Capacity utilisation is measured using the following
Maximum possible output
This means that if a company is
able to produce 100,000 units a week, but it only produced 75,000 units per
week, it would be operating at 75% efficiency.
A rugby stadium capable of holding 80,000 is at full capacity when all
the seats are filled.
Capacity (the amount a firm can
make) depends upon the amount of buildings, machinery and labour it has
available. When the firm is
making full use of all its resources, it is said to be working at full
capacity or 100% capacity utilisation.
The same logic applies to
service sector industries, though it is harder to identify a precise figure.
This is because it can take a different amount of time to serve each
customer. Demand may exceed
capacity at certain times of the day or year, this will lead to queues
forming. At other times staff
may not have anything to do. A
service business wishing to manage costs effectively will measure demand at
different times of the day and then schedule the staffing levels to match.
Many businesses (particularly
service sector) are better able to cope with fluctuating demand by employing
temporary or part-time workers. There
are more and more temporary and part-time workers in the UK now as they can
increase capacity easily and quickly. If
demand then falls temporary staff can be laid off without redundancy payments
and part-time workers can have their hours reduced, thereby reducing capacity
easily and cheaply. This
flexibility is good for business as it can help to reduce any expensive spare
capacity. This situation,
however, may not be as appealing to the workers who have far fewer rights
than their full-time predecessors and colleagues.
Fixed Costs And Capacity
Fixed costs remain the same
irrespective of the level of output. This
means that fixed costs will remain the same whether capacity is 50% or 100%.
If a football club has a large
expensive playing staff, it will have large fixed costs.
What is the effect of capacity on the fixed costs?
(fixed costs) per unit
When the stadium capacity
utilisation is at 50%, then £10 of the ticket price is needed for the
players’ wages alone. When the
stadium is full (i.e., full capacity) the fixed costs are spread over many
more tickets, reducing the fixed costs per unit to £5.
This shows the higher the
capacity utilisation, the lower fixed costs per unit will be. This enables the producer to either cuts prices to boosts
demand or enjoy higher profit margins.
means that increasing capacity utilisation is a valid method for increasing a
firm’s profitability. If
capacity utilisation is low, the fixed costs per unit may become too high
forcing the business into bankruptcy.
The ideal capacity is therefore
at or near 100%, this spreads the fixed costs as thinly as possible.
There are three concerns about operating at or near 100% capacity
If demand rises, it can only be met by competitors as you are
already working flat out.
The risk that you will never have time to service machinery,
change/improve production methods or train/retrain staff.
This may increase the chances of production breakdown.
It can lead to managers and workers being over worked and can
increase stress levels.
The production ideal,
therefore, is a capacity utilisation of around 90%.
How To Increase Capacity Utilisation
There are two approaches to
increasing capacity utilisation:
Increase demand for existing products by promotional activity,
price cutting or re-positioning in the market.
It could also be possible to launch new products.
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.
Which approach a firm chooses
to take will depend upon the cause of the low capacity utilisation.
Is it due to known temporary shortfall, such as a seasonal decline or
due to an economic recession, which may last for 18-24 months.
It can be a mistake to reduce capacity in the long run, however it may
be necessary in order to ensure short-term survival.
It is therefore important to identify whether the short fall is short
or long term.
Operating At Near Full Capacity
Operating at near full capacity
can have a number of advantages:
Its fixed costs per unit are at their lowest possible level.
The firm is assumed to be using all of its fixed assets
effectively, therefore profits should be high.
It will be perceived as a successful country both internally
and externally leading to positive effects.
Internally, employees will feel a sense of pride working for such a
successful organisation. Externally, if customers know that a firm is working at full
capacity it will assume that it is offering a good product.
Firm’s operating at or near
full capacity may wish to increase their total capacity, this can be done in
a number of ways:
Employing more workers.
Building larger buildings for manufacture or providing service.