4.3 Capacity Utilisation and Outsourcing – Measurement of Capacity Utilisation
Objective
Calculate capacity utilisation accurately.
Interpret what the percentage tells a business about costs, quality and flexibility.
Use the analysis to decide whether to improve internal capacity or to outsource.
1. What is Capacity Utilisation?
Capacity utilisation measures the proportion of a firm’s available production capacity that is actually used in a given period. It is a *performance measure* – the higher the percentage, the more of the firm’s fixed resources are being put to work.
2. Why the Syllabus Distinguishes “Measurement” from “Impact”
The Cambridge 9609 syllabus first asks students to measure utilisation (i.e., calculate a percentage). Once the figure is known, students must analyse the impact of operating under‑ or over‑capacity on the business (cost structure, quality, competitive position, and the decision to outsource). The two steps are linked: the calculation provides the evidence on which the impact discussion is based.
3. Capacity Terminology (Cambridge – what you need for the exam)
Term
Definition (exam‑relevant)
Effective capacity
The realistic maximum output that can be achieved under normal operating conditions, allowing for scheduled maintenance, holidays and a reasonable amount of downtime. This is the capacity figure that the exam expects you to use in the utilisation formula.
Note: Design capacity (the theoretical 24 h/365 d maximum) and practical capacity (capacity with an intentional cushion) are useful concepts but are not required for the AS exam. Mention them only if you need extra depth, and label them as “optional”.
Reasons for keeping a cushion include seasonal demand peaks, planned maintenance, flexibility for new products, and risk mitigation against breakdowns or quality problems.
7. Numerical Example (Effective Capacity)
A garment factory has an effective capacity of 12 000 shirts per month. In August it produced 9 600 shirts.
Parameter
Value
Effective Capacity (monthly)
12 000 shirts
Actual Output (August)
9 600 shirts
Capacity Utilisation
\(\frac{9 600}{12 000}\times100 = 80\%\)
Capacity Cushion
100 % – 80 % = 20 %
The factory is using 80 % of its effective capacity, leaving a 20 % cushion for unexpected orders or maintenance.
8. Impact of Operating Under or Over Capacity (Syllabus Requirement)
Utilisation Band
Typical Impact on the Business
Below 60 %
Fixed cost per unit is high → lower profitability.
Idle labour/equipment can lead to skill loss and morale problems.
Opportunity cost – unused capacity could be rented out or outsourced.
Break‑even point rises because the contribution per unit is reduced.
60 % – 80 %
Often regarded as the “sweet spot”.
Balances economies of scale with enough slack to absorb demand spikes.
Unit variable costs are moderate; quality control is easier.
Break‑even point is reasonable and the firm retains flexibility.
Above 80 %
Over‑utilisation may require overtime → higher variable cost per unit.
Increased risk of bottlenecks, lower quality and higher defect rates.
Lost sales if demand exceeds capacity (opportunity cost).
Break‑even point falls, but the firm may become vulnerable to capacity constraints.
9. Linking Utilisation to Outsourcing Decisions
Calculate the marginal (incremental) cost of producing one more unit internally (including overtime premiums, extra material, etc.).
Obtain the price quoted by an external supplier for the same unit.
If Supplier price < Internal marginal cost → outsource (convert a fixed cost into a variable cost). If Supplier price > Internal marginal cost → keep production in‑house and look for internal efficiency gains.
Consider strategic factors – core competence, quality control, long‑term capacity strategy, and risk of dependency.
Numeric Illustration
Suppose the garment factory wants to produce an extra 2 000 shirts during a peak month.
Internal marginal cost (including overtime) = £8 per shirt.
External supplier quote = £6 per shirt.
Because £6 < £8, the firm should outsource the extra 2 000 shirts. The fixed cost of the plant remains unchanged, but the variable cost of the additional output is reduced.
10. Impact of Outsourcing on a Business (Syllabus Requirement)
Cost structure – Fixed costs stay in‑house; variable cost is transferred to the supplier.
Quality control – May improve (specialist supplier) or deteriorate (loss of direct oversight).
Strategic control – Outsourcing can free resources for core activities but creates dependency on the supplier.
Potential risks – loss of core competence, intellectual‑property exposure, reduced flexibility, and possible supply‑chain disruptions.
11. Methods for Improving Capacity Utilisation (Syllabus Requirement)
Process optimisation (Lean, Six Sigma) – reduce set‑up times, eliminate waste.
Preventive maintenance schedules – shift breakdowns from random to planned.
Technology upgrades – faster machinery or automation to raise effective capacity.
Capacity re‑allocation – move under‑used resources to higher‑demand product lines.
Outsourcing – use external suppliers for non‑core or overflow activities when internal marginal cost exceeds the supplier’s price.
Decision‑Tree (Suggested Schematic)
Use the following flow‑chart as a quick revision tool:
Is utilisation < 60 %?
→ Look first at demand forecasting and possible outsourcing of idle capacity.
Is utilisation between 60 % and 80 %?
→ Consider minor process tweaks or shift adjustments to raise utilisation.
Is utilisation > 80 %?
→ Check for bottlenecks, overtime costs, and quality issues. If costs rise sharply, evaluate outsourcing the overflow.
12. Cambridge‑Style Case‑Study Snippets
Under‑utilisation – Alpha Electronics – Plant operates at 45 % utilisation. Fixed overheads per unit are twice the industry average, giving a 12 % lower profit margin. Management is analysing whether to outsource the assembly line to turn fixed costs into a variable charge.
Over‑utilisation – Beta Textiles – Utilisation has risen to 92 % during the festive season. Overtime has increased labour cost by 18 % and defect rates by 5 %. The firm is weighing the option of outsourcing the finishing stage to maintain quality while keeping core weaving in‑house.
13. Capacity Utilisation and CVP (Cost‑Volume‑Profit) Analysis
Higher utilisation reduces the fixed cost allocated to each unit, lowering the break‑even point and increasing contribution margin. Conversely, low utilisation inflates unit fixed cost, raising the break‑even point. When evaluating outsourcing, compare the contribution margin after outsourcing (fixed cost unchanged, variable cost reduced) with the current margin.
14. Summary Checklist
Identify the appropriate capacity measure (effective capacity – note any optional design/practical references).
Record actual output for the chosen period.
Apply the capacity utilisation formula.
Calculate the capacity cushion, if required.
Interpret the percentage using the impact table (costs, quality, opportunity cost, competitive position).
Outsource – using the marginal‑cost vs. supplier‑price test and the strategic considerations.
Suggested diagram: A 12‑month line graph showing a flat “Effective Capacity” line at 12 000 units and a plotted “Actual Output” line. Colour‑code months where utilisation falls below 60 % (red) and above 80 % (orange). Add call‑out boxes indicating “Consider outsourcing” or “Apply process optimisation” at the relevant points.
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