Module 2

Capacity and Location planning

Importance of capacity decisions; Defining and measuring capacity; Determinants of

effective capacity; Determining capacity requirement; Developing capacity alternatives
Evaluating alternatives Need for location decisions; Nature of locations decisions;
General procedure for making locations decisions; Evaluating locations decisions;
Facilities layout; Need for layout decisions Types of processing Numerical problems on
Layout Selection Numerical problems on Capacity planning

CAPACITY PLANNING
Capacity is the upper limit or ceiling on the load that an operating unit can handle.
The load might be in terms of units produced or services performed.
Capacity also includes

– Equipment
– Space
– Employee skills
The goal of capacity planning of an organization is to achieve a match between long-
term capabilities and the long-term demand.

Overcapacity causes high operating costs, while under capacity causes strained
resources and possible loss of customers.
The basic questions in capacity handling are:

 What kind of capacity is needed?

The question of what kind of capacity is needed depends on the products and
services that management intends to produce or provide.
 How much is needed? (Forecasts are key inputs)
Forecasts are key inputs used to answer the question of how much is needed.
 When is it needed? (Frequency)
The factors that influence this frequency are the stability of demand, the rate of
technological change in equipment and product design, and competitive factors.
IMPORTANCE OF CAPACTY DECISIONS

Capacity decisions are among the most fundamental of all the design decisions that
managers must make.

1. Impacts ability to meet future demands: Having capacity to satisfy demand can allow
a company to take advantage of tremendous opportunities.

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2. Affects operating costs: Ideally, when capacity and demand match, it tends to
minimize operating costs. In practice, this is not always achieved because actual
demand either differs from expected demand or tends to vary.

3.Major determinant of initial costs: The greater the capacity of a productive unit, the
greater its cost. Hence while planning capacity future trend of product to be kept in
mind.

4. Involves long-term commitment: Once they are implemented, it may be difficult or

impossible to modify those decisions without incurring major costs.
5. Affects competitiveness: If a firm has excess capacity, or can quickly add capacity,
that fact may serve as a barrier to entry by other firms.

6. Affects ease of management: Having appropriate capacity makes management easier

than when capacity is mismatched.

7. Globalization adds complexity: Far-off supply chains and distant markets add to the
uncertainty about capacity needs.
8. Impacts long range planning: Some facility might take years to be functional at which
it must be able to match the actual demand.
DEFINING AND MEASURING CAPACITY
Capacity often refers to an upper limit on the rate of output.
In selecting a measure of capacity, it is important to choose one that does not require
updating. For example, rupee amounts are often a poor measure of capacity (e.g.,
capacity of Rs 30 crore a year) because price changes necessitate updating of that
measure.

Where only one product or service is involved, the capacity of the productive unit may
be expressed in terms of that item.

However, when multiple products or services are involved, as is often the case, using a
simple measure of capacity based on units of output can be misleading. An appliance
manufacturer may produce both refrigerators and freezers. If the output rates for these
two products are different, it would not make sense to simply state capacity in units
without reference to either refrigerators or freezers. The preferred alternative in such
cases is to use a measure of capacity that refers to availability of inputs.
Thus,
• a hospital has a certain number of beds,
• a factory has a certain number of machine hours available,
• a bus has a certain number of seats. Measures of capacity

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Concepts of Capacity:
1. Design capacity: the maximum output that can possibly be attained.

2. Effective capacity: the maximum possible output (Design capacity) minus allowances
such as personal time, maintenance, and scrap.
Actual output cannot exceed effective capacity and is often less because of machine
breakdowns, absenteeism, shortages of materials, and quality problems.

