Capacity Planning

भारतीय प्रबंधन संस्थान शिलांग

Indian Institute of Management Shillong
Capacity planning and facility layout
➢ What is capacity planning?
➢ What kind of capacity is needed?
➢ Which capacity planning strategy is best suited ?
➢ How much capacity is needed to match demand?
➢ When more capacity is needed?
➢ Where facilities should be located (location)
➢ How facilities should be arranged (layout)
Capacity planning
Capacity is the maximum capability to produce.
• It is the upper limit or ceiling on the load that an operating
unit can handle. It includes
➢ equipment,
➢ space,
➢ employee skills

• Capacity planning should also answer—

➢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?
Continues…
➢ Goal
➢ To attain a match between the long-term supply
capabilities of an organization and the predicted level of
long-run demand
➢Over-capacity → operating costs that are too high

➢Under-capacity → strained resources and possible loss

of customers
Importance of capacıty decısıons
• Impact the ability of the organization to meet future demands
• Affect operating costs
• Affect lead time responsiveness
• Are a major determinant of initial costs
• Involve long-term commitment of resources
• Affect competitiveness
• Affect ease of management
• Are more important and complex due to globalization
• Need to be planned for in advance due to their consumption of
financial and other resources
Type of capacity planning
Long-term capacity planning
Intermediate term capacity planning
Short term capacity planning

Long-term Add facilities

planning Add long lead time equipment *
Intermediate- Subcontract Add personnel
term Add equipment Build or use inventory
planning Add shifts

Schedule jobs
Short-term
planning
* Schedule personnel
Allocate machinery

Modify capacity Use capacity

* Limited options exist
Long- term capacity planning
Long-term capacity planning is a strategic decision that establishes
a firm’s overall level of resources.

It extends over a time horizon long enough to obtain those

resources—usually a year or more for building or expanding
facilities or acquiring new businesses.

Capacity decisions affect

➢ product lead times
➢ customer responsiveness
➢ operating costs, and
➢ a firm’s ability to compete.
Capacity expansion strategies
How much to increase capacity
depends on—
• The volume and certainty of
anticipated demand;
• Strategic objectives in terms
of growth, customer service,
and competition; and
• The costs of expansion and
operation.

Example: Consider higher education’s strategy in preparing for a tripling of

the state’s college-bound population in the next decade.
Capacity lead strategy
Capacity is expanded in anticipation of demand growth.
• This aggressive strategy is used
to lure customers from competitors
who are capacity constrained
• Also to gain a foothold
in a rapidly expanding market.
• It allows companies to respond
to unexpected surges in demand
and to provide superior levels of service
during peak demand periods.

Example: A young university might lead capacity expansion in hopes of

capturing students not admitted to the more established universities.
Capacity lag strategy
Capacity is increased after an increase in
demand has been documented.
• This conservative strategy produces a
higher return on investment but may
lose customers in the process.
• It is used in industries with standard
products and cost-based or weak
competition.
• The strategy assumes that lost
customers will return from competitors
after capacity has expanded.

Example: An established university, guaranteed applicants even in lean years,

may follow a capacity lag strategy.
Average capacity strategy
Capacity is expanded to coincide with
average expected demand.
• This is a moderate strategy in which
managers are certain they will be
able to sell at least some portion of
expanded output, and endure some
periods of unmet demand.
• Approximately half of the time
capacity leads demand, and half of
the time capacity lags demand.

Example: A community college may choose the average capacity strategy to

fulfill its mission of educating the state’s youth but with little risk.
Incremental versus one-step expansion
Capacity can be increased incrementally
or in one large step.

• Incremental expansion is less risky but

more costly.

