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BU COLLEGE OF BUSINESS AND ECONOMICS DEPARTMENT OF MANAGEMENT
OPERATIONS MANAGEMENT HANDOUT
CHAPTER FOUR
PROCESS SELECTION AND CAPACITY PLANNING
Chapter Objectives
At the end of this chapter students will be able to:
Discuss Process selection
Discuss strategic capacity planning
Develop capacity alternatives
4. Introduction
Product and service choices, capacity planning, process selection, and layout of facilities are
among the most basic decisions managers make because they have long-term consequences for
business organizations, and they impact a wide range of activities and capabilities. This section is
about process selection and capacity planning.
Processes convert inputs into outputs; they are at the core of operations management. But the
impact of process selection goes beyond operations management: It affects the entire organization
and its ability to achieve its mission, and it affects the organization’s supply chain. So, process
selection choices very often have strategic significance. Different process types have different
capacity ranges, and once a process type is functioning, changing it can be difficult, time
consuming, and costly. Obviously, long-term forecasts as well as an organization’s mission and
goals are important in developing a process strategy.
Process selection has operational and supply chain implications. Operational implications include
equipment and labor requirements, operations costs, and both the ability to meet demand and the
ability to respond to variations in demand. Supply chain implications relate to the volume and
variety of inputs and outputs and the degree of flexibility that is required. Technology is often a
factor in process selection and layout. Three aspects of technology can be factors: product
technology, processing technology, and information technology. Process selection and facility
layout are closely tied, and for that reason, these two topics are presented in this section. The first
part of the section covers the basic options for processing work. This is followed by a discussion
of how processes and layout are linked. The remainder of the section is devoted to layout design.
COMPILED BY: CHERNET TEFERA 1

4.1. Process selection

Process selection: refers to deciding on the way production of goods or services will be organized.
It has major implications for capacity planning, layout of facilities, equipment, and design of work
systems. Process selection occurs as a matter of course when new products or services are being
planned. However, it also occurs periodically due to technological changes in products or
equipment, as well as competitive pressures.
The figure above is an overview of where process selection and capacity planning fit into system
design. Forecasts, product and service design, and technological considerations all influence
capacity planning and process selection. Moreover, capacity and process selection are interrelated,
and are often done in concert. They, in turn, affect facility and equipment choices, layout, and
work design. How an organization approaches process selection is determined by the
organization’s process strategy. Key aspects include:
• Capital intensity: the mix of equipment and labor that will be used by the organization.
• Process flexibility: the degree to which the system can be adjusted to changes in processing
requirements due to such factors as changes in product or service design, changes in
volume processed, and changes in technology.
Process choice is demand driven. The two key questions in process selection are:
1. How much variety will the process need to be able to handle?
2. How much volume will the process need to be able to handle?
Answers to these questions will serve as a guide to selecting an appropriate process. Usually,
volume and variety are inversely related; a higher level of one means a lower level of the other.
However, the need for flexibility of personnel and equipment is directly related to the level of
variety the process will need to handle: the lower the variety, the less the need for flexibility, while
the higher the variety, the greater the need for flexibility. There is another aspect of variety that is
important. Variety means either having separate operations for each product or service, with a
steady demand for each, or being willing to live with some idle time, or to get equipment ready
every time there is the need to change the product being produced or the service being provided.
4.2. PROCESS TYPES
1. Job Shop. A job shop usually operates on a relatively small scale. It is used when a low
volume of high-variety goods or services will be needed. Processing is intermittent; work
includes small jobs, each with somewhat different processing requirements. High flexibility
using general-purpose equipment and skilled workers are important characteristics of a job
shop. A manufacturing example of a job shop is a tool and die shop that is able to produce
one-of-a-kind tools. A service example is a veterinarian’s office, which is able to process a
variety of animals and a variety of injuries and diseases.
2. Batch. Batch processing is used when a moderate volume of goods or services is desired, and
it can handle a moderate variety in products or services. The equipment need not be as flexible
as in a job shop, but processing is still intermittent. The skill level of workers doesn’t need to
be as high as in a job shop because there is less variety in the jobs being processed. Examples
of batch systems include bakeries, which make bread, cakes, or cookies in batches; movie
theaters, which show movies to groups (batches) of people; and airlines, which carry
planeloads (batches) of people from airport to airport. Other examples of products that lend
themselves to batch production are paint, ice cream, soft drinks, beer, magazines, and books.
Other examples of services include plays, concerts, music videos, radio and television
programs, and public address announcements.
3. Repetitive. When higher volumes of more standardized goods or services are needed,
repetitive processing is used. The standardized output means only slight flexibility of
equipment is needed. Skill of workers is generally low. Examples of this type of system
include production lines and assembly lines. In fact, this type of process is sometimes referred
to as assembly. Familiar products made by these systems include automobiles, television sets,
pencils, and computers. An example of a service system is an automatic carwash. Other