Efficiency and Utilization: Design capacity is the maximum rate of output achieved
under ideal conditions. Effective capacity is usually less than design capacity owing to
the need for periodic maintenance of equipment, lunch breaks, coffee breaks, problems
in scheduling and balancing operations, and similar circumstances.
Efficiency is the ratio of actual output to effective capacity.
Utilization is the ratio of actual output to design capacity.
*Both measures are expressed as percentages

It is common for managers to focus exclusively on efficiency, but in many instances,

this emphasis can be misleading. This happens when effective capacity is low compared
with design capacity. In those cases, high efficiency would seem to indicate effective use
of resources when it does not.
Because effective capacity acts as a lid on actual output, the real key to improving
capacity utilization is to increase effective capacity by correcting quality problems,
maintaining equipment in good operating condition, fully training employees, and fully
utilizing bottleneck equipment.

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Hence, increasing utilization depends on being able to increase effective capacity, and
this requires knowledge of what is constraining effective capacity.
Efficiency/Utilization Example – Compute the efficiency and the utilization of the vehicle
repair department:

DETERMINANTS OF EFFECTIVE CAPACITY

Increasing utilization depends on being able to increase effective capacity, and this
requires knowledge of what factors affect effective capacity. The main factors relate to
facilities, products or services, human considerations, operational factors, the supply
chain, and external factors.
1.Facilities
•The design of facilities, including size and provision for expansion.
•Location factors, such as transportation costs, labor, energy sources.
•Layout of the work area often determines how smoothly work can be performed.
•Environment factors such as heating, lighting, and ventilation also play a significant
role in effective planning.
2.Product/Service factors
•When products are similar, the ability of the system to produce those items is generally
much greater than with products that differ.
•Thus, a restaurant that offers a limited menu can usually prepare and serve meals at
a faster rate than a restaurant with an extensive menu.

•Generally speaking, the more uniform the output, the more opportunities there are for
standardization of methods and materials, which leads to greater capacity.
3.Process factors

•If quality of output does not meet standards, the rate of output will be slowed by the
need for inspection and rework activities.
•Hence process improvements that increase quality should be a part of effective
capacity.

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4.Human factors

•Training, skill, and experience required to perform a job have an impact on the potential
and actual output.
•Employee motivation has a very basic relationship to effective capacity.
5.Operational factors

•Inventory stocking, late deliveries, acceptability of purchased materials, quality

inspection can have an impact on effective capacity.

•Inventory shortages of even one component of an assembled item can cause a

temporary halt to assembly operations until new components become available.
•Insufficient capacity in one area can affect overall capacity.
6.Supply chain factors
• Supply chain factors must be taken into account in capacity planning is substantial
capacity changes are involved.

• Key questions include – what impact will the changes have on suppliers, warehousing,
transportation and distributors?
7.External factors
• Defined quality and performance standards can restrict management’s options for
increasing and using capacity.
• Union contract limits the number of hours and type of work an employee may do
DETERMINING (FORECASTING) CAPACITY REQUIREMENTS
Capacity planning decisions involve both long-term and short-term considerations.
Long-term considerations relate to overall level of capacity, such as facility size; Short-
term considerations relate to how well the capacity is used to meet the demand.

Long term capacity is for the long run of the organization when initial plant is setup. We
determine
long-term capacity needs by forecasting demand over a time horizon and then converting
those forecasts into capacity requirements. For this the organization looks into trend
and cyclical forecasts.
• When trends are identified, the fundamental issues are
(1) how long the trend might persist, because few things last forever, and
(2) the slope of the trend.
• If cycles are identified, interest focuses on
(1) the approximate length of the cycles, and

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(2) the amplitude of the cycles (i.e., deviation from average).

Short term capacity is how we deal with the current demand. For this the organization
looks into seasonal and random forecasts. These deviations are particularly important
because they can place a severe strain on a system’s ability to satisfy demand at some
times and yet result in idle capacity at other times.

DEVELOPING CAPACITY ALTERNATIVES

Things organization can do to enhance capacity management:
1.Design flexibility into systems
•Have provision for future expansion in the original design can be obtained at a small
price compared to what it would cost to remodel an existing structure.
•Example, if future expansion of a restaurant seems likely, water lines, power hookups,
and waste disposal lines can be put in place initially.
•Obtaining adjacent land.

