Capacity Utilisation
• Capacity utilisation measures the output of a firm
as a percentage of its maximum output:
Actual output
Maximum output
X 100
• For example, a school might have the capacity for
2,000 students, but have 1,700 on its roll, ie 85%
• What determines capacity?
• Quantity and quality of factors of production,
particularly labour and capital (buildings and machinery)
• Full capacity is when all buildings, machinery and staff
are fully used
Importance of capacity utilisation?
• Should a firm have a high or low utilisation:
• Benefits of high utilisation?
• Benefits of low capacity utilisation
Benefits of high utilisation
• High utilisation means fixed
costs are spread over
greater output and since
fixed costs do not change as
output changes, fixed costs
per unit are lower with
higher utilisation
• This means a firm can make
higher profits per unit, or
lower price to gain an
increase in demand
• Particularly important when
fixed costs are high such as?
School: capacity 2,000 students
Students
2,000
1,500
1,000
£3m
£3m
£3m
Capacity
utilisation
Termly
fixed costs
Fixed cost
per pupil
Capacity utilisation examples
Car factory: monthly capacity 50,000
Output
25,000
30,000
40,000
50%
60%
80%
£400m
£400m
£400m
Variable costs
per car
£10,000
£10,000
£10,000
Price per car
£20,000
£20,000
£20,000
Capacity
utilisation
Monthly fixed
costs
Fixed costs
per car
Monthly
profit/loss
• Fixed costs are particularly
high in capital-intensive
industries like cars, which
means high capacity
utilisation is very important
• The key benefit of high
utilisation is the spreading of
fixed costs over a greater
output, which means lower
fixed costs per unit
• This means higher profits per
unit sold, which means higher
total profits
• Alternatively, this enables a
firm to lower its price and to
see an increase in demand
Problems with over-utilisation
• If a firm is already producing as much as it can (and
it is possible to produce more than 100% for a
while), then:
• If demand increases, or it receives a large order, it will
not be able to fulfil this demand. Could have made
more revenues and profits
• May have disgruntled customers if it cannot meet their
demand
• Machines need maintenance, so there is a risk of a
breakdown if a machine is used continuously without
shutting it down for regular maintenance
• Staff need training, and if they have no spare time they
will not be able to undertake training
Increasing capacity utilisation
If a firm is operating at well below capacity it needs to
address this since costs per unit will be too high. Two
ways:
• Increase demand
• Marketing mix
• Reduce capacity
• But take care that the low utilisation is not temporary – big
mistake to cut capacity and then later on have to increase
again
Assessing low capacity utilisation
Key point is to understand why
• Positive reason
• Recent expansion in capacity to meet future demand?
• Demand fallen recently and temporarily (eg recession)?
• In these cases there is no real problem
• Negative reasons
• Fall in competitiveness?
• New competitor
• Change in trend/fashion
• In these cases there is an issue a firm needs to address
either by acting to increase demand or by reducing
capacity