Strategic Capacity

Planning for
Products and
Services

5-1
 Capacity
 The upper limit or ceiling on the load that an operating
unit can handle
 Capacity needs include
 Equipment
 Space
 Employee skills

5-2
LO 5.1
 Goal
 To achieve a match between the long-term supply
capabilities of an organization and the predicted level of
long-term demand
 Overcapacity → operating costs that are too high
 Undercapacity → strained resources and possible loss of
customers

5-3
LO 5.1
 Key questions:
 What kind of capacity is needed?
 How much is needed to match demand?
 When is it needed?
 Related questions:
 How much will it cost?
 What are the potential benefits and risks?
 Are there sustainability issues?
 Should capacity be changed all at once, or through several smaller
changes
 Can the supply chain handle the necessary changes?

5-4
LO 5.1
  Capacity decisions
1. Impact the ability of the organization to meet future demands
2. Affect operating costs
3. Are a major determinant of initial cost
4. Often involve long-term commitment of resources
5. Can affect competitiveness
6. Affect the ease of management
7. Have become more important and complex due to globalization
8. Need to be planned for in advance due to their consumption of
financial and other resources

5-5
LO 5.2
  Measure capacity in units that do not require
updating
 Why is measuring capacity in dollars problematic?
 Two useful definitions of capacity
 Design capacity
 The maximum output rate or service capacity an operation,
process, or facility is designed for
 Effective capacity
 Design capacity minus allowances such as personal time and
maintenance

5-6
LO 5.3
  Actual output
 The rate of output actually achieved
 It cannot exceed effective capacity
 Efficiency
actual output
Efficiency =
effective capacity
 Utilization
actual output
Utilizatio n =
design capacity
Measured as percentages
5-7
LO 5.3
  Design Capacity = 50 trucks per day
 Effective Capacity = 40 trucks per day
 Actual Output = 36 trucks per day

actual output 36
Efficiency = = = 90%
effective capacity 40

actual output 36
Utilizatio n = = = 72%
design capacity 50

5-8
LO 5.3
  Facilities
 Product and service factors
 Process factors
 Human factors
 Policy factors
 Operational factors
 Supply chain factors
 External factors

5-9
LO 5.4
 Strategies are typically based on assumptions and
predictions about:
 Long-term demand patterns
 Technological change
 Competitor behavior

5-10
 Leading
 Build capacity in anticipation of future demand increases
 Following
 Build capacity when demand exceeds current capacity
 Tracking
 Similar to the following strategy, but adds capacity in relatively
small increments to keep pace with increasing demand

5-11
 Capacity cushion
 Extra capacity used to offset demand uncertainty
 Capacity cushion = 100% - utilization
 Capacity cushion strategy
 Organizations that have greater demand uncertainty typically
have greater capacity cushion
 Organizations that have standard products and services
generally have smaller capacity cushion

5-12
How many (annual volume)? Market estimate

Number of units scheduled through production = ?

Market estimate + scrap

Pk = % of scrap produced in operation k

Ok = desired output of non-defective product from operation k
Ik = production input to operation k

Ok = Ik – PkIk Ok = Ik (1 – Pk)

Ik = Ok /(1 – Pk) I1 = On /(1 – P1) (1 – P2) … (1 – Pn)

5-13
A product has a market estimate of 97,000 components and requires three
processing steps (turning, milling, and drilling) having scrap estimates of P 1
= 0.04, P2 = 0.01, and P3 = 0.03. The market estimate is the output required
from step 3. Therefore,
I3 = 97,000 = 100,000
1 – 0.03
Assuming no damage between operations 2 and 3 and an inspection
operation to remove all rejects, the output of good components from
operation 2 (O2) may be equated to the input to operations 3 (I3).
Therefore, the number of of components to start into operation 2 (I2) is –
I2 = 100,000 = 101,000
1 – 0.01
Likewise, for operation 1:
I1 = 101,000 = 105,219
1 – 0.04
5-14
The calculations are identical to :
I1 = 97,000 = 105,219
(1 – 0.03)(1 – 0.01)(1 – 0.04)
The amount of raw material and processing on operation 1 is
not be based on the market estimate of 97,000 components,
but on 105,219 components, as summarized in the ff:
Operation Production Quantity Expected
Number of Good Scheduled
(Units) Units Produced
Turning 105,219 101,010
Milling 101,010 100,000
Drilling 100,000 97,000