•Flexible design involve layout of equipment, location, equipment selection, production

planning.
2. Take stage of life cycle into account
Capacity requirements are often closely linked to the stage of life cycle that a product or
service is in.

•At the introduction phase, it is difficult to determine how the market reacts, therefore,
organizations should be cautious while making large or inflexible capacity investments
(a cautious approach).

•In the growth phase, the organization's share grows, which will need increase in
capacity, investment and complexity.

•In the maturity phase, organizations tend to have a stable market share making full
use of capacity and profitability.
•In the decline phase an organization is faced with underutilization of capacity. During
this phase organization may decide to sell excess capacity, introduce new products, or
transfer capacity to another location that has lower labour costs.

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3. Take a “big picture” approach to capacity changes

When developing capacity alternatives, it is important to consider how parts of the

system interrelate. For example, when making a decision to increase the number of
rooms in a hotel, one should also take into account probable increased demands for
parking, entertainment and food, and housekeeping. This is a “big picture” approach.
The risk of not taking big-picture approach is that the system will be unbalanced –
possible bottleneck situation.

A bottleneck operation is an operation whose capacity is lower than other capacities of

other operations in the sequence. As a result, the capacity of this operation limits the
system capacity. Organizations should work on eliminating bottleneck situation.
4. Prepare to deal with capacity “chunks”

Capacity increases are often acquired in fairly large chunks rather than smooth
increments, making it difficult to achieve a match between desired capacity and feasible
capacity.
For instance,
Desired capacity – 55 units/hr. Machine capacity – 40 units/hr.
Another machine would increase the excess capacity by 25 units/hr.
5. Attempt to smooth out capacity requirements
Unevenness in capacity requirements can create certain problems. At certain times the
system will tend to be overloaded, while at other times it will tend to be under loaded,
which tends to alternate between underutilization and over utilization of the system.
One possible approach to this problem is to identify products or services that have
complementary demand patterns, that is, patterns that tend to offset each other.
For instance, demand for air-conditioner is greater in the summer, and demand for
heating equipment is greater winter. These products involve the use of the same
resources but at different times, so that overall capacity requirements remain stable.
6. Identify the optimal operating level

Production units typically have an ideal or optimal level of operation in terms of unit
cost of output. At the ideal level, cost per unit is the lowest for that production unit;
larger or smaller rates of output will result in a higher unit cost. Organization tends to
manage their operations so that fall into this range.
Choose a strategy if expansion is involved
• Consider whether incremental expansion or single step is more appropriate.
• Lead or follow competitors.

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EVALUATING ALTERNATIVES

An organization needs to examine alternatives for future capacity from a number of

different perspectives.
Most obvious are economic considerations:
– Will an alternative be economically feasible?
–How much will it cost?
–How soon can we have it?
–What will be operating and maintenance costs be?
–What will its useful life be?
–Will it be compatible with present personnel and present operations?

LOCATION PLANNING
The choice of location for a business organization is of paramount importance for
various reasons. Although it might appear that location decisions are one-time problems
pertaining to new organizations, existing organizations often have a bigger stake in these
kinds of decisions than new organizations.
THE NATURE OF LOCATION DECISIONS
The usual objectives managers have when making location choices.
1.Strategic Importance
• Low-cost producer or increasing profits by increasing market.
• Location choices can impact capacity and flexibility.
• Local restrictions may restrict the types of products or services that can be offered.
• Long term commitment impact on investments, revenues, and operations.
• Transportation costs, availability of raw materials labour.
2.Objectives
• Profit potential
• No single location may be better than others
• Identify several locations from which to choose
• Supply chain.

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3. Options

• Expand existing facilities - This option can be attractive if there is adequate room for
expansion.
• Add new facilities while retaining existing ones.
• Shut down at one location and move to another - An organization must weigh the costs
of a move and the resulting benefits against the costs and benefits of remaining in an
existing location.

