Capacity Utilisation

Full Capacity and Spare Capacity

Capacity: the most a firm can produce in a given period with its existing premises, machinery and staff.

Full capacity: producing at that maximum, with no resources standing idle.

Spare capacity: the gap between what a firm produces and the most it could produce. The firm could raise output by this much without new premises or machinery.

A restaurant with 50 seats is at full capacity when every seat is taken. On a quiet Monday with 20 diners, it has spare capacity of 30 seats.

Calculating Capacity Utilisation

Capacity utilisation (CU): the firm's current output as a percentage of its maximum possible output: \[ \text{CU } (\%) = \frac{\text{Current output}}{\text{Maximum output}} \times 100 \]

A hotel with 80 rooms that fills 60 a night on average has capacity utilisation of 60 ÷ 80 × 100 = 75%. The other 25%, or 20 rooms, is spare capacity.

Implications of Under- and Over-Utilisation

Capacity utilisation matters because of fixed costs. Rent, machinery and salaried staff cost the same whether the firm is busy or quiet, so the fuller it is, the less fixed cost each unit has to carry.

Under-Utilisation

When a firm has a lot of spare capacity:

• Unit costs: low output → fixed costs are spread over fewer units → higher average cost → the firm must raise prices or accept lower margins, and becomes less competitive.
• Staff: quiet shifts and idle machines → workers worry about their jobs → lower motivation and productivity.

Some spare capacity is useful. The firm can take a large order at short notice, and has time to maintain machines and train staff.

Over-Utilisation

Running at or near full capacity gives the lowest fixed cost per unit, but brings its own problems:

• Machinery: no time for maintenance → more breakdowns → lost output and repair bills.
• Staff: long hours and overtime → tiredness, stress and mistakes → lower quality, and higher wage costs from overtime pay.
• Customers: the firm has to turn down extra orders → customers go to rivals → lost sales that may not come back.

So most firms aim for a high rate of utilisation that stops short of 100%.

How much the rate matters depends on:

• How long it lasts: a seaside hotel expects to be quiet in winter and plans for it. Low utilisation all year round means the firm has more capacity than it needs.
• The share of fixed costs: airlines, hotels and cinemas have high fixed costs, so each empty seat or room pushes average cost up a lot. A firm whose costs are mostly variable is hit far less.

Ways of Improving Capacity Utilisation

A firm with too much spare capacity can either raise output to fill it, or cut capacity to match its output.

To raise output:

• Increase demand: marketing, new markets or lower prices at quiet times → more sales → higher utilisation. Cinemas and gyms charge less off-peak for this reason.
• Make something else: use idle machines for a new product, or take on work for other firms as a subcontractor. A bakery might bake bread overnight for local cafés.

Rationalisation: cutting capacity to match demand, for example by closing a site, selling machinery, cutting shifts or making staff redundant.

Rationalisation → fewer premises, machines and staff → lower fixed costs → higher utilisation and lower average cost at the same output.

Each route has a cost:

• Price cuts: fill capacity but lower revenue per unit, and only raise revenue if demand is price elastic (unit 2.2.1).
• Rationalisation: brings redundancy payments and lower morale among the staff who stay. If demand recovers, the firm may not be able to meet it.

A firm that is over-utilised does the opposite. It adds capacity by buying machinery or running an extra shift, or outsources work to other firms. Adding capacity only makes sense if the extra demand is expected to last.