Ceiling on the amount of load
Capacity at NSU
Adeyl Khan, Faculty, BBA, NSU
Capacity Planning
 Capacity is the upper limit or ceiling on the load
that an operating unit can handle.
Capacity also includes
• Equipment
• Space
• Employee skills
The basic questions in capacity handling are:
• What kind of capacity is needed?
• How much is needed?
• When is it needed?
Adeyl Khan, Faculty, BBA, NSU
5-2
Importance of Capacity Decisions
 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
Adeyl Khan, Faculty, BBA, NSU
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5-3
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.
Adeyl Khan, Faculty, BBA, NSU
5-4
Efficiency and Utilization
Actual output
Efficiency =
Effective capacity
Actual output
Utilization =
Design capacity
Both measures expressed as percentages
Adeyl Khan, Faculty, BBA, NSU
5-5
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 = 40 units/ day
Actual output = 36 units/day
Utilization =
-----------------------------------
= 72%
Design capacity = 50 units/day
Adeyl Khan, Faculty, BBA, NSU
5-6
Determinants of Effective Capacity
 Facilities
 Product and service factors
 Process factors
 Human factors
 Policy factors
 Operational factors
 Supply chain factors
 External factors
Adeyl Khan, Faculty, BBA, NSU
5-7
Strategy Formulation
 Capacity strategy for long-term demand
 Demand patterns
 Growth rate and variability
 Facilities
 Cost of building and operating
 Technological changes
 Rate and direction of technology changes
 Behavior of competitors
 Availability of capital and other inputs
Adeyl Khan, Faculty, BBA, NSU
5-8
Key Decisions of Capacity Planning
 Amount of capacity needed
 Capacity cushion (100% - Utilization)
 Timing of changes
 Need to maintain balance
 Extent of flexibility of facilities
Capacity cushion – extra demand intended to offset uncertainty
Adeyl Khan, Faculty, BBA, NSU
5-9
Adeyl Khan, Faculty, BBA, NSU
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Steps for Capacity Planning
 Estimate future capacity requirements
 Evaluate existing capacity
 Identify alternatives
 Conduct financial analysis
 Assess key qualitative issues
 Select one alternative
 Implement alternative chosen
 Monitor results
Adeyl Khan, Faculty, BBA, NSU
5-11
Forecasting Capacity Requirements
 Long-term vs. short-term capacity needs
 Long-term relates to overall level of capacity such
as facility size, trends, and cycles
 Short-term relates to variations from seasonal,
random, and irregular fluctuations in demand
Adeyl Khan, Faculty, BBA, NSU
5-12
Calculating Processing Requirements
Product
Annual
Demand
#1
#2
#3
400
300
700
Standard
processing time
per unit (hr.)
5.0
8.0
2.0
Processing time
needed (hr.)
2,000
2,400
1,400
5,800
If annual capacity is 2000 hours, then we need three machines to handle the
required volume: 5,800 hours/2,000 hours = 2.90 machines
Adeyl Khan, Faculty, BBA, NSU
5-13
Planning Service Capacity
 Need to be near customers
 Capacity and location are closely tied
 Inability to store services
 Capacity must be matched with timing of demand
 Degree of volatility of demand
 Peak demand periods
Adeyl Khan, Faculty, BBA, NSU
5-14
In-House or Outsourcing
 Available capacity
 Expertise
 Quality considerations
 Nature of demand
 Cost
 Risk
Outsource: obtain a good or service
from an external provider
Adeyl Khan, Faculty, BBA, NSU
5-15
Developing Capacity Alternatives
 Design flexibility into systems
 Take stage of life cycle into account
 Take a “big picture” approach to capacity changes
 Prepare to deal with capacity “chunks”
 Attempt to smooth out capacity requirements
 Identify the optimal operating level
Adeyl Khan, Faculty, BBA, NSU
5-16
Bottleneck Operation
Machine #1
Machine #2
10/hr
10/hr
Machine #3
Bottleneck
Operation
30/hr
10/hr
Machine #4
Adeyl Khan, Faculty, BBA, NSU
Bottleneck operation: An operation
in a sequence of operations whose
capacity is lower than that of the
other operations
10/hr
Figure 5.2
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Machine Type
A
B
C
D
40
200
200
40
120
40
Adeyl Khan, Faculty, BBA, NSU
40
F
50
200
200
E
120
50
700
50
700
50
700
50
Bottleneck Operation
Bottleneck
Operation 1
20/hr.
