STRATEGIC

CAPACITY
MANAGEMENT

Chapter Five
McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objectives
 LO5–1: Explain what capacity management is and
why it is strategically important.
 LO5–2: Exemplify how to plan capacity.
 LO5–3: Evaluate capacity alternatives using
decision trees.
 LO5–4: Compare capacity planning in services to
capacity planning in manufacturing

5-2
 Economies of Scale Made of Steel

 The Economics of Very Big Ships

 Economy of Container Ships
 Allows a T-shirt made in China to be sent to
the Netherlands for just 2.5 cents.
 The Eleonora Maersk and the other seven ships
in her class are among the largest ever built:
 Almost 400 m long, or the length of four soccer
fields, and another half-field across.
 The ships can carry 7,500 or so 40-foot
containers, each of which can hold 70,000 T-
shirts.
 On this voyage, the Eleonora was carrying supplies
for Europe’s New Year celebrations: 1,850 tons of
fireworks, including 30 tons of gunpowder.

5-3
 Capacity Management in Operations

 Capacity – the ability to hold, receive, store, or accommodate

 In business, viewed as the amount of output that a system is capable of achieving
over a specific period of time
 Capacity management needs to consider both inputs and outputs

5-4
 Capacity Planning Time Durations

Long range Long-range Add facilities

• Greater than one year

planning Add long lead time equipment
*
Intermediate Subcontract Add personnel
Intermediate range -range Add equipment Build or use inventory
planning Add shifts
• Monthly or quarterly plans
covering the next 6 to 18 months
Schedule jobs
Short-range Schedule personnel
Short range planning
* Allocate machinery

• Less than one month

Modify capacity Use capacity

* Limited options exist 5-5

Capacity and Strategy

 Capacity decisions impact all

decisions of operations management
as well as other functional areas of the
organization
 Capacity decisions must be integrated
into the organization’s mission and
strategy
Strategic Capacity Planning
 Determining the overall level of capacity-
intensive resources that best supports the
company’s long-range competitive
strategy
 Facilities
 Equipment
 Labor force size

5-7
 Capacity Planning Concepts
 Capacity utilization rate – a measure of how
close the firm is to its best possible operating
level
 Economies of scale – the idea that as a planet
gets larger and volume increases, the average
cost per unit tends to drop
 Diseconomies of scale – at some point, the
plant becomes too large and average cost per
unit begins to increase
Jaguar, the luxury automobile
producer, recently found it had
too many plants. Jaguar was
employing 8,560 workers in three
plants that produced 126,122 cars,
about 15 cars per employee.
Volvo’s plant in Torslanda, Sweden,
was nearly twice as productive,
building 158,466 cars with 5,472
workers, or 29 cars per employee.
By contrast, BMW AG’s Mini unit
made 174,000 vehicles at a single
British plant with just 4,500 workers,
or 39 cars per employe
5-8
Utilization and Efficiency

5-9
Bakery Example

Actual production last week = 148,000 rolls

Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Utilization = 148,000/201,600 = 73.4%

Efficiency = 148,000/175,000 = 84.6%

5-10
Economies of Scale – Diseconomies of Scale

(dollars per room per night) 25 - room

Average unit cost

roadside motel
75 - room
50 - room roadside motel
roadside motel

Economies Diseconomies
of scale of scale
25 50 75
Number of Rooms
5-11
 Capacity Planning Concepts

 Capacity focus – the idea

that a production facility
works best when it is
concentrated on a limited
set of production
objectives
 Focused factory or plant
within a plant (PWP)
concept

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 Capacity Flexibility

 Capacity flexibility – the Flexible • Ability to quickly adapt to change

ability to rapidly increase or
decrease product levels or
the ability to shift rapidly
from one product or service
to another
 Comes from the plant,
processes, and workers or from
strategies that use the capacity
of other organizations
• Zero-changeover time
Plants
Flexible • Flexible manufacturing systems
• Simple, easily set up equipment
Processes
• Ability to switch from one kind of
Flexible task to another quickly
Workers • Multiple skills (cross training)

