RMIT Classification: Trusted

Operations Management

Week 6
Capacity Planning

13-1
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Learning Objective:

You should be able to:

 Name the three key questions in capacity planning

 Explain the importance of capacity planning

 Describe ways of defining and measuring capacity

 Name several determinants of effective capacity

 Discuss factors to consider when deciding whether to perform

in-house or outsource
 Discuss the major considerations related to developing capacity
alternatives
 Describe the steps used to resolve constraint issues

 Briefly describe approaches that are useful for evaluating

capacity alternatives
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Capacity Planning

Capacity

 The upper limit or ceiling on the load that an operating

unit can handle
 Capacity needs include
 Equipment
 Space
 Employee skills
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Strategic Capacity Planning

 Goal
 To achieve a match between the long-term supply
capabilities of an organization and the predicted level of
long-term demand
 Overcapacity  operating costs that are too high
 Undercapacity  strained resources and possible loss of customers
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Capacity Planning Questions

 Key questions:
 What kind of capacity is needed?
 How much 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?
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Capacity Decisions Are Strategic

Capacity decisions
1. Impact the ability of the organization to meet future
demands
2. Affect operating costs

3. Are a major determinant of initial cost

4. Often involve long-term commitment of resources

5. Can affect competitiveness

6. Affect the ease of management

7. Have become more important and complex due to

globalization
8. Need to be planned for in advance due to their
consumption of financial and other resources
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Defining and Measuring Capacity

 Measure capacity in units that do not require

updating
 Why is measuring capacity in dollars problematic?
 Two useful definitions of capacity
 Design capacity
 The maximum output rate or service capacity an operation,
process, or facility is designed for
 Effective capacity
 Design capacity minus allowances such as personal time and
maintenance
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Measures of capacity

Business Inputs Outputs

Auto Labor hours, Number of cars per shift
manufacturing machine hours
Steel mill Furnace size Tons of steel per day
Oil refinery Refinery size Gallons of fuel per day
Farming Number of acres, Bushels of grain per acre per year,
number of cows gallons of milk per day
Restaurant Number of tables, Number of meals served per day
seating capacity
Theater Number of seats Number of tickets sold per
performance
Retail sales Square feet of floor Revenue generated per day
space

Measures of capacity
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Measuring System Effectiveness

 Actual output

 The rate of output actually achieved

 It cannot exceed effective capacity

 Efficiency

 Utilization

Measured as percentages
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Example – Efficiency and Utilization

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

actual output 36
Efficiency    90%
effective capacity 40

actual output 36
Utilization    72%
design capacity 50
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Determinants of Effective Capacity

 Facilities
 Product and service factors
 Process factors
 Human factors
 Policy factors
 Operational factors
 Supply chain factors
 External factors
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Strategy Formulation

 Strategies are typically based on assumptions and

predictions about:

 Long-term demand patterns

 Technological change
 Competitor behavior
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Capacity Strategies

 Leading
 Build capacity in anticipation of future demand
increases
 Following
 Build capacity when demand exceeds current
capacity
 Tracking
 Similar to the following strategy, but adds capacity in
relatively small increments to keep pace with
increasing demand
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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 cushions
 Organizations that have standard products and services generally
have smaller capacity cushions
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Steps in Capacity Planning

1. Estimate future capacity requirements

2. Evaluate existing capacity and facilities; identify
gaps
3. Identify alternatives for meeting requirements
4. Conduct financial analyses
5. Assess key qualitative issues
6. Select the best alternative for the long term
7. Implement alternative chosen
8. Monitor results
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Forecasting Capacity Requirements

 Long-term considerations relate to overall level of

capacity requirements
 Require forecasting demand over a time horizon and
converting those needs into capacity requirements
 Short-term considerations relate to probable variations
in capacity requirements
 Less concerned with cycles and trends than with seasonal
variations and other variations from average
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Demand Patterns
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Calculating Processing Requirements

Example:
A department works one 8-hour shift, 250 days a year, and has the following
figures for usage of a machine that is currently being considered. Determine
the number of machine needed to handle the total demand of the products.

Annual Standard Processing Processing Time

Product Demand Time per Unit (hr) Needed (hr)

1 400 5 2000

2 300 8 2400

3 700 2 1400

5800
Solution: 5800 hours/2000 hr per machine = 2.9 or 3 machines are needed
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Demand Management Strategies

Strategies used to offset capacity limitations and

that are intended to achieve a closer match between
supply and demand

 Pricing
 Promotions
 Discounts
 Other tactics to shift demand from peak
periods into slow periods
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In-House or Outsource?

