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Capacity PlanningCapacity Planning

Definition of CapacityDefinition of Capacity ““ Capacity is the limiting capability of aCapacity is the limiting capability of a

productive unit to produce within a stated timeproductive unit to produce within a stated time

period , normally expressed in terms of output period , normally expressed in terms of output

units per unit of timeunits per unit of time. . ””

Capacity needs include• Equipment

• Space

• Employee skills

Determinants of Effective Determinants of Effective CapacityCapacity

FacilitiesFacilities

Product and service factorsProduct and service factors

Process factorsProcess factors

Human factorsHuman factors

Policy factorsPolicy factors

Supply chain factorsSupply chain factors

External factorsExternal factors

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Strategic Capacity PlanningStrategic Capacity Planning

GoalGoal To achieve a match between the longTo achieve a match between the long--term term

supply capabilities of an organization and the supply capabilities of an organization and the predicted level of longpredicted level of long--run demandrun demand•• OvercapacityOvercapacity operating costs that are too highoperating costs that are too high

•• UndercapacityUndercapacity strained resources and possible strained resources and possible loss of customersloss of customers

Capacity Planning QuestionsCapacity Planning QuestionsKey Questions:Key Questions:

What kindWhat kind of capacity is needed?of capacity is needed?

How much How much capacity is needed to match demand?capacity is needed to match demand?

WhenWhen is it needed?is it needed?

Related Questions:Related Questions:

How much will it cost?How much will it cost?

What are the potential benefits and risks?What are the potential benefits and risks?

Are there sustainability issues?Are there sustainability issues?

Should capacity be changed all at once, or through Should capacity be changed all at once, or through several smaller changesseveral smaller changes

Can the supply chain handle the necessary changes?Can the supply chain handle the necessary changes?

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Capacity Decisions Are Capacity Decisions Are StrategicStrategic

Capacity decisionsCapacity decisions impact the ability of the organization to meet future impact the ability of the organization to meet future

demandsdemands

affect operating costsaffect operating costs

are a major determinant of initial costare a major determinant of initial cost

often involve longoften involve long--term commitment of resourcesterm commitment of resources

can affect competitivenesscan affect competitiveness

affect the ease of managementaffect the ease of management

are more important and complex due to globalizationare more important and complex due to globalization

need to be planned for in advance due to their need to be planned for in advance due to their consumption of financial and other resourcesconsumption of financial and other resources

CapacityCapacity

Design capacityDesign capacitymaximum output rate or service capacity an operation, maximum output rate or service capacity an operation,

process, or facility is designed forprocess, or facility is designed for

Effective capacityEffective capacity Design capacity minus allowances such as personal Design capacity minus allowances such as personal

time, maintenance, and scraptime, maintenance, and scrap

Actual outputActual output rate of output actually achievedrate of output actually achieved----cannot cannot

exceed effective capacity.exceed effective capacity.

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Measuring System EffectivenessMeasuring System Effectiveness

Actual outputActual output The rate of output actually achievedThe rate of output actually achieved

It cannot exceed effective capacityIt cannot exceed effective capacity

EfficiencyEfficiency

UtilizationUtilization

Measured as percentagesMeasured as percentages

capacity effective

output actualEfficiency

capacitydesign

output actualnUtilizatio

ExampleExample–– Efficiency and Efficiency and UtilizationUtilization

Design Capacity = 50 trucks per dayDesign Capacity = 50 trucks per day

Effective Capacity = 40 trucks per dayEffective Capacity = 40 trucks per day

Actual Output = 36 trucks per dayActual Output = 36 trucks per day

%9040

36

capacity effective

output actualEfficiency

%7250

36

capacitydesign

output actualnUtilizatio

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Measures of capacity for different types of organizationsMeasures of capacity for different types of organizations

Available semester or quarter sectionsAvailable semester or quarter sectionsSchool of Business AdministrationSchool of Business Administration

Available laborAvailable labor--hourshoursJobbing machine shopJobbing machine shop

AvailableAvailable seatseat--turnsturnsRestaurantRestaurant

Available seatAvailable seat--performanceperformanceMovie theaterMovie theater

Available bedAvailable bed--daysdaysHospitalHospital

Available seat miles (ASMs)Available seat miles (ASMs)AirlineAirline

Megawatts of electricityMegawatts of electricityNuclear power plantNuclear power plant

Cases of beerCases of beerBeer PlantBeer Plant

Tons of steelTons of steelSteel PlantSteel Plant

Number of autosNumber of autosAuto plantAuto plant

Capacity MeasureCapacity MeasureType of OrganizationsType of Organizations

* When output units are more diverse , it is common to use a measure of the availability of the limiting resource as the capacity measure.

