CAPACITY MANAGEMENT

CHAPTER 4

LOGO
 Content

1. Understanding Capacity

2. Capacity Issues

3. Evaluating Alternatives

4. Theory of constraints

5. Understanding Productivity
UNDERSTANDING CAPACITY
Understanding Capacity

• Capacity is the capability of a

manufacturing or service resource such as:
• A facility
• Process
• Workstation
• Piece of equipment
To accomplish its purpose over a specified
time period.
 Understanding Capacity

• Impact on the ability of the

organization to meet future demands
• Limits the rate of output possible.
• Affect operating costs.
• A major determinant of initial cost.
• Involve long-term commitment of
resources
• Affect competitiveness.
• Affects the ease of management
• Involve substantial financial and other
resources
Understanding Capacity

Capacity is determined by:

- The resources available to the organization —how
they are organized, and their efficiency
- Specific work methods.

Capacity can be viewed in one of two ways:

1. As the maximum rate of output per unit of time,
or
2. As units of resource availability.
Solved Problem

An automobile transmission-assembly factory

normally operates two shifts per day, five days per
week. During each shift, 400 transmissions can be
completed under ideal conditions. What is the
capacity of this factory?
Capacity = (2 shifts/day)(5 days/week) X
(400 tranmissions/shift) X
(4 weeks/month)
= 16,000 transmissions/month
Definition and Measures of Capacity

Designed The maximum capacity that can be

Capacity: achieved under ideal conditions

Effective The percent of design capacity actually

capacity: expected

Rated Capacity: Maximum usable capacity of a

particular facility
RC = (Capacity)(Utilization)(Efficiency)
Utilization

 Measure of planned or actual capacity

usage of a facility, work center, or
machine
Planned capacity
Utilization =
Capacity
Planned hours to be used
=
Total hours available
Actual Output
=
Capacity
Bakery Example

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

Weekly Design capacity = (7 x 3 x 8) x (1,200)

= 201,600 rolls
Bakery Example

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

Weekly Design capacity = (7 x 3 x 8) x (1,200)

= 201,600 rolls
Utilization = 148,000/201,600 = 73.4%
Efficiency

 Measure of how well a facility or machine

is performing when used
Actual output
Efficiency =
Effective capacity
= Actual output in units
Standard output in units
Average actual time
=
Standard time
Bakery Example

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

Weekly Design capacity = (7 x 3 x 8) x (1,200)

= 201,600 rolls
Utilization = 148,000/201,600 = 73.4%

Efficiency = 148,000/175,000 = 84.6%

Bakery Example: Estimating Output of
a New Facility

They are considering adding a second production line

and they plan to hire new employees and train them to
operate this new line
Effective capacity on this new line = 175,000 rolls which
is the same on the first line
However, due to new hires they expect that efficiency of
this new line will be 75% rather than 84.6%

Expected Output = (Effective Capacity) * (Efficiency)

= (175,000) * (.75) = 131,250 rolls

Safety capacity

• Safety capacity (often called the capacity

cushion) is an amount of capacity reserved for
unanticipated events, such as demand surges,
materials shortages, and equipment breakdowns.

Average safety capacity (%)

= 100% − Average resource utilization %
Capacity Planning Process

Develop Quantitative
Forecast
Alternative Factors
Demand
Plans (e.g., Cost)

Compute Evaluate Qualitative

Rated Capacity Factors
Capacity Plans (e.g., Skills)

Compute Select Best

Implement
Needed Capacity
Best Plan
Capacity Plan
Factors that determine effective capacity

 Facilities  Human factors

 Design  Job content
 Location  Job design
 Layout  Training and experience
 Environment  Motivation
 Product/service  Compensation
 Design  Learning rates
 Product or service mix  Absenteeism and labor
 Process turnover
 Quantity capabilities  Policy
 Quality capabilities
Factors that determine effective capacity

 Operational
 Scheduling
 Materials management
 Quality assurance
 Maintenance policies
 Equipment breakdowns
 Supply chain
 External factors
 Product standards
 Safety regulations
 Unions
 Pollution control standards
CAPACITY ISSUES
Key Capacity Issues

• How large should facility, process, or equipment

capacity be?

• Can the facility, process, or equipment

accommodate new goods and services and
adapt to changing demand for existing goods
and services?

• When should capacity changes take place?

Economies of scale

• Economies of scale are achieved when the

average unit cost of a good or service decreases
as the capacity and/or volume of throughput
increases.

