5-1 Capacity Planning
Long-Range Capacity Planning
William J. Stevenson
9th edition
5-2 Capacity Planning





Learning Objectives
Explain the importance of capacity planning.
Discuss ways of defining and measuring
capacity.
Describe the determinants of effective capacity.
Discuss the major considerations related to
developing capacity alternatives.
Briefly describe approaches that are useful for
evaluating capacity alternatives
5-2
5-3 Capacity Planning
The Hierarchy of Production
Decisions





All planning starts with the demand forecast.
Demand forecasts are the basis for the top level long_range
capacity, and medium term aggregate planning.
The Master Production Schedule (MPS) is the result of
disaggregating aggregate plans down to the individual item
level.
Based on the MPS, MRP is used to determine the size and
timing of component and subassembly production.
Detailed shop floor schedules are required to meet
production plans resulting from the MRP.
5-4 Capacity Planning
Hierarchy of
Production Decisions
Long-range Capacity Planning
5-5 Capacity Planning
Capacity Planning

Capacity is the upper limit or ceiling on the
load that an operating unit can handle.
 The basic questions in capacity handling are:

What kind of capacity is needed?
 How much is needed? (Forecasts are key
inputs)
 When is it needed?
5-6 Capacity Planning
Importance of Capacity Decisions
 Capacity
decisions are important to all
departments of the organization;
An accountant would be interested in
collecting cost accounting information in
order to ensure that correct capacity
expansion decision is reached.
5-7 Capacity Planning
Importance of Capacity Decisions
 Similarly
a financial manager would
be interested in performing the financial
analysis of whether the investment
decision is justified for a plant or
capacity increase.
5-8 Capacity Planning
Importance of Capacity Decisions
 An
Information Technology Manager
would end up preparing data bases that
would aid the organization to decide about
the capacity and last but not the least an
operations manager would select strategies
that would help the organization achieve the
optimum capacity levels to meet the
customer demand.
5-9 Capacity Planning
Importance of Capacity Decisions
1.
2.
3.
4.
5.
6.
7.
8.
Impacts ability to meet future demands
Affects operating costs
Major determinant of initial costs
Involves long-term commitment
Affects competitiveness
Affects ease of management
Globalization adds complexity
Impacts long range planning
Globalization adds complexity
5-10 Capacity Planning
 Capacity
decision often involves making
a decision in a foreign country which
requires the management to know about
the political, economic and cultural
issues.
5-11 Capacity Planning

Design capacity


maximum output rate or service capacity an
operation, process, or facility is designed for
Effective capacity


Capacity
Design capacity minus allowances such as
personal time, maintenance, and scrap
Actual output

rate of output actually achieved--cannot
exceed effective capacity.
5-12 Capacity Planning
Efficiency and Utilization
Actual output
Efficiency =
Effective capacity
Actual output
Utilization =
Design capacity
Both measures expressed as percentages
5-13 Capacity Planning
Efficiency/Utilization Example
Design capacity = 50 trucks/day
Effective capacity = 40 trucks/day
Actual output = 36 units/day
Actual output
=
36 units/day
Efficiency =
= 90%
Effective capacity
Utilization =
Actual output
Design capacity
40 units/ day
=
36 units/day
50 units/day
= 72%
5-14 Capacity Planning
Key Decisions of Capacity Planning
1.
2.
3.
4.
Amount of capacity needed
Timing of changes
Need to maintain balance
Extent of flexibility of facilities
Capacity cushion – extra demand intended to offset uncertainty
The greater the degree of demand uncertainity, the greater the
amount of cushion
5-15 Capacity Planning
Steps for Capacity Planning
1.
2.
3.
4.
5.
6.
7.
8.
Estimate future capacity requirements
Evaluate existing capacity
Identify alternatives
Conduct financial analysis
Assess key qualitative issues
Select one alternative
Implement alternative chosen
Monitor results
Calculating Processing
Requirements
5-16 Capacity Planning
Standard
processing time
per unit (hr.)
Product
Annual
Demand
Processing time
needed (hr.)
#1
400
5.0
2,000
#2
300
8.0
2,400
#3
700
2.0
1,400
5,800
If annual capacity is 2000 (8hr/day*250 days *1 machine) hours, then we need
three machines to handle the required volume:
5,800 hours/2,000 hours = 2.90 machines
5-16
5-17 Capacity Planning
Planning Service Capacity