examples of service include cafeteria lines and ticket collectors at sports events and concerts.
Also, mass customization is an option.
4. Continuous. When a very high volume of non-discrete, highly standardized output is desired,
a continuous system is used. These systems have almost no variety in output and, hence, no
need for equipment flexibility. Workers’ skill requirements can range from low to high,
depending on the complexity of the system and the expertise workers need. Generally, if
equipment is highly specialized, worker skills can be lower. Examples of non-discrete
products made in continuous systems include petroleum products, steel, sugar, flour, and salt.
Continuous services include supplying electricity to homes and businesses, and the Internet.
These process types are found in a wide range of manufacturing and service settings. The ideal
is to have process capabilities match product or service requirements. Failure to do so can
result in inefficiencies and higher costs than are necessary, perhaps creating a competitive
disadvantage.
Process type also impacts supply chain requirements. Repetitive and continuous processes require
steady inputs of high-volume goods and services. Delivery reliability in terms of quality and
timing is essential. Job shop and batch processing may mean that suppliers have to be able to deal
with varying order quantities and timing of orders. In some instances, seasonality is a factor, so
suppliers must be able to handle periodic large demand. The processes discussed do not always
exist in their “pure” forms. It is not unusual to find hybrid processes—processes that have
elements of other process types embedded in them. For instance, companies that operate primarily
in a repetitive mode, or a continuous mode, will often have repair shops (i.e., job shops) to fix or

make new parts for equipment that fails. Also, if volume increases for some items, an operation
that began, say, in a job shop or as a batch mode may evolve into a batch or repetitive operation.
This may result in having some operations in a job shop or batch mode, and others in a repetitive
mode.
4.3.STRATEGIC CAPACITY PLANNING
Capacity refers to an upper limit or ceiling on the load that an operating unit can handle. After
selection of a production process, managers need to determine capacity. Capacity is the
“throughput,” or the number of units a facility can hold, receive, store, or produce in a given time.
Capacity decisions often determine capital requirements and therefore a large portion of fixed cost.
Capacity also determines whether demand will be satisfied or whether facilities will be idle. If a
facility is too large, portions of it will sit unused and add cost to existing production. If a facility
is too small, customers—and perhaps entire markets—will be lost. Determining facility size, with
an objective of achieving high levels of utilization and a high return on investment, is critical.
Capacity planning is a key strategic component in designing the system. It encompasses many
basic decisions with long-term consequences for the organization. In this chapter, you will learn
about the importance of capacity decisions, the measurement of capacity, how capacity
requirements are determined, and the development and evaluation of capacity alternatives. Note
that decisions made in the product or service design stage have major implications for capacity
planning. Designs have processing requirements related to volume and degree of customization
that affect capacity planning.
The goal of strategic capacity planning is to achieve a match between the long-term supply
capabilities of an organization and the predicted level of long-term demand. Organizations become
involved in capacity planning for various reasons. Among the chief reasons are changes in demand,
changes in technology, changes in the environment, and perceived threats or opportunities. A gap
between current and desired capacity will result in capacity that is out of balance. Overcapacity
causes operating costs that are too high, while under capacity causes strained resources and
possible loss of customers.