Determinants of Effective Determinants of Effective CapacityCapacity

FacilitiesFacilities

Product and service factorsProduct and service factors

Process factorsProcess factors

Human factorsHuman factors

Policy factorsPolicy factors

Supply chain factorsSupply chain factors

External factorsExternal factors

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Capacity StrategiesCapacity Strategies

LeadingLeading Build capacity in anticipation of future demand Build capacity in anticipation of future demand

increasesincreases

FollowingFollowing Build capacity when demand exceeds current capacityBuild capacity when demand exceeds current capacity

TrackingTracking Similar to the following strategy, but adds capacity in Similar to the following strategy, but adds capacity in

relatively small increments to keep pace with relatively small increments to keep pace with increasing demandincreasing demand

Strategy FormulationStrategy Formulation

Strategies are typically based on Strategies are typically based on assumptions and predictions about:assumptions and predictions about: LongLong--term demand patternsterm demand patterns

Technological changeTechnological change

Competitor behaviorCompetitor behavior

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Capacity CushionCapacity Cushion

Capacity CushionCapacity Cushion Extra capacity used to offset demand Extra capacity used to offset demand

uncertaintyuncertainty

Capacity cushion = 100% Capacity cushion = 100% -- UtilizationUtilization

Capacity cushion strategyCapacity cushion strategy•• Organizations that have greater demand Organizations that have greater demand

uncertainty typically have greater capacity uncertainty typically have greater capacity cushioncushion

•• Organizations that have standard products and Organizations that have standard products and services generally have greater capacity cushionservices generally have greater capacity cushion

Steps in Capacity PlanningSteps in Capacity Planning

1.1. Estimate future capacity requirementsEstimate future capacity requirements

2.2. Evaluate existing capacity and facilities; identify gapsEvaluate existing capacity and facilities; identify gaps

3.3. Identify alternatives for meeting requirementsIdentify alternatives for meeting requirements

4.4. Conduct financial analysesConduct financial analyses

5.5. Assess key qualitative issuesAssess key qualitative issues

6.6. Select the best alternative for the long termSelect the best alternative for the long term

7.7. Implement alternative chosenImplement alternative chosen

8.8. Monitor resultsMonitor results

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Calculating Processing Calculating Processing RequirementsRequirements

Calculating processing requirements Calculating processing requirements requires reasonably accurate demand requires reasonably accurate demand forecasts, standard processing times, and forecasts, standard processing times, and available work timeavailable work time

horizon planning theduring available timeprocessing

horizon planning theduring product for demand

product for timeprocessing standard

machines required ofnumber

where

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ip

N

T

DpN

i

i

R

k

iii

R

Service Capacity PlanningService Capacity Planning

Service capacity planning can present a Service capacity planning can present a number of challenges related to:number of challenges related to: The need to be near customersThe need to be near customers

•• Convenience Convenience

The inability to store servicesThe inability to store services•• Cannot store services for consumption laterCannot store services for consumption later

The degree of demand volatilityThe degree of demand volatility•• Volume and timing of demandVolume and timing of demand

•• Time required to service individual customersTime required to service individual customers

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Demand Management Demand Management StrategiesStrategies

Strategies used to offset capacity Strategies used to offset capacity limitations and that are intended to achieve limitations and that are intended to achieve a closer match between supply and a closer match between supply and demanddemand PricingPricing

PromotionsPromotions

DiscountsDiscounts

Other tactics to shift demand from peak Other tactics to shift demand from peak periods into slow periodsperiods into slow periods

InIn--House or Outsource?House or Outsource?

Once capacity requirements are determined, the Once capacity requirements are determined, the organization must decide whether to produce a good organization must decide whether to produce a good or service itself or outsourceor service itself or outsource

Factors to consider:Factors to consider: Available capacityAvailable capacity

ExpertiseExpertise

Quality considerationsQuality considerations

The nature of demandThe nature of demand

CostCost

RisksRisks

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Developing Capacity Developing Capacity AlternativesAlternatives

Things that can be done to enhance capacity Things that can be done to enhance capacity managementmanagement Design flexibilityDesign flexibility

Take stage of life cycle into accountTake stage of life cycle into account

Take a Take a ““bigbig--picturepicture”” approach to capacity changesapproach to capacity changes

Prepare to deal with capacity Prepare to deal with capacity ““chunkschunks””

Attempt to smooth capacity requirementsAttempt to smooth capacity requirements

Identify the optimal operating levelIdentify the optimal operating level

Choose a strategy if expansion is involvedChoose a strategy if expansion is involved

