Strategic Capacity

Planning
Chapter Five-Text Book
Capacity Planning
Capacity is the upper limit or ceiling on the load that an operating unit
can handle.

The key questions are in capacity planning are following:

 What kind of capacity is needed?- Depends on the product or the service

management intends to produce or provide.

 How much capacity is needed?

 When the capacity is needed? - Forecasting process helps us to find out

how much is needed and when it is needed.
Nature of Capacity Planning
Capacity Decisions are Strategic. The reasons behind:

 Impacts ability to meet future demands

 Affects operating costs

 Major determinant of initial costs

 Involves long-term commitment

 Affects competitiveness

 Affects ease of management

 Globalization adds complexity

 Impacts long range planning

Measuring Capacity
Design Capacity: The maximum output rate or service capacity an operation,
process or facility is designed for.

 Design capacity is the maximum rate of output achieved under ideal

conditions.

Effective capacity: Design capacity minus allowances such as personal time,

maintenance and scrap.

 Effective capacity is usually less than design capacity owing to realities of

changing product mix, periodic maintenance of equipment, lunch breaks,
coffee breaks etc.

Actual Output: Rate of output actually achieved, cannot exceed effective

capacity.

 Machine breakdowns, shortages of materials, quality problem etc.

Efficiency and Utilization
Efficiency =

Utilization =

Example:
In an automobile service center, Design Capacity is repair of 50 trucks per
day, Effective Capacity is 40 trucks per day, and actual output is 36 trucks per
day . Compute Efficiency and Utilization of that service center.

Efficiency =
Utilization =

Which measurement has more significant value?

Capacity Requirements
Suppose a department works 8 hours a day and 250 days a year (machine
running time) and has these figures for usage of a machine that is currently
being considered:
Product Annual Demand Processing Time Total Processing Time
Per Unit (hours) (hours)
1 400 5.0 2000
2 300 8.0 2400
3 700 2.0 1400
Total 5800

How many machines will be required to fulfill the Demand?

Requirements =
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
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 constant with volume

6. Revenue per unit exceeds variable cost per unit

Cost-Volume Analysis

Formula:
TC= FC+VC
VC= Q x v

TR = Q x R
P = TR – TC
QBEP =
TR = TC
Example
The owner of old fashion berry pies, Mr. Simon, is planning a new lines of pies, which will
require leasing new equipment for a monthly payment of $6,000. Variable costs would be
$2.00 per pie, and pies retail for $7.00 each.
1. How many pies must be sold in order to break even?
2. What would be profit or loss if 1,000 pies sold in a month?
3. How many pies must be sold to realize a profit of $4,000?
4. If 2,000 can be sold. And profit target is $5,000, what price should be charged per pie?

Answer:
1. 1,200 pies/month
2. -$1,000 (loss)
3. 2,000 pies
4. $7.50
Example
A manager has the option of purchasing one, two, or three machines. Fixed costs and
potential volumes are as follows:

Number of Machines Total Annual Fixed Corresponding Range Variable Cost is $10
Cost of Output per unit, and revenue
1 $9,600 0 to 300 is $40 per unit.
2 $15,000 301 to 600
3 $20,000 601 to 900

a. Determine the break-even point for each range (Options)?

b. If projected annual is between 580 and 660 units, how many machines should the manager
purchase?
Example

b. The manager should

purchase two machines.

Challenges of Planning Service Capacity

 The need to be near customers
 The inability to store service
 The degree of volatility of demand