Capacity utilisation measures how much of a business’s available production capacity is currently being used, playing a vital role in operational efficiency.
What Is Capacity Utilisation?
Capacity utilisation is a key operational performance metric that assesses how effectively a business is using its production resources, such as machinery, facilities, and labour, to generate output. It is expressed as a percentage of the maximum output capacity that is actually being used during a given time frame.
This metric helps businesses understand how well they are converting their resources into products or services. Operating at a high level of capacity utilisation can be a sign of efficient resource management, while low utilisation can indicate underused assets and higher operational costs.
For example, if a bakery has the facilities, staff, and equipment to produce 10,000 loaves of bread per week but is only making 7,000 loaves, its capacity utilisation is 70%.
Capacity utilisation is important in decision making because it informs businesses whether they are using their existing resources optimally, if there is room to grow, or if restructuring is necessary. It also affects pricing, profitability, and investment decisions.
Formula for Capacity Utilisation
The formula for calculating capacity utilisation is as follows:
Capacity Utilisation (%) = (Actual Output / Maximum Possible Output) x 100
Where:
Actual Output is the number of goods or services the business is currently producing.
Maximum Possible Output is the highest number of goods or services the business could produce if all resources were fully utilised.
This formula helps managers assess the degree to which current operations are making use of existing production capabilities.
Example:
If a furniture manufacturer has the capacity to produce 1,000 chairs per week, but is currently producing 800:
Capacity Utilisation = (800 / 1,000) x 100 = 80%
This means the business is operating at 80% of its maximum productive capacity.
A business would aim for a balance: high enough to maximise efficiency and reduce costs, but not so high that it leads to operational strain or reduces flexibility.
Implications of High vs Low Capacity Utilisation
Understanding the effects of varying levels of capacity utilisation is critical for businesses to manage resources efficiently and make informed strategic decisions.
High Capacity Utilisation
High capacity utilisation typically means a business is operating near full capacity, with most of its resources fully employed. This is usually seen as a positive indicator of operational efficiency and demand, but it is not without challenges.
Advantages:
Lower Unit Costs: When more units are produced, fixed costs (e.g. rent, salaries, machinery depreciation) are spread across a larger number of outputs, reducing the cost per unit.
Higher Profit Margins: With unit costs lower, businesses can retain more profit per sale or price more competitively.
Strong Return on Investment: Assets such as buildings and equipment are being used effectively, providing a better return on capital expenditure.
Disadvantages:
Increased Risk of Equipment Breakdown: Machinery and equipment used at or near full capacity for extended periods are more likely to suffer wear and tear, leading to maintenance issues and potential downtime.
Overworked Employees: Employees may face pressure and stress when operations are consistently stretched, potentially reducing morale, increasing absenteeism, or resulting in higher turnover.
Reduced Flexibility: A business operating at near 100% has little capacity to respond to unexpected increases in demand, seasonal surges, or special orders.
Quality Concerns: Rushing to meet high output targets can lead to errors, shortcuts, or quality issues if proper controls aren't maintained.
Example:
A car manufacturer producing at 95% of its capacity might enjoy low unit costs and high revenue. However, if a sudden increase in demand occurs, it may not be able to meet orders quickly without risking delays or compromising product quality.
Low Capacity Utilisation
Low capacity utilisation means a business is using less of its available resources than it could. While this may sometimes be strategic, it usually indicates inefficiency.
Disadvantages:
Higher Unit Costs: With fewer units to absorb fixed costs, the average cost per product increases, reducing profitability.
Wasted Resources: Expensive assets such as machinery and factory space remain underused, which is a poor use of investment capital.
Lower Competitiveness: High production costs may force a business to increase prices or accept lower margins, making it less competitive in the market.
Negative Perception: Investors, employees, or stakeholders may view consistent underutilisation as a sign of poor management or declining demand.
Possible Causes:
Poor sales performance or falling demand.
Seasonal dips (e.g. sunscreen manufacturers in winter).
Overexpansion – investing in more capacity than is needed.
Inefficient production scheduling or operational issues.