• Diseconomies of scale occur when the

average unit cost of the good or service begins
to increase as the capacity and/or volume of
throughput increases.
emand versus Capacity Problem Structure
Managing Existing Capacity

Demand Management Capacity Management

¨ Vary prices  Vary staffing
¨ Vary promotion  Change equipment
¨ Change lead times & processes
(e.g., backorders)  Change methods
¨ Offer complementary  Redesign the
products
product for faster
processing
easonal Demand & Complementary Products
Long-Term Capacity Strategies

• Capacity expansion strategies require determining:

- Amount
- Timing
- Form
of capacity changes.
Long-Term Capacity Strategies

Four basic strategies:

1. One large capacity increase.
2. Small capacity increases that match average
demand.
3. Small capacity increases that lead demand.
4. Small capacity increases that lag demand
Long-Term Capacity Strategies

(a) Leading demand with (b) Leading demand with a

incremental expansion one-step expansion
New
New capacity
capacity

Demand
Demand

Expected Expected
demand demand

(c) Lagging demand with (d) Attempts to have an average

incremental expansion capacity with incremental
New expansion
capacity New
Expected
Demand

Demand capacity Expected

demand demand
Developing capacity strategies

 Design flexibility into systems.

 Take stage of life cycle into account.
 Take a “big-picture” (i.e., systems) approach
to capacity changes.
 Prepare to deal with capacity “chunks.”
 Attempt to smooth out capacity
requirements.
 Identify the optimal operating level.
 Choose a strategy if expansion is involved.
EVALUATING CAPACITY
ALTERNATIVES
Evaluating alternatives
 

• Cost–Volume Analysis
• Financial Analysis
• Decision Theory
• Waiting-Line Analysis
Cost–Volume Analysis

¨ Technique for evaluating process & equipment

alternatives
¨ Objective: Find the point ($ or units) at which total
cost equals total revenue
¨ Assumptions
¨ Revenue & costs are related linearly to volume
¨ All information is known with certainty
¨ No time value of money
Cost–Volume 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
Breakeven Chart
Cost in Dollars (Thousands)

Total revenue line

Breakeven point Profit
Total cost = Total revenue
Total cost line

Variable cost

Loss Fixed cost

Volume (units/period)

7-33
Break-Even Analysis

BEPx = break- x = number of units

even point in units produced
BEP$ = break- TR = total revenue =
even point in dollars Px
P = price per unit F = fixed costs
(after all discounts) V = variable cost per
unit
TC = total costs = F +
Break-even point occurs when Vx

TR = TC F
or BEPx =
P-V
Px = F + Vx
Break-Even Analysis

BEPx = break- x = number of units

even point in units produced
BEP$ = break- TR = total revenue =
even point in dollars Px
P = price per unit F = fixed costs
(after all discounts) V = variable cost per
unit
TC = total costs = F +
BEP$ = BEPx P Vx
F Profit = TR - TC
= P - VP = Px - (F + Vx)
F
= (P - V)/P = Px - F - Vx
F = (P - V)x - F
= 1 - V/P
Multiproduct Break-Even Analysis

Each product’s contribution is weighted by

its proportion of sales

F
BEP$ =
∑ 1-
Vi
Pi
x (Wi)

where Vi = variable cost per unit

Pi = price per unit
F = fixed costs
Wi = percent each product is of total dollar sales
i = each product
 Multiproduct Example

Fixed costs = $3,000 per month

ITEM PRICE COST ANNUAL FORECASTED SALES UNITS
Sandwich $5.00 $3.00 9,000
Drink 1.50 .50 9,000
Baked potato 2.00 1.00 7,000

1 2 3 4 5 6 7 8
ANNUAL WEIGHTED
SELLING VARIABLE FORECASTED % OF CONTRIBUTION
ITEM (i) PRICE (P) COST (V) (V/P) 1 - (V/P) SALES $ SALES (COL 5 X COL 7)

Sandwich $5.00 $3.00 .60 .40 $45,000 .621 .248

Drinks 1.50 0.50 .33 .67 13,500 .186 .125

Baked
potato 2.00 1.00 .50 .50 14,000 .193 .097

$72,500 1.000 .470

 Multiproduct Example
F
BEP$ =
∑ 1-
Vi
Pi
x (Wi)
Fixed costs = $3,000 per month
Annualx Forecasted
$3,000 12
Item Price Cost = Sales Units
= $76,759
.469
Sandwich $5.00 $3.00 9,000
Drink 1.50 .50
Daily 9,000
$76,759
Baked potato 2.00 sales = 312 days
1.00 = $246.02
7,000

Annual Weighted
Selling Variable .621 x $246.02% of Contribution
Forecasted
Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales = 30.6
(col 531
$5.00$ Sales sandwiches
x col 7)
Sandwich $5.00 $3.00 .60 .40 $45,000 .621 per day.248
Drinks 1.50 .50 .33 .67 13,500 .186 .125
Baked 2.00 1.00 .50 .50 14,000 .193 .096
potato
$72,500 1.000 .469
Financial Analysis

 Two important terms in financial analysis are :

