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Capacity is the capability of a worker, machine, work center, plan or organization to produce output per period of time. It is the rate of doing work, not of quantity of work done.

A firms plant productive capacity is the total level of output or production that it could produce in a given time period. Plant Capacity utilization is the percentage of the firms total production capacity that is actually being used. Or The term capacity, or plant capacity, is used to define the maximum rate of output that a plant is able to produce under a given set of assumed operating conditions. It is closely related to production rate. The assumed operating conditions refer to the number of shifts per day, number of days in the week that the plant operates, employment levels, whether overtime is included or not, and so on. Whether based on sales forecasts or specific customer's orders, production plans must be related to the actual productive capacity of the plant and to technical requirements of sequence and timing. The former may be accomplished through analysis of capacity, the latter through preliminary scheduling and knowledge of process limitations. Although the objectives are the same, production planning problems and procedures vary considerably from industry to industry and from one type of plant to another.

Planning problems emphasize inventory planning and transportation economics to a much greater degree than factors inherent in the production process itself. In a custom machine shop, on the other hand, machine capacity, alternative routing, and process balance occupies the planner's attention. Between the extremes lies a whole range of industrial situations that mix these elements in varying proportions. There are three types of capacity are often referred to:
Potential Capacity The capacity that can be made available to influence the planning of senior

management (e.g. in helping them to make decisions about overall business growth, investment etc). This is essentially a long-term decision that does not influence day-to-day production management

Immediate Capacity The amount of production capacity that can be made available in the short-term. This is the maximum potential capacity - assuming that it is used productively

Effective Capacity

An important concept. Not all productive capacity is actually used or usable. It is important for production managers to understand what capacity is actually achievable.


Capacity of a system or resource is the need to produce a desired output in a given time period Determining the capacity to achieve the priority plans as well as providing, monitoring and controlling that capacity so the priority plan can be met. the function of establishing, measuring, monitoring, and adjusting limits or levels of capacity in order to execute all manufacturing schedules


Plant Capacity utilization (%) = Actual output per month (or per annum) x 100% ___________________________________________________ Maximum possible output per month (or per annum) For example, if a firm could produce 1200 units per month, but is actually producing 600 per month, its capacity utilization is as follows: Capacity utilization % = 600 units per month x 100% 1200 units per month = 50%

If a company is able to produce 100,000 units a week, but it only produced 75,000 units per week, it would be operating at 75% efficiency. A rugby stadium capable of holding 80,000 is at full capacity when all the seats are filled.

Capacity (the amount a firm can make) depends upon the amount of buildings, machinery and labor it has available. When the firm is making full use of all its resources, it is said to be working at full capacity or 100% capacity utilization.

The same logic applies to service sector industries, though it is harder to identify a precise figure. This is because it can take a different amount of time to serve each customer. Demand may exceed capacity at certain times of the day or year, this will lead to queues forming. At other times staff may not have anything to do. A service business wishing to manage costs effectively will measure demand at different times of the day and then schedule the staffing levels to match.

Many businesses (particularly service sector) are better able to cope with fluctuating demand by employing temporary or part-time workers. There are more and more temporary and parttime workers in the UK now as they can increase capacity easily and quickly. If demand then falls temporary staff can be laid off without redundancy payments and part-time workers can have their hours reduced, thereby reducing capacity easily and cheaply. This flexibility is good for business as it can help to reduce any expensive spare capacity. This situation, however, may not be as appealing to the workers who have far fewer rights than their full-time predecessors and colleagues.

Fixed Costs and Capacity

Fixed costs remain the same irrespective of the level of output. This means that fixed costs will remain the same whether capacity is 50% or 100%. If a football club has a large expensive playing staff, it will have large fixed costs. What is the effect of capacity on the fixed costs?

Full Stadium 50,000 fans Weekly salary bill 250,000 (fixed costs) Salary (fixed costs) per unit 5 250,00050,000

Half full 25,000 fans 250,000 10 250,00025,000

When the stadium capacity utilization is at 50%, then 10 of the ticket price is needed for the players wages alone. When the stadium is full (i.e., full capacity) the fixed costs are spread over many more tickets, reducing the fixed costs per unit to 5.

This shows the higher the capacity utilisation, the lower fixed costs per unit will be. This enables the producer to either cuts prices to boosts demand or enjoy higher profit margins. This means that increasing capacity utilisation is a valid method for increasing a firms profitability. If capacity utilisation is low, the fixed costs per unit may become too high forcing the business into bankruptcy.

The ideal capacity is therefore at or near 100%, this spreads the fixed costs as thinly as possible. There are three concerns about operating at or near 100% capacity utilisation: If demand rises, it can only be met by competitors as you are already working flat out. The risk that you will never have time to service machinery, change/improve production methods or train/retrain staff. This may increase the chances of production breakdown. It can lead to managers and workers being over worked and can increase stress levels.

The production ideal, therefore, is a capacity utilisation of around 90%.