4.4.CAPACITY DECISIONS ARE STRATEGIC
For a number of reasons, capacity decisions are among the most fundamental of all the design
decisions that managers must make. In fact, capacity decisions can be critical for an organization:
1. Capacity decisions have a real impact on the ability of the organization to meet future
demands for products and services; capacity essentially limits the rate of output possible.
Having capacity to satisfy demand can often allow a company to take advantage of
tremendous benefits.
2. Capacity decisions affect operating costs. Ideally, capacity and demand requirements will
be matched, which will tend to minimize operating costs. In practice, this is not always
achieved because actual demand either differs from expected demand or tends to vary (e.g.,
cyclically). In such cases, a decision might be made to attempt to balance the costs of over-
and under capacity.
3. Capacity is usually a major determinant of initial cost. Typically, the greater the capacity
of a productive unit, the greater its cost. This does not necessarily imply a one-for-one
relationship; larger units tend to cost proportionately less than smaller units.
4. Capacity decisions often involve long-term commitment of resources and the fact that, once
they are implemented, those decisions may be difficult or impossible to modify without
incurring major costs.
5. Capacity decisions can affect competitiveness. If a firm has excess capacity, or can quickly
add capacity, that fact may serve as a barrier to entry by other firms. Then too, capacity
can affect delivery speed, which can be a competitive advantage.
6. Capacity affects the ease of management; having appropriate capacity makes management
easier than when capacity is mismatched.
7. Globalization has increased the importance and the complexity of capacity decisions. Far-
flung supply chains and distant markets add to the uncertainty about capacity needs.
8. Because capacity decisions often involve substantial financial and other resources, it is
necessary to plan for them far in advance. For example, it may take years for a new power-
generating plant to be constructed and become operational. However, this increases the risk
that the designated amount of capacity will not match actual demand when the capacity
becomes available.

4.5.DEFINING AND MEASURING CAPACITY
MEASURING CAPACITY
Capacity often refers to an upper limit on the rate of output. Even though this seems simple enough,
there are subtle difficulties in actually measuring capacity in certain cases. These difficulties arise
because of different interpretations of the term capacity and problems with identifying suitable
measures for a specific situation. Up to this point, we have been using a general definition of
capacity. Although it is functional, it can be refined into two useful definitions of capacity:
1. Design capacity: The maximum output rate or service capacity an operation, process, or
facility is designed for.
2. Effective capacity: Design capacity minus allowances such as personal time, and
maintenance. Design capacity is the maximum rate of output achieved under ideal
conditions. Effective capacity is always less than design capacity owing to realities of
changing product mix, the need for periodic maintenance of equipment, lunch breaks,
coffee breaks, problems in scheduling and balancing operations, and similar circumstances.
Actual output cannot exceed effective capacity and is often less because of machine
breakdowns, absenteeism, shortages of materials, and quality problems, as well as factors
that are outside the control of the operations managers.
These different measures of capacity are useful in defining two measures of system effectiveness:
efficiency and utilization. Efficiency is the ratio of actual output to effective capacity. Capacity
utilization is the ratio of actual output to design capacity.
• Efficiency = Actual Output / Effective capacity X 100%

• Utilization = Actual output / Design capacity X 100%
Both measures are expressed as percentages. It is not unusual for managers to focus exclusively
on efficiency, but in many instances this emphasis can be misleading. This happens when effective
capacity is low compared to design capacity. In those cases, high efficiency would seem to indicate
effective use of resources when it does not. The following example illustrates this point. Given the
following information, compute the efficiency and the utilization of the vehicle repair department:

Design capacity 50 trucks per day Effective capacity 40 trucks per day Actual output 36 trucks per
day.
Compared to the effective capacity of 40 units per day, 36 units per day looks pretty good.
However, compared to the design capacity of 50 units per day, 36 units per day is much less
impressive although probably more meaningful. Because effective capacity acts as a lid on actual
output, the real key to improving capacity utilization is to increase effective capacity by correcting
quality problems, maintaining equipment in good operating condition, fully training employees,
and fully utilizing bottleneck equipment.
Forecasting demand fluctuations
Forecasting is a key input to capacity planning and control. Although demand forecasting is usually
the responsibility of the sales and/or marketing functions, it is a very important input into the
capacity planning and control decision and so is of interest to operations managers. After all,
without an estimate of future demand it is not possible to plan effectively for future events, only
to react to them. It is therefore important to understand the basis and rationale for these demand
forecasts. As far as capacity planning and control is concerned, there are three requirements from
a demand forecast.
It is expressed in terms which are useful for capacity planning and control
If forecasts are expressed only in money terms and give no indication of the demands that will be
placed on an operation’s capacity, they will need to be translated into realistic expectations of
demand, expressed in the same units as the capacity (for example, machine hours per year,
operatives required, space, etc.).

It is as accurate as possible
In capacity planning and control, the accuracy of a forecast is important because, whereas demand
can change instantaneously, there is a lag between deciding to change capacity and the change
taking effect. Thus, many operations managers are faced with a dilemma. In order to attempt to
meet demand, they must often decide output in advance, based on a forecast which might change
before the demand occurs, or worse, prove not to reflect actual demand at all.
It gives an indication of relative uncertainty
Decisions to operate extra hours and recruit extra staff are usually based on forecast levels of
demand, which could in practice differ considerably from actual demand, leading to unnecessary
costs or unsatisfactory customer service.
Seasonality of demand
In many organizations, capacity planning and control is concerned largely with coping with
seasonal demand fluctuations. Almost all products and services have some demand seasonality
and some also have supply seasonality, usually where the inputs are seasonal agricultural products
– for example, in processing frozen vegetables. These fluctuations in demand or supply may be
reasonably forecastable, but some are usually also affected by unexpected variations in the weather
and by changing economic conditions.
4.6. The alternative capacity plans
With an understanding of both demand and capacity, the next step is to consider the alternative
methods of responding to demand fluctuations. There are three ‘pure’ options available for coping
with such variation:
• ignore the fluctuations and keep activity levels constant (level capacity plan);
• adjust capacity to reflect the fluctuations in demand (chase demand plan);
• attempt to change demand to fit capacity availability (demand management).
In practice, most organizations will use a mixture of all of these ‘pure’ plans, although often one
plan might dominate.

Level capacity plan
In a level capacity plan, the processing capacity is set at a uniform level throughout the planning
period, regardless of the fluctuations in forecast demand. This means that the same number of staff
operates the same processes and should therefore be capable of producing the same aggregate
output in each period. Level capacity plans of this type can achieve the objectives of stable
employment patterns, high process utilization and usually also high productivity with low unit
costs. Unfortunately, they can also create considerable inventory which has to be financed and
stored. Perhaps the biggest problem, however, is that decisions have to be taken as to what to
produce for inventory rather than for immediate sale.
Chase demand plan
The opposite of a level capacity plan is one which attempts to match capacity closely to the varying
levels of forecast demand. This is much more difficult to achieve than a level capacity plan, as
different numbers of staff, different working hours and even different amounts of equipment may
be necessary in each period. For this reason, pure chase demand plans are unlikely to appeal to
operations which manufacture standard, non-perishable products. Also, where manufacturing
operations are particularly capital-intensive, the chase demand policy would require a level of
physical capacity, all of which would be used only occasionally. A pure chase demand plan is
more usually adopted by operations which cannot store their output, such as customer-processing
operations or manufacturers of perishable products. It avoids the wasteful provision of excess staff
that occurs with a level capacity plan and yet should satisfy customer demand throughout the
planned period. Where output can be stored, the chase demand policy might be adopted in order
to minimize or eliminate finished goods inventory.
Methods of adjusting capacity
The chase demand approach requires that capacity is adjusted by some means. There are a number
of different methods for achieving this, although they may not all be feasible for all types of
operation. Some of these methods are listed below.
Overtime and idle time: Often the quickest and most convenient method of adjusting capacity is
by varying the number of productive hours worked by the staff in the operation. When demand is

