the impact of operating under or over maximum capacity on a business

4.3 Capacity Utilisation and Outsourcing – Capacity Utilisation

Objective

To understand:

• Why measuring capacity utilisation is essential for a business,
• How it is measured (including the standard formula, units and alternative bases),
• The consequences of operating under or over maximum sustainable capacity,
• Strategic options – especially process improvement, demand‑management and outsourcing – that can raise utilisation.

1. Definition and Significance (4.3.1)

Maximum Sustainable Capacity – the highest level of output that can be maintained over the long‑term without compromising product quality, employee health or incurring excessive cost.

Capacity Utilisation Rate (CUR) – the proportion of this capacity that is actually used, expressed as a percentage.

Why it matters

• Resource efficiency: Identifies idle labour, plant and premises so that fixed costs can be spread over a larger output.
• Cost control: Direct link to average unit cost – lower CUR usually means higher per‑unit cost.
• Strategic planning: Informs decisions on new capacity, process redesign or demand‑management.
• Benchmarking: Enables comparison with industry standards or the firm’s own historical performance.

2. Measuring Capacity Utilisation (4.3.1)

Standard output‑based formula

Units: percentage (%). The abbreviation CUR is used throughout the syllabus.

Alternative measurement bases

3. Impact of Operating Under Capacity (CUR < 100 %)

4. Impact of Operating Over Capacity (CUR > 100 %)

5. Methods of Improving Capacity Utilisation (4.3.2)

Four‑step improvement cycle (analyse → plan → implement → review) – the framework expected by the syllabus for any capacity‑improvement initiative.

• Process / Lean improvement
  • Eliminate waste, adopt Just‑In‑Time (JIT) and standardised work.
  • Use Six Sigma or Kaizen to raise effective capacity.
• Schedule optimisation
  • Introduce additional or staggered shifts, flexible start times, or split‑day working.
  • Use software to balance workloads across the day/week.
• Overtime & temporary staff management
  • Apply controlled overtime only when demand exceeds a pre‑set threshold.
  • Recruit part‑time or agency workers for peak periods.
• Capacity‑focused investment
  • Upgrade machinery, introduce automation or expand premises to raise maximum sustainable capacity.
• Demand‑management techniques
  • Price discrimination – higher prices at peak, discounts off‑peak.
  • Promotions that shift demand to slower periods.
  • Advance order booking, order‑lot sizing and reservation systems.
• Benchmarking
  • Internal benchmarking – compare current CUR with the firm’s best‑performing plant or department.
  • Industry benchmarking – compare CUR with competitors or sector averages to identify improvement gaps.

6. Outsourcing as a Strategic Option (4.3.3)

Outsourcing – contracting part of a production or service process to an external supplier rather than performing it in‑house.

Decision‑making checklist for outsourcing

1. Is the activity non‑core and does it divert management attention?
2. Can an external supplier perform it at a lower total cost (including hidden costs)?
3. Does the supplier have the required capability, capacity and reliability?
4. Are quality, confidentiality and contractual controls adequately protected?

7. Strategic Choices When Near Capacity Limits

1. Invest in additional capacity – new plant, extra machinery or larger premises.
2. Outsource part of production – use external suppliers for overflow or specialised components.
3. Improve process efficiency – apply the four‑step improvement cycle, lean, automation or better scheduling.
4. Adjust product mix – prioritise higher‑margin items that consume less capacity per £ of revenue.
5. Implement demand‑management – price discrimination, promotions, advance booking or order‑lot sizing to smooth peaks.

8. Illustrative Example

Scenario: A furniture manufacturer has a maximum sustainable capacity of 10 000 chairs per month.

• Month A – Under capacity
  • Actual output = 7 500 chairs
  • CUR = (7 500 ÷ 10 000) × 100% = 75 %
  • Fixed costs = £100 000 → unit cost = £13.33 (vs £10 at full capacity)
  • Implications: higher unit cost, idle labour & machinery, but the firm can meet a sudden surge without extra investment.
• Month B – Over capacity
  • Actual output = 11 200 chairs (including overtime)
  • CUR = (11 200 ÷ 10 000) × 100% = 112 %
  • Overtime premium (1.5× normal wage) adds ≈ £5 000 to variable cost.
  • Defect rate rises by 2 % → re‑work cost ≈ £1 200.
  • Implications: short‑term revenue rise, but higher labour cost, equipment wear and a small quality penalty.
• Strategic response – The firm could:
  • Introduce a second shift (schedule optimisation) to raise sustainable capacity to 12 000 chairs, or
  • Outsource 1 200 chairs to a specialised subcontractor during peak months, or
  • Implement lean techniques to reduce set‑up time and increase effective capacity without new assets.

9. Summary

• Capacity utilisation is measured as CUR = (Actual Output ÷ Maximum Sustainable Capacity) × 100 % and can be expressed in output, labour‑hour, machine‑hour or value terms.
• Operating under capacity raises unit costs and leaves resources idle, but provides flexibility for demand spikes.
• Operating over capacity can boost short‑term revenue but incurs overtime premiums, equipment wear, quality loss and staff fatigue.
• Improvement options include the four‑step cycle, process/lean changes, schedule optimisation, capacity investment, demand‑management, benchmarking and, where appropriate, outsourcing.
• Choosing the right mix depends on the firm’s long‑term objectives, cost structure and market conditions.