Why is capacity utilisation crucial in production method decisions?

Capacity utilisation is crucial in production method decisions as it directly impacts efficiency, costs, and profitability of a business.

Capacity utilisation refers to the extent to which a firm or a business entity uses its installed productive capacity. It's the relationship between output produced with the resources and time used. In other words, how much of the potential output is actually being realised. When deciding on production methods, businesses need to consider their current and potential capacity utilisation.

High capacity utilisation can lead to increased efficiency as resources are being fully utilised and not wasted. This can result in lower unit costs as the total cost of production is spread over a larger number of units. This can enhance profitability, especially if the firm can sell the extra output.

However, operating at full capacity can also have drawbacks. For instance, machinery may be overused leading to more frequent breakdowns and higher maintenance costs. Workers may also be overworked, leading to fatigue and lower productivity in the long run. Therefore, businesses need to strike a balance and operate at an optimal level of capacity utilisation.

On the other hand, low capacity utilisation means that a business has resources that are not being used to their full potential. This can lead to higher unit costs as the fixed costs of production (such as rent and salaries) are spread over fewer units. This can reduce profitability.

Moreover, low capacity utilisation can indicate that a business has too much capacity, which might have been caused by poor demand forecasting or overinvestment in production capacity. This can tie up capital that could have been used elsewhere in the business.

In conclusion, capacity utilisation is a key factor in production method decisions. It can help businesses identify inefficiencies and make necessary adjustments to improve profitability. Therefore, businesses should regularly monitor and manage their capacity utilisation to ensure they are operating at an optimal level.