Course Code: BAC506A

Course Title: Operations

Management
Course Leader:
Dr. Chandra Sen Mazumdar
Email: chandrasen.ms.mc@msruas.ac.in

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Capacity Planning

2
Learning objectives
• 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

3
Capacity Planning

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

4
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
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?

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Production Capacity Planning

Labor Equipment Packaging

Capacity Capacity Capacity

Material Equipment
Production
Receiving Maintenance
Capacity Capacity
Capacity

Inventory
Facility Sales Force
Storage
Capacity Capacity
Capacity
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 Measures of Capacity

• We measure the capacity of a plant, machine

department, worker, hospital, etc., either
• in terms of output (number of units or number of
pounds manufactured) or
• in terms of input (e.g. number of machine hours,
machines, labor hours, …).
• A major function of capacity planning is to match
the capacity of the machine or facility with the
demand for the products of the firm.

8
 Capacity Planning Horizons

Capacity planning can be classified into three planning horizons:

• Long range planning horizons of one year or longer to provide sufficient
time to build a new facility, to expand the existing facility or to move to a
new facility due to expected changes in demand.
• Medium range planning horizon ranges approximately from one month
and less than a year. At this level of planning, decisions or activities
include acquisition of a major piece of machinery and subcontracting.
• Short range planning horizon covers capacity planning activities on a daily
or a weekly basis and are generated as a result of disaggregation of the
long or medium range capacity plans. These activities include machine
loading and detailed production scheduling.

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Capacity Planning

• Output rate is uncertain because:

• Employee absences
• Equipment breakdown
• Vacations
• Material delivery delays and shortages
• Quality problems and rework

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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

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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.

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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

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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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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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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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Table 1: Factors that determine effective capacity

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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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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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 Forecasting Capacity Requirements
• Long-term considerations relate to overall level of capacity requirements
• Require forecasting demand over a time horizon and converting those needs into
capacity requirements
• Short-term considerations relate to probable variations in capacity
requirements
• Less concerned with cycles and trends than with seasonal variations and other
variations from average

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

pD i i
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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 Calculating Processing Requirements
SS t taa nn dd aa r rdd
AA nn nn uu aa l l pp r roo ccee ssssi ni n gg t ti mi m ee PP r roo ccee ssssi ni n gg t ti mi m ee
PP r roo dd uu cct t DD ee mm aa nn dd pp ee r r uu nn i ti t ( (hh r r. .) ) nn ee ee dd ee dd ( (hh r r. .) )

## 11 44 00 00 55 . .00 22 , ,00 00 00

## 22 33 00 00 88 . .00 22 , ,44 00 00

## 33 77 00 00 22 . .00 11 , ,44 00 00
55 , ,88 00 00

If annual capacity is 2000 hours, then we need three machines to handle the
required volume: 5,800 hours/2,000 hours = 2.90 machines

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 Calculating Processing Requirements

• If a department works one eight hour shift, 250 days per year how
many machines are needed?

• (5,800)/(8 X 250) = 2.9 or 3 machines

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Service Capacity Planning
• Service capacity planning can present a number of
challenges related to:
• The need to be near customers
• Convenience
• The inability to store services
• Cannot store services for consumption later
• The degree of demand volatility
• Volume and timing of demand
• Time required to service individual customers

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Demand Management Strategies
• Strategies used to offset capacity limitations and that
are intended to achieve a closer match between
supply and demand
• Pricing
• Promotions
• Discounts
• Other tactics to shift demand from peak periods into slow
periods

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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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Developing Capacity Alternatives
• Things that can be done to enhance capacity management:
• 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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Capacity Strategies
• Leading
• Build capacity in anticipation of future demand increases
• Following
• Build capacity when demand exceeds current capacity
• Tracking
• Similar to the following strategy, but adds capacity in relatively small
increments to keep pace with increasing demand

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Bottleneck Operation
• An operation in a
sequence of operations
whose capacity is lower
than that of the other
operations

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 Bottleneck Operation
10/hr Bottleneck operation: An operation
Machine
Machine #1
#1 in a sequence of operations whose
capacity is lower than that of the
other operations
10/hr
Machine
Machine #2
#2 Bottleneck
Bottleneck 30/hr
Operation
Operation
Machine
Machine #3
#3 10/hr

Machine
Machine #4
#4 10/hr

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Bottleneck Operation
Bottleneck

Operation 1 Operation 2 Operation 3

10/hr.
20/hr. 10/hr. 15/hr.

Maximum output rate

limited by bottleneck

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Optimal Operating Level

Average cost per unit

Minimum
cost

Optimal Rate of output

Output
Rate

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Economies and Diseconomies of Scale
• Economies of Scale
• If output rate is less than the optimal level, increasing the
output rate results in decreasing average per unit costs
• Diseconomies of Scale
• If the output rate is more than the optimal level, increasing
the output rate results in increasing average per unit costs

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Economies of Scale
• Economies of Scale
• If output rate is less than the optimal level, increasing the
output rate results in decreasing average per unit costs
• Reasons for economies of scale:
• Fixed costs are spread over a larger number of units
• Construction costs increase at a decreasing rate as facility size
increases
• Processing costs decrease due to standardization

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Diseconomies of Scale
• Diseconomies of Scale
• If the output rate is more than the optimal level, increasing the
output rate results in increasing average per unit costs
• Reasons for diseconomies of scale
• Distribution costs increase due to traffic congestion and shipping
from a centralized facility rather than multiple smaller facilities
• Complexity increases costs
• Inflexibility can be an issue
• Additional levels of bureaucracy

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Facility Size and Optimal Operating Level
Minimum cost & optimal operating rate are
functions of size of production unit.

