Strategic Capacity Planning
Chapter 11
Strategic Capacity Planning

Capacity

The maximum level of output

The amount of resource inputs available
relative to output requirements at a particular
time

Capacity is the upper limit or ceiling on the
load that an operating unit can handle.
Examples of Capacity Measures
Type of
Organization
Manufacturer
Hospital
Airline
Restaurant
Retailer
Theater
Measures of Capacity
Inputs
Outputs
Machine hours
Number of units
per shift
per shift
Number of beds Number of
patients treated
Number of planes Number of
or seats
seat-miles flown
Number of seats Customers/time
Area of store
Sales dollars
Number of seats Customers/time
Capacity Planning
 The
basic questions in capacity
planning are:
 What
type of capacity is needed?
 How much is needed?
 When is it needed?
 How does productivity relate to capacity?
Two Capacity Strategies
Forecast of
capacity needed
Time between
increments
Expansionist Strategy
Forecast of
Planned use of
short-term options capacity needed
Capacity
Capacity
Planned unused
capacity
Wait-and-See Strategy
Capacity Utilization
 Capacity
 rate
 Best
used
of output actually achieved
operating level
 capacity
for which the process was designed
(effective or maximum capacity)
Utilization =
Capacity Used
_______________
Best Operating Level
Utilization--Example
 Best
operating level = 120 units/week
 Actual
output = 83 units/week
Capacity used
83 units/wk
= .692
=
 Utilization
= operating
?
Best
level 120 units/wk
Utilization =
Best Operating Level
Average
unit cost
of output
Underutilization
Over-utilization
Best Operating
Level
Volume
Economies & Diseconomies of Scale
Long Run Average Cost Curve
Average
unit cost
of output
100-unit
plant
200-unit
plant
Volume
300-unit
plant
400-unit
plant
Amount ($)
Cost-Volume Relationships
Fixed cost (FC)
0
Q (volume in units)
Amount ($)
Cost-Volume Relationships
0
Q (volume in units)
Amount ($)
Cost-Volume Relationships
0
BEP units
Q (volume in units)
Break-Even Problem with Step Fixed Costs
3 machines
2 machines
1 machine
Quantity
Step fixed costs and variable costs.
Break-Even Problem with Step Fixed Costs
$
BE
P 3
BEP2
TC
3
TC
2
1
Quantity
Multiple break-even points
TC
Breakeven Analysis
Breakeven quantity =
Fixed Costs
Price - Variable Costs
Breakeven example
Thomas Manufacturing intends to increase
capacity by overcoming a bottleneck operation
through the addition of new equipment. Two
vendors have presented proposals as follows:
Proposal
A
B
Fixed Costs
$ 50,000
$ 70,000
Variable Costs
$12
$10
The revenue for each product is $20
What is the breakeven quantity for each
proposal?
Breakeven Solution
FC
BEQ =
P- VC
Proposal A
BEQ =
$ 50,000
=
6250
=
7000
$20 - 12
Proposal B
BEQ =
$ 70,000
$20 - 10
Breakeven Analysis
In the previous example, at what capacity would
both plans incur the same cost?
Solution -consider total cost
Total cost = Fixed cost + Variable Cost (Q)
$50,000 + $12Q = $70,000 + $10 Q
Q = 10,000
The Experience Curve
As plants produce more products, they
