Strategic Capacity Management: Discussion Questions

Chapter 05 - Strategic Capacity Management
CHAPTER 5
STRATEGIC CAPACITY MANAGEMENT
Discussion Questions
1. What capacity problems are encountered when a new drug is introduced to the market?
The primary concerns come from uncertain demand for the drug and the high capital investment
typically needed for modern drug production. Being a new drug, there are no historical sales data on
which to base forecasts of future demand. If forecasts are too high, significant capital resources will
be underutilized. If forecasts are too low, there may be insufficient capital resources to meet the
actual demand, resulting in lost sales when the price for the new drug is typically highest.
2. List some practical limits to economies of scale; that is, when should a plant stop growing?
The obvious answer is that a plant should stop growing when its long-run average cost curve hits the
inflection point and starts increasing. Factors leading to this situation include difficulties
coordinating and managing a facility of that size, demand variations that can lead to regular periods
of low capacity utilization, and capacity imbalance within the facility.
3. What are some capacity balance problems faced by the following organizations or facilities?
a. An airline terminal
Congested flight arrival/departure scheduling typically leads to problems throughout the system,
including waiting areas, distances from boarding gates, ground crew requirements, runways,
baggage handling, etc.
b. A university computing lab
The number of computer workstations, the size of each workstation (room for student papers, etc.),
the mix of different computer types (Mac or PC), the number of printers, the capacity of the network
access, study space for students waiting. These problems are exacerbated by surges in demand
during certain points in the semester (e.g. finals week).
c. A clothing manufacturer
Many manufacturers now use highly decentralized shops to make clothes. This means that capacity
of multiple sites must be accounted for in planning production.
4. At first glance, the concepts of the focused factory and capacity flexibility may seem to contradict
each other. Do they really?
This is not necessarily true. This will depend on the available technology of the facility and on the
type of industry it competes in. An FMS plant may, for example, use flexible processes to enlarge the
variety of products produced and delivered in a very short time. Therefore, it can choose to compete
5-1
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on fast delivery of customized products rather than on cost. The PWP concept can capitalize on the
overall facility economies of scale while maintaining focus within each individual PWP.
5. Management may choose to build up capacity in anticipation of demand or in response to

