Capacity costs are fixed costs associated with running a business, such as rent or IT services. While they can be reduced, they cannot be eliminated without negative consequences. Utilities may or may not be considered capacity costs.
Capacity cost is a type of fixed cost that is associated with the continued operation of a business. Costs of this type typically experience little to no variation from month to month, making managing those resources much easier in terms of adjusting costs without actually impacting production. Addressing the cost of capacity is one of the ways to decrease overhead and allow a company to earn more than a net return on operation without having any chance of reaching production levels.
An example of a capacity cost is renting an office or production facility. This type of expense tends to be consistent from month to month, and can possibly be reduced by renegotiating the monthly rent with the landlord or moving the operation to a new location where the rental rate is lower. If steps are taken to reduce this particular cost, and it can be achieved without interfering with the efficiency of the production process, then the business will increase profits simply by reducing one of its major expenses.
There are situations where the cost of capacity can be reduced by outsourcing certain functions. For example, a small business may choose to reduce costs by hiring an outside company to service its information technology needs, rather than keeping a full-time IT professional on a salary. This reduces the fixed cost of a salary to a fixed cost for a monthly fee to the external partner, which is typically much lower than the cost of providing benefits to an employee. The same approach can be taken with accounting functions such as payroll or billing functions, allowing the business to still manage those tasks efficiently but at a reduced cost.
One characteristic of a capacity cost is that while it is possible to reduce that cost and thus increase the profitability of a business, it cannot be eliminated without creating some type of negative impact on the entire operation. This means that while it is possible to save a great deal of money by outsourcing IT functions, eliminating IT support in any form would eliminate a capacity cost, but would likely result in other issues that would ultimately have a negative impact that could close the deal. business.
There is some difference of opinion as to whether utilities should be classified as a capacity cost. One school of thought holds that public services should be classified in this way, since they are constant and necessary for operation. Others point out that utilities are often variable costs rather than fixed costs, and should be excluded for that reason. Both approaches are viable in terms of considering the cost of capacity, as long as utilities look the same from one economic period to the next.
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