Capacity utilization refers to the manufacturing and production capabilities that are being utilized by a nation or enterprise at any given time. It is the relationship between the output produced with the given resources and the potential output that can be produced if capacity was fully used.[1]

Background

Capacity utilization can also be defined as the metric used to calculate the rate at which the prospective levels of output are being met or used. The rate is displayed as a percentage and provides an insight into the total utilization of resources and how a company can increase its output without increasing the costs associated with production. The capacity utilization rate is also called the operating rate.

Formula for Capacity Utilisation

The mathematical formula for calculating capacity utilisation is:

Capacity Utilisation Formula

Example of Capacity Utilisation

Suppose XYZ Company is producing 20,000 and it is determined that the company can produce 40,000 units. The company’s capacity utilization rate is 50% [(20,000/40,000) * 100]. If all the resources are utilized in production, the capacity rate is 100%, indicating full capacity. If the rate is low, it signifies a situation of excess capacity or surplus capacity.

It is unlikely that an economy or company will function at a 100% capacity rate as there are always hurdles in the production process (such as the malfunction of equipment or unequal distribution of resources). A rate of 85% is considered the optimal rate for most companies. The capacity utilization rate is used by companies that manufacture physical products and not services because it is easier to quantify goods than services.

Effects of Low Utilisation

Low capacity utilization is a problem for fiscal and monetary policymakers who use such policies to stimulate the economy. According to World Bank data from late 2018, the manufacturing sector in Zimbabwe accounted for about 8.18% of Gross Domestic Product (GDP). This is down from its level in 2016 and 2017 when it accounted for 11.59% and 10.78% of the country's GDP, respectively.

In order to revive the manufacturing sector from its 2019 state, a number of recommendations were to be made. These include the development of new policies to support manufacturers, the promotion of local content, an equitable distribution of energy in the productive sector and commitment to sustainable agricultural development.[2]

Capacity Utilisation in Zimbabwe

According to the Confederation of Zimbabwe Industries’s (CZI) 2019 CZI Manufacturing Sector Survey, industry’s capacity utilisation fell by 11.8 percentage points to 36.4% in 2019 from 48.2% recorded in 2018. This prompted CZI to project that industry’s capacity utilisation was to fall to 27% in 2020 if the government does not change its policy direction.[3]

Driving the decline in the manufacturing sector’s capacity utilisation was a combination of low output due to energy challenges, inflation (Zimbabwe Inflation Rates) and foreign currency shortages. There is an interplay between these factors where forex shortages results in low energy imports, while there is also a direct relationship between the movement in exchange rates and inflation.

As Zimbabwe’s economy keep getting worse, most of the companies are facing underutilisation of capacity because of working capital requirements. There is less demand because of low buying capacity of consumers, whilst companies operations are also blighted by antiquated machinery which constantly breaks down.[4]

This demonstrates the failure of both government and private-sector efforts to arrest de-industrialisation mainly due to the absence of funding to bailout struggling local companies, serious energy challenges, rising inflation, depressed consumer spending, which is also expected to remain constrained.



References

  1. [1], Corporate Finance Institute, Accessed: 19 November, 2020
  2. [2], Ecofin Agency, Published: 18 February, 2020, Accessed: 19 November, 2020
  3. Tatira Zwinoira, [3], The Standard, Published: 16 February, 2020, Accessed: 19 November, 2020
  4. Raynold Mhotseka, [4], Equity Axis, Published: 14 February, 2020, Accessed: 19 November, 2020