methods of improving capacity utilisation

4.3 Capacity Utilisation and Outsourcing – Capacity Utilisation

1. Significance of Capacity Utilisation (CU)

• Definition: CU is the proportion of a firm’s available productive capacity that is actually used in a given period.
• Why it matters:
  • Cost efficiency: Higher CU spreads fixed costs over more units, lowering the unit cost of production.
  • Productivity: CU is a direct indicator of how productively labour, plant and equipment are being employed.
  • Effectiveness: A firm that can meet demand with existing resources is more competitive.
  • Sustainability: Better utilisation reduces energy use, waste and the carbon footprint per unit, supporting the sustainability sub‑topic in the Cambridge 9609 syllabus.
  • Strategic positioning: Consistently high CU strengthens profitability and the firm’s market position.

2. Measuring Capacity Utilisation

The standard formula is:

$$ CU = \frac{\text{Actual Output}}{\text{Maximum Potential Output}} \times 100\% $$

Key terms

• Actual Output – volume of goods or services produced in the period under review.
• Maximum Potential Output – the theoretical highest output if **all** resources (labour, plant, materials, space, legal/health‑safety limits) were fully employed with no breakdowns or idle time.

Worked example

• Maximum potential output = 10 000 units per month
• Actual output achieved = 8 000 units

$$ CU = \frac{8\,000}{10\,000}\times100\% = 80\% $$

An 80 % utilisation means that 20 % of the plant’s capacity is idle. This figure provides a baseline for any improvement measure.

3. Impact of Operating Below or Above Capacity

Condition	Consequences
Under‑utilisation (CU < 85 %)	Higher unit costs – fixed costs spread over fewer units. Idle labour and equipment – can erode skills and morale. Opportunity cost – missed sales that could have been met with existing capacity. Higher working‑capital needs – excess inventory may be required to keep the plant running.
Over‑utilisation (CU > 100 % or sustained high overtime)	Overtime premiums and accelerated wear‑and‑tear raise variable costs. Higher defect rates and reduced product quality. Employee fatigue, absenteeism and safety risks. Bottlenecks that limit the ability to respond to further demand spikes.

4. Methods of Improving Capacity Utilisation

Before applying any method, calculate the current CU, implement the change, then recalculate to confirm the improvement. The table below summarises each method, when it is most appropriate, and its main drawback.

Method	Typical actions	When most suitable	Potential drawback
Increase output levels	Introduce overtime or a third shift. Hire temporary/seasonal staff. Run the plant 24 hours a day.	Short‑term demand spikes where capital investment is not justified.	Higher labour costs and risk of employee fatigue.
Reduce downtime	Schedule preventive maintenance (PM) instead of reactive repairs. Apply SMED (Single‑Minute Exchange of Die) to shorten set‑up times. Maintain critical spare‑part inventories.	Plants with frequent breakdowns or long change‑over times.	Planning effort and possible temporary output loss during PM.
Improve scheduling & planning	Use Advanced Planning & Scheduling (APS) software. Implement Just‑In‑Time (JIT) production. Balance workloads across workstations (line balancing).	Variable demand environments or multiple product families.	Heavy reliance on accurate forecasts; poor data can worsen CU.
Enhance workforce skills	Provide training on equipment operation and routine maintenance. Cross‑train staff to cover several stations. Introduce productivity‑linked incentive schemes.	When low productivity stems from skill gaps or high absenteeism.	Training costs and temporary line downtime.
Adopt new technology	Upgrade to more efficient machinery or automation. Introduce CNC (Computer‑Numerical‑Control) equipment. Use data‑analytics tools to locate bottlenecks.	Long‑term strategic improvement with a clear ROI.	High capital expenditure and possible need for specialised staff.
Process re‑engineering (lean)	Identify and eliminate non‑value‑adding activities. Apply lean tools: Kaizen, 5S, value‑stream mapping. Redesign workflow to minimise movement and waiting.	When the process contains excessive waste or unnecessary steps.	Cultural resistance; requires a continuous‑improvement mindset.
Flexible production arrangements	Sub‑contract or outsource during peak periods. Share facilities with other firms (capacity pooling). Use contract manufacturing for specific product lines.	Highly seasonal demand or desire to keep core capacity free for strategic products.	Loss of direct control over quality and delivery times.
Strategic capacity expansion	Invest in additional plant or equipment. Relocate to larger premises. Outsource non‑core activities to free internal capacity for higher‑margin work.	Sustained long‑term demand growth that cannot be met by internal efficiencies alone.	Large capital commitment and longer lead‑time before benefits materialise.

