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Cambridge International AS & A Level Business · 9609 · AS Level
4.3 Capacity Utilisation and Outsourcing
Businesses need enough capacity to meet demand without leaving expensive resources idle. This topic explains how capacity utilisation is measured, why under- or over-capacity matters, and when outsourcing may improve operations.
Exam-focusedComplete Topic 4.3Interactive questions
What you need to know
For strong exam answers, connect capacity decisions to demand, costs, quality, employees, finance and customer service. High capacity utilisation can lower unit costs, but operating at or above the practical limit for too long can put pressure on people and equipment.
High-grade habit: do not assume that 100% capacity utilisation is always best. Judge whether the level is sustainable and whether demand is temporary or likely to continue.
Subtopics
These subtopics follow the textbook table of contents. Select one to jump directly to it.
4.3.1
Significance and measurement of capacity utilisation
CapacityThe maximum amount a business can produce at a given time with its existing resources.
Capacity depends on the quantity and quality of the business's factors of production. For example, it can be affected by the number and skills of employees, the amount and standard of equipment, and how efficiently the transformation process is organised.
Examples of capacity: a bus operator can measure capacity by passengers carried, a restaurant by meals served, a school by students accepted, and an airline by the passengers its aircraft can carry.
Measuring capacity utilisation
Capacity utilisationExisting output expressed as a percentage of maximum possible output over the same period.
Capacity utilisation (%) = (existing output ÷ maximum possible output) × 100
Worked example 1: if a factory produces 300 units each week and can produce a maximum of 500, capacity utilisation = (300 ÷ 500) × 100 = 60%.
Worked example 2: if output is 400 units and capacity utilisation is 80%, maximum capacity = 400 ÷ 0.80 = 500 units.
Visual example: 80% capacity utilisation
0%Maximum capacity 100%
Calculation tip: keep the time period consistent. Weekly output must be compared with weekly maximum capacity, not monthly capacity.
Why capacity utilisation matters
Low utilisationResources are sitting idle and fixed costs are spread over relatively few units.
High but manageableResources are used efficiently while the business still has some room to cope with disruption or extra demand.
Very close to 100%Sales potential is high, but sustained pressure can strain employees and equipment.
The impact of operating under capacity
Capacity under-utilisationA business is producing less than the maximum possible output available from its existing resources.
Low utilisation means some resources are not being fully used. If demand existed, the business could produce and sell more. It also raises unit costs because fixed costs are shared across fewer units.
Fixed-cost effect: if a market stall costs $500 to rent and sells 250 items, each item must contribute $2 just to cover the rent. If it sells 1,000 items, the fixed rental cost per item falls to $0.50.
- Idle labour, buildings or machinery may represent wasted resources.
- Fixed cost per unit is likely to be higher.
- Profit margins may be lower if the selling price does not rise.
- Trying to raise prices simply to cover high unit costs may reduce demand further.
Ways to improve low capacity utilisation
Increase demandRenew marketing activity through offers, greater sales effort or advertising to increase sales.
Reduce capacityRationalise by reducing staff, equipment or other resources if lower demand appears permanent.
RationalisationReducing the scale of operations and lowering capacity when existing capacity is no longer needed.
SubcontractingOne business employs another business to undertake some of the work.
Evaluation: reducing labour capacity may be easier than selling part of a building or specialised machinery. The practical response depends on how flexible each factor of production is.
High levels of demand relative to capacity
Operating close to full capacity can be profitable because resources are well used, but running at the limit for a sustained period can create operational problems.
- Employees may become tired or feel under pressure.
- Routine maintenance may be postponed, raising the risk of breakdown.
- There may be little spare capacity to deal with unexpected orders or disruption.
Short-term responses can include longer opening hours, overtime or subcontracting some output. A business may also create a waiting list or raise prices to reduce demand. If demand is expected to remain high, managers may invest in additional facilities, equipment or employees.
Capacity shortage
A capacity shortage exists when demand is greater than the amount the business can supply with its current resources. The appropriate response depends heavily on whether the extra demand is temporary or lasting.
Expand capacity
If high demand is likely to continue, investment in more labour, equipment or premises may allow additional sales.
Outsource or subcontract
External producers can increase available output, although the business gives up some direct control and must pay the supplier's margin.
Example: if a venue has more customers wanting tickets than seats available, management could keep a waiting list, raise ticket prices, or invest in a larger venue if strong demand is expected to continue.
Judgement: investment in extra capacity is most convincing when managers expect demand to remain high long enough for the additional sales and contribution to justify the cost.
4.3.2
Outsourcing
OutsourcingUsing other producers or specialist providers to undertake some of the business's operations.
A business may outsource activities it does not consider central to its main purpose, such as catering, security or customer-service call centres. It may also outsource important production when it needs extra capacity to meet customer orders.
The businessDecides which activity or output is required.
→External specialistPerforms the agreed activity or produces output for the business.
Why a business may outsource
Specialist expertise
An external provider may have equipment, knowledge or experience that would be uneconomic for the business to develop itself.
Lower costs
A specialist provider may operate efficiently at a larger scale, making it cheaper than performing the activity in-house.
More capacity
Outsourcing can help the business meet demand without immediately investing in more internal resources.
Example: a school may outsource production of a prospectus because a printing specialist already owns the required equipment and can produce a relatively small print run more efficiently.
What managers must consider before outsourcing
CostThe supplier needs to make a profit, so managers must compare the full outsourced cost with producing internally.
QualityThe provider may offer better specialist quality, but standards and monitoring must be clear because direct control is reduced.
ReliabilityThe supplier must deliver on time so that the rest of the business's operations are not delayed.
EmployeesMoving work outside the business can threaten internal jobs and may lead to workforce resistance.
Outsourcing: advantages and disadvantages
| Possible advantage | Why it may matter | Possible limitation |
|---|---|---|
| Access to specialists | The business can use expertise or equipment it does not possess. | The business becomes dependent on another organisation. |
| Potentially lower costs | A specialist may benefit from scale and experience. | The provider adds its own profit margin, so outsourcing is not automatically cheaper. |
| Extra capacity | Orders can be met without immediate internal expansion. | Quality and delivery may be harder to control directly. |
| Focus on core activities | Managers can concentrate on the operations they regard as most important. | Existing employees may resist if jobs or responsibilities are transferred outside. |
Evaluation: the strongest answers compare outsourcing with the realistic in-house alternative. The decision should consider cost, quality, reliability, capacity needs and the effect on employees rather than assuming outsourcing is automatically more efficient.
4.3 revision checklist
Define capacity and explain what determines it.
Calculate capacity utilisation using the correct formula.
Calculate maximum capacity when output and utilisation are given.
Explain why low capacity utilisation can increase unit costs.
Explain the effects of capacity under-utilisation.
Explain ways to increase capacity utilisation.
Define rationalisation and subcontracting.
Explain the risks of operating close to full capacity for too long.
Explain responses to a temporary capacity shortage.
Evaluate when expanding capacity is appropriate.
Define outsourcing.
Explain why specialist expertise may encourage outsourcing.
Explain how outsourcing may increase available capacity.
Evaluate the cost and quality implications of outsourcing.
Explain why supplier reliability matters when outsourcing.
Evaluate the effect of outsourcing on the existing workforce.
Questions open in a pop-up. Each answer is marked immediately, with an explanation so you know why it is correct or incorrect.