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Ch 22

Ch 22

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Improving Operational Efficiency Ch22
 
(Capacity, Scale of operation and Work Study) Capacity
“Capacity is the maximum amount the organization can produce in a given period in shortrun, 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 intensiveuse 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 100Full capacity output per period
A firm’s capacity utilization is of considerable financial importance, because of the impactof fixed overheads per unit on profit margins.
 Example:
A firm has a maximum capacity to produce 100,000 units in a month. There isaverage $ 50,000 fixed cost in a month to the firm.
If 
firm produces 25000 units in amonth, it means that fixed cost per unit will be $ 2.
If 
firm produce 100,000 units at fullcapacity, fixed cost per unit will be $ .5.
So,
high capacity utilization keeps fixed costs per unit down, by spreading the overheadsover 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 segmentcan 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 capacityoutput of a business.
Spare capacity in short term
 – seasonal problemMaintain output level and add to stock but this is risky and expensive. Or adopt moreflexible 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 calledeconomies of scale.
Economies of Scale
 
These are the factors that cause average costs to be lower in large scale production. Thesefactors 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 interestrates 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 needto develop an effective communication network which causes cost. Problems like poor feedback etc
Coordination cost/problems- large firms require delegation of powers, to ensure itthat objectives of each decision maker should be in same direction as the business,needs strong coordination among department managers, division and countrymanagers etc causes huge cost.
Alienation of workforce- it is difficult to involve every worker in decision makingand 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 avoidedManagement by Objectives (MBO)DecentralizationReduce diversification
Work Study
“Work study comprises a series of techniques aimed atimproving 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 realisticoutput targets”.
Also known as time and motion study devised by F WTaylor.
These techniques are grouped under two headings;Method studyWork measurementMethod StudyThis is a systematic and critical examination of the ways of doing things in order to makeimprovements. It involves a detailed analysis of the present method of work, developmentand testing of new methods, the training of the workforce, and installation and regular testing of new methods.
Work MeasurementIt aims to construct standard times needed for an average worker to complete the varioustasks involved in job.
Advantages
Improvement in productivity
Improved use of space and equipments

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