Operations Management

Dr. TRAN QUYNH LE

Industrial Systems Engineering Department
Mechanical Engineering Faculty
Ho Chi Minh City University of Technology (HCMUT)–
VNUHCM
CHAPTER 5: Capacity Planning

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 LEARNING OUTCOME
After completing this chapter, you should be able to:

• Explain the importance of capacity planning.

• Describe ways of defining and measuring capacity.

• Name several determinants of effective capacity.

• Discuss factors to consider when deciding whether to perform in-house or

outsource.

• Discuss the major considerations related to developing capacity alternatives.

• Describe the steps used to resolve constraint issues.

• Briefly describe approaches that are useful for evaluating capacity alternatives.

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5.1 INTRODUCTION

Capacity The upper limit or ceiling on the load that an operating

unit can handle

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5.1 INTRODUCTION

• The key questions in capacity planning:

1. What kind of capacity is needed?
2. How much is needed to match demand?
3. When is it needed?
• Related questions include:
1. How much will it cost?
2. What are the potential benefits and risks?
3. Are there sustainability issues?
4. Should capacity be changed all at once, or through several smaller changes
5. Can the supply chain handle the necessary changes?

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5.2 CAPACITY DECISIONS ARE STRATEGIC

• Impact ability to meet future demand

• Affect operating costs
• Major determinant of initial cost
• Involve a long-term commitment of resource
• Affect competitiveness
• Affects the ease of management
• Globalization adds complexity
• Impact long range planning

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5.3 DEFINING AND MEASURING CAPACITY

• Up to this point, we have been using a general definition of capacity. Although it

is functional, it can be refined into two useful definitions of capacity
✓ Design capacity : The maximum designed service capacity or output rate
✓ Effective capacity : Design capacity minus personal and other allowances
✓ Actual output: Rate of output actually achieved-cannot exceed effective câpcity

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5.3 DEFINING AND MEASURING CAPACITY

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5.3 DEFINING AND MEASURING CAPACITY

✓ These different measures of capacity are useful in defining two measures of

system effectiveness: efficiency and utilization. Efficiency is the ratio of actual
output to effective capacity. Capacity utilization is the ratio of actual output to
design capacity

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5.3 DEFINING AND MEASURING CAPACITY

Example: Given the following information, compute the efficiency and the utilization
of the vehicle repair department:
• Design capacity = 50 trucks per day
• Effective capacity = 40 trucks per day
• Actual output = 36 trucks per day

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5.4 DETERMINANTS OF EFFECTIVE CAPACITY
Facilities. The design of facilities, including size and provision for expansion, is key. Locational factors,
such as transportation costs, distance to market, labor supply, energy sources, and room for expansion,
are also important.

Product and Service Factors. Product or service design can have a tremendous influence on capacity.

Process Factors. The quantity capability of a process is an obvious determinant of capacity. A more
subtle determinant is the influence of output quality.

Human Factors. The tasks that make up a job, the variety of activities involved, and the training, skill,
and experience required to perform a job all have an impact on the potential and actual output.

Policy Factors. Management policy can affect capacity by allowing or not allowing capacity options
such as overtime or second or third shifts.

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5.4 DETERMINANTS OF EFFECTIVE CAPACITY

Operational Factors: Scheduling problems, inventory stocking decisions,

late deliveries, purchasing requirements, acceptability of purchased
materials and parts, and quality inspection and control procedures

Supply Chain Factors. Supply chain factors must be taken into account
in capacity planning if substantial capacity changes are involved.

External Factors. Product standards, especially minimum quality and

performance standards, can restrict management's options for increasing
and using capacity

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5.5 STRATEGY FORMULATION

A leading capacity strategy A following strategy builds A tracking strategy is similar

builds capacity in capacity when demand to a following strategy, but it
anticipation of future exceeds current capacity. adds capacity in relatively
demand increases small increments to keep
pace with increasing
demand.