Improvement Checklist

1. Calculate current CU using the formula.
2. Select the most appropriate method(s) from the table above.
3. Estimate the expected change in output or reduction in downtime.
4. Re‑calculate CU after implementation.
5. Compare the new CU with the target (normally ≥ 85 %).
6. Analyse the financial impact (change in unit cost, contribution margin, working‑capital requirements).

5. Outsourcing – Using External Capacity

Outsourcing is the use of an external organisation to perform activities that could be carried out internally. It is a strategic decision that links directly to capacity utilisation, cost management and the focus on core competencies.

5.1 Strategic rationale

• Free internal capacity for core, higher‑value activities.
• Access economies of scale and specialised expertise not owned in‑house.
• Reduce capital expenditure and associated financing costs.
• Increase flexibility to respond quickly to demand fluctuations.

5.2 Advantages

• Lower variable cost per unit (pay‑as‑you‑go).
• Rapid capacity increase without long lead‑times.
• Potential quality improvements if the supplier is a specialist.
• Reduced need for investment in plant, equipment and training.

5.3 Disadvantages

• Reduced control over quality, delivery and intellectual property.
• Dependence on supplier reliability; risk of supply disruption.
• Possible negative impact on employee morale (redundancies or redeployment).
• Hidden costs – contract management, monitoring, renegotiation.

5.4 Risk mitigation

• Conduct thorough supplier selection (financial stability, reputation, certifications).
• Use detailed contracts with clear Service‑Level Agreements (SLAs) and penalties for non‑performance.
• Implement regular performance monitoring and audits.
• Maintain a backup supplier or a small in‑house capability for critical items.

5.5 Impact on stakeholders

Stakeholder	Potential impact
Employees	Redeployment or redundancy; need for retraining or transition support.
Customers	Expect consistent quality and delivery; outsourcing must not compromise service levels.
Suppliers	New partnership opportunities; risk of over‑reliance on a single third‑party.
Shareholders	Expect cost savings, improved return on assets and higher profitability.
Society / CSR	Ethical considerations about labour standards, environmental impact and community effects of third‑party producers.

5.6 Financial link

Outsourcing typically converts a fixed cost (depreciation of plant) into a variable cost (contract fee). This can improve cash flow and working‑capital ratios, but the firm must monitor the total cost of ownership, including logistics, quality‑control and contract‑management expenses.

6. Comparison: Internal Improvement vs. Outsourcing

Aspect	Internal improvement methods	Outsourcing (external capacity)
Typical cost structure	Lower variable cost; may require upfront capital for training, equipment or software.	Higher variable cost per unit; avoids large capital expenditure.
Control over quality & timing	High – managed directly by the firm.	Variable – depends on contract terms and supplier performance.
Flexibility to scale	Limited by existing plant and workforce; scaling often needs investment.	High – capacity can be added or reduced quickly through contract adjustments.
Strategic fit	Best for core activities where competence and brand reputation are critical.	Best for non‑core or highly seasonal activities.
Typical examples	Shift work, preventive maintenance, lean re‑engineering, automation.	Contract manufacturing, third‑party logistics, joint ventures, capacity‑pooling agreements.

7. Decision‑Making Flowchart (Suggested Diagram)

8. Syllabus Alignment Review (Cambridge 9609 – Topic 4.3)

Syllabus Requirement	Current coverage	Gap / Weakness	Suggested improvement
4.3.1 Significance & measurement of capacity utilisation	Definition, formula, worked example, target ≥ 85 %.	No explicit link to productivity, efficiency and sustainability; “maximum potential output” described only as “full efficiency”.	Added paragraph linking CU to productivity, efficiency and sustainability. Clarified that maximum potential output includes all resource constraints (labour, plant, materials, space, legal/health‑safety limits).
4.3.2 Methods of improving capacity utilisation	Eight detailed methods with when‑to‑use and drawbacks.	Methods were listed but not explicitly tied to the syllabus sub‑topics (e.g., lean, technology, outsourcing).	Grouped methods under clear headings, added a summary table and linked each method to relevant syllabus concepts (e.g., “Process re‑engineering” → lean, “Adopt new technology” → productivity).
4.3.3 Outsourcing and external capacity	Rationale, advantages, disadvantages, risk mitigation, stakeholder impact, financial link.	Missing explicit comparison with internal methods and a decision‑making tool.	Inserted a side‑by‑side comparison table and a flowchart placeholder to aid exam‑style decision making.