A Level Business Studies - Responding to a fall in industry capacity utilisation

Many car manufacturers are expected to respond to a fall in overall capacity utilisation in the industry by cutting prices. To what extent is cutting prices a good way for any business to respond to a fall in the overall capacity utilisation in its industry?

Capacity utilisation is the percentage of total capacity that is actually achieved in a period of time. The extent to which cutting prices is a good way for a business to respond to a fall in capacity will depend on the price elasticity. This essay will look at whether it is good for all businesses or not.

Cutting prices would lead to the product becoming more accessible. Reducing overall capacity utilisation means that the business will have higher costs as demand is lower; goods being sold will not have their revenue spread across the fixed costs. A Daihatsu car may work to combat this because a car is a luxury product and is price elastic, meaning that demand will change as the price does. A fall in selling price will mean there will be increased demand and sales, therefore increasing sales revenue. This would be beneficial for a business experiencing low capacity utilisation – the benchmark figure is 90% - as they would be able to regenerate and compensate the capital lost from having higher unit costs as a result of poor capacity utilisation. An example of this is service providers like hotels, planes and trains. Companies in these industries will operate on a price discrimination strategy, charging customers different prices for the same service in order to sell the remaining tickets or seats they have, preventing wastage. It may be difficult for some businesses to cut prices, namely designer brands which may suffer a blow to their reputation as these companies use their quality as a means to sell the product. Cutting prices is therefore a good way for some businesses to respond to a fall in industry capacity utilisation, however there are certain factors it requires from a business which means it cannot work for all.

A better way for a business to respond would be by reducing capacity. This could be done through the sale of assets like machinery or land, or perhaps through making current employees in the business redundant. Doing so would lead to an increase in capacity utilisation as the overall capacity lowers, decreasing the unit cost for each product made. Service sector businesses would be able to cope with this as they already employ temporary workers, meaning capacity can increase easily and quickly. An example of this may be a seasonal café which experiences most of its business in the summer months. This method has the chance of working for more businesses that the option of cutting costs as it has little effect on reputation and brand image, and also keep production costs at a lower expense than previously, making the business more competitive in a crowded market. This may be a strategy for Daihatsu to consider as the issue regarding capacity utilisation is industry wide, and so being the first to take action would give them a competitive edge, meaning they could experience more demand from consumers.

In conclusion, cutting prices is only a good way for some businesses in response to lower capacity utilisation. This method of trying to solve the problem only works for certain types of businesses as it depends on price elasticity of demand and whether the business wants to be dealt a blow to its reputation. Cutting prices could be a more short-term response whilst a company handles its finances and assets, giving them time so they can come up with a more detailed plan on lowering maximum capacity.