developing demand. Cite the advantages and disadvantages of both approaches.
The strategy of building up capacity ahead of demand is a risk-taking stance. Investment is based on
projections. This investment involves costs for new facilities, equipment, human resources, and
overhead. If the demand materializes, the investment is worthwhile since the firm may capture a
large amount of market share. If it does not materialize, the firm must redirect the invested
resources. This strategy is most appropriate in high growth areas.
If the demand materializes, but the capacity planning strategy is risk averse, i.e., building capacity
only as demand develops, then most likely market share will be lost. The growth in demand will
encourage new entrants, resulting in more competition. The risk averse strategy may be most
appropriate for small firms who cannot afford to invest in unproven prospects. To prevent potential
loss of market share, firms may choose to incrementally increase capacity to match the increase in
demand.
6. What is capacity balance? Why is it hard to achieve? What methods are used to deal with capacity
imbalances?
In a perfectly balanced plant, the output of each stage provides the exact input requirement for the
subsequent stage. This continues throughout the entire operation. This condition is difficult to
achieve because the best operating levels for each stage generally differ. Variability in product
demand and the processes may also lead to imbalance, in the short run.
There are various ways of dealing with capacity imbalances. One is to add capacity to those stages
that are the bottlenecks. This can be achieved by temporary measures such as overtime, leasing
equipment, or subcontracting. Another approach is to use buffer inventories so that
interdependence between two departments can be loosened. A third approach involves duplicating
the facilities of one department upon which another is dependent.
7. What are some reasons for a plant to maintain a capacity cushion? How about a negative capacity
cushion?
A plant may choose to maintain a capacity cushion for a number of reasons. If the demand is highly
unstable, maintaining cushion capacity will ensure capacity availability at all times. Also, capacity
cushions can be useful if high service quality levels are established. Some organizations choose to use
capacity cushions as a competitive weapon to create barriers to entry for competitors.
Negative capacity cushions may be maintained when demand is expected to decrease rapidly and
capacity investment is high enough to discourage short run capacity acquisitions. It may also make
sense where capital investment needed to achieve a capacity cushion is extremely expensive, and
capacity can be easily increased in the short run by methods such as overtime or subcontracting.
5-2
8. Will the use of decision tree analysis guarantee the best decision for a firm? Why or why not? If not,
why bother using it?
No they cannot, due to the effect of future chance events. First, the probabilities are not known with
certainty, but are just estimates. However, even if the probabilities used are accurate, we are still
just computing expected values. For any one decision, there is no guarantee it will be the best
possible decision. Then why use it? For any one decision you are going with the “best odds” so to
speak. For a series of decisions over time, the best long-term results will come from decision tree
analysis with accurate probabilities.
9. Consider the example in Exhibit 5.5. Can you think of anything else you might do with that example
that would be helpful to the ultimate decision maker?
As with the probabilities in the prior question, the rate of return used in NPV analysis is only an
estimate. The analyst could repeat the decision tree analysis with multiple rates of return,
performing sort of a sensitivity analysis on the decision model with respect to the rate of return. If
the same solution results from all of the analyses, the decision maker can feel more confident in
choosing the recommend approach.
10. What are some major capacity considerations in a hospital? How do they differ from those of a
factory?
Some capacity considerations are size and composition of nursing staff (RNs vs. LPNs), balance
between operating room and intensive care units, emergency rooms, etc., and, of course, how many
beds are to be available. One of the differences in capacity considerations between a hospital and a
factory is that a hospital can add capacity rather quickly in the short run, through “simply” adding
more staff and more beds. A factory is usually technologically limited, and, therefore, must plan well
in advance to add major chunks of capacity. On the other hand, though, the general uncertainty
which surrounds the demand for hospital services on any given day is much greater than would be
faced by a factory. Additionally, factory management generally has the ability to backlog demand in
such a way as to achieve more efficient levels of capacity utilization than does a hospital. Sick and
injured patients cannot be put on a shelf and made to wait during periods of peak demand.
11. Refer to Exhibit 5.6. Why is it that the “critical zone” begins at a utilization rate of about 70 percent
in a typical service operation? Draw upon your own experiences as either a customer or a server in
common service establishments.
Uncertainty in the arrival and service rates is the key problem here. The utilization rate of 70 percent
is based on the average arrival rate and service rate. As most of us have observed, both can vary
widely throughout the day or even from one customer to the next. Sometimes things just “get busy”
as more customers than average arrive during a short time window. Also, a “problem customer” or
two can greatly extend the time to service them and consume valuable resources. Even though the
average utilization rate may be 70 percent, these issues can make the short term utilization rate
exceed 100 percent occasionally.
5-3
Objective Questions
1. A manufacturing shop is designed to operate most efficiently at an output of 1,170 units per day. In
the past month the plant produced 1,020 units. What was their capacity utilization rate last month?
1,020
𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 𝑢𝑡𝑖𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 = = 87.2%
1,170
2. A company has a factory that is designed so that it is most efficient (average unit cost is minimized)
when producing 28,500 units of output each month. However, it has an absolute maximum output
capability of 35,000 units per month, and can produce as little as 7000 units per month without
corporate headquarters shifting production to another plant. If the factory produces 23,000 units in
October, what is the capacity utilization rate in October for this factory?
23,000
𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 𝑢𝑡𝑖𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 = = 80.7%
28,500
3. Hoosier Manufacturing operates a production shop that is designed to have the lowest unit
production cost at an output rate of 195 units per hour. In the month of July, the company operated
the production line for a total of 365 hours and produced 45,400 units of output. What was its
capacity utilization rate for the month?
45,400
𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 𝑢𝑡𝑖𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 = (365)∗(195) = 63.8%
4. AlwaysRain Irrigation, Inc., would like to determine capacity requirements for the next four years.
Currently two production lines are in place for making bronze and plastic sprinklers. Three types of
sprinklers are available in both bronze and plastic: 90-degree nozzle sprinklers, 180-degree nozzle
sprinklers, and 360-degree nozzle sprinklers. Management has forecast demand for the next four
years as follows:
Both production lines can produce all the different types of nozzles. The bronze machines
needed for the bronze sprinklers require two operators and can produce up to 12,000 sprinklers.
The plastic injection molding machine needed for the plastic sprinklers requires four operators
and can produce up to 200,000 sprinklers. Three bronze machines and only one injection
5-4
molding machine are available. What are the capacity requirements for the next four years?
(Assume that there is no learning.)
Solution:
Plastic Year 1 Year 2 Year 3 Year 4

97 115 136 141
Demand for plastic sprinklers
48.5% 57.5% 68.0% 70.5%
Percentage of capacity used
.485 .575 .680 .705
Machine requirements
1.94 2.30 2.72 2.82
Labor requirements
Bronze Year 1 Year 2 Year 3 Year 4

Demand for bronze sprinklers 21 24 29 34
Percentage of capacity used 58.3% 66.7% 80.6% 94.4%
Machine requirements 1.75 2.00 2.42 2.83
Labor requirements 3.50 4.00 4.83 5.66
There is sufficient capacity to meet expected demand over the 4-year planning horizon. The only concern
might be year 4 on the bronze line. Capacity is approaching 100% in that year, and forecast error might
lead to an over-capacity situation. It is probably not a large concern at this point in time, but
management should pay special attention to that point in time as forecasts are updated in the future.
5. Requirements for plastic remain unchanged.

