CAPACITY UTILISATION AND

OUTSOURCING
SIGNIFICANCE AND MEASUREMENT OF CAPACITY UTILISATION

 Capacity measures the maximum amount of output a firm can produce -at a given
moment with its existing sources.

 Capacity utilisation measures the existing output relative to the maximum. It can be
calculated using the following equation:

 Per cent capacity = existing output over a given time period x 100
Maximum possible output over a given time period
 EXAMPLES

a. Existing output is 300 units a week, maximum output is 500 units a week.
Capacity utilisation = (300 ÷ 500) x 100 = 60 per cent
b. Existing output is 400 units a week, maximum output is 500 units a week.
 Calculate the capacity utilisation
THE IMPACT OF OPERATING UNDER CAPACITY

 If capacity utilisation is low, it means that the existing output is relatively low
compared to what could be produced.
 This is inefficient because resources are not being fully utilized. The business
could be producing more and assuming the demand was there, earning more
revenue and profit.
  Higher levels of capacity utilisation are desirable because they spread the fixed
costs of a business over more units.
 The fixed costs of a business are those costs that do not change with output; for
example, the rent on a building or the interest payments on a loan, As output
expands, these fixed costs can be divided by more units.
 For example, if fixed costs are $10 million and 1 unit is produced, the fixed cost
per unit is $10 million; if 10 million units are produced, the fixed cost per unit is
$1. Higher capacity utilisation therefore helps reduce unit costs and, therefore,
increase profit margins.
 Improving the position of the business may therefore involve increasing the
capacity utilisation, either by boosting demand (which may be through marketing
activities) or reducing the capacity of the business if some of it is no longer
needed.
METHODS OF IMPROVING CAPACITY UTILISATION

 Your capacity is under-utilised (that is, capacity utilization is low) if demand is

not matching the level of output you are able to provide. For example, you have a
cinema that can take 400 people but there are only 80 watching the film (this is
20 per cent capacity utilisation. Capacity under-utilisation therefore occurs
when demand is too low. In this situation the business may;
 do nothing. If this is seen as a temporary issue, the business may accept under-
utilisation for a short time for example, capacity utilisation in restaurants is
usually lower during the week compared to the weekend.
 Renew its marketing activities to boost demand. For example, changes in the
promotional strategy may be made: new offers, increased efforts by the sales
teams or more advertising may help increase sales
 Reduce the Level of capacity. If, over time, demand is lower than capacity, the
business may rationalise. Rationalisation means the business may reduce its
capacity Levels. For example, you may reduce the number of staff you have, you
may sell off some of your production equipment if it is not needed, or you may
sell off some land if this is not required
 Subcontract for other firms. If you do have excess capacity, you may offer
your resources to other firms and produce on their behalf. This is subcontracting.
HIGH LEVELS OF DEMAND RELATIVE TO CAPACITY

 If demand is high, a business may be operating close to 100 cent capacity

utilization.
 This may be possible in the short run, but it may put pressure on resources if the
business is operating at full capacity for a sustained period of time
 Employees may feel under pressure and become tired. There may not be time for
day-to-day maintenance and repair-of equipment, increasing the risk of
breakdown or failure.
 A business may, therefore, wish to operate below 100 percent capacity utilisation
over a period.
 If demand is above the normal capacity of a business, managers may respond in
various ways.
 In the short term, they may try to increase the capacity by opening longer and
asking employees to work more hours than usual.
 Another response might be to subcontract output to other producers. This brings
risks because the original business is no longer directly responsible for quality. It
is also expensive because the subcontractor will want to make a profit. However,
using a subcontractor can allow a business to continue to meet its customers'
orders and may maintain goodwill.
 Starting a waiting list. This can increase the sense of exclusivity which may suit
premium brands, but customers may switch to another business where they can
buy the products they want.
 Increasing prices. Higher prices can be used to reduce demand. This can
increase profit margins, but the business will need to set the price at the right
level to avoid ending up with demand becoming too low.
 CAPACITY SHORTAGE

