Strategic Capacity Planning for

Products and Services

Process Selection
Benedicta Ochuwa Idaewor
Grace Angela Marasigan
Ma Chere Gracita Reyes-Bilog

Capacity Planning
Capacity
The number of units a facility can hold,
receive, store or produce in a period of time.
The upper limit or ceiling on the load that an
operating unit can handle.
Capacity needs include:
Equipment
Space
Employees Skills

Strategic Capacity Planning

Goal
To achieve a match between the long-term supply
capabilities of an organization and the predicted
level of long-run demand.
Overcapacity - causes operating costs that are

too high.
Under-capacity causes strained resources and
possible loss of customers.

Examples
Overcapacity
The
factory's
overcapacity
led
to
falling prices in the
stores.
Under-capacity
An event that has a
small venue but a lot of
attendees.

Capacity Planning
Questions
Key Questions:
What kind of capacity is needed?
How much capacity is needed to match demand?
When is it needed?
Related Questions:
How much will it cost?
What are the potential benefits and risks?
Should capacity be changed all at once or through
several smaller changes?
Can the supply chain handle the necessary
changes?

Capacity Decisions Are Strategic

Capacity decisions
1.) Impact the ability of the organization to meet
future demands
2.) Affect operating costs
3.) Are a major determinant of initial cost
4.) Often involve long-term commitment of resources
5.) Can affect competitiveness
6.) Affect the ease of management
7.) Are more important and complex due to
globalization
8.) Need to be planned for in advance due to their
consumption of financial and other resources

Defining and Measuring

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.

Measuring System
Effectiveness
Actual output
The rate of output actually achieved
It cannot exceed effective capacity
Efficiency

Utilization
Measured as percentages

Example of Efficiency
and Utilization
Design Capacity = 50 trucks per day
Effective Capacity = 40 trucks per day
Actual Output = 36 trucks per day

Determinants of Effective
Capacity
Facilities
Product and Service Factors
Process Factors
Human Factors
Policy Factors
Operational Factors
Supply Chain Factors
External Factors

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.
Key decisions of capacity planning relate to:
1.) The amount of capacity needed.
2.) The Timing of changes.
3.) The need to maintain balance throughout the
system.
4.) The extent of flexibility of facilities and the
workforce.

Strategy Formulation
Deciding on the amount of capacity involves

consideration of expected demand and capacity cost.

Capacity Cushion, which is an amount of excess

capacity in excess of expected demand when there is

uncertainty about demand.

The greater the degree of demand uncertainty,

the greater the amount cushion used.

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.) Asses key qualitative issues for each alternative.
6.) Select the best alternative for the long term.
7.) Implement the selected alternative.
8.) Monitor results.

Forecasting Capacity
Requirements
Long-term considerations relate to overall

level of capacity requirements

Short-term considerations relate to probable

variations in capacity requirements

Time

Volume

Cyclical

Volume

Growth

Time

Decline

Time

Volume

Volume

Some Possible Growth / Decline

Patterns

Stable

Time

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

The Challenges of Planning Service

Capacity
Capacity planning for services can present
special challenges due to the nature of
services.
Three very important factors in
planning service capacity are:
1.) Need to be near customers
2.) Inability to store services
3.) Degree of demand volatility balance

Make or Buy?
The make-or-buy decision is the act of
making a strategic choice between
producing an item internally (in-house)
or buying it externally (from an outside
supplier). The buy side of the decision
also is referred to as outsourcing.
Factors Considered:
1.) Available Capacity
2.) Expertise
3.) Quality Considerations
4.) Nature of Demand
5.) Cost
6.) Risks

Developing Capacity
Alternatives
Aside from the general considerations about the
development of alternatives, other things that can
enhance capacity management such as:
1.) Design Flexibility into system
2.) Take Stage of life cycle into account
- Capacity requirements are often closely linked to the
stage of the life cycle that a product or service is in.

Developing Capacity
Alternatives
3.) Take a big picture approach to capacity changes
- Consider how parts of the system interrelate
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
5.) Attempt to smooth out capacity requirements
- Unevenness in capacity requirements also can create
certain problems.
6.) Identify the optimal operating level
- Production units have an optimal rate of output for
minimal cost.

Evaluating Alternatives

At the ideal level, cost per unit is the lowest level for that
production unit. Outside the ideal, it will result to either
economies of scale or diseconomies of scale.

Economies of scale - If the

output rate is less than the
optimal level, increasing the
output rate will result in
decreasing average unit cost,
i.e., the cost per unit of output
drops as volume of output
increases
The reasons for economies
of scale include the
following:
a. Fixed costs are spread over
more units, reducing the fixed
cost per unit.
b. Construction costs increase
at a decreasing rate with
respect to the size of the
facility to be built.
c. Processing costs decrease
as output rates increase

However, if output is increased beyond the optimal level, average

unit costs would become increasingly larger. This is known as
the diseconomies of scale. The reasons for diseconomies
of scale are as follows:
a. Distribution costs increase due to traffic congestion and
shipping from one large centralized facility instead of several
smaller, decentralized facilities.
b. Complexity increases costs; control and communication
become more problematic.
c. Inflexibility can be an issue.
d. Additional levels of bureaucracy exist, slowing decision making
and approvals for changes.

