Capacity utilisation and outsourcing

Business AS · Operations management. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.

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The idea

Capacity is the most a business can produce in a period with its present resources. Capacity utilisation is how much of that maximum is being used, as a percentage. High utilisation spreads fixed costs over more units, so the fixed cost per unit falls.

Very low utilisation means idle resources and high unit costs. Working at or above full capacity brings other problems: no time for maintenance, stressed staff, overtime pay, falling quality and no room for new orders. Many firms aim for a little below 100%.

Outsourcing means paying another business to carry out an activity that could be done in-house. It can save cost and give access to specialists, but the firm loses some control.

Rules to remember

Capacity utilisation (%) = current output ÷ maximum possible output × 100.
Current output = maximum output × utilisation %. Maximum output = current output ÷ utilisation %.
Fixed cost per unit = total fixed costs ÷ output. It falls as utilisation rises.
To raise utilisation: increase sales (promotion, lower prices, new markets), take on work for other firms, or cut capacity (sell or rent out assets, close a site).
Spare (excess) capacity = 100% − capacity utilisation %.
Outsourcing benefits: lower costs, specialist skills, fixed costs become variable, the firm can focus on its core activities, extra capacity when demand is high.
Outsourcing drawbacks: less control over quality and delivery, dependence on the supplier, risk to reputation and to confidential information, possible job losses.

Common mistake

The percentage must be worked out on the maximum output, not the current output. If capacity itself rises and output stays the same, capacity utilisation falls.

Worked example

A cinema has 400 seats and runs 5 shows a day. On one day it sells 1,300 tickets. What is its capacity utilisation and its spare capacity?

Maximum capacity = 400 × 5 = 2,000 tickets a day.
Capacity utilisation = 1,300 ÷ 2,000 × 100 = 65%.
Spare capacity = 100% − 65% = 35%.

Answer: Capacity utilisation is 65%, so 35% of capacity is unused.

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