5-15
The Colonial House Furniture Company manufactures four-drawer oak cabinets in six
stages. In the first stage, the boards forming the walls of the cabinets are cut; in the
second stage the front drawer panels are woodworked; in the third stage the boards are
sanded and finished; in the fourth stage the boards are cleaned, stained, and painted
with a clear finish; in the fifth stage the hardware for pulls, runners, and fittings is
installed; and in the final stage the cabinets are assembled. Inspection occurs at each
stage of the process, and the average percentages of good-quality units are as follows,
Stage Average Percentage
Good Quality
1 87%
2 91%
3 94%
4 93%
5 93%
6 96%
The cabinets are produced in weekly production runs with a product input for 300 units.
a. Determine the weekly product yield of good-quality cabinets.
Solution: 186
5-16
Answer: a. 186

O= (300)(0.87)(0.91)(0.94)(0.93)(0.93)(0.96) = 185.3 = 186

5-17
The Colonial House Furniture Company manufactures four-drawer oak cabinets in six
stages. In the first stage, the boards forming the walls of the cabinets are cut; in the
second stage the front drawer panels are woodworked; in the third stage the boards are
sanded and finished; in the fourth stage the boards are cleaned, stained, and painted
with a clear finish; in the fifth stage the hardware for pulls, runners, and fittings is
installed; and in the final stage the cabinets are assembled. Inspection occurs at each
stage of the process, and the average percentages of good-quality units are as follows,
Stage Average Percentage
Good Quality
1 87%
2 91%
3 94%
4 93%
5 93%
6 96%
The cabinets are produced in weekly production runs with a product input for 300 units.
b. What would weekly product input have to be in order to achieve a final weekly product
yield of 300 cabinets?

Solution: 486
5-18
Answer: d. 486

I = 300 / (0.87)(0.91)(0.94)(0.93)(0.93)(0.96)
I = 485.5 = 486

5-19
The Colonial House Furniture Company has investigated the manufacturing process to identify
potential improvements that would improve quality.
Stage Average Percentage
Good Quality
1 87%
2 91%
3 94%
4 93%
5 93%
6 96%
The cabinets are produced in weekly production runs with a product input for 300 units. The
company has identified four alternatives, each costing $15,000, as follows:
AlternativeQuality Improvement
1 Stage 1: 93%
2 Stage 2: 96%, Stage 4: 97%
3 Stage 5: 97%, Stage 6: 98%
4 Stage 2: 97%

a. Which alternative would result in the greatest increase at what product yield?
5-20
Solution: a. alternative 2 at 203
Cushion with Reworking

Liam Manufacturing Company has a weekly

product input of 2,800 units. The average
percentage of good-quality product is 87 percent.
Of the poor quality products 60 percent can be
reworked and sold as good-quality products.
Determine the weekly product output?

5-21
Capacity Cushion with Reworking

Liam Manufacturing Company has a weekly

product input of 2,800 units. The average
percentage of good-quality product is 87 percent.
Of the poor quality products 60 percent can be
reworked and sold as good-quality products.
Determine the weekly product output?

Answer: 2,654

O = 2,800(0.87) + 2,800(0.13)(0.60)
O = 2,436 + 218.4
O = 2,654.4 = 2,654

5-22
1. Estimate future capacity requirements
2. Evaluate existing capacity and facilities; identify gaps
3. Identify alternatives for meeting requirements
4. Conduct financial analyses
5. Assess key qualitative issues
6. Select the best alternative for the long term
7. Implement alternative chosen
8. Monitor results

5-23
 Long-term considerations relate to overall level of
capacity requirements
 Require forecasting demand over a time horizon and
converting those needs into capacity requirements
 Short-term considerations relate to probable
variations in capacity requirements
 Less concerned with cycles and trends than with
seasonal variations and other variations from average

5-24
 Calculating processing requirements requires
reasonably accurate demand forecasts, standard
processing times, and available work time
k

pD i i
NR = i =1
T
where
N R = number of required machines
pi = standard processing time for product i
Di = demand for product i during the planning horizon
T = processing time available during the planning horizon
5-25
 What is equipment fraction?
The quantity of equipment required for an operation

Equipment fraction = Total time required to perform the operation

Time available to complete the operation

Total time required to perform an operation =

standard time for the operation * number of times performed

Question about: • Efficiency

• Reliability

5-26
F = number of machines required per shift
S = standard time (minutes) per unit produced
Q = number of units to be produced per shift
E = actual performance, expressed as a % of standard time
H = amount of time (minutes) available per machine
R = reliability of the machine, expressed as % “up-time”

F = SQ/EHR

5-27
Example 1

Assume that production volume is 1,600

pieces per day, the standard time is 0.004
hour per piece, 8 working hours per day, setup
time at 0.2 hr per day, and scrap rate of 0.10.
Find the fractional machine number.

