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Capacity utilisation and profitability: a decomposition of short run profit efficiency

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  • COELLI, Tim
  • GRIFELL-TATJE, Emili
  • PERELMAN, Sergio

Abstract

The principal aim of this paper is to measure the amount by which the profit of a multi-input, multi-output firm deviates from maximum short-run profit, and then to decompose this profit gap into components that are of practical use to managers. In particular, our interest is in the measurement of the contribution of unused capacity, along with measures of technical inefficiency, and allocative inefficiency, in this profit gap. We survey existing definitions of capacity and, after discussing their shortcomings, we propose a new ray economic capacity measure that involves short-run profit maximisation, with the output mix held constant. We go on to describe how the gap between observed profit and maximum profit can be calculated and decomposed using linear programming methods. The paper concludes with an empirical illustration, involving data on 28 international airline companies. The empirical results indicate that these airline companies achieve profit levels which are on average US$815m below potential levels, and that 70% of the gap may be attributed to unused capacity.

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Bibliographic Info

Paper provided by Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) in its series CORE Discussion Papers with number 2001052.

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Date of creation: 00 Nov 2001
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Handle: RePEc:cor:louvco:2001052

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Keywords: capacity utilisation; profit decomposition; technical efficiency; allocative efficiency;

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  1. Winston, Gordon C, 1974. "The Theory of Capital Utilization and Idleness," Journal of Economic Literature, American Economic Association, vol. 12(4), pages 1301-20, December.
  2. Lawrence R. Klein, 1958. "The Measurement of Capacity," Cowles Foundation Discussion Papers 49, Cowles Foundation for Research in Economics, Yale University.
  3. Tulkens, Henry & Vanden Eeckaut, Philippe, 1995. "Non-parametric efficiency, progress and regress measures for panel data: Methodological aspects," European Journal of Operational Research, Elsevier, vol. 80(3), pages 474-499, February.
  4. Berndt, Ernst R & Morrison, Catherine J, 1981. "Capacity Utilization Measures: Underlying Economic Theory and an Alternative Approach," American Economic Review, American Economic Association, vol. 71(2), pages 48-52, May.
  5. Gold, Bela, 1973. "Technology, productivity and economic analysis," Omega, Elsevier, vol. 1(1), pages 5-24, February.
  6. Eilon, Samuel & Teague, Judith, 1973. "On measures of productivity," Omega, Elsevier, vol. 1(5), pages 565-576, October.
  7. Fare, Rolf & Grosskopf, Shawna & Kokkelenberg, Edward C, 1989. "Measuring Plant Capacity, Utilization and Technical Change: A Nonparametric Approach," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(3), pages 655-66, August.
  8. Eilon, Samuel, 1975. "Changes in profitability components," Omega, Elsevier, vol. 3(3), pages 353-354, June.
  9. Eilon, S & Gold, Bela & Soesan, Judith, 1975. "A productivity study in a chemical plant," Omega, Elsevier, vol. 3(3), pages 329-343, June.
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Citations