higher than nominal capacity, overtime is worked, and when demand is lower than nominal
capacity, the amount of time spent by staff on productive work can be reduced. In the latter case,
it may be possible for staff to engage in some other activity such as cleaning or maintenance.
Varying the size of the workforce: If capacity is largely governed by workforce size, one way to
adjust it is to adjust the size of the workforce. This is done by hiring extra staff during periods of
high demand and laying them off as demand falls, or hire and fire. However, there are cost and
ethical implications to be taken into account before adopting such a method.
Using part-time staff: A variation on the previous strategy is to recruit part-time staff, that is, for
less than the normal working day. This method is extensively used in service operations such as
super markets and fast-food restaurants but is also used by some manufacturers to staff an evening
shift after the normal working day. However, if the fixed costs of employment for each employee,
irrespective of how long he or she works, are high, then using this method may not be worthwhile.
Sub-contracting: In periods of high demand, an operation might buy capacity from other
organizations, called sub-contracting. This might enable the operation to meet its own demand
without the extra expense of investing in capacity which will not be needed after the peak in
demand has passed. Again, there are costs associated with this method. The most obvious one is
that sub-contracting can be very expensive.
Manage demand plan
Demand management: An approach to medium-term capacity management that attempts to change

or influence demand to fit available capacity. The most obvious mechanism of demand
management is to change demand through price. Although this is probably the most widely applied
approach in demand management, it is less common for products than for services.
4.7.STRATEGY FORMULATION
The three primary strategies are leading, following, and tracking. A leading capacity strategy
builds capacity in anticipation of future demand increases. If capacity increases involve a long lead
time, this strategy may be the best option. A following strategy builds capacity when demand
exceeds current capacity. A tracking strategy is similar to a following strategy, but it adds capacity
in relatively small increments to keep pace with increasing demand.

An organization typically bases its capacity strategy on assumptions and predictions about long-
term demand patterns, technological changes, and the behavior of its competitors. These typically
involve (1) the growth rate and variability of demand, (2) the costs of building and operating
facilities of various sizes, (3) the rate and direction of technological innovation, (4) the likely
behavior of competitors, and (5) availability of capital and other inputs.
In some instances, a decision may be made to incorporate a capacity cushion, which is an amount
of capacity in excess of expected demand when there is some uncertainty about demand. Capacity
cushion = capacity - expected demand. Typically, the greater the degree of demand uncertainty,
the greater the amount of cushion used. Organizations that have standard products or services
generally have smaller capacity cushions. Cost and competitive priorities are also key factors.
Steps in the Capacity Planning Process
1. Estimate future capacity requirements.

2. Evaluate existing capacity and facilities and identify gaps.
3. Identify alternatives for meeting requirements.
4. Conduct financial analyses of each alternative.
5. Assess key qualitative issues for each alternative.
6. Select the alternative to pursue that will be best in the long term.
7. Implement the selected alternative.
8. Monitor results.
Capacity planning can be difficult at times due to the complex influence of market forces and
technology.
4.8.FORECASTING CAPACITY REQUIREMENTS
Capacity planning decisions involve both long-term and short-term considerations. Long-term
considerations relate to overall level of capacity, such as facility size; short-term considerations
relate to probable variations in capacity requirements created by such things as seasonal, random,
and irregular fluctuations in demand. Because the time intervals covered by each of these
categories can vary significantly from industry to industry, it would be misleading to put times on