Operation 2
10/hr.
Operation 3
15/hr.
10/hr.
Maximum output rate
limited by bottleneck
Adeyl Khan, Faculty, BBA, NSU
5-19
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
 Diseconomies of scale
 If the output rate is more than the optimal level,
increasing the output rate results in increasing
average unit costs
Adeyl Khan, Faculty, BBA, NSU
5-20
Optimal Rate of Output
Average cost per unit
Production units have an optimal rate of output for minimal cost.
Minimum average cost per unit
Minimum
cost
0
Figure 5.4
Adeyl Khan, Faculty, BBA, NSU
Rate of output
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Economies of Scale
Average cost per unit
Minimum cost & optimal operating rate are
functions of size of production unit.
Figure 5.5
Adeyl Khan, Faculty, BBA, NSU
0
Small
plant
Medium
plant
Large
plant
Output rate
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Evaluating Alternatives
 Cost-volume analysis
 Break-even point
 Financial analysis
 Cash flow
 Present value
 Decision theory
 Waiting-line analysis
Adeyl Khan, Faculty, BBA, NSU
5-23
Amount ($)
Amount ($)
Cost-Volume Relationships
Fixed cost (FC)
0
0
Q (volume in units)
Figure 5.6
Adeyl Khan, Faculty, BBA, NSU
Q (volume in units)
5-24
Amount ($)
Cost-Volume Relationships
0
BEP units
Q (volume in units)
Figure 5.6c
Adeyl Khan, Faculty, BBA, NSU
5-25
BEP Problem with Step Fixed Costs
3 machines
2 machines
Figure 5.7a
1 machine
Quantity
Step fixed costs and variable costs.
Adeyl Khan, Faculty, BBA, NSU
5-26
BEP Problem with Step Fixed Costs
$
BEP
3
TC
BEP2
TC
3
TC
2
1
Figure 5.7b
Quantity
Multiple break-even points
Adeyl Khan, Faculty, BBA, NSU
5-27
Assumptions of Cost-Volume Analysis
 One product is involved
 Everything produced can be sold
Simple Solution
to our Capacity
Problem?
 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
Adeyl Khan, Faculty, BBA, NSU
5-28
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.
Adeyl Khan, Faculty, BBA, NSU
5-29
Decision Theory
 Helpful tool for financial comparison of alternatives
under conditions of risk or uncertainty
 Suited to capacity decisions
 See Chapter 5 Supplement
Adeyl Khan, Faculty, BBA, NSU
5-30
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
Adeyl Khan, Faculty, BBA, NSU
5-31
Chapter 5
Example 4
 Purchase 1, 2 or 3 machines
 Variable cost 10/unit
 Revenue 40/piece
 BEP for each range?
 Demand 580-660, how many to buy?
Adeyl Khan, Faculty, BBA, NSU
No. of
Machines
Total Annual Corresponding
Fixed Cost
range of output
1
9600
0-300
2
15000
301-600
3
20000
601-900
32
 QBEP = FC/(R-v)
 QBEP = $9600/($40/unit -$10/unit) = 320 unit
 QBEP = $15000/($40/unit -$10/unit) = 500 unit
 QBEP = $20000/($40/unit -$10/unit) = 666.67 unit
 Answer part B
 Demand 580-660, how many to buy?
Adeyl Khan, Faculty, BBA, NSU
No. of
Machines
Total Annual Corresponding
Fixed Cost
range of output
1
9600
0-300
2
15000
301-600
3
20000
601-900
33
Adeyl Khan, Faculty, BBA, NSU
34
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
Adeyl Khan, Faculty, BBA, NSU
5-35