Capacity

Here is a response from Rob Verheyden to the question “Out of curriosity can you offer some ways firms might cut capacity beyond the typical reductions in the workforce? “

The only time that cutting capacity is justified is when a company is truly on the ropes in terms of cash flow, when it really is a matter of survival. Admittedly, that is pretty much the case these days, though in past downturns, it was done purely to manage the #’s - to pad the bottom line.

A well-managed company, however, should have sufficient resources to treat this as an opportunity. Ideally, management should take advantage of this excess capacity as an opportunity to:

Take equipment out of service to perform a major overhaul, upgrade or even to replace it.
Implement training programs for the labor force.

If necessary, implement initiatives to bring about culture change - I know this sounds vague, but it is imperative that the philosophic, intellectual and bureaucratic inertia be dealt with in a company that must change to survive.

Visit customers, visit vendors and examine the supply chain in great detail. If people have time to worry about excess capacity, then they have time to talk and tour each other’s facilities. This is an excellent time to develop stronger relationships.

Examine the company’s processes and emphasize continuous improvement programs.
After all, if you can’t afford to do these things now, when you have the time, then the only alternative is to do so when you are busy and your people more harried than receptive. I recall a study from the late 80’s or early 90’s that pointed out that companies which go through these cycles of layoffs incur heavy training and quality costs during the ensuing upturn and inevitably lose ground to their more progressive competitors each time.

OK, so now that I’ve described the ‘big picture’, I should probably answer your question as it was posed. First, we should recognize that cutting excess capacity is really just another term for cost cutting. One of my accounting prof’s taught us to perform a differential analysis when comparing two or more alternatives and he made it very clear that we should remember two things - always include the intangible / non-quantifiable factors, and only the AVOIDABLE cash flows count.

That’s the rub, in this case the company only benefits to the extent that it can avoid cash outflows and many of the costs that we are familiar with simply do not represent avoidable cash flows. Salary and wages are avoidable (unless you dealt with the UAW), but depreciation is not. If you cut the headcount significantly, then you cut the cash outflows significantly. No wonder it’s so popular.

The fact is, we don’t really want to cut capacity, we just want to stop paying for it! This is probably one of the factors that drives decisions to outsource. The company can sell, close or spin off a portion of the operation, then buy only what is needed from a vendor without cutting productive capacity at all. This works, as long as you aren’t outsourcing the company’s core competencies - that would be slow death.

Following a similar course, the company can push more responsibility down to the vendors. This can be as complex as looking to them to handle more of the engineering, or it might be something as straight forward as implementing a vendor managed inventory system. Ironically, to the extent that such moves would open up floor space, they could actually allow the company to make inexpensive, incremental increases in capacity.

Finally, implementation of lean manufacturing principles, value stream analysis, continuous improvement, etc. can have a huge impact upon the cost of everything from headcount to inventory investment and energy consumption. Again, while creating the opportunity to increase capacity, rather than cut it.

Thanks Rob

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