Capacity Planning

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 Capacity planning
 Capacity is the maximum output rate of a facility
OR
Maximum volume (quantity) of output that can be
produced in a given period of time.
 Capacity planning is the process of establishing the
output rate that can be achieved at a facility:
 Strategic issues: how much and when to spend

capital for additional facility & equipment

 Tactical issues: workforce & inventory levels, &

day-to-day use of equipment

 Measuring Capacity Examples
 There is no one best way to measure capacity
 Output measures like quantity of car manufactured per day
are easier to understand
 With multiple products, inputs measures work better
Input Measures of Output Measures
Type of Business
Capacity of Capacity
Car manufacturer Labor hours Cars per shift
Hospital Available beds Patients per month
Pizza parlor Labor hours Pizzas per day
Floor space in
Retail store Revenue per foot
square feet

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 Measuring Available Capacity
 Design capacity:
 Maximum output rate under ideal conditions
 A bakery can make 30 custom cakes per day
 Effective capacity:
 Maximum output rate under normal (realistic)
conditions
 On the average this bakery can make 20
custom cakes per day

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Measuring Effectiveness of Capacity Use
 Measures how much of the available
capacity is actually being used:
actual output rate
Utilization   100%
capacity

 Measures effectiveness
 Use either effective or design capacity in
denominator

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 Example of Computing Capacity Utilization: A bakery’s
design capacity is 30 custom cakes per day. Currently the bakery is
producing 28 cakes per day. What is the bakery’s capacity
utilization relative to both design and effective capacity?

actual output 28
Utilization effective  (100%)  (100%)  140%
effective capacity 20

actual output 28
Utilization design  (100%)  (100%)  93%
design capacity 30

 The current utilization is only slightly below its design

capacity and considerably above its effective capacity
 The bakery can only operate at this level for a short period
of time

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 Capacity Considerations
 The Best Operating Level is the output that results in
the lowest average unit cost
 Economies of Scale:
 Where the cost per unit of output drops as volume of output
increases
 Spread the fixed costs of buildings & equipment over multiple
units, allow bulk purchasing & handling of material
 Diseconomies of Scale:
 Where the cost per unit rises as volume increases
 Often caused by congestion (overwhelming the process with too
much work-in-process) and scheduling complexity

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 Best Operating Level and Size

 Alternative 1: Purchase one large facility, requiring one large

initial investment
 Alternative 2: Add capacity incrementally in smaller chunks as
needed
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 Trends in Demand Forecasts

Decline
Demand
Growth Demand trend
forecast
trend forecast

Time Time

Demand
forecast Demand
Cyclical forecast Stable
trend trend

Time Time

Products A & B

Demand Product B
forecast

Product A

Time

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Other Capacity Considerations
 Focused factories:
 Small, specialized facilities with limited
objectives
 Plant within a plant (PWP):
 Segmenting larger operations into smaller
operating units with focused objectives
 Subcontractor networks:
 Outsource non-core items to free up
capacity for what you do well

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Temporary (Operational level) Capacity Changes

Type Action
Inventories Stockpile finished goods during slack periods to meet later
demand
Backlogs During peak demand periods, ask willing customers to
wait for some time before receiving their products. File
their order and fulfill it after the peak demand period
Employment Hire additional employees or layoff employees as demand
levels for output increases or decreases
Workforce Have employees work overtime during peaks and be idle
utilization or work for fewer hours during slack demand periods

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 Temporary Capacity Changes………….

Type Action
Process design Change the job content at each work station to
increase the productivity. Use of work method analysis
to redesign jobs
Subcontracting During peak periods, hire other firms temporarily to
make product or some of its subcomponents
Maintenance Temporary discontinue routine preventive
maintenance on facilities and equipment's so that
during peak periods the facility can be operated when
it would otherwise be idle
Employee training Instead of having each employee specialized in one
task, train each in several tasks. This alternative to
hiring and lay offs for getting needed skills
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 Making Capacity Planning Decisions

The four-step procedure for making

capacity planning decisions is as
follows:
1. Identify Capacity Requirements
2. Assess Available Capacity
3. Develop Capacity Alternatives
4. Evaluate Capacity Alternatives
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 Identifying capacity requirements
 Forecasting Capacity:
 Long-term capacity requirements based on future demand

 Identifying future demand based on forecasting

 Forecasting, at this level, relies on qualitative forecast models

 Executive opinion

 Delphi method

 Forecast and capacity decision must included strategic implications

 Capacity cushions
 Plan to underutilize capacity to provide flexibility
 Strategic Implications
 How much capacity a competitor might have
 Potential for overcapacity in industry a possible hazard

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 Developing & Evaluating Capacity
Alternatives

 Capacity alternatives include

 Could do nothing,
 expand large now (may included capacity
cushion), or
 expand small now with option to add
later
 Use decision support aids to evaluate
decisions (decision tree most
popular)
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Capacity Expansion Strategies
 Decision trees
Diagramming technique which uses
 Decision points – points in time when decisions
are made, squares called nodes
 Decision alternatives – branches of the tree off
the decision nodes
 Chance events – events that could affect a
decision, branches or arrows leaving circular
chance nodes
 Outcomes – each possible alternative listed

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 Decision tree diagrams

Decision trees developed by

 Drawing from left to right
 Use squares to indicate decision points
 Use circles to indicate chance events
 Write the probability of each chance by the
chance (sum of associated chances = 100%)
 Write each alternative outcome in the right
margin

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Example Using Decision Trees: A restaurant owner has
determined that she needs to expand her facility. The alternatives
are to expand large now and risk smaller demand, or expand on a
smaller scale now knowing that she might need to expand again in
three years. Which alternative would be most attractive? (see notes)

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 Evaluating the Decision Tree
 Decision tree analysis utilizes expected value
analysis (EVA)
 EVA is a weighted average of the chance events
 Probability of occurrence * chance event outcome
 Refer to previous slide
 At decision point 2, choose to expand to maximize
profits ($200,000 > $150,000)
 Calculate expected value of small expansion:
 EVsmall = 0.30($80,000) + 0.70($200,000) = $164,000

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 Evaluating the Decision Tree con’t…
 Calculate expected value of large expansion:
 EVlarge = 0.30($50,000) + 0.70($300,000) =
$225,000
 At decision point 1, compare alternatives &
choose the large expansion to maximize the
expected profit:
 $225,000 > $164,000
 Choose large expansion despite the fact that
there is a 30% chance it’s the worst decision:
 Take the calculated risk!
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