Capacity Utilisation 2.4.2
Maximum capacity - the maximum amount of output achievable if all resources are fully utilised.
Capacity Utilisation - measures what proportion or percentage of the theoretical maximum possible outcome is actually produced.
Under - utilization of capacity - means that some resources are not being used and production is not as high as it could be
Over - Utilisation - means that the business is trying to produce more than its capital equipment was design for
Unit costs - TOTAL COSTS (FC + VC) / CURRENT OUTPUT
Within an individual business, capacity utilisation shows how much of the company's resources are actually in use. If all available resources, all labour, machinery and space are in use at any one time, the business cannot produce any more output and is said to be at 100% capacity utilisation.
In the long run capacity CAN BE INCREASED by acquiring more resources e.g. bigger premises, more machinery, introducing a 3rd shift
In the long run capacity CAN BE REDUCED by downsizing resources e.g. laying off worker, smaller premises, less machinery
But... having some under-utlilised capacity can be a good thing. It gives the business a degree of flexibility.
Capacity Utilisation - measures what proportion or percentage of the theoretical maximum possible outcome is actually produced.
Under - utilization of capacity - means that some resources are not being used and production is not as high as it could be
Over - Utilisation - means that the business is trying to produce more than its capital equipment was design for
Unit costs - TOTAL COSTS (FC + VC) / CURRENT OUTPUT
Within an individual business, capacity utilisation shows how much of the company's resources are actually in use. If all available resources, all labour, machinery and space are in use at any one time, the business cannot produce any more output and is said to be at 100% capacity utilisation.
In the long run capacity CAN BE INCREASED by acquiring more resources e.g. bigger premises, more machinery, introducing a 3rd shift
In the long run capacity CAN BE REDUCED by downsizing resources e.g. laying off worker, smaller premises, less machinery
A BUSINESS WILL AIM TO MATCH CAPACITY TO DEMAND
Capacity Utilisation % = Current Output / Maximum possible output x 100
For example:
The Eden Hotel has 320 hotel rooms of which only 250 are occupied
Capacity utilisation = 250/350 x 100 = 78%
IMPLICATIONS OF OVER AND UNDER UTILISATION
Under-utilisation is inefficient because the business is not getting the full use or maximum potential output from its resources. Unit costs are increased because the total fixed costs is spread over a lower level of output and therefore profit margins are squeezed. Spare capacity represents a waste of resources.
If some of your production capacity is idle, your investment in the facilities and equipment is not generating any income and reducing your potential profit. Since additional production volume does not increase fixed costs, higher capacity utilization may result in lower per-unit product costs as the costs are spread over a higher level of output and higher potential profits. For example, if your facilities have a capacity of 1,000 units per month and cost $10,000 per month to operate, producing 500 units with a variable cost of $20 costs 500 x $20 plus $10,000 for a total of $20,000 (total costs), or a unit cost of $40 ($20,000/500 units) (Total costs /Actual output) . If you produce 800 units, your costs are $20 x 800 plus $10,000 for a total of $26,000, or $32.50 per unit. If you can sell 800 units at a reduced price of $35, your overall profit increases. This can also result in high labour turnover and other associated costs which may be down to workers feeling insecure about their jobs when there is spare capacity.
If some of your production capacity is idle, your investment in the facilities and equipment is not generating any income and reducing your potential profit. Since additional production volume does not increase fixed costs, higher capacity utilization may result in lower per-unit product costs as the costs are spread over a higher level of output and higher potential profits. For example, if your facilities have a capacity of 1,000 units per month and cost $10,000 per month to operate, producing 500 units with a variable cost of $20 costs 500 x $20 plus $10,000 for a total of $20,000 (total costs), or a unit cost of $40 ($20,000/500 units) (Total costs /Actual output) . If you produce 800 units, your costs are $20 x 800 plus $10,000 for a total of $26,000, or $32.50 per unit. If you can sell 800 units at a reduced price of $35, your overall profit increases. This can also result in high labour turnover and other associated costs which may be down to workers feeling insecure about their jobs when there is spare capacity.
But... having some under-utlilised capacity can be a good thing. It gives the business a degree of flexibility.
- This can be especially useful if last minute orders arrive as new customers will not be kept waiting.
- Machinery sometimes breaks down; if there is a spare machine, production can continue while it is repaired. The same applies to the maintenance and serving of equipment.
Over-utilisation - When capacity utilization passes its maximum due to demand that exceeds
your ability to supply the products, your costs rise and product quality
decreases. To meet excess demand, you have to schedule overtime that
results in higher costs and stressed workers who make more mistakes.
There is less time for equipment maintenance, and employees cut corners
to maintain high levels of production which hurts quality severely. Taking
on potentially profit making new orders is not possible when the
business' capacity is being over-utilised as these new customers may not
be prepared to wait because the business' production equipment can't
cope with this new level of demand or a product that does not have the
expected levels of quality. Staff absence can slow down production,
especially if the business is labour intensive and not capital
intensive. You have to avoid
over-utilization of capacity by acting to reduce demand with longer
delivery times and higher prices.
Importance of getting Capacity right
- Ability to match supply to demand
- Inverse relationship between capacity utilisation and unit costs (e.g. CU goes up, UC goes down)
- Image / public perception (for example, over capacity utilisation can lead to threatened quality and affects brand image)
- Workforce motivation (High CU means overtime and workers being stressed out because demand is too high, or low CU means staff are just waiting around for orders)
If capacity is UNDER-UTILISED ...
1) INCREASE DEMAND
- Improving marketing so as to increase sales
- Diversify into new markets
- Adding a new product line to the range
- Taking on production for other businesses that have over-utilised capacity or want to offer own-brand lines that are very similar to their existing product
3) LEASE OFF SPARE CAPACITY (e.g. machinery)
If capacity is OVER-UTILISED ... (there are ways that a business can i crease output even if they are not working at 100%)
1) Temporarily need to increase production, the business can...
1) Temporarily need to increase production, the business can...
- Staff could work more shifts, come in at the weekends or during holidays (However, this depends on staff motivation and commitment to the company, they don't want to feel like they're slaves to the business, they will want something more in reward).
- Some production could be sub-contracted out.
- Temporary or part-time staff could be taken on
- Invest in more capacity, extend the premises and/or buy more machinery
- Recruit more full time staff
- Sub-contract or outsource some production
- Work on improving productivity e.g. re-organisation of the organisational structure, staff motivation, for example job empowerment.
- To lower the capacity by either reducing the factors of production employed or to move to smaller premises. The danger with moving to a smaller building is that if demand picks up in the future, it will be very difficult to increase supply in response to it. This process is known as rationalising.
- Reduce demand e.g. through longer delivery times and higher prices (but this comes at the cost of losing customers)
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