5-28
Example 1

Assume that production volume is 1,600 pieces

per day, the standard time is 0.004 hour per
piece, 8 working hours per day, setup time at
0.2 hr per day, and scrap rate of 0.10. Find the
fractional machine number.

Answer: c. 0.91

F = [(1600)/0.90](0.004)/ (8 – 0.2) = 0.91

5-29
2.9 Part X requires machining on a milling machine (operations A & B are required).
Find the number of machines required to produce 3000 parts per week. Assume the
company will be operating 5 days per week, 18 hrs. / day. The ffg. Information is
known:

OPERATION STD. TIME EFFICIENCY RELIABILITY SCRAP

A 3 mins. 95% 95% 2%
B 5 mins. 95% 90% 5%

NOTE: The milling machine requires tool changes & preventive maintenance after every lot of 500 parts.
These changes requires 30 mins.
5-30
SOLUTION:

Formula: S = Standard time

Q = no. of machines to be produced per shift
F= SQ R = reliability
REH E = Efficiency
H = available time of machine per shift

OPERATION A
S = 3 mins.
Q = 3000 / 0.98 1 - 0.2 = 0.98
R = 0.95 scrap
E = 0.95
H = 5400 - 6 (30)
5400 = 18 (5) (60)

F= 3 [ 3000 / 0.98 ] F = 1.95 = 2 machines / week

{ 0.95 (0.95) [ 5400 - 6 (30)]}

OPERATION B
S = 5 mins.
Q = 3000 / 0.95 1 - 0.5 = 0.95
R = 0.90 scrap
E = 0.95
H = 5400 - 6 (30)
5400 = 18 (5) (60)

F= 5 [ 3000 / 0.95 ] F = 3.35 = 4 machines / week

{ 0.95 (0.90) [ 5400 - 6 (30)]}
5-31
Pij = desired production rate for product i on machine j
(pieces/production period)
Tij = production time for product i on machine j
(hours/piece)
Hij = number of hours in the production period available for
the production of product i on machine j
Mj = number of machines of type j required per production
period
n = number of products

n PijTij
M =
j i=1 H
ij
5-32
• Six different products are being produced
• Same type of machine is used for processing these products
• Standard number of pieces to be produced/hour (1/Tij) for each product
• Desired production rate (Pij)
• Number of hours in a month (Hij = 150)

Standard
Product Required Hours/month
prod. rate, PijTij/Hij
number, i prod. rate, Pij , Hij
1/Tij
2501 6,000 120 150 0.333
2502 9,000 150 150 0.400
3104 15,000 100 150 1.000
3206 2,000 100 150 0.133
3617 8,000 120 150 0.444
3618 4,000 80 150 0.333
2.643
5-33
 Service capacity planning can present a number of
challenges related to:
 The need to be near customers
 Convenience
 The inability to store services
 Cannot store services for consumption later
 The degree of demand volatility
 Volume and timing of demand
 Time required to service individual customers

5-34
UNDERSTANDING CAPACITY

Capacity is the maximum output level a person

or machine can sustain to provide its product
or service

148.75
7* hours per 21.25 days manhours per
day per person per month month per
person

*Employee is in the office for 9hrs. 1hr is allotted for lunch break ,
AVAILABLE TIME OF 0.5hr for am/pm breaks, and 0.5 is an allowance for leaves and
1 EMPLOYEE IN A other interruptions
MONTH

5-35
TYPES OF ACTIVITIES

✓ Policy
Encoding
✓ COE
Preparation
✓ OR Issuance 1 2
VOLUME NON-VOLUME
BASED BASED

2.
a ✓ Weekly Update
FIXED
Meeting
✓ Trainings
2.
b ✓ Adhoc Tasks
NON-FIXED
✓ UAT Tasks

5-36
HOW TO COMPUTE FOR THE CAPACITY?
Step 1 List down all activities of the person and identify their activity type
ACTIVITIES TYPE
Activity 1 VOLUME-BASED
Activity 2 VOLUME-BASED
Activity 3 FIXED
Activity 4 NON-FIXED

Step 2 Determine the average handling time (AHT) per activity

ACTIVITY 1 UNIT 1 2 3 4 AVE

(in mins) (in mins) (in mins) (in mins)

Tasks to Task 1 per OR 0.82 0.80 0.52 0.84 0.74

carry out Task 2 per OR 1.00 1.08 1.11 1.15 1.10
the
activity Task 3 per OR 0.18 0.24 0.08 0.13 0.16
TOTAL 2.00

5-37
HOW TO COMPUTE FOR THE CAPACITY?
Step 1 List down all activities of the person and identify their activity type
ACTIVITIES TYPE
Activity 1 VOLUME-BASED
Activity 2 VOLUME-BASED
Activity 3 FIXED
Activity 4 NON-FIXED

Step 2 Determine the average handling time in minutes (AHT) per activity

ACTIVITIES TYPE AHT (in mins.) REMARKS

Activity 3 FIXED 420 mins.

