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Capacity Utilisation and Outsourcing - Coggle Diagram
Capacity Utilisation and Outsourcing
Definition
Maximum capacity is the total possible level of output that can be sustained by a business in a given time period
Capacity utilisation refers to the proportion of maximum output capacity currently being achieved. It measures the efficiency of the business usage of its resources
Current output level/maximum output level x100
Operation at maximum capacity and minimum capacity
When capacity utilization is high or near max capacity, fixed costs like rent and machinery depreciation are shared among many units. This means average or unit fixed costs are lower. When capacity utilization is low, these fixed costs are spread over fewer units. Thus, average fixed costs become higher.
Benefit of Operating at Maximum Capacity:
Average fixed cost is at lowest possible level
Employee feel their job is secure due to constant high demand and feel proud of being a part of the business, increasing their loyalty.
If corporated business, it increases people willingness to invest, which might raise finance.
Business can use this for marketing purposes which might entice potential customers to check out the “hype”.
Drawbacks of Operating at Maximum capacity:
High workload can increase employee stress, affecting their performance negatively.
Production mistakes are costly due to no slack time.
Increased orders may lead to lost customers if not managed, it will put the long term customer relation with the business in danger.
Continuous machine operation can delay maintenance, risking future issues.
It can lead to fast depreciation of the machineries used by the business.
Therefore, each business aims to operate near maximum (optimal) capacity rather than the full capacity. They keep the spare capacity for unforeseen events that can inevitably occur.
Operation at Spare Capacity
When the level of output is below full capacity output of a business.
Businesses tries to improve their capacity utilisation which can be done in two ways: Short term & Long term
Short-term excess capacity:
This occurs due to low seasonal demand, to improve capacity utilisation in such periods, business have options such as:
Adopting flexible production system, which lets business make different sort of product at different time of the year. This creates a need for flexible workforce which likely increases wage.
High output levels Increases inventories, potentially costly and risky if sales don't recover.
Having flexible employment contracts Reduces hours during low demand to cut costs, but may impact employee morale and motivation.
Long-term Excess Capacity:
This occurs due to recession or technological changes. To improve utilisation of capacity during such period, businesses can either:
Rationalisation
Advantages
Lowers overhead costs.
Increases capacity utilization of remaining units.
Disadvantages
Workers might have concerns about job security.
Risk of industrial action.
Potential need for increased capacity if the economy improves or new products are developed.
Potential criticism for failing to meet social responsibilities.
Might have to bear redundancy payments.
Research and Develop New
Disadvantages
May not prevent cutbacks in time.
Risk of launching products too rapidly without a solid market strategy, potentially leading to failure.
Can be costly to develop and launch.
Advantages
New products can replace outdated ones and enhance competitiveness.
Quick introduction of new products may help avoid rationalization issues.
Capacity Shortage
When demand for a products of the business exceeds its production capacity.
To raise production capacity for long-term operation, a business considers:
Should the business increase production level by acquiring additional production resources?
Should they maintain existing capacity but outsource or subcontract work to other businesses?
Should they operate at full capacity without expansion due to potential risk of declining demand.
Ways to reduce long-term capacity shortage
Use subcontractors or outsource suppliers:
Advantages
Requires no major capital investment.
Comparatively quick to arrange.
It provides greater flexibility than expanding facilities. Contracts can be ended if demand decreases.
Disadvantages
Potential uncertainty regarding delivery times and reliability.
Unit costs might be higher due to the supplier fulfilling its profit margin.
Lesser control over output quality.Lesser control over output quality
It might raise administration and transport costs.
Invest in capital for expansion of production facilities:
Advantages
Increases long-term capacity.
Might give access economies of scale.
New facilities enables the business to use of the latest equipment and methods.
Business has control over quality and delivery times.
Disadvantages
Building new facilities and equipping it with appropriate machineries takes time and customers might go to another business.
The higher capacity can become a problem if demand for products of the business decreases over an extended period.
High capital costs and difficulty can occur when raising funds.
Outsourcing
Using another (a third party) to undertake a part of the production process rather than doing it within the business using the firm’s own employees.
Advantages & Disadvantages
Advantages
It turns fixed costs to variable costs and allows for flexibility for the business depending on demand.
Outsourcing is usually cheaper than hiring full-time specialists and leverages economies of scale.
This method can provide high-quality services or resources which might not be available internally.
They helps management to concentrate on core activities by outsourcing functions such as HR or finance
It frees up resources which can be used for other business improvements
Disadvantages
Outsourcing can negatively impact employee motivation and public image might be questioned due to possible redundancies and ethical standards as business might from low-wage economies
Due to hiring workers from low-wage economies, can undermine CSR commitments regarding workers and the environment
Outsourced IT functions can pose security risks and accountability issues for lost data
It is difficult to monitor outsourced quality. Therefore, the business need quality control on-site to ensure quality being up to the highest standards.