Predicting Future Capacity RequirementsPredicting Future Capacity Requirements Industry Capacity and Competitive DynamicsIndustry Capacity and Competitive Dynamics

Mature Products with Stable DemandMature Products with Stable Demand

OROR New Products and Risky SituationsNew Products and Risky Situations

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warehouse capacitywarehouse capacity(5,000)(5,000)--3,0003,0005,0005,000Capacity (gap) or slackCapacity (gap) or slack

------15,00015,000Receiving, shipping, and factory Receiving, shipping, and factory

(10,000)(10,000)(5,000)(5,000)(2,000)(2,000)--Capacity (gap) or slackCapacity (gap) or slack

------10,00010,000Assembly capacityAssembly capacity

(9,000)(9,000)(4,000)(4,000)(1,000)(1,000)1,0001,000Capacity (gap) or slackCapacity (gap) or slack

------11,00011,000Machine shop capacityMachine shop capacity

20,00020,00015,00015,00012,00012,00010,00010,000Predicted capacity requirementsPredicted capacity requirements

199719971992199219891989Current,Current,

19871987

Capacity, Units per YearCapacity, Units per Year

Predicted Requirements , Current Capacities, and Projected capacity differences

16,00016,00012,80012,80011,00011,00010,00010,000Pessimistic requirementsPessimistic requirements

62,00062,00025,00025,0001414,,50050010,00010,000Optimistic requirementsOptimistic requirements

20,00020,00015,00015,00012,00012,00010,00010,000Expected capacity requirementsExpected capacity requirements

199719971992199219891989Current,Current,

19871987

Capacity, Units per YearCapacity, Units per Year

Expected, Optimistic, and Pessimistic Predictions of Requirements

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(47,000)(47,000)(10,000)(10,000)5005005,0005,000Capacity (gap) or slackCapacity (gap) or slack

warehouse capacitywarehouse capacity

------15,00015,000Receiving, shipping, and factory Receiving, shipping, and factory

(52,000)(52,000)(15,000)(15,000)(4,500)(4,500)--Capacity (gap) or slackCapacity (gap) or slack

------10,00010,000Assembly capacityAssembly capacity

(51,000)(51,000)(14,000)(14,000)(3,500)(3,500)1,0001,000Capacity (gap) or slackCapacity (gap) or slack

------11,00011,000Machine shop capacityMachine shop capacity

62,00062,00025,00025,00014,50014,50010,00010,000Predicted capacity requirementsPredicted capacity requirements

199719971992199219891989Current,Current,

19871987

Capacity, Units per YearCapacity, Units per Year

The Optimistic Prediction

(1,000)(1,000)2,2002,2004,0004,0005,0005,000Capacity (gap) or slackCapacity (gap) or slack

warehouse capacitywarehouse capacity

------15,00015,000Receiving, shipping, and factory Receiving, shipping, and factory

(6,000)(6,000)(2,800)(2,800)(1,000)(1,000)--Capacity (gap) or slackCapacity (gap) or slack

------10,00010,000Assembly capacityAssembly capacity

(5,000)(5,000)(1,800)(1,800)--1,0001,000Capacity (gap) or slackCapacity (gap) or slack

------11,00011,000Machine shop capacityMachine shop capacity

16,00016,00012,80012,80011,00011,00010,00010,000Predicted capacity requirementsPredicted capacity requirements

199719971992199219891989Current,Current,

19871987

Capacity, Units per YearCapacity, Units per Year

The Pessimistic Prediction

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Generation of Alternative Capacity PlansGeneration of Alternative Capacity Plans Large or small Capacity IncrementsLarge or small Capacity Increments

Noted: Noted: Whether smaller or larger increments of capacity Whether smaller or larger increments of capacity will be more economical depends on the balance of will be more economical depends on the balance of incremental capital and the operating costs of a incremental capital and the operating costs of a particular organization and on whether or not particular organization and on whether or not economies of scale exist. economies of scale exist.

Alternative sources of CapacityAlternative sources of Capacity

Noted: Noted: The cost effects of using alternative sources of The cost effects of using alternative sources of capacity are the tradecapacity are the trade--off of some of the costs off of some of the costs carrying slack capacity against the costs of overtime carrying slack capacity against the costs of overtime and multiple shifts, productivity losses resulting from and multiple shifts, productivity losses resulting from pushing capacity beyond normal limits, and the extra pushing capacity beyond normal limits, and the extra costs of subcontracting units of output.costs of subcontracting units of output.

