Q&A - Operations - What is spare capacity and does it matter?

When a business is operating at less than 100% capacity, it is said to have “spare capacity”. What are the cause of spare capacity and does it matter?

There are several reasons why a business will operate with spare capacity:

Lower demand:
- General reduction in overall market demand (e.g. during the credit crunch)
- Loss of market share (perhaps unsuccessful marketing, competitors introduce better product)
- Seasonal variation in demand - i.e. temporary, but expected spare capacity

Increase in capacity not yet matched by increased demand
- Possibly because new technology has been introduced in anticipation of higher demand in the future
- Improvements in productivity mean capacity increases for a given level of demand
- Be careful that the business has not over-invested in fixed assets

Provide some “slack”
- Allow some spare capacity to be able to respond to short-term or unexpected increases in demand
- Provide time for maintenance, repairs and training

Inefficiency
- A problem = less competitive - implies higher unit costs than the competition

Does spare capacity matter?

There are some potential downsides to operating with spare capacity:

- Higher fixed costs per unit produced implies lower profitability than could be achieved
- De-motivated employees: boredom, fear of job losses (factory workers who have been made redundant often say that they could “see it coming” because production had been quiet
- The opportunity cost of the spare capacity - the returns foregone from the cash invested

However, it is often said that a business should maintain a capacity buffer - somewhere around 10% of capacity to allow for unexpected demand, staff training and development