Chapter 5

Strategic Capacity
Planning

Sam Lampropoulos
© 2021 McGraw-Hill Education Limited.
George Brown College
 Capacity Planning at Ford
Like other major automobile manufacturers, Ford
has a highly systematic process in place to ensure
that its key suppliers are capable of delivering the
required quantities of parts and components at the
right times.

© 2021 McGraw-Hill Education Limited. 2

 Learning Objectives

 Define capacity, explain the importance of long-term

capacity, know how to measure capacity and understand
two related performance measures, know overall
equipment effectiveness and describe factors influencing
effective capacity.
 Describe the strategic capacity planning process in
organizations, know long term demand patterns and
calculate capacity requirements, and discuss major
considerations for developing capacity alternatives.
 Describe the break-even analysis approach for evaluating
capacity alternatives, and use it to solve problems.
© 2021 McGraw-Hill Education Limited. 3
 Chapter Outline
 What is capacity?
 Measuring capacity
 Factors influencing capacity
 Strategic capacity planning in organizations
 Calculate capacity requirements
 Develop capacity alternatives
 Evaluating alternatives

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 What is Capacity?

Capacity is the upper limit on the load

that an operating unit can handle.

The basic questions in capacity handling

are:
 What kind of capacity is needed?
 How much is needed?
 When is it needed?
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 Strategic Capacity Planning
 The systematic determination of facility and major
machine/equipment requirements to meet long-
term demand for goods and services.
 Overcapacity causes operating costs that are too
high, while under capacity causes strained
resources and possible loss of customers.

not enough
too much

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 Importance of Long-Term Capacity

 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 increases complexity and
requires substantial resources

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 Measuring Capacity
 Design capacity
• Maximum obtainable output rate under
ideal conditions.
 Effective capacity
• Maximum output rate given work breaks,
product mix, scheduling difficulties,
equipment maintenance, delays, and other
realities (i.e. standard output rate).

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 Common Measures of Capacity
Business Inputs Outputs
Auto manufacturing Number of cars per shift
Steel mill Tonnes of steel per day
Oil refinery Barrels of crude oil used Barrels of gasoline per
per day day
Farming Number of acres Bushels of grain per
acres per year, litres of
milk per day
Restaurant Number of tables, Number of meals / day
number of seats
Theatre Number of seats Number of tickets sold
per day
Retail sales Square metres of floor Revenue generated per
space, sales per sq. ft. day

Table 5-1
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 Efficiency and Utilization
Efficiency: The ratio of actual output rate to
effective capacity.
Utilization of a unit of a resource during a period.
Uptime is divided by available time.

Actual output rate

Efficiency 
Effective capacity
Uptime
Utilization 
Available time

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 Efficiency/Utilization Example

Design capacity = 50 trucks/day

Effective capacity = 40 trucks/day
Actual output = 36 units/day
Available hours = 8 hrs x 5 days per week
Downtime = 5 hours per week
Actual Output 36 units day
Efficiency    90%
Effective Capacity 40units/day
Uptime 40  5hrs / week
Utilization    87.5%
Available time 40hrs / week
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 Example: Capacity
• Actual production last week = 32,000 units
• Effective capacity = 35,000 units
• Design capacity = 250 units per hour
• Factory operates 7 days/week, 3 - 8 hour shifts
• Maintenance is 20 hours per week and other
downtime is 12 hours per week.

Available hours = 7 days x 3 shifts x 8 hours = 168 hrs

Design capacity = 168 hrs x 250units = 42,000 units

 What is the design capacity for one week?

 Calculate the efficiency and utilization rates.
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 Example: Capacity
Actual production last week = 32,000 units
Effective capacity = 35,000 units
Design capacity = 250 units per hour
Factory operates 7 days/week, 3 - 8 hour shifts
Maintenance is 20 hours per week and other
downtime is 12 hours per week.

Available hours = 7 days x 3 shifts x 8 hours = 168 hrs

Design capacity = 168 hrs x 250units = 42,000 units

Efficiency = 32,000/35,000 = 91.4%

© 2021 McGraw-Hill Education Limited. 13
 Example: Capacity
• Actual production last week = 32,000 units
• Effective capacity = 35,000 units
• Design capacity = 250 units per hour
• Factory operates 7 days/week, 3 - 8 hour shifts
• Maintenance is 20 hours per week and other
downtime is 12 hours per week.
Available hours = 7 days x 3 shifts x 8 hours = 168 hrs
Design capacity = 168 hrs x 250units = 42,000 units

Efficiency = 32,000/35,000 = 91.4%

Utilization = 168 – (20+12) / 168 = 81%
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 Factors Influencing Capacity

Facilities and
Product mix Workers
machines

Planning and Supply chain External

Operational factors

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Factors Influencing Effective Capacity
 Facilities and Machines
• Floor space, layout
 Product Mix
• Limited vs. extensive menu in a restaurant
 Workers
• Training, skills and experience
 Planning and Operational
• Shifts per day, bottlenecks, inventory, quality control
 Supply chain factors
• Warehousing, transportation and distributors
 External factors
• Product standards, pollution standards, regulatory paper work

© 2021 McGraw-Hill Education Limited. 16

Strategic Capacity Planning Process
1. Forecast demand one to five years ahead

2. Calculate capacity requirements to meet the forecast

3. Measure the capacity now and

decide how to bridge the gap
a) Generate feasible b) Evaluate c) Choose the best
alternatives alternatives alternative and
considering economic implement it
and non-economic
aspects

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Calculating Capacity Requirements
A department works one eight hour shift, 250 days a year. How
many machines (with the given processing times) would be
needed to handle the required volume?