7.) Choose a strategy if expansion is involved Consider

whether incremental expansion or single step is more appropriate.
Factors include competitive pressures, market opportunities, costs
and availability of finds, disruption of operations, and training
requirements, Also, decide whether to lead or follow competitors.
Leading is more risky but it may have greater potential for
rewards.

CONSTRAINT MANAGEMENT
The Theory of Constraints was developed and

popularized by Eliyahu Goldratt. TOC, as it is

commonly called, recognizes that
organizations exist to achieve a goal.
A factor that limits a company's ability to

achieve more of its goal is referred to as a

"constraint"

7 Principles of the Theory of

Constraints
1.) The focus is on balancing flow, not on balancing capacity.
2.) Maximizing output and efficiency of every resource will not
maximize the throughput of the entire system.
3.) An hour lost at a bottleneck or constrained resource is an
hour lost for the whole system. An hour saved at a nonconstrained resource does not necessarily make the whole
system more productive.
4.) Inventory is needed only in front of the bottlenecks to
prevent them from sitting idle, and in front of assembly and
shipping points to protect customer schedules. Building
inventories elsewhere should be avoided.

7 Principles of the Theory of

Constraints
5.) Work should be released into the system only as frequently
as the bottlenecks need it. Bottleneck flows should be equal to
the market demand. Pacing everything to the slowest resource
minimizes inventory and operating expenses.
6.) Activation of non-bottleneck resources cannot increase
throughput, nor promote better performance on financial
measures.
7.) Every capital investment must be viewed from the
perspective of its global impact on overall throughput (T),
inventory (I), and operating expense (OE).

7 Categories of Constraints
Market
Resource
Material
Financial
Supplier
Knowledge or

competency
Policy

However, in general, these types

of constraints can just be either
internal or external to the system.
An internal constraint is in
evidence
when
the
market
demands more from the system
than it can deliver. If this is the
case, then the focus of the
organization
should
be
on
discovering that constraint and
following the five focusing steps to
open it up (and potentially remove
it). An external constraint exists
when the system can produce
more than the market will bear. If
this is the case, then the
organization should focus on
mechanisms
to
create
more

Five-step process for recognizing

and managing limitations
Step 1: Identify the
constraint
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

EXAMPLE
The demand for parts produced by
a computer-controlled piece of
equipment known as the NCX10
exceeded the machine's capacity.
Since the factory could only
assemble and sell as many products
as they had parts from the
machine.
The capacity of the factory to make
money was tied directly to the
output of the NCX10. The NCX10,
therefore, was the constraint.

STEP 1 IDENTIFY THE CONSTRAINT

In order to manage a constraint, it is first necessary

to identify it.
In the above example, the NCX10 was identified as
the constraint.
This knowledge helped the company determine
where an increase in "productivity" would lead to
increased profits.
Concentrating on a non-constraint resource would
not increase the throughput because there would not
be an increase in the number of products assembled.
To increase throughput, flow through the constraint
must be increased.

STEP 2 DEVELOP PLAN FOR

OVERCOMING CONSTRAINT
Once the constraint is identified, the next step is

to focus on how to get more production within the

existing capacity limitations.
When the company and the labor union agreed to
stagger lunches, breaks, and shift changes so the
machine could produce during times it previously
sat idle.
This added significantly to the output of the
NCX10, and therefore to the output of the entire
plant.
To manage the output of the plant, a schedule was
created for the constraint. The schedule showed
the sequence in which orders would be processed
and their approximate starting time.

STEP 3 FOCUS RESOURCES ON

ACCOMPLISHING STEP 2 or SUBORDINATE
Exploiting the constraint does not ensure that the

materials needed next by the constraint will always

show up on time.
The most important component of subordination is
to control the way material is fed to the nonconstraint resources.
TOC says that non-constraint resources should only
be allowed to process enough materials to match
the output of the constraint.
The release of materials is closely controlled and
synchronized to the constraint schedule

STEP 4 REDUCE THE EFFECTS OF CONSTRAINTS

BY OFFLOADING WORK OR EXPANDING
CAPABILITY
The next step is to determine if the output of the

constraint is enough to supply market demand. If not, it is

necessary to find more capacity by "elevating" the
constraint.
In the above example, schedulers were able to remove
some of the load from the constraint by rerouting it
across two other machines.
They also outsourced some work and brought in an older
machine that could process some of the parts made by
the NCX10.
These were all ways of adding capacity, or elevating the
constraint.

STEP 5 - GO BACK TO STEP

1
Once the output of the constraint is no

longer the factor that limits the rate of

fulfilling orders, it is no longer a constraint.
Step 5 is to go back to Step 1 and identify

a new constraint because there always is

one.

EVALUATING ALTERNATIVES
Alternatives should be evaluated from varying perspectives.

