Strategic Capacity Management
Learning Objectives
Capacity and how to “manage” it.
Impact of economies of scale on the capacity.
3. Decision trees to analyze alternatives of adding
capacity.
4. Planning capacity for service firms.
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Capacity Management in Operations
 Capacity can be defined as the ability to hold, receive,
store, or accommodate
 Strategic capacity planning is an approach for
determining the level of resources required over a time
horizon
 Long range: greater than one year
 Intermediate range: six to 18 months
 Short range: less than one month
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Capacity Planning Concepts
 Capacity: an attainable rate of output
 Best operating level: capacity for which the process
was designed
 Capacity utilization rate reveals how close a firm is to
its best operating level
Capacity used
Capacity utilization rate 
Best operating level
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Economies and Diseconomies
of Scale
 Economies of scale: as a plant gets larger, the average
cost per unit drops
 Lower operating and capital costs
 Per unit cost of equipment drops
 More specialization of labor
 At some point, the plant becomes too large
 Diseconomies of scale becomes a problem
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Capacity Flexibility
 Capacity flexibility: the ability to rapidly increase or
decrease production levels or to shift production
capacity quickly from one product or service to
another
 Flexible plants: low changeover times
 Flexible processes: easily set up equipment
 Flexible workers: workers have multiple skills
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Considerations in Changing
Capacity
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Maintaining system balance
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Frequency of capacity additions
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Want similar capacities at each operation
Deal with bottlenecks
Cost of upgrading too frequently
Cost of upgrading too infrequently
External sources of capacity
Outsourcing
2. Sharing capacity
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Frequent Versus Infrequent
Capacity Expansions
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Determining Capacity
Requirements
Use forecasting techniques to predict sales for
individual products
2. Calculate equipment and labor requirements to
meet forecasts
3. Project labor and equipment availability over the
planning horizon
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Example: Determining Capacity
Requirements
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Steward Company produces two flavors of salad
dressing
Paul’s
2. Newman’s
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Each is available in bottles and single-serving bags
Management would like to determine equipment
and labor requirements for the next five years
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Step 1: Forecasting to Predict Sales for Individual Products
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Step 2: Calculate Equipment and Labor Requirements
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Example: Equipment and Labor
Requirements
 450,000 bottling capacity with 3 machines and 2
operators per machine – total 6 operators available
 1,250,000 bagging capacity with 5 machines and 3
operators per machine – total 15 operators needed; 20
operators are available
 Year 1
 135 /450 = 0.3 or 30% for bottling; .3x3 = .9 machines
 300 /1,250 = 0.24 or 24% for bagging; .24x5=1.2 machines
 0.9 bottle machines x 2 operators = 1.8 operators
 1.2 bag machines x 3 operators = 3.6 operators
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Example Step 3: Project Equipment
and Labor Availabilities
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Using Decision Trees to
Evaluate Capacity Alternatives
 Decision tree: a schematic model of the sequence of
steps in a problem and the conditions and
consequences of each step
 Decision tree helps understand problem and helps
find solution
 Decision trees are composed of decision nodes with
branches
 Squares represent decision points
 Circles represent chance events
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Example: Decision Trees
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Strong growth, 55 percent probability
New site and strong growth=$195,000, weak=$115,000
Expansion and strong growth=$190,000, weak=$100,000
Exist and no change strong=$170,000, weak=$100,000
Expansion costs $87,000
Move costs $210,000
Expansion in second year costs $87,000
Operating costs equal
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Calculating Values
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Diagramming Problem
Decision
Chance
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Decision
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Decision Tree Analysis
Value of this
decision
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Value of this
decision
Expected
value
Value of this
branch
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Decision Tree Analysis: NPV
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Planning Service Capacity
 Time: goods can not be stored for later use and
capacity must be available to provide a service when it
is needed
 Location: service goods must be at the customer
demand point and capacity must be located near the
customer
 Volatility of demand: much greater than in
manufacturing
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Capacity Utilization and
Service Quality
 Must consider the day-to-day relationship between
service utilization and service quality
 Optimal utilization rate is very context specific
 Low rates are appropriate when both the degree of
uncertainty and stakes are high
 Relatively predictable services or service facilities
without customer contact can operate much nearer 100
percent utilization
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Relationship Between the Rate of Service
Utilization and Service Quality
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