Supplement 7: Capacity and Constraint Management

1. Capacity
• Happens after the selection of a production process.
• Capacity is the throughput, or number of units a facility can hold,
receive, store, or produce in a given time.
• Capacity is a large part of the fixed cost.
• Determines if demand will be satisfied or facility will be idle.
• Can be viewed in three-time horizon.
▪ Long range capacity (< 3 years)
• Adding facilities
• Adding equipment
▪ Intermediate range capacity (36 months – 3 years)
• Adding equipment
• Adding personnel
• Adding shifts
• Build or use inventory.
▪ Short range capacity (> 36 months)
• Scheduling jobs and people.
• Design and Effective Capacity
▪ Design capacity is the maximum theoretical output of a system
in a given period under ideal conditions.
• Maximum units a company can produce under idea
circumstances.
• Expressed as rate.
• Can be measured in terms of beds (hospital) or active
member (Church) or any other unit: it is not always the
amount produced.
• Most companies operate below their design capacity since
it allows them to be more efficient and not stretch
resources to their limits.
▪ Effective capacity is the capacity a firm expects to achieve while
taking in consideration planned operating constraints.
• Often lower than design capacity.
▪ Utilization is the percentage of design capacity actually
achieved.
 • Presents itself according to the following formula:
𝐴𝑐𝑡𝑢𝑎𝑙 𝑂𝑢𝑡𝑝𝑢𝑡
𝑈𝑡𝑖𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 =
𝐷𝑒𝑠𝑖𝑔𝑛 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦

▪ Efficiency is the percentage effective capacity actually used.

• Presents itself according to the following formula:
𝐴𝑐𝑡𝑢𝑎𝑙 𝑂𝑢𝑡𝑝𝑢𝑡
𝐸𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦 =
𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦
• Often companies are evaluated based on this factor.
• Very hard to achieve 100 percent.
• Expected output can be derived with this formula:
𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑂𝑢𝑡𝑝𝑢𝑡 = 𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 ∗ 𝐸𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦
• If inadequate, the capacity must be increased.
• Capacity Consideration
▪ Forecast demand accurately.
• Product life cycle, competition actions and accurate
forecasting can be a challenge.
▪ Match technology increments and sales volumes
• Technology can be a constraint to capacity.
• Large capacity can complicate the job.
▪ Find the optimum operating size.
• Economies and diseconomies often dictate the capacity
and size of a facility in general.
▪ Build for change.
• Build flexibility into facilities.
• Changes occur in processes.
• Managing Demand
▪ Demand > Capacity
• Raising Price
• Scheduling long load times
• Discouraging marginally profitable businesses.
• Long term solution: Increase capacity.
▪ Demand < Capacity
• Stimulate demand.
• Aggressive marketing
 • Accommodate old and inflexible processes.
• Layoffs and closing plants may be necessary to bring
down capacity to be in line with demand.
▪ Adjusting to Season Demands
• Seasonal or cyclic pattern is another challenge for capacity
management.
• Solution: offer products with complementary product
demand: when one demand is low, the other will be high
and vise-versa.

▪ Tactics for Matching Capacity to Demand.

• Making staff changes
• Adjusting Equipements
• Improving Process to increase capacity.
• Redesign product to facilitate capacity.
• Adding process flexibility
• Closing facilities.
• Service Sector Demand And Capacity Management.
▪ Demand Management: is scheduling costumers.
• Capacity and demand are matched, then management can
be handled with
▪ Appointments (Doctor office…)
▪ Reservations (Car agencies…)
▪ First come first serve rule (Restaurants…)
• Each industry has its own method.
• Aggressive method: early bird discounts.
 ▪ Capacity Management is about scheduling the workforce.
• Managing demand is not feasible.
• Need to change in full-time, part-time or temporary staff.
2. Bottleneck Analysis and the Theory of Constraints
• Seeks to match capacity to demand.
• Each interdependent work areas have their own capacity.
• Capacity analysis is determining the capacity of workstations in a
system and ultimately the capacity of the whole system.
• Bottleneck is an operation in a system that is a constraint in a production
system.
▪ Limits the system’s output.
▪ Bottlenecks, as a term, is the bottle of a neck (literally) that
constraints the flow and is used as a metaphor.
▪ Bottlenecks can be found everywhere around us.
• Process time is the amount of time to produce a unit in a station.
▪ For 16 costumers coming in 60 minutes, we can say that the
process time of the station is 3.75 minutes.
• Bottleneck time:
▪ Simply identify the workstation with the highest process time.
▪ Process time for the slowest station.
• Throughput time:
▪ Time it takes a unit to go through the production system from
start to end.
▪ When calculating it, we assume that there is no waiting at all.
• The bottleneck time determines the system’s capacity (Unit/minute)
and the throughput time determines the ability to produce new units
from scratch in the next 25 hours.
• In the following example, we can claim that the process time of a toaster
is 20 seconds, while it takes 40 seconds to toast.
▪ The reason is that it is a parallel station: two sandwiches can be
toasted in 40 seconds, hence the average time for one sandwich
is 20 seconds.
▪ It makes the process faster.
▪ Cannot be applied if the parallel stations are not identical.

