Impact of Capacity on Revenue Potential

Considering Capacity Cuts?

SYNOPSIS: When trying to rebalance cost structures in the face of business disruption or uncertain demand, it is important not to underestimate the role of capacity in revenue management or the potential impact of permanently removing capacity. 

This article was republished on LinkedIn.

ESTIMATED READING TIME: 3.5 min

Waves of Disruption

As the economic tsunami (substantially caused by the Covid-19 pandemic) continues to pummel economies, many industries have had their hands forced by a combination of economic realities and or lockdown regulations. The disruption and economic fallout thus far have not been limited to a specific industry and it seems no, or preciously few, industries have been spared. Then there is the knock-on effect – the reverberations in one industry is felt in many others.

• According to the Restaurant Association of SA, nearly a third of SA restaurants had already shuttered since the onset of the lockdown[1], their best efforts to stay open notwithstanding. Comparatively, in the US, restaurant closures by July 2020 represented the highest total business closures in the country, surpassing retail [2].
• South African motor vehicle financing transactions (and possibly to an extent total vehicle sales) in Q2 is down by -71% compared to the number of new and used cars financed over the same period in 2019. In Europe, sales for the half-year reduced steeply by between -35% (Germany) to 51% (Spain)[3]. Russia is down -23%, Brazil -39% and Japan around -23%.
• South African factory output had dropped 49.4% by April[4] compared to EU figures indicating -20.9% [5].

Adjusting to changing market conditions

As a result, business executives are forced to strategise, and where possible re-calibrate overheads and variable costs to right-size the cost base in the face of reduced demand or increased demand uncertainty (#NewNormal). Some common cost savings strategies deployed to date include:

• Retrenchments
• Salary cuts
• Reducing shifts
• Temporary factory shutdowns
• Reducing stock and reviewing re-order levels

It is becoming clear that some industries (notably capital-intensive industries) have been forced into taking a longer-term view, while others have already been dealt their cards and seriously handicapped by the fallout:

• To date, the container shipping industry has responded with an unprecedented high number of blank sailings (tactical sailing cancellations) - resulting in 10% of the global fleet sitting idle in May and June[6]. 

• Owners are now looking at more serious measures to right-size capacity, resulting in shipping lines such as Hapag-Lloyd (5th biggest container shipper line in the world) announcing an indefinite postponement of an order for a new fleet of 23,000 TEU mega-ships [7]. 

• This type of decision impacts industry capacity which, in turn, has a knock-on impact on e.g. ports and harbours - now resulting in planned port capacity expansion being curtailed by 40% over the next 5 years[8].

• The biggest cruise line operator in the world, Carnival Corporation, confirmed its plans to sell a total of 13 of its ships this year, in a bid to deal with the losses faced due to the COVID-19 pandemic [9]. 

• Due to Covid-19 factory lockdowns, commercial airline manufacturers such as Airbus and more notably Boeing, have fallen behind with deliveries of new airlines[10]. Boeing has also specifically been hit by customers cancelling orders in 2020, resulting in it bearing the brunt of 800 or more cancelled orders[11] to date.

Considering the Impact of Capacity Reduction

Why is Capacity Reduction a much more serious decision than e.g. reducing shifts or salary cuts? If we break it down (simplistically speaking): 

Revenue is a function of Price x Units sold 

Subject to the constraints of: 

• Market demand, 
• The Business Model, 
• Internal Capacity and 
• Productivity.

For capacity-driven operations, maximum revenue is thus limited by inter alia demand and capacity. It is difficult to increase demand, and even more unlikely for sales to exceed demand. Attempting to sell more than available capacity permits, or to sell more than productivity allows is not sustainable or feasible in the long run either. Optimising productivity to match capacity is also difficult.