Machine requirements 2.67 3 3.42 4.33
Labor requirements 5.33 6 6.83 8.67
It is obvious that not enough capacity is available after year two to meet the increased demand.
AlwaysRain will have to consider purchasing additional machines for the bronze operations.
6.

Machine requirements 2.67 3.00 3.42 4.33
Labor requirements 5.33 6.00 6.83 8.67
5-5
No. An additional machine will provide enough capacity cushion until the third year. AlwaysRain
must consider additional ways of meeting the fourth year demand. This can include purchasing or
leasing an additional machine, or outsourcing some of the demand.
7.
Year 1 Year 2 Year 3 Year 4

Labor requirements-bronze 5.33 6.00 6.83 8.67
Labor requirements-plastic 1.94 2.30 2.72 2.82
Total labor requirements 7.27 8.30 9.55 11.49
AlwaysRain will face a problem of not having enough trained personnel for running the equipment
after the third year. At that time, they will need to either hire new trained employees or initiate a
training program for existing employees from other workstations who can be utilized at the bronze
or plastic molding machines.
8.
$12.0 million
High growth
P = .40
Small Factory $10.8 million

EV = $10.8 – 6.0 million
$10.0 million
EV = $4.8 million Low growth
P = .60
Do Nothing, EV = $0
Build Large Factory $14.0 million

High growth
EV = $11.6 – 9.0 million P = .40
EV = $2.6 million
$11.6 million
$10.0 million
Low growth
P = .60
For the small facility,
NPV = .40 ($12 Million) + .60 ($10 Million) - $6 Million = $4.8 Million
5-6
Do nothing,
NPV = $0
For the large facility
NPV = .40($14 Million) + .60($10 Million) - $9 Million = $2.6 Million
Therefore, build the small facility.
9.
Do Nothing
EV = $0
Sell to dept. chain @ $6.0 million
P = .70
1 EV = $5.4 – 1.0 million = $4.4 million
Sell to insurance co. @ $4.0 million

P = .30
Buy/Develop Property Rezoned
EV = $3.5 – 2.0 million P = .70
EV = $1,500,000
3 EV = $3.5 millionBuild 1,100 apts. @ $2,700 = $2.97 million
High price
P = .70
2 EV = $2.871 - $1.0 million = $1.871 million
1,100 apts. @ $2,400 = $2.64 million

Low price
P = .30
Not Rezoned
P = .30
Build 400 homes @ $3,500 = $1.4 million
The “Do Nothing” option is included here for completeness.
Rezoned shopping center (includes $1.0 rezoning costs):
Point 1: Expected value = .70($6 Million) + .30($4 Million) - $1.0 million = $4.4 Million
Rezoned apartments:
Point 2: Expected value = .70($2.97 Million) + .30($2.64 Million) - $1.0 million = $1.871 Million
5-7
Since a shopping center has more value, prune the apartment choice. In other words, if rezoned, build
a shopping center with a revenue of $4.4 Million - $2 Million = $2.4 Million. (The purchase cost could
be included here if desired, but would need to be included in the calculations for all development
options. This solution shows it at the leftmost part of the tree.)
If not rezoned the revenue will be $1.4 million from building homes:
Point 3: Expected value of developing the land is .7*($4.4 million) + .3*($1.4 million) = $3.5 million.
Expected profit of buying and developing the land is $3.5 million - $2 million purchase cost = 1.5 million.
Since this is a positive expected value, prune the option of doing nothing.
10. A local restaurant is concerned about their ability to provide quality service as they continue to grow
and attract more customers. They have collected data from Friday and Saturday nights, their busiest
time of the week. During these time periods about 75 customers arrive per hour for service. Given
the number of tables and chairs, and the typical time it takes to serve a customer, they figure they
can serve on average about 100 customers per hour. During these nights, are they in the zone of
service, the critical zone, or the zone of non-service?
75
𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 𝑢𝑡𝑖𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 = 100 = 75%
According to the text, this restaurant is in the critical zone on these nights.
11. The restaurant in the prior problem anticipates that in one year, their demand will double as long
as they can provide good service to their customers. How much will they have to increase their
service capacity to stay out of the critical zone?
If demand doubles, they will be receiving about 150 customers per hour on average. Find the service
rate necessary to result in a utilization rate of 70%.
150
𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 𝑢𝑡𝑖𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 = = 70% ⟹ 𝜇 = 214.3
𝜇
Therefore, the restaurant will have to increase capacity to at least 215 customers per hour to stay out
of the critical zone. That will be quite an expansion.
5-8
Case: Shouldice Hospital - A Cut Above
1. Mon. - Fri. Operations with 90 beds (30 patients per day)
Beds Required
Monday Tuesday Wednesday Thursday Friday Saturday Sunday
Monday 30 30 30
Tuesday 30 30 30
Wednesday 30 30 30
Check-in Thursday 30 30 30
On
Friday
Saturday
Sunday 30 30 30
Total 60 90 90 90 60 30 30 450
Utilization 66.7% 100.0% 100.0% 100.0% 66.7% 33.3% 33.3% 71.4%
2. Mon. - Sat. Operations with 90 beds (30 patients per day)
Beds Required
Monday 30 30 30
Tuesday 30 30 30
Wednesday 30 30 30
On
Friday 30 30 30
Saturday
Sunday 30 30 30
Total 60 90 90 90 90 60 60 540
Utilization 66.7% 100.0% 100.0% 100.0% 100.0% 66.7% 66.7% 85.7%
5-9
3. Mon. - Fri. Operations with 135 beds (minimum)
Beds Required
Monday 45 45 45
Tuesday 45 45 45
Wednesday 45 45 45
On
Friday
Saturday
Sunday 45 45 45
Total 90 135 135 135 90 45 45 675
Utilization 66.7% 100.0% 100.0% 100.0% 66.7% 33.3% 33.3% 71.4%
Can the capacity of the rest of Shouldice keep up?

