Chapter 5

Strategic Capacity Planning for Products and

Services

McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
 Learning Objective: Chapter 5
• You should be able to:
1. Summarize the importance of capacity planning
2. Discuss ways of defining and measuring capacity
3. Describe the determinants of effective capacity
4. Discuss the major considerations related to
developing capacity alternatives
5. Briefly describe approaches that are useful for
evaluating capacity alternatives

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Instructor Slides
 Capacity Planning
• Capacity
– The upper limit or ceiling on the load that an
operating unit can handle
– Capacity needs include
• Equipment
• Space
• Employee skills

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Instructor Slides
 Strategic Capacity Planning
• Goal
– To achieve a match between the long-term supply
capabilities of an organization and the predicted
level of long-term demand
• Overcapacity operating costs that are too high
• Undercapacity strained resources and possible loss of
customers

5-4
Instructor Slides
 Capacity Planning Questions
• Key Questions:
– What kind of capacity is needed?
– How much is needed to match demand?
– When is it needed?
• Related Questions:
– 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?

5-5
Instructor Slides
 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. have become more important and complex due to
globalization
8. need to be planned for in advance due to their
consumption of financial and other resources
5-6
Instructor Slides
 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.

5-7
Instructor Slides
 Defining and Measuring Capacity
• Measure capacity in units that do not require
updating
– Why is measuring capacity in dollars problematic?
• Two useful definitions of capacity
– Design capacity
• The maximum output rate or service capacity
an operation, process, or facility is designed for
– Effective capacity
• Design capacity minus allowances such as
personal time and maintenance
5-8
Instructor Slides
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 Measuring System Effectiveness
• Actual output
– The rate of output actually achieved
– It cannot exceed effective capacity
• Efficiency
actual output
Efficiency 
effective capacity

• Utilization
actual output
Utilizatio n 
design capacity
Measured as percentages
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Instructor Slides
 Example– Efficiency and Utilization
• Design Capacity = 50 trucks per day
• Effective Capacity = 40 trucks per day
• Actual Output = 36 trucks per day
actual output 36
Efficiency    90%
effective capacity 40

actual output 36
Utilizatio n    72%
design capacity 50

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Instructor Slides
 Determinants of Effective Capacity
• Facilities
• Product and service factors
• Process factors
• Human factors
• Policy factors
• Operational factors
• Supply chain factors
• External factors
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Instructor Slides
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 Strategy Formulation
• Strategies are typically based on assumptions
and predictions about:
– Long-term demand patterns
– Technological change
– Competitor behavior

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 Capacity Cushion
• Capacity Cushion
– Extra capacity used to offset demand uncertainty
– Capacity cushion = 100% - Utilization
– Capacity cushion strategy
• Organizations that have greater demand uncertainty
typically have greater capacity cushion
• Organizations that have standard products and
services generally have smaller capacity cushion

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Instructor Slides
Examples

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 Steps in Capacity Planning
1. Estimate future capacity requirements
2. Evaluate existing capacity and facilities; identify gaps
3. Identify alternatives for meeting requirements
4. Conduct financial analyses
5. Assess key qualitative issues
6. Select the best alternative for the long term
7. Implement alternative chosen
8. Monitor results

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Instructor Slides
Calculating Processing Requirements
• Calculating processing requirements requires
reasonably accurate demand forecasts,
standardk
processing times, and available work
time  pi Di
NR i 1
T
where
N R  number of required machines
pi  standard processing time for product i
Di  demand for product i during the planning horizon
T  processing time available during the planning horizon
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Instructor Slides
Example

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 Cost-Volume Analysis
• 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
– VC = Quantity(Q) x variable cost per unit (v)
• Total Cost
– TC = FC + VC
• Total Revenue (TR)
– TR = revenue per unit (R) x Q

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Instructor Slides
 Break-Even Point (BEP)
• BEP
– The volume of output at which total cost and total
revenue are equal
– Profit (P) = TR – TC = R x Q – (FC +v x Q)
= Q(R – v) – FC
FC
QBEP 
Rv

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Instructor Slides
Example

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 Cost-Volume Analysis Assumptions
• Cost-volume analysis is a viable tool for comparing capacity
alternatives if certain assumptions are satisfied
– One product is involved
– Everything produced can be sold
– The variable cost per unit is the same regardless of 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

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Instructor Slides
 In-House or Outsource?
• Once capacity requirements are determined, the organization
must decide whether to produce a good or service itself or
outsource
• Factors to consider:
– Available capacity
– Expertise
– Quality considerations
– The nature of demand
– Cost
– Risks

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Instructor Slides