Chapter Eight

Capacity planning

Learning objectives
 Define the term ‘capacity’
 Understand the importance of capacity for the success of an organization
 Discuss the manner in which capacity can be implemented
 Understand the critical capacity decisions
 Understand the considerations that must be taken into account when capacity
is determined
 Understand the necessity for capacity measurement
 Compute effectiveness, utilization, and capacity loads
 Establish effective capacity
 Strategize capacity
 Discuss capacity needs predictions
 Understand constraints on capacity and how to manage them
 Develop alternative capacity plans

8.1 Introduction

 Capacity =
- Highest possible perimeter/highest yield value of a specific operation,
process or system, articulated in definite unit of time, when the said
operating, process or system is operating within an ideal environment
 Capacity is never constant, it changes according to demand. Capacity
planning is part of the strategic planning effort of every organization.
 Intimately related to demand: The airline kulula.com must determine the
capacity of its aircraft to guarantee that enough capacity (seats) will be
available per flight to satisfy the demand.
 NB questions to be addressed with capacity is planned
o What is the amount of capacity required?
o What facilities, equipment, machines and labour will be part of the
planned capacity: Volkswagen SA must ensure that there will be
enough material, labour, equipment and machines available to produce
the number of vehicles demanded by the customers
o Does the organisation predict any changes in existing demand patterns
o Should the organisation erect new facilities to meet demand?
o When will the organisation require the capacity

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 8.2 Economies and Diseconomies of Scales

 An increase in the size of the production unit or volume would result in a

higher utilization of resources.
 Reasons:
o Learning by employees : It is a known fact that the more often an
employee does the task, the more proficient that employee will
become in completing the task
o Fixed cost allocations: Fixed cost can be defined as the costs that
are incurred during the production process that are not influenced
by the volume of the product manufactured. That can include
machinery depreciation insurance premiums and other indirect
costs.
o Purchasing cost will decrease: Most organizations are willing to
offer organizations substantial discounts for larger order quantities
of raw material.
o Cost incurred for enlarging facilities: the costs incurred during the
enlargement of facilities do not increase dramatically id the size of
the facility increases.

8.3 Critical capacity decisions

 To modify and utilize capacity optimally.

 Time horizons of decisions
o Long term – longer than one year: procurement of assets required
(long term assets like machinery, buildings, equipment etc.)
o Medium term - quarterly or monthly basis: time horizon of this
planning can be between 6 to 18 months.
o Short term – 1 day to 30 days: the decisions mostly influence then
scheduling of work within the production unit. The major purpose of
this type of capacity planning is to reduce the variance between the
planned and actual output

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Figure 8.1: Critical capacity decisions-making interaction

Capacity adaption

-
Short term Long term Medium term
-
No planning possible Build new facilities Subcontracting
-
Buy new machines Small equipment
Buy new equipment Add/remove shifts

Capacity

- Long term Medium term Short term

No planning
- possible Increase labour Job scheduling
Utilize inventory Labour scheduling
Chase/even production Machine scheduling
rates Equipment schedules

Capacity utilization

The following factors must be taken into account when the critical capacity decision
are made:

 Capacity decisions have a major bearing on the financial performance.

 The availability of capacity will affect the production of an organization.
 The management of an organization will be direct Influenced by available
capacity management.
 Capacity decisions requires long-term commitment of scarce resources.
 Capacity decisions are Influence ability to meet demand for goods and
services
 The availability of capacity will determine the competitiveness of an
organization.

8.4 Capacity measurement

 To prepare capacity successfully managers have to figure out how to compute

it. The blame for unsuccessful functioning of the organization can mostly be
ascribed to capacity problems the organization experiences.

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Table 8.1: Capacity measures per industry type

ORGANISATION INPUTS OUTPUTS

Restaurant (Spur, Wimpy) 1. Number of tables Quantity of customers

2. Number of served per day
customers seated
3. Kitchen capacity
4. Labour capacity

Vehicle manufacturers 1. Worker hours Number of vehicles

2. Machine hours produced per unit.
3. Size of facility

 Types:
- Design capacity: It is assumed that a well-designed operation process or
system will have a predetermined measure of capacity available to
achieve its goal
- Effective capacity: Described as the possible capacity that an
organization can anticipate if all the existing constrains under which the
organization is operating are taken into account.
- Actual capacity: actual capacity available within an organization.
Available 2000 hours available per week
- Output capacity: Only one service or product is produced where a single
product capacity will be measured.
- Input capacity: measurement is utilized by low volume, flexible processes
such as customized products.
 Measuring effectiveness, efficiency and load of capacity: the effectiveness
and efficiency of capacity can be measured as well using a number of
available methodologies.
 Efficiency: is the ratio of production output to effective capacity.
 Worked examples;

EXAMPLE:
The workshop of a Volkswagen dealership would like to compute the
efficiency ratio and the utilisation ratio for the workshop. The workshop
manager has gathered the following information;
Design capacity of the workshop is 80 cars
Effective capacity of the workshop is 70 cars
Actual service rate is 66cars for the past week.

• Compute the efficiency ratio of the workshop

• Compute the utilisation rate of the work shop

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 • Efficiency = AC (actual capacity)

EC (effective capacity)

= 66 = 94.2%

70

• Utilisation = AC (actual capacity)

DC (design capacity)

= 66 = 82.50%

80

8.5 Establishing capacity

 Facility issues: If a facility is poorly designed the effective capacity suffers as

a result.
 Goods and services issues: the design of goods and services establishes the
amount of capacity it will require. The more elaborate the design of the
operation, process or system, the more effective capacity it will consume.
 Process issues: The capabilities of the process to deal with the manufacturing
quantities determine effective capacity.
 Employee issues: The job content of the jobs that employees must do
determines the consumption of effective capacity. The more difficult the job,
the more effective capacity will be consumed.
 Operational issues: The effective scheduling of work reduces the consumption
of effective capacity. Inventory management has an impact- readily available
inventory consumers.

