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Capacity Strategy

An operations capacity dictates its potential level of productive activity. It is, the maximum level of value-added activity over a period of time that the operation can achieve under normal conditions.

Capacity is not same as output.

The capacity strategy of an operation defines its overall scale, the number and size of different sites between which its capacity is distributed, the specific activities allocated to each site and the location of each site.

Issues in capacity strategy

Capacity Strategy

Configuring Capacity

Managing Capacity Change

Overall Level of Capacity

Type of Capacity

Location of Capacity

Timing of Change

Magnitude of Change

Location of changed capacity

Utilization and efficiency measures for two divisions of a food processing company
Ice Cream Division
Efficiency = Actual output Effective capacity = 90.08% Avoidable Loss 410 hrs Actual Output 3724 hrs

Canned Food Division

Efficiency = Actual output Effective capacity = 85.01%

= 3724 4134 Planned Loss 3762 hrs

= 4622 5437

Total Capacity 7896 hrs

Total Capacity 7896 hrs

Planned Loss 2459 hrs

Avoidable Loss 815 hrs

Effective Capacity 4134 hrs

Effective Capacity 5437 hrs Actual Output 4622 hrs


Actual output Total capacity 3724 = = 47.16% 7896



Actual output Total capacity 4622 = = 58.54% 7896


Capacity at three levels

Level Time Scale Decisions concern provision of . . . Buildings and facilities Process technology Span of decisions Starting point of decision Key questions

Strategic capacity Decisions

Years Months

All parts of the process

Probable markets to be served in the future Current capacity configuration

How much capacity do we need in total? How should the capacity be distributed? Where should the capacity be located? To what extent do we keep capacity level fluctuate capacity levels? Should we change staffing levels as demand changes? Should we subcontract off-load demand?

Mediumterm capacity decisions

Months Weeks

Aggregate number of people Degree of subcontracted resources

Business site

Market forecasts Physical capacity constraints

Contd .
Level Time - Scale Decisions concern provision of . . . Individual staff within the operation Loading of individual facilities Span of decisions Starting point of decision Key questions

Short-term capacity decisions

WeeksHours Minutes

Site Department

Current demand Current available capacity

Which resources are to be allocated to what tasks? When should activities be loaded on individual resources?

The overall level of operations capacity

Forecast level of demand Changes in future demand

Availability of capital Cost structure of capacity increment

Economies of scale Flexibility of capacity provisions

Overall level of MARKET capacity REQUIREMENTS

Consequences of over/under supply

Uncertainty of future demand

Some factors influencing the overall level of capacity

Cost, Volume profit illustration

Unit Costs
Total cost = Fixes Cost + variable cost * Demand Unit cost = Total Cost / output For example, the theoretical capacity in Figure was based on an assumption that the operation would be working 112 hours a week (14 shifts a week out of a possible 21 shifts a week) whereas the operation is theoretically available168 hours a week. Utilising some of this unused time for production will help to spread further the fixed costs of the operation but could also incur extra costs. For example, overtime payments and shift premiums together with incrementally higher energy bills may be incurred after a certain level of output. There may also be less obvious costs of operating above nominal capacity levels.

Long periods of overtime may reduce productivity levels, reduced or delayed maintenance time may increase the chances of breakdown, operating facilities and equipment at a higher rate or for longer periods may also expose problems which hitherto lay dormant. These diseconomies of over-using capacity can have the effect of increasing unit costs above a certain level of output. However, all the fixed costs are not usually incurred at one time at the start of operations. Rather they occur at many points as volume increases. Operations managers often have some discretion as to where these fixed-cost breaks will occur. The factors that go together to reduce costs as volume increases are often called economies of scale. Those that work to increase unit costs for increased output beyond a certain volume are called diseconomies of scale.

Unit Cost Curve

In practice Unit costs are are capable of being extended beyond nominal capacity;

often show increases in cost beyond a certain level of volume;

are best represented by a band within which the true cost will lie, rather than a smooth, clean line

Flexibility of capacity provision

Committing to an investment in a particular level of capacity may be managed in such a way as to facilitate later expansion Effective capacity requires all the required resources and processes to be in place in order to produce goods and services. This may not necessarily imply that all resources and processes are put in place at the same time. It may be possible, for example, to construct the physical outer shell of an operation without investing in the direct and indirect process technologies which will convert it into productive capacity One option involves building the whole physical facility (with a larger net cash outflow) but only equipping it to half its potential physical capacity. Only when demand justifies it would expenditure be made to fully exploit this capacity.

The alternative is to build a fully equipped facility of half the capacity. A further identical capacity increment would then beadded as required. Although this latter strategy requires a lower initial cash outflow, it shows a lower cumulative cash flow in the longer term.

