IBBusinessDPBusiness ManagementHLRevision Notes5. Operations Management5.6 Production PlanningUseful Production Metrics

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

Lisa Eades

Written by: Lisa Eades

Reviewed by: Steve Vorster

Updated on

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


    Capacity space utilisation space equals space fraction numerator space space Current space output over denominator Maximum space possible space output end fraction space cross times space 100

Worked Example

Bäkkerei Lola produces specialist Indian and Bangladeshi breads which are sold to restaurants in the Munich area. Batch production is used in the factory to manufacture the range of breads and the factory can produce a maximum of 68,400 units per month. In May factory output was 51,420 units

Calculate Bäkkerei Lola's capacity utilisation in May [2 marks]

Step 1 - Divide the current output by the maximum output

equals space fraction numerator 51 comma 420 space units over denominator 68 comma 400 space units end fraction space space space space space space equals space space 0.75 space space(1 mark)

Step 2 - Multiple the outcome by 100 to obtain the percentage capacity utilisation

equals space 0.75 space straight x space 100 equals space 75 percent sign (1 mark)

Examiner Tips and Tricks

In your exam, you may need to rearrange the capacity utilisation formula. You may be given the percentage of capacity utilisation and have to calculate the volume of output.

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 

Worked Example

Production Data for Pencil Manufacturers A and B

Manufacturer

Capacity Utilisation

A

55%

B

80%

Explain one implication of the level of capacity utilisation for pencil manufacturer A, compared to manufacturer B.  [2 marks]

Step 1 - Identify an implication

One implication is that manufacturer A's unit costs are likely to be higher than those of manufacturer B    (1 mark)

Step 2: Develop the point with a reason

because resources such as workers and machinery are not being used to their full potential    (1 mark)

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

Defect space rate space equals space fraction numerator Number space of space defective space items over denominator Total space output end fraction space cross times space 100

Worked Example

HomeFlex manufactures high-strength universal charging cables for mobile phones. In 2022 it manufactured and tested 14,220 cables of which 213 were found to be defective 

Calculate Homeflex's defect rate in 2022.  [2 marks]

Step 1: Divide the number of defects by the total output

equals space fraction numerator 213 space cables over denominator 14220 space cables end fraction space equals space 0.015 (1 mark)

Step 2: Multiply the outcome by 100 and express as a percentage

equals space 0.015 space cross times space 100 equals space 1.50 percent sign (1 mark)

  • 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 

begin mathsize 16px style text Defect rate =  end text fraction numerator Number space of space defective space items over denominator Number space of space items space tested end fraction space cross times space 100 end style

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

Examiner Tips and Tricks

The defect rate is likely to be much lower when businesses adopt a system of quality assurance, especially Total Quality Management (TQM)

However these approaches usually require a whole-business commitment to quality which may not be easy - or quick - to achieve

Businesses may therefore be willing to operate with a determined level of defects in order to avoid the upheaval and expense of moving to quality assurance

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

    Labour space productivity space equals space fraction numerator Output over denominator Number space of space workers end fraction

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

Higher labour productivity improves businesses competitiveness
Higher labour productivity improves businesses competitiveness

Worked Example

The table shows the number of pairs of luxury wool socks produced by Sokkemani in 2021 and 2022

Year

Units Produced

2021

46,000

2022

69,000

In 2021 Sokkemani employed 50 staff. In 2022 the number of staff employed by the business increased by 20%

Calculate the percentage change in labour productivity between 2021 and 2022.  

