Capacity utilisation — Edexcel A-Level Business
Test yourself on Capacity utilisation with PEARSON EDEXCEL A-Level practice questions.
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Capacity utilisation explained
This is a percentage, worked out by taking the output actually produced in a period, dividing it by the most that the plant, staff and hours available could deliver in that same period, then multiplying by one hundred.
Read the full explanation
It matters because fixed costs do not shrink when the factory is quiet, so at forty per cent the rent, rates and depreciation are spread over few units and fixed cost per unit is punishing, while at ninety per cent the same overhead is carried by many units and the firm looks efficient. Airlines quote it as load factor and hotels as occupancy, and Ryanair running above ninety per cent is a large part of why its cost per seat undercuts rivals. Most manufacturers treat somewhere near ninety per cent as comfortable, leaving slack for maintenance, absence and a rush order.
b) Implications of under- and over-utilisation of capacity
Running well below the maximum leaves rent, rates, salaries and depreciation spread over too few units, so cost per unit rises and margins are squeezed; it also unsettles staff, who read idle machines as redundancies coming, and it can make the business look like it is failing to potential investors. The compensations are real though, because spare capacity means a large order can be accepted at once and maintenance can be done properly. Running at or beyond the sensible maximum flips every one of those. Unit cost is low and the site looks profitable, but there is no slack for breakdowns, quality slips as work is rushed, lead times stretch, staff work overtime and get stressed, and labour turnover climbs. Most judgements turn on whether the imbalance is seasonal and temporary or structural and permanent.
c) Ways of improving capacity utilisation
There are only two levers, lift demand to fill the capacity or cut the capacity to fit the demand, and each carries a cost. On the demand side a firm can promote harder, discount off peak, open new segments or markets, take on subcontract work for another manufacturer, or extend the product range so quiet weeks are filled; cinemas and hotels do this with midweek pricing. On the supply side it can rationalise by closing a site or selling machinery, mothball a line, cut shifts, use short term or agency contracts, or subcontract work out at peak instead of owning the extra capacity. The trade-offs are sharp. Discounting fills seats but damages margin and can cheapen the brand, while rationalising saves overhead yet costs redundancy pay, destroys capacity the firm may need again, and frightens the staff who remain.
Your focus
- a) Capacity utilisation: current output (divided by) maximum possible output (x 100)
- b) Implications of under- and over-utilisation of capacity
- c) Ways of improving capacity utilisation
Capacity utilisation exam tips
Marking Points
- Sets the calculation out with both figures in the same time period, weekly output against weekly maximum, and gives the answer as a percentage to one decimal place
- Interprets the number for the business rather than stopping at it, linking a low percentage to high fixed cost per unit and a high percentage to low unit cost
- Says what a good figure looks like in that industry, for example a hotel at sixty per cent in the off season is normal while a car plant at sixty per cent is losing money
- Uses the result to support a decision, such as whether to accept a special order, cut prices off peak or close a site
- Builds a chain for under utilisation, spare capacity means fixed costs are shared between fewer units, so cost per unit rises, so either margin falls or the price has to rise and the firm loses competitiveness
- Builds the matching chain for over utilisation, no downtime for maintenance means breakdowns and rushed work, so defects and late deliveries rise, so customers are lost despite the low unit cost
- Recognises the human consequences on both sides, fear of redundancy and demotivation when quiet, stress, overtime and rising labour turnover when stretched
- Evaluates by distinguishing a seasonal dip, which a firm rides out, from a permanent fall in demand, which forces rationalisation
- Separates the two routes clearly, raising output sold through marketing, pricing or new markets, and reducing maximum capacity through rationalisation, mothballing or shorter shifts
- Applies a route to the named business with a reason it fits, for example off peak pricing suits a business with a fixed asset and perishable capacity such as a hotel room or an airline seat
- Quantifies where data allows, showing the new percentage after the change or the fixed cost saved by closing a site
- Judges the option against the cause of the problem, temporary dips favour flexible fixes such as agency staff or subcontracting, permanent falls favour rationalisation
Examiner Tips
- 💡The calculation itself is usually worth two marks, but the marks after it are for interpretation, so always add a sentence on what the figure does to cost per unit for the named business
- 💡Watch for data given per shift or per machine, since you may need to multiply up to a whole week before dividing
- 💡Examiners reward comparison over time or against a competitor, so if the case gives last year's figure, say whether the business is improving and why that might be
- 💡These appear as analyse questions worth eight to ten marks where two developed chains beat five undeveloped points, so pick one cost effect and one non financial effect and follow each through
- 💡Anchor the answer in the case data, quoting the utilisation percentage and the industry, because a hotel and a chemical plant tolerate very different levels
- 💡In evaluation, say what it depends on, usually whether demand is seasonal, how quickly capacity can be changed, and how close competitors are to their own limits
- 💡Questions here are usually recommend or justify for ten to twelve marks, so choose one option, explain why it beats the alternative for this firm, and state the main risk
- 💡Use the numbers in the case to show the size of the gap before choosing, because a five per cent shortfall and a forty per cent shortfall call for completely different answers
- 💡Reserve a sentence for the time frame, since short term fixes such as subcontracting can be reversed while closing a factory cannot
Common Mistakes
- Inverting the calculation and dividing maximum capacity by actual output, which produces a figure above one hundred per cent and is instantly wrong
- Forgetting to convert the decimal into a percentage, so an answer of nought point seven five is written down instead of seventy five per cent
- Mixing time periods, such as dividing a week's output by an annual capacity figure, which gives a tiny meaningless percentage
- Assuming full utilisation is the goal, when running flat out leaves no room for maintenance, breakdowns or an unexpected order
- Writing that low utilisation means low profit without explaining the fixed cost per unit mechanism, which is the analysis mark the chain is built for
- Treating full capacity as automatically good, ignoring the quality, maintenance and staff costs of running with no slack, and the orders that have to be turned away
- Confusing spare capacity with wasted stock or unsold output, which is a separate issue about demand forecasting
- Offering advertise more as a whole answer, with no mechanism, no cost and no estimate of whether the extra demand would actually fill the gap
- Ignoring the cost of cutting capacity, including redundancy payments, loss of skilled staff and the expense of reopening if demand returns
- Recommending a price cut without checking price elasticity, since demand for a differentiated product may be inelastic and revenue would fall