Abstract
We present an elaborate numerical example of a competitive manufacturing industry in the United States facing demand fluctuations to illustrate cost of idle capacity in manufacturing. We show that given demand fluctuations, such as the business cycle, significant cost of idle capacity is not only ordinary and necessary but desirable! We recommend manufacturing firms in the United States increase outsourcing major parts and components to increase output-rates flexibility. Outsourcing is rising in recent years with advances in internet, computers, and telephone. Manufacturers today can depend on getting needed parts “just-in-time” from outside suppliers without maintaining inventories of parts or capacity to produce parts.
Highlights
Clark attributed the main problems of the business cycle to the dominant role of fixed costs that are incurred irrespective of output rates: “It is needless to point out that overhead costs play a fundamental part in the behavior of business at every stage of that many-sided phenomenon, the business cycle
The part they play is most paradoxical. For they make regular operation peculiarly desirable and peculiarly profitable, so that business feels a definite loss whenever output falls below normal capacity, yet it is largely due to this very fact of large fixed capital that business breads these calamities for itself, out of the laws of its own being
Baxendale-Foster showing cost of idle capacity by activity is an important refinement over Sopariwala, who shows just the total idle capacity to the firm
Summary
In our Cost Management March/April 2011 article [2] we argued, referring to Baxendale-Foster Cost Management September/October 2010 article [3]:. Clark advocated cost accountants to isolate cost of idle capacity from cost of producing goods. Baxendale-Foster showing cost of idle capacity by activity is an important refinement over Sopariwala, who shows just the total idle capacity to the firm. Baxendale-Foster has a good discussion, showing the importance of isolating cost of idle capacity. We can hope cost-accountants will do as Baxendale-Foster illustrates: use ABC costing and isolate cost of idle capacity by activity. I. Cost Management September/October 2014 [5] they note with approval: “Aranoff proposes a further refinement to consider activity capacity constraints to separate the cost of idle capacity in Baxendale and Foster and Sopariwala into excess capacity cost and idle-capacity cost. The caveat in the above articles is the importance of considering the cost of idle capacity in determining the economic cost for pricing and efficient management of operations”
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