 Cash flow - the difference between the cash
received from sales and other sources and the
cash outflow for labor, materials, overhead, and
taxes.
 Present value expresses in current value the sum
of all future cash flows of an investment proposal.
 The three most commonly used methods:
 Payback
 Present value
 Internal rate of return
Financial Analysis

 Payback focuses on the length of time it will take for

an investment to return its original cost
 Present value (PV) method summarizes the initial
cost of an investment, its estimated annual cash
flows, and any expected salvage value in a single
value called the equivalent current value, taking into
account the time value of money
 Internal rate of return (IRR) identifies the rate of
return that equates the estimated future returns and
the initial cost.
Decision Theory

 Identifying a set of possible future conditions

that could influence results, listing alternative
courses of action, and developing a financial
outcome for each alternative–future condition
combination.
Waiting-Line Analysis

 Often useful for designing or modifying

service systems
 Form in a wide variety of service systems
 Useful in helping managers choose a
capacity level that will be cost-effective
through balancing the cost of having
customers wait with the cost of providing
additional capacity.
 Aid in the determination of expected costs for
various levels of service capacity.
BOTTLENECK ANALYSIS
AND THEORY OF
CONSTRAINTS
Measurements – Throughput

• The average number of entities completed

per unit time— the output rate—from a
process is called throughput.
– Throughput might be measured as parts per
day, transactions per minute, or customers per
hour, depending on the context.
Theory of Constraints

• Constraint: Anything that limits an organization

from moving toward or achieving its goal.
Theory of Constraints

• A physical constraint is associated with the

capacity of a resource (e.g., machine, employee).
• A nonphysical constraint is environmental or
organizational (e.g., low product demand or an
inefficient management policy or procedure).
Theory of Constraints

Seven categories of constraints: 

 Market: Insufficient demand.
 Resource: Too little of one or more resources
 Material: Too little of one or more materials.
 Finance: Insufficient funds.
 Supplier: Unreliable, long lead time,
substandard quality.
 Knowledge or competency: Needed
knowledge or skills missing or incomplete.
 Policy: Laws or regulations interfere.
 Bottleneck

• A bottleneck is the work activity that effectively

limits throughput of the entire process.

– Identifying and breaking process bottlenecks is an

important part of process design and improvement,
and will increase the speed of the process, reduce
waiting and work-in-process inventory, and use
resources more efficiently.
Theory of Constraints

The Theory of Constraints (TOC) is a set of

principles that focuses on increasing total process
throughput by maximizing the utilization of all
bottleneck work activities and workstations.
 Theory of constraints

Production planning approach that emphasizes balancing flow

throughout a system, and pursues a perpetual five-step:
1. Determine what is constraining the operation.
2. Exploit the constraint (i.e., make sure the constraining
resource is used to its maximum).
3. Subordinate everything to the constraint (i.e., focus on the
constraint).
4. Determine how to overcome (eliminate) the constraint.
5. Repeat the process for the next highest constraint.

Improvement process centered around the system’s currently

most restrictive constraint.
Bottleneck Analysis

 Each work area can have its own unique

capacity
 Capacity analysis determines the
throughput capacity of workstations in a
system
 A bottleneck is a limiting factor or constraint
 Bottleneck Management

1. Release work orders to the system at the pace of

set by the bottleneck
2. Lost time at the bottleneck represents lost time for
the whole system
3. Increasing the capacity of a non-bottleneck station
is a mirage
4. Increasing the capacity of a bottleneck increases
the capacity of the whole system
Capacity Analysis

► The bottleneck time is the time of the

slowest workstation (the one that takes
the longest) in a production system
► The throughput time is the time it takes a
unit to go through production from start
to end

A B C

2 min/unit 4 min/unit 3 min/unit

Capacity Analysis

► Two identical sandwich assembly lines

► Each assembly line has two workers and two
operations
► All completed sandwiches are wrapped
Bread Fill
15 sec/sandwich 20 sec/sandwich
Wrap/
Order Toaster
Deliver
30 sec/sandwich 20 sec/sandwich
Bread Fill 37.5 sec/sandwich

15 sec/sandwich 20 sec/sandwich
Capacity Analysis
Bread Fill

15 sec 20 sec

Order Wrap/
Toaster
Deliver
30 sec 20 sec

Bread Fill 37.5 sec

15 sec 20 sec

► The two lines each deliver a sandwich every

20 seconds
► At 37.5 seconds, wrapping and delivery has
the longest processing time and is the
bottleneck
► Capacity per hour is 3,600 seconds/37.5
seconds/sandwich = 96 sandwiches per
hour
► Throughput time is 30 + 15 + 20 + 20 + 37.5
= 122.5 seconds
 Capacity Analysis

