Capacity utilisation (expressed as a percentage) is calculated using this formula:

Here is an example of the formula above in action:

Capacity utilisation is an important concept:

• It is often used as a measure of productive efficiency
• Average production costs tend to fall as output rises – so higher utilisation can reduce unit costs, making a business more competitive
• So firms usually aim to produce as close to full capacity (100% utilisation) as possible

Is there an ideal level of capacity utilisation? The answer is – it depends!

There are several reasons why businesses operate at less than 100% capacity utilisation:

Lower demand:

• General reduction in overall market demand
• Loss of market share
• Seasonal variation in demand

Increase in capacity not yet matched by increased demand:

• Possibly new technology introduced
• Provide some "slack"

Inefficiency (a problem = less competitive unit costs)

• Poor maintenance, quality, employee disruption

When a business is operating at less than 100% capacity, it is said to have "spare capacity".

Sometimes spare capacity is not the problem – a business finds itself with excess demand (i.e. it cannot produce enough to meet demand). In such circumstances, what can it do to operate at higher than 100% normal capacity? It can often:

• Increase workforce hours (e.g. extra shifts; encourage overtime; employ temporary staff)
• Sub-contract some production activities (e.g. assembly of components)
• Reduce time spent maintaining production equipment

However, there are some potential pitfalls with operating at very high capacity (i.e. around 100%):

Negative effect on quality (possibly)

• Production is rushed
• Less time for quality control

Employees suffer

• Added workloads & stress
• De-motivating if sustained for too long

Loss of sales

• Less able to meet sudden or unexpected increases in demand
• Production equipment may require repair