5

Capacity Planning
For Products and
Services

McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 Strategic Capacity Planning
Chapter 5 - Lesson 2
Lecture/Discussion
 Capacity planning – what and why
 Measures of Capacity - Utilization and Efficiency
 Comparing Capacity Alternatives - Breakeven
Analysis

Management tools exercises:

 Capacity Planning Exercise - Running the Business
School
Problem Solving:
 Utilization and Efficiency
 Breakeven Analysis
5-2
 Capacity Planning
 Capacity is the upper limit or ceiling on
the load that an operating unit can handle.
 Capacity also includes
 Equipment
 Space
 Employee skills
 The basic questions in capacity handling
are:
 What kind of capacity is needed?
 How much is needed?
 When is it needed?
5-3
 Importance of Capacity Decisions

1. Impacts ability to meet future demands

2. Affects operating costs
3. Major determinant of initial costs
4. Involves long-term commitment
5. Affects competitiveness
6. Affects ease of management
7. Globalization adds complexity
8. Impacts long range planning

5-4
 Capacity
 Design capacity
 maximum output rate or service capacity an
operation, process, or facility is designed for
 Effective capacity
 Design capacity minus allowances such as
personal time, maintenance, and scrap
 Actual output
 rate of output actually achieved--cannot
exceed effective capacity.

5-5
 Efficiency and Utilization
Actual output
Efficiency =
Effective capacity

Actual output
Utilization =
Design capacity

Both measures expressed as percentages

5-6
 Efficiency/Utilization Example
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

5-7
 Determinants of Effective
Capacity
 Facilities
 Product and service factors
 Process factors
 Human factors
 Policy factors
 Operational factors
 Supply chain factors
 External factors

5-8
 Key Decisions of Capacity
Planning
1. Amount of capacity needed
• Capacity cushion (100% - Utilization)
2. Timing of changes
3. Need to maintain balance
4. Extent of flexibility of facilities

Capacity cushion – extra demand intended to offset uncertainty

5-9
 Steps for Capacity Planning
1. Estimate future capacity requirements
2. Evaluate existing capacity
3. Identify alternatives
4. Conduct financial analysis
5. Assess key qualitative issues
6. Select one alternative
7. Implement alternative chosen
8. Monitor results

5-10
 Forecasting Capacity
Requirements
 Long-term vs. short-term capacity needs
 Long-term relates to overall level of capacity
such as facility size, trends, and cycles
 Short-term relates to variations from
seasonal, random, and irregular fluctuations
in demand

5-11
 Calculating Processing
Requirements
SS t taa nn dd aa r rdd
AA nn nn uu aa l l pp r roo ccee ssssi ni n gg t ti mi m ee PP r roo ccee ssssi ni n gg t ti mi m ee
PP r roo dd uu cct t DD ee mm aa nn dd pp ee r r uu nn i ti t ( (hh r r. .) ) nn ee ee dd ee dd ( (hh r r. .) )

## 11 44 00 00 55 . .00 22 , ,00 00 00

## 22 33 00 00 88 . .00 22 , ,44 00 00

## 33 77 00 00 22 . .00 11 , ,44 00 00
55 , ,88 00 00

If annual capacity is 2000 hours, then we need three machines to handle the
required volume: 5,800 hours/2,000 hours = 2.90 machines

5-12
 Planning Service Capacity
 Need to be near customers
 Capacity and location are closely tied
 Inability to store services
 Capacity must be matched with timing of
demand
 Degree of volatility of demand
 Peak demand periods

5-13
 In-House or Outsourcing
Outsource: obtain a good or service
from an external provider

1. Available capacity
2. Expertise
3. Quality considerations
4. Nature of demand
5. Cost
6. Risk

5-14
Developing Capacity Alternatives
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

5-15
 Bottleneck Operation
Figure 5.2 Bottleneck operation: An operation
in a sequence of operations whose
10/hr capacity is lower than that of the
Machine
Machine #1
#1 other operations

