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Strategic Capacity Planning for Products and Services. Chapter 5. Learning Objectives:. You should be able to: Summarize the importance of capacity planning Discuss ways of defining and measuring capacity Describe the determinants of effective capacity

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learning objectives
Learning Objectives:
  • You should be able to:
    • Summarize the importance of capacity planning
    • Discuss ways of defining and measuring capacity
    • Describe the determinants of effective capacity
    • Discuss the major considerations related to developing capacity alternatives
    • Briefly describe approaches that are useful for evaluating capacity alternatives

Instructor Slides

capacity planning
Capacity Planning


  • Capacity
    • The upper limit or ceiling on the load that an operating unit can handle (rate of output)
    • Dollar amounts are not good measure (why?)
    • Capacity needs include:
      • Equipment
      • Space
      • Employee skills
strategic capacity planning
Strategic Capacity Planning


  • Goal:
    • To achieve a match between the long-term supply capabilities and the predicted level of long-term demand
      • Overcapacity

operating costs that are too high

      • Undercapacity

strained resources and possible loss of customers

capacity planning questions
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 that need to be addressed?
    • Should capacity be changed all at once, or through several smaller changes?
    • Can the supply chain handle the necessary changes?
capacity decisions are strategic
Capacity Decisions Are Strategic


  • Capacity decisions:
    • impact the ability of the organization to meet future demands
    • affect operating costs
    • are a major determinant of initial cost
    • often involve long-term commitment of resources
    • can affect competitiveness (influence delivery speed)
    • affect the ease of management
    • have become more important and complex due to globalization
    • need to be planned for in advance due to their consumption of financial and other resources


  • 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, scrap etc.
  • Actual output
    • Rate of output actually achieved—cannot exceed effective capacity.
measuring system effectiveness
Measuring System Effectiveness


  • Efficiency

Measured as percentages

  • Utilization

Measured as percentages

example efficiency and utilization
Example– Efficiency and Utilization


Design Capacity = 50 trucks per day

Effective Capacity = 40 trucks per day

Actual Output = 36 trucks per day

determinants of effective capacity
Determinants of Effective Capacity


  • Facilities
    • Size, expansions, layout, transportation costs, distance to market, labor supply, energy sources
  • Product and service factors
    • Uniformity of output, product/service mix
  • Process factors
    • Productivity, quality, setup-time
  • Human factors
    • Tasks, variety of activities, training, skills, learning, experience, motivation, labor turnover
determinants of effective capacity1
Determinants of Effective Capacity


  • Policy factors
    • Overtime, second/third shifts
  • Operational factors
    • Scheduling, inventory, purchasing, materials, quality assurance/control, breakdowns, maintenance
  • Supply chain factors
    • Impact of capacity change on suppliers, warehousing, transportation, distributors
  • External factors
    • Product standards, minimum quality, safety, environment, regulations, unions
capacity strategies
Capacity Strategies


  • Three primary capacity strategies:
    • Leading:
      • build capacity in anticipation of future demand increase (when capacity increase has long lead time).
    • Following:
      • build capacity when demand exceed current capacity.
    • Tracking:
      • similar to Following but in relatively small increments.
capacity cushion
Capacity Cushion


  • Capacity Cushion
  • Extra capacity used to offset demand uncertainty
    • Capacity cushion = Capacity – expected demand
    • Capacity cushion strategy
      • Organizations that have greater demand uncertainty typically use greater capacity cushion
      • Organizations that have standard products and services generally use smaller capacity cushion
calculating processing requirements
Calculating Processing Requirements


  • Calculating processing requirements requires:
    • reasonably accurate demand forecasts,
    • standard processing times
    • available work time
calculating processing requirements1
Calculating Processing Requirements

If annual capacity is 2,000 hours, then

# machines required = 5,800 hours/2,000 hours = 2.90 ->3 machines

service capacity planning
Service Capacity Planning


  • Service capacity planning can present a number of challenges related to:
    • The need to be near customers
      • Convenience
    • The inability to store services
      • Cannot store services for consumption later
    • The degree of demand volatility
      • Volume and timing of demand
      • Time required to service individual customers
demand management strategies
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
evaluating alternatives
Evaluating Alternatives


  • Techniques for Evaluating Alternatives
    • Cost-volume analysis
      • Break-even point
    • Financial analysis
      • Cash flow
      • Present value
    • Decision theory
      • Comparison of alternatives under risk and uncertainty.
    • Waiting-line analysis
      • Balance waiting cost and increased capacity cost
    • Simulation
      • Evaluate “what-if” scenarios
cost volume analysis assumptions
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
cost volume analysis
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) x variable cost per unit (v)
      • Total Cost
        • TC = FC + VC
      • Total Revenue (TR)
        • TR = revenue per unit (R) x Q
break even point bep
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

0 = QBEP(R – v) – FC


Indifference Point (Profit)

Two (multiple) Alternatives

  • The quantity at which a decision maker would be indifferent between two competing alternatives

Choose A

Choose B


Example - Indifference Point (Cost)

  • A manufacturer has 3 options:
  • Use process A with FC=$80,000 and VC=$75/unit
  • Use process B with FC=$200,000 and VC=$15/unit
  • Purchase for $200/units


QPA=640 units


QAB=2,000 units

Choose lowest cost:

0-640 units : Purchase

640-2,000 units: Process A

Above 2,000 units: Process B

optimal rate of output

Average cost per unit




Rate of output

Optimal Rate of Output

Production units have an optimal rate of output for minimal cost.

  • Diseconomies of Scale
  • If the output rate is more than the optimal level, increasing the output rate results in increasing average per unit costs
  • Economies of Scale
  • If output rate is less than the optimal level, increasing the output rate results in decreasing average per unit costs

Minimum average cost per unit

economies of scale
Economies of Scale


  • Economies of Scale
    • If output rate is less than the optimal level, increasing the output rate results in decreasing average per unit costs
    • Reasons for economies of scale:
      • Fixed costs are spread over a larger number of units
      • Processing costs decrease due to standardization
diseconomies of scale
Diseconomies of Scale


  • Diseconomies of Scale
    • If the output rate is more than the optimal level, increasing the output rate results in increasing average per unit costs
    • Reasons for diseconomies of scale
      • congestion (transportation)
      • Complexity
      • Inflexibility
      • Additional levels of bureaucracy