1. Strategic Capacity Planning for Products and Services
Chapter 5

2. Learning Objectives: You should be able to:
Summarize 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
Instructor Slides

3. Capacity Planning Capacity
The upper limit or ceiling on the load that an operating unit can handle (rate of output)
Dollar amounts are not good measure (why?)
Capacity needs include:
Equipment
Space
Employee skills
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4. Strategic Capacity Planning
Goal:
To achieve a match between the long-term supply capabilities and the predicted level of long-term demand
Overcapacity
operating costs that are too high
Undercapacity
strained resources and possible loss of customers
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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 that need to be addressed?
Should capacity be changed all at once, or through several smaller changes?
Can the supply chain handle the necessary changes?
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6. Capacity Decisions Are Strategic
impact the ability of the organization to meet future demands
affect operating costs
are a major determinant of initial cost
often involve long-term commitment of resources
can affect competitiveness (influence delivery speed)
affect the ease of management
have become more important and complex due to globalization
need to be planned for in advance due to their consumption of financial and other resources
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7. Capacity Design capacity Effective capacity Actual output
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, scrap etc.
Actual output
Rate of output actually achieved—cannot exceed effective capacity.
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8. Measuring System Effectiveness
Efficiency
Measured as percentages
Utilization
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9. Example– Efficiency and Utilization
Design Capacity = 50 trucks per day
Effective Capacity = 40 trucks per day
Actual Output = 36 trucks per day
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10. Determinants of Effective Capacity
Facilities
Size, expansions, layout, transportation costs, distance to market, labor supply, energy sources
Product and service factors
Uniformity of output, product/service mix
Process factors
Productivity, quality, setup-time
Human factors
Tasks, variety of activities, training, skills, learning, experience, motivation, labor turnover
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11. Determinants of Effective Capacity
Policy factors
Overtime, second/third shifts
Operational factors
Scheduling, inventory, purchasing, materials, quality assurance/control, breakdowns, maintenance
Supply chain factors
Impact of capacity change on suppliers, warehousing, transportation, distributors
External factors
Product standards, minimum quality, safety, environment, regulations, unions
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12. Capacity Strategies Three primary capacity strategies: Leading:
build capacity in anticipation of future demand increase (when capacity increase has long lead time).
Following:
build capacity when demand exceed current capacity.
Tracking:
similar to Following but in relatively small increments.
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13. Capacity Cushion Capacity Cushion
Extra capacity used to offset demand uncertainty
Capacity cushion = Capacity – expected demand
Capacity cushion strategy
Organizations that have greater demand uncertainty typically use greater capacity cushion
Organizations that have standard products and services generally use smaller capacity cushion
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14. Calculating Processing Requirements
Calculating processing requirements requires:
reasonably accurate demand forecasts,
standard processing times
available work time
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15. Calculating Processing Requirements
If annual capacity is 2,000 hours, then
# machines required = 5,800 hours/2,000 hours = >3 machines

16. 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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17. 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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18. Evaluating Alternatives
Techniques for Evaluating Alternatives
Cost-volume analysis
Break-even point
Financial analysis
Cash flow
Present value
Decision theory
Comparison of alternatives under risk and uncertainty.
Waiting-line analysis
Balance waiting cost and increased capacity cost
Simulation
Evaluate “what-if” scenarios
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19. 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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20. 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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21. Break-Even Point (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
0 = QBEP(R – v) – FC
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22. Cost-Volume Relationships
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23. Indifference Point (Profit) Two (multiple) Alternatives
The quantity at which a decision maker would be indifferent between two competing alternatives
Choose A
Choose B

24. Example - Indifference Point (Cost)
A manufacturer has 3 options:
Use process A with FC=$80,000 and VC=$75/unit
Use process B with FC=$200,000 and VC=$15/unit
Purchase for $200/units
80,000+75Q=200Q
QPA=640 units
80,000+75Q=200,000+15Q
QAB=2,000 units
Choose lowest cost:
0-640 units : Purchase
640-2,000 units: Process A
Above 2,000 units: Process B

25. Production units have an optimal rate of output for minimal cost.
Minimum
cost
Average cost per unit
Rate of output
Diseconomies of Scale
If the output rate is more than the optimal level, increasing the output rate results in increasing average per unit costs
Economies of Scale
If output rate is less than the optimal level, increasing the output rate results in decreasing average per unit costs
Minimum average cost per unit

26. 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
Processing costs decrease due to standardization
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27. 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
congestion (transportation)
Complexity
Inflexibility
Additional levels of bureaucracy
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