10/hr
Machine
Machine #2
#2 Bottleneck
Bottleneck 30/hr
Operation
Operation
Machine
Machine #3
#3 10/hr

Machine
Machine #4
#4 10/hr

5-16
 Bottleneck Operation

Bottleneck

Operation 1 Operation 2 Operation 3

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

Maximum output rate

limited by bottleneck

5-17
 Evaluating Alternatives
 Cost-volume analysis
 Break-even point
 Financial analysis
 Cash flow
 Present value
 Decision theory
 Waiting-line analysis

5-18
 Cost-Volume Relationships
Figure 5.6a

F C
+
Amount ($)

VC C)
s
=
t t (V
s
c o co
t al le
b
To ri a
l va
o ta
T
Fixed cost (FC)

0
Q (volume in units)

5-19
 Cost-Volume Relationships
Figure 5.6b

ue
en
Amount ($)
e v
l r
ta
To

0
Q (volume in units)

5-20
 Cost-Volume Relationships
Figure 5.6c

u e
e n fi t
Amount ($)

ev ro
r P
al t
t o s
To t a l c
To

0 BEP units
Q (volume in units)

5-21
 Break-Even Problem with Step
Figure 5.7a Fixed Costs
C =
+ V
FC
TC
= TC
V C
+
FC 3 machines
T C
C =
V
F C + 2 machines

1 machine
Quantity
Step fixed costs and variable costs.

5-22
 Break-Even Problem with Step
Figure 5.7b
Fixed Costs

$
BEP
3
TC
BEP2
TC
3
TC
2
TR 1
Quantity
Multiple break-even points

5-23
 Capacity Planning Exercise
Running the Business School
What is the major capacity planning issue when operating a
University “School”?

How would you go about developing a strategic capacity plan for

the Stetson School of Business?

What data is important to obtain?

 __
 __
 __

Develop a capacity plan for:

 Number of full time professors
 Number of adjunct professors
 Classrooms (not for this exercise)

5-24
Utilization and Efficiency Exercises
Determine the utilization and efficiency for the
following:

a. A loan processing operation that processes an

average of 7 loans per day. The operation has a
design capacity of 10 loans per day and an
effective capacity of 8 loans per day.

b. A furnace repair team that services an average of

four furnaces a day if the design capacity is six
furnaces per day and the effective capacity is
five furnaces a day.
5-25
Utilization and Efficiency Exercises
In a job shop, effective capacity is only 50 percent
of design capacity, and actual output is 80% of
effective output. What design capacity would be
needed to achieve an actual output of eight jobs
per week?

5-26
 Breakeven Analysis
A producer of pottery is considering the addition of a
new plant to absorb the backlog of demand.
The primary location being considered will have
fixed costs of $9,200 per month and variable
costs of 70 cents per unit produced. Each item
is to retailers at a price that averages 90 cents.
a. What volume per month is required in order to
break even?

b. What profit would be realized on a monthly

volume of 61,000 units? 87,000 units?
5-27
 Breakeven Analysis
A producer of pottery is considering the addition of a
new plant to absorb the backlog of demand.
The primary location being considered will have
fixed costs of $9,200 per month and variable
costs of 70 cents per unit produced. Each item
is to retailers at a price that averages 90 cents.
c. What volume is needed to obtain a profit of
$16,000 per month?

5-28
 Breakeven Analysis
A small firm intends to increase the capacity of a
bottleneck operation by adding a new machine.
Alternative A Alternative B
Annual fixed cost $40,000 $30,000
Variable cost/unit $10 $15

Revenue / unit = $15

a. Determine each alternative’s breakeven point.

5-29
 Breakeven Analysis
A small firm intends to increase the capacity of a
bottleneck operation by adding a new machine.
Alternative A Alternative B
Annual fixed cost $40,000 $30,000
Variable cost/unit $10 $11

Revenue / unit = $15

b. At what volume would the two alternative yield

the same profit?

5-30