CAPACITY UTILIZATION

INTRODUCTION

Extent or level to which the productive

capacity of a plant, firm, or country is being
used in generation of goods and services.
Expressed usually as a percentage, it is
computed by dividing the total capacity with
the portion being utilized.
 WHAT IS CAPACITY
Capacity utilization is an economics concept which
refers to the extent to which an enterprise or a
nation actually uses its installed productive
capacity. Thus, it refers to the relationship between
actual output produced and potential output that
could be produced with installed equipment, if
capacity was fully used.
 PRODUCTION CAPACITY
Production capacity is usually defined in terms of the
following three factors:
 Factors of production that is used in production
activities of company,
 Product which is obtained as result of utilization of
production factors,
 Being of the whole occupations and efforts of
production within a certain period of time,
Consequently, the production capacity is said that
business will bring about the amount of production by
using the factors of production in a rational manner in
a certain period of time.
 TYPES OF CAPACITY

Three types of capacity are often referred to:

Potential Capacity

Immediate Capacity

Effective Capacity
 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.
 MEASURING CAPACITY
Capacity, being the ability to produce work in
a given time, must be measured in the unit of
work.
For example, consider a factory that has a
capacity of 10,000 " machine hours" in each
40 hour week. This factory should be capable
of producing 10,000 "standard hours of work"
during a 40-hour week.
The actual volume of product that the factory
can produce will depend on:
the amount of work involved in production
(e.g. does a product require 1, 5, 10 standard
hours?
any additional time required in production
(e.g. machine set-up, maintenance)
the productivity or effectiveness of the
factory
 CAPACITY UTILIZATION RATE
The capacity utilization rate, also known as the
capacity utilization ratio, is a percentage-
based ratio that applies to the actual
productivity of a business or country. It
specifically references the ratio between true
output – what is actually produced, and
potential output – what could be produced.
In general, maximum actual output of a company is
always going to be less than 100% due to the actual
resources. it possesses, human factors including
employee output, machinery limitations and
maintenance

 Capacity utilization rate reveals how close a firm is

to its best operating point.

 Capacity used
rate of output actually achieved
 Best operating level
capacity for which the process was designed
 Example of Capacity Utilization Rate
 During one week of production, a plant produced
83 units of a product. Its historic highest or best
utilization recorded was 120 units per week. What
is this plant’s capacity utilization rate?
 DETERMINATION OF CAPACITY
Capacity determination is a strategic decision in
plant planning or factory planning. Capacity
decisions are important because:
I. They have a long-term impact.
II. Capacity determines the selection of
appropriate technology, type of labour and
equipments, etc.
III. Right capacity ensures commercial viability of
the business venture.
IV. Capacity influences the competitiveness of a
firm.
 Factors affecting determination of Plant Capacity:
a) Market demand for a product/service.
b) The amount of capital that can be invested.
c) Degree of automation desired.
d) Level of integration (i.e. vertical integration).
e) Type of technology selected.
f) Dynamic nature of all factors affecting
determination of plant capacity changes in the
product design, process technology, market
conditions and product life cycle, etc.
g) Difficulty in forecasting future demand and future
technology
Factors affecting determination of Plant Capacity:

h) Obsolescence of product and technology over a

period of time.
i) Present demand and future demand both over
short-range, intermediate-range and long-range
time horizons.
j) Flexibility for capacity additions.
 Factors which will be cared while a
capacity of plant is being examined:
 Growth opportunities of the facility in future,
 the development plans of the facility for the future,
 Scale value of the facility that took place in the economic
sector,
 Efficiency, productivity and profitability are targets which is
anticipated by the facility
 Funding opportunities which can be benefited by the
facility,
 Technological level and production methods,
 Production Types
 Production quality assurance / security,
 Demand / sales level
 Factors which will be cared while a
capacity of plant is being examined:
 Growth opportunities of the facility in future,
 the development plans of the facility for the future,
 Scale value of the facility that took place in the economic
sector,
 Efficiency, productivity and profitability are targets which is
anticipated by the facility
 Funding opportunities which can be benefited by the
facility,
 Technological level and production methods,
 Production Types
 Production quality assurance / security,
 Demand / sales level
Capacity Planning
FOR
Products and Services
 CAPACITY

PRODUCT AND
LOCATION SERVICE
PLANNING
SYSTEM
DESIGN

ARRANGEMENT OF ACQUISITION AND

DEPARTMENTS PLACEMENT OF
EQUIPMENT
Achieve a match between supply
capabilities and the predicted level of
demand

It is a long-term capacity planning

Reasons of capacity planning

Changes in
demand

Changes in
Opportunity
technology

capacity
planning

Changes in Perceived
environment threats
The basic questions in capacity planning

How much
is needed?

forecasting

What kind
When is it of capacity
needed? is needed?
 When capacity planning ?

