Capacity Planning for
Products and Services
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?
When is it needed?
Importance of Capacity Decisions
1. Impacts ability to meet future demands
2. Affects operating costs
3. Major determinant of initial costs
4. Involves long-term commitment
5. Affects competitiveness
6. Affects ease of management
7. Globalization adds complexity
8. Impacts long range planning
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.
Efficiency and Utilization
Actual output
Efficiency =
Effective capacity
Actual output
Utilization =
Design capacity
Both measures expressed as percentages
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
Utilization = Actual output = 36 units/day
=
72% Design capacity 50 units/day
Determinants of Effective Capacity
Facilities
Product and service factors
Process factors
Human factors
Operational factors
Supply chain factors
External factors
Strategy Formulation
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
Key Decisions of Capacity Planning
1. Amount of capacity needed
2. Timing of changes
3. The Need to maintain balance
4. Extent of flexibility of facilities
Capacity cushion
– extra demand intended to offset uncertainty
Steps for Capacity Planning
1. Estimate future capacity requirements
2. Evaluate existing capacity
3. Identify alternatives
4. Conduct financial analysis
5. Assess key qualitative issues
6. Select one alternative
7. Implement alternative chosen
8. Monitor results
Make or Buy?
1. Available capacity
2. Expertise
3. Quality considerations
4. Nature of demand
5. Cost
6. Risk
Outsourcing: obtain a good or service from an
external provider.
Things to keep in mind when planning capacity
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
6. Identify the optimal operating level
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
Economies of Scale
Production units have an optimal rate of output for minimal cost.
Average cost per unit
Minimum average cost per unit
Minimum
cost
0 Rate of output
Economies of Scale
Minimum cost & optimal operating rate are
functions of size of production unit.
Average cost per unit
Small
plant Medium
plant Large
plant
0 Output rate
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
Cost-Volume Relationships
FC
Amount ($) +
VC
t = C )
os (V
l c st
ota co
T b le
r ia
Va
Fixed cost (FC)
0
Q (Quantity in units)
Total cost (TC) = Fixed cost (FC) + Variable cost (VC)
= Fixed cost (FC) + Unit cost (v) X Quantity
(Q)
Cost-Volume Relationships
ue
e n
e v
Amount ($) l r
t a
To
0
Q (Quantity in units)
Total revenue = Revenue per unit (R) X Quantity (Q)
Cost-Volume Relationships
u e
e n r o fit
Amount ($)
ev + