1. 4.3 Increasing efficiency and productivity
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Learning outcomes
What you need to know:
Why capacity is important and how to utilise it
AQA A-level Business © Hodder & Stoughton Limited 2015

3. What is capacity? (Recap)
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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4. Importance of capacity
Getting capacity right is important because managers need to decide on the correct scale of production for the organisation.
Too low and they will not be able to meet demand for their products; get it too high and they will waste money with idle resources (machinery, people or stock, etc.).
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5. Importance of capacity
Efficient capacity management can ensure that a firm is not spending excessive amounts on capital equipment and other resources and therefore is able to control its unit costs – low unit costs help the firm to achieve higher profit margins
A firm’s capacity should allow some flexibility between different production lines, so that supply can meet demand if one particular product experiences a sudden increase in popularity
Some industries (e.g. Farming) experience seasonal production – they need to ensure that they have the capacity to cope with the peak production period
Some industries have seasonal demand (tourism) – these industries need to plan capacity to cope with the periods when demand peaks
If a business has no close competition, then lack of capacity might not be an issue, but where there is lots of competition, there can be serious repercussions - firms may need to sub-contract or outsource (this means they don’t need to spend money on expanding capacity, but can become more expensive)

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In terms of capacity utilisation, there are 2 types of situation that a firm needs to manage:
Under-utilisation of capacity (excess capacity or spare capacity)
Capacity shortage (why do you think this is an issue)
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7. Spare capacity There are several reasons this can occur:
New competitors or products entering the market (e.g. Pizza restaurants)
Fall in demand due to changes in taste or fashion (e.g. McDonald’s and healthier alternatives)
Unsuccessful marketing (e.g. Benetton and controversial images )
Seasonal demand (e.g. Thorpe Park)
Over-investment in fixed assets (e.g. Littlewoods stores)
Merger or takeover leading to duplication of resources or sites (e.g. Derbyshire Building Society and Nationwide)

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Under-utilisation of capacity helps a firm cope with unexpected problems or increases in demand, but it can increase costs. There are also other problems:
Firms have a higher proportion of fixed costs per unit
Higher unit costs lead to either lower profit or price increases – and therefore potentially lower sales
Spare capacity can portray a negative image for a firm suggesting it is unsuccessful – gyms/shops where there are no customers can put other customers off
With less work to do, employees can become bored and demoralised lowering motivation and efficiency and potentially worrying about losing their jobs
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9. Advantages of spare capacity
More time for maintenance and repair of machinery
Less pressure and stress placed upon employees
Businesses will be able to cope with a sudden increase in demand. Businesses in expanding markets will increase their capacity beforehand, so that their sales are not limited by the size of the factory or shop
A firm may use calculations of spare capacity to see the maximum possible sales that it could achieve before it needs to expand its capacity
If a business has spare capacity, it might decide to follow a policy of rationalisation in order to reduce its capacity and save unnecessary expenditure – rationalisation leads to a cut in the capacity of a firm and thus to a reduction in its maximum output

10. Ways of reducing capacity
Selling off all or part of its production area – this will cut fixed costs but is not a good idea if spare capacity is a short-term problem
Changing to a shorter working week or shorter day – saves costs and cuts production, but may lead to lower motivation and a higher staff turnover
Laying off workers – saves money and reduces costs, but fixed costs will remain the same and it can be costly and time-consuming if they need more staff in the future
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Capacity shortage
The main cause of this is an increase in demand, outpacing the firm’s ability to increase its production levels. It is also possible that capacity shortage might occur through the expiry of a lease on property, but firms can usually renew leases.
AQA A-level Business © Hodder & Stoughton Limited 2015

12. How to increase capacity
For businesses to increase capacity they need to:
Invest in capital machinery (build or extend factories or plants)
Invest in employees through training
Hire more employees
Ask staff to work overtime or longer hours
A flexible workforce
Change production practices to be more efficient
Outsourcing or subcontracting work
Transferring resources from another area