close to full capacity (100% utilisation) as possible

Why Produce at < 100% Capacity?

• Lower demand– General reduction in overall market demand– Loss of market share– Seasonal variation in demand

• Increase in capacity– Possibly new technology introduced– Provide some “slack”

• Inefficiency– Poor maintenance, quality, employee disruption

How to Produce > 100% Capacity

• Tends to be in the short-term• Increase workforce hours

– Extra shifts; encourage overtime; temporary staff

• Sub-contract some production activities– E.g. assembly of components

• Reduce time spent maintaining production equipment

Problems Working at High Capacity

• Negative effect on quality (possibly)– Production is rushed– Less time for quality control

• Employees suffer– Added workloads & stress– De-motivating if sustained for too long

• Loss of sales– Less able to meet sudden or unexpected increases in

demand– Production equipment may require repair

ProductionEfficiency

Ways to Measure Productive Efficiency

• Productivity– Measures the relationship between inputs into the production

process and the resultant outputs.– Examples:

• Output per worker or hour of labour• Output per hour / day / week• Output per machine

• Unit costs– Divide total costs by the number of units produced. A falling

ratio would indicate that efficiency was improving• Non-productive (“idle”) resources

– Which resources are used by a business? Are employees often left with nothing to do? Are machines only used for part of available time? Too many idle resources are a common sign of inefficiency in production.

Productive Efficiency

• Lowest cost per unit at which production can take place

• Why is this important?– A more efficient business will produce lower cost

goods than competitors– May generate more profit possibly at lower prices– Investing in production assets (e.g. equipment,

factory buildings) is expensive – a business needs to maximise the return it makes on these assets

More on Productivity

• What productivity means– An important measure of productive efficiency– Describes how much input can be turned into products

• How measured– Output per worker, sales per square metre (in a shop)

or output per machine– E.g. a manufacturer of fridges produces 20,000 fridges

this month and has a workforce of 1,000– Productivity = 20,000 divided by 1,000 which equals

20 fridges per person per month

Ways to Improve Productivity

• Training• Improved motivation• More capital equipment• Better capital equipment• Better quality raw materials (reduces amount

of time wasted on rejected products)• Improved organisation of production – e.g.

less wastage

Stock Levels and Efficiency

• Business will have a target stock level for finished goods to achieve

• This is calculated to satisfy demand:– Expected by marketing department plans– Based on what production department thinks they

can produce

• If stock level falls below this level:– Productive efficiency has reduced since output per

worker has not met planned requirements

Mass Production and Poor Productivity

• Mass production is often associated with poor productivity – why?

• Mass production leads to repetition of work, which can de-motivate workers

• Breakdown on any part of line can mean a shutdown of whole operation, reducing number of units per hour produced

Methods of Lean Production

• “Lean production” has become a very popular concept in business

• Japanese businesses led the way – proving it was possible to produce more goods, of better quality, at lower cost, using lean production techniques

• Objective of lean production methods:– To minimise use of any resource that does not add value to

product or service– E.g. operating Just-in-time production (where goods are made

just in time to meet customer demand, so no stocks held)– To make product right first time (not wasting time checking and

re-checking)

Lean Production – Main Methods

• Cell production• Kaizen / Quality Circles• Just in time (“JIT”)

Production and Seasonal Demand

• Changes in seasonal demand can mean a requirement for:– Lots of stock at particular times of year & little demand at other

times– E.g. demand for children’s toys is highest in pre-Christmas period

• Implications for producers– May make sense to “build for stock” during periods of quiet

demand– Make use of production equipment that would otherwise lie idle

• Produce of perishable products– Here, production process needs to be designed flexibly– Additional production capacity can be added when close to time

when demand increases (e.g. bring in more part-time, temporary employees)

Cell Production

• Cell production is where work is organised into teams

• Teams are given responsibility of doing a part of production process as product moves through assembly line.

• Cell production often leads to improved productivity due to:– Increased motivation (team spirit and added

responsibility)– Specialisation

Kaizen / Quality Circles

• Kaizen is a Japanese term which means Continuous Improvement

• A process where overall improvement and progress comes from small improvements being made all time

• Management and workers are focused on trying to make small adjustments, even when process/product seems to be working well

• Kaizen is usually implemented by creating “quality circles” – groups of employees who meet regularly to discuss ways in which production quality can be improved

Just-in-time (“JIT”) Production

• What is JIT?– A concept of lean production first developed at Toyota– JIT involves the rearrangement of plant and the re-

organisation of procedures so that material required for production arrives exactly at the time it is needed

• Advantages– Reduces costs of holding stock e.g. warehousing– No money tied up in stock

• Disadvantages– Needs suppliers and employees to be reliable– May find it difficult to meet sudden increase in

demand

Technology and Improved Efficiency

• Investment in technology is one way of improving productive efficiency

• Speed of production (machine can perform repetitive and complicated tasks more quickly)

• Increased accuracy therefore less wastage• Can work longer hours• However – a business needs to be happy that

the improved financial returns from better efficiency justify the investment in technology

Economies of Scale

• What are they?– A reduction in long run unit costs which arise from an

increase in production• Economies of scale occur when larger firms

are able to lower their unit costs. This may happen for a variety of reasons

• A larger firm may be able to buy in bulk• It may be able to organise production more

efficiently• It may be able to raise capital cheaper and

more efficiently

Economies of scale

Bulk Buying Economies

As businesses grow they need to order larger quantities of production inputs (e.g. raw materials) As the order value increases, a business obtains more bargaining power with suppliers and should be able to get better prices

Technical Economies

Businesses with large-scale production can use more advanced machinery (or use existing machinery more efficiently); can use mass production techniques and afford to invest more in research and development

Financial Economies

Larger firms find it easier to find potential lenders and to raise money at lower interest rates

Marketing Economies

Many marketing costs are fixed costs and so as a business gets larger, it is able to spread the cost of marketing over a wider range of products and sales – cutting the average marketing cost per unit

Managerial Economies

As a firm grows, there is greater potential for managers to specialise in particular tasks (e.g. marketing & finance). In a small firm, many roles are performed by the same person. This can create inefficiency since they are not as expert or highly qualified in one area.

External Economies of Scale

• External economies of scale occur when whole industry business is in grows

• Main kinds are:– Transport and communication links improve

(Silicon Valley)– Training and education becomes more focused on

industry (more IT courses at college)– Other industries grow to support this industry

Diseconomies of Scale

• When a business grows very large cost per unit can increase

• Mainly due to:– Poor communication between different

departments and along chain of command;– Lack of motivation– Loss of direction and co-ordination

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Making Operational Decisions