Capacity Planning

What is Capacity

Capacity is the throughput, or the number of units a

facility can hold, receive, store, or produce in a period
of time
Or
Capacity is the upper limit or ceiling on the load that an
operating unit can handle

Capacity needs;
 Equipment
 Space
 Employee skills
Capacity Planning

Capacity Planning is the study of the level

of capacity the organization produces at
each stage of the production or service
delivery system to meet its objectives.

Capacity Planning is a long-term strategic

decision that establishes a firm’s overall
level of resources.
Capacity Planning Questions
Key Questions:
 What kind of capacity is needed?
 How much capacity 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?
 Should capacity be changed all at once, or through several smaller
changes
 Can the supply chain handle the necessary changes?
Objective of capacity planning
The integral objective of capacity planning
is to achieve a match between the long-
term supply capabilities of an
organization and the predicted level of
long-run demand.

It should be noted that;

Overcapacity operating costs that are too high
Undercapacity strained resources and
possible loss of customers
Why Capacity Decisions are strategic?
impact the ability of the organization to meet future
demands
affect operating costs
establishes a firm’s overall level of resources.
are a major determinant of initial cost
often involve long-term commitment of resources
can affect competitiveness
affect the ease of management
need to be planned for in advance due to their
consumption of financial and other resources
Planning Over a Time Horizon

Long-range Add facilities

planning Add long lead time equipment

Intermediate- Subcontract Add personnel

range Add equipment Build or use inventory
planning Add shifts

Schedule jobs
Short-range
Schedule personnel
planning
Allocate machinery

Modify capacity Use capacity

Long-range planning

 Long-range capacity planning is the process of making

sure that adequate production resources;
 (facilities,
 people,
 equipment, and
 operating hours)
are available to meet an organization’s long-range
production requirements.
Medium-range planning

 Medium-range capacity planning is designed to

recognize whether adequate capacity should be
available at individual work centers or machines to
meet the material necessities plan.
 Probable problem areas can be recognized and
changes made consequently, by modifying the plan,
planning for additional capacity, or offloading the
work to other machines.
Short-range planning

 In short-range capacity planning, the importance

shifts toward scheduling orders, so that due dates
will be met within existing capacity.
 Planning tools recognize probable problem areas so
that changes can be made prior to real problems
occur.
 All the planning methods advance an organization’s
ability to diminish its lead times and to meet delivery
due dates.
Classification facility capacity

Design capacity
 maximum output rate or service capacity an operation,
process, or facility is designed for.

Effective capacity
 Effective capacity is the capacity a firm expects to
achieve given current operating constraints
 Design capacity minus allowances such as personal time,
maintenance, and scrap
 Often lower than design capacity
Utilization and Efficiency
Utilization is the percent of design capacity
achieved
actual output
Utilization 
design capacity
Efficiency is the percent of effective capacity
achieved
actual output
Efficiency 
effective capacity

Actual output
•The rate of output actually achieved
•It cannot exceed effective capacity
Example – 1
Design Capacity = 50 trucks per day
Effective Capacity = 40 trucks per day
Actual Output = 36 trucks per day

actual output 36
Efficiency    90%
effective capacity 40

actual output 36
Utilization    72%
design capacity 50
 Example 2
The following data are extracted from operations of
the Bakery firm.
 Actual production last week = 148,000 rolls
 Effective capacity = 175,000 rolls
 Design capacity = 1,200 rolls per hour
 Bakery operates 7 days/week, 3 - 8 hour shifts
a. Compute the firms’ Utilization and Efficiency
b. If the efficiency of the new production line is
estimated to be 75%, what will be the expected
actual Output?
Capacity Cushion

Capacity Cushion is an extra capacity used to offset

demand uncertainty.