5-38
HOW TO COMPUTE FOR THE CAPACITY?
Step 2 Determine the average handling time in minutes (AHT) per activity
ACTIVITIES TYPE AHT (in mins.
Activity 1 VOLUME-BASED 2 mins.
Activity 2 VOLUME-BASED 10 mins.
Activity 3 FIXED 420 mins.
Activity 4 NON-FIXED

Step 3 Determine the volume for each activity

MONTH
ACTIVITIES VOLUME
TYPE AHT (in mins. AVE. MONTHLY VOL.
JAN 1
Activity 999
VOLUME-BASED 2 mins. 1000
FEB 1000
Activity 2 VOLUME-BASED 10 mins. 50
MAR 1001
Activity
APR 3 FIXED 1002 420 mins. 4
Activity
MAY 4 NON-FIXED
998
JUN 1002 MINIMUM: at least 3 months worth of data
JUL 996
AVERAGE 999.71 ≈ 1000

5-39
HOW TO COMPUTE FOR THE CAPACITY?
Step 4 Compute for the manhours per month of each activity
ACTIVITIES TYPE AHT (in mins.) AVE. MONTHLY VOL. MANHOURS PER MONTH
Activity 1 VOLUME-BASED 2 mins. 1000
Activity 2 VOLUME-BASED 10 mins. 50
Activity 3 FIXED 420 mins. 4
Activity 4 NON-FIXED
AVERAGE HANDLING
VOLUME
TIME MANHOURS PER
(Unit: units)
(Unit: mins/unit) MONTH

(Unit: hours)
60

5-40
HOW TO COMPUTE FOR THE CAPACITY?
Step 4 Compute for the manhours per month of each activity
ACTIVITIES TYPE AHT (in mins.) AVE. MONTHLY VOL. MANHOURS PER MONTH
Activity 1 VOLUME-BASED 2 mins. 1000 33.33
Activity 2 VOLUME-BASED 10 mins. 50 8.33
Activity 3 FIXED 420 mins. 4 28
Activity 4 NON-FIXED 2
AVERAGE HANDLING
VOLUME MANHOURS PER
TIME
1000 MONTH
2
33.33
60

Non-fixed activities have no definite AHT and Monthly Volume meaning they are not
quantifiable using the above mentioned formula. For these types of activities, a
IMPORTANT sound
estimation of manhours rendered is needed (with verification from process owner)

5-41
HOW TO COMPUTE FOR THE CAPACITY?
Step 5 Compute for the FTE of each activity

1. WHAT DOES FTE MEAN?

2. WHAT IS IT FOR?
A Full-Time Equivalent (FTE)
✓ Evaluate current capacity of an
a unit of measurement equivalent
individual/ business unit
to an employee’s full work day or
✓ Identify manpower requirement
workload.
of an activity/task
If an employee’s computed FTE is:
✓ Measure manpower savings of
> 1.0 = overcapacity/overutilized
an improvement point
< 1.0 = under utilized

5-42
HOW TO COMPUTE FOR THE CAPACITY?
Step 5 Compute for the FTE of each activity
ACTIVITIES TYPE AHT (in mins.) AVE. MONTHLY VOL. MANHOURS PER MONTH FTE
Activity 1 VOLUME-BASED 2 mins. 1000 33.33 0.22
Activity 2 VOLUME-BASED 10 mins. 50 8.33 0.06
Activity 3 FIXED 420 mins. 4 28 0.19
Activity 4 NON-FIXED 2 0.01
TOTAL
= 0.48
148.75 manhours per FTE
Manhours per month FTE
month per person

Activity 1
148.75 manhours per
33.33 0.22
month per person

5-43
 Strategies used to offset capacity limitations and that
are intended to achieve a closer match between supply
and demand
 Pricing
 Promotions
 Discounts
 Other tactics to shift demand from peak periods into
slow periods

5-44
  Once capacity requirements are determined, the organization
must decide whether to produce a good or service itself or
outsource
 Factors to consider:
 Available capacity
 Expertise
 Quality considerations
 The nature of demand
 Cost
 Risks