 If demand is too high for the firm's capacity, there is a capacity shortage; for
example there are queues outside the night club, or there is a waiting list for a
product. In this situation a business may:
 Do nothing. You may think that the fact that the product is in short supply
relative to demand adds to its appeal. Some clubs might want to build on the
image that they are difficult to get into. You may also think that the excess
demand is temporary and so not want to make any major changes, given that it
may not last. In this situation people will simply have to wait. A business may
start a waiting list or limit the number any one person can buy
 Expand capacity. If you believe demand is likely to remain high then you may
increase capacity. This will require investment (for example, you may need more
people, more equipment and bigger premises)
 Outsource. If you cannot meet all the demand yourself, you may use other
producers to produce for you. This increases the amount you can supply but you
need to be careful that quality does not suffer and, because the outsourcing suppliers
will want to make a profit, your own profits may be less on the units they make
compared to you making them yourself. Alternatively, a business may outsource
some of its non-core activities so that it can focus on the essential elements of the
business. For example, in a school the governors may decide to outsource activities
such as the catering, the maintenance and the security so that they can focus on
teaching and learning.
 Increase the price. If demand is too high relative to supply, a business may
increase the price to bring demand down to the 'right' level. This is what happens
in many markets. If demand for a particular company's shares increases, there is
only a certain number available and so the holders of the shares can increase the
price.
 OUTSOURCING

 Outsourcing occurs when the business uses other producers to undertake some of its
operations. A business may outsource some aspects of its operations, which it does
not regard as critical to what it does and/or where it may benefit from the expertise
and scale of others.
 A business might outsource its catering and security, for example. similarly, it may
outsource its customer enquiry helplines to specialist call centers.
 Outsourcing may enable a business:
 To use the specialist services of another business An outsourcing supplier may be
using specialist equipment which it is not cost-effective for the business to invest in
f& itself, given the scale of this particular operation
 To benefit from lower costs by using a business that specialises in an activity (such
as customer credit checks) rather than trying to learn how to do it itself.
 The impact on costs. The provider will want to take profit and therefore the business
needs to make sure that outsourcing is better value than doing it itself. Sometimes a
business may outsource initially but, as the scale of the activity grows, it may be
worth taking the activity back in-house
 The impact on quality. The quality of work from a specialist provider may be better
than the business could produce itself, but the business needs to be sure. The business
is not directly in control of what is happening and therefore must ensure that specific
and expectations are clear and that there are system in place to monitor quality.
 Reliability of delivery. The outsourcing supplier must be able to deliver reliably, on
time, so that the rest of the business' operations are not held up.
 The response of the existing workforce. By outsourcing, a business is moving
production away from the business itself. This may lead to a loss of jobs. This may
meet with resistance from the employees.
BUSINESS FINANCE
BUSINESS FAILURE

 A lack of finance is a common cause of business failure. A business fails when it is

unable to pay debts and is unable to continue trading. This is called insolvency. A
business is judged to be insolvent when its debts (or liabilities)exceed its ability to
pay them.
1 Bankruptcy
 A business whose owners are not Legally separate from the business itself known as
an unincorporated business, The owners of these businesses do not have the
protection of limited Liability, If an is unable to settle its debts, it will be declared
bankrupt by a court of law. The Assets owned by the bankrupt business will be sold;
this can include the private possessions of the business owners, such as property and
savings, The money raised from this sale will be shared between the individuals and
organizations who are owed money.
2. Administration and liquidation
 Company (that is an incorporated business) that is judged to be insolvent will often
have its assets sold to settle its Liabilities. These assets will not include the private
possessions of the business' owners (normally shareholders). The process of selling
assets for cash is called liquidation. The process of liquidation takes two forms:
 Compulsory liquidation. This occurs when a creditor seeks an order from a court of
law to have tie business' assets sold as it has not received payment of a debt. In such
circumstances, the court will- appoint a receiver. A receiver may be able to keep the
business going its finances are not too weak. However, it is very common for
receivers to close the business down and to sell all its assets.
 Voluntary liquidation. This is when the owners of the -company decide to enter
liquidation. This might be because they recognize the weakness of the business'
financial position. It can also occur when the owners of a company want to retire and
are unable to sell the business.