5-13
 Considerations in Changing Capacity

Maintaining System Balance Frequent versus Infrequent

• Similar capacities desired at each Capacity Expansions
operation
• Manage bottleneck operations
Frequency of Capacity
Additions
• Cost of upgrading too frequently
• Cost of upgrading too infrequently
External Sources of Capacity
• Outsourcing
• Sharing capacity
Decreasing Capacity
• Temporary reductions
• Permanent reductions

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BASIC CAPACITY EXPANSION
STRATEGIES
(a) Leading demand with (b) Leading demand with
incremental expansion one-step expansion
New New
capacity capacity

Demand

Demand
Expected Expected
demand demand

(c) Capacity lags demand with (d) Attempts to have an average

incremental expansion capacity with incremental
New
expansion
capacity New
Demand

Demand
Expected capacity Expected
demand demand

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Managing Demand

 Demand exceeds capacity

 Curtail demand by raising prices, scheduling
longer lead time
 Long term solution is to increase capacity
 Capacity exceeds demand
 Stimulate market
 Product changes
 Adjusting to seasonal demands
 Produce products with complementary
demand patterns
Complementary Demand Patterns

4,000 –
Sales in units

3,000 –

2,000 –
Jet ski
1,000 – engine
sales

JFMAMJJASONDJFMAMJJASONDJ
Time (months)
Figure S7.3
Complementary Demand Patterns

4,000 –
Sales in units

Snowmobile
3,000 – motor sales

2,000 –
Jet ski
1,000 – engine
sales

JFMAMJJASONDJFMAMJJASONDJ
Time (months)
Figure S7.3
Complementary Demand Patterns

Combining both
demand patterns
reduces the
variation
4,000 –
Sales in units

Snowmobile
3,000 – motor sales

2,000 –
Jet ski
1,000 – engine
sales

JFMAMJJASONDJFMAMJJASONDJ
Time (months)
Figure S7.3
Tactics for Matching Capacity to
Demand

1. Making staffing changes

2. Adjusting equipment
 Purchasing additional machinery
 Selling or leasing out existing equipment
3. Improving processes to increase throughput
4. Redesigning products to facilitate more
throughput
5. Adding process flexibility to meet changing
product preferences
6. Closing facilities
Determining Capacity
Requirements

Project labor and

Use forecasting Calculate labor
equipment
to predict sales and equipment
availability over
for individual requirements to
the planning
products meet forecasts
horizon

5-21
Example 5.1—Determining Capacity Requirements

 Stewart Company produces two flavors of salad

dressing.
 Paul’s and Newman’s
 Each is available in bottles and single-serving bags.
 What are the capacity and labor requirements for
the next five years?

5-22
Determining Capacity
Requirements
Step 1: Use forecasting to predict Year
sales for individual products 1 2 3 4 5
Bottles (000s) 60 100 150 200 250
Paul’s
Plastic bags (000s) 100 200 300 400 500
Bottles (000s) 75 85 95 97 98
Newman’s
Plastic bags (000s) 200 400 600 650 680

5-23
Determining Capacity Requirements
Step 2: Calculate equipment and Year
labor requirements 1 2 3 4 5
Bottles (000s) 135 185 245 297 348
Plastic bags (000s) 300 600 900 1050 1180

Bottling Operation Bagging Operation

 

5-24
Determining Capacity
Requirements
Step 3: Project equipment and Year
labor availabilities 1 2 3 4 5
Percentage capacity 24 48 72 84 94
utilized
Plastic Bag
Operation Machine requirement 1.2 2.4 3.6 4.2 4.7
Labor requirement 3.6 7.2 10.8 12.6 14.1
Percentage capacity 30 41 54 66 77
utilized
Bottle
Operation Machine requirement 0.9 1.23 1.62 1.98 2.31
Labor requirement 1.8 2.46 3.24 3.96 4.62