the intervals. However, the distinction will serve as a framework within which to discuss capacity
planning.
Long-term capacity needs require forecasting demand over a time horizon and then converting
those forecasts into capacity requirements.
Short-term capacity needs are less concerned with cycles or trends than with seasonal variations
and other variations from average. These deviations are particularly important because they can
place a severe strain on a system’s ability to satisfy demand at some times and yet result in idle
capacity at other times.
An organization can identify seasonal patterns using standard forecasting techniques. Although
commonly thought of as annual fluctuations, seasonal variations are also reflected in monthly,
weekly, and even daily capacity requirements.
The task of determining capacity requirements should not be taken lightly. Substantial losses can
occur when there are misjudgments on capacity needs. One key reason for those misjudgments can
be overly optimistic projections of demand and growth. Marketing personnel are generally
optimistic in their outlook, which isn’t necessarily a bad thing. But care must be taken so that that
optimism doesn’t lead to overcapacity, because the resulting underutilized capacity will create an
additional cost burden. Another key reason for misjudgments may be focusing exclusively on sales
and revenue potential, and not taking into account the product mix that will be needed to generate
those sales and revenues. To avoid that, marketing and operations personnel must work closely to
determine the optimal product mix needed and the resulting cost and profit. A reasonable approach
to determining capacity requirements is to obtain a forecast of future demand, translate demand
into both the quantity and the timing of capacity requirements, and then decide what capacity
changes (increased, decreased, or no changes) are needed.
Long-term capacity alternatives include expansion or contraction of an existing facility, opening

or closing branch facilities, and relocation of existing operations. At this point, a decision must be
made on whether to make or buy a good, or provide or buy a service.

4.9.ADDITIONAL CHALLENGES OF PLANNING SERVICE CAPACITY
While the foregoing discussion relates generally to capacity planning for both goods and services,
it is important to note that capacity planning for services can present special challenges due to the
nature of services. Three very important factors in planning service capacity are:
(1) there may be a need to be near customers,
(2) the inability to store services, and
(3) the degree of volatility of demand.
Convenience for customers is often an important aspect of service. Generally, a service must be
located near customers. For example, hotel rooms must be where customers want to stay; having
a vacant room in another city won’t help. Thus, capacity and location are closely tied.
Capacity also must be matched with the timing of demand. Unlike goods, services cannot be
produced in one period and stored for use in a later period. Thus, an unsold seat on an airplane,
train, or bus cannot be stored for use on a later trip. Similarly, inventories of goods allow customers
to immediately satisfy wants, whereas a customer who wants a service may have to wait. This can
result in a variety of negatives for an organization that provides the service. Thus, speed of
delivery, or customer waiting time, becomes a major concern in service capacity planning.
Demand volatility presents problems for capacity planners. Demand volatility tends to be higher
for services than for goods, not only in timing of demand, but also in the amount of time required
to service individual customers. For example, banks tend to experience higher volumes of demand
on certain days of the week, and the number and nature of transactions tend to vary substantially
for different individuals. Then, too, a wide range of social, cultural, and even weather factors can
cause major peaks and valleys in demand. The fact that services can’t be stored means service
systems cannot turn to inventory to smooth demand requirements on the system the way goods-
producing systems are able to. Instead, service planners have to devise other methods of coping
with demand volatility and cyclical demand. For example, to cope with peak demand periods,
planners might consider hiring extra workers, hiring temporary workers, outsourcing some or all
of a service, or using pricing and promotion to shift some demand to slower periods.