Capacity cushion = 100% - Utilization

Capacity cushion strategy

 Organizations that have greater demand uncertainty
typically have greater capacity cushion
 Organizations that have standard products and services
generally have greater capacity cushion
Capacity and Strategy

 Capacity decisions impact all 10

decisions of operations management
as well as other functional areas of the
organization
 Capacity decisions must be integrated
into the organization’s mission and
strategy
Capacity Strategies
Leading
 Build capacity in anticipation of future demand
increases
Following
 Build capacity when demand exceeds current capacity
Tracking
 Similar to the following strategy, but adds capacity in
relatively small increments to keep pace with
increasing demand
 Managing Demand

 Even with good forecasting and facilities built to

that forecast, there may be a poor match between
the actual demand that occurs and available
capacity.
 A poor match may mean demand exceeds
capacity or capacity exceeds demand.
 However, in both cases firms have options:
 Managing Demand
 Demand exceeds capacity
 Curtail demand by raising prices, scheduling
longer lead time
 Long term solution is to increase capacity
 Capacity exceeds demand
 Stimulate market
 Product changes
 Adjusting to seasonal demands
 Produce products with complimentary demand
patterns
Tactics for Matching Capacity to
Demand
1. Making staffing changes
2. Adjusting equipment and processes
 Purchasing additional machinery
 Selling or leasing out existing equipment

3. Improving methods to increase

throughput
4. Redesigning the product to facilitate
more throughput
Economies of Scale
This refers to the cost advantage that the firm obtain due to its
expansion. When economist are talking about economies of scale, they
are usually talking about internal economies of scale. These are
advantages gained by individual firm by increasing its size i.e. having
lager or more plants.
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

 Construction costs increase at a decreasing rate as facility

size increases
 Processing costs decrease due to standardization
Diseconomies of Scale
OR These are the disadvantage of being too large. A firm that
increases its scale of operation to a point where encounter rising long
run average cost is said to be experiencing internal 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
 Distribution costs increase due to traffic congestion and

shipping from a centralized facility rather than multiple

smaller facilities
 Complexity increases costs

 Inflexibility can be an issue

 Additional levels of bureaucracy

 Economies and Diseconomies of Scale
(dollars per room per night)
Average unit cost

25 - Room 75 - Room
Roadside Motel 50 - Room Roadside Motel
Roadside Motel

Economies Diseconomies
of scale of scale
25 50 75
Number of Rooms
Figure S7.2
Steps in Capacity Planning
1. Estimate future capacity requirements
2. Evaluate existing capacity and facilities; identify gaps
3. Identify alternatives for meeting requirements
4. Conduct financial analyses
5. Assess key qualitative issues
6. Select the best alternative for the long term
7. Implement alternative chosen
8. Monitor and evaluation results
Evaluating Alternatives
 Alternatives should be evaluated from varying
perspectives
 Economic
 Cost-volume analysis
 Financial analysis
 Decision theory
 Waiting-line analysis
 Simulation
 Non-economic
 Public opinion
1. 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 = Q x v
 Total Revenue (TR)
TR = revenue per unit (P) x Q
Cost-Volume Relationships
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(P – V) – FC

FC
QBEP 
P V
Break-Even Analysis

 Technique for evaluating process and

equipment alternatives
 Objective is to find the point in
dollars and units at which cost
equals revenue
 Requires estimation of fixed costs,
variable costs, and revenue
Break-Even Analysis
 Fixed costs are costs that continue
even if no units are produced
 Depreciation, taxes, debt, mortgage
payments
 Variable costs are costs that vary with
the volume of units produced
 Labor, materials, portion of utilities
 Contribution is the difference between
selling price and variable cost
Break-Even Analysis
Assumptions
 Costs and revenue are linear
functions
 Generally not the case in the real
world
 We actually know these costs
 Very difficult to accomplish
 There is no time value of money
Break-Even Analysis
–
Total revenue line
900 –

800 – i dor
Break-even point orr Total cost line
700 – Total cost = Total revenue of it c
Pr
Cost in dollars

600 –

500 –
Variable cost
400 –

300 –
o ss or
200 – L rid
r
co
100 – Fixed cost
| | | | | | | | | | | |
–
0 100 200 300 400 500 600 700 800 900 1000 1100
Volume (units per period)
Break-Even Analysis
BEPQ= Break- Q = Number
even point in units of units produced
BEP$ = Break- TR = Total
even point in dollars revenue = PQ
P = Price F= Fixed costs
per unit (after all V =
discounts) Variable costs
BEP$ = BEPQ P TC =
costs = F + VQ
Total
F
= P - V *P Profit = TR - TC
F = PQ - (F + VQ)
= (P - V)/P = PQ - F - VQ
F = (P - V)Q – F
= 1 - V/P
BEP ……..