gain experience in the best production
methods and reduce their costs per unit.
Cost or
price
per unit
Total accumulated production of units
Capacity Flexibility: Having the ability
to respond rapidly to demand volume
changes and product mix changes.
 Flexible
plants
 Flexible processes
 Flexible workers
Capacity Bottlenecks
Operation 1
Raw
material
Bottleneck
Operation
200/hour
Operation 2
75/hour
Operation 3
200/hour
Determining Capacity
Requirements
 Forecast
sales within each individual
product line
 Calculate
equipment and labor
requirements to meet the forecasts
 Project
equipment and labor availability
over the planning horizon
Example--Capacity
Requirements
A manufacturer produces two lines of ketchup,
FancyFine and a generic line. Each is sold in
small and family-size plastic bottles.
The following table shows forecast demand for
the next four years.
Year:
FancyFine
Small (000s)
Family (000s)
Generic
Small (000s)
Family (000s)
1
2
3
4
50
35
60
50
80
70
100
90
100
80
110
90
120
100
140
110
Example of Capacity Requirements:
The Product from a Capacity Viewpoint
 Question:
Are we really producing
two different types of ketchup from
the standpoint of capacity
requirements?
Answer: No, it’s the same product just
packaged differently.
Example of Capacity Requirements:
Equipment and Labor Requirements
Year:
Small (000s)
Family (000s)
1
150
115
2
170
140
3
200
170
4
240
200
Three 100,000 units-per-year machines are available
for small-bottle production. Two operators required
per machine.
Two 120,000 units-per-year machines are available
for family-sized-bottle production. Three operators
required per machine.
31
Question: Identify the Year 1 values for capacity, machine, and labor?
Year:
Small (000s)
Family (000s)
1
150
115
2
170
140
3
200
170
Small
Mach. Cap.
300,000
Labor
Family-size
Mach. Cap.
240,000
Labor
150,000/300,000=50%
At 1 machine for 100,000, it
takes 1.5 machines for 150,000
Small
Percent capacity used
50.00%
Machine requirement
1.50
Labor requirement
3.00
At 2 operators for
Family-size
100,000, it takes 3
Percent capacity used
47.92%
operators for 150,000
Machine requirement
0.96
Labor requirement
2.88
4
240
200
6
6
©The McGraw-Hill Companies, Inc., 2001
32
Question: What are the values for columns 2, 3 and 4 in the table below?
Year:
Small (000s)
Family (000s)
Small
Family-size
Small
Percent capacity used
Machine requirement
Labor requirement
Family-size
Percent capacity used
Machine requirement
Labor requirement
1
150
115
2
170
140
3
200
170
4
240
200
Mach. Cap.
Mach. Cap.
300,000
240,000
Labor
Labor
6
6
50.00% 56.67%
1.50 1.70
3.00 3.40
66.67%
2.00
4.00
80.00%
2.40
4.80
47.92% 58.33%
0.96 1.17
2.88 3.50
70.83%
1.42
4.25
83.33%
1.67
5.00
©The McGraw-Hill Companies, Inc., 2001
Capacity Cushion
Capacity Cushion = level of capacity in excess of the average
utilization rate or level of capacity in excess of the expected
demand .
Cushion = Best Operating Level
Capacity Used
- 1
Large capacity cushion
Required to handle uncertainty in demand




