Operations and Supply Chain Management Week 5

CHAPTER 5 | STRATEGIC CAPACITY

MANAGEMENT

1. CAPACITY MANAGEMENT IN OPERATIONS AND SUPPLY CHAIN

MANAGEMENT
A dictionary definition of capacity is “the ability to hold, receive, store, or
accommodate.”
In a service setting, this might be the number of customers that can be handled between
noon and 1:00 P.M. In manufacturing, this might be the number of automobiles that can
be produced in a single shift.
When looking at capacity, operations managers need to look at both resource inputs and
product outputs. For planning purposes, real (or effective) capacity depends on what is
to be produced.
While many industries measure and report their capacity in terms of outputs, those
whose product mix is very uncertain often express capacity in terms of inputs.
An operations and supply chain management view also emphasize the time dimension
of capacity.
Capacity planning is generally viewed in three-time durations:
i. Long range—greater than one year. Where productive resources (such as
buildings, equipment, or facilities) take a long time to acquire or dispose of,
long-range capacity planning requires top management participation and
approval.
ii. Intermediate range—monthly or quarterly plans for the next 6 to 18 months.
Here, capacity may be varied by such alternatives as hiring, layoffs, new tools,
minor equipment purchases, and subcontracting.
iii. Short range—less than one month. This is tied into the daily or weekly
scheduling process and involves making adjustments to eliminate the variance
between planned and actual output. This includes alternatives such as overtime,
personnel transfers, and alternative production routings.

Strategic capacity planning – provide an approach for determining the overall

capacity level of capital-intensive resources—facilities, equipment, and overall labor
force size—that best supports the company’s long-term competitive strategy.
A. Capacity Planning Concept
Capacity – The output that a system is capable of achieving over a period of time.
Best operating level – The level of capacity for which the process was designed and the
volume of output at which average unit cost is minimized.
Capacity utilization rate – Measure of how close the firm’s current output rate is to its
best operating level (percent).

B. Economies and Diseconomies of Scale

Idea that as the plant gets larger and volume increases, the average cost per unit drops.
At some point, the plant gets too large and cost per unit increases.
In many cases, the size of a plant may be influenced by factors other than the internal
equipment, labor, and other capital expenditures. A major factor may be the cost to
transport raw materials and finished product to and from the plant. A cement factory,
for example, would have a difficult time serving customers more than a few hours from
its plant.

C. Capacity Focus
Focused Factory – A facility designed around a limited set of production objectives.
Typically, the focus would relate to a specific product or product group.
Plant within a Plant (PWP) – An area in a larger facility that is dedicated to a specific
production objective (for example, product group). This can be used to operationalize
the focused factory concept.

D. Capacity Flexibility
Capacity flexibility means having the ability to rapidly increase or decrease production
levels, or to shift production capacity quickly from one product or service to another.
i. Flexible Plants - Perhaps the ultimate in plant flexibility is the zero-changeover-
time plant. Using movable equipment, knockdown walls, and easily accessible
and reroutable utilities, such a plant can quickly adapt to change.
ii. Flexible Processes - Flexible processes are epitomized by flexible manufacturing
systems on the one hand and simple, easily set up equipment on the other.

2
 1. Economies of scope - When multiple products can be produced at lower
cost in combination than they can be separately.
iii. Flexible Workers - They require broader training than specialized workers and
need managers and staff support to facilitate quick changes in their work
assignments.

2. CAPACITY PLANNING
A. Considerations in Changing Capacity
i. Maintaining System Balance
In a perfectly balanced plant with three production stages, the output of stage 1
provides the exact input requirement for stage 2. Stage 2’s output provides the exact
input requirement for stage 3, and so on. One reason is that the best operating levels for
each stage generally differ.
Various ways of dealing with imbalance:
1. One is to add capacity to stages that are bottlenecks. This can be done by
temporary measures
2. A second way is through the use of buffer inventories in front of the
bottleneck stage to ensure it always has something to work on.
3. A third approach involves duplicating or increasing the facilities of one
department on which another is dependent.

ii. Frequency to Capacity Additions

The cost of upgrading too frequently and that of upgrading too infrequently.
Direct costs include removing and replacing old equipment and training employees on
the new equipment.
Infrequent expansion means that capacity is purchased in larger chunks. Any excess
capacity that is purchased must be carried as overhead until it is utilized.
iii. External Sources of Operations and Supply Capacity
Two common strategies used by organizations are outsourcing and sharing capacity
iv. Decreasing Capacity
Shedding capacity in response to decreased demand can create significant problems for
a firm. More permanent reductions in capacity would typically require the sale of
equipment or possibly even the liquidation of entire facilities.

B. Determining Capacity Requirements

Address the demands for individual product lines, individual plant capabilities, and
allocation of production throughout the plant network.

3
 iv. Use forecasting techniques (see Chapter 18) to predict sales for individual
products within each product line.
v. Calculate equipment and labor requirements to meet product line forecasts.
vi. Project labor and equipment availabilities over the planning horizon.
Often, the firm then decides on some capacity cushion that will be maintained between
the projected requirements and the actual capacity measured as a percentage in excess
of the expected demand.
Capacity Cushion - Capacity in excess of expected demand.
When a firm’s design capacity is less than the capacity required to meet its demand, it is
said to have a negative capacity cushion.

2. USING DECISION TREES TO EVALUATE CAPACITY ALTERNATIVES

A convenient way to lay out the steps of a capacity problem is through the use of
decision trees. A decision tree is a schematic model of the sequence of steps in a
problem and the conditions and consequences of each step.
Decision trees are composed of decision nodes with branches extending to and from
them. Branches from decision points show the choices available to the decision maker;
branches from chance events show the probabilities for their occurrence.
In solving decision tree problems, we work from the end of the tree backward to the
start of the tree. In calculating the expected value, the time value of money is important
if the planning horizon is long.
Once the calculations are made, we prune the tree by eliminating from each decision
point all branches except the one with the highest payoff. This process continues to the
first decision point, and the decision problem is thereby solved.

3. PLANNING SERVICE CAPACITY

A. Capacity Planning in Services versus Manufacturing
i. Time - Unlike goods, services cannot be stored for later use. The capacity must
be available to produce a service when it is needed.
ii. Location – In face-to-face settings, the service capacity must be located near the
customer. In manufacturing, production takes place, and then the goods are
distributed to the customer. The capacity to deliver the service must first be
distributed to the customer (either physically or through some communications
medium, such as the telephone), then the service can be produced.
iii. Volatility of Demand - The volatility of demand on a service delivery system is
much higher than that on a manufacturing production system for three reasons.
First, as just mentioned, services cannot be stored. The second reason is that the

4
 customers interact directly with the production system—and these customers
often have different needs, will have different levels of experience with the
process, and may require a different number of transactions. The third reason
for the greater volatility in service demand is that it is directly affected by
consumer behavior.

B. Capacity Utilization and Service Quality

Planning capacity levels for services must consider the day-to-day relationship between
service utilization and service quality. The term arrival rate refers to the average
number of customers that come to a facility during a specific period of time. The service
rate is the average number of customers that can be processed over the same period of
time when the facility is operating at maximum capacity.
In the critical zone, customers are processed through the system, but service quality
declines. Above the critical zone, where customers arrive at a rate faster than they can
be served, the line builds up and it is likely that many customers may never be served.
The optimal utilization rate is very context specific. Low rates are appropriate when
both the degree of uncertainty and the stakes are high.