CHAPTER 5: STRATEGIC

CAPACITY MANAGEMENT
LO5–1: Explain what capacity management is and why it is
strategically important.
LO5–2: Exemplify how to plan capacity.
LO5–3: Evaluate capacity alternatives using decision trees.
LO5–4: Compare capacity planning in services to capacity
planning in manufacturing.

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Capacity Management in Operations and
Supply Chain Management
• Capacity: the ability to hold, receive, store, or
accommodate
• In business, viewed as the amount of output that a system
is capable of achieving over a specific period of time
• Capacity management needs to consider both inputs and
outputs
• Many industries measure and report capacity in terms of
output
• Industries whose product mix is very uncertain, like
hospitals, often express capacity in terms of inputs

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 Capacity Management in Operations and
Supply Chain Management
• Strategic capacity planning is an approach for
determining the overall capacity level of capital intensive
resources, including facilities, equipment, and overall
labour force size.
• Capacity used is the rate of output actually achieved.
• The best operating level is nominally the capacity for
which the process was designed.

Capacity Used
Capacity Utilization Rate =
Best Operating Level
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Capacity Planning Time Durations
Long range

• Greater than one year

Intermediate range

• Monthly or quarterly plans covering the next 6

to 18 months

Short range

• Less than one month

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Strategic Capacity Planning
• Determining the overall level of capacity-intensive
resources that best supports the company’s long-range
competitive strategy
• Facilities
• Equipment
• Labor force size
• Capacity level selected has a critical impact on response
rate, its cost structure, its inventory policies, and
management and staff support requirements
• Too low and the firm will lose customers and encourage
competitors
• Too high and firm may have to cut costs or underutilize its capacity

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 Best Operating Level
• Example:
• Engineers design engines and assembly lines to operate at an ideal
or best operating level to maximize output and minimize wear.

Average
unit cost Under-utilization Over-utilization
of output

Best Operating Level

Volume
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 Capacity Utilization
• Example:
• During one week of production, a plant produced 83 units of a
product. Its historic best utilization was 120 units per week. What is
this plant’s capacity utilization rate?

Capacity Used
Capacity Utilization Rate =
Best Operating Level

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83/120=69%

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 Economies of Scale
Economies of scale and operating level curves

100-unit
Average plant
unit cost 200-unit
of output plant 400-unit
300-unit
plant
plant

Diseconomies of scale start to take effect

Volume
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Capacity Planning Concepts
• Capacity focus – the idea
that a production facility
works best when it is
concentrated on a limited
set of production
objectives (Cost, Quality,
delivery speed,
reliability,…)
• Focused factory or plant
within a plant (PWP) concept

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Capacity Planning Concepts
• Capacity flexibility – the ability to rapidly increase or
decrease product levels or the ability to shift rapidly from
one product or service to another
• Comes from the plant, processes, and workers or from strategies
that use the capacity of other organizations (such as suppliers,
outsourcing,…)

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Capacity Flexibility

Flexible • Ability to quickly adapt to change

Plants • Zero-changeover time

Flexible • Flexible manufacturing systems

Processes • Simple, easily set up equipment

Flexible • Ability to switch from one kind of

task to another quickly
Workers • Multiple skills (cross training)

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Capacity Flexibility

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Flexible Manufacturing

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Group Discussion

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Group Discussion

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Considerations in Changing Capacity
Maintaining System Balance

• Similar capacities desired at each operation

• Manage bottleneck operations

Frequency of Capacity Additions

• Cost of upgrading too frequently

• Cost of upgrading too infrequently

External Sources of Capacity

• Outsourcing
• Sharing capacity

Decreasing Capacity

• Temporary reductions
• Permanent reductions

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 Frequent versus Infrequent Capacity
Expansions

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Determining Capacity Requirements

Use Calculate labor Project labor

forecasting to and equipment and equipment
predict sales requirements availability over
for individual to meet the planning
products forecasts horizon

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Example 2 —Determining Capacity
Requirements
• A manufacturer produces mustard in small and family-sized
plastic bottles, with the following demand forecasts.

Year 1 Year 2 Year 3 Year 4

Small (000's) 150 170 200 240
Family (000's) 115 140 170 200

• Three 100,000 units-per-year machines are available for small bottle

production. 2 operators are required per machine.
• Two 120,000 units-per-year machines are available for family-sized
bottle production. 3 operators are required per machine.

• How much capacity is used and what are the machine and
labour requirements?
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 Example 2 —Determining Capacity
Requirements
• Machine capacity: 300 000 small, 240 000 family size
• Labour availability: 6 for small, 6 for family size

Year 1 Year 2 Year 3 Year 4

Small (000's) 150 170150 000
= =200
0.50 240
Family (000's) 115 140300 000 170 200
Small 115 000 150 000
% capacity
115 000 used 50.00% = =
56.67% 66.67%= 0.9680.00%
= 1.5
= = 0.4792 120 000 per100machine
000 per machine
machines
240 000 req'd 1.50 1.70 2.00 2.40
labour req'd 3.00 3.40 4.00 4.80
3 operators
Family Size = 0.96 machines  2 operators = 2.88
% capacity used 47.92% = 58.33%1.5 machines  machine83.33%
70.83% = 3.0
machine
machines req'd 0.96 1.17 1.42 4.25
labour req'd 2.88 3.50 4.25 5.00
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Example 3 —Determining Capacity
Requirements
• Stewart Company produces two flavors of salad dressing
• Paul’s and Newman’s
• Each is available in bottles and single-serving bags
• Have three machines that can package 150,000 bottles
each year
• Each machine requires two operators
• Have five machines that can package 250,000 plastic
bags per year
• Each machine requires three operators
• What are the capacity and labor requirements for the next
five years?