In some instances, demand management strategies can be used to offset capacity limitations.
Pricing, promotions, discounts, and similar tactics can help to shift some demand away from peak
periods and into slow periods, allowing organizations to achieve a closer match in supply and
demand.
4.10. DO IT IN-HOUSE OR OUTSOURCE IT?
Once capacity requirements have been determined, the organization must decide whether to
produce a good or provide a service itself, or to outsource from another organization. Many
organizations buy parts or contract out services, for a variety of reasons. Among those factors are
1. Available capacity. If an organization has available the equipment, necessary skills, and
time, it often makes sense to produce an item or perform a service in-house. The additional
costs would be relatively small compared with those required to buy items or subcontract
services. On the other hand, outsourcing can increase capacity and flexibility.
2. Expertise. If a firm lacks the expertise to do a job satisfactorily, buying might be a
reasonable alternative.
3. Quality considerations. Firms that specialize can usually offer higher quality than an
organization can attain itself. Conversely, unique quality requirements or the desire to
closely monitor quality may cause an organization to perform a job itself.
4. The nature of demand. When demand for an item is high and steady, the organization is
often better off doing the work itself. However, wide fluctuations in demand or small orders
are usually better handled by specialists who are able to combine orders from multiple
sources, which results in higher volume and tends to offset individual buyer fluctuations.
5. Cost. Any cost savings achieved from buying or making must be weighed against the
preceding factors. Cost savings might come from the item itself or from transportation cost
savings. If there are fixed costs associated with making an item that cannot be real located
if the service or product is outsourced, that has to be recognized in the analysis. Conversely,
outsourcing may help a firm avoid incurring fixed costs.
6. Risks. Buying goods or services may entail considerable risks. Loss of direct control over
operations, knowledge sharing, and the possible need to disclose proprietary information
are three risks. And liability can be a tremendous risk if the products or services of other
companies cause harm to customers or the environment, as well as damage to an
organization’s reputation. Reputation can also be damaged if the public discovers that a
supplier operates with substandard working conditions.
4.11. DEVELOPING CAPACITY STRATEGIES
There are a number of ways to enhance development of capacity strategies:
1. Design flexibility into systems. The long-term nature of many capacity decisions and the
risks inherent in long-term forecasts suggest potential benefits from designing flexible
systems. For example, provision for future expansion in the original design of a structure
frequently can be obtained at a small price compared to what it would cost to remodel an
existing structure that did not have such a provision. Hence, if future expansion of a
restaurant seems likely, water lines, power hookups, and waste disposal lines can be put in
place initially so that if expansion becomes a reality, modification to the existing structure
can be minimized.
2. Take stage of life cycle into account. Capacity requirements are often closely linked to
the stage of the life cycle that a product or service is in. At the introduction phase, it can
be difficult to determine both the size of the market and the organization’s eventual share
of that market. Therefore, organizations should be cautious in making large and/or
inflexible capacity investments. In the growth phase, the overall market may experience
rapid growth. However, the real issue is the rate at which the organization’s market share
grows, which may be more or less than the market rate, depending on the success of the
organization’s strategies. Organizations generally regard growth as a good thing. They
want growth in the overall market for their products or services, and in their share of the
market, because they see this as a way of increasing volume, and thus, increasing profits.
However, there can also be a downside to this because increasing output levels will require
increasing capacity, and that means increasing investment and increasing complexity. In
addition, decision makers should take into account possible similar moves by competitors,
which would increase the risk of overcapacity in the market, and result in higher unit costs
of the output. Another strategy would be to compete on some nonprice attribute of the
product by investing in technology and process improvements to make differentiation a
competitive advantage. In the maturity phase, the size of the market levels off, and
organizations tend to have stable market shares. Organizations may still be able to increase