Financial implications
A firms level of capacity utilization determines how much fixed costs should be allocated per unit, so as a firms capacity utilization increases, the fixed costs (and therefore also, total costs) per unit will decrease. For example, if the firm above had fixed costs of 12,000 per month, the fixed costs per unit would be 20 per unit at 50% capacity utilization, but only 10 per unit at 100% capacity utilisation. It therefore follows that a firm should be most efficient if it is running at 100% capacity utilisation. However, if a firm is running at full capacity, there are a number of potential drawbacks:

There may not be enough time for routine maintenance, so machine breakdowns may occur more frequently and orders will be delayed It may not be possible to meet new or unexpected orders so the business cannot grow without expanding its scale of production Staff may feel under excessive pressure, leading to increased mistakes, absenteeism and labour turnover If the factory space is overcrowded, work may become less efficient due to the untidy working conditions It may be necessary to spend more on staff overtime to satisfy orders, increasing labour costs

NB these drawbacks are not to be confused with diseconomies of scale, which can arise from a firm operating on a larger scale e.g. by opening a larger factory. See separate revision note on economies of scale. In general, businesses would feel most comfortable at something between 80 to 90% capacity utilisation because fixed costs per unit are relatively low and there is some scope to meet new orders or carry out maintenance and training. A firm that has just invested in major new facilities in anticipation of major growth could take some time before reaching a good level of utilisation, so it is important to consider sales trends when discussing capacity utilisation.

In capacity management there are usually two potential constraints - TIME and CAPACITY Time may be a constraint where a customer has a particular required delivery date. In this situation, capacity managers often "plan backwards". In other words, they allocate the final

stage (operation) of the production tasks to the period where delivery is required; the penultimate task one period earlier and so on. This process helps identify whether there is sufficient time to meet the production demands and whether capacity needs to be increased, albeit temporarily.

A schedule is a representation of the time necessary to carry out a particular task. A job schedule shows the plan for the manufacture of a particular job. It is created through "work / study" reviews which determine the method and times required. Most businesses carry out several production tasks at one time - which entails amalgamating several job schedules. This process is called "scheduling". The result is known as the production schedule orfactory schedule for the factory/plant as a whole. In preparing a production schedule, attention needs to be paid to: - Delivery dates(when are finished products due?) - Job schedules for each relevant production task - Capacities of production sections or departments involved - Efficiency of these production sections or departments - Planned holidays - Anticipated sickness / absenteeism / training - Availability of raw materials, components and packaging

There are two key problems with production scheduling:

(1) Measurement of performance (e.g. should financial performance be most important (e.g. minimise the amount of stock), or are marketing objectives more important - e.g. always produce enough to meet customer demand). (2) The large number of possible schedules - often caused by too much complexity or variety in the production needs of the business.


There are a number of reasons why a firm might be experiencing low capacity utilisation, including the following:

New competitors taking market share or causing over-supply in the market Fall in market demand due to changes in consumer tastes or fashion

Unsuccessful marketing one or more aspect of the marketing mix may simply mean that the firm is not successful Seasonal demand this is especially apparent in the tourist industry where firms like hotels and leisure parks are full in the summer but see much lower utilisation at other times of the year

Exam hint: In examination questions on this subject, look for clues as to the root causes of under-utilisation so that you can assess whether it is a long term problem or not, and what the firm could do to remedy the situation


Higher fixed costs per unit mean reduced profitability; if prices were raised to cover these costs, this would probably lead to reduced sales unless the product was price inelastic Spare capacity can portray a negative image, particularly in a business where it can be seen that it is no longer busy such as a shop or a health club - signifying loss of popularity Staff can become bored and demoralised if they dont have as much to do, especially if they fear losing their jobs


Low capacity utilisation is unlikely to be desirable in the long term as the higher unit costs will make it difficult to compete. However it is not all bad news and possible short term benefits include:

A firm may have more time for maintenance and repairs and for staff training, to prepare for an upturn in trade There may be less stress for employees than if they were working at full capacity The firm can cope with new orders; firms in expanding markets may expect to have low utilisation whilst they build their sales


There are two approaches to increasing capacity utilisation: Increase demand for existing products by promotional activity, price cutting or repositioning in the market. It could also be possible to launch new products. To lower the capacity by either reducing the factors of production employed or to move to smaller premises. The danger with moving to a smaller building is that if demand picks up in the future, it will be very difficult to increase supply in response to it. This process is known as rationalising.

Which approach a firm chooses to take will depend upon the cause of the low capacity utilisation. Is it due to known temporary shortfall, such as a seasonal decline or due to an economic recession, which may last for 18-24 months. It can be a mistake to reduce capacity in the long run, however it may be necessary in order to ensure short-term survival. It is therefore important to identify whether the short fall is short or long term.

Operating At Near Full Capacity Operating at near full capacity can have a number of advantages: Its fixed costs per unit are at their lowest possible level. The firm is assumed to be using all of its fixed assets effectively, therefore profits should be high. It will be perceived as a successful country both internally and externally leading to positive effects. Internally, employees will feel a sense of pride working for such a successful organisation. Externally, if customers know that a firm is working at full capacity it will assume that it is offering a good product.

Firms operating at or near full capacity may wish to increase their total capacity, this can be done in a number of ways: Employing more workers.

Building larger buildings for manufacture or providing service. Purchasing more raw materials/stock.