Capacity Utilization

Introducing the PAGE 376

topic
Capacity utilization

   “The proportion of maximum output capacity currently being achieved”

 Determines operational efficiency of a business

 i.e. hotel → total capacity = total number of rooms available

factory → total level of output from all existing resources
Impact on fixed costs

 When utilization is high, average fixed costs will be spread out

over a large number of units – unit fixed costs will be relatively
low

 Table 25.1
Operating at full capacity

Benefits Drawbacks
 Unit fixed costs at their lowest,  Staff under pressure, managers can’t
allows to lift profits slack off
 Successful business  Regular customers might be turned
 Job security and sense of pride away
 Machine maintenance might not be
possible
Activity 25.1 QUESTION 2
Excess capacity

“Exists when the current levels of demand are less than the full
capacity output of a business”

 aka spare capacity

2 questions to consider when attempting to reduce this

1) Is it a short term / seasonal problem?
i. Maintain high output levels, add to stocks | could be expensive
ii. Adopt flexible production system, other good can be made | needs staff, machines, other resources
iii. Offer only flexible employment | negative impact on staff morale and motivation

2) Is it a long term problem?

i. Cut production capacity (aka rationalization) | unexpected turn in demand will leave with little
capacity and disappointed customers
Activity 25.2
Working at full capacity

“When a business produces at maximum output”

 Increase scale of operation?

 Keep existing capacity but outsource/subcontract?
 Can quality be obtained from subcontractors?
 Keep working at full capacity and not expand?
Capacity shortage

“When the demand for a business’s products exceeds production capacity”

 Important to analyze the cause of excess demand and the time period it is
likely to last
 Options to meet demand
 Use subcontractors
 Capital investment in production facilities
Outsourcing

“Using another business to undertake a part of the production rather than doing it
within the business using the firm’s own employees”

Business-process outsourcing (BPO)

A form of outsourcing that uses a third party to take responsibility for certain
business functions i.e. HR and finance
Outsourcing done for various reasons, not just shortage of capacity:
 Reduction and control of operating costs
 Increased flexibility
 Improved company focus
 Access to quality service or resources
 Freed-up internal resources
Drawbacks of outsourcing:
 Loss of jobs within business
 Quality issues
 Customer resistance
 Security
Evaluation of outsourcing

 Is not without risks

 Should conduct substantial cost-benefit analysis
 What is a truly core activity that must be kept in the business? What can we outsource?

TOP TIP
You will be asked to give your advice on outsourcing. The more important an activity is, the less
likely it is that outsourcing will be appropriate.