The Cost of Capacity

by Milt Vine

I recently read about a really interesting study in Management Accounting, a publication of which I'm quite fond. (Trust me on this, accounting studies can be fascinating.) The photo of a Heidelberg press on the first page caught my eye, but it was the article's topic that captured my interest.

Entitled "Who is Accounting for the Cost of Capacity?", the article discussed an issue that is an "elephant in the lobby" for those of us in manufacturing-you know, one of those huge problems that no one will even acknowledge. We've all been seduced by the siren song of equipment sales literature promising huge increases in throughput. We just know that turning out more pieces per hour will increase profits... or will it?

The article's authors, John Brausch and Thomas Taylor, point out all too clearly that when we fail to identify the cost of underutilized capacity, we give away competitive advantage to companies who do a better job of managing their resources. In our industry, we are under constant pressure to find ways to increase capacity while avoiding increases in fixed costs. Adding new equipment often seems like the easiest, fastest way to increase revenue; however, it may not be the best way to increase profits.

I'd like to describe a scenario from the study because it is frighteningly familiar. "In 1992 a very successful, profitable two-plant manufacturing company built a new facility less than one mile from its already existing largest facility. This new facility did nothing that the older facility was not already doing." (Four-color printing can still be done on a two-color press, right?) The authors go on to describe how management got caught up in the excitement of a new plant, knowing "in its heart that the new plant was the key to becoming a bigger player in the industry." Management had a marketing department that "could easily sell the new capacity." (Hmmmm, never heard that one!) Operations people said the new plant would allow them to "run more efficiently" and "reduce cost per unit." Finance folks put together some great forecasts based on the most favorable scenarios. (Hmmmm, another new one.)

Operation of the new facility resulted in an increase in sales of 30%. (Not bad on the surface). However, fixed costs tripled-and turned the company's profit to a loss! The authors demonstrate that the extra work could actually have been produced in the existing facilities with no increase in fixed costs. They describe the failure to analyze the available data and proceed with unnecessary capital investments as "squandering" precious company resources.

And, even worse, among the 51 company executives interviewed, only three used any systematic method to measure the cost of unused capacity. Interestingly, one of those employed a measure of "opportunity cost," calculating "lost profit margin" resulting from unused capacity. This reportedly "captured senior management's attention" (as I'm sure it would mine).

Hey, listen, I'm as guilty as the next guy. At our shop, we run two shifts, five days a week with some occasional overtime thrown in. I know we're not operating at capacity. Yet I shudder at the management challenge entailed in adding more shifts. How can we schedule the staff? Who will work on the weekend or at night? Where will we find qualified people? Can we sell enough additional work to keep the equipment running all night? So, sometimes I just throw up my hands in frustration, bite the bullet, and buy more equipment, giving up a piece of our margin in the process.

Now, we could get technical and talk about expected vs. practical vs. normal capacity and throw in full absorption costing and cost drivers, but we'll leave that to the experts. The important message is this: If you're thinking of purchasing new equipment, think twice. Instead, look for other ways to increase capacity without increasing fixed costs. Here are a few ideas.

My conclusion, after pondering the study's findings, could best be described as a "blinding flash of the obvious." If we order new equipment without a detailed analysis of the true costs of not employing 100% of what we already have, we are back to the days of "going with the gut"-making critical business decisions based only on what we personally can see, feel, touch, smell and taste. This doesn't seem to me to be the way to get ahead of the local competition, let alone compete with the "big boys and girls" who are ready to gobble up those of us who aren't taking advantage of all our available resources.


Milt Vine is president of Seattle Bindery, a post-production house specializing in custom index tabbing in addition to bindery services including plastic spiral, Wire-O® and perfect binding; folding; stitching; scoring; perforating and trimming services for the trade. You can reach Milt at 206/682-2558. For more information about Seattle Bindery, check out their web site at www.seattlebindery.com ©1997, Seattle Bindery. Reprinted from Seattle Bindery Printing Journal Column #2, September, 1997.

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