One operating room can handle about 1 patient every hour. Since there are five operating rooms,
each must be able to handle 45/5 or 9 patients per day. This means they must be operated 9 hours
a day. In order to finish operating early enough for all patients to recover by the evening, Shouldice
would probably have to add operating room capacity although it might be easy to just start earlier in
the day. With 45 patients each day the total number of operations each week is 225. The 12
surgeons would need to do between 18 and 19 each week or between 3 and 4 a day. This should be
feasible and even if it were not Shouldice could hire some additional surgeons. These guys would be
making over $450,000/year (3 ops/day x 5 days/week x 50 weeks/yr x $600 = $450,000)!
4. Using the financial data given in the fourth discussion question it is easy to justify the expansion to
135 beds. The following is the analysis as presented in the spreadsheet. Based on average costs
and full capacity utilization, the hospital would pay back its investment in about 86 weeks, or 1.72
years.
5-10
Beds Required
Mon Tues Wed Thurs Fri Sat Sun
Mon 45 45 45
Tues 45 45 45
Wed 45 45 45
Check-in day Thurs 45 45 45
Fri
Sat
Sun 45 45 45
Total Beds Total 90 135 135 135 90 45 45 675
135 Utilization 66.7% 100.0% 100.0% 100.0% 66.7% 33.3% 33.3% 71.4%
Operating Rooms Operations 45

5 Oper/Room 9
Surgeons
12 Oper/Surg 3.75
Cost of expansion Beds 45

Cost/Bed $100,000
Total $4,500,000
Incremental Rev/Oper $1,300

Revenue
Surgeon $600
Incr Rev $700
Additional Oper/Week 75
Rev/Week $52,500
Payback 85.7 Weeks
5-11

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Chapter 05 - Strategic Capacity Management

b. A university computing lab

5. Management may choose to build up capacity in anticipation of demand or in response to

Plastic Year 1 Year 2 Year 3 Year 4

Bronze Year 1 Year 2 Year 3 Year 4

5. Requirements for plastic remain unchanged.

Bronze Year 1 Year 2 Year 3 Year 4

Bronze Year 1 Year 2 Year 3 Year 4

Year 1 Year 2 Year 3 Year 4

Small Factory $10.8 million

Build Large Factory $14.0 million

For the small facility,

For the large facility

NPV = .40($14 Million) + .60($10 Million) - $9 Million = $2.6 Million

Therefore, build the small facility.

1 EV = $5.4 – 1.0 million = $4.4 million

Sell to insurance co. @ $4.0 million

2 EV = $2.871 - $1.0 million = $1.871 million

1,100 apts. @ $2,400 = $2.64 million

Build 400 homes @ $3,500 = $1.4 million

The “Do Nothing” option is included here for completeness.

Rezoned shopping center (includes $1.0 rezoning costs):

Case: Shouldice Hospital - A Cut Above

1. Mon. - Fri. Operations with 90 beds (30 patients per day)

Utilization 66.7% 100.0% 100.0% 100.0% 66.7% 33.3% 33.3% 71.4%

2. Mon. - Sat. Operations with 90 beds (30 patients per day)

Utilization 66.7% 100.0% 100.0% 100.0% 100.0% 66.7% 66.7% 85.7%

3. Mon. - Fri. Operations with 135 beds (minimum)

Total 90 135 135 135 90 45 45 675

Utilization 66.7% 100.0% 100.0% 100.0% 66.7% 33.3% 33.3% 71.4%

Can the capacity of the rest of Shouldice keep up?

Operating Rooms Operations 45

Cost of expansion Beds 45

Incremental Rev/Oper $1,300

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