▪ In the example above, the hygienist cleaning and x-ray exam are
not identical stations and hence their process time is respectively
24 minutes and 5 minutes.
• Theory of Constraints
▪ Theory of Constraints deals with anything that limits the
organization’s ability to achieve its goals.
▪ Can be physical constraints or nonphysical constraints.
▪ Five steps:
• Identify constraint(s)
• Develop a plan to overcome it.
• Focus on resources to overcome it.
• Reduce the effect of constraints (expand capability,
offload…)
• Go back to step one an identify the new constraint.
• Bottleneck management
▪ The most crucial constraint is the bottleneck.
▪ Managers must focus their attention on removing it.
▪ Four ways to manage bottlenecks:
• Release work orders to the system at the pace set by the
bottleneck capacity.
▪ Uses theory of drum, buffer, rope.
▪ Drum is the beat of the system.
 ▪ Buffer is the resources, usually inventory. It is
helpful to keep the bottleneck operating at the pace
of the drum.
▪ Rope provides synchronization and communication
necessary to pull units through the system.
• Lost time at the bottleneck represents lost capacity for the
whole system.
▪ Bottleneck should always eb busy with work.
• Increasing the capacity of non-bottlenecks stations is a
mirage.
▪ It has no impact on the system’s capacity.
▪ It will just create extra inventory.
• Increasing the capacity of bottleneck increases the
capacity of the whole system.
▪ Improvement efforts should be dedicated to the
bottleneck.
▪ Can be improved by many means.
▪
3. Break-Even Analysis
• Break-even analysis is a critical tool for determining the capacity a
facility must have to achieve profitability.
 • Objective: find the point, in dollars and volume, where costs are equal
to revenue. It is called the break-even point.
▪ Firms must operate above this point in order to make a profit.
• Break-even analysis requires the estimation of
▪ Fixed Costs (F): costs that continue, even if no units are
produced.
▪ Variable Costs (V): vary with the volume of units produced.
▪ Price per Unit (P): Price each unit is sold for.
• Single Product Case
▪ Case if the firm is focusing on the revenue incurred by one
product.
▪ (Full demonstration of derived formulas are in the book)
𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡 𝐹
𝐵𝐸𝑃(𝑥 ) = =
𝑃𝑟𝑖𝑐𝑒 − 𝑉𝑎𝑟𝑖𝑏𝑎𝑙𝑒 𝐶𝑜𝑠𝑡 𝑃 − 𝑉

𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡 𝐹
𝐵𝐸𝑃($) = =
𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡 𝑉
1− 1−
𝑃𝑟𝑖𝑐𝑒 𝑃
• Multiproduct Case
▪ Most firms, many products are evaluated at the same time.
▪ Each one as a certain percentage of making the final revenue, W.
▪ The formula in this case will be
𝐹
𝐵𝐸𝑃($) =
𝑉𝑖
∑[(1 − ) ∗ 𝑊𝑖]
𝑃𝑖

4. Reducing Risk with Incremental Value

• Determining capacity after the break-even point might be more
difficult.
• Lead Capacity is capacity needed to stay ahead of demand.
5. Applying Expected Monetary Value (EMV) to Capacity
Decisions.
• Determing EMV requires two or more alternatives and various states of
natures.
• It happens as follows.