 Standard process for cleaning teeth

 Cleaning and examining X-rays can happen
simultaneously

Hygienist
Cleans
the teeth
A Lab Ass. A Lab Ass 24 min/unit Dentist
Customer re-processes Customer
Checks in
Takes Develops
pays
X-ray X-ray Dentist
Examines
2 min/unit 2 min/unit 4 min/unit X-ray and 8 min/unit 6 min/unit
processes

5 min/unit
Capacity Analysis Cleaning

Check Takes Develops 24 min/unit Check

Dentist
in X-ray X-ray out

2 min/unit 2 min/unit 4 min/unit X-ray 8 min/unit 6 min/unit

exam

5 min/unit

 All possible paths must be compared

 Cleaning path is 2 + 2 + 4 + 24 + 8 + 6 = 46 minutes,
X-ray exam path is 2 + 2 + 4 + 5 + 8 + 6 = 27
minutes
 Longest path involves the hygienist cleaning the
teeth, so the throughput time is 46 min. The patient
will be out of door after 46 min.
 Bottleneck is the hygienist at 24 minutes.
 Hourly System capacity is (1/24)*60 min = 2.5
patients/per hour
PRODUCTIVITY
Productivity

¨ Measure of process improvement

¨ Represents output relative to input
Productivity = Units produced
Input used
¨ Productivity increases improve standard of
living
 Measuring Productivity

 Productivity is a measure of how efficiently

inputs are converted to outputs
Productivity = output/input
 Total Productivity Measure
Productivity relative to all inputs

 Partial Productivity Measure

Productivity relative to a single input
(e.g., labor hours)
 Multifactor Productivity Measure
 Productivity Variables

Productivity =
Output
Labor + material + energy + capital + miscellaneous
Labor Productivity example

Example:
 Assume two workers paint twenty-four tables in
eight hours:
 Inputs: 16 hours of labor (2 workers x 8 hours)
 Outputs: 24 painted tables

Outputs 24 tables
  1.5 tables / hour
Inputs 16 hours
 Multifactor Productivity example

 Convert all inputs & outputs to $ values

 Example (labor and materials productivity):
 200 units produced that sell for $12.00 each
 Materials cost $6.50 per unit
 40 hours of labor were required at $10 an hour

Outputs 200 units  $12 / unit


Inputs 200 units  $6.50 / unit   40 hours  $10 / hour 
$2400
  1.41
$1700
Productivity Growth Rate

 Can be used to compare a process’s

productivity at a given time (P2) to the
same process’ productivity at an earlier
time (P1)
P2  P1
Growth Rate 
P1
Productivity Growth Rate example

Example:
 Last week a company produced 150 units using 200 hours of labor
 This week, the same company produced 180 units using 250 hours of labor

150 units
P1   0.75 units / hour
200 hours
180 units
P2   0.72 units / hour
250 hours
P  P 0.72  0.75
Growth Rate  2 1   0.04
P1 0.75
or a negative 4% growth rate
Productivity example

An automobile manufacturer has presented the following data for the past
three years in its annual report. As a potential investor, you are interested
in calculating yearly productivity and year to year productivity gains as one
of several factors in your investment analysis.

2003 2002 2001

2003 2002 2001
Labor Productivity
Unit car 2,700,000 2,400,000 2,100,000
sales
Unit Car Sales/Employee 24.1 21.2
18.3
Employees 112,000 113,000 115,000
Year-to-year Improvement 13.7% 15.8%

$ Sales $49,000 $41,000 $38,000 Total Productivity

(billions$)
Total Cost Productivity 1.26 1.24 1.19

Cost of $39,000 $33,000 $32,000

Year-to-year Improvement 1.6% 4.2%
Sales
(billions)
Which is the best measurement?
Measurement Problems

 Quality may change while the quantity of inputs

and outputs remains constant
 External elements may cause an increase or
decrease in productivity
 Precise units of measure may be lacking
Factors That Affect Productivity

 Technology  A shortage of
 Standardizing technology-savvy
 Quality differences workers
 Use of the Internet  Layoffs
 Computer viruses  Labor turnover
 Searching for lost or  Design of the
misplaced items workspace
 Scrap rates  Incentive plans that
reward productivity
 New workers
increases…
 Safety
Improving Productivity

 Develop productivity measures for all

operations.
 Look at the system as a whole in deciding which
operations are most critical.
 Develop methods for achieving productivity
improvements
 Establish reasonable goals for improvement.
 Make it clear that management supports and
encourages productivity improvement. Consider
incentives to reward workers for contributions.
 Measure improvements and publicize them.
 Key Terms

 Bottleneck operation  Internal rate of return

 Break-even point (BEP) (IRR)
 Capacity  Pay back
 Cash flow  Present Value
 Complementary  Process Yield
good/service  Productivity
 Constraint  Rated Capacity
 Designed capacity  Safety capacity/ Capacity
 Economies of Scale cushion
 Effective capacity  Throughput
 Efficiency  Utilization
LOGO