Need to be near customers


Inability to store services


Capacity and location are closely tied
Capacity must be matched with timing of
demand
Degree of volatility of demand

Peak demand periods
5-17
5-18 Capacity Planning
Make or Buy?
Available capacity. If an organization has available the equipment, necessary skills, and time, it often
makes sense to produce an item or perform a service in-house.
Expertise. If a firm lacks the expertise to do a job satisfactorily, buying might be a reasonable
alternative.
Quality considerations. Firms that specialize can usually offer higher quality than an organization
can attain itself. Conversely, unique quality requirements or the desire to closely monitor quality may
cause an organization to perform a job itself.
The nature of demand. When demand for an item is high and steady, the organization is often better
off doing the work itself. However, wide fluctuations in demand or small orders are usually better
handled by specialists who are able to combine orders from multiple sources, which results in higher
volume and tends to offset individual buyer fluctuations.
Cost. Cost savings might come from the item itself or from transportation cost savings. If there are
fixed costs associated with making an item that cannot be reallocated if the service or product is
outsourced, that has to be recognized in the analysis. Conversely, outsourcing may help a firm avoid
incurring fixed costs.
Risk. Outsourcing may involve certain risks. One is loss of control over operations. Another is the need
to disclose proprietary information.
18
http://www.baskent.edu.tr/
~kilter
Capacity Planning Based-on
Bottleneck Operation
5-19 Capacity Planning
Figure 5.2
Machine #1
Machine #2
Bottleneck operation: An operation
in a sequence of operations whose
capacity is lower than that of the
other operations
10/hr
10/hr
Machine #3
Bottleneck
Operation
10/hr
Machine #4
10/hr
5-19
30/hr
5-20 Capacity Planning
Bottleneck Operation
Bottleneck
Operation 1
20/hr.
Operation 2
10/hr.
Operation 3
15/hr.
10/hr.
Maximum output rate
limited by bottleneck
5-20
5-21 Capacity Planning
Developing Capacity Alternatives
1. Design flexibility into systems
2. Take stage of life cycle into account
3. Take a “big picture” approach to capacity
changes
4.Prepare to deal with capacity “chunks”
5. Attempt to smooth out capacity requirements
(due to random variations or seasonal variations)
6. Identify the optimal operating level
5-22 Capacity Planning
Prepare to deal with capacity “chunks.” Capacity increases are often acquired in fairly
large chunks rather than smooth increments, making it difficult to achieve a match
between desired capacity and feasible capacity.
Attempt to smooth out capacity requirements. Unevenness in capacity requirements also
can create certain problems.
22
http://www.baskent.edu.tr/
~kilter
5-23 Capacity Planning

Economies of scale


Economies of Scale
If the output rate is less than the optimal level,
increasing output rate results in decreasing
average unit costs. This results from fixed costs,
labor cost being spread over more units
Diseconomies of scale

If the output rate is more than the optimal level,
increasing the output rate results in increasing
average unit costs. Due to scheduling problems,
quality problems, reduced morale, increased use
of overtime.
5-24 Capacity Planning
Evaluating Alternatives
Figure 5.3
Average cost per unit
Production units have an optimal rate of output for minimal cost.
Minimum average cost per unit
Minimum
cost
0
Rate of output
5-25 Capacity Planning
Economies and Diseconomies of Scale
Average Unit
Cost of Output ($)
Economies
of Scale
Diseconomies
of Scale
Best Operating Level
Annual Volume (units)
Larger Plants Tend to Have
Higher Optimal Output Rates
5-26 Capacity Planning
Figure 5.4
Average cost per unit
Minimum cost & optimal operating rate are
functions of size of production unit.
0
Small
plant
Medium
plant
Large
plant
Output rate
5-27 Capacity Planning
Evaluating Alternatives

