operations management

Lecture 4
Capacity planning

Year 2023
 Lecture 4 Objectives

After this lecture you should be able to:

 Name the three key questions in capacity planning
 Explain the importance of capacity planning
 Describe ways of defining and measuring capacity
 Name several determinants of effective capacity
 Discuss factors to consider when deciding whether to
operate in-house or outsource
4.1 Introduction

Capacity refers to an upper limit or ceiling on the load that

an operating unit can handle.
 The load might be in terms of the number of physical
units produced (e.g., bicycles assembled per hour) or the
number of services performed (e.g., computers upgraded
per hour).
 The operating unit might be a plant, department, machine,
store, or worker.
 Capacity needs include equipment, space, and employee
skills.

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Cont…

 The goal of strategic capacity planning is to achieve a match

between the long-term supply capabilities of an organization
and the predicted level of long-term demand.
 Organizations become involved in capacity planning for
various reasons. Among the chief reasons are changes in
demand, changes in technology, changes in the environment,
and perceived threats or opportunities.
 A gap between current and desired capacity will result in
capacity that is out of balance. Overcapacity causes operating
costs that are too high, while under capacity causes strained
resources and possible loss of customers.

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Cont…

The key questions in capacity planning are the following:

1. What kind of capacity is needed?
2. How much is needed to match demand?
3. When is it needed?
The question of what kind of capacity is needed depends on
the products and services that management intends to produce
or provide. Hence, in a very real sense, capacity planning is
governed by those choices.
Forecasts are key inputs used to answer the questions of how
much capacity is needed and when is it needed.

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4.2 CAPACITY DECISIONS ARE STRATEGIC

For a number of reasons, capacity decisions are among the most

fundamental of all the design decisions that managers must make.
1.Capacity essentially limits the rate of output possible. Capacity
decisions have a real impact on the ability of the organization to meet
future demands for products and services; E.g. Shortages of flu vaccine
in some years due to production problems.
2. Capacity decisions affect operating costs. Ideally, capacity and DD
requirements will be matched, which will tend to minimize operating
costs. In practice, actual demand may differs from expected demand
3. Capacity decisions often involve long-term commitment of resources
and the fact that, once they are implemented, those decisions may be
difficult or impossible to modify without incurring major costs.

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Cont…

5. Capacity decisions can affect competitiveness. If a firm has

excess capacity, or can quickly add capacity, that fact may serve as a
barrier to entry by other firms. Then too, capacity can affect delivery
speed, which can be a competitive advantage.
6. Capacity affects the ease of management; having appropriate
capacity makes management easier than when capacity is
mismatched.
7. Globalization has increased the importance and the complexity of
capacity decisions. Wide-ranging supply chains and distant markets
add to the uncertainty about capacity needs.
8. Because capacity decisions often involve substantial financial and
other resources, it is necessary to plan for them far in advance.

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MEASURING CAPACITY

Design capacity is the maximum rate of output achieved

under ideal conditions. Effective capacity is always less
than design capacity, the need for periodic maintenance
of equipment, lunch breaks, coffee breaks, problems in
scheduling and balancing operations, and similar
circumstances. Actual output cannot exceed effective
capacity and is often less because of machine
breakdowns, absenteeism, shortages of materials, and
quality problems, as well as factors that are outside the
control of the operations managers.

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Cont.

These different measures of capacity are useful in defining

two measures of system effectiveness:
Efficiency and utilization.
Efficiency is the ratio of actual output to effective capacity.
Utilization is the ratio of actual output to design capacity.

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Cont.

Computing Efficiency and Utilization

Given the following information, compute the efficiency
and the utilization of the vehicle repair department:
Design capacity = 50 trucks per day
Effective capacity = 40 trucks per day
Actual output = 36 trucks per day

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Cont.

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Cont.

Compared to the effective capacity of 40 units per day, 36

units per day looks pretty good.
But, compared to the design capacity of 50 units per day,
36 units per day is much less impressive, although
probably more meaningful.
The real key to improving capacity utilization is to
increase effective capacity by correcting quality
problems, maintaining equipment, training employees.
Eliminating waste, which is a key aspect of lean
operation can also help to improve effective capacity.

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4.3 DETERMINANTS OF EFFECTIVE
CAPACITY

Many decisions about system design have an impact

on capacity. The same is true for many operating
decisions. This lecture briefly describes some of these
factors, which are then elaborated on elsewhere in the
lecture series.
The main factors relate to facilities, products or
services, processes, human considerations, Policy
Factors. operational factors, the supply chain, and
external forces.

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Cont…

1. Facilities.
 Design of facilities, including size and provision for
expansion, is key.
 Locational factors, such as transportation costs, distance
to market, labor supply, energy sources, and room for
expansion, are also important.
 Layout of the work area often determines how smoothly
work can be performed.
 Environmental factors such as heating, lighting, and
ventilation

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Cont…

2. Product and Service Factors.

 Product or service design can have a tremendous
influence on capacity. when items are similar, the ability
of the system to produce those items is generally much
greater than when successive items differ. E.g., a
restaurant that offers a limited menu can usually prepare
& serve meals at a faster rate than a restaurant with an
extensive menu.
 Product or service mix must also be considered, because
different items will have different rates of output.