However, once the capacity has been reduced, the supply curve moves left and maximum income potential shifts down. This means maximum income potential has been fixed at a permanently lower level unless a way can be found to significantly increase the following to sufficiently compensate for the loss of Capacity:

• Demand, 
• Productivity and or 
• Price 

For industries and companies where capacity is a key driver of costs and revenue-generating ability, while any cutting back of capacity could yield significant savings, it could equally impact revenue management and (depending on costs structures) possibly even the ability to break-even. While it does not make financial sense to have unused capacity sitting idle for extended periods of time, cutting capacity is still not a decision to be taken lightly. 

In some cases, notably the likes of Airbnb and Uber, they rely on in-sourced (crowd-sourced) capacity and they are not hamstrung by their infrastructure or capital. For more traditional companies, however, such as rental fleet operators, logistics companies, transport, manufacturers, warehouses, office buildings, hotels and recreation, a cut in capacity has more strategic and longer-term implications:

• Capacity influences the ability to retain or gain market share.
• Reduced capacity will have a more significant impact on the variability and certainty of revenue e.g. 1 out of 10 units becomes unavailable vs. if 1 out 5 units were unavailable.
• If participants in any industry start shedding capacity (equipment, buildings, vehicles etc) simultaneously, e.g. by selling it in the open market during a period of low demand, this can result in oversupply, prices will fall further and this can result in losses.
• If any hypothetical future economic improvement occurs or if demand increases there could be significant competition to regain capacity. This could result in long delays - meaning everybody will have to wait their turn and it could take years to get back to historic capacity levels.
• If suppliers of capacity have been significantly affected themselves (e.g. Boeing) and they are still catching up with the backlog or have had to scale down permanently, this could lead to significant cost increases, specifically in the event of a bidding or price war, until the market has self-corrected again.
• If capacity is sold and the cash is used to e.g. pay for day-to-day expenses or to service debt, it might influence the business's ability to expand capacity again in future.

When considering strategic alternatives and definitely before finalising any decisions, consider the following:

• Experiment with your digital twin or conduct financial and operational simulations to better understand the impact of proposed capacity cuts on both the business and bottom line.
• Consider possible alternatives such as outsourcing excess capacity, re-allocating capacity to different product lines, hybrid shared-capacities, licensing or shared operating agreements.
• Thoroughly assess market conditions, current demand, disposal costs and the probable range of net realisable values before you decide to sell.
• Evaluate and decide on a case-by-case or unit-by-unit basis.

How do you suggest dealing with the thorny issue of excess capacity? Please comment in the comment section below.

If you have found this article useful or thought-provoking, please share with others your company or industry.

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[1][1] https://www.iol.co.za/business-report/opinion/facing-an-existential-crisis-the-restaurant-industry-starts-fighting-back-3734ccf4-09f1-45dd-b57f-ccce1f38dfcb

[2] https://www.barrons.com/news/pandemic-an-apocalypse-for-restaurants-in-us-01596340207

[3] https://www.spotlightmetal.com/international-automobile-markets-slumped-sharply-a-950697/

[4] https://www.news24.com/fin24/economy/factory-output-falls-by-the-most-on-record-in-april-20200709

[5] https://www.reuters.com/article/us-eurozone-economy-industrialoutput/euro-zone-industry-output-recovers-less-than-expected-idUSKCN24F0XI

[6] https://www.joc.com/maritime-news/container-lines/carriers-could-make-permanent-capacity-cuts-prolonged-downturn-drewry_20200714.html

[7] https://www.porttechnology.org/news/hapag-lloyd-postpones-mega-ship-order/

[8]https://splash247.com/pace-of-boxport-capacity-expansion-forecast-to-contract-at-least-40-in-the-wake-of-coronavirus/

[9] https://www.marineinsight.com/shipping-news/worlds-biggest-cruise-line-operator-to-sell-13-ships-to-cope-with-losses-due-to-covid-19-pandemic/

[10] https://www.statista.com/chart/19713/airbus-vs-boeing-deliveries/

[11] https://www.seattletimes.com/business/boeing-aerospace/boeing-has-lost-more-than-800-orders-for-the-737-max-this-year/