Example:
A packaging company built a new facility anticipating a surge in demand. However, demand did not grow as expected, and only 50% of its capacity is being used. As a result, the business faces high unit costs and excess overheads.
Strategies to Improve Capacity Utilisation
Businesses facing either persistent underutilisation or occasional spikes in demand can implement a variety of strategies to increase their capacity utilisation effectively and sustainably.
1. Increase Demand
Boosting sales is often the most direct way to improve utilisation.
Marketing Campaigns: Attracting new customers through promotions, advertising, or digital marketing can raise sales volume.
Price Adjustments: Temporary price reductions or special offers may stimulate demand and increase order volumes.
Entering New Markets: Expanding into new geographic or demographic markets can create additional demand for existing capacity.
Product Development: Creating new products or variations to appeal to different customer segments.
Example:
A textile firm with spare weaving capacity runs a ‘Buy One Get One Free’ promotion on selected fabric lines to boost orders and increase output levels.
2. Outsource or Subcontract Excess Work
If demand exceeds current internal capacity, businesses can outsource production to third parties rather than expanding facilities or buying more equipment.
Reduces the need to invest in long-term fixed assets.
Allows businesses to meet demand without overextending resources.
Maintains service levels without overburdening staff.
Example:
A luxury chocolate company nearing full capacity at Valentine’s Day may subcontract basic packaging to another supplier to focus on high-value product areas.
3. Lease or Sell Excess Capacity
When low utilisation is due to long-term drops in demand, a business may choose to generate income from idle resources.
Leasing unused warehouse space, factory time, or equipment.
Selling surplus machinery or facilities.
Sharing facilities with other firms during off-peak times.
Example:
A printing company with unused press capacity leases time slots to a smaller business needing professional printing for limited product runs.
4. Reschedule or Reallocate Work
Adjusting work schedules can optimise how capacity is used.
Shift Work: Implementing multiple shifts (e.g. evening or night shifts) allows a factory to operate longer hours using existing equipment.
Flexible Working: Adjusting employee hours to match demand patterns.
Cross-Training Staff: Staff trained to perform multiple roles can be moved to where they are most needed.
Example:
A call centre previously open from 9 am to 5 pm introduces a second shift from 5 pm to 10 pm to accommodate evening calls and utilise the office space more effectively.
5. Reduce Capacity
If low utilisation persists and demand is unlikely to recover, a business might choose to reduce overall capacity to match new demand levels.
Close underused facilities or production lines.
Lay off staff or reduce hours.
Sell or retire older machinery.
Caution:
Reducing capacity should be approached carefully, as it may affect a business’s ability to scale back up quickly if demand returns. It is a long-term, often irreversible decision.
Worked Examples and Calculations
Example 1: Calculating Capacity Utilisation
A shoe factory has the maximum capacity to produce 12,000 pairs of shoes each month. Last month, it only produced 9,000.
Capacity Utilisation = (9,000 / 12,000) x 100 = 75%
Interpretation:
The business is operating at 75% of its full capacity.
There may be opportunities to produce more using existing resources without additional investment.
Example 2: Impact on Unit Cost
Factory A and Factory B both have annual fixed costs of £600,000.
Factory A produces 300,000 units annually: unit fixed cost = 600,000 / 300,000 = £2
Factory B produces only 150,000 units: unit fixed cost = 600,000 / 150,000 = £4
The lower utilisation in Factory B results in double the fixed cost per unit, affecting pricing and profit margins.
Example 3: Expansion and Changing Utilisation
A printing company increases capacity from 5,000 pages/day to 8,000 pages/day after investing in new machines. However, it only prints 4,000 pages/day currently.
Before expansion: (4,000 / 5,000) x 100 = 80%
After expansion: (4,000 / 8,000) x 100 = 50%
Although production output hasn’t changed, the business now has significantly lower capacity utilisation, which may indicate overinvestment or the need to increase demand to justify the expansion.
Example 4: Improving Utilisation by Entering New Market
A bottled water company uses 60% of its capacity producing for UK supermarkets. It begins exporting to the EU, which increases output by 20%.
Previous utilisation = 60%
New output = 80% of capacity
Increased utilisation leads to lower unit costs, better use of fixed costs, and potentially higher profitability.
