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.

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