COVID-19 BACK-TO-WORK PLANNING GUIDELINES AND RESOURCES

Photo Credit; VIACOM-CBS. Like Captain Picard of the USS Enterprise, leadership will have to steer the ship safely through the battlefield

BUSINESS UNUSUAL: BACK-TO-WORK PLANNING GUIDELINES AND RESOURCES FOR COVID-19 READINESS

ON 1 MAY 2020 PHASE 4 OF THE EMERGENCY REGULATIONS WENT LIVE IN ALL 9 PROVINCES. SOUTH AFRICANS WILL RETURN TO WORK IN A PHASED APPROACH AFTER AN UNPRECEDENTED COVID19 LOCK-DOWN STARTED MORE THAN 5 WEEKS EARLIER.

READING TIME: 4 min

This article was originally published on LinkedIn - you can read the original post here.

For many organisations, reopening might not simply be a case of unlocking the doors and switching the lights back on. Quite a lot might have happened while nothing happened during the lockdown.

The following is a high-level checklist / key considerations for executives and business owners alike. Additional South African and international resources are provided at the end of the article, some of which contain detailed examples, boilerplate templates, etc.

While some of the references specifically refer to South African business law and requirements, the recommendations are generic and applicable to businesses in various countries

1. Conduct an Overall Assessment

Brace yourself - while the damage or impact of the lockdown might not be immediately visible or easily identifiable the moment you walk back through the doors, the organisation might have "sprung a leak below the waterline” (metaphorically speaking). There is also the very real possibility of a future risk event that might still fully unfold in the next few weeks or months (e.g. as a consequence of the chosen strategy, implementation thereof, and extent of compliance with regulations, or other factors). 

Conduct a thorough and comprehensive assessment to determine the impact of the lockdown/virus to date on:

• Staff and management
• Business Assets, Stock, IT systems
• Other Stakeholders – customers, suppliers, shareholders, creditors, landlords, regulators, etc.
• Business operations
• Business Finances and Cashflow

2. Understand the requirement of the various Stages and Regulations of the Disaster Management Act [1] and its impact on your strategy, operating model, and plan corrective action:

• Establish a Covid19 Task Team (if you have not done so yet, and appoint specific COVID19 Compliance Officer(s) ), co-opt expertise and allocate responsibilities and develop a strategy as well as supporting policies.
• Confirm if and when your business or organisation qualifies to open and trade during a specific Phase of the lockdown. Also, confirm whether or not any additional permits are required. If unclear or if your specific organisation falls in a grey area which is not spelt out in the Emergency Regulations, contact your legal advisor and obtain professional legal advice.
• Take the time to do a detailed impact assessment to understand exactly what the requirements for each phase are, and how these may impact both your organisation as well as the wider industry in which you operate. Note that there are different requirements for different sizes, types of businesses and industries which might affect locations or different types of outlets differently.
• In real-world terms, these requirements could affect the date that your business can practically open for business because these measures need to be put in place first, e.g. steps to ensure social distancing, preventing crowding in admin offices or public spaces like the staff canteen, or while customers wait for quotes or while collecting goods. This is also impacted by the required level of hygiene, PPE for employees, additional safety requirements, etc.
• Consider whether the business operations should be suspended, and if not, which products and services can be offered now, vs. phased in subsequently in compliance with lockdown regulations.
• Plan the necessary workforce and capacity requirements accordingly.
• Demand planning may require a rethink, as well as any impact of these changes on outsourced services and contracts where capacity might have to be reallocated in the short run, in consultation with service providers.
• Reopening requires a high degree of Response Preparedness [12], and may necessitate Scenario planning – e.g. how will you handle a situation where the company operates across multiple provinces, but some of these provinces operate under different phases (e.g. Phase 5 or Phase 3)

Covid19 Workplace Plans[2] should include:

• Return-To-Work Policies, updated HR and Operational Policies and Procedures,
• Risk and Hazard assessments and Preventative Measures,
• Compliance Checklists