Expanding physical capacity in advance of effective capacity can bring greater returns in the longer term

Number and size of sites

The decision of how many separate operational sites to have is concerned with where a business wants to be on the spectrum between many small sites on one hand and few large sites on the other. Small Units - If demand for a businesss products or services is widely distributed. This will be especially true if customers demand high absolute levels, or immediate service. Of course, dividing capacity into small units may also increase costs because of the difficulty of exploiting the economies of scale possible in larger units. A small number of larger units may also be less costly to supply with their input resources. There again, in material transformation operations, a single large unit will bear extra transportation costs in supplying its distributed market.

Some factors influencing the number and size of sites

Suppose a company which stores and distributes books to book shops is considering its capacity strategy. Currently in its European market it has three distribution centres, one in the UK, one in France and one in Germany. The UK depot looks after the UK and Ireland, the French depot looks after France, Spain, Portugal and Belgium, and the German depot looks after the rest of Europe. The consultants decide to simulate the alternative operations in order to estimate (a) the cost of running the depots (this includes fixed costs such as rent and local taxes, heating, wages, security, and working capital charges for the inventory, etc.),

(b) transportation costs of delivering the books to customers, and

(c) the average delivery time in working days between customers requesting books and them being delivered. Table 3.2 shows the results of this simulation


By moving to one large site it can save 9.1 million per year (the savings on depot costs easily outweighing the increase in transportation costs). Yet, delivery times will increase on average by 1.4 days. Alternatively, moving to six smaller sites would increase costs by 9.3 million per year, yet gives what looks like a significant improvement in delivery time of 2.5 days.

In practice, however, the decision is probably more sensibly approached by presenting a number of questions to the companys managers.
Is an increase in average delivery time from 6.3 to 7.7 days likely to result in losses of business greater than the 9.1 million savings in moving to a large site? Is the increase in business which may be gained from a reduction in delivery time from 6.3 days to 3.8 days likely to compensate for the 9.3 million extra cost of moving to six smaller sites?

Are either of these alternative positions likely to be superior to its existing profitability?

One final point: In evaluating the sizes and number of sites in any operation, it is not just the increase in profitability which may result from a change in configuration that needs to be considered, it is whether that increase in profitability is worth the costs of making the change. Presumably, either option will involve this company in not only capital expenditure, but also a great deal of management effort and disruption to its existing business. It may be that these costs and risks outweigh any increase in profitability.

Capacity Change
Planning changes easier if it were not for two characteristics of capacity:
lead-time economies of scale.

If capacity could be introduced with zero delay between the decision to expand and the capacity coming on stream, an operation could wait until demand clearly warranted the change. Deciding to Change capacity inevitably involves some degree of risk, but so does delaying the Decision leading to more problems This means that, when changing capacity levels, there is pressure to make the change big enough to exploit scale economies Capacity by too little may mean Opportunity risks of tying the operation in to small, non-economic units of capacity. Put both long lead-times and signicant economies of scale together and capacity Change decisions become particularly risky.

The timing of capacity Change

Lead-time of capacity change Forecast level of demand Competitor activity

Ability to cope with change


Time of Capacity Change

Uncertainty of future demand Required level of service

Economies of scale

Some factors influencing the timings of capacity change

Generic Timings Strategies

There are three generic strategies for timing capacity change: Capacity leads demand timing the introduction of capacity in such a way that there is always sufficient capacity to meet forecast demand. Capacity lags demand timing the introduction of capacity so that demand is always equal to or greater than capacity. Smoothing with inventories timing the introduction of capacity so that current capacity plus accumulated inventory can always supply demand.

(a) Capacity-leading and capacity-lagging strategies; (b) smoothing with inventory means using the excess capacity of one period to produce inventory which can be used to supply the under-capacity period

Generic Timings Strategies

The advantages and disadvantages of pure leading, pure lagging and smoothing with inventories strategies of capacity timing

The Magnitude of Capacity Change

Large units of capacity also have some disadvantages when the capacity of the operation is being changed to match changing demand. If an operation where forecast demand is increasing seeks to satisfy all demand by increasing capacity using large capacity increments, it will have substantial amounts of over-capacity for much of the period when demand is increasing, which results in higher unit costs. However, if the company uses smaller increments, although there will still be some over-capacity it will be less than that using large capacity increments. This results in higher capacity utilisation and therefore lower costs. .

Capacity plans for meeting demand using either 800- or 400-unit capacity plants; (b) smaller-scale capacity increments allow the capacity plan to be adjusted to accommodate changes in demand

Balancing Capacity change

Resource costs Land and facilities investment OPERATIONS RESOURCES Resource availability Community factors Location of sites

Required service level Suitability of site MARKET REQUIREMENTS Image of location

Some factors influencing the location of sites

government financial or planning assistance

local tax rates capital movement restrictions


political stability local amenities (schools, theatres, shops, etc.)


history of labour relations, absenteeism, productivity, etc environmental restrictions and waste disposal

Resource Cost