Improving Operational Efficiency Ch

22
(Capacity, Scale of operation and Work Study)

Capacity
 “Capacity is the maximum amount the organization can produce in a given period in short
run, i.e. without extra fixed assets and/ or fixed overheads”.
 Capacity is often difficult to estimate as more output can be produced by a more intensive
use of plant e.g. motivated work force, better material, better maintenance or shift work.

Capacity Utilization
 “Capacity utilization is the extent to which the maximum capacity of the firm is being used,
i.e. actual output as a percentage of maximum potential output”.
Formula: Actual output per period x 100
Full capacity output per period
 A firm’s capacity utilization is of considerable financial importance, because of the impact
of fixed overheads per unit on profit margins.
Example: A firm has a maximum capacity to produce 100,000 units in a month. There is
average $ 50,000 fixed cost in a month to the firm. If firm produces 25000 units in a
month, it means that fixed cost per unit will be $ 2. If firm produce 100,000 units at full
capacity, fixed cost per unit will be $ .5.
So, high capacity utilization keeps fixed costs per unit down, by spreading the overheads
over many units of output.

Full Capacity Utilization

When firm produced products at maximum capacity level, it is called full capacity utilization.
 Benefits
 Sense of job security to the employees
 By passing benefit of low fixed cost per unit to the customers, large market segment
can be targeted.
 Increase in profit margin
 It can attract investors for further investments.
 Drawback
 Work load on staff
 Regular customers can be affected
 Insufficient time to maintain the machinery
 Firm will not be able to meet sudden demand

Excess Capacity
Excess (spare) capacity exists when the current levels of demand are less then the full capacity
output of a business.
 Spare capacity in short term – seasonal problem
Maintain output level and add to stock but this is risky and expensive. Or adopt more
flexible production methods and machines to produce the other goods.
 Spare capacity in long term- due to change in fashion, technological developments,
competitors, economic recession.

Increasing the Scale of Operation

Why a firm wants to increase the scale of operation when they know that it requires huge finance.
This happens when firms wants to enjoy the full benefits of large scale production which are called
economies of scale.
 Economies of Scale
 These are the factors that cause average costs to be lower in large scale production. These
factors are;
 Purchasing economies – benefits of bulk buying
 Technical economies- use of automated equipments; this is only feasible when the
fixed costs of the machines can be spread thinly over many units of output.
 Financial economies- lower cost of capital charged to large firms i.e. low interest
rates are charged to big firms then small firms.
 Marketing economies- cost on making an advertising campaign can be spread over
large numbers of units.
 Managerial economies- specialized staff can be affordable which can give more
productivity.
 Diseconomies of Scale
These are factors causing higher costs per unit when the scale of output is greater, i.e.
causes of inefficiency in large organizations. The main factors are;
 Communication costs/problems- due to many layers of hierarchy, large firms need
to develop an effective communication network which causes cost. Problems like
poor feedback etc
 Coordination cost/problems- large firms require delegation of powers, to ensure it
that objectives of each decision maker should be in same direction as the business,
needs strong coordination among department managers, division and country
managers etc causes huge cost.
 Alienation of workforce- it is difficult to involve every worker in decision making
and giving them importance. This will lead to de motivation and de motivated staff
can not give a good result.
 How diseconomies of scale can be avoided
Management by Objectives (MBO)
Decentralization
Reduce diversification

Work Study
 “Work study comprises a series of techniques aimed at
improving the efficiency and effectiveness of work.”
 “Work study is the systematic measurement of working
process and timings with the intention of identifying the best available method and realistic
output targets”.
 Also known as time and motion study devised by F W
Taylor.
 These techniques are grouped under two headings;
Method study
Work measurement
Method Study
This is a systematic and critical examination of the ways of doing things in order to make
improvements. It involves a detailed analysis of the present method of work, development
and testing of new methods, the training of the workforce, and installation and regular
testing of new methods.
 Work Measurement
It aims to construct standard times needed for an average worker to complete the various
tasks involved in job.
 Advantages
 Improvement in productivity
 Improved use of space and equipments
 Problems
 Workforce resistance
 Accurate measurement- workers can work faster then normal to impress.