3. Review of Financial position

• Do not arbitrarily increase prices to make up for losses or to profiteer from market shortages [15]
• Carry out a line-by-line analysis of expenses to determine minimum cost and strategies to curtail costs until business conditions improve,
• Determine restructuring costs (if applicable) as well as Covid-19 related expenses, and bring these into consideration when completely re-working the budgets, forecasts, projections and cash flow. Communicate these changes to the line managers,
• Review solvency and liquidity, financing arrangements and debt repayments,
• Review and (re)negotiate trading terms with a view to optimise liquidity and maximise working capital.

More resources available from [8] and [11] below.

4. Consider Occupational Health & Safety requirements[3] and Sectoral or Industry Guidelines:

New risk assessments are required that could necessitate amendments to existing Risk Management as well as HR policies, AND special measures to be implemented such as proper social distancing, action plans in case of infection or symptom screening, etc. Existing Risk management policies and procedures will have to be updated (refer to Point 9 below).

The OHSA further requires employers, to ensure, as far as is reasonably practicable, that all persons who may be directly affected by their activities (including but not limited to own employees, customers, clients, contractors who enter their workplace or come into contact with their employees) are not exposed to hazards to their health or safety. 

Source: https://www.zupermar.com/

• For one business this might require social distancing, supplying employees with PPE and hand sanitizers while electronically screening customers for fever at the door and recording their details. Note the Department of Trade and Industry published requirements for material masks

Source: Gautrain Whole-body Disinfection

• For another, this might e.g. require intermittent professional disinfecting of public areas and or equipment or further steps. 

5. Review the Supply Chain:

Supply chains and logistics could have been significantly affected due to:

• Supplier factory lockdowns,
• delayed raw material shipments or stockouts,
• import delays due to ships unable to dock at ports or air cargo curbed,
• warehouses might have limited capacity to accept new stock,
• some stock items might have spoiled or deteriorated or might simply be unavailable for an undefined period.

Under the current circumstances, the efficient frontier might have shifted and you may need to find a new happy balance between service, capacity, inventory, and lead time.

• Review stock levels, re-order levels (specifically where programmed/automated re-order levels exist) and investigate outstanding orders. Ensure that no artificial shortages are created in the process [15].
• Re-rate suppliers: consider supplier resilience, flexibility under fluctuating demand and ultimately, supplier reliability,
• Reassess respectively, the degree of visibility, and the viability of the current supply chain – resources and capacity might have to be rebalanced.

6. HR considerations, Staff Planning and Consultation

The Department of Labour communicated stringent requirements in a briefing by Labour Minister Thulas Nxesi on 3 May 2020 (view on Youtube). The media statement with transcribed speech can be found here [16].

Consider staffing capacity requirements and re-activation, e.g.:

• identifying specific staff members forming part of the first 30% or applicable regulated percentage for your type of business,
• vs each subsequent wave as lockdown restrictions are gradually lifted.
• This will require a detail situational assessment to e.g. deal with employees currently based in other provinces or other cities.

All changes to existing Policies and Procedures, as well as any new requirements, must be communicated formally with staff [2]. Staff may also require training in new or amended operational procedures.

Consider flexible work arrangements such as:

• staff rotation,
• or continued working from home,
• and how IT can be used to your benefit to reduce the need for clients or staff to come to the office.

7. Assess the IT landscape

Consider the potential impact of changes in business operations on critical infrastructure, systems, and processes, e.g.:

• Productivity software to improve work-from-home efficiency and productivity,
• Disinfecting of keyboards, electronic equipment, access control equipment, and or contactless alternatives for time and access control systems,
• Consider increased IT risks (refer to point 9 below).