 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
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Developing Capacity Alternatives

 Things that can be done to enhance capacity

management:

 Design flexibility into systems

 Take stage of life cycle into account
 Take a “big-picture” approach to capacity changes
 Prepare to deal with capacity “chunks”
 Attempt to smooth capacity requirements
 Identify the optimal operating level
 Choose a strategy if expansion is involved
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Bottleneck Operation

An operation in a sequence
of operations whose
capacity is lower than that
of the other operations
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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
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Evaluating Alternatives

 Alternatives should be evaluated from varying

perspectives
 Economic
• Is it economically feasible?
• How much will it cost?
• How soon can we have it?
• What will operating and maintenance costs be?
• What will its useful life be?
• Will it be compatible with present personnel and
present operations?

 Non-economic
• Public opinion
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Evaluating Alternatives (cont.)

Techniques for Evaluating Alternatives

• Cost-volume analysis
• Financial analysis
• Decision theory
• Waiting-line analysis
• Simulation
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Cost-Volume Analysis

Cost-volume analysis
 Focuses on the relationship between cost, revenue, and volume of
output
 Fixed Costs (FC)

• Tend to remain constant regardless of output volume

 Variable Costs (VC)

• Vary directly with volume of output

• VC = Quantity(Q) × variable cost per unit (v)

 Total Cost

• TC = FC + VC

 Total Revenue (TR)

• TR = revenue per unit (R) × Q

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Break-Even Point (BEP)

 BEP
 The volume of output at which total cost and total revenue
are equal
 Profit (P) = TR – TC = R × Q – (FC + v × Q)
= Q(R – v) – FC

FC
QBEP 
Rv
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Cost-Volume Relationships
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BEP Example

The owner of Old-Fashioned Berry Pies, S. Simon, is contemplating

adding a new line of pies, which will require leasing new
equipment for a monthly payment of $6,000. Variable costs would
be $2 per pie, and pies would retail for $7 each.
a. How many pies must be sold in order to break even?
b. What would the profit (loss) be if 1,000 pies are made and sold
in a month?
c. How many pies must be sold to realize a profit of $4,000?
d. If 2,000 can be sold, and a profit target is $5,000, what price
should be charged per pie?
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BEP Example: Solution

FC = $6,000, VC= $2 per pie, R = $7 per pie

a. QBEP = 6000/(7-2)= 1200 pies/month

b. P = 1000(7-2)-6000= -1000
c. 4000 = 7Q- 6000-2Q
Q=10000/5 = 2000 pies
d. 5000= 2000 (R-2)-6000
R= $7.5
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BEP and Step Costs

Capacity alternatives may involve step costs, which are

costs that increase stepwise as potential volume
increases.
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BEP and Step Costs Example

A manager has the option of purchasing one, two, or three machines. Fixed
costs and potential volumes are as follows. Variable cost is $10 per unit, and
revenue is $40 per unit.
a. Determine the break-even point for each range.
b. If projected annual demand is between 580 and 660 units, how many
machines should the manager purchase?

Number of Total Annual Fixed Corresponding Range of

Machines Costs Output

1 9600 0-300

2 15000 301-600

3 20000 601-900
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BEP and Step Costs Example Solution

a. Compute the break-even point for each range using the formula QB EP FC/( R -
v)

For one machine: QB EP - 9600/(40-10) = 320 units (not in range)

For one machine: QB EP - 15000/(40-10) = 500 units
For one machine: QB EP - 20000/(40-10) = 666.67 units
b. the manager should choose two machines.
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Cost-Volume Analysis Assumptions

 Cost-volume analysis is a viable tool for comparing capacity

alternatives if certain assumptions are satisfied
 One product is involved
 Everything produced can be sold
 The variable cost per unit is the same regardless of volume
 Fixed costs do not change with volume changes, or they are step
changes
 The revenue per unit is the same regardless of volume
 Revenue per unit exceeds variable cost per unit
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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 flow of an
investment proposal
Decision Theory
Decision theory is a helpful tool for financial comparison of alternatives under
conditions of risk or uncertainty.

Waiting-Line Analysis
Analysis of lines is often useful for designing or modifying service systems.

Simulation
Simulation can be a useful tool in evaluating what-if scenarios.
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Question

13-37