Capacity strategy
Some factors influencing the overall
level of capacity
Availability of
capital
Forecast
level of
demand
Cost structure
of capacity
increment
OPERATIONS
RESOURCES
Changes in
future
demand
Overall level of
MARKET
capacity
REQUIREMENTS
Uncertainty
of future
demand
Economies
of scale
Flexibility of
capacity
provisions
Consequences
of over/undersupply
Capacity strategy issues include…..
NUMBER OF
SITES
CAPACITY OF
EACH SITE
ALLOCATION
OF TASKS
TO EACH SITE
LOCATION OF
EACH SITE
LONG-TERM
CAPACITY
CHANGE
STRATEGY
Importance of capacity strategy
Capacity is regarded by some people as a particularly
‘dry’ subject. The reality is very different.
 Not only is the idea of capacity at the very heart of
what operations management is about, the failure to
get capacity decisions right in the long-term (or in
the short-term for that matter) can be dramatic and
sometimes disastrous.
 Not only that, but also there are always examples of
capacity strategy in the press.
 News stories that look at location decisions,
reducing capacity by reducing the number of jobs in a
firm, being surprised by the volume of demand,
getting forecasts hopelessly wrong and so on, can all
be exploited to illustrate aspects of capacity strategy.

Capacity can be considered as:
Strategic capacity
Strategic capacity (contd.)
Strategic capacity (contd.)
Strategic capacity (contd.)
Questions
NUMBER OF SITES and
CAPACITY OF SITES
LOCATION
OF SITES
Options
Many small sites?
Few larger sites?
Supply side dominated?
Demand side dominated?
ALLOCATION OF TASKS
TO SITES
All sites make all products/services?
LONG-TERM CAPACITY
CHANGE STRATEGY
Capacity leads demand?
Each site focuses on a few products/
services?
Capacity lags demand?
Why is capacity strategy important?
Without an appropriate capacity
strategy, operations will always be
struggling to supply markets in a
competitive manner
Getting capacity strategy right is the
starting point for developing
competitive operations
Why is capacity strategy important?
Without an appropriate capacity
strategy, operations will always be
struggling to supply markets in a
competitive manner
Getting capacity strategy right is the
starting point for developing
competitive operations
How should one judge a capacity
strategy ?
NUMBER
OF SITES
CAPACITY
OF EACH
SITE
ALLOCATION
OF TASKS
TO SITES
Costs
LOCATION
OF EACH SITE
LONG-TERM
CAPACITY
CHANGE
STRATEGY
What performance
measures will all
these decisions
have a major
impact on?
Revenues
Cash
requirements
Service levels
The 4 V’s of capacity
Three levels of capacity decisions
Key points in capacity strategy




How we manage capacity in the longer term is influenced by
both market and operations resource factors.
The idea of the break-even point is hugely important.
Profitability and volume are not always related in a
straightforward manner.
The idea of economies of scale and diseconomies of scale
apply to all types of operations. In particular, diseconomies of
scale are a function of customer perception as well as
straightforward cost implications of scale.
Various decisions that make up a capacity strategy are
interrelated. In particular, the idea of how many sites, how big
each site should be, whether it should be specialist or
generalist and its location, are all connected.
Key points in capacity strategy






The dynamics of capacity change are as
important as a static analysis.
As volume changes, capacity must also change.
Making changes that are too early, too late or of
the wrong magnitude can all have serious
consequences.
Location is becoming a particularly important
decision.
The economies of location in many industries
are changing fundamentally.
Easier communication and globalised industries
mean that the number of location options
available is now often very great.
Some factors influencing the number
and size of sites
Economies of
scale
Required
service level
OPERATIONS
RESOURCES
Supply
costs
Size and number
MARKET
of sites
REQUIREMENTS
Geographical
distribution
of demand
Different approaches to location are
taken by different types of business
Cost, volume, profit
illustration
12
Costs / Revenue
($)
10
8
Cost
6
4
Revenue
2
0
0
2
4
6
Volume in
thousands of units
8
10
12
Forecast demand
= 9,000 units
Unit cost curve
Unit cost (total cost / volume)
(a)
8
6
Nominal
capacity limit
4
2
0
0
1
2
4
3
Volume in thousands of units
5
6
Unit cost curve
Unit cost (total cost/volume)
(b)
8
6
Diseconomies
of scale kick in
4
2
0
0
1
2
4
3
Volume in thousands of units
5
6
Economies of scale

Generally, the cost (Cy) of providing
capacity in one increment of size y is
given by
Cy = Kyk,
 Where K is a constant scale factor and k
is a factor which indicates the degree of
economies of scale for the technology
involved (usually between 0.5 and 1.0)

Exploiting economies of scale




When Ford took over the car-making division of Sweden’s
Volvo for $6.45 billion, it made relatively little difference to
Ford’s overall size.
Volvo’s modest output of less than 400,000 cars per year was
tiny by world standards. Yet the effect on Volvo’s ability to
compete was significant.
Even in the short term, cost savings could come from tapping
into Ford’s logistics and purchasing functions. Ford’s logistics
network in the USA could easily cope with Volvo’s products
and the United States was Volvo’s biggest market.
Similarly with purchasing: although Volvo had its own platform
designs, even in the short term, it could substitute some of
Ford’s components which it bought from specialist suppliers.
Changes in demand
Long-term demand lower than shortterm demand
 Short-term demand lower than long-term
demand
 Decision varies with circumstances

