What is a 'Capacity Cost'

A capacity cost is an expense incurred by a company or organization in order to provide for or increase its ability to conduct business operations. Capacity costs are associated with things that allow a business to increase its production above a set point or reach markets beyond their current distribution network. Capacity costs are a given in business if the business wishes to grow beyond its current production capacity and generally can be reduced or avoided only by reducing staff or shutting down business locations, both of which may reduce capacity, or outsourcing.

BREAKING DOWN 'Capacity Cost'

Capacity costs include a wide range of cost types. Some are fixed and are not affected by small shifts in business productivity. Typical examples of this nature are items such as rent or lease payments, depreciation on equipment or machinery, property taxes, insurance and basic utilities such as heating. If a company greatly increases its sales and needs to increase its production to make sure products are available to its new customers, the business may need to add additional manufacturing facilities. That would increase all of the mentioned capacity costs.

Capacity costs can also be more closely related to consumer demand. If a distribution center is experiencing a period of high volume due to increased sales productivity, they might add additional workers or additional shifts to keep up with the high demand. These increases in personnel are also capacity costs, as they allow the business to increase its production capacity. Once the high volume period passes, the company can scale back on personnel to reduce their costs.

RELATED TERMS
  1. Capacity Management

    Capacity management is the management of the limits of an organization's ...
  2. Aggregate Capacity Management

    Aggregate capacity management is the process of planning and ...
  3. Global Crossing

    Global Crossing is a company that filed for bankruptcy protection ...
  4. Underwriting Capacity

    Underwriting capacity is the maximum liability that an insurance ...
  5. Throughput

    In business, the rate at which an organization reaches a given ...
  6. Production Cost

    Production costs are costs incurred by a business when manufacturing ...
Related Articles
  1. Investing

    Understanding Marginal Cost of Production

    Marginal cost of production is an economics term that refers to the change in production costs resulting from producing one more unit.
  2. Retirement

    Save More for Your Retirement by Managing Risks

    To fund your lifestyle in retirement you need to balance your risk capacity and tolerance.
  3. Investing

    A Look at The U.S Shale Oil Production Industry

    A convergence of sustained bank financing, falling production costs and rising oil prices might position the US shale industry for a greater market role.
  4. Investing

    It's Finally Time To Bet On Solar

    After experiencing some of the worst years in its history, the solar energy sector could be having one of its best. New installed capacity is growing and will finally overtake wind energy in ...
  5. Investing

    The world's top 10 utility companies

    Learn who the Top Ten utility companies in the world are, along with tips for investing in the utilities sector.
  6. Investing

    Why $50 Oil Won't Be Sustainable (USO, XLE)

    Examine why the recent upswing in oil prices looks to be short-lived, and discover the dynamics between the increasing level of supply and diminishing demand.
  7. Managing Wealth

    Leveraging Leverage For Bigger Profits

    Leverage is like fire. Find out how to use it to heat up your investing without burning your portfolio.
  8. Investing

    Operating leverage captures relationships

    Find out how fixed and variable costs interact to shed new light on old companies.
  9. Investing

    Would Airlines Be Better Off With $100 Oil? (DAL, LUV)

    The cost of jet fuel -- the biggest expense for most airlines -- has declined by about $1 per gallon since this time last year. As a result, airlines have been among the biggest beneficiaries ...
  10. Investing

    Key Financial Ratios for Manufacturing Companies

    An investor can utilize these financial ratios to determine whether a manufacturing company is efficient, profitable and a good long-term investment option.
RELATED FAQS
  1. What are the types of costs in cost accounting?

    Cost accounting aids in decision-making by helping a company's management evaluate its costs. There are various types of ... Read Answer >>
  2. What's the difference between production cost and manufacturing cost?

    Learn more about fixed and variable expenses incurred by businesses. Find out how production and manufacturing costs impact ... Read Answer >>
  3. What economic indicators do oil and gas investors need to watch?

    Leading indicators for oil and gas investments are centered around the levels of production, consumer demand and inventory ... Read Answer >>
  4. How Do Fixed and Variable Costs Affect the Marginal Cost of Production?

    Learn about the marginal cost of production and how it is affected by changes in fixed and variable costs. Read Answer >>
Hot Definitions
  1. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  2. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  3. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  4. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
  5. Relative Strength Index - RSI

    Relative Strength Indicator (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent ...
  6. Dividend

    A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders.
Trading Center