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Step 1: Use Forecast to Predict Sales for
Individual Products

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 Step 2: Calculate Equipment and Labor
Requirements
Bottling Operation Bagging Operation
• Capacity: 450,000 • Capacity: 1,250,000
• 150,000 x 3 • 250,000 x 5
• Operators: 6 • Operators: 15
• 2x3 • 3x5
• Year 1 • Year 1
135 300
• 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 𝑢𝑡𝑖𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 = = 0.3 • 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 𝑢𝑡𝑖𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 = = 0.24
450 1,250

• 𝑀𝑎𝑐ℎ𝑖𝑛𝑒 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡 = 0.3 × 3 = 0.9 • 𝑀𝑎𝑐ℎ𝑖𝑛𝑒 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡 = 0.24 × 5 = 1.2

• 𝐿𝑎𝑏𝑜𝑟 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡 = 1.3 × 3 = 3.6
• 𝐿𝑎𝑏𝑜𝑟 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡 = 0.9 × 2 = 1.8

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Step 3: Project Equipment and Labor
Availabilities over the Planning Horizon

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Using Decision Trees to Evaluate
Capacity Alternatives
• A decision tree is a schematic model of the sequence of
steps in a problem – including the conditions and
consequences of each step
• Decision trees help analysts understand the problem and
assist in identifying the best solution
• Decision tree components include the following:
• Decision nodes – represented with squares (Yes/No)
• Chance nodes – represented with circles (Probability)
• Paths – links between nodes
• Work from the end of the tree backwards to the start of
the tree
• Calculate expected values at each step
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 Decision Trees Example
• A glass factory specializing in crystal experiences substantial backlog, and
management is considering three courses of action:
A.Arrange for subcontracting
B.Construct new facilities
C.Do nothing (no change)
• The correct choice depends largely upon demand, which may be low,
medium, or high. By consensus, management estimates the
respective demand probabilities as 0.1, 0.5, and 0.4.
• The management also estimates the profits when choosing from the
three alternatives under the differing probable levels of demand. These
profits, are as follows:
Low (p=0.1) Medium (p-0.5) High (p=0.4)
A 10 000 50 000 90 000
B -120 000 25 000 200 000
C 20 000 40 000 60 000
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 Decision Trees Example (2)
Decisions: States, probabilities, and payoffs:
High demand (0.4) $90k
Medium demand (0.5) $50k

A Low demand (0.1) $10k

High demand (0.4) $200k

Start
Medium demand (0.5) $25k
B Low demand (0.1) -$120k

High demand (0.4) $60k

C
Medium demand (0.5) $40k
Low demand (0.1) $20k

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 Decision Trees Example (3)
Expected values of each decision:
EVA =  PA,i  VA,i High demand (0.4) $90k
i

Medium demand (0.5) $50k

EVA = 0.4  90 + 0.5  50 + 0.1 10 = $62k
Low demand (0.1) $10k
A

High demand (0.4) $200k

Medium demand (0.5) $25k
B Low demand (0.1) -$120k
EVB = 0.4  200 + 0.5  25 + 0.1 ( −120 ) = $80.5k
Choose decision B
(highest expected value)
High demand (0.4) $60k
C
Medium demand (0.5) $40k
Low demand (0.1) $20k
EVC = 0.4  60 + 0.5  40 + 0.1 20 = $46k

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Planning Service Capacity
Manufacturing Service
Capacity Capacity
Capacity must be available
Goods can be stored for
when service is needed –
later use
cannot be stored

Goods can be shipped to Service must be available

other locations at customer demand point

Volatility of demand is Much higher volatility is

relatively low typical

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Capacity Utilization and Service Quality
• The relationship between
service capacity utilization
and service quality is
critical
• Arrival rate: the average
number of customers that
come to a facility during a
specific period of time (𝜆)
• Service rate: the average
number of customers that can
be processed over the same
period of time (𝜇)
• Best operating point is near 70
percent
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Capacity Utilization and Service Quality
• Optimal levels of utilization are context specific
• Low rates are appropriate when the degree of uncertainty (in
demand) is high and/or the stakes are high (e.g., emergency
rooms, fire departments)
• Higher rates are possible for predictable services or those without
extensive customer contact (e.g., commuter trains, postal sorting)

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Summary
• An operations and supply chain management view of
capacity emphasizes the time dimension of capacity
• Long range, intermediate range, and short range
• Best operating level is the rate that is sustainable by the
system
• With economies of scale, as volume increases, average
cost per unit drops
• Focused manufacturing plants are designed to produce
multiple products using a concept called plant within a
plant
• From a strategic, long-term view, capacity additions or
reductions come in chunks
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Summary Continued
• A useful technique for analyzing capacity problems is the
decision tree
• With this format, the sequences of decisions are organized like
branches in a tree
• The potential consequences of the decisions are
enumerated based on their probability of occurrence and
corresponding expected value
• Often, services require that capacity be available
immediately and that it be near where the customer
resides
• Firms that offer services often need to deal with dramatic changes
in customer demand over time

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