Production planning

Capacity utilisation is the proportion of a firm's maximum possible output that it is actually producing, expressed as a percentage. It is calculated as actual output divided by maximum possible output, multiplied by 100, and shows how fully the firm is using its productive resources.

Buffer (minimum) stock is the minimum level of inventory a business chooses to hold in reserve as a safety margin. It is kept to cover unexpectedly high demand or a delay in a delivery, so that the firm can keep operating without running out of stock; stock is not intended to fall below this level.

Two principles are: (1) sourcing (procurement) — carefully selecting reliable suppliers of inputs and deciding between local/global and single/multiple sourcing to balance cost and risk; and (2) efficient logistics — the transport, warehousing and distribution of goods so that materials and finished products move quickly and cheaply to where they are needed. (Managing stock levels and building strong supplier relationships are also acceptable.)

(a) Capacity utilisation = actual output ÷ maximum output × 100 = 6,000 ÷ 8,000 × 100 = 75%. (b) At 75% the firm has 25% (2,000 units) of spare capacity. The main implication is that its fixed costs (rent, machinery, salaries) are spread over relatively few units, so the fixed cost per unit — and therefore the average cost per unit — is higher than it would be at full utilisation, making the firm less price-competitive. On the positive side, this spare capacity gives the firm flexibility to accept a sudden large order without needing to expand.

(a) Reorder level = (lead time × average daily usage) + buffer stock = (4 × 60) + 150 = 240 + 150 = 390 units. (b) If the lead time rose to 6 days but the reorder level stayed at 390, the firm would still place its order when stock hit 390 units, but the delivery would now take 6 days instead of 4. During those 6 days it would use 6 × 60 = 360 units, leaving only 390 − 360 = 30 units on delivery day — far below the 150-unit buffer. The firm would risk a stock-out and a halt in production. To avoid this it should raise the reorder level to (6 × 60) + 150 = 510 units.

On a stock-control (sawtooth) chart, stock is shown on the vertical axis and time on the horizontal axis. Stock falls steadily as it is used, producing a downward slope, and jumps back up when a delivery arrives, giving the sawtooth shape. Three horizontal lines guide decisions: the maximum stock level (the ceiling the firm is willing to hold), the reorder level (the point at which a new order must be placed) and the buffer/minimum stock (the safety floor). The business decides WHEN to reorder using the reorder level, which is set so that, over the supplier's lead time, stock falls just to the buffer level as the delivery arrives — calculated as (lead time × average daily usage) + buffer stock. It decides HOW MUCH buffer stock to hold by weighing the risk and cost of a stock-out against the cost of holding stock: greater demand uncertainty or longer, less reliable lead times justify a larger buffer (a just-in-case approach), whereas reliable suppliers and short lead times allow a minimal buffer (closer to just-in-time), freeing up cash and storage space. So the chart turns two judgements — reliability of supply and cost of holding stock — into clear reorder and buffer lines.

At 96% capacity utilisation the manufacturer has almost no spare capacity — only about 4% headroom — so with demand still rising it will soon be unable to meet orders from its existing plant. Investing in new capacity (machinery, premises, extra staff) would let it capture the growing demand, protect customer relationships and avoid turning away sales. It would also restore the operational slack that 96% removes: room for machine maintenance, for coping with breakdowns and for accepting rush orders, all of which reduce the current risk of quality faults, staff burnout and reliability problems. And because higher output spreads fixed costs over more units and can unlock economies of scale (bulk-buying, technical), unit costs may fall, improving competitiveness.

However, investing in capacity carries serious risks. It is expensive and often requires significant finance, which raises fixed costs and gearing; if the expected demand does not materialise, the firm could be left with NEW spare capacity and even higher fixed costs per unit — the opposite of the intended effect. Capacity expansion is also slow and hard to reverse, so it is risky if the demand rise is temporary or cyclical. There are cheaper, more flexible alternatives: overtime or an extra shift can lift output quickly, and OUTSOURCING production to another manufacturer meets extra demand without any capital outlay (though at some cost to quality control and margin). These preserve flexibility while the firm confirms whether the demand growth is durable.