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Cont…

3. Process Factors. The quantity capability of a process is an

obvious determinant of capacity.
A more subtle determinant is the influence of output quality. E.g.,
if quality of output does not meet standards, the rate of output
will be slowed by the need for inspection & rework activities.
Process improvements that increase quality and productivity can
result in increased capacity. Also, if multiple products or multiple
services are processed in batches, the time to change over
equipment settings must be taken into account.

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Cont…

4. Human Factors. Job content, job design, the variety

of activities involved, and the training, skill, and
experience required to perform a job all have an impact
on the potential and actual output. In addition, employee
motivation has a very basic relationship to capacity, as
do absenteeism and labor turnover.
5. Policy Factors. Management policy can affect
capacity by allowing or not allowing capacity options
such as overtime or second or third shifts.

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Cont…

6. Operational Factors. Inventory stocking decisions, late

deliveries, purchasing requirements, acceptability of
purchased materials and parts, and quality inspection and
control procedures also can have an impact on effective
capacity.
Inventory shortages of even one component of an
assembled item (e.g., computers, refrigerators, automobiles)
can cause a temporary halt to assembly operations until the
components become available.
This can have a major impact on effective capacity. Thus,
insufficient capacity in one area can affect overall capacity.

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Cont…

7. Supply Chain Factors. Supply chain factors must be

taken into account in capacity planning if substantial
capacity changes are involved.
Key questions include: What impact will the changes have
on suppliers, warehousing, transportation, and distributors?
If capacity will be increased, will these elements of the
supply chain be able to handle the increase?
Conversely, if capacity is to be decreased, what impact will
the loss of business have on these elements of the supply
chain?

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Cont…

8. External Factors. Product standards, especially

minimum quality and performance standards, can restrict
management’s options for increasing and using capacity.
Thus, pollution standards on products and equipment often
reduce effective capacity, as does paperwork required by
government regulatory agencies by engaging employees in
nonproductive activities.
A similar effect occurs when a union contract limits the
number of hours and type of work an employee may do.

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Summary of factors that determine effective capacity

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DO IT IN-HOUSE OR OUTSOURCE IT?

Once capacity requirements have been determined, the

organization must decide whether to produce a good or
provide a service itself, or to outsource from another
organization.
Many organizations buy parts or contract out services, for
a variety of reasons. Among those factors are:
 Available capacity. If an organization has available the
equipment, necessary skills, and time, it often makes
sense to produce an item or perform a service in-house.

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Cont.

 Expertise. If a firm lacks the expertise to do a job

satisfactorily, buying might be a reasonable
alternative.
 Quality considerations. Firms that specialize can
usually offer higher quality than an organization can
attain itself. Conversely, unique quality requirements
or the desire to closely monitor quality may cause an
organization to perform a job itself.

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Cont.

 The nature of demand. When demand for an item is

high and steady, the organization is often better off
doing the work itself. However, wide fluctuations in
demand or small orders are usually better handled by
specialists who are able to combine orders from
multiple sources, which results in higher volume and
tends to offset individual buyer fluctuations.

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Cont.

 Cost. Any cost savings achieved from buying or

making must be weighed against the preceding factors.
Cost savings might come from the item itself or from
transportation cost savings.
If there are fixed costs associated with making an item
that cannot be reallocated if the service or product is
outsourced, that has to be recognized in the analysis.
Conversely, outsourcing may help a firm avoid incurring
fixed costs.

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Cont.

 Risks. Buying goods or services may entail

considerable risks. Loss of direct control over
operations, knowledge sharing, and the possible need
to disclose proprietary information are three risks.
Liability can also be a tremendous risk if the products
or services of other companies cause harm to
customers or the environment, as well as damage to an
organization’s reputation. Reputation can also be
damaged if the public discovers that a supplier
operates with substandard working conditions.

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Case 4

Ever wonder how some sit-down restaurants are able to offer a huge
variety of menu items, and how they are able to serve everything on
that menu quickly? Could they have humongous kitchens and a
battery of chefs scurrying around? Or maybe a few amazing chefs
whose hands are almost quicker than the eye? Maybe, and maybe
not. In fact, that great-tasting restaurant entrée or dessert you are
served might have been prepared in a distant kitchen, where it was
partially cooked, then flash-frozen or vacuum-packed, and shipped
to your restaurant, awaiting your order.

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Cont…

Then the entrée was finished cooking, perhaps in a microwave oven,

and soon it was served to you—fresh made, so to speak. Surprised?
Don’t be. Many restaurants, from chains like Fuddruckers and
Perkins, to top-quality restaurants, are going the outsourcing route.
And companies such as Sara Lee, Land O’ Lakes, and Stockpot
Soup Company of Redwood, Washington, are only too happy to
oblige them. Advertisements in restaurant trade magazines abound,
with taglines such as “Hours versus ours” and “Just heat and serve.”
Not exactly like mother used to make, but then mother never had to
contend with labor costs that run about 30 percent of revenue, or
worry about keeping up with the competition.

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Cont…

Questions
1. Explain the meaning of the phrase “Hours versus ours.”
2. What advantages are there when restaurants outsource?
3. What are some important disadvantages or limitations of
outsourcing for restaurants?
4. Do you consider restaurant outsourcing to be dishonest?
Unethical? Explain.
5. Does restaurant outsourcing increase capacity? Explain.

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End of lecture 4

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