Topics

Capacity and capacity utilisation

Capacity

Capacity is the maximum output a business can produce in a given period with the resources it has — its plant, equipment, premises and staff.
Capacity utilisation is how much of that maximum is actually being used:

$\text{capacity utilisation} = \frac{\text{actual output}}{\text{maximum possible output}} \times 100$

A factory able to make 10,000 units a month that produces 7,500 is operating at 75% capacity utilisation.

Spare capacity means part of the business's resources are paid for but not producing: an unused building, an idle machine, staff with nothing to do.
The problem is that fixed costs continue regardless. Rent, lease payments, insurance, depreciation and salaried wages are the same at 40% utilisation as at 90%, so the fixed cost carried by each unit produced is much higher.
Consequences:
- High unit costs, which force either higher prices or a smaller margin
- Staff who are under-used become bored and demotivated, and may fear redundancy
- The business looks unsuccessful to lenders and investors
Responses:
- Rationalisation — closing or selling the unused part of the business to cut fixed costs
- Finding a new use for the space or equipment — a retail outlet, a visitor experience, subletting
- Producing for another business under contract (subcontracting in)
- Increasing demand through marketing or a new market

Working at or very near 100% sounds ideal, and unit costs are at their lowest there — but it creates real problems.

Why full capacity looks good	Why full capacity is risky
Fixed costs spread over the maximum number of units, so unit costs are lowest	No room to accept a large new order, so growth opportunities are turned away
Equipment and staff are fully used, so nothing is being paid for idly	No slack for maintenance, so machines break down more often
Signals a healthy level of demand to lenders and investors	Staff work under sustained pressure, raising errors, stress and turnover
	Quality slips as the business rushes to keep up, damaging brand reputation
	Any disruption — a breakdown, an absence — immediately becomes a late delivery

Responses to being at capacity:
- Investing in more capacity — a second line, a larger site (expensive, and risky if demand falls)
- Outsourcing the overflow to another producer
- Extending hours with a second shift
- Raising prices to reduce demand to a level the business can serve profitably

The examiner is not looking for "full capacity is good" or "spare capacity is bad".
The answer is that the right level of utilisation depends on how variable demand is:
- Steady, predictable demand → operate close to capacity, because there is little risk of being caught short.
- Seasonal or unpredictable demand → keep some spare capacity, because the cost of turning away a peak order exceeds the cost of a slightly higher unit cost the rest of the year.

Capacity is the maximum output a business can produce in a given period with the resources it has — its plant, equipment, premises and staff.
Capacity utilisation is how much of that maximum is actually being used:

$\text{capacity utilisation} = \frac{\text{actual output}}{\text{maximum possible output}} \times 100$

A factory able to make 10,000 units a month that produces 7,500 is operating at 75% capacity utilisation.

Spare capacity means part of the business's resources are paid for but not producing: an unused building, an idle machine, staff with nothing to do.
The problem is that fixed costs continue regardless. Rent, lease payments, insurance, depreciation and salaried wages are the same at 40% utilisation as at 90%, so the fixed cost carried by each unit produced is much higher.
Consequences:
- High unit costs, which force either higher prices or a smaller margin
- Staff who are under-used become bored and demotivated, and may fear redundancy
- The business looks unsuccessful to lenders and investors
Responses:
- Rationalisation — closing or selling the unused part of the business to cut fixed costs
- Finding a new use for the space or equipment — a retail outlet, a visitor experience, subletting
- Producing for another business under contract (subcontracting in)
- Increasing demand through marketing or a new market

Working at or very near 100% sounds ideal, and unit costs are at their lowest there — but it creates real problems.

Why full capacity looks good	Why full capacity is risky
Fixed costs spread over the maximum number of units, so unit costs are lowest	No room to accept a large new order, so growth opportunities are turned away
Equipment and staff are fully used, so nothing is being paid for idly	No slack for maintenance, so machines break down more often
Signals a healthy level of demand to lenders and investors	Staff work under sustained pressure, raising errors, stress and turnover
	Quality slips as the business rushes to keep up, damaging brand reputation
	Any disruption — a breakdown, an absence — immediately becomes a late delivery

Responses to being at capacity:
- Investing in more capacity — a second line, a larger site (expensive, and risky if demand falls)
- Outsourcing the overflow to another producer
- Extending hours with a second shift
- Raising prices to reduce demand to a level the business can serve profitably

The examiner is not looking for "full capacity is good" or "spare capacity is bad".
The answer is that the right level of utilisation depends on how variable demand is:
- Steady, predictable demand → operate close to capacity, because there is little risk of being caught short.
- Seasonal or unpredictable demand → keep some spare capacity, because the cost of turning away a peak order exceeds the cost of a slightly higher unit cost the rest of the year.