Capacity Planning for

Products and Services

Capacity Planning

Capacity is the upper limit or ceiling on the load

that an operating unit can handle.

The basic questions in capacity handling are:

What kind of capacity is needed?

How much is needed?

When is it needed?
Importance of Capacity Decisions

1. Impacts ability to meet future demands

2. Affects operating costs
3. Major determinant of initial costs
4. Involves long-term commitment
5. Affects competitiveness
6. Affects ease of management
7. Globalization adds complexity
8. Impacts long range planning
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.
Efficiency and Utilization

Actual output
Efficiency =
Effective capacity

Actual output
Utilization =
Design capacity

Both measures expressed as percentages

Efficiency/Utilization Example

Design capacity = 50 trucks/day

Effective capacity = 40 trucks/day
Actual output = 36 units/day

Actual output = 36 units/day

Efficiency = =
90%
Effective capacity 40 units/ day

Utilization = Actual output = 36 units/day

=
72% Design capacity 50 units/day
Determinants of Effective Capacity

Facilities
Product and service factors
Process factors
Human factors
Operational factors
Supply chain factors
External factors
Strategy Formulation

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
 Key Decisions of Capacity Planning

1. Amount of capacity needed

2. Timing of changes
3. The Need to maintain balance
4. Extent of flexibility of facilities

Capacity cushion
– extra demand intended to offset uncertainty
Steps for Capacity Planning

1. Estimate future capacity requirements

2. Evaluate existing capacity
3. Identify alternatives
4. Conduct financial analysis
5. Assess key qualitative issues
6. Select one alternative
7. Implement alternative chosen
8. Monitor results
Make or Buy?

1. Available capacity
2. Expertise
3. Quality considerations
4. Nature of demand
5. Cost
6. Risk

Outsourcing: obtain a good or service from an

external provider.
Things to keep in mind when planning capacity

1. Design flexibility into systems

2. Take stage of life cycle into account

3. Take a “big picture” approach to capacity

changes
4. Prepare to deal with capacity “chunks”
5. Attempt to smooth out capacity
requirements
6. Identify the optimal operating level
Economies of Scale

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
Economies of Scale

Production units have an optimal rate of output for minimal cost.

Average cost per unit

Minimum average cost per unit

Minimum
cost

0 Rate of output
Economies of Scale

Minimum cost & optimal operating rate are

functions of size of production unit.
Average cost per unit

Small
plant Medium
plant Large
plant

0 Output rate
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
 Cost-Volume Relationships

FC
Amount ($) +
VC
t = C )
os (V
l c st
ota co
T b le
r ia
Va
Fixed cost (FC)

0
Q (Quantity in units)
Total cost (TC) = Fixed cost (FC) + Variable cost (VC)
= Fixed cost (FC) + Unit cost (v) X Quantity
(Q)
 Cost-Volume Relationships

ue
e n
e v
Amount ($) l r
t a
To

0
Q (Quantity in units)

Total revenue = Revenue per unit (R) X Quantity (Q)

Cost-Volume Relationships

u e
e n r o fit
Amount ($)
ev + P
l r
ota o s t
T t a lc
To

ss
- Lo

0 BEP Q (volume in units)

Break-even point (BEP): the quantity of output at

which total cost and total revenue are equal.
 Break-Even Problem with Step Fixed Costs
Figure 5.6a
C R
=T T
3

V C 3
+
FC 3

C
=T
2

V C 2
3 machines
+
FC 2

TC
1

= 2 machines
VC
1
+
FC
1

1 machine
Quantity
Multiple break-even points
Assumptions of Cost-Volume Analysis

1. One product is involved

2. Everything produced can be sold
3. Variable cost per unit is the same regardless of
volume
4. Fixed costs do not change with volume
5. Revenue per unit constant with volume
6. Revenue per unit exceeds variable cost per unit
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.
Calculating Processing Requirements

S t a n d a r d
A n n u a pl r o c e s s i n g P t i rm o ce e s s i n g t i m e
P r o d u c D t e m a n d p e r u n i t ( h r .n ) e e d e d ( h r . )

# 1 4 0 0 5 . 0 2 , 0 0 0

# 2 3 0 0 8 . 0 2 , 4 0 0

# 3 7 0 0 2 . 0 1 , 4 0 0
5 , 8 0 0

Q: How many machines are needed? A machine operates 10 hours

per day and 250 days a year.
One machine has total processing time per year:
10 X 250 = 2500.
Number of machines needed is 5800/2500 = 2. 35
THREE machines!
Calculating Processing Requirements cont.

S t a n d a r d
A n n u a pl r o c e s s i n g P t i rm o ce e s s i n g t i m e
P r o d u c D t e m a n d p e r u n i t ( h r .n ) e e d e d ( h r . )

# 1 4 0 0 5 . 0 2 , 0 0 0

# 2 3 0 0 8 . 0 2 , 4 0 0

# 3 7 0 0 2 . 0 1 , 4 0 0
5 , 8 0 0

Q: How many machines are needed? Average utilization of a

machine is 50%.
One machine has total effective processing time per year:
10 X 250 X 50% = 1250.
Number of machines needed is 5800/1250 = 4. 7
FIVE machines!
Recap

Capacity
Capacity cushion
Economy of scale
Diseconomy of scale
Outsource
Break-even point
(BEP)
Cash flow
Present value