Capacity utilisation

Capacity utilisation is the proportion of a firm's maximum possible output that it is actually producing (1), expressed as a percentage (actual ÷ maximum × 100) (1).

Capacity utilisation = (actual ÷ maximum) × 100 (Knowledge 1) = (40,000 ÷ 50,000) × 100 = 80% (Application 2). Spare capacity = 50,000 − 40,000 = 10,000 bottles (Analysis 1).

At 60% utilisation, CanCo's fixed costs are spread over relatively few units, so its fixed cost per unit — and therefore its unit cost — is high (Knowledge + Application). This squeezes CanCo's margins and leaves it less price-competitive than rivals running nearer full capacity, reducing its profit (Analysis).

Low utilisation also means CanCo's machines and staff are underused — an expensive idle resource it is still paying for (Knowledge + Application). Underused workers may fear redundancy, becoming demotivated, and if CanCo cuts staff it faces redundancy costs and lost morale — further harming productivity and its reputation as an employer (Analysis).

Running at 100% capacity has clear benefits for FreshBake. Its fixed overheads are absorbed across the maximum possible output, so its unit cost is as low as it can be, and its ovens and production lines are running at full throughput — a sign of strong demand and efficient use of its plant. In the short term this maximises revenue and margins.

However, 100% for six months brings real problems. FreshBake has no spare capacity to accept incoming orders, so it must turn buyers away — potentially losing them permanently to rivals and forgoing growth. There is no window for planned maintenance on its ovens and lines, risking unplanned breakdowns, and staff and equipment are under relentless strain, which can cause errors, quality defects and burnout. Any disruption immediately halts output because there is no slack in the schedule.

Whether full capacity is 'good' therefore depends on how long it lasts and FreshBake's plans. As a short-term response to a demand peak it is efficient and profitable. But sustained at 100%, it becomes risky and constrains growth — which suggests FreshBake should expand capacity (additional ovens, staff, floor space, or outsourcing to third-party bakers) if the high demand is expected to continue. Operating with a little slack — nearer 90% — would let FreshBake keep unit costs low while retaining the flexibility to take on new orders and schedule maintenance, making it a stronger long-term position than a permanent 100%.

SofaWorks' 50% utilisation is a serious problem — its fixed overheads are now absorbed across only half its potential output, so its unit costs are high and its margins squeezed. It has two broad responses: raise demand to fill the capacity, or rationalise to cut the capacity.

Raising demand. SofaWorks could market aggressively, win new retail accounts, or develop new product ranges to replace the lost customer. If successful, this restores throughput, lifts utilisation, spreads fixed costs again and preserves jobs and future capacity. But it takes time and marketing spend, and there is no guarantee SofaWorks can quickly replace such a large account — leaving it absorbing high unit costs on idle plant in the meantime.

Rationalising. Alternatively, SofaWorks could cut its capacity — sell surplus machinery, mothball a production line, or reduce headcount — to match the lower demand. This strips out fixed costs immediately and raises the utilisation % on what remains, improving unit costs quickly. But it involves redundancy costs, lost morale, and — crucially — limits SofaWorks' ability to scale back up if it wins a new large account, and shrinking can damage reputation.

Judgement. The best response depends on whether the fall in demand is temporary or permanent. If SofaWorks believes it can realistically win replacement accounts — a temporary loss — it should prioritise rebuilding demand and avoid hasty rationalisation that it would later regret. If the lost customer reflects a permanent contraction in its market, rationalising to a lower, sustainable capacity is the sensible route to protect profitability. In practice SofaWorks might do both cautiously: pursue new accounts hard while making limited, reversible cost savings (e.g. cutting overtime and agency shifts rather than closing a line) until it knows whether demand will recover — avoiding the risk of scrapping capacity it soon needs again.

Maximising capacity utilisation is tempting for MetalFab because it minimises unit costs, but 'always' maximising ignores the serious downsides of running near 100%, so the right level depends on MetalFab's market and need for flexibility.

Why high utilisation is attractive. MetalFab's fixed costs (factory, machining plant, salaries) must be paid whatever it produces. The higher its utilisation, the more units it absorbs those fixed costs over, so the fixed cost per unit — and its overall unit production cost — falls. Lower unit cost lets MetalFab bid more keenly for contracts or widen its margins, improving competitiveness and profit. High utilisation also signals strong demand and efficient use of expensive machining equipment. For a manufacturer with high fixed costs, keeping throughput high genuinely matters.

Why maximising to 100% is risky. However, running at (or near) 100% brings problems that can outweigh the cost saving. MetalFab would have no spare capacity to accept new or urgent contracts, so it must turn work away — potentially losing valuable customers to rivals and forgoing growth. There would be no window for planned maintenance and servicing, risking breakdowns that halt the line, and staff and plant under constant strain, causing errors, quality defects and burnout. With no slack, any disruption (a machine fault, a raw-material delivery delay) immediately causes problems. In engineering, where large one-off contracts arrive at short notice, the inability to take them on could cost MetalFab far more than the unit-cost saving.

What it depends on. Whether MetalFab should maximise utilisation therefore depends on context. It depends on the variability of its demand and order book — if demand is steady and predictable, running very high is safer; if MetalFab tenders for irregular, large contracts, it needs spare capacity to respond. It depends on the cost of an unfulfilled order versus the unit-cost saving. And it depends on its need for flexibility and maintenance — capital-intensive machining equipment must be serviced. Many manufacturers therefore target around 90%, not 100% — low unit costs with a buffer.

Conclusion. On balance, MetalFab should aim for high but not maximum utilisation. Keeping utilisation high is important because it lowers unit costs and improves competitiveness, so persistently low utilisation (lots of idle plant) is a real weakness it should avoid. But 'always maximising' to 100% is not optimal: it sacrifices the flexibility, maintenance time and quality that a manufacturer needs, and can cost more in lost contracts than it saves in unit cost. The best target for MetalFab is a level — commonly around 90% — that keeps unit costs low while retaining slack to take on new orders and service its equipment. The ideal level ultimately depends on how variable its demand and contracts are: the more unpredictable, the more spare capacity MetalFab should deliberately keep.