3. What is Capacity?
The maximum output
that a business can
produce in a given period
with the available
resources
4. 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
5. What is Capacity Utilisation?
The percentage of total
capacity that is actually
being achieved in a given
period
6. Capacity Utilisation Formula
Capacity utilisation (expressed as a percentage) is
calculated using this formula:
Actual level of output
X 100
Maximum possible output
7. Capacity Utilisation Example
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
Capacity utilisation in January 2009 =
Actual output (3,200)
X 100
Maximum possible output (4,000)
= 80.0%
8. 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
9. 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
10. 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
11. 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
14. 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.
15. 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
16. 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
17. 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
18. 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
19. 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
20. 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)
21. Lean Production – Main Methods
• Cell production
• Kaizen / Quality Circles
• Just in time (“JIT”)
22. 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)
23. 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
24. 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
25. 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
26. 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
27. 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
28. Economies of scale
Bulk Buying As businesses grow they need to order larger quantities of production
Economies 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 Businesses with large-scale production can use more advanced
Economies machinery (or use existing machinery more efficiently); can use mass
production techniques and afford to invest more in research and
development
Financial Larger firms find it easier to find potential lenders and to raise money at
Economies lower interest rates
Marketing Many marketing costs are fixed costs and so as a business gets larger, it
Economies is able to spread the cost of marketing over a wider range of products
and sales – cutting the average marketing cost per unit
Managerial As a firm grows, there is greater potential for managers to specialise in
Economies 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.
29. 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
30. 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
