Learning Objective 4 Identify unused capacity and learn how to manage it
As we saw in our discussion of the productivity component (see section Productivity Component of Change in Operating Income), fixed costs are tied to capacity. Unlike variable costs, fixed costs do not change automatically with changes in activity levels (for example, fixed conversion costs do not change with changes in the quantity of silicon wafers started into production). How then can managers reduce capacity-based fixed costs? By measuring and managing Unused capacity, which is the amount of productive capacity available over and above the productive capacity employed to meet customer demand in the current period.
Cost-leadership strategies require managers to pay special attention to capacity costs. Companies such as United Airlines have struggled to achieve profitability because of the difficulties they have had in managing capacity-related fixed costs. For a given number of flights, most of United’s costs, such as the cost of airplane leases, fuel, and wages, are fixed. United must anticipate future revenues and decide on a level of capacity and the related costs. If revenues fall short, it is difficult for United Airlines to reduce its costs quickly.
Consider conversion costs. At the start of 2019, Chipset committed to capacity to process 3,750,000 square centimeters of silicon wafers for the year. Chipset ended up producing 1,000,000 units of CX1 by processing 3,000,000 square centimeters of silicon wafers in 2019. Unused manufacturing capacity for 2019 is 750,000 square centimeters of silicon-wafer processing capacity. At the 2019 conversion cost of $4.28 per square centimeter,