This is a detailed article about capacity shortage.
Capacity in business is the maximum output that a business can produce in a given period with the available resources. It is a measure of the business’s ability to deliver goods or services to its customers. Capacity can be measured in terms of physical resources, such as the number of machines or production lines, or in terms of human resources, such as the number of employees or hours of labor available.
What is capacity shortage?
Capacity shortage exists when the current levels of demand for a business’s products are more than the full production capacity of a business.
High levels of capacity utilization will typically lead to low unit Fixed Costs (FC).
How to overcome capacity shortage?
When making decisions about how to deal with increasing capacity it is important to consider both the length of time that the capacity shortage might exist for and the causes of the problem. Before this question can be answered, the time factor needs to be considered. So, what options do firms have when attempting to increase?
A. SHORT-TERM PROBLEM OF CAPACITY SHORTAGE
This might be caused by any unexpected orders from customers.
SOLUTION 1: Outsourcing. When the firm does not have enough capacity, consider using help from external businesses that can undertake a part of the production process for you, or help supply the firm’s products. You will simply buy supplies, components or even finished goods from other firms. Using subcontractors instead of doing everything within the business using the firm’s own employees should be quite quick to arrange and can offer much greater flexibility. No major capital investment is required in expansion of facilities. And when demand falls back, then the contracts with other firms can be suspended or ended. However, the business has less control over quality of output, uncertainty over delivery times and questions about transportation costs. All these factors may increase the unit cost than ‘in-house’ production. Moreover, due to the supplier’s profit margin the firm’s profit margins are likely to be lower (prices constant) or prices need to be raised (profit margins constant) which may reduce the demand for a firm’s products.
NOTE: Business Process Outsourcing (BPO) is a form of outsourcing that uses a third party to take responsibility for certain business functions, such as marketing, Human Resources (HR) and finance.
B. LONG-TERM PROBLEM OF CAPACITY SHORTAGE
This might be caused by a growing market or new trends.
SOLUTION 1: Expanding production facilities. This option will be the most suitable for businesses that experience long-term demand for their products as it requires high capital investment in expansion of production facilities. Long-term increase in total capacity which allows for production economies of scale. The business is in control of quality of its products using latest equipment and modern production methods as well as final delivery times. However, new production facilities require high capital costs. Also, the business may have problems with raising such capital as many sources of finance may not be available. There are also other problems related to:
- Not expanding: Failure to expand capacity in a growing market will lead to a shrinking market share when competitors do expand. Or, becoming increasingly dependent on external contractors to fulfill new orders.
- Expanding too early: Rapid expansion before demand trends become clear will lead to having excess capacity, especially if demand trends change.
- Expanding too late: Slow expansion along with long time necessary to build and equip a new production facility will leave customers empty-handed. Many of them will not wait, but switch to competitors.
In short, capacity management is the process of ensuring that a business has the right amount of capacity to meet customer demand. This involves forecasting demand, planning for production, and managing resources effectively. Capacity management is important for businesses of all sizes, but it is especially important for businesses that operate in competitive industries or that have cyclical demand.
