Five minutes to spare: The first dough at Mill Lane is ready for the oven at 2.30 a.m. The vans leave at 5. In between, the one oven bakes 600 loaves an hour.
Since Station Road opened, Priti needs 1,450 loaves a night. That is two hours and 25 minutes of oven time in a two-and-a-half-hour window. Five minutes to spare.
The most a business can make with the equipment, people and time it has is its productive capacity. Mill Lane's is 2.5 hours × 600 loaves = 1,500 loaves a night.
How much of that it actually uses is its capacity utilization rate:
Capacity utilization rate = actual output ÷ productive capacity × 100
| Actual output | Productive capacity | Capacity utilization rate | |
|---|---|---|---|
| Before Station Road | 1,200 loaves | 1,500 loaves | 1,200 ÷ 1,500 × 100 = 80% |
| Now | 1,450 loaves | 1,500 loaves | 1,450 ÷ 1,500 × 100 = 96.7% |
| With a second oven | 1,450 loaves | 3,000 loaves | 1,450 ÷ 3,000 × 100 = 48.3% |
High: the good side
- The rent, the oven and Priti's pay are spread over more loaves, so each loaf costs less
- Nothing stands idle: the oven and the bakers are paid for and used
High: the risks
- No room for a new order: a café asking for 100 more loaves must be refused
- Staff under pressure, tired and less motivated
- Rushed batches, so more burnt or flat loaves
- No time for maintenance, so breakdowns; lead times grow; unit costs can start to rise
Low: the risks
- The same fixed costs spread over fewer loaves, so each loaf costs more
- Ovens and bakers stand idle but are still paid for
- Staff may worry that jobs will go
Close to 100% is not the aim: 96.7% sounds efficient. At Mill Lane it means one oven fault, or one late flour delivery, and some shops open with empty shelves.
Many businesses aim to run a little below full capacity on purpose, keeping room for a breakdown or a new customer.
Moving the rate
Too high: add capacity
The $45,000 second oven doubles capacity to 3,000 loaves, and the rate falls to 48.3%.
Too high: share the work
Bake the rolls on an earlier shift, or have another bakery make some of the output (subcontracting).
Too low: fill the quiet times
Promotions, a lower price at quiet times, special orders for events: anything that brings more output, not just more revenue.
Too low: cut capacity
Sell or rent out a machine, or shorten a shift, so the same output uses less of what is paid for.
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The crate at the back: Before the vans leave, Priti checks every batch: colour, weight, shape. A loaf that fails goes into a crate at the back (5.2.4).
At the end of the week she counts the crate. The count only means something next to how many loaves were baked.
The share of output that fails the quality standard, as a percentage, is the defect rate:
Defect rate = defective units ÷ total output × 100
Divide by everything made, the good and the bad together. The answer is a percentage, so it carries a % sign.
One week at Mill Lane
Total output
Six nights of 1,450 loaves: 6 × 1,450 = 8,700 loaves.
Defective units
87 loaves ended up in the crate: burnt, flat or the wrong weight.
Defect rate
87 ÷ 8,700 × 100 = 1.0%. One loaf in every hundred fails.
| Defect rate | What it tells Lena | |
|---|---|---|
| Before lean production (5.2.4) | About 40 of 1,370 = 2.9% | Nearly three loaves in every hundred thrown away |
| This week | 87 of 8,700 = 1.0% | Down by two-thirds since the changes of 5.3.1 |
| The best bakeries in the benchmarking scheme | Under 1% | Mill Lane is close, but not yet there |
Why a lower defect rate matters
- Lower costs. 87 loaves use about 87 × $0.90 = $78.30 of ingredients a week, plus the bakers' time, all thrown away.
- More good output from the same capacity. Every failed loaf used oven time that a good one could have had: 87 loaves is almost nine minutes of oven time a week.
- Reputation. Fewer bad loaves reach a shop, so fewer customers are let down.
- Contracts that need proof of quality, such as the hotel chain that buys only from certified suppliers (5.2.4).
Rushing shows up in the crate: A defect rate often rises when capacity utilization is very high. At 96.7% the last batch is always hurried, and hurried loaves burn.
A buyer checks a supplier's defect rate too. If a box of 2,000 printed cracker packets arrives with 60 misprinted, that is 60 ÷ 2,000 × 100 = 3%: fewer usable packets than Lena paid for.
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Full is not the same as productive: Capacity utilization says how full the oven is. It does not say how much Mill Lane gets out of each baker, each oven or each dollar it spends.
That is productivity: output for each unit of input. Three measures, one idea.
Three ways to measure it, with one night's numbers
Labour productivity
Output ÷ number of workers (or hours worked).
Priti and six bakers make 1,450 loaves: 1,450 ÷ 7 = 207 loaves per person a night.
Capital productivity
Output ÷ capital used (machines, or machine hours).
One oven, 1,450 loaves: 1,450 loaves per oven a night.
Productivity rate
Total output ÷ total input × 100, with both measured in the same units, often dollars.
Loaves worth 1,450 × $3 = $4,350 from $2,500 of inputs: 4,350 ÷ 2,500 × 100 = 174%.
The $2,500 is the whole night's input: $1,305 of ingredients, $840 of wages and $355 of energy and other costs. A productivity rate of 174% means every $100 of inputs becomes $174 of bread.
