Capacity Management
Q1 Fill in the gaps is the maximum total level of output that a business can produce with its resources in a given time period. Capacity measures the extent to which the company’s possible output is being reached. It can be calculated using the formula: Capacity Utilisation = /maximum output x 100 Any company not working at 100% capacity utilisation is said to have capacity. In other words it is possible to increase . Ideally a firm would like to achieve a capacity utilisation of %. This allows some scope for maintenance and repair or being able to to sudden orders. Choose from: production, 90, actual output, respond, maximum, Capacity, utilisation, spare Q2 Calculation time 2.1 Calculate the capacity utilisation of Kentmere Paper Mill which has a maximum output of 500 tonnes but was producing 360 tonnes of paper during the year. 2.2 Calculate the maximum capacity of Sleaford Ice Cream using the following data: Capacity utilisation was 80% 2800 litres of ice cream were produced in the year Q3 True or False? 3.1 Capacity utilisation can be increased by using new technology to increase output 3.2 Fixed costs per unit can be reduced by increasing capacity utilisation 3.3 Reducing the level of assets is likely to cause spare capacity 3.4 Capacity utilisation is a key factor influencing competitiveness © Tutor2u Limited 2015
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Capacity Management
Q4 Briefly explain why 4.1 Reducing capacity by selling a factory or machine could be a poor decision in the long term 4.2 Extending a factory to increase capacity may be preferable to using subcontracting 4.3 Laying off workers may not be the best way to increase capacity utilisation Q5 Identify each word from the anagrams below 5.1 titian it capaciously 5.2 rapacitys cape 5.3 yacc pita 5.4 obstructing can © Tutor2u Limited 2015
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Capacity Management - Answers
Q1 Fill in the gap Capacity, utilisation, maximum, actual output, spare, production, 90, respond Q2 Calculations 2.1 360/500 x 100 = 72% 2.2 2800/80 x 100 = 3500 Q3 True or False? 3.1 False. Increasing output does nothing to increase utilisation of capacity – it only increases capacity which more likely will lower capacity utilisation. 3.2 True 3.3 False – the opposite would occur 3.4 True, as it helps reduce unit cost by spreading fixed costs efficiently Q4 Answers 4.1 This may only be wise if long term demand is falling. If demand has only fallen temporarily to cause spare capacity (for example during a recession) then when demand picks up again the firm would be left without the capacity to cope. 4.2 Firstly subcontracting orders to another firm could lead to a deterioration in quality or a failure to deliver on time, letting down customers. Secondly, if demand is rising then it makes sense to invest in new capacity especially since the profit margin may be higher making the product “in house” than when paying another firm to make the goods as they would need to make a profit margin themselves. 4.3 Laying off staff could cause lower morale in the workplace due to insecurity (Maslow) and additionally a loss of skills – if demand were to pick up in the future the firm would have to spend valuable time and money recruiting and training staff again. © Tutor2u Limited 2015
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Capacity Management - Answers
Q5 Anagrams 5.1 capacity utilisation 5.2 spare capacity 5.3 capacity 5.4 subcontracting © Tutor2u Limited 2015
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Kentmere Paper Mill (Capacity Management)
Specification topic: Capacity Management Case Study: Kentmere Paper Mill Last year was another successful year for Kentmere Paper Mill (KPM) who have produced paper and cardboard products from their factory in Cumbria for over 60 years. Despite overseas competition KPM have managed to compete effectively on price with rivals. Output has been rising gradually for the last five years as the economy continues to grow in the UK keeping sales of paper high. Operations manager Brian Moorby takes huge credit for the operational efficiency of the factory and in particular with managing the capacity to cope with demand. In recent times however he has been criticised for over investing in new equipment with two state of the art machines costing £2.3m and moving into new premises next door adding a further £1.6m per year to rental costs. Technology has been useful in one way but not in another. As more and more people use computers rather than paper in their daily life (for example with paperless bank statements and bills and online news programmes) the global demand for paper is expected to fall in the next decade and beyond. At KPM labour turnover and absenteeism fell again last year which Human Resources manager Jayne Pickerden puts down to the staff feeling less pressurised in their work as the new equipment has started to increase productivity in the factory. Large trade customers such as YPO (Yorkshire Purchasing Organisation) are placing more and more orders with KPM. They have tough terms of trade such as a lead time of 1 week from placing an order to delivery. KPM have not only increased their reliability recently but have been able to take on several other large orders with retailers and wholesalers in the UK and Europe. Some data has been gathered for KPM on their operational and worker performance: KPM data This year Last year Annual factory output 590 tonnes 545 tonnes Factory capacity 830 tonnes 550 tonnes Delivery % on time 99 93 Labour turnover % 3 11 £0.04 £0.03 Unit cost per sheet of paper Exam-­‐style questions 1. Analyse the ways in which the Operations Manager could increase capacity utilisation at KPM in the next year (9 marks) 2. To what extent do you agree that the decision to increase capacity from 545 tonnes to 830 tonnes was correct for KPM (16 marks) © Tutor2u Limited 2015
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Kentmere Paper Mill (Capacity Management)
1. Analyse the ways in which the Operations Manager could increase capacity utilisation at KPM in the next year (9 marks) Possible arguments include: •
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Increase demand by lowering price– given the lower unit cost it may be possible to reduce price further and if the market is price elastic this could boost orders from paper wholesalers Increase demand by promotion – personal selling could help to increase distribution sending reps out to potential paper retailers/wholesalers therefore production could be increased using more of the capacity available Lay off some staff – the new automated equipment has boosted productivity thus less workers are required to meet the output level required. By reducing capacity available it ought to boost capacity utilisation. By reducing wage costs this reduces fixed costs and helps to lower overall unit costs further 2. To what extent do you agree that the decision to increase capacity from 545 tonnes to 830 tonnes was correct for KPM (16 marks) Possible arguments for include: •
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Capacity utilisation was very high at 545/550 x 100 = 99% meaning potentially they could let down customers if there was any problem with production as no spare capacity would be available to cope or speed up delivery. Capacity utilisation has now fallen to 590/830 x 100 = 71% allowing for rework, maintenance and stoppages without risking letting down customers as the plant is not working flat out Staff were stressed and overworked shown by the higher absenteeism and labour turnover which has reduced since capacity has been increased Delivery reliability has improved suggesting the firm is now under less pressure so can meet the demands of trade customers who have strict conditions for delivery The firm is looking to take advantage of a growing economy and sales have been steadily growing so expanding capacity meets their objective of increasing demand – new orders can be taken on without the risk of disrupting current order levels Possible arguments against include: •
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There is now a huge amount of spare capacity with 71% capacity used, meaning the fixed costs are not spread efficiently as many firms aim for 90% capacity utilisation This could be the reason why unit costs have risen given the increase in fixed costs associated with increased rent and the depreciation on the expensive machinery The outlook for long term demand is not promising given that paper is being used less in society due to computerisation. There is nothing to suggest that KPM can buck the trend in the future especially given their rising unit costs Evaluation: •
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If price is the most important factor the rise in unit cost could have the most important bearing on the decision However, given the importance of delivery reliability this could be the right decision especially as sales have been consistently growing. Lower capacity utilisation gives workers less pressure and more time to get delivery right for trade customers © Tutor2u Limited 2015
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