CAPACITY PLANNING

FOR PRODUCTS AND SERVICES

 FACILITY PLANNING
Facility planning answers:
 What kind of capacity is needed?
 How much capacity is needed to match demand?
 When more capacity is needed?
 Where facilities should be located (location)
 How facilities should be arranged (layout)
 CAPACITY (DEFINITION OF)

The number of units a facility can hold, receive, store

or produce in a period of time

It is the upper limit or ceiling on the load that an

operating unit can handle. It includes
 equipment,
 space,
 employee skills
STRATEGIC CAPACITY PLANNING
 Goal
To achieve a match between the long-term supply
capabilities of an organization and the predicted
level of long-run demand
Overcapacity  operating costs that are too
high
Undercapacity  strained resources and
possible loss of customers
 CAPACITY PLANNING QUESTIONS
Key Questions:
What kind of capacity is needed?
How much capacity 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?
 ISSUES TO BE CONSIDERED IN
STRATEGY FORMULATION
Capacity strategy
Demand patterns
Growth rate and variability
Facilities
 (Cost of the building and operating)
Technological changes
 (Rate and direction of technology changes)
Behavior of competitors
Availability of capital and other inputs.
 TYPES OF PLANNING OVER A
TIME HORIZON

Long Range Add Facilities

Planning Add long lead time equipment *

Intermediate Sub-Contract Add Personnel

Range Planning Add Equipment Build or Use Inventory
Add Shifts

Schedule Jobs
Short Range * Schedule Personnel
Planning AllocateMachinery

*Limited options exist Modify Capacity Use Capacity

 IMPORTANCE OF CAPACITY
DECISIONS
1. impact the ability of the organization to meet future
demands
2. affect operating costs
3. affect lead time responsiveness
4. are a major determinant of initial costs
5. involve long-term commitment of resources
6. affect competitiveness
7. affect ease of management
8. are more important and complex due to globalization
9. need to be planned for in advance due to their
consumption of financial and other resources
 CAPACITY MEASURES
 Design capacity
Maximum output rate or service capacity an
operation, process, or facility is designed for
 Effective capacity
Capacity a firm can expect to attain given its
product mix, methods of scheduling, maintenance
and standards of quality. Design capacity minus
allowances such as personal time, maintenance and
scrap
 CAPACITY RELATED CONCEPTS
 Actual output
Rate of output actually achieved—cannot exceed
effective capacity
 Utilization
Actual output as a percent of design capacity
 Efficiency
Actual output as a percent of effective capacity
 EFFICIENCY

Measure of how well a facility or machine is performing

when used

Actual output
Efficiency =
Effective Capacity

(expressed as a percentage)
 UTILIZATION
Measure of actual capacity usage of a facility, work
center, or machine

Actual Output
Utilization =
Design Capacity

(expressed as a percentage)
EXAMPLE- EFFICIENCY/UTILIZATION

Design capacity = 50 trucks/day

Effective capacity = 40 trucks/day
Actual output = 36 units/day

Actual output = 36 units/day

Efficiency = = 90%
Effective capacity 40 units/ day

Utilization = Actual output = 36 units/day

= 72%
Design capacity 50 units/day
 DETERMINANTS OF EFFECTIVE
CAPACITY
Facilities
Product and Service Factors
Process Factors
Human Factors
Policy Factors
Operational Factors
Supply Chain Factors
External Factors
 STRATEGY FORMULATION

Strategies are typically based on assumptions and

predictions about:
Long-term demand patterns
Technological change
Competitor behavior
 SPECIAL REQUIREMENTS FOR
MAKING GOOD CAPACITY
DECISIONS
 Forecasting the demand accurately
 Understanding the technology and capacity
increments
 Finding the optimal operating level (volume)
 Building for change
 KEY DECISIONS IN CAPACITY
PLANNING
 Amount of capacity needed
 Timing of changes (frequency of capacity additions)
 Extent of flexibility of facilities
 External sources of capacity
 Need to maintain balance
AMOUNT OF CAPACITY NEEDED
STEPS OF CAPACITY PLANNING
 Estimate future capacity requirements
 Evaluate existing capacity and facilities and
identify gaps
 Identify alternatives for meeting requirements
 Conduct financial analysis
 Assess key qualitative issues
 Select the best alternative for the long term
 Implement the alternative chosen
 Monitor results
 FORECASTING CAPACITY
REQUIREMENTS

Long-term considerations relate to overall level of

capacity requirements

Short-term considerations relate to probable variations

in capacity requirements
 CALCULATING PROCESSING
REQUIREMENTS
 Forecast sales within each individual product line

 Calculate equipment and labor requirements to

meet the forecasts
 CALCULATING PROCESSING
REQUIREMENTS
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
 CALCULATING PROCESSING
REQUIREMENTS: EXAMPLE 1 (1 of 2)
Standard
Annual processing time Processing time
Product Demand per unit (hr.) needed (hr.)