BEP (in units) = Total fixed cost

Price – Variable cost

BEP (in dollars) = Total fixed cost

1- Variable cost
Selling price
 Example 1

CBE cafeteria has fixed cost of $10,000 this period.

Direct labour cost is $1.50 per unit, and material is $
0.75 per unit. The selling price is 400 per unit.
Compute the BEP
a) In units
b) In dollars
Break-Even Example
Fixed costs = $10,000 Material = $.75/unit
Direct labor = $1.50/unit Selling price = $4.00 per unit

F $10,000
BEP$ = 1 = 1 - [(1.50 + .75)/(4.00)]
(V/P)
Break-Even Example
Fixed costs = $10,000 Material = $.75/unit
Direct labor = $1.50/unit Selling price = $4.00 per unit

F $10,000
BEP$ = 1 - (V/P) = 1 - [(1.50 + .75)/(4.00)]

$10,000
= .4375 = $22,857.14

F $10,000
BEPQ= = 4.00 - (1.50 + .75) = 5,714
P-V
Break-Even (Graphical presentation)

50,000 –

Revenue
40,000 –
Break-even
point Total
30,000 – costs
Dollars

20,000 –

Fixed costs
10,000 –

| | | | | |
0– 2,000 4,000 6,000 8,000 10,000
Units
BEP- Multiproduct Case

F
BEP$ =

∑ 1-
Vi
Pi
x (Wi)

where V = variable cost per unit

P = price per unit
F = fixed costs
W = percent each product is of total dollar sales
i = each product
Multiproduct Example
Fixed costs = $3,500 per month
Annual Forecasted
Item Price Cost Sales Units
Sandwich $2.95 $1.25 7,000
Soft drink .80 .30 7,000
Baked potato 1.55 .47 5,000
Tea .75 .25 5,000
Salad bar 2.85 1.00 3,000
 Multiproduct Example
Fixed costs = $3,500 per month
Annual Forecasted
Item Price Cost Sales Units
Sandwich $2.95 $1.25 7,000
Soft drink .80 .30 7,000
Baked potato 1.55 .47 Annual 5,000 Weighted
Tea Selling Variable .75 .25Forecasted 5,000
% of Contribution
Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7)
Salad bar 2.85 1.00 3,000
Sandwich $2.95 $1.25 .42 .58 $20,650 .446 .259
Soft drink .80 .30 .38 .62 5,600 .121 .075
Baked 1.55 .47 .30 .70 7,750 .167 .117
potato
Tea .75 .25 .33 .67 3,750 .081 .054
Salad bar 2.85 1.00 .35 .65 8,550 .185 .120
$46,300 1.000 .625
Multiproduct Example
F
BEP$ =
∑ 1-
Vi
Pi
x (Wi)

$3,500 x 12
= .625 = $67,200

Daily $67,200
sales= 312 days
= $215.38
2. 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 flow of
an investment proposal
In-House or Outsource?
Once capacity requirements are determined, the
organization must decide whether to produce a good
or service itself or outsource
Factors to consider:
 Available capacity
 Expertise
 Quality considerations
 The nature of demand
 Cost
 Risks
Break-Even Analysis Example
 Ex-1: For a make or buy decision, the
following details are given;
Particular Make Buy
Annual Fixed Cost $150,000 ---
Variable Cost/Unit $60 $80
Annual Volume 12000 12000

a. Whether the item should be made or purchased?

b. If volume changes, at what volume the manager would
be indifferent between making and buying?
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