Source: Youtube Fever Screening Solution

8. Legal Review: Contracts, SLAs and Projects, ongoing Litigation and Disputes

Stay on top of existing litigation and disputes pre-dating the pandemic.
Investigate and identify any potential new contract breaches, terms not complied with, obligations not met, situations where performance was delayed, partially or completely withheld, where deliverables and deadlines were missed during the lockdown – both from the viewpoint where:

• your organization is the recipient of goods or services, as well as where
• your organization is the provider of goods or services.

Identify any instances where it was, or remains impossible to perform or fully comply, as a result of a set of circumstances beyond the reasonable control of either party.

• Obtain professional legal advice – some situations might be remedied with respectful and mutually pragmatic (re)negotiation.
• Standard contracts, terms and conditions might need some improvement going forward.

For more legal resources, please refer to [13] and also refer below under Governance and Risk.

9. Governance and Risk management

Be mindful of Directors Duties [4] in general, and specifically under Covid19 conditions (see resources here [5] and here [6]) where financial distress [7] poses a very real risk. Review your risk management plans.

• Consider any additional governance/reporting requirements [2][3].
• Consider increased IT-related risks (e.g. cybercrimes such phishing, malicious websites, and malware [9]) targeting a distributed workforce, or leaking of information [10].
• Institute strict record-keeping and improve overall risk management[11], including but not limited to OHS/PPE compliance and fever temperature screening. Accurate and complete record keeping will be crucial as the new Emergency Regulations appear to shift the onus and burden of proof onto the employer.
• Review insurance policies, business interruption, liability cover, etc.
• When in any doubt, obtain legal advice.

10. Stakeholder management

Communicate as may be required with, and monitor communication from certain stakeholders including Staff, Customers, Suppliers, Shareholders, Creditors, Landlords, Regulators, Government, Other interested parties.

Conclusion:

Successfully navigating the risk and many pitfalls of the Covid-19 crisis will require leadership, teamwork, frequent measurement, and adapting the plan and operations to changes in the environment from time to time.

If you found the article helpful or interesting, please feel free to share.

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Resources*: The following resources were consulted in the compilation of this article.

[1] https://www.gov.za/documents/disaster-management-act-regulations-29-apr-2020-0000
[2]https://neasa.co.za/covid-19-return-to-work-toolkit/
[3] http://www.gpwonline.co.za/Gazettes/Gazettes/43257_29-04_Labour.pdf
[4] https://www2.deloitte.com/content/dam/Deloitte/za/Documents/governance-risk-compliance/ZA_DutiesOfDirectors2013_16042014.pdf
[5] https://www.werksmans.com/firm-news/covid-19-duties-of-directors/
[6] https://www.financialinstitutionslegalsnapshot.com/2020/04/managing-a-company-and-covid-19-south-african-directors-and-their-duties/
[7] https://www.bowmanslaw.com/insights/restructuring/covid-19-financial-distress-insolvency-and-restructuring/
[8] https://www.ansarada.com/ COVID-19 resources
[9]https://www.riskiq.com/blog/analyst/covid19-cybercrime-update/
[10]https://www.ensafrica.com/news/detail/2651/south-africa-coronavirus-covid-19-how-to-avoi/
[11] https://www.aon.com/event-response/coronavirus.aspx (generic but valuable information)
[12] https://www.aon.com/COVIDplanningtoolkit/default (generic but valuable information)
[13]https://www.lexisnexis.co.za/news-and-insights/covid-19-resource-centre
[14]http://www.treasury.gov.za/comm_media/press/2020/Annexure%20B%20-%20Recommended%20Guidelines%20Fabric%20Face%20Masks%20RSA%20DTIC.pdf
[15] https://www.bowmanslaw.com/insights/competition/excessive-pricing-in-south-africa-in-the-age-of-covid-19-2/
[16] https://www.gov.za/speeches/minister-thulas-nxesi-directions-coronavirus-covid-19-alert-level-4-3-may-2020-0000

*Information made available in the public interest and shared in good faith. Respective sources remain fully responsible and liable for the accuracy of the information published by them.

** All artwork and photos remain the property of their respective owners.