On balance, the decision depends chiefly on how CONFIDENT and PERMANENT the demand growth is. If market evidence shows sustained, long-term growth, investing in capacity is justified and probably necessary, because relying on overtime and outsourcing indefinitely is costly and risks quality and reliability. If the growth is uncertain or possibly temporary, the wiser first step is to meet the extra demand through overtime and outsourcing, monitor the trend, and only commit to permanent capacity once the higher demand is confirmed. The recommendation is therefore conditional: expand capacity if the growth is proven and lasting; bridge with flexible measures if it is not. This staged approach captures the sales upside while limiting the risk of over-investing.

Under JIT the retailer holds almost no buffer stock, so materials and goods must arrive exactly when needed. This has clearly reduced storage costs and cash tied up in inventory, but the two stock-outs show its central weakness: with no safety stock, a single late delivery halts sales, disappoints customers and can permanently drive them to competitors. Switching to a just-in-case (JIC) system — deliberately holding buffer stock — would directly address this. A buffer would keep the retailer trading through late deliveries or demand spikes, protecting sales revenue, customer loyalty and reputation, which for a retailer are critical.

However, JIC has real costs. Holding buffer stock ties up cash that could be used elsewhere, incurs storage and insurance costs, and risks stock becoming obsolete, damaged or (for perishable goods) unsellable. If the true cause of the stock-outs is unreliable SUPPLIERS rather than the JIT system itself, then simply piling up stock treats the symptom, not the cause; the retailer might do better to improve supplier relationships, use more reliable or multiple suppliers, or set a more realistic reorder level and lead-time assumption while keeping stock lean. A full switch to JIC could therefore add cost without being strictly necessary.

On balance, I would not recommend a wholesale switch to a high-buffer JIC system, but rather a targeted MIDDLE course: introduce a modest buffer stock for the most critical, fast-selling or hard-to-replace lines (a partial move toward JIC where stock-outs hurt most), while tackling the root cause by sourcing from more reliable suppliers or adding a second supplier and recalculating reorder levels for realistic lead times. This keeps most of JIT's cost advantages while removing the vulnerability that caused the stock-outs. A full switch to JIC would only be justified if suppliers cannot be made reliable and the cost of further stock-outs (lost customers) clearly outweighs the higher holding costs. The judgement hinges on the reliability of supply and the value of the sales at risk.

Before recommending action, the firm must recognise what a fall from 90% to 60% means: 40% of capacity now stands idle, so fixed costs are spread over far fewer units and the average cost per unit has risen sharply, making the firm less price-competitive at exactly the moment it has lost a key customer. Doing nothing is not an option, but the best adjustment depends on whether the lost demand is permanent.

One option is to fill the spare capacity by winning new demand — increased marketing, new products or new markets — or by OUTSOURCING the idle capacity, doing contract or own-label work for other firms. This turns idle machines and staff into revenue, helps cover the fixed costs and, crucially, keeps the workforce and flexibility intact should demand recover. The risk is that new work may be hard to win quickly, and outsourcing arrangements raise quality-control and confidentiality concerns. A second option is RATIONALISATION: cutting capacity to fit the lower demand by closing a line, selling machinery, subletting space or making staff redundant. This raises the utilisation of what remains and permanently lowers fixed costs, but it brings redundancy costs, damages morale and reputation, and removes the flexibility to scale back up if a new large customer is found.

The firm should also adjust its STOCK and scheduling: with lower output it needs lower reorder levels and smaller reorder quantities, and can reduce buffer stock, freeing up cash — though it should avoid cutting stock so far that it cannot respond to new orders. On balance, my recommendation is to act in stages: in the short term, avoid drastic redundancies and instead push hard to replace the lost demand and outsource spare capacity to cover fixed costs, while trimming stock levels to match lower output. If, after a reasonable period, the demand loss proves permanent and no replacement work is secured, the firm should then rationalise capacity to restore healthy utilisation and cost competitiveness. This staged approach avoids the irreversible costs of premature rationalisation while protecting the firm from indefinitely carrying expensive idle capacity. The decisive factor is whether the fall in demand is temporary or permanent.