How Economically Significant Are Unused Capacity Costs? A Large-Scale Empirical Analysis

Management Science, Forthcoming

70 Pages Posted: 9 Mar 2017 Last revised: 13 Sep 2019

See all articles by Merle Ederhof

Merle Ederhof

Stanford University

Venky Nagar

University of Michigan, Stephen M. Ross School of Business

Madhav V. Rajan

Booth School of Business, University of Chicago

Date Written: Auguest 9, 2019

Abstract

This study uses a confidential Census sample of 151,900 U.S. manufacturing plant-years from 1974-2011 to investigate the impact of excluding the costs of unused capacity from key financial indicators, namely product costs and gross margins. We estimate the magnitude of unused capacity cost as a percent of sales to be about 4.8 percent, which for Compustat manufacturing firms in 2011 amounts to $142 billion (by comparison, the well-researched topic of R&D expense totals to $223 billion). We find that excluding the cost of unused capacity decreases product costs by approximately 6 percent and increases gross margins by around 26 percent. These magnitudes are economically significant and pervasive across industries and over time. Excluding the cost of unused capacity also smooths the time-series variation in unitized product costs and gross margins, with the standard deviation of gross margins declining (significantly) by 5 percent. Additional analyses indicate the presence of congestion and other costs at high capacity utilization levels, as predicted by the operations literature.

Suggested Citation

Ederhof, Merle and Nagar, Venky and Rajan, Madhav V., How Economically Significant Are Unused Capacity Costs? A Large-Scale Empirical Analysis (Auguest 9, 2019). Management Science, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2930238 or http://dx.doi.org/10.2139/ssrn.2930238

Merle Ederhof (Contact Author)

Stanford University ( email )

Stanford, CA 94305
United States

Venky Nagar

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States
734-647-3292 (Phone)
734-764-3146 (Fax)

Madhav V. Rajan

Booth School of Business, University of Chicago

1101 East 58th Street
Chicago, IL 60637-1561
United States

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