8.6 Strategy formulation for capacity planning

 Capacity planning cannot be a success if it not linked to organizational vision,

mission & capital
 Four important capacity decisions that must be taken into account:
- The importance of maintaining a balance throughout the system
- Flexibility of the system and the employees who operate within that system
- Changes taking place within the system and the timing of these changes
- Capacity requirements throughout system

Spare capacity = Capacity - utilization

8.7 Capacity needs prediction

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  Long and short term influences must be taken into account when capacity
plan are considered.
 Most important determinant is the future demand expected

Table 8.2: The variation in time horizon

TIME ORGANISATION AND PRODUCT

Yearly  SAB miller – beer

 Kulula.com – airline
 Eskom – power generation

Monthly  Standard Bank – transaction on

customer accounts

Weekly  Spar - sales

 JHB Metro Police - volume of
traffic

Daily  Telkom – calls by customers

 Universities – classroom
utilization

8.8 Constraint management

 Theory of constraints (TOC)

- Theory of constraints approach
- Five steps of TOC:
o Identify every constraint – what obstacles to face
o Exploit – as soon as obstacle has been identified, strategies must
be expounded to conquer them
o Subordinate – the available assets must be clustered around the
expounded strategies to eliminate the constraint
o Elevate – the capacity of a system or process must be increased
o Repeat – when the constraint has been eliminated, the process has
been repeated to attack another constrain.
 Constrains can be tangible or non-tangible
 TOC tries to increase the throughput while at the same time reducing
inventory and operation expenses. Low throughput rate will result in low
profitability.
 Most important barriers to the implementation of TOC methodology are:
o Management are focused on a less important and tertiary level
o Prescribed and unofficial procedures of an organization are never
addressed

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 o The management concepts common in an organisation are neglected
o The principles of the organisation are ignored.
 Drum, Buffer and Rome (DBR)
o Capacity constrained resources would be the root of bottlenecks in the
production system. A bottleneck occurs at a machine or operation in
the where the throughput level is lower than at the preceding
machines operations.

8.9 Developing alternative capacity plans

Guaranteeing sufficient capacity is not an easy task. The most important factor to
take into account is the economic impact that the capacity plan will have on the
organisation. The following are questions that must be considered before a decision
can be taken on a capacity plan:

 Which option will be the most economical and realistic?

 What will the cost of the capacity plan be?
 What is the lead time in which the option will be available?
 Will the plan be well suited to the current operations within the organisations?

A number of methodologies are available to evaluate all the options available. The
methodology used most often is the break-even analysis. This methodology
computes a point at which income (revenue) and cost are equal. This can be in
monetary value or units produced. This point is known as the break-even point. At
this point the organisation will not earn a profit earned but neither will it incur a loss.

 Break-even analysis
 Fixed costs (FC)
 Variable costs (VC)
 Selling price (SP)
 Profit/Loss
 Units

Total costs
Total income

Profit
Variable costs
R- Cost

Break-even point

Loss Fixed costs

Levels of activity

Total income (TI) = Total cost (TC)

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EXAMPLES:

Measuring effectiveness, efficiency and load of capacity :

• Capacity efficiency is the ratio of production output to effective capacity. It is a

measure of effective management in utilising effective capacity, It is
calculated using the following formula:

AC = actual capacity

EC = Efficiency capacity

DC = Designed capacity

The workshop of a Volkswagen dealership would like to compute the efficiency ratio
and utilisation ratio for the workshop. The workshop manager has gathered the
following information. Designed capacity of the workshop is 80 cars. Effective
capacity of the workshop is 70 cars. Actual service rate is 66 cars for the past week.

Efficiency = AC = 66 = 94.2% Utilisation = AC = 66 = 82.5%

EC 70 DC 80

Capacity planning:

• Calculation of lead time to service a backlog can be calculated as follows:

• LT = BL LT = Lead time / BL = Back log / C = Capacity

The computation will indicate the time it would take until the last customer in the
operation, process or system is served. Let us illustrate this by means of the
following example:

Calculate how long it will take to serve the customers if the backlog is 10 customers
with a capacity to serve 20 customers per hour.

LT = BL = 10 = 0.5 hours It will take a half an hour to serve

C 20 customers that form part of the

backlog in the system.

Break-even point is computed as:

• Total income (TI) = Total cost (TC) (meaning no profit no loss)

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 • The formula for calculating the break-even point is the following:

P*X = FC + VC*X

P = Price per unit

X = Quantity produced

TI = Total income P*X (Price times quantity produced)

TC = Total cost

FC = Fixed cost

VC = Variable cost

• The business is baking home-made pies which are distributed to local

home industries, supermarkets and convenient stores. Your annual
fixed cost is R10000 and the direct labour is R3.50 per pie. The
materials consumed per pie are R4.50. Your pies are selling for R12.50
each. You are required to do the following:

• Compute the monetary break-even point

• Compute the unit break-even point

• Monetary break-even point MBEPR = FC

1 – VC

= 10 000

1- 8

12.50

= 10 000

1 - 0.64

= 27 777.78

This means that you will have to sell pies to the value of R27 777.80 to cover
all your costs without earning a profit.

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Compute the break-even point: UBEPX = FC

P – VC

= 10 000

12.50 – 8.00

= 10 000

4.50

= 2 222.22

= 2 222 pies

You will to sell 2 222 pies to break even. Every pie after this will contribute
towards profit.

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