profitability by reducing costs and making full use of capacity. However, some
organizations may still try to increase profitability by increasing capacity if they believe
this stage will be fairly long, or the cost to increase capacity is relatively small. In the
decline phase, an organization is faced with underutilization of capacity due to declining
demand. Organizations may eliminate the excess capacity by selling it, or by introducing
new products or services. An option that is sometimes used in manufacturing is to transfer
capacity to a location that has lower labor costs, which allows the organization to continue
to make a profit on the product for a while longer.
3. Take a “big-picture” (i.e., systems) approach to capacity changes. When developing
capacity alternatives, it is important to consider how parts of the system interrelate. For
example, when making a decision to increase the number of rooms in a motel, one should
also take into account probable increased demands for parking, entertainment and food,
and housekeeping. Also, will suppliers be able to handle the increased volume?
4. Identify the optimal operating level. Production units typically have an ideal or optimal
level of operation in terms of unit cost of output. At the ideal level, cost per unit is the
lowest for that production unit. If the output rate is less than the optimal level, increasing
the output rate will result in decreasing average unit costs. This is known as economies of
scale. Economies of scale is states that if the output rate is less than the optimal level,
increasing the output rate results in decreasing average unit costs. By economies of scale
the fixed costs are spread over more units, reducing the fixed cost per unit and processing
costs decrease as output rates increase because operations become more standardized,
which reduces unit costs.
Summary of capacity planning
Capacity refers to a system’s potential for producing goods or delivering services over a specified
time interval. Capacity decisions are important because capacity is a ceiling on output and a major
determinant of operating costs. Three key inputs to capacity planning are the kind of capacity that
will be needed, how much will be needed, and when it will be needed. Accurate forecasts are
critical to the planning process. The capacity planning decision is one of the most important
decisions that managers make. The capacity decision is strategic and long-term in nature, often
involving a significant initial investment of capital.

Capacity planning is particularly difficult in cases where returns will accrue over a lengthy period
and risk is a major consideration. A variety of factors can interfere with effective capacity, so
effective capacity is usually somewhat less than design capacity. These factors include facilities
design and layout, human factors, product/ service design, equipment failures, scheduling
problems, and quality considerations.
Capacity planning involves long-term and short-term considerations. Long-term considerations

relate to the overall level of capacity; short-term considerations relate to variations in capacity
requirements due to seasonal, random, and irregular fluctuations in demand. Ideally, capacity will
match demand. Thus, there is a close link between forecasting and capacity planning, particularly
in the long term. In the short term, emphasis shifts to describing and coping with variations in
demand.
Development of capacity alternatives is enhanced by taking a systems approach to planning, by

designing flexible systems, and by considering product/service complements as a way of dealing
with various patterns of demand.

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BU COLLEGE OF BUSINESS AND ECONOMICS DEPARTMENT OF MANAGEMENT

OPERATIONS MANAGEMENT HANDOUT

PROCESS SELECTION AND CAPACITY PLANNING

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4.1. Process selection

4.2. PROCESS TYPES

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4.4.CAPACITY DECISIONS ARE STRATEGIC

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4.5.DEFINING AND MEASURING CAPACITY

• Efficiency = Actual Output / Effective capacity X 100%

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Forecasting demand fluctuations

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It gives an indication of relative uncertainty

4.6. The alternative capacity plans

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Level capacity plan

Chase demand plan

Methods of adjusting capacity

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Manage demand plan

Demand management: An approach to medium-term capacity management that attempts to change

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Steps in the Capacity Planning Process

1. Estimate future capacity requirements.

4.8.FORECASTING CAPACITY REQUIREMENTS

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Long-term capacity alternatives include expansion or contraction of an existing facility, opening

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4.9.ADDITIONAL CHALLENGES OF PLANNING SERVICE CAPACITY

(1) there may be a need to be near customers,

(2) the inability to store services, and

(3) the degree of volatility of demand.

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4.10. DO IT IN-HOUSE OR OUTSOURCE IT?

There are a number of ways to enhance development of capacity strategies:

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Summary of capacity planning

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Capacity planning involves long-term and short-term considerations. Long-term considerations

Development of capacity alternatives is enhanced by taking a systems approach to planning, by

COMPILED BY: CHERNET TEFERA 18

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