• Do nothing - If a detailed analysis of potential locations fails to uncover benefits that

make one of the previous three alternatives attractive, a firm may decide to maintain
the status quo, at least for the time being.
FACTORS AFFECTING LOCATION DECISIONS
There are many factors that affect the location of businesses
1. Production methods and location decisions
Small scale: transport and location of suppliers are less important.
Large scale: transport and location of suppliers are more important.
2. Market
Need to be near to transport perishable goods. Need to be near to cut transportation
expenses.
3. Raw materials/components
Need to be near to transport perishable goods. Need to be near to cut transportation
expenses.
4. External economies of scale
How good nearby businesses are.
For maintenance of equipments. For training workers, etc…
5. Availability of labour
Wages of the labourers.
How skilled they are.
6. Government influence
Grants/subsidies.
Restrictions on dumping, etc…
7. Transport and communication
To be able to transport product easily.

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8. Power
Need a reliable source of power to operate effectively.
9. Water supply
A lot of water is needed in the production process (e.g. cooling, cleaning) Cost of water.
10. Personal preferences of the owners
• May locate in areas that:
O They come from.
O They like.
O Pleasant weather, etc…
11. Climate
E.g. to reduce heating costs in a warmer climate. Some climates are required to produce
certain items.

Types of Layout
1. Product or line layout
2. Process or functional layout
3. Fixed position or location layout
4. Combined or group layout

1. Product or line layout

In an industrial set up, sometime, the machines and equipments are arranged in one
line depending upon the sequence of operations required for the product.
The raw materials and semi-finished materials move from one workstation to another
sequentially without any backtracking or deviation. The output of one machine
becoming input of the next

e.g. in a paper mill, bamboos are fed into the machine at one end and paper comes out
at the other end.
2. Process or functional layout
In this type of layout machines of a similar type are arranged together at one place.
For example, machines performing drilling operations are arranged in the drilling
department, machines performing casting operations be grouped in the casting
department.

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Therefore, the machines are installed in the plants, according to various processes in
the factory layout.
3. Fixed position or location layout

Fixed position layout involves the movement of manpower and machines to the product
which remains stationary. The movement of men and machines is advisable as the cost
of moving them would be lesser. This type of layout is preferred where the size of the job
is bulky and heavy.

Example of such type of layout is locomotives, ships, boilers, generators, wagon

building, aircraft manufacturing, etc.
4. Combined or group layout

Certain manufacturing units may require all three processes namely intermittent
process (job shops), the continuous process (mass production shops) and the
representative process combined process [i.e. miscellaneous shops]. In most of
industries, only a product layout or a process layout or a fixed location layout does not
exist. Thus, in manufacturing concerns where several products are produced in
repeated numbers with no likelihood of continuous production, combined layout is
followed.
e.g. for industries involving the fabrication of parts and assembly, fabrication tends to
employ the process layout, while the assembly areas often employ the product layout.

Types of Processes
1. Job shops
Involve the production of a variety of products in small quantities.

This process requires great flexibility of equipment and high-skilled personnel, allowing
a wide variety of work.
the drawbacks of this type include high cost per unit and complex scheduling.
An example of the job shops is a jewelry repair shop or veterinarian services.
2. Batches
Batches are used for medium production and moderate product variety.
A good example is bakeries or services for groups of people, like air travel.
3. Repetitive
Repetitive process type products are production lines for cars, TVs, pencils.

The advantage of this type is that it allows large volumes, but the disadvantages are the
high cost of equipment downtime and low flexibility.

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4. Continuous

The continuous process involves the production of the highest volumes, rigid
equipment, and low-skilled personnel.

Examples of a continuous process type are sugar, flour, gasoline, steel production, and
supplying electricity or the Internet
5. Project process
Project process type is usually chosen in project work cases.
Project type can have characteristics of all types because of the projects’ variety.
for example, filming a movie, publishing a book, building a dam.

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