Cost-volume analysis


Break-even point
Financial analysis

Cash flow
 Present value

Decision theory
 Waiting-line analysis
 Simulation
5-27
5-28 Capacity Planning
Assumptions of Cost-Volume Analysis
1.
2.
3.
4.
5.
6.
One product is involved
Everything produced can be sold
Variable cost per unit is the same regardless
of volume
Fixed costs do not change with volume
Revenue per unit constant with volume
Revenue per unit exceeds variable cost per
unit
5-29 Capacity Planning
Cost-Volume Relationships
Amount ($)
Figure 5.5a
Fixed cost (FC)
0
Q (volume in units)
5-30 Capacity Planning
Cost-Volume Relationships
Amount ($)
Figure 5.5b
0
Q (volume in units)
5-31 Capacity Planning
Cost-Volume Relationships
Amount ($)
Figure 5.5c
0
BEP units
Q (volume in units)
5-32 Capacity Planning
Break-Even Problem with Step Fixed Costs
Figure 5.6a
3 machines
2 machines
1 machine
Quantity
Step fixed costs and variable costs.
5-33 Capacity Planning
Break-Even Problem with Step Fixed Costs
Figure 5.6b
$
BEP
3
TC
BEP2
TC
3
TC
2
1
Quantity
Multiple break-even points
5-34 Capacity Planning
Example 4: page 195
A manager has the option of purchasing one, two, or
three machines.
# of mach.
Tot. Annual FC
Correspond. Output
1
$9600
0 – 300
2
15000
301 - 600
3
20000
601 – 900
Variable cost is $10, revenue is $40 per unit.
a)
b)
Determine the break-even point for each range.
If projected demand is between 580 and 660 units, how many
machines should the manager purchase?
5-35 Capacity Planning
Example 2
a) For one machine Q = 9600/(40-10)= 320 units
For two machines Q= 15000/(40-10)= 500 units
For three machines Q=20000/(40-10)=666.67 units
b) Manager should choose two machines. Because even
if demand is at low end of the range (i.e., 580), it would
be above the break-even point and thus yield a profit. If
three machines are purchased, even at the top end of
projected demand (i.e., 660), the volume would still be
less than the break-even point for that range, so there
would be no profit.
5-36 Capacity Planning
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 flows of an investment
proposal.
5-37 Capacity Planning
Decision Tree Analysis

Structures complex, multiphase decisions
 Allows objective evaluation of alternatives
 Incorporates uncertainty
 Develops expected values
5-38 Capacity Planning
Example: Decision Tree Analysis
Good Eats Café is about to build a new
restaurant. An architect has developed three
building designs, each with a different
seating capacity. Good Eats estimates that
the average number of customers per hour
will be 80, 100, or 120 with respective
probabilities of 0.4, 0.2, and 0.4. The payoff
table showing the profits for the three
designs is on the next slide.
5-39 Capacity Planning
Example: Decision Tree Analysis

Payoff Table
Average Number of Customers Per Hour
c1 = 80 c2 = 100 c3 = 120
Design A
Design B
Design C
$10,000
$ 8,000
$ 6,000
$15,000
$18,000
$16,000
$14,000
$12,000
$21,000
5-40 Capacity Planning
Example: Decision Tree Analysis

Expected Value For Each Decision
d1
EV = .4(10,000) + .2(15,000) + .4(14,000)
= $12,600
2
Design A
1
Design B d2
EV = .4(8,000) + .2(18,000) + .4(12,000)
= $11,600
3
Design C
d3
EV = .4(6,000) + .2(16,000) + .4(21,000)
= $14,000
4
Choose the design with largest EV -- Design C.
5-41 Capacity Planning
Waiting-Line Analysis

Useful for designing or modifying service systems
 Waiting-lines occur across a wide variety of
service systems
 Waiting-lines are caused by bottlenecks in the
process
 Helps managers plan capacity level that will be
cost-effective by balancing the cost of having
customers wait in line with the cost of additional
capacity
5-41