Average cost per unit

Small
plant Medium
plant
Large
plant

Output rate

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Constraint Management
• Constraint
• Something that limits the performance of a process or system in
achieving its goals
• Categories
• Market
• Resource
• Material
• Financial
• Knowledge or competency
• Policy

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Resolving Constraint Issues

1. Identify the most pressing constraint

2. Change the operation to achieve maximum benefit, given the constraint
3. Make sure other portions of the process are supportive of the constraint
4. Explore and evaluate ways to overcome the constraint
5. Repeat the process until the constraint levels are at acceptable levels

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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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Evaluating Alternatives
• Techniques for Evaluating Alternatives
• Cost-volume analysis
• Financial analysis
• Decision theory
• Waiting-line analysis
• Simulation

41
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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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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Cost-Volume Relationships

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Cost-Volume Relationships

• Capacity alternatives may involve step costs, which

are costs that increase stepwise as potential
volume increases.
• The implication of such a situation is the possible
occurrence of multiple break-even quantities.
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Break-Even Problem with Step Fixed
Costs

= TC
C
FC +V

= TC
VC
FC +
3 machines
= TC
C
+V 2 machines
FC

1 machine
Quantity
Step fixed costs and variable costs.
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Cost-Volume Analysis
• FC = Fixed cost
• VC = Total Variable Cost
• v = Variable cost per unit
• TC = Total cost
• TR = Total revenue
• R = Revenue per unit
• Q = Quantity
• QBEP = Breakeven Quantity
• P = Profit
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Cost-Volume Analysis
• TC = FC + VC
• VC = v x Q
• TR = R x Q
• P = TR – TC
• P = R x Q – (FC + v x Q)
• P = Q(R – v) – FC
• Q = (P + FC) / (R - v)
• QBEP = FC / (R – v)

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Cost-Volume Analysis Example 1

Given FC = ₹6,000; VC = ₹2 / unit;

Revenue = ₹7 / unit
Q1 : Breakeven point?
QBEP = FC / (R – v) = 6000 / (7-2) = 1,200 units

Q2 : What is the profit if 1,000 units are sold?

P = Q(R – v) – FC = 1,000(7-2)-6,000 = -1,000

Q3: How many units must be sold to realize a profit

of ₹4,000?
Q = (P + FC) / (R - v) = (4,000+6,000)/(7-2)
Q = 2,000 units
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 Cost-Volume Analysis Example 2

• Given the following costs for a make or buy decision:

Make Buy
Annual fixed cost ₹150,000 None
Variable cost/unit ₹60 ₹80

Q1: For an annual volume of 12,000, should we make

or buy?
TCmake = 150,000 + 60 x 12,000 = ₹870,000
TCbuy = 80 x 12,000 = ₹960,000
Decision: make 50
Cost-Volume Analysis Example 2

Q2: Determine the volume at which the two choices

would be equivalent.
TCmake = 150,000 + 60 x Q
TCbuy = 80 x Q
TCmake = TCbuy
150,000 + 60Q = 80Q
Q = 7,500 units

Q3: Over what range of volume the “buy” decision is

preferred?
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Cost-Volume Analysis Example 3

• Alternatives: Buy 1, 2 or 3 machines:

# of Fixed Output
Machines Costs Range
1 $ 9,600 0-300
2 $ 15,000 301-600
3 $ 20,000 601-900
Variable cost is ₹10; revenue is ₹40 per unit
Q1: Determine QBEP for each output range.

1: QBEP = 9600/(40-10) = 320 > 300 not BEP

2: QBEP = 15000/(40-10) = 500 units
3: QBEP = 20000/(40-10) = 666.67 52
Cost-Volume Analysis Example 3
• If projected annual demand is between 580 and 660
units, how many machines should the manager
purchase?

• Answer: 2 machines (why?)

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Break-Even Problem with Step Fixed Costs

₹
BEP
3
TC
BEP 2
TC
3
TC
2
TR 1
Quantity
Multiple break-even points
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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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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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Operations 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 organization’s 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
• Capacity disposal strategies become important under these
conditions

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References

Essential Reading
• Stevenson, William J. (2015) Operations Management, 11th Edition,
Mc Graw Hill Education
Recommended Reading
• Kumar, S. A., & Suresh, N. (2008) Operations Management, 2nd
edition. New Age International Publishers
Magazines and Journals
• Operations Research/Management Science Today
• International Journal of Operational Research, Inderscience Publishers
Websites
• https://harvardmagazine.com/tags/quantitative-methods
• https://sloanreview.mit.edu/
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Disclaimer

• All data and content provided in this presentation are

taken from the reference books, internet – websites
and links, for informational purposes only.

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