Key Takeaways for A-Level Students
Capacity utilisation is a vital operational metric that reveals how well a business is using its resources.
Higher utilisation = more efficiency, but not without potential risks such as inflexibility or employee fatigue.
Lower utilisation = higher costs per unit, and may signal structural issues that require strategic change.
Managers must balance utilisation with flexibility, quality, and workforce well-being, using appropriate strategies like demand stimulation, outsourcing, or resource reallocation.
Students should be able to apply the capacity utilisation formula confidently, interpret results in context, and suggest appropriate actions for businesses with low or high utilisation rates.
FAQ
Yes, operating below full capacity can provide strategic advantages in certain contexts. It allows flexibility to scale up production quickly in response to sudden increases in demand, without requiring immediate investment in new facilities or staff. It also gives time for maintenance, staff training, or product testing without disrupting output. Some businesses intentionally leave capacity unused during low seasons or when launching new products, allowing smoother quality control. However, the key is whether the underutilisation is temporary, planned, and justified by future expected demand or operational needs.
Capacity utilisation plays a critical role in guiding expansion decisions. If a business consistently operates at high utilisation levels (e.g. over 90%), it may indicate that there is insufficient capacity to meet demand, justifying investment in new machinery, premises, or staff. Conversely, if capacity utilisation is low, expansion would not be justified and could worsen inefficiency. Managers must consider long-term trends, not just temporary spikes, and weigh potential returns against fixed cost increases and risk of overcapacity.
Capacity utilisation helps businesses understand whether low productivity is due to inefficient processes or simply underuse of available resources. A firm might have high productivity per worker but still show poor financial performance if it uses only 50% of its productive capacity. By analysing both productivity and utilisation, managers can better identify the root causes of inefficiency. High productivity and high utilisation together suggest strong operational performance, while a mismatch might point to issues like poor demand forecasting or overinvestment in capacity.
Businesses can monitor capacity utilisation through regular collection of output data and comparison with maximum theoretical capacity. This often involves production reports, factory floor logs, or automated systems tracking machine usage. It’s important to define maximum capacity accurately—considering realistic limits based on shift patterns, downtime, and maintenance. Using software tools like ERP systems enables businesses to visualise trends over time and spot underuse early. Regular reviews allow for proactive adjustments, such as rescheduling, marketing campaigns, or resource reallocation.
There is no one-size-fits-all ideal, but many businesses aim for around 85–90% utilisation. This strikes a balance between efficiency and flexibility, allowing room for unexpected demand without overstretching resources. Operating at 100% may seem optimal but usually leads to stress on staff, increased maintenance needs, and limited responsiveness. On the other hand, consistent utilisation below 70% may indicate structural inefficiency or poor demand forecasting. The ideal level varies by industry—labour-intensive services may require more flexibility than capital-heavy manufacturing operations.
Practice Questions
Analyse the possible implications for a business of operating with a high level of capacity utilisation. (10 marks)
A high level of capacity utilisation indicates efficient resource use, potentially lowering unit costs and improving profit margins. However, operating close to full capacity can lead to strain on machinery and staff, reducing flexibility and increasing the risk of breakdowns or quality issues. The business may struggle to meet unexpected demand or seasonal peaks. Overworked employees may experience stress or reduced morale, affecting productivity. While profitability may initially improve, long-term sustainability could be at risk if no spare capacity is available. Effective capacity planning is essential to balance efficiency with flexibility and ensure consistent product or service quality.
Recommend and justify one strategy a business could use to improve low capacity utilisation. (12 marks)
One effective strategy to improve low capacity utilisation is to increase demand through targeted marketing. This approach encourages higher sales, making better use of existing resources and spreading fixed costs over more units, thus reducing unit costs and improving profitability. It avoids the need for downsizing or asset disposal, preserving flexibility. For example, offering promotions or entering new markets can attract additional customers. This strategy is particularly suitable when underutilisation is due to temporary factors, such as weak brand awareness or seasonal dips. Compared to cutting capacity, boosting demand can support long-term growth while improving operational efficiency.
