Excess Capacity

For almost all businesses, production and sales are primary operations. Excess capacity is a result of production in excess of market demand. It is helpful to understand the role of production and excess capacity in order to create a profitable and efficient business.

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We will define excess capacity, look at its causes, describe why it is important and as well answer commonly asked questions about excess capacity.

Table of Contents

What is Excess Capacity?

A term used to describe when a business produces a product or services that exceeds the market’s demand is known as Excess Capacity. The capability to produce and manufacture products or services to generate output is known as capacity. When you calculate capacity, it helps to create output expectations and establish an organization’s actual output in order to prevent a scenario whereby there is low or excess capacity. It also offers insight into how effective an organization’s operational procedures and also the demand for a particular product or service.

Excess capacity can be an indicator of a healthy business growth, most organizations would rather meet market demands than exceed it. By doing this, there is a reduction in production costs and remains profitable. Excess capacity can be beneficial to consumers, as it could force organizations to sell their products or services at lower prices due to excess of the product and services.

Why Does Measuring Excess Capacity Matter?

There is a benefit excess capacity can have on businesses and consumers but when there is much excess, it can introduce obstacles and limit the ability of a company to earn a profit.

By identifying excess capacity will assist an organization to strategize to reduce capacity and sell any excess products or services. If a company experiences excess capacity and then decides to sell excess products at a cost equal to its production, at least money from production should be recovered. A new marketing and sell strategy to prevent excess capacity in the future can be created.

What Causes Excess Capacity?

Once an organization identifies common causes of excess capacity, they may be able to develop strategies to prevent it from occurring. Excess capacity may occur due to the following reasons?

Organizations investing heavily in manufacturing of products.
Human error while capacity predictions were created.
Similar products are sold by competitors thereby creating repressed demand.
When supply and demand are misunderstood.
Financial resources are allocated ineffectively.
Adhering to unrealistic business goals.

Frequently Asked Questions (FAQs)

How can a business manage excess capacity?

A great way to understand the efficiency of a business and gain insight into the demand for your services and products is by calculating capacity utilization rates. If after you calculate capacity utilization rates and you realize your business experiences excess capacity, you might consider the following management strategies.

Production rates should be reduced
The price of products should be lowered
Create a prevention procedure by testing different situations in which excess capacity may occur.
Allocation of financial resources methods should be improved.
Eliminate excess products by creating a sales promotion.
A financial advisor should be hired to implement better practices of capacity management.
Production rates should be compared to competitive organizations to gain insight into market demand.

How do you calculate excess capacity?

For excess capacity to be calculated effectively, the following formula should be used:

Excess capacity = total capacity – actual output.

Without increasing costs and reducing profits, potential output is the maximum output your organization may accomplish. The exact number of goods and services produced in a particular time period is the actual output. For instance, if you own a grocery company and you order 150 products, but you sell 100 products, you may determine that you have an excess capacity of 50 products.

What are the benefits of excess capacity?

It can be vital to an organization because it ensures that organizations don’t exhaust its products for a period of time. Excess capacity is beneficial to consumers as organizations will likely sell their products at a lower price. Other benefits are;

To identify wastage of products or financial allocations.
Effective strategies for capacity utilization can be actualized.
Product quality and efficiency are increased.
Insight into methods can be gained that can lead to lower product manufacturing costs.