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Introduction - Definitions
Capacity can be defined as the ability to hold,
receive, store, or accommodate

Capacity planning is an approach for

determining the overall capacity level of
capital intensive resources, including facilities,
equipment, and overall labor force size
Examples of Capacity
Amount of output that a system is capable of
Number of customers Served within a specific period
Number of products produced in a single shift
Real or effective capacity depends on what is to be
Amount of resource inputs available relative to
output requirements
Strategic Capacity Planning
Helps determine overall capacity level of
capital intensive resources
Capacity level selected has impact on:
Firms service rate
Cost structure
Inventory policies
Management and staff support requirements
Capacity Level
Inadequate capacity leads to:
Slow service
Loss of customers
Entry of new competitors
Excess capacity
Reduction in prices to stimulate demand
Underutilization of workforce
Carrying excess inventory
Seeking additional, less profitable products
Capacity Planning Concepts
Best operating levels design capacity
Capacity utilization rate how close to best
operating level
Capacity utilization rate = (Capacity used) /
(Best Operating Level)
Capacity Utilization

Capacityutilization rate
Best operatinglevel
Capacity used
rate of output actually achieved
Best operating level
capacity for which the process was designed
Best Operating Level
Example: Engineers design engines and assembly lines to
operate at an ideal or best operating level to maximize
output and minimize ware

unit cost
of output Underutilization Overutilization
Best Operating

Example: Capacity Utilization
During one week of production, a plant produced 83
units of a product. Its historic highest or best utilization
recorded was 120 units per week. What is this plants
capacity utilization rate?

Capacity utilization rate = Capacity used
Best operating level

= 83/120
=0.69 or 69%
Economies of Scale
Average cost per unit of output drops as plant gets
Plants also gain efficiencies when they become large
Diseconomies become a problem when plants
become too large
Size of plant influenced by external factors:
Cost of transporting raw materials and products
Potential market size
Effect of Learning Curve
Plants gain experience as they produce more
Cost of production falls in a predictable manner
Learning curve percentage vary across industries
Large plants gain both from economies of scale and
learning curve advantages
Product must meet customers needs
Demand must be large to support volume
Illustration: Learning Curve

Cost or Today
price Tomorrow
per unit

Total accumulated production of units

As plants produce more products, they gain experience in the best
production methods and reduce their costs per unit
Economies/Diseconomies of Scale
Economies of Scale and the Learning Curve working

Average plant
unit cost 200-unit
of output plant 300-unit 400-unit
plant plant

Diseconomies of Scale start working

Capacity Focus
Focus on a fairly limited set of production
Difficulty to excel in all aspects of production,
i.e. cost quality, flexibility
Select a limited set of tasks that contribute the
most to corporate objectives
Plants within plants (PWP) may be used
Capacity Flexibility
Ability to rapidly increase or decrease production
Ability to shift production capacity quickly from one
product to another
Achieved through flexible plants, processes and
Flexible plants zero-changeover-time
Flexible processes flexible manufacturing
Flexible workers multiple skills
Capacity Expansion
When adding capacity the following are
System balance
Frequency of capacity addition
External capacity
Example: System Balance
Unbalanced stages of production
per Stage 1 Stage 2 Stage 3
6,000 7,000 5,000
Maintaining System Balance: Output of one stage is the
exact input requirements for the next stage
Balanced stages of production
per Stage 1 Stage 2 Stage 3
6,000 6,000 6,000
Balance System
Perfectly balanced plant is not possible in practice
Best operating levels for various stages of the plant may differ
Variability in product demand and the processes lead to
Dealing with imbalance:
Capacity can be added to stages that are bottlenecks
Buffer inventories in front of bottleneck stages
Duplicating facilities of a department that others depend on
Frequency of Capacity Additions
Costs of upgrading too frequently
Direct costs purchasing equipment
Costs of upgrading too infrequently
Capacity is purchased in larger chunks
Leading to excess capacity
Capacity Upgrade
External Sources of Capacity
May be cheaper to use some existing external
Outsourcing to partners
Share capacity with other firms
Capacity Requirements
Demand for individual product lines
Individual plant capabilities
Allocation of production throughout plant
Determine Capacity
Use forecasting techniques to predict sales
Calculate equipment and labor requirements
Project labor and equipment available over
the planning horizon
Capacity cushion to be maintained
Example: Capacity Requirements
A manufacturer produces two lines of mustard,
FancyFine and Generic line. Each is sold in small
and family-size plastic bottles.

The following table shows forecast demand for the

next four years:
Year: 1 2 3 4
Small (000s) 50 60 80 100
Family (000s) 35 50 70 90
Small (000s) 100 110 120 140
Family (000s) 80 90 100 110
Product from Capacity Viewpoint

Question: Are we really producing two

different types of mustards from the
standpoint of capacity requirements?
Answer: No, its the same product just
packaged differently.
Equipment & Labor Requirements
Year: 1 2 3 4
Small (000s) 150 170 200 240
Family (000s) 115 140 170 200
Three 100,000 units-per-year machines are available for
small-bottle production. Two operators required per
Two 120,000 units-per-year machines are available for
family-sized-bottle production. Three operators required
per machine.
Homework: What are the Year 1 values for capacity,
machine, and labor?
Service Capacity
Service capacity is more time and location
Subject to more volatile demand fluctuations
Utilization directly impacts service quality
Unlike goods, service cannot be stored for later use
Capacity must be available to produce a service
when needed