An attractive alternative to expanding capacity is

outsourcing, in which suppliers absorb the risk of demand
uncertainty.
Design and effective capacity
▪ 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, and scrap
▪ Actual output
▪ Rate of output actually achieved--cannot
exceed effective capacity.
Determinants of effective capacity
A) Facilities
- Location (transportation cost, distance, labor supply)
- Design (room for expansion)
- Layout (material transfer, line balance)

B) Product/service
- Design (similar products→ standardization)
C) Process
- Quantitiy capabilities (productivity, using automated
machines)
- Quality capabilities (the more time spent for inspection
and rework the less capacity)
Determinants of effective capacity
D) Human Factors
- job content
- training and experience
- motivation
- absenteeism and labor turnover
E) Operational Factors
- scheduling
- materials management
- quality assurance
- maintenance policies
- equipment breakdowns
F) External Factors
- Pollution control standards
- Unions
Efficiency and utilization
Actual output
Efficiency =
Effective capacity

Actual output
Utilization =
Design capacity
Example: Design capacity = 50 units/day; Effective capacity = 40 units/day
Actual output = 36 units/day
Actual output = 36 units/day
Efficiency = = 90%
Effective capacity 40 units/ day

Utilization = Actual output = 36 units/day

= 72%
Design capacity 50 units/day
Capacıty cushıon
• Extra capacity used to offset demand uncertainty
• Capacity cushion = 100% - Utilization
• Capacity cushion strategy
➢ Helps to meet excess demand during peak demand seasons
➢ Lowers production costs
➢ Provides product and volume flexibility
➢ Improves quality of products and services
➢ Organizations that have greater demand uncertainty
typically have greater capacity cushion
➢ Organizations that have standard products and services
generally have greater capacity cushion
Identify the optimal operating level
Cost of Output ($)
Average Unit

Economies Diseconomies
of Scale of Scale

Best Operating Level

Annual Volume (units)

Identify the optimal operating level
Minimum cost & optimal operating rate are
functions of size of production unit.
Average cost per unit

Small
plant Medium
plant Large
plant

0 Output rate
Economies of scale
Best operating level - least average unit cost

Economies of scale - If the output rate is less than the optimal

level, increasing output rate results in decreasing average unit
costs. Declining costs up to the best operating level result
from fixed costs, labor cost being spread over more units
Average cost per unit decreases as the volume increases.
Diseconomies of scale
Diseconomies of scale –
If the output rate is more than the optimal level, increasing the
output rate results in increasing average unit costs.

Average cost per unit increases as the volume increases due to

scheduling problems, quality problems, reduced morale,
increased use of overtime
Bottleneck Analysis
► Each work area can have its own unique capacity
► Capacity analysis determines the throughput capacity of
workstations in a system
► A bottleneck is a limiting factor or constraint
►A bottleneck has the lowest effective capacity in a system
► The bottleneck time is the time of the slowest workstation (the
one that takes the longest) in a production system
► The throughput time is the time it takes a unit to go through
production from start to end, with no waiting

A B C

2 min/unit 4 min/unit 3 min/unit

भारतीय प्रबंधन संस्थान शिलांग

3 November
2022
Theory of Constraints
➢Five-step process for recognizing and managing limitations

Step 1: Identify the constraints

Step 2: Develop a plan for overcoming the constraints
Step 3: Focus resources on accomplishing Step 2
Step 4: Reduce the effects of constraints by offloading work or
expanding capability
Step 5: Once overcome, go back to Step 1 and find new
constraints

भारतीय प्रबंधन संस्थान शिलांग

3 November
2022
Break-Even Analysis
► Technique for evaluating process and equipment alternatives
► Objective is to find the point in dollars and units at which cost
equals revenue
► Requires estimation of fixed costs, variable costs, and
revenue
► Fixed costs are costs that continue even if no units are
produced
► Depreciation, taxes, debt, mortgage payments

► Variable costs are costs that vary with the volume of units
produced
► Labor, materials, portion of utilities

भारतीय प्रबंधन संस्थान शिलांग

3 November
2022
Continues…
–
Total revenue line
900 –

800 –
Break-even point Total cost line
700 – Total cost = Total revenue
Cost in dollars

600 –

500 –
Variable cost
400 –

300 –

200 –

100 – Fixed cost

| | | | | | | | | | | |
0 100 200 300 400 500 600 700 800 900 1000 1100
Volume (units per period)

