Strategic Capacity
Planning for
Products and
Services
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
 Capacity
 The upper limit or ceiling on the load that an operating
unit can handle
 Capacity needs include
 Equipment
 Space
 Employee skills
Instructor Slides
5-2
Strategic Capacity Planning
 Goal
 To achieve a match between the long-term supply
capabilities of an organization and the predicted level
of long-run demand
 Over-capacity operating costs that are too high
 Under-capacity strained resources and possible loss of
customers
Capacity
Design capacity

maximum output rate or service capacity an operation, process, or
facility is designed for
Effective capacity

Design capacity minus allowances such as personal time,
maintenance, and scrap
Actual output


rate of output actually achieved
Cannot exceed effective capacity.
Measuring System Effectiveness
 Efficiency
 Utilization
actual output
Efficiency 
effective capacity
actual output
Utilization 
design capacity
Measured as percentages
Example– Efficiency and Utilization P. 197
 Design Capacity = 50 trucks per day
 Effective Capacity = 40 trucks per day
 Actual Output = 36 trucks per day
actual output
36
Efficiency 

 90%
effective capacity 40
actual output
36
Utilizatio n 

 72%
design capacity 50
Capacity Cushion
 Capacity Cushion
 Extra capacity used to offset demand uncertainty
 Capacity cushion = 100% - Utilization
 Capacity cushion strategy
 Organizations that have greater demand uncertainty
typically have greater capacity cushion
 Organizations that have standard products and services
generally have smaller capacity cushion
Example 2, P 202
A center works one shift (8-hr shift), 250 days a
year, and these figures for a machine that is
current being considered:
Annual
Stand Processing
Processing
Product
Demand Time per Unit (hr) Time Needed
#1
400
5
5 x 400=2000
#2
300
8
8 x 300=2400
#3
700
2
2 x 700=1400
Total: 5800
Example 2, P. 202 (Cont’d)
How many machines do we need to
handle the required volume?
Total Requires 5800 Hrs
8 Hrs/day x 250 days/Yr
5800Hrs

 2.9 machines
2000Hrs
In-House or Outsource?
 Once capacity requirements are determined, the
organization must decide whether to produce a good or
service itself or outsource
 Factors to consider:
 Available capacity
 Expertise
 Quality considerations
 The nature of demand
 Cost
 Risks
Bottle Neck Operation
Complementary Demand Patterns
Average cost per unit
Optimal Operating Level
Minimum
cost
Optimal
Output
Rate
Rate of output
Average cost per unit
Minimum cost & optimal operating rate are
functions of size of production unit.
Small
plant
Medium
plant
Large
plant
Output rate
Instructor Slides
5-14
Cost-Volume Analysis
 Cost-volume analysis
 Focuses on the relationship between cost, revenue, and
volume of output
 Fixed Costs (FC)
 tend to remain constant regardless of output volume
 Variable Costs (VC)
 vary directly with volume of output
 VC = Quantity(Q) x variable cost per unit (v)
 Total Cost (TC)
 TC = FC+VC=FC+Q x v
 Total Revenue (TR)
 TR = revenue per unit (R) x Q
Cost-Volume Relationships
Break-Even Point (BEP)
 BEP
 The volume of output at which total cost and total
revenue are equal
 Profit (P) = TR – TC = R x Q – (FC +v x Q)
Profit (P) = Q(R – v) – FC
Q profit
P  FC

Rv
QBEP
FC

Rv
Example 3: P. 211
If FC=$6000/Month, VC=$2/pie, Price=$7/pie
 How many pies must be sold to Break Even?
QBEP
FC
6000


 1200 Pies / Month
Re venue  VC 7  2
 If 1000 pies sold in a month, What would be the
profit or loss?
Profit=TR-TC=$7(1000)-($6000+$2x1000)= -$1000
Loss $1000
Example 3: P. 211 (Cont’d)
 How many pies must be sold for a profit of $4000?
QPr ofit
Pofit  FC 4000  6000


 2000 Pies
R V
72
 If 2000 pies can be sold, a profit goal is $5000, what price
should be charged per pie?
Profit = Q(R-v) – FC
5000 = 2000(R – 2) – 6000
5000 = 2000R – 4000 – 6000
2000R= 15000
R = $7.50, Price = $7.50
Example 4: P. 212
 A manager has the option of purchasing 1,2, or 3
machines. Fixed costs & potential volumes are as
follows:
# Machines Annual FC
Range of Output
1
$ 9,600
0 to 300
2
15,000
301 to 600
3
20,000
601 to 900
VC=$10/unit Revenue=$40/unit
Example 4: P. 212 (Cont’d)
 Determine the break-even point for each range.
1 Machine Q(Bep)= 9600/(40-10)=320units (not in range)
2 Machine Q(Bep)=15000/(40-10) =500units
3 Machine Q(Bep)=20000/(40-10)=666.7units

If projected annual demand is between 580 and
660 units, how machines should the manager
purchase?
Manager should choose 2 machines
Make or Buy
 Available Capacity
 Quality Consideration
 Nature of Demand
 Cost
Example 5: Make or Buy
Annual FC
VC/Unit
Annual Volume
MAKE
$150000
$60
12000 units
P. 216
BUY
0
$80
12000 units
 Annual Cost of each alternative:
TC = FC + VC x Q
TCMake=$150000 +$60x12000=$870,000
TCBuy = 0
+$80x12000=$960,000
Alternative Make is better
Example 5: Make or Buy P. 216 (Cont’d)
 There is a possibility that volume could change in the future.
What would be Indifferent Volume between Making & Buying?
TCMake = TCBuy
FC +V*Q = FC+V*Q
150000+60Q = 0 +80Q
150000=80Q - 60Q = 20Q
Q = 7500 units
If Volume >= 7500 units, Choose MAKE
If Volume <= 7500 units, Choose BUY