Excel: Capacity Re
quirements 5-25
Decision Trees for Capacity Analysis

 A decision tree is a schematic model of the

sequence of steps in a problem – including the
conditions and consequences of each step.
 Decision trees help analysts understand the
problem and assist in identifying the best solution.
 Decision tree components include the following:
 Decision nodes – represented with squares
 Chance nodes – represented with circles
 Paths – links between nodes

5-26
Example 5.2: Decision Trees
 The owner of Hackers Computer Store is evaluating three
options – expand at current site, expand to a new site, do
nothing.
 The decision process includes the following assumptions
and conditions.
 Strong growth has a 55% probability
 New site cost is $210,000
 Payoffs: strong growth = $195,000; weak growth = $115,000
 Expanding current site cost is $87,000 (in either year 1 or 2)
 Payoffs: strong growth = $190,000; weak growth = $100,000
 Do nothing
 Payoffs: strong growth = $170,000; weak growth = $105,000

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Example 5.2: Decision Trees
 Calculate the value of each alternative

5-28
Example 5.2: Decision Trees
 Diagram the problem chronologically
Events

Decision
Decision

5-29
Example 5.2: Decision Trees
 Calculate value of each branch
$765,000

$365,000

$863,000

$413,000

$843,000

$850,000

$525,000

5-30
 Example 5.2
 Work backwards to calculate the value of each decision/event

$765,000

$365,000
Do nothing has higher
value than expand, so
$660,500 choose to$863,000
do nothing
$413,000
Do nothing = $703,750
$843,000
Do nothing has higher Do nothing = $850,000
$703,750
value than expand or $850,000
move, so choose to do
nothing $525,000

5-31
Example 5.2: Decision Trees
 Decision tree analysis with net present value
calculations

Excel: Decision Tr
ees

5-32
Break-Even Analysis
 Defined as standard approach to choosing among
alternative processes or equipment.
 Model seeks to determine the point in units produced where
a company will start making profit on the process.
 Model seeks to determine the point in units produced where
total revenue and total cost are equal.
Purchase cost of process or equipment
Breakeven Demand 
Price per unit - Cost per unit
or
Total fixed costs of process or equipment

Unit price to customer - Variable cost per unit

7-33
Example 7.1: Break-Even Analysis
 Buy for $200
 Make on lathe for $75
 Make on machining center for $15
 Buy has no fixed costs
 Lathe has $80,000 fixed costs
 Machining center has $200,000 fixed costs

7-34
Example 7.1: Total Cost for Each Option

 Purchase
Cost = $200 x Demand

 Produce Using Lathe

Cost = $80,000 + $75 x Demand

 Produce Using Machining Center

Cost = $200,000 + $15 x Demand

7-35
Example 7.1: Costs Shown Graphically

7-36
Example 7.1:Finding Points A and B
Point A
$80,000  $75  Demand  $200,000  $15  Demand
$80,000  $60  Demand  $200,000
$60  Demand  $120,000
Demand  $120,000  2,000
$60

Point B
$200  Demand  $80,000  $75  Demand
$125  Demand  $80,000
Demand  $80,000  640
$125 7-37
Demand and Capacity Management in the Service Sector

 Demand management
 Appointment, reservations, FCFS rule
 Capacity
management
 Full time,
temporary,
part-time
staff
Planning Service Capacity

Manufacturing
Service Capacity
Capacity
Capacity must be available
Goods can be stored for later
when service is needed –
use.
cannot be stored.

Goods can be shipped to Service must be available at

other locations. customer demand point.

Volatility of demand is Much higher volatility is

relatively low. typical.

5-39
Capacity Utilization and Service Quality

 The relationship between service capacity utilization

and service quality is critical.
 Utilization is measured by the portion of time servers are
busy.
 Optimal levels of utilization are context specific.
 Low rates are appropriate when the degree of uncertainty
(in demand) is high and/or the stakes are high (e.g.,
emergency rooms, fire departments).
 Higher rates are possible for predictable services or those
without extensive customer contact (e.g., commuter trains,
postal sorting).
5-40