भारतीय प्रबंधन संस्थान शिलांग

3 November
2022
Continues…
► Revenue function begins at the origin and proceeds upward
to the right, increasing by the selling price of each unit
► Where the revenue function crosses the total cost line is the
break-even point
Assumptions
➢Costs and revenue are linear functions
• Generally not the case in the real world
➢We actually know these costs
• Very difficult to verify
➢Time value of money is often ignored

भारतीय प्रबंधन संस्थान शिलांग

3 November
2022
Continues…
BEPx = break-even point x = number of units
in units produced
BEP$ = break-even point TR = total revenue = Px
in dollars F = fixed costs
P = price per unit V = variable cost per unit
(after all discounts)
TC = total costs = F + Vx

Break-even point occurs when

TR = TC F
or BEPx =
P–V
Px = F + Vx
Continues…
BEPx = break-even point x = number of units
in units produced
BEP$ = break-even point TR = total revenue = Px
in dollars F = fixed costs
P = price per unit V = variable cost per unit
(after all discounts)
TC = total costs = F + Vx
F Profit = TR - TC
BEP$ = BEPx P = P
P–V = Px – (F + Vx)
F = Px – F – Vx
=
(P – V)/P
= (P - V)x – F
F
=
1 – V/P
Break-Even Example for Single Product
Problem: Stephens, Inc., wants to determine the minimum dollar volume and unit volume
needed at its new facility to break even. The firm first determines that it has fixed costs of
$10,000 this period. Direct labor is $1.50 per unit, and material is $.75 per unit. The selling
price is $4.00 per unit.

Fixed costs = $10,000 Material = $.75/unit

Direct labor = $1.50/unit Selling price = $4.00 per unit

F $10,000
BEP$ = =
1 – (V/P) 1 – [(1.50 + .75)/(4.00)]

$10,000
= = $22,857.14
.4375
F $10,000
BEPx = = = 5,714
P–V 4.00 – (1.50 + .75)
भारतीय प्रबंधन संस्थान शिलांग
3 November
2022
Continues…

50,000 –

Revenue
40,000 –
Break-even
point Total
30,000 –
costs
Dollars

20,000 –

Fixed costs
10,000 –

| | | | | |
0 2,000 4,000 6,000 8,000 10,000
Units

भारतीय प्रबंधन संस्थान शिलांग

3 November
2022
Break-Even Example for Multiproduct
Break-even F
point in dollars =
éæ V ö ù
(BEP$) åêêç1- Pi ÷ ´ Wi úú ( )
ëè i ø û

where V = variable cost per unit

P = price per unit
F = fixed costs
W = percent each product is of total dollar sales
expressed as a decimal
i = each product

Problem: Le Bistro, like most other restaurants, makes more than one product and would like
to know its break-even point in dollars. Information for Le Bistro follows.
Fixed costs are $3,000 per month.

भारतीय प्रबंधन संस्थान शिलांग

3 November
2022
Continues… F
BEP$ =
éæ V ö ù
Fixed costs = $3,000 per month åêêç1- Pi ÷ ´ Wi úú ( )
ëè i ø û
ANNUAL FORECASTED
ITEM SALES UNITS PRICE x 12
$3,000 COST
Sandwich 9,000 = $5.00 = $76,596
$3.00
.47
Drink 9,000 1.50 .50
Daily $76,596
Baked potato 7,000 2.00 1.00
sales = 312 days = $245.50
1 2 3 4 5 6 7 8 9
ANNUAL ANNUAL WEIGHTED
FORECASTED SELLING VARIABLE FORECASTED CONTRIBUTION
ITEM (i) SALES UNITS PRICE (P) COST (V) (V/P) 1 - (V/P) SALES $ % OF SALES (COL 5 X COL 7)

Sandwich 9,000 $5.00 $3.00 .60 .40 $45,000 .621 .248

Drinks 9,000 1.50 0.50 .33 .67 13,500 .186 .125

Baked 7,000
potato 2.00 1.00 .50 .50 14,000 .193 .097

$72,500 1.000 .470

भारतीय प्रबंधन संस्थान शिलांग

3 November
2022
Thank You