2.4.2 Capacity Utilisation

Capacity Utilisation

• Capacity utilisation can be seen as a measure of efficiency because it shows how much a business' resources are being used. It all available resources are being use, then the business is using all of its capacity and cannot produce any more output; it is said to be at 100% capacity utilisation. It does not matter if it is a car factory with a large output or a small village cafe, the concept of capacity utilisation applies equally to both businesses.
• The formula for capacity utilisation is current output divided by maximum output times 100, and is expressed as a percentage.
• CAPACITY UTILISATION (%) = (CURRENT OUTPUT)/(MAXIMUM OUTPUT) x 100

Implications of Under-Utilisation

• Capacity utilisation is a problem for business managers and can be tricky to get right. Not enough is a problem because productivity and efficiency will fall. Strangely, 100% capacity utilisation can also be a problem as there is no room for error, attempts to stretch production to the limit can cause breakdowns and bottlenecks with also reduce productivity and efficiency.
• Under-utilisation of capacity means that some resources are not being used and production is not as high as it could be. If it it not fully using all of its resources then the unused proportion will be standing idle and creating a cost, either directly or as an opportunity cost. Unused capacity will also increase average costs, this is because the total of the fixed costs are shared over a lower level of output. As a result average fixed cost will rise and as they are a part of average total cost then this will increase as well.
• An increase in average costs indicates a loss of efficiency and will reduce profit margins if the price remains unchanged. If price increases to maintain profit margins, there may be a subsequent loss of competitive advantage and sales. Under-utilisation can lead to loss of motivation as workers may be bored, become frustrated at the lack of opportunities for extra work or fear of losing their jobs because they are producing too little.
• Profitability and worker motivation are both likely to be better if the business can find some way of improving capacity utilisation without taking the option of piling up unsold stock. Otherwise, there is likely to be increasing pressure to cut capacity.
• On the other hand, under-utilisation can be beneficial. Minor hold-ups to production are easier to cope with if they don't cause pressure and delays in a fully extended system. It gives the business flexibility; special orders from customers can be accommodated, perhaps even rush orders, creating goodwill and the possibility for future orders. Delivery times are likely to be shorter without the potential of full of over-utilisation. Machinery and plant require servicing and repairs during their working life spare capacity enables this to happen without delaying production.

Ways of improving under-utilisation

• The simplest response to under-utilisation is just to increase output, producing more to use the spare capacity that exists. However, there is not point in doing this if there is no demand for the extra production, it will just accumulate as unsold stock and may cause cash flow problems. Promotion may be a possible strategy to increase demand, as long as the other aspects of the marketing mix are in place. If the reason for under-utilisation is falling demand due to un competitive products. then promotion is unlikely to work.
• It may be possible to extend the product range with a new product or even to find a new market for the existing one(s). In a global economy, a new export market can often be possible.
• Taking the same approach further, plants can sometimes be modified to allow entry to a new market where demand is healthier. For example, some shipyards which had become uncompetitive have successfully switched to production or oil and has exploration.
• Sometimes it is possible to use the extra capacity to produce for other businesses rather than the producer trying to sell more.
• Persistent under-utilisation can be solved by reducing the resources employed and adjusting the capacity making changes to supply than demand. Assets such as machinery can be sold off or simply scraped if they have no residential value. Property and land can be sold for alternative uses. A large organisation might be able to transfer surplus labour to other work, otherwise redundancies might be necessary. Once capacity is lost in these ways, it becomes much more difficult to increase production in the future should demand increase. Businesses are reluctant to do this unless they accept that there is a long-term fall in demand for the product.

Implications of over-utilisation

• Over-utilisation arises when a business is trying to produce more than its capital equipment and systems were designed for. This too can result in an increase in average costs as bottlenecks, breakdowns and overcrowding are all likely and can all be expected to reduce efficiency.
• It may not be possible to accept extra orders or take on potentially lucrative new customers. Maintenance and servicing of machinery means halting production as everything is being kept busy. People are under pressure and the risk of mistakes and accidents increases. Such a situation can lead to increased stress levels for workers and management. As with under-utilisation this means that the business is not as efficient as it could be, average total costs are not minimised.
• Clearly, both under and over utilisation of capacity have their drawbacks. In an ideal world a business would like to operate with 100% capacity utilisation but in reality this will bring problems and be difficult to sustain. A level of around 90% is probably seen as ideal in many circumstances. This makes good use of most of the capacity but allows for unexpected orders or increases in demand. In individual situations the best balance might sometimes be found at a little more or a little less than 90%.
• The more flexible a business can be, the better it will cope with capacity utilisation. Using some part-time or temporary staff and equipment (e.g hiring extra vehicles or specialist equipment) can make it easier to adjust production and to address bottlenecks. This can keep labour productivity high and avoid having idle equipment or people with time on their hands, so keeping costs of production at a minimum.

Ways of improving over-utilisation

• Over-utilisation rarely affects all parts of a business in the same way. What tends to happen is that bottlenecks and shortages appear in some areas. It may be possible to identify and tackle those problem areas; perhaps by minor changes to capital equipment or by diverting labour from a relatively underused area of production to the