#1 400 5.0 2,000

#2 300 8.0 2,400

#3 700 2.0 1,400

5,800
 CALCULATING PROCESSING
REQUIREMENTS: EXAMPLE 1 (2 of 2)

If the department works one eight hour shift, 250 days a

year, calculate the number of machines that would be
needed to handle the required volume.

Solution:
5800/(250)(8) = 2.9 (3 machines are needed)
 CAPACITY CUSHION

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 greater capacity cushion
SERVICE CAPACITY PLANNING

 Service capacity planning can present a number of

challenges related to:
The inability to store services
The need to be near customer
The degree of demand volatility
 SERVICE CAPACITY PLANNING
 Time: Inability to store services for later consumption.
Capacity must be available to provide a service when it is
needed (capacity must be matched with the timing of
demand)

 Location: Need to be near customers for convenience.

Capacity and location are closely tied. Service goods must
be at the customer demand point and capacity must be
located near the customer
 Volatility of Demand: (Much greater than in
manufacturing)
 Volume and timing of demand

 Time required to service individual customers

 CAPACITY UTILIZATION &
SERVICE QUALITY

 Best operating point is near 70% of capacity

 From 70% to 100% of service capacity, what do

you think happens to service quality?
TIMING AND SIZE OF CHANGES
(FREQUENCY OF CAPACITY
ADDITIONS)
 CAPACITY EXPANSION

Factors to be considered:
 Volume and certainty of anticipated demand
 Strategic objectives for growth
 Costs of expansion and operation
 Incremental or one-step expansion
 Frequency of capacity additions
CAPACITY EXPANSION STRATEGIES
(1 of 5)
Expected Demand Expected Demand

New Capacity New Capacity

Demand
Demand

Time in Years Time in Years

Capacity leads demand with an incremental expansion Capacity leads demand with a one-step expansion

Expected Demand Expected Demand

New Capacity
New Capacity
Demand

Demand

Time in Years Time in Years

Attempts to have an average capacity, with
Capacity lags demand with an incremental expansion
an incremental expansion
CAPACITY EXPANSION STRATEGIES
(2 of 5)
Expected Demand

New Capacity
Demand

Time in Years

Capacity leads demand with an incremental expansion

CAPACITY EXPANSION STRATEGIES
(3 of 5)
Expected Demand

New Capacity
Demand

Time in Years
Capacity leads demand with a one-step expansion
CAPACITY EXPANSION STRATEGIES
(4 of 5)
Expected Demand
New Capacity
Demand

Time in Years
Capacity lags demand with an incremental expansion
 CAPACITY EXPANSION STRATEGIES
(5 of 5)
Expected Demand
New Capacity
Demand

Time in Years
Attempts to have an average capacity, with an incremental
expansion
 MAKE OR BUY?
1. Available capacity
2. Expertise
3. Quality considerations
4. Nature of demand
5. Cost
6. Risk
OPTIMAL OPERATING LEVEL
OPTIMAL OPERATING LEVEL
Average cost per room

Best operating
level

Economies Diseconomies
of scale of scale

250 500 1000

# Rooms
 ECONOMIES OF SCALE
 Economies of scale
If the output rate is less than the optimal level,
increasing output rate results in decreasing average
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
 DISECONOMIES OF SCALE

 Diseconomies of scale
 If the output rate is more than the optimal level,
increasing the output rate results in increasing average 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
 ECONOMIES OF SCALE
Minimum cost & optimal operating rate are
Average cost per unit functions of size of production unit.

Small
plant Medium
plant Large
plant

0 Volume or output rate

 ECONOMIES AND DISECONOMIES OF
SCALE
Economies of Scale and the Experience Curve working

100-unit
Average plant
unit cost 200-unit
of output plant 400-unit
300-unit
plant
plant

Diseconomies of Scale start working

Volume
 THE
As plants produce more products, they gain
EXPERIENCE experience in the best production methods
and reduce their costs per unit
CURVE

Yesterday

Cost or Today
price Tomorrow
per unit

Total accumulated production of units

EXTERNAL SOURCES OF CAPACITY
 IN-HOUSE OR OURSOURCE?

