The effect of manufacturing overhead on policies for allocating production capacity

Abstract

This research explores how manufacturing overhead influences profit margins under different capacity allocation policies in a build-to-order context. By applying a multi-period Mixed-Integer-Programming model to assess industries with varying overhead structures, the study establishes a link between the levels of capacity allocation and profitability, underscoring the strategic significance of overhead costs in capacity management decisions. Our results indicate that industries with lower overhead costs benefit more significantly from increased capacity allocation, with up to a 25% improvement in profit, compared to a 5–10% improvement in higher overhead industries. Conversely, at full capacity demand rates, increased allocation levels detrimentally affect profit, particularly in industries with higher overhead ratios. The study utilises a 3-way ANOVA to confirm the significance of these findings, revealing that industry type, demand rates, and allocation levels are critical factors in optimising profit. This research highlights the need for a pragmatic approach to capacity allocation that aligns with industry characteristics and demand levels, steering away from revenue maximisation to a more holistic view of profitability that includes overhead cost management.