Expanding physical capacity in advance of effective
capacity can bring greater returns in the longer term
Physical
capacity of
facilities
Demand
Effective capacity
Time
Expanding physical capacity in advance of
effective capacity can bring greater returns in the
longer term Cash flow with
extended physical
capacity
Cash flow with two identical
capacity increments
Time
Some factors influencing the location of
sites
Resource
costs
Required
service level
Land and
facilities
investment
Suitability of
site
OPERATIONS
RESOURCES
Location of
sites
MARKET
REQUIREMENTS
Image of
location
Resource
availability
Community
factors
Location decisions
We could try contrasting the different
approaches to location taken by different
types of business.
 For example, we could compare the location
decision facing a company wishing to build a
new factory in a region, with a fast-food
restaurant looking for a location in a town
where it has no existing outlets.
 The idea here is to contrast two very different
types of location decision.

The new factory location
The new factory location would follow the ideas as
set out in the chapter.
 These tend to assume that location is being chosen
primarily on the grounds of minimizing the costs
associated with the site.
 The amount of products sold by the company is
unlikely to be very much affected by its location, but
its costs could be very much affected by location
factors.
 Furthermore, there are likely to be a very large
number of sites that the company could choose
from.

The fast food restaurant







The fast-food restaurant, on the other hand, involves a
different sort of location decision.
Both revenue and costs will be affected by the location.
Locating the restaurant away from other restaurants and/or
away from passing trade is likely to mean a reduction in
revenue.
Some locations are better than others at attracting
customers.
Also, the costs of the location (such as rent, rates etc.) are
affected by location.
Finally, there are rarely a large number of options to choose
the location from. Usually location is more opportunistic.
The fast-food restaurant might wait until a site becomes
available and then take the decision as to whether to have
that site or to wait in case a better one becomes available.
The cost breakdown of a shirt made in
various countries and sold in France
15.55€
France
14.33€
Portugal
Turkey
11.43€
Thailand
11.43€
Labour
11.13€
Morocco
Transport
10.82€
Romania
China
Fabric
10.37€
Supplies
Customs duties
9.60€
Myanmar
0
2
4
8
6
Cost in euros
10
12
14
16
Source: Slack, N., Chambers, S. and Johnston, R. (2007) Operations Management, 5th edn. Harlo
Some factors influencing the timing of
capacity change
Lead-time of
capacity
change
Ability to
cope with
change
Forecast
level of
demand
Competitor
activity
OPERATIONS
RESOURCES
Overall level of
MARKET
capacity
REQUIREMENTS
Uncertainty
of future
demand
Economies
of scale
Required level
of service
2,400
Volume (Units / week)
2,000
Capacity plans for meeting demand
using either 800- or 400-unit capacity
plan using
plants Capacity
800-unit plants
Capacity plan
using 400-unit
plants
Demand
1,600
1,200
800
400
Time
Smaller-scale capacity increments allow the capacity
plan to be adjusted to accommodate changes in
plan using
demandCapacity
800-unit plants
2,400
Volume (Units/week)
2,000
Capacity plan
using 400-unit
plants
Forecast demand
Actual demand
1,600
1,200
800
400
Time
Rarely does each stage of a supply chain have
perfectly balanced capacity because of different
optimum capacity increments
Current capacity
= 1,010 units
Current capacity
= 1,000 units
Current capacity
= 900 units
Current capacity
= 1,100 units
Required new
capacity
= 1,800 units
Required new
capacity
= 1,800 units
Required new
capacity
= 1,800 units
Required new
capacity
= 1,800 units
Capacity increment
800 units
Capacity increment
600 units
Capacity increment
Operating cost
Distribution
Operating cost
Warehouse
Operating cost
Assembly
plant
Operating cost
Parts
manufacture
Capacity increment
Cost, volume, profit illustration
Costs / Revenue ($)
10
8
Cost
6
4
Revenue
2
0
0
2
4
6
8
Volume in thousands of units
Forecast demand = 9,000 units
12
10
12
Strategies for expanding long-term
capacity
The three options …..
Demand
Capacity
Time Time
Demand
Capacity
Time
Demand
Capacity
Time
The advantages and disadvantages of
pure leading, pure lagging and
smoothing with inventories strategies
of capacity timing
Capacity-leading strategy
Capacity-lagging strategy
Smoothing-with-inventories strategy
Output
Capacity planning with certain forecasts and
capacity introduction
Planned
capacity
Forecast
demand
Time
Capacity
increment
1
Capacity
increment
2
Capacity
increment
3
Capacity
increment
4
Decision tree for simple capacity expansion
example
$10m
A
$3m
$5m
B
$5m
Decision tree for
two-year analysis
$32m
$18m
C
$24m
$24m
A
$15m
$8m
D
$17m
$9m
$18m
$18m
E
$8m
$8m
B
$18m
$14m
F
$8m
$8m