3.4.3 Making operational decisions to improve performance: increasing efficiency and productivity - Operational management

What is capacity?

The maximum amount of goods/services a business can produce, deliver, or handle within a given time period

What are the advantages of increasing capacity?

1. Improves quantity of customers fulfilled in a given time period because the business can allocate spare capacity to an unexpected change in market demands. Consequently, improves dependability because customers can rely on/trust the firm which increases customer and brand loyalty -depends if suppliers are as flexible/dependable as the business-. Furthermore, a competitive advantage is achieved which reduces price elasticty of demand. Therefore, total revenue is increased if you increase prices (premium) -depends if the PED coefficient is price inelastic-

2. Increases long term sales because you are able to fulfill higher order volumes

What are the disadvantages of increasing capacity?

• Increases average unit costs because of increased storage/fixed costs -depends on the time period because if you increase capacity for a volatile stimulus (e.g. seasonal demand) then costs are relatively small-

• Will the marginal revenue generated from improved flexibility offset marginal costs?

• Will shareholders lose motivation if costs increase because it leads to lower profits/dividends?

• Will staff motivation be impacted because they may feel less valued (diseconomies of scale) which leads to reduced labour productivity?

• Depends on the size of the business so can marginal costs be financed?

• Depends on capacity utilisation so is increased capacity efficient/productive?

• Depends on the flexibility of capacity so can it adapt more easily to an unexpected change in demand e.g. increase capacity if demand rises to optimise capacity utilisation?

What is capacity utilisation?

The % of the capacity being used in a given time period

What is the capacity utilisation formula?

Actual output × 100

Potential output