1. 4.2 Analysing operational performance
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Learning outcomes
What you need to know:
Calculate operational data:
Labour productivity
Unit costs
Capacity
Capacity utilisation
Interpret the operational data above and use it to make operational decisions
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3. Overview of key concepts
Businesses have to be as efficient as possible otherwise they risk wasting money and resources.
Being efficient should lower costs and thereby raise profit margins.
Operations managers use key measures to calculate their efficiency rates for labour, machinery and how much it costs to make each unit.
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Efficiency
All businesses try to be as efficient as possible. This means controlling costs when making goods or services.
Part of the operational objectives (from Unit 4.1) is to be able to measure the efficiency of the business. This can be done using:
Labour productivity
Unit costs
Capacity
Capacity utilisation
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Labour intensive
Definition: ‘When labour costs outweigh capital costs of a business’ In other words, when the business has spent more (on investing in) people to complete their goods or services than the capital (money) they have invested in it.
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6. Examples of labour intensive businesses
Think of some labour intensive businesses?
Morgan Cars
Wedding cake manufacturers
How would the intensity of the labour they have to employ affect the efficiency of their factory?
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Labour productivity
Definition: ‘The amount (volume) of output that is obtained from each employee.’ This is a measure of business efficiency, especially for firms which have a labour-intensive production process.
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Labour productivity
Calculation for labour productivity: Labour productivity = output per period No. of employees in that period The calculation has a significant impact upon unit costs.
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9. Labour productivity and units costs in four firmsE F
Units of output
No of employees
Labour productivity
(B/C)
Wage costs £400 per wk
(C x £400)
Wage costs per unit
(E/B)
Firm W
400 2
Firm X
660 4
Firm Y
750 5
Firm Z
1080 6
Adding in the wage cost allows operations managers to calculate in money terms how much in wages each unit costs to produce. This can aid decision-making.
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10. Achieving high labour productivity
Getting the workforce to be more productive is not an easy task and is influenced by:
Quality (and extent) of machinery
Skills, motivation and ability of workforce
The methods of production used
Reliability of raw material and suppliers
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11. Productivity can be increased by:
Increasing the number of hours worked
Training to employ output
Investment in equipment and technology
Changing the way the work is done
Motivating employees (see Unit 6)
Operations managers will use the calculations to decide which of the above they can most easily achieve.
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Discussion point
The higher the labour productivity the lower the wage cost per unit.
What does this mean for businesses?
Why is it so important?
How can they achieve high labour productivity?
That staff are very productive – i.e. very efficient
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Unit costs
Another measure of efficiency is unit costs This is defined as: ‘The cost of producing one unit of output’ This is equally as important if you are a large or small business.
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14. Unit costs (or average costs)
Unit costs example: How much would it cost you to produce one cupcake? Unit cost = * Total cost (in £) Units of output (in volume)
* Total costs = fixed costs + variable costs
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15. Total costs = fixed costs + variable costs
Fixed costs (FC)
Costs that do not change no matter how many units you make
For example, rent, insurance, telephone
Variable costs (VC)
Costs that change when output changes
For example, raw materials, distribution
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Unit costs
Sometimes known as average cost (AC) or average total cost (ATC).
If a business produces 20 units of output at a total cost of £50 then the average cost (for that unit) is £50/20 = £2.50
This means it costs £2.50 to make each unit.
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17. Monthly costs and output
Units of output
Fixed costs
Variable costs
Total costs
Unit cost 50 20 40 60 80
100
120
This assumes that the capacity of the factory is 120 units – maximum possible output
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Competitors
When competition is based on price it is vital to achieve the lowest unit costs.
Note: not all businesses compete on purely price!!! (More on this in Unit 3)
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19. Which is the most efficient business?
Units of output
Fixed costs (£)
Variable costs (£)
Total costs (£)
Unit costs (£)
Company A 40
200
160
360
Company B 80
300
600
Company C
100
500
1100
Company D
150
675
1275
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Unit cost influences
Unit costs are influenced by:
How many units a business can make with its resources
How efficient the workforce is at producing the goods
How efficient the machinery (fixed assets) are at producing the goods.
How easily variable costs can be controlled
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Capacity
Definition: the maximum total level of output or production that a business can produce in a given time period. A company that is producing at this level is said to be producing at full capacity. N.B. Working at full capacity is not always a good thing!!!!
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Capacity utilisation
Definition: The percentage of a firm’s total possible production level that is being reached.
For example, 95 per cent capacity utilisation for a machine which can make 100 widgets a day means that it is making 95 widgets out of a possible 100 every day.
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Capacity utilisation
Capacity utilisation = capacity output per annum (or month) x 100 maximum possible output per annum (or month) A company that can produce 4,500 units per year but is actually producing 3,800 units per year is working at: 3,800 x 100 = 84% 4,500 The company is working at 84 per cent capacity – they have 16 per cent spare capacity
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24. Which business has the best capacity utilisation?
Capacity output per annum
Maximum possible output
Capacity utilisation
Company A
5,000
4,000
Company B
6,000
5,500
Company C
3,500
2,500
Company D
2,250
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Spare capacity
Allows you to plan maintenance time – This is essential, especially if the machine or tools are very high value to the firm.
Most people recognise that 90 per cent or above capacity utilisation is the best.
Every point below 100 per cent shows that resources are not being used – therefore high fixed costs per unit produced.
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26. Causes of spare capacity: Examples
New competitors or new products entering the market (Google Nexus and iPad) means a fall in demand for existing products
Fall in demand for the product due to changes in taste or fashion (McDonalds vs healthy options)
Unsuccessful marketing
Seasonal demand (hotels)
Over-investment in fixed assets (Channel Tunnel)
A merger or takeover leading to duplication of resources (high street banks merging)
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Spare capacity
Advantages
Disadvantages
More time for maintenance and repair
Improvements can be planned in
Less pressure on employees
Can cope with sudden increase in demand – especially in a fast moving industry
Higher proportion of fixed costs per unit
Higher unit costs lead to lower profits, therefore lower sales volume
Negative image of being unsuccessful
With less work employees become bored or demoralised
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28. Using data to make decisions
The aim of operations managers is to use as few resources as possible to produce a given output, but conversely they are also seeking to maintain a given level of quality. Therefore productivity is a vital measure to help operations managers make decisions. The higher the productivity the more units each worker (or machine) makes.
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Profitability
Profit is calculated:
Sales revenue – (fixed costs + variable costs)
This means that to increase profit there are three things that can happen:
Increase revenue – can be hard to do and cost money to market products
Reduce fixed costs – can be hard and can reduce your capacity
Reduce variable costs – this is the easiest to do – decrease unit costs by increasing capacity utilisation.
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Increasing capacity
Increasing capacity is often a major decision and would have to fit in with corporate objectives of growth. Businesses need to ensure that there is future demand for the products as well as finance available (Unit 5).
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31. Exam-style question with tips
‘We have twelve coaches, each of which can carry 49 passengers. At the moment the average demand is for four coaches a day. This is unsustainable. We are operating way below capacity.’ Analyse the possible problems caused for the business above by the under-utilisation of capacity. (9 marks) Exam tip: Analyse – This means look at the problems and decide what their impact upon the coach business will be. Consider at least two of the impacts in detail.
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Summary
Businesses need to be able to measure their efficiencies so that operations managers can make decision about how to improve.
The different measures allow the managers to make better decision about which products, machines or people need improving, training or updating.
Changes to capacity can require large amounts of investment.
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