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5.5 STRATEGY FORMULATION
• An organization typically bases its capacity strategy on assumptions and
predictions about:

✓ long-term demand patterns,

✓ technological changes, and
✓ the behavior of its competitors
These typically involve (1) the growth rate and variability of demand, (2) the costs
of building and operating facilities of various sizes, (3) the rate and direction of
technological innovation, (4) the likely behavior of competitors, and (5) availability of
capital and other inputs
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5.5 STRATEGY FORMULATION
• Capacity cushion Extra capacity used to offset demand uncertainty

Capacity cushion = capacity − expected demand

• The greater the degree of demand uncertainty, the greater the amount of cushion
used.

• Organizations that have standard products or services generally have smaller

capacity cushions.

• Cost and competitive priorities are also key factors

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Steps in the Capacity Planning Process
1. Estimate future capacity requirements.

2. Evaluate existing capacity and facilities and identify gaps.

3. Identify alternatives for meeting requirements.

4. Conduct financial analyses of each alternative.

5. Assess key qualitative issues for each alternative.

6. Select the alternative to pursue that will be best in the long term.

7. Implement the selected alternative.

8. Monitor results.
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5.6 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 probable variations in capacity

requirements created by such things as seasonal, random, and irregular
fluctuations in demand

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Calculating Processing Requirements
• Calculating processing requirements requires reasonably accurate demand
forecast, standard processing times, and available working time

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Calculating Processing Requirements
• Example: A department works one 8-hour shift, 250 days a year, and has these
figures for usage of a machine that is currently being considered:

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Calculating Processing Requirements
• Example: A department works one 8-hour shift, 250 days a year, and has these
figures for usage of a machine that is currently being considered:

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5.7 ADDITIONAL CHALLENGES OF PLANNING SERVICE CAPACITY

• Three very important factors in planning service capacity are:

(1) there may be a need to be near customers,
(2) the inability to store services, and
(3) the degree of volatility of demand.

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5.7 ADDITIONAL CHALLENGES OF PLANNING SERVICE CAPACITY

• Three very important factors in planning service capacity are:

(1) there may be a need to be near customers
- Convenience
(2) the inability to store services
- Cannot store service for consumption later
(3) the degree of volatility of demand.
- Volume and timing of demand
- Time required to service individual customers

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5.7 ADDITIONAL CHALLENGES OF PLANNING SERVICE CAPACITY

• In some instances, demand management strategies can be used to offset

capacity limitations, allowing organizations to achieve a closer match in supply
and demand:
✓ Pricing,
✓ Promotions,
✓ Discounts,
✓ Tactics can help to shift some demand away from peak periods and into slow
periods

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5.8 DO IT IN-HOUSE OR OUTSOURCE IT?
• Once capacity requirements are determined, the organization must decide
whether to produce a good or service itself or outsource
✓ Available capacity
✓ Expertise – where will it come from if I don’t have it?
✓ Quality considerations
✓ The nature of demand
✓ Cost
✓ Risks

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5.9 DEVELOPING CAPACITY STRATEGIES
• There are a number of ways to enhance development of capacity strategies:
✓ Design flexibility into systems
✓ Take stage of life cycle into account
✓ Take a “big-picture” approach to capacity changes
✓ Prepare to deal with capacity “chunks”
✓ Attempt to smooth capacity requirements
✓ Identify the optimal operating level
✓ Choose a strategy if expansion is involved.

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5.9 DEVELOPING CAPACITY STRATEGIES
• Bottleneck operation An operation in a sequence of operations whose capacity
is lower than that of the other operations

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5.9 DEVELOPING CAPACITY STRATEGIES
• Economies of scale If the output rate is less than the optimal level, increasing
the output rate results in decreasing average unit costs.
• Diseconomies of scale If the output rate is more than the optimal level,
increasing the output rate results in increasing average unit costs.