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Cited by:
  1. Greer, Mark, 2009. "Is it the labor unions' fault? Dissecting the causes of the impaired technical efficiencies of the legacy carriers in the United States," Transportation Research Part A: Policy and Practice, Elsevier, vol. 43(9-10), pages 779-789, November.
  2. Subhash C. Ray, 2004. "The Directional Distance Function and Measurement of Super-Efficiency: An Application to Airlines Data," Working papers 2004-16, University of Connecticut, Department of Economics.
  3. Cheng, Liang-Chieh (Victor), 2011. "Assessing performance of utilizing organizational modularity to manage supply chains: Evidence in the US manufacturing sector," International Journal of Production Economics, Elsevier, vol. 131(2), pages 736-746, June.
  4. Breustedt, Gunnar & Latacz-Lohmann, Uwe & Tiedemann, Torben, 2011. "Organic or conventional? Optimal dairy farming technology under the EU milk quota system and organic subsidies," Food Policy, Elsevier, vol. 36(2), pages 223-229, April.
  5. Zou, Bo & Elke, Matthew & Hansen, Mark & Kafle, Nabin, 2014. "Evaluating air carrier fuel efficiency in the US airline industry," Transportation Research Part A: Policy and Practice, Elsevier, vol. 59(C), pages 306-330.
  6. Dimara, Efthalia & Pantzios, Christos J. & Skuras, Dimitris & Tsekouras, Kostas, 2005. "The impacts of regulated notions of quality on farm efficiency: A DEA application," European Journal of Operational Research, Elsevier, vol. 161(2), pages 416-431, March.
  7. Han, Chaodong & Porterfield, Tobin & Li, Xiaolin, 2012. "Impact of industry competition on contract manufacturing: An empirical study of U.S. manufacturers," International Journal of Production Economics, Elsevier, vol. 138(1), pages 159-169.
  8. Briec, Walter & Kerstens, Kristiaan & Prior, Diego & Van de Woestyne, Ignace, 2010. "Tangency Capacity Notions Based upon the Profit and Cost Functions: A Non-Parametric Approach and a General Comparison," Working Papers 2010/04, Hogeschool-Universiteit Brussel, Faculteit Economie en Management.
  9. Sudipto Sarkar, 2009. "A real-option rationale for investing in excess capacity," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 30(2), pages 119-133.
  10. Kostas Tsekouras & Dimitris Skuras, 2005. "Productive efficiency and exports: an examination of alternative hypotheses for the Greek cement industry," Applied Economics, Taylor & Francis Journals, vol. 37(3), pages 279-291.
  11. Breustedt, Gunnar & Latacz-Lohmann, Uwe & Tiedemann, Torben, 2010. "Organic Or Conventional? Optimal Dairy Farming Technology Under The Eu Milk Quota System And Organic Subsidies," 50st Annual Conference, Braunschweig, Germany, September 29-October 1, 2010 93934, German Association of Agricultural Economists (GEWISOLA).
  12. Hansson, Helena, 2007. "Strategy factors as drivers and restraints on dairy farm performance: Evidence from Sweden," Agricultural Systems, Elsevier, vol. 94(3), pages 726-737, June.
  13. Bruno De Borger & Kristiaan Kerstens & Diego Prior & Ignace Van de Woestyne, 2013. "Static efficiency decompositions and capacity utilization: integrating economic and technical capacity notions," Applied Economics, Taylor & Francis Journals, vol. 45(24), pages 3529-3529, August.
  14. Kalyuzhnova, Yelena & Vagliasindi, Maria, 2006. "Capacity utilization of the Kazakhstani firms and the Russian financial crisis: A panel data analysis," Economic Systems, Elsevier, vol. 30(3), pages 231-248, October.
  15. Sahoo, Biresh K. & Tone, Kaoru, 2009. "Decomposing capacity utilization in data envelopment analysis: An application to banks in India," European Journal of Operational Research, Elsevier, vol. 195(2), pages 575-594, June.
  16. Ruiz, José L., 2013. "Cross-efficiency evaluation with directional distance functions," European Journal of Operational Research, Elsevier, vol. 228(1), pages 181-189.
  17. Wu, Wei-Ming, 2009. "An approach for measuring the optimal fleet capacity: Evidence from the container shipping lines in Taiwan," International Journal of Production Economics, Elsevier, vol. 122(1), pages 118-126, November.
  18. Greer, Mark R., 2008. "Nothing focuses the mind on productivity quite like the fear of liquidation: Changes in airline productivity in the United States, 2000-2004," Transportation Research Part A: Policy and Practice, Elsevier, vol. 42(2), pages 414-426, February.
  19. Itziar Lazkano, 2008. "Cost Structure and Capacity Utilisation in Multi-product Industries: An Application to the Basque Trawl Industry," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 41(2), pages 189-207, October.
  20. Walter Briec & Kristiaan Kerstens & Diego Prior, 2009. "Tangency Capacity Notions Based upon the Pro?t and Cost Functions: A Non-Parametric Approach and a Comparison," Working Papers 2009-ECO-05, IESEG School of Management.
  21. Altendorfer, Klaus & Jodlbauer, Herbert, 2011. "Which utilization and service level lead to the maximum EVA?," International Journal of Production Economics, Elsevier, vol. 130(1), pages 16-26, March.
  22. Haerian, Laila & Homem-de-Mello, Tito & Mount-Campbell, Clark A., 2006. "Modeling revenue yield of reservation systems that use nested capacity protection strategies," International Journal of Production Economics, Elsevier, vol. 104(2), pages 340-353, December.

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