Product Annual Standard Processing Processing time

Demand time per unit (hr.) needed (hr.)
#1 400 5.0 2,000
#2 300 8.0 2,400
#3 700 2.0 1,400

8  250  2,000 machine hours per year

2,000  2,400  1,400
 2.9 machines
2,000
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 Major Considerations for
Developing Capacity Alternatives
Design flexibility into systems
Differentiate between new and mature products
Take a “big picture” approach to capacity changes
Choose capacity timing and increments
Prepare to deal with capacity “chunks”
Attempt to smooth out capacity requirements
Use capacity cushion
Identify the optimal operating level

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 Bottleneck Operation
An operation in a sequence of operations
whose capacity is lower than that of the
other operations.

Figure 5-2

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 Capacity Timing
Consider whether capacity is to be installed
before, during, or after demand occurs. If before,
it is called leading strategy and if after, lagging
strategy.

Figure 5-3
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 Complementary Demand Patterns
The demand for air conditioning equipment is
offset by demand for heating equipment.

Figure 5-4
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 Capacity Cushion
The excess of capacity over the average demand.

Figure 5-5

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 Optimal Operating Level
Production units have an optimal rate of output for
minimum cost.

Figure 5-6 Minimum cost & optimal operating rate are

functions of size of production unit.
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Economies and Diseconomies of Scale

 Economies of scale
• Fixed costs (facilities, equipment, management)
spread out over more units
• Volume purchase discounts
 Diseconomies of scale
• Worker fatigue, equipment breakdown, less room
for error, difficulties in coordination

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 Planning Service Capacity

 Capacity planning for services can present

special challenges due to the nature of
services.
 Three very important factors in planning
service capacity are:
(1) The potential need to be near customers
(2) The inability to store services
(3) The degree of volatility of demand
 Convenience for customers is often an
important aspect of service.
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 Evaluating Alternatives
 Economic considerations
• Cost, useful life, compatibility, revenue
 Non economic considerations
• Public opinion, reactions from employees,
community pressure
 Techniques used for evaluation:
• Break Even Analysis (explored in this chapter)
• Payback Period
• Net Present Value

© 2021 McGraw-Hill Education Limited. 27

Break Even Analysis
Break-even analysis focuses on the relationship between
costs, revenue, and volume.
TC  FC  VC FC = Fixed Cost

VC  Q  v VC = Total Variable Cost

V = Variable cot per unit
TR  R  Q
P  TR  TC  R  Q  FC  v  Q 
TC = Total Cost
TR = Total Revenue
P  Q( R  v)  FC R = Revenue per unit (ie, price)
P  FC Q = Quantity or volume of output
Q 
Rv QBEP = Break-even quantity
FC P = Profit
QBEP 
Rv
Table 5-2

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Make or Buy Analysis

Figure 5-8 a
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Example: Break-Even

Fixed costs = $40,000 Material = $1.50/unit

Labour costs = $3/unit Selling price = $10.00 per unit

FC $40,000
QBEP = R-v = 10.00 - (3 +1.50) = 7273

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 Example: 5-4 Break-Even Analysis

Example 5-4
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Example: Break-Even Analysis
 The school cafeteria can make pizza for
about $0.30 per slice.
• Cost for kitchen and labour is $200 per day

 The nearby Pizza Den delivers for $9.00

per pizza (8 slices).
• Cost for labour reduced to $75 per day

Should they make or buy pizza?

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Break-Even Problem with Step Fixed Costs
Step Costs are costs that increase stepwise as range of
output increases.

Figure 5-9a

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Multiple Break-Even Points
Multiple break-even quantities may occur, possibly one
for each range.

Figure 5-9b
Multiple break-even points
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Break-Even Point in Dollars
FC  Total Fixed Cost
R  Total Revenue
v  variable cost per unit
QBEP $  break even volume in dollars
FC
QBEP  Wi  proportion of revenue due to product i (index)
( R  v)

QBEP $  RxQBEP  R ( FC ) /( R  v)  FC /(1  v / R )

when  1 type of output use :

FC
QBEP $ 
sum[(1  vi / Ri )Wi ]
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Assumptions of Break Even Analysis
One product is involved

Everything produced can be sold

Variable cost per unit is the same regardless of volume

Fixed costs do not change with volume

Revenue per unit constant with volume

Revenue per unit exceeds variable cost per unit

© 2021 McGraw-Hill Education Limited. 36
 Chapter Outline
 Design capacity is the theoretical maximum output rate, but effective
capacity is limited by break hours, maintenance, etc.
 Efficiency is the ratio of actual output rate to effective capacity, and
utilization is the proportion of the time the system is operating.
 A variety of factors can influence effective capacity: facility design and
layout, human factors, product factors, equipment maintenance,
scheduling problems, and quality considerations.
 Capacity planning is enhanced by considering product life cycle,
designing systems with flexible capacity, taking a systems approach to
planning, recognizing that capacity increments are often acquired in
chunks, practicing demand management, using capacity cushion, and
choosing the right capacity and optimal operating level.
 In evaluating capacity alternatives, a manager must consider both
quantitative (eg economic factors) and qualitative considerations (eg.
operational fit and personal preferences of managers).
 Break-even analysis finds quantity beyond which profit will be
attained.
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 Learning Checklist
 Define capacity and identify some common ways
it is measured.
 Distinguish between efficiency and utilization and
be able to calculate them.
 Describe factors that influence effective capacity.
 Describe the steps of the strategic capacity
planning process.
 Calculate capacity requirements.
 Discuss major considerations for developing
capacity alternatives.
 Use break-even analysis to solve problems.
© 2021 McGraw-Hill Education Limited. 38