[4]

Step 1 - Calculate the labour productivity for 2021

equals space fraction numerator 46 comma 000 space units over denominator 50 space workers end fraction space space space space space equals space 920 space units space per space worker space     (1 mark)      

 Step 2 - Calculate the labour productivity for 2022

equals space fraction numerator space 69 comma 000 space units over denominator space 60 space workers end fraction space space space space space equals space 1 comma 150 space units space per space worker space space         (1 mark)

Step 3 - Calculate the percentage difference between the two years ((new-old) / old)

equals space fraction numerator space 1 comma 150 space minus space 920 space units over denominator 920 space units end fraction space space space cross times space space space space space 100 space space space equals space 25 space percent sign space    (1 mark)

Step 4 - Identify whether the percentage difference is an increase or decrease

  • Labour productivity has increased by 25%     (1 mark)

  • 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

Capital space productivity space equals space fraction numerator Output over denominator Number space of space machines end fraction
 

  • 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

Worked Example

Ferramenta forecasts that by the end of the year it will produce 250,800 units and that capital productivity will be 1,100 units per machine

Calculate the number of machines Ferramenta has in use.

 [2]

Step 1 - Divide the output by the capital productivity

equals space fraction numerator 250 comma 800 space units over denominator space 1 comma 100 space units end fraction space space space space space space space (1 mark)

equals space 228 space machines (1 mark)

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

begin mathsize 16px style Cost space to space buy space equals space open parentheses Purchase space price space cross times space Quantity space close parentheses space plus space Delivery space costs end style

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

Cost space to space make space equals space open parentheses Average space variable space cost space cross times space Quantity space close parentheses space plus space Fixed space costs

Worked Example

Orosi Valley Farm has decided to sell free range eggs in its popular shop. It could introduce chickens to the farm and sell the eggs they produce. Alternatively it could source eggs from a neighbouring farm. It expects to sell around 5,000 eggs per week.

Costs associated with each option are shown in the table below

 

Purchase eggs from neighbouring farm

Source eggs from own chickens

Average cost per egg

7.2 pence

6.4 pence

Delivery cost

£5 per 1000

N/A

Fixed costs

N/A

£60 per week

Recommend whether Orosi Valley Farm should make or buy eggs to sell in its shop. You are advised to show your calculations.  

[5]

Step 1: Calculate the cost to buy the eggs

equals space £ 0.072 space cross times space 5 comma 000 space equals space £ 360 space space space (1 mark)

T h e n space a d d space d e l i v e r y space cos t s equals space £ 5 space cross times space 5 space equals space £ 25 equals space £ 360 space plus space £ 25 space equals space £ 385 space (1 mark)

Step 2: Calculate the cost to make the eggs

equals space £ 0.064 space cross times space 5 comma 000 space equals space £ 320 space space (1 mark)

 T h e n space a d d space f i x e d space cos t s equals £ 320 space plus space £ 60 space equals space £ 380 space space space (1 mark)

Step 3: Make a recommendation

  • Orosi Valley Farm should make the eggs, as the cost to make is lower than the cost to buy.    (1 mark)

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

Capacity

Quality

  • Is there spare capacity in-house?

  • Will further staff be required?

  • Will other output be affected?

  • Are standards met?

  • What is the defect rate?

  • How are problems resolved?

Reliability

Core competency

  • How quickly can products be made?

  • Does the supplier have a good reputation?

  • Have targets/deadlines/standards been met previously?

  • Does the business specialise in producing this item?

  • Could efforts be used more productively on other processes?

Examiner Tips and Tricks

When considering make or buy decisions, you must weigh up both the quantitative factors (calculations) and qualitative factors 

Look for clues in the case study that can support your qualitative points and ensure that your decision is holistic - in other words, consider all of the evidence!

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    Author
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    Lisa Eades

    Author: Lisa Eades

    Expertise: Business Content Creator

    Lisa has taught A Level, GCSE, BTEC and IBDP Business for over 20 years and is a senior Examiner for Edexcel. Lisa has been a successful Head of Department in Kent and has offered private Business tuition to students across the UK. Lisa loves to create imaginative and accessible resources which engage learners and build their passion for the subject.

    Steve Vorster

    Reviewer: Steve Vorster

    Expertise: Economics & Business Subject Lead

    Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.