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
NEED TO MAINTAIN BALANCE
 CAPACITY PLANNING: BALANCE
Unbalanced stages of production
Units
per Stage 1 Stage 2 Stage 3
month
6,000 7,000 5,000
Maintaining System Balance: Output of one stage is the
exact input requirements for the next stage
Balanced stages of production
Units
per Stage 1 Stage 2 Stage 3
month
6,000 6,000 6,000
 BOTTLENECK OPERATION
Bottleneck operation: An operation
10/hr
Machine #1 in a sequence of operations whose
capacity is lower than that of the
other operations
10/hr
Machine #2
Bottleneck 30/hr
Operation
Machine #3
10/hr

Machine #4 10/hr
BOTTLENECK OPERATION

Bottleneck

Operation 1 Operation 2 Operation 3

10/hr.
20/hr. 10/hr. 15/hr.

Maximum output rate

limited by bottleneck
 CONSTRAINT MANAGEMENT
Constraint
Something that limits the performance of a process or
system in achieving its goals

Categories
Market
Resource
Material
Financial
Knowledge or competency
Policy
 RESOLVING CONSTRAINT ISSUES
 Identify the most pressing constraint
 Change the operation to achieve maximum benefit,
given the constraint
 Make sure other portions of the process are supportive
of the constraint
 Explore and evaluate ways to overcome the constraint
 Repeat the process until the constraint levels are at
acceptable levels
STRATEGIES FOR MATCHING
CAPACITY TO DEMAND
 DEMAND MANAGEMENT
STRATEGIES
Strategies used to offset capacity limitations and
that are intended to achieve a closer match
between supply and demand
 Pricing
 Promotions
 Backorders
 Offering complementary products
 Discounts
 Other tactics to shift demand from peak periods
into slow periods
 COMPLEMENTARY PRODUCTS
Sales (Units)
5,000
Total
4,000 Snow-
3,000 mobiles
2,000
1,000 Jet Skis
0
J M M J S N J M M J S N J
Time (Months)
 CAPACITY MANAGEMENT
STRATEGIES
1. Adjusting equipment and processes – which might
include purchasing additional machinery or selling
or leasing out existing equipment
2. Making staffing changes (increasing or decreasing
the number of employees)
3. Improving methods to increase throughput
4. Redesigning the product to facilitate more
throughput (for faster processing)
 THINGS THAT CAN BE DONE TO
ENHANCE CAPACITY MANAGEMENT

1. Design flexibility into systems

2. Take stage of life cycle into account
3. Take a “big picture” approach to capacity changes
4. Prepare to deal with capacity “chunks”
5. Attempt to smooth out capacity requirements
6. Identify the optimal operating level
7. Choose a strategy if expansion is involved
CAPACITY FLEXIBILITY
 CAPACITY FLEXIBILITY

Flexible plants

Flexible processes

Flexible workers
 EVALUATING ALTERNATIVES
Alternatives should be evaluated from varying
perspectives
ECONOMIC
 Cost-volume analysis
Break-even point
 Financial analysis
Cash flow
Present value
 Decision theory
 Waiting-line analysis
 Simulation
NON-ECONOMIC
 Public opinion
COST-VOLUME RELATIONSHIPS
(1 OF 3)

Amount ($)

Fixed cost (FC)

0
Q (volume in units)
COST-VOLUME RELATIONSHIPS
(2 OF 3)

Amount ($)

0
Q (volume in units)
COST-VOLUME RELATIONSHIPS
(3 OF 3)
Amount ($)

0 BEP units
Q (volume in units)
 BREAK-EVEN POINT (BEP)

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
COST-VOLUME RELATIONSHIPS
BREAK-EVEN PROBLEM WITH STEP
FIXED COSTS (1 of 2)

3 machines

2 machines

1 machine
Quantity
Step fixed costs and variable costs.
BREAK-EVEN PROBLEM WITH STEP
FIXED COSTS (2 of 2)
$
BEP
3
TC
BEP2
TC
3
TC
2

1
Quantity
Multiple break-even points
 ASSUMPTIONS OF COST-VOLUME
ANALYSIS

1. One product is involved

2. Everything produced can be sold
3. Variable cost per unit is the same regardless of
volume
4. Fixed costs do not change with volume
5. Revenue per unit is the same regardless of
volume
6. Revenue per unit exceeds variable cost per unit
 FINANCIAL ANALYSIS

 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 flows
of an investment proposal.