One number on its own says little. Compare it with last month, or with another bakery, and it starts to talk.
| Today | With the second oven, same 1,450 loaves | With an eighth person, same 1,450 loaves | |
|---|---|---|---|
| Capacity utilization | 96.7% | 48.3% | 96.7% |
| Capital productivity | 1,450 loaves per oven | 725 loaves per oven | 1,450 loaves per oven |
| Labour productivity | 207 loaves per person | 207 loaves per person | 181 loaves per person |
More inputs, same output, lower productivity: A second oven or an extra baker takes the pressure off. But if output stays at 1,450, each oven or each person now makes less.
Extra capacity pays off only when the extra output follows, such as a fifth shop or a new café customer.
Ways to raise productivity
- Training, so each baker shapes more loaves an hour and ruins fewer.
- Better equipment, such as a faster mixer or a larger oven.
- Motivation and involvement: people who are listened to find better ways to work (unit 2).
- Less waste: lean production (5.3.1) means fewer inputs for the same loaves.
- A careful eye on quality: pushing for speed can raise the defect rate, and a failed loaf is output nobody buys.
Crispwell's offer: Crispwell, a cracker maker two towns away, offers to bake Lena's crackers to her recipe and deliver them in her packets for $0.95 a packet.
Lena makes them for less than that per packet on the variable cost alone. But she also pays $7,280 a year of fixed costs to make them: a baker's afternoons, oven time, van space.
Two sums decide it. The cost to make (CTM) is everything the business pays to produce the quantity itself. The cost to buy (CTB) is what a supplier charges for the same quantity.
CTM = fixed costs + (variable cost per unit × quantity)
CTB = supplier's price per unit × quantity
| Packets a year | Cost to make | Cost to buy | Cheaper |
|---|---|---|---|
| 18,000 (2025) | $7,280 + ($0.60 × 18,000) = $18,080 | $0.95 × 18,000 = $17,100 | Buy, by $980 |
| 20,800 | $7,280 + ($0.60 × 20,800) = $19,760 | $0.95 × 20,800 = $19,760 | The same |
| 24,000 | $7,280 + ($0.60 × 24,000) = $21,680 | $0.95 × 24,000 = $22,800 | Make, by $1,120 |
When the variable cost per unit is not given: A case may give only total costs, total fixed costs and output. Work the variable cost per unit out first: (total costs − total fixed costs) ÷ output. For the crackers: ($18,080 − $7,280) ÷ 18,000 = $0.60.
For an extra order, add only what the order changes: any extra cost per unit (such as overtime) and the fixed costs allocated to that order, not the whole year's.
The two choices also give Lena different cost structures. Making, about 40% of her cracker costs are fixed ($7,280 of $18,080). Buying, none are: she pays Crispwell only for the packets she orders.
How much of a business's costs are fixed decides how hard profit swings when sales change. That is operating leverage: the more fixed costs, the higher it is.
| Packets sold at $2.50 | Profit if made | Profit if bought |
|---|---|---|
| 14,400 (sales down 20%) | $20,080 (down 25.4%) | $22,320 (down 20%) |
| 18,000 | $26,920 | $27,900 |
| 21,600 (sales up 20%) | $33,760 (up 25.4%) | $33,480 (up 20%) |
Operating leverage cuts both ways: With fixed costs, each extra packet adds its whole contribution to profit once they are covered, so profit rises faster than sales. When sales fall, the fixed costs stay, and profit falls faster.
High operating leverage suits a business confident its sales will grow. Low operating leverage is safer when sales are uncertain.
Reasons to keep making
- Control over the recipe and the quality of every packet
- No risk of a supplier delivering late or running short
- Cheaper above 20,800 packets, if sales keep growing
- The recipe stays inside Mill Lane
Reasons to buy
- Cheaper at 18,000 packets, by $980 a year
- Frees the baker's afternoons and oven time for other products
- No fixed costs: lower operating leverage, less risk if sales fall
What to check first
- Crispwell's defect rate and how reliably it delivers
- Whether its price will stay at $0.95
- Whether the $7,280 really disappears, or the baker is still paid
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How this comes up: Short parts on a case: calculate a capacity utilization rate, for one mark with no working or two with working; define the defect rate, or calculate one from a supplier's figures; state two disadvantages of a high capacity utilization rate.
Then explain, for two marks: one challenge of running at 90% capacity, or one way to raise capacity utilization in the quiet months. One mark for the point, one for showing it in the case.
Make or buy comes as a pair: the cost to make an extra order, finding the variable cost per unit first, for three marks, and the cost to buy it, for one.
The two-mark pattern
- Name one challenge. At a very high rate there is no room for extra orders.
- Show it in the case, with a figure. Mill Lane needs 1,450 of its 1,500 loaves, so a café's order for 100 more cannot be baked before the vans leave.
Two traps: A point with no case. "Staff get tired" is one mark. "Priti's bakers have five minutes to spare each night" is the second.
Revenue is not capacity. For a way to raise capacity utilization, give something that brings more output, such as a promotion or a special order. A price rise earns more money and fills no oven.
Explain one challenge for Lena's Bakery Ltd of operating the Mill Lane oven at a capacity utilization rate of 96.7%.
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