- The capacity of an organisation is the maximum output that it can produce in a given period without buying any more fixed assets - machinery, factory space, etc.
- Capacity depends on the number of employees and how skilled they are.
- Capacity depends on the kind of production process the business uses.
- Capacity depends on technology - what machinery and computer systems a business has and the state it's in.
- The amount of investment in the business is also a factor.
- Number of employees
- Production process
- Technology - machines and computer systems
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- Capacity Utilisation is how much capacity is being used.
- Capacity Utilisation (%) = Output / Capacity x 100
- E.g. a hotel with half its rooms booked out has a capacity utilisation of 50%.
- E.g. a clothing factory with an output of 70,000 shirts per month and a maximum capacity of 100,000 shirts is running at 70% capacity utilisation.
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- Low capacity utilisation is called under-utilisation.
- It's inefficient because it means a business is not getting as much use as it could out of machines and facilities that have been paid for, which causes unit costs to rise.
- Unit costs = Total costs / Output
- E.g. a chocolate factory's total costs are £7,200 a month. In June, output was 18,000 chocolate bars, giving a unit cost of £0.40. In July, absenteeism caused output to fall to 16,000 bars, and the unit cost rose to £0.45.
- Under-utilisation increases costs because fixed costs are spread over less output, so unit costs increase.
- Higher capacity utilisation creates economies of scale, which means a decrease in variable costs.
- Operating under capacity in the long term can cause firms to make big losses and force them to rationalise.
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Causes of capacity under-utilisation
- Lack of demand for a good or service.
- Seasonal variation in demand.
- Overall increase in capacity. Potential output increases but actual output stays the same, so capacity utilisation is lower. This can be caused by over-investment in new technology/capital equipment which can make production more efficient, but reduce capacity utilisation if output does not increase because of a lack of demand.
- Inefficiency caused by poor maintenance, a poorly-motivated workforce, poor quality control, or poor stock control methods.
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Disadvantages of working below full capacity
- Higher unit costs as fixed costs are spread over fewer units of output. This can reduce a business's profits.
- A greater risk of failing to supply customers. Operating below capacity may mean that a business can't supply customers, which may deter them to other businesses.
- Can demotivate workers, if they are not fully used they may feel lower job security and may be bored due to a lack of activity.
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Advantages of working below full capacity
- Can allow firms to cope with unexpected increases in demand.
- Less stress and tiredness for the workforce, possibly meaning reduced absenteeism and risk of accidents.
- Easier to maintain machinery, therefore less risk of breakdowns.
- Can provide a better service to consumers individually due to a greater working time.
- Reduced cash outflows as running costs are lower.
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Capacity utilisation can be increased by reducing
- If a business is operating under capacity and they think that demand isn't going to go up in the future, they need to reduce their capacity. This is called rationalisation (or downsizing). It's popular with large firms who want to stay competitive by cutting their production costs.
- Businesses can reduce capacity in the short term by stopping overtime or reducing the length of the working week, allocating staff to other work in the business, and by not renewing temporary contracts.
- Businesses can reduce capacity in the long term by not replacing staff as they retire (natural wastage), making staff redundant, and by selling off factories or equipment.
- An area of work with low capacity utilisation can be subcontracted out to a specialist firm.
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- Over capacity production means firms need more staff working more often.
- If a firm is operating near to full capacity and has a sudden increase in demand, there are methods it can use to allow to operate at over 100% capacity for a short period of time:
- Businesses can use their facilities for more of the working week. They can have staff working in shifts or working overtime on weekends and bank holidays. They can also employ temporary or part-time staff.
- Businesses can also increase their capacity utilisation by increasing productivity. They can reorganise production by reallocating staff to the busiest areas of the company. In the long term, they might try to improve productivity by increasing staff motivation.
- It's also possible for businesses to sub-contract work to other businesses in busy periods. Subcontracting is when a business pays another business to make a product on its behalf. The advantage of subcontracting excess work is that it allows firms to respond to unexpected increases in demand without having the costs of extra staff and facilities all year round.
- If the increased demand is expected to last a long time, firms might consider recruiting new staff. Permanent staff are cheaper than temporary workers in the long run.
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Changing capacity utilisation to meet predicted de
- Demand changes over time, so firms must think about demand in the future as well as the current demand.
- The key to long-term success is planning capacity changes to match long-term changes in demand. Market research helps predict future demand, but it's not 100% certain. There's always an element of risk.
- Firms should be flexible and temporarily increase capacity utilisation if an increase in demand isn't expected to continue in the long term - e.g. with seasonal products like Christmas crackers, products heading towards decline in their life cycle, and one-off special orders.
- Long-term solutions end up giving lower unit costs - as long as predictions of demand turn out to be true.
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