Capacity Utilisation Capacity utilisation measures the output of a firm as a percentage of its maximum output: 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 Actual output Maximum output X 100

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 Capacity utilisation Termly fixed costs £3m Fixed cost per pupil

Capacity utilisation examples Car factory: monthly capacity 50,000 Output 25,000 30,000 40,000 Capacity utilisation 50% 60% 80% Monthly fixed costs £400m Fixed costs per car Variable costs per car £10,000 Price per car £20,000 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