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5.9 DEVELOPING CAPACITY STRATEGIES
• Minimum cost and optimal operating rate are functions of the size of a
production unit

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5.10 CONSTRAINT MANAGEMENT
• Constraint Something that limits the performance of a process or system in
achieving its goals
• There are seven categories of constraints:
Market
Resource
Policy
Material
Financial

Knowledge or
competency

Supplier

Goal
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5.10 CONSTRAINT MANAGEMENT
• Resolving Constraint Issues

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5.11 EVALUATING ALTERNATIVES
Alternatives should be evaluated from varying perspectives
• Economic
✓ Is it economically feasible?
✓ How much will it cost?
✓ How soon can we have it?
✓ What will operating and maintenance costs be?
✓ What will its useful life be?
✓ Will it be compatible with present personnel and present operations?
• Non-economic
✓ Public opinion

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5.11 EVALUATING ALTERNATIVES
• Techniques for Evaluating Alternatives
✓ Cost-volume analysis
✓ Financial analysis
✓ Decision theory
✓ Waiting-line analysis
✓ Simulation

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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
• Quantity(Q)
• Variable cost per unit (v)
• Total Cost (TC)
• Total Revenue (TR)
• Revenue per unit (R)
• 𝑄BEP = Break-even quantity
• P = Profit

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Cost–Volume Analysis

TC = FC + VC
VC = Q × v
TR = R × Q

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Cost–Volume Analysis
Break-even point (BEP) The volume of output at which total cost and total revenue
are equal.

P = TR − TC = R × Q − (FC + v × Q)
P = Q(R − v) − FC
P + FC
Q=
R−v

FC
𝑄𝐵𝐸𝑃 =
R−v
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Cost–Volume Analysis

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Cost–Volume Analysis
Example: The owner of Old-Fashioned Berry Pies, S. Simon, is contemplating
adding a new line of pies, which will require leasing new equipment for a monthly
payment of $6,000. Variable costs would be $2 per pie, and pies would retail for $7
each.
a. How many pies must be sold in order to break even?
b. What would the profit (loss) be if 1,000 pies are made and sold in a month?
c. How many pies must be sold to realize a profit of $4,000?
d. If 2,000 can be sold, and a profit target is $5,000, what price should be charged
per pie?

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Cost–Volume Analysis
Example:

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Cost–Volume Analysis
Example 4: A manager has the option of purchasing one, two, or three machines.
Fixed costs and potential volumes are as follows:

Variable cost is $10 per unit, and revenue is $40 per unit.
a. Determine the break-even point for each range.
b. If projected annual demand is between 580 and 660 units, how many machines
should the manager purchase?

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Cost–Volume Analysis
Example 4:

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Cost–Volume Analysis
Example 4:

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Financial Analysis
▪ Cash flow: The difference between cash received from sales and other sources,
and cash outflow for labor, material, overhead, and taxes
▪ Present value : The sum, in current value, of all future cash flow of an
investment proposal

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Decision Theory
▪ Helpful tool for financial comparison of alternatives under conditions of risk or
uncertainty
▪ Suited to capacity decisions

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Waiting-Line Analysis
▪ Useful for designing or modifying service systems
▪ Waiting-lines occur across a wide variety of service systems
▪ Waiting-lines are caused by bottlenecks in the process
▪ Helps managers plan capacity level that will be cost-effective by balancing the
cost of having customers wait in line with the cost of additional capacity

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AIC
1. Determine the utilization and efficiency for situation: A loan processing operation that
processes an average of 7 loans per day. The operation has a design capacity of 10
loans per day and an effective capacity of 8 loans per day
2. In a job shop, effective capacity is only 50 percent of design capacity, and actual
output is 80 percent of effective capacity. What design capacity would be needed to
achieve an actual output of eight jobs per week?
3. A producer of pottery is considering the addition of a new plant to absorb the backlog
of demand that now exists. The primary location being considered will have fixed costs of
$9,200 per month and variable costs of 70 cents per unit produced. Each item is sold to
retailers at a price that averages 90 cents.
a. What volume per month is required in order to break even?
b. What profit would be realized on a monthly volume of 61,000 units? 87,000 units?
c. What volume is needed to obtain a profit of $16,000 per month?
d. What volume is needed to provide a revenue of $23,000 per month?
e. Plot the total cost and total revenue lines.

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