1987 1989 1991 19951993 1997 1999

10000

12000

14000

16000

18000

20000

22000

1987 (current) capacity

2000 unit every 2 years

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1987 1989 1991 19951993 1997 1999

10000

12000

14000

16000

18000

20000

22000

1987 (current) capacity

4000 unit every 4 years

1987 1989 1991 19951993 1997 1999

10000

12000

14000

16000

18000

20000

22000

1987 (current) capacity

Planned use of alternative sources of capacity

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Economies of ScaleEconomies of Scale

Monthly production, units

Cos

t per

uni

t A B C

Economic Evaluation of Capacity PlansEconomic Evaluation of Capacity Plans Mature Products with Stable Demand GrowthMature Products with Stable Demand Growth

ExampleExample1.Capacity added January 1, 1987, and January 1, 1989, in increm1.Capacity added January 1, 1987, and January 1, 1989, in increments of ents of

2000 units.2000 units.

2.Capacity of 4000 units added January 1, 1987.2.Capacity of 4000 units added January 1, 1987.

3.Capacity added July 1, 1987, and July 1, 1989, in increments o3.Capacity added July 1, 1987, and July 1, 1989, in increments of 2000 f 2000 units, depending on overtime and multiple shifts to meet requireunits, depending on overtime and multiple shifts to meet requirements ments during the first six months of 1987 and 1989.during the first six months of 1987 and 1989.

4.Capacity of 4000 units added January 1, 1988, depending on ove4.Capacity of 4000 units added January 1, 1988, depending on overtime rtime and multiple shifts to meet requirements during 1987.and multiple shifts to meet requirements during 1987.

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Original Original Invesment Invesment Requirements and Requirements and Operating CostOperating Cost

Plant Size, Units per Year

Original invesment Operating Costs per unit

Operating Costs per Unit When Using Alternative Sources of Capacity

2000 $1,000,000 $ 10 $ 11 4000 1,8000,000 9 10

i = annual interest rate in decimals = 0.15

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The present value for the four alternative areThe present value for the four alternative are1.1. $$ 1,812,0701,812,070

2.2. $$ 1,850,4631,850,463

3.3. $1,697,665$1,697,665

4.4. $1,617,398$1,617,398

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New Products and Risky SituationsNew Products and Risky Situations

An ExampleAn ExampleSuppose that we are planning future capacity for a product that Suppose that we are planning future capacity for a product that is in the is in the

rapid development phase. Present annual capacity is 20,000 unitsrapid development phase. Present annual capacity is 20,000 units. New . New competition is becoming very aggressive ,but the enterprise expecompetition is becoming very aggressive ,but the enterprise expects retain its cts retain its market share. The sales department feels that market shares shoumarket share. The sales department feels that market shares should be increased ld be increased with aggressive promotion. Estimates of the total market vary, wwith aggressive promotion. Estimates of the total market vary, with some feeling ith some feeling that growth might be explosive in the next four to five years. Othat growth might be explosive in the next four to five years. On the other hand, n the other hand, there is the additional uncertainty concerning continuing technothere is the additional uncertainty concerning continuing technological innovation logical innovation that could stunt the growth of the current line. Thus, expected,that could stunt the growth of the current line. Thus, expected, optimistic, and optimistic, and pessimistic market prediction are made and assigned probabilitiepessimistic market prediction are made and assigned probabilities that each might s that each might occur. The predictions are converted to capacity requirements peoccur. The predictions are converted to capacity requirements per year as follows:r year as follows:

25,00025,00023,00023,00021,00021,00019,00019,00017,00017,000Pessimistic (Pessimistic (pp = 0.25)= 0.25)

35,00035,00029,00029,00034,00034,00020,00020,00017,00017,000Expected (Expected (pp = 0.50)= 0.50)

66,00066,00048,00048,00034,00034,00024,00024,00017,00017,000Optimistic (Optimistic (pp = 0.25)= 0.25)

CurrentCurrent

199119911990199019891989198819881987,1987,

Strategies.Strategies. Three alternative strategies are Three alternative strategies are developed,eachdeveloped,each designed with the three market designed with the three market assumptions in assumptions in mind.Themind.The variable cost of production variable cost of production are the same as for the present capacity because no are the same as for the present capacity because no new process technology is involved. The three new process technology is involved. The three alternative are.alternative are.

1.1. Install new capacity in 1989,1990 and 1991 in Install new capacity in 1989,1990 and 1991 in increments of 15,000 units.increments of 15,000 units.

2.2. Install new capacity in 1989, 1990, and 1991 in Install new capacity in 1989, 1990, and 1991 in increments of 5,000 unitsincrements of 5,000 units

3.3. Make no capacity additions.Make no capacity additions.

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