What do we mean by capacity?

• The capacity of a business is a measure of how much output it can achieve in a given period

Capacity is a dynamic concept:

• Capacity can change:

  • E.g. when a machine is undergoing maintenance, capacity is reduced

  • Capacity is linked to labour: e.g. by working more production shifts, capacity can be increased

• Capacity needs to take account of seasonal or unexpected changes in demand

• E.g. Chocolate factories need the capacity to make Easter Eggs in November and December before shipping them to shops after Christmas

• E.g. Ice-cream factories in the UK needed to increase capacity during a heat wave quickly

Why capacity utilisation matters:

• It is a useful measure of productive efficiency since it measures whether there are idle (unused) resources in the business

• Average production costs tend to fall as output rises- so higher utilisation can reduce costs, making a business more competitive

• Businesses usually aim to produce as close to full capacity (100% utilisation) as possible to minimise unit costs

• A high level of capacity utilisation is required if a business has a high break-even output due to significant fixed costs of production

The costs of capacity:

• Since capacity is all about the output a business can achieve, it is easy to see what costs are involved in making that capacity available

  • Equipment: e.g production line

  • Facilities: e.g building rent, insurance

  • Labour: Wages and salaries of employees involved in production or delivering a service

Why most businesses operate below capacity (utilisation <100%):

• Lower than expected market demand: A change in customer tastes

• A loss of market share: Competitors gain customers

• Seasonal variations in demand: Weather changes lead to lower demand

• Recent increase in capacity: A new production line has been added

• Maintenance and repair programmes: Capacity is temporarily unavailable

Evaluation: Dangers of operating at low capacity utilisation:

• Higher unity costs- impact on competitiveness

• Less likely to reach breakeven output

• Capital tied up in under-utilised assets

Evaluation: Problems working at high capacity:

• Negative effect on quality (possibly):

  • Production is rushed

  • Less time for quality control

• Employees suffer:

  • Added workloads and stress

  • De-motivating if sustained for too

• Loss of sales:

  • Less able to meet sudden or unexpected increases in demand

  • Production equipment may require repair