Useful Production Metrics (DP IB Business Management: HL): Revision Note

Capacity utilisation

• Capacity utilisation measures how effectively a business uses its assets to produce output

• It compares current output to the maximum possible output a business can produce using all of its assets

• Capacity utilisation is calculated using the following formula and expressed as a percentage

  
  $\mathrm{Capacity}\mathrm{utilisation}=\frac{\mathrm{Current}\mathrm{output}}{\mathrm{Maximum}\mathrm{possible}\mathrm{output}}\times 100$
  

Implications of under- and over-capacity utilisation

Under-utilisation

• Low capacity utilisation means resources are being under-used

  • This is likely to increase unit costs because fixed costs are spread over fewer units of output

  • Workers are under-deployed leading to fears of redundancy

• Operating under capacity provides flexibility

  • Workers are freed up to complete maintenance tasks

  • The business can respond to sudden increases in demand

Over-utilisation

•  High capacity utilisation may mean flexibility to respond to new orders is lost

  • Staff are under pressure to increase output

  • Overworked staff may leave increasing staff turnover 

  • Machinery operates at its limit and is more prone to breakdowns which disrupts production

• High capacity utilisation minimises unit costs and increases competitiveness

  • Busy workers feel secure in their employment 

  • A busy business is likely to be well thought-of and attract customers who are willing to wait for delivery of products 

Defect rate

• The defect rate is the proportion of output that is judged to be substandard in a given time period

• It is expressed as a percentage and calculated using the formula

$\mathrm{Defect}\mathrm{rate}=\frac{\mathrm{Number}\mathrm{of}\mathrm{defective}\mathrm{items}}{\mathrm{Total}\mathrm{output}}\times 100$

• Sometimes it is not feasible to quality check every item of output

• In these cases the defect rate is expressed as a percentage and is calculated using the formula 

$\text{Defect rate = }\frac{\mathrm{Number}\mathrm{of}\mathrm{defective}\mathrm{items}}{\mathrm{Number}\mathrm{of}\mathrm{items}\mathrm{tested}}\times 100$

Reasons to reduce the defect rate

• Businesses take steps to reduce the defect rate for several reasons

  • Avoid loss of revenue as faulty products can rarely be sold

  • Customers will likely complain about substandard products which causes dissatisfaction and impacts business reputation

  • Unsafe products may harm customers and could lead to legal issues/prosecution

  • Defective products are often returned and require refunds, processing and disposal

Measuring productivity

• Productivity is the output per input (person or machine) per hour

  • For example, an Ikea worker is able to produce 2 Poāng chairs per hour

• Labour productivity measures output per worker during a specified period of time

• It is expressed as a number of units and calculated using the formula

  $\mathrm{Labour}\mathrm{productivity}=\frac{\mathrm{Output}}{\mathrm{Number}\mathrm{of}\mathrm{workers}}$

• Businesses aim to increase the level of labour productivity to improve competitiveness

The link between high labour productivity and competitive edge

• Capital productivity measures of the output of capital employed (e.g. machinery) during a specified period of time

• Capital productivity is expressed as a number of units and is calculated using the formula

$\mathrm{Capital}\mathrm{productivity}=\frac{\mathrm{Output}}{\mathrm{Number}\mathrm{of}\mathrm{machines}}$
 

• Businesses aim to maximise capital productivity as expenditure on machines is likely to be high
  

Ways to minimise lost production time due to breakdowns

• Upgrading and recalibrating machinery

• Regular servicing and maintenance

• Training workers using machinery

• Use good-quality raw materials and components

Factors that determine productivity

• Rivalry is an incentive for managers and workers to increase productivity 

• Investments in technology such as ICT improves worker productivity by allowing flexible working and higher quality output 

• Innovations such as online scheduling software give employees tools to make their tasks more efficient

• Workers' skills and experience is improved by careful recruitment and ongoing training

• Business owners' or managers' attitude towards risk determines the steps taken to improve productivity

Cost to buy (CTB) and cost to make (CTM)

• Make or buy decisions occur when a business has to choose between manufacturing a product itself or purchasing it from an external supplier

• The business compares the cost to buy and the cost to make

• The Cost to Buy (CTB) is expressed as a monetary value and calculated using the formula

$\mathrm{Cost}\mathrm{to}\mathrm{buy}=\left(\mathrm{Purchase}\mathrm{price}\times \mathrm{Quantity}\right)+\mathrm{Delivery}\mathrm{costs}$

• The Cost to Make (CTM) is expressed as a monetary value and calculated using the formula

$\mathrm{Cost}\mathrm{to}\mathrm{make}=\left(\mathrm{Average}\mathrm{variable}\mathrm{cost}\times \mathrm{Quantity}\right)+\mathrm{Fixed}\mathrm{costs}$

Make or buy decisions

• Comparison of the cost to buy and cost to make determines a businesses choice

  • If the cost to buy is greater than the cost to make production should be kept in-house

  • If the cost to make is greater than the cost to buy production should be outsourced 

• A range of non-financial factors may be considered

  • This is particularly important if a potential supplier is being used for the first time

Qualitative factors in make or buy decisions