1. Production and Operations Management
Capacity Planning
For Products and Services

2. Learning Objectives Explain the importance of capacity planning.
Discuss ways of defining and measuring capacity.
Describe the determinants of effective capacity.
Discuss the major considerations related to developing capacity alternatives.
Briefly describe approaches that are useful for evaluating capacity alternatives

3. Introduction
Capacity is the upper limit or ceiling on the load that an operating unit can handle.
Capacity also includes
Equipment
Space
Employee skills
The basic questions in capacity handling are:
What kind of capacity is needed?
How much is needed?
When is it needed?

4. Importance of Capacity Decisions
Impacts ability to meet future demands
Affects operating costs
Major determinant of initial costs
Involves long-term commitment
Affects competitiveness
Affects ease of management
Globalization adds complexity
Impacts long range planning

5. 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

6. Defining and Measuring Capacity -- Efficiency and Utilization
Actual output
Efficiency =
Effective capacity
Utilization =
Design capacity
Both measures expressed as percentages

7. Example 1 Design capacity = 50 trucks/day
Effective capacity = 40 trucks/day
Actual output = 36 units/day
Actual output units/day
Efficiency = = = 90%
Effective capacity units/ day
Utilization = Actual output units/day
= = 72% Design capacity units/day

8. Determinants of Effective Capacity
Facilities
Product and service factors
Process factors
Human factors
Policy factors
Operational factors
Supply chain factors
External factors

9. Strategy Formulation Capacity strategy for long-term demand
Demand patterns
Growth rate and variability
Facilities
Cost of building and operating
Technological changes
Rate and direction of technology changes
Behavior of competitors
Availability of capital and other inputs

10. Strategy Formulation -- Key Decisions of Capacity Planning
Amount of capacity needed
Capacity cushion (100% - Utilization)
Timing of changes
Need to maintain balance
Extent of flexibility of facilities
Capacity cushion – extra demand intended to offset uncertainty

11. Strategy Formulation -- Steps for Capacity Planning
Estimate future capacity requirements
Evaluate existing capacity
Identify alternatives
Conduct financial analysis
Assess key qualitative issues
Select one alternative
Implement alternative chosen
Monitor results

12. Forecasting Capacity Requirements
Long-term vs. short-term capacity needs
Long-term relates to overall level of capacity such as facility size, trends, and cycles
Short-term relates to variations from seasonal, random, and irregular fluctuations in demand

13. Forecasting Capacity Requirements -- Calculating Processing Requirements (Example 2)
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

14. Planning Service Capacity
Need to be near customers
Capacity and location are closely tied
Inability to store services
Capacity must be matched with timing of demand
Degree of volatility of demand
Peak demand periods

15. In-House or Outsourcing  Make or Buy?
Outsource: obtain a good or service from an external provider
Available capacity
Expertise
Quality considerations
Nature of demand
Cost
Risk

16. Developing Capacity Alternatives
Design flexibility into systems
Take stage of life cycle into account
Take a “big picture” approach to capacity changes
Bottleneck operations
Prepare to deal with capacity “chunks”
Attempt to smooth out capacity requirements
Identify the optimal operating level

17. Developing Capacity Alternatives -- Bottleneck Operation
Bottleneck operation: An operation in a sequence of operations whose capacity is lower than that of the other operations
Bottleneck
Operation
Machine #1
Machine #3
Machine #4
10/hr
30/hr
Machine #2

18. Developing Capacity Alternatives -- Bottleneck Operation
Operation 1 20/hr.
Operation 2 10/hr.
Operation 3 15/hr.
10/hr.
Maximum output rate limited by bottleneck

19. Developing Capacity Alternatives -- Economies of Scale
If the output rate is less than the optimal level, increasing output rate results in decreasing average unit costs
Diseconomies of scale
If the output rate is more than the optimal level, increasing the output rate results in increasing average unit costs

20. Developing Capacity Alternatives -- Optimal Rate of Output
Production units have an optimal rate of output for minimal cost.
Minimum average cost per unit
Average cost per unit
Minimum
cost
Rate of output

21. Developing Capacity Alternatives -- Economies of Scale
Minimum cost & optimal operating rate are
functions of size of production unit.
Small
plant
Average cost per unit
Medium
plant
Large
plant
Output rate

22. Evaluating Alternatives
Cost-volume analysis
Break-even point (BEP)
Financial analysis
Cash flow
Present value
Decision theory
Waiting-line analysis
Simulation

23. Cost–Volume Relationships
Amount ($)
Q (volume in units)
Total cost = VC + FC
Total variable cost (VC)
Fixed cost (FC)

24. Cost–Volume Relationships
Amount ($)
Q (volume in units)
Total revenue

25. Cost–Volume Relationships
Amount ($)
Q (volume in units)
BEP units
Profit
Total revenue
Total cost

26. Break-Even Problem with Step Fixed Costs
FC + VC = TC
FC + VC = TC
3 machines
FC + VC = TC
2 machines
1 machine
Quantity
Step fixed costs and variable costs

27. Break-Even Problem with Step Fixed Costs$ TC
BEP 2 3 TR
Quantity 1
Multiple break-even points

28. Assumptions of Cost–Volume Analysis
One product is involved
Everything produced can be sold
Variable cost per unit is the same regardless of volume
Fixed costs do not change with volume
Revenue per unit is constant with volume
Revenue per unit exceeds variable cost per unit

29. 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 flows of an investment proposal.

30. Decision Theory
Helpful tool for financial comparison of alternatives under conditions of risk or uncertainty
Suited to capacity decisions