service industries
high level of uncertainty in demand (in terms of
both volume and product-mix)
to permit allowances for vacations,
holidays, supply of materials delays, equipment
breakdowns, etc.
if subcontracting, overtime, or the cost of
missed demand is very high
Sources of Uncertainty
Manufacturing
•Process design
•Product design
•Capacity
•Quality
Supplier Performance
•Responsiveness
•Transportation
•Location
•Quality
•Information
Customer Deliveries
•Transportation
•Location
•Information
Customer Demand
•Past performance
•Market research
•Analytical techniques
•Promotions / Incentives
Small capacity cushion
Unused capacity still incurs the fixed costs
 highly
capital intensive businesses
 time perishable capacity
Example: Target 5% Cushion
cushion = Best Operating Level
Capacity Used
.05 = (1800/x) - 1
1.05 = (1800/x)
1.05x = 1800
x = 1714.3
- 1
1714.3/1800 = .9524
Capacity Example
An automobile equipment supplier wishes to install a
sufficient number of ovens to produce 400,000 good
castings per year. The baking operation takes 2.0
minutes per casting, and management requires a
capacity cushion of 5%. How many ovens will be
required if each one is available for 1800 hours (of
capacity) per year?
Solution
Required system capacity =
400,000 good units per year
Number of oven minutes required =
400,000 x 2 min/unit = 800,000
Number of oven minutes available/oven =
(1800 hrs/oven) x(60 minutes/hour) (.9524)
= 102,859 minutes/oven
Number of ovens required
= 800,000 min /102,859 min/oven
= 7.8 or 8 ovens
How does Quality affect
capacity?
Suppose a three operation process is
followed by an inspection. If the average
proportion of defectives produced at
operations 1, 2, and 3 are .04, .01, and
.02 respectively, and if the demand is 200
units, then what is the required capacity
for this operation?
Capacity requirements with
Yield Loss
Notation:
di = avg. proportion of defective units at operation i
n = number of operations in the production process
M= order quantity (good units only or desired yield)
B = avg. number of units at the start of the
production process
B =
M
[(1-d1)(1-d2)….(1-dn)]
Solution
Desired yield = 200
Operation
Defective rate
1
.04
2
.01
3
.02
(1) What is the capacity required?
B=
200
(1-.04)(1-.01)(1-.02)
= 215
Capacity and Quality
Suppose we have a 6 process assembly
line that must produce 1000 good
products. Each process produces only
1% defects. How is capacity affected?
1000
Capacity required
=
(.99)6
=
1062 units
Decision Trees
A glass factory specializing in crystal is experiencing a
substantial backlog, and the firm's management is
considering three courses of action:
A) Arrange for subcontracting,
B) Construct new facilities.
C) Do nothing (no change)
The correct choice depends largely upon demand, which
may be low, medium, or high. By consensus,
management ranks the respective probabilities as .10,
.50, and .40. A cost analysis that reveals the effects
upon costs is shown in the following table.
Payoff Table
A
B
C
0.1
Low
10
-120
20
0.5
Medium
50
25
40
0.4
High
90
200
60
We start with our decisions...
Subcontracting
A
B
Construct new facilities
C
Do nothing
Then add our possible states of
nature, probabilities, and payoffs
High demand (.4)
Medium demand (.5)
Low demand (.1)
A
High demand (.4)
B
Medium demand (.5)
Low demand (.1)
$90k
$50k
$10k
$200k
$25k
-$120k
C
High demand (.4)
Medium demand (.5)
Low demand (.1)
$60k
$40k
$20k
Determine the expected value
of each decision
High demand (.4)
Medium demand (.5)
$62k
Low demand (.1)
A
EVA=.4(90)+.5(50)+.1(10)=$62k
$90k
$50k
$10k
Solution
High demand (.4)
Medium demand (.5)
$62k
A
B
$80.5k
Low demand (.1)
High demand (.4)
Medium demand (.5)
Low demand (.1)
$90k
$50k
$10k
$200k
$25k
-$120k
C
High demand (.4)
$46k
Medium demand (.5)
Low demand (.1)
$60k
$40k
$20k
Planning Service Capacity
 Time
 Location
 Volatility
of Demand
Capacity Utilization &
Service Quality
 Best
operating point is near 70% of
capacity
 From
70% to 100% of service capacity,
what do you think happens to service
quality? Why?
Two Capacity Strategies
Forecast of
capacity needed
Time between
increments
Expansionist Strategy
Forecast of
Planned use of
short-term options capacity needed
Capacity
Capacity
Planned unused
capacity
Wait-and-See Strategy
Advantages/Disadvantages of each strategy
Advantages
Disadvantages
Expansionist
• ahead of competition
• no lost sales
• risky if demand
changes
Wait-and-See
• no unused capacity
• easier to adapt to
new technologies
• rely on shortterm options
Some Short-Term Capacity Options

lease extra space temporarily
 authorize overtime
 staff second or third shift with temporary workers
 add weekend shifts
 alternate routings, using different work stations
that may have excess capacity
 schedule longer runs to minimize
capacity losses
Some Short-Term Capacity Options
 level
output by building up inventory
in slack season
 postpone preventive maintenance (risky)
 use multi-skilled workers to alleviate
bottlenecks
 allow backorders to increase, extend due
date promises, or have stock-outs.
 subcontract work