1.) ECONOMIC
Cost-volume analysis

Break-even point
Financial analysis
Cash flow
Present value
Decision theory
Waiting-line analysis
Simulation

2.) NON-ECONOMIC
Public opinion

Cost-Volume Analysis
Focuses on the relationship between cost,

revenue and volume of out-put.

Purpose

of cost-volume analysis is to
estimate the income of an organization
under different operating conditions.

It

is particularly useful as a
comparing capacity alternatives.

tool

for

Assumptions of Cost-Volume
Analysis
One product is involved.
Everything produced can be sold.
The variable cost per unit is the same regardless

of the volume.
Fixed costs do not change with volume changes,
or they are step changes.
The revenue per unit is the same regardless of
volume.
Revenue per unit exceeds variable cost per unit.

Financial Analysis
Important terms in 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

3 Most commonly used methods

of financial analysis
a. Payback - a crude but widely used method that focuses on
the length of time it will take for an investment to return its
original costs. Payback ignores the time value of money. Its
use is easier to rationalize for short-term than for long-term
projects.
b. Present Value summarizes the initial costs of an
investment, its estimated annual cash flows, and any
expected salvage value in a single value called equivalent
current value, taking into account the time value of money
(interest rates)
c. Internal Rate of Return (IRR) summarizes the initial
cost, expected annual cash flows, and estimated future
salvage value of an investment proposal in an equivalent
interest rate. In other words, this method identifies the rate of
return that equates the estimate future returns and the initial

3 Most commonly used methods

of financial analysis
These techniques are appropriate when
there is a high degree of certainty
associated with estimates of future cash
flows.
In
many
instances,
however,
operations managers and other managers
must deal with situations better described as
risky or uncertain.

Decision Theory
A helpful tool for financial comparison of alternatives under
conditions of risk or uncertainty. It is suited to capacity
decisions and to a wide range of other decisions managers
must make such as product and service design, equipment
selection and location planning.

Causes of Poor Decision

1.) Mistakes in Decision

Process
2.) Bounded Rationality
3.) Suboptimization

Mistakes in Decision
Process
It happens because of mistakes on the
following decisions steps:

Suboptimization
Usually occurs because
organizations typically
departmentalize decisions.
The result of different
departments each attempting
to reach a solution that is
optimum for that department.
Unfortunately, what is optimal
for one department may not
be optimal for the
organization as a whole.

Decision-making under Certainty

When it is known for certain which of the possible future

conditions will actually happen, the decision is usually

relatively straightforward simply choose the alternative
that has the best payoff under that state of nature.
Decision-making under Uncertainty
At the opposite extreme is complete uncertainty. No

information on how likely the various states of nature

are.

Under those conditions, 4 possible

decision criteria are:

Decision-making under Risk

Between

the two extremes of certainty and

uncertainty lies the case of risk: the probability of
occurrence for each state is known. Decisions
made under the condition that the probability of
occurrence for each state of nature can be
estimated. A widely applied criterion is expected
monetary value (EMV).

In EMV, the manager determines the expected

payoff of each alternative, and then chooses the

alternative that has the best expected payoff. This
approach is most appropriate when the decision
maker is neither risk averse nor risk seeking

Decision Tree
A schematic representation of the alternatives available to a

decision maker and their possible consequences. The term

gets its name from the tree-like appearance of the diagram.
The decision tree is particularly useful for analyzing
situations that involve sequential decisions. A decision tree
is composed of a number of nodes that have branches
emanating from them.

Other methods under Decision Theory

are:
Expected Value of Perfect Information

(EPVI) - The difference between the

expected payoff with perfect information
and the expected payoff under risk
Sensitivity Analysis provides a range

of probability for which an alternative has

the best expected payoff.

WAITING-LINE ANALYSIS
Analysis of lines is often useful for
designing or modifying service
systems. Waiting lines have a
tendency to form in a wide variety
of service systems. The lines are
symptoms of bottleneck operations.
Analysis is useful in helping
managers choose a capacity level
that will be cost-effective through
balancing the cost of having
customers wait with the cost of
providing additional capacity.

SIMULATION
One will be able to answer
questions like:
This is useful in evaluating
what if scenarios. What if
analysis is a powerful tool for
improvement that evaluates
how strategic, tactical or
operational
changes
may
impact the business. Through
different scenarios you will be
able to perform a true-to-life
analysis of your processes
without putting your business
operation at risk.

How would the processing

time of a case decrease if the
number of available resources
is doubled?
What would be the
cost/benefit rate of reducing
the process time in a
specified activity?
What would be the effect of
altering the working shift
configuration in the
operational cost and service

OPERATION STRATEGY
Capacity planning impacts all areas of the organization
It determines the conditions under which operations will have to

function
Flexibility allows an organization to be agile
It reduces the organizations dependence on forecast
accuracy and reliability
Many organizations utilize capacity cushions to achieve
flexibility
Bottleneck management is one way by which
organizations can enhance their effective capacities
Capacity expansion strategies are important organizational

considerations
Expand-early strategy
Wait-and-see strategy
Capacity contraction is sometimes necessary

Thank You!!!
Happy Valentines Day

Next is Chapter 6A
Process Selection