5-45
LO 5.5
  Things that can be done to enhance capacity management:
 Design flexibility into systems
 Take stage of life cycle into account
 Take a “big-picture” approach to capacity changes
 Prepare to deal with capacity “chunks”
 Attempt to smooth capacity requirements
 Identify the optimal operating level
 Choose a strategy if expansion is involved

5-46
LO 5.6
  An operation in a
sequence of operations
whose capacity is lower
than that of the other
operations

5-47
LO 5.6
 Average cost per unit

Minimum
cost

Optimal Rate of output

Output
rate
5-48
LO 5.6
  Economies of scale
 If output rate is less than the optimal level, increasing
the output rate results in decreasing average per unit
costs
 Diseconomies of scale
 If the output rate is more than the optimal level,
increasing the output rate results in increasing average
per unit costs

5-49
LO 5.6
  Economies of scale
 If output rate is less than the optimal level, increasing
the output rate results in decreasing average per unit
costs
 Reasons for economies of scale:
 Fixed costs are spread over a larger number of units
 Construction costs increase at a decreasing rate as facility size
increases
 Processing costs decrease due to standardization

5-50
LO 5.6
  Diseconomies of scale
 If the output rate is more than the optimal level, increasing the
output rate results in increasing average per unit costs
 Reasons for diseconomies of scale
 Distribution costs increase due to traffic congestion and
shipping from a centralized facility rather than multiple smaller
facilities
 Complexity increases costs
 Inflexibility can be an issue
 Additional levels of bureaucracy

5-51
LO 5.6
 Minimum cost & optimal operating rate are
functions of size of production unit.
Average cost per unit

Small
plant Medium
plant
Large
plant

Output rate

5-52
LO 5.6
  Constraint
 Something that limits the performance of a process or system in
achieving its goals
 Categories
 Market
 Resource
 Material
 Financial
 Knowledge or competency
 Policy

5-53
LO 5.7
 1. Identify the most pressing constraint
2. Change the operation to achieve maximum benefit, given
the constraint
3. Make sure other portions of the process are supportive of
the constraint
4. Explore and evaluate ways to overcome the constraint
5. Repeat the process until the constraint levels are at
acceptable levels

5-54
LO 5.7
  Alternatives should be evaluated from varying
perspectives
 Economic
 Is it economically feasible?
 How much will it cost?
 How soon can we have it?
 What will operating and maintenance costs be?
 What will its useful life be?
 Will it be compatible with present personnel and present
operations?
 Non-economic
 Public opinion

5-55
LO 5.8
  Techniques for Evaluating Alternatives
 Cost-volume analysis
 Financial analysis
 Decision theory
 Waiting-line analysis
 Simulation

5-56
LO 5.8
  Cost-volume analysis
 Focuses on the relationship between cost, revenue, and
volume of output
 Fixed Costs (FC)
 Tend to remain constant regardless of output volume
 Variable Costs (VC)
 Vary directly with volume of output
 VC = Quantity(Q) x variable cost per unit (v)
 Total Cost
 TC = FC + VC
 Total Revenue (TR)
 TR = revenue per unit (R) x Q

5-57
LO 5.8
  BEP
 The volume of output at which total cost and total
revenue are equal
 Profit (P) = TR – TC = R x Q – (FC +v x Q)
= Q(R – v) – FC

FC
QBEP =
R−v

5-58
LO 5.8
 .

5-59
LO 5.8
  Capacity alternatives may involve step costs, which are
costs that increase stepwise as potential volume
increases
 The implication of such a situation is the possible occurrence of
multiple break-even quantities
5-60
LO 5.8
  Cost-volume analysis is a viable tool for comparing
capacity alternatives if certain assumptions are
satisfied
 One product is involved
 Everything produced can be sold
 The variable cost per unit is the same regardless of volume
 Fixed costs do not change with volume changes, or they are step
changes
 The revenue per unit is the same regardless of volume
 Revenue per unit exceeds variable cost per unit

5-61
LO 5.8
  Cash flow
 The difference between cash received from sales and
other sources, and cash outflow for labor, material,
overhead, and taxes
 Present value
 The sum, in current value, of all future cash flow of an
investment proposal

5-62
LO 5.8
 Capacity planning impacts all areas of the organization
 It determines the conditions under which operations will have to function
 Flexibility allows an organization to be agile
 It reduces the organization’s dependence on forecast accuracy and reliability
 Many organizations utilize capacity cushions to achieve flexibility
 Bottleneck management is one way by which organizations can enhance
their effective capacities
 Capacity expansion strategies are important organizational considerations
 Expand-early strategy
 Wait-and-see strategy
 Capacity contraction is sometimes necessary
 Capacity disposal strategies become important under these
conditions

5-63