Capacity Management
Capacity has a cost, whether it is used
or not
1
Capacity

Capacity is the maximum output or producing
ability of a machine, person, factory, etc.

Capacity can be measured in physical terms

Measure of the amount of work done

Capacity is the measure of the maximum amount
of work that can be done in a given time
2
Capacity


Capacity = R * T

R is the rate of output per unit of time

T is the maximum amount of time available
Capacity has a cost

Cost to acquire or rent the facility, machine,
operating costs, wages, utilities, insurance, etc.

The cost is incurred even if capacity is underused
3
Measuring the Cost of Capacity

Traditional measures do not reflect the cost
of capacity usage or over capacity

Costs are part of overhead and allocated to
production

Focus is on inventory valuation, not managing capacity

Allocation base is chosen from five alternatives

Theoretical

Maximum output when operating continuously at
maximum efficiency
4
Measuring the Cost of Capacity

Practical


Normal


Average level of output achieved or anticipated over
several years
Budget


Level of output under current conditions, allowing for
normal downtime for setups, maintenance,
vacations, etc.
Level of output anticipated for the current year
Actual

Level of output actually achieved in the current year
5
Measuring the Cost of Capacity

Amount of capacity-related overhead charged to the output
depends on the allocation base chosen
A stamping machine costs $400,000 per year to operate.
The machine can produce 200 stampings per hour.
The machine runs 24 hours per day.
The company does not work on weekends (104 days) or holidays (10 days)
Downtime for maintenance, setups, etc. averages 15 days per year.
The machine is idle because of lack of materials for an average of 5 days per year.
The equivalent of 8 days of production is lost each year because of defects
produced by the machine.
Management expects to produce an average of 1,000,000 stampings per year
over the next five years.
Planned output for the current year was 1,050,000 stampings.
Actual output for the current year was 1,032,000 stampings, requiring 215 days.
If successfully negotiated, a new contract with a customer would increase demand
for the stampings by 24,000 units per year.
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Measuring the Cost of Capacity
Traditional cost allocation measures
Output
Theoretical capacity
Units per hour
Hours per day
Days per year
Theoretical capacity
Operating
cost
Cost per
unit
*
*
=
200
24
365
1,752,000
$400,000
$0.228
*
*
=
200
24
231
1,108,800
$400,000
$0.361
Normal capacity
Expected 5 year average output
1,000,000
$400,000
$0.400
Budget capacity
Planned output for the current year
1,050,000
$400,000
$0.381
Actual capacity
Actual output for the current year
1,032,000
$400,000
$0.388
Practical capacity
Units per hour
Hours per day
Operating days per year*
Practical capacity
* 365-104-10-15-5=231 days
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Measuring the Cost of Capacity

CAM-I capacity model focuses on the cost of
used and unused capacity

Capacity is divided into four categories

Rated capacity


Same as theoretical capacity
Productive capacity

Capacity used to produce usable output
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Measuring the Cost of Capacity

Nonproductive capacity


Capacity that does not result in usable output

Downtime for maintenance, setups, lack of
materials, etc.

Productive time lost due to waste, scrap, rework,
etc.
Idle capacity

Capacity that is not available due to policy decisions
or market reasons such as holidays, lack of orders,
etc.
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Measuring the Cost of Capacity

Cost is attached to the capacity categories based on
the theoretical cost per unit
Capacity category
Rated
Productive
Nonproductive
Setups
Standby
Defects
Subtotal
Idle
Weekends, holidays
Marketable
Not marketable
Subtotal
Total
Days
365
215
15
5
8
Output
(4,800 units per day)
1,752,000
1,032,000
72,000
24,000
38,400
28
114
5
3
Capacity cost
$
400,000
235,616
16,438
5,479
8,767
134,400
$0.228 $
$0.228
$0.228
$0.228
124,932
5,479
3,288
585,600
1,752,000
$0.228 $
$0.228
$0.228
$0.228
$0.228
547,200
24,000
14,400
122
365
Cost per
unit
$0.228
$0.228
30,685
$
133,699
400,000
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Measuring the Cost of Capacity

Capacity utilization can be shown graphically
100%
$30,685
Nonproductive
capacity
80%
$133,699
Idle capacity
60%
40%
$235,616
20%
Productive
capacity
0%
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Managing Capacity Costs

Management can use the information from
the CAM-I model to understand the financial
impact under-utilizing the available capacity

The cost impact of changes in the utilization rates
can also be calculated
12
Managing Capacity Costs
Rated
Operating
cost
$
400,000
Volume
1,752,000
Cost per
stamping
$ 0.228
Productive
$
400,000
1,032,000
$
0.388
400,000
1,032,000
24,000
1,056,000
$
0.379
400,000
1,032,000
38,400
1,070,400
$
0.374
If defects and standby can be eliminated and output sold
Current productive
Productive capacity from reduced defects
Productive capacity from reduced standby
New total productive capacity
$
400,000
1,032,000
38,400
24,000
1,094,400
$
0.365
Capacity category
If the new order is received
Current productive
Productive capacity from new order
New total productive capacity
$
If defects can be eliminated and output sold
Current productive
Productive capacity from reduced defects
New total productive capacity
$
13
Managing Capacity Costs

Capacity costs may be fixed, but can still be
managed

Reduction of idle capacity

Increasing sales to use unused capacity

Renting unused capacity to others

Reduction in “days off”
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Managing Capacity Costs

Reduction of nonproductive capacity


Reduction of setup time, defects, etc.
Reduction of rated capacity

Replace the asset with one having less capacity

Lower capacity asset can be more fully utilized
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Implications of the CAM-I Model

Illustrates the reasons for idle and
nonproductive capacity

Improves accountability

Illustrates the cost of idle and nonproductive
capacity

Helps management prioritize capacity
utilization efforts
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Practical Considerations in
Measuring Capacity

How is capacity defined?

Worker, machine, factory, etc.


Higher-level capacity (process, factory, etc.) is
determined by the lowest capacity component
Capacity may change over time

Assets slowing with age

Technological improvements to assets
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Practical Considerations in
Measuring Capacity

Capacity may depend on the mix of work
processed on the asset


The machine may take longer to stamp one type
of product than it takes to stamp another type
What costs should be included?

Operating costs?

Sunk costs?

Financing costs?
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