It is made infrequently and in others,

it is made regularly depends on the
following factors :
 Equipment and product design
•The stability of demand
•The rate of technological change
 Competitive factors
 Others factors
•The type of product and services
•Whether styles changes are important
 Capacity terminology
 Design capacity ( Max. Capacity )
is the maximum theoretical output of a system
 Normally expressed as a rate
 Under ideal conditions
 Effective capacity ( Best Operating Level )
is the capacity a firm expects to achieve given current
operating constraints
 Often lower than design capacity
 Under ideal conditions
 Actual output ( Capacity Used )
is rate of output actually achieved
 Cannot exceed effective capacity.
 Utilization and Efficiency

Utilization is the percent of design

capacity achieved
Utilization = Actual Output/Design Capacity

Efficiency is the percent of

effective capacity achieved
Efficiency = Actual Output/Effective Capacity

Both measures expressed as percentages

Ex. Efficiency/Utilization
Design capacity = 50 trucks/day
Effective capacity = 40 trucks/day
Actual output = 36 units/day

Actual output 36 units/day

Efficiency = = = 90%
Effective capacity 40 units/ day

Actual output 36 units/day

Utilization = = = 72%
Design capacity 50 units/day
 Efficiency vs Utilization
100.00%

90.00%
90.00%

80.00%
72.00%
70.00%

60.00%

50.00%

40.00%

30.00%

20.00%

10.00%

0.00%
Efficiency Utilization
 Utilization Example

• Best operating level = 120 units/week

• Actual output = 83 units/week

Capacity used 83 units/wk

Utilization = = = .692
• UtilizationBest
= ?operating level 120 units/wk
 Best Operating Level

Average
unit cost
of output

Underutilization Over-utilization

Best Operating
Level

Volume
 Measuring capacity
Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week,
Shifts/day = 3,
Hours/shift = 8
Design capacity = (7 x 3 x 8) x (1,200)
= 201,600 rolls/week
Utilization = 148,000/201,600 = 73.4%
Efficiency = 148,000/175,000 = 84.6%
 Examples of Capacity Measures

Type of Measures of Capacity

Organization Inputs Outputs
Manufacturer Machine hours Number of units
per shift per shift
Hospital Number of beds Number of
patients treated
Airline Number of planes Number of
or seats seat-miles flown
Restaurant Number of seats Customers/time
Retailer Area of store Sales dollars
Theater Number of seats Customers/time
 Determinants of Effective Capacity
• Facilities (size, location, layout, heating, lighting, ventilations)
• Product and service factors (similarity of products)
• Process factors (productivity, quality)
• Human factors (training, skills, experience, motivations, absentation,
turnover)

• Policy factors (overtime system, no. of shifts)

• Operational factors (scheduling problems, purchasing requirements,
inventory shortages)
• Supply chain factors (warehousing, transportation, distribution)
• External factors (product standards, government agencies, pollution
standard)
 Steps for Capacity Planning
Estimate future capacity requirements
Evaluate existing capacity
Identify alternatives
Conduct financial analysis for each alt.
Assess key qualitative issues for each alt.
Select one alternative
Implement alternative chosen
Monitor results
 Calculating Processing
Requirements

Determine type of products or services

Forecast for the Demand
Determine the process requirements
•The standard processing time / unit of
product
•The number of workdays / year
•The number shifts that will be used
 Calculating Processing Requirements

A dept. works 8-hour shift, 250 days/year

Standard
Annual processing time Processing time
Product Demand per unit (hr.) needed (hr.)

#1 400 5.0 2,000

#2 300 8.0 2,400

#3 700 2.0 1,400

5,800

annual capacity is 250*8 = 2000 hours,

number of machines required = 5,800 hours/2,000 hours = 2.90 machines
then we need three machines to handle the required volume
 Make or Buy ?
In-House or Outsourcing
Outsource: obtain a good or service completely or partially
from an external provider
1. Available capacity (equip.,skills,time)
2. Expertise
3. Quality considerations (labs, inspect.)
4. Nature of demand (high, steady)
5. Cost (fixed, savings)
6. Risk
 Make or Buy ?
A firm’s manager must decide whether to make or buy a
certain item used in the production of vending machines ,
making the item would involve annual lease costs of
$150000 . Cost and volume estimates are as follows:
Make Buy
Annual fixed cost $150000 None
Variable cost/unit $60 $80
Annual volume (units) 12000 12000

•Should the firm make or buy ?

•If the volume changed , at what volume would the
manager be indifferent between making and buying ?
 Sol.
Make or Buy ?
• Total cost = Fixed cost + (Volume * Variable cost)
in case of make = $150000 + (12000*60) = $870000
in case of buy = 0 + (12000*80) = $960000
TCost (make) < TCost (buy)
So the solution is “Make”
• Tcost(make) = Tcost(buy)
$150000 + Q*60 = 0 + Q*80
Q = 7500 unit

Q
 Economies of Scale
Minimum cost & optimal operating rate are
Average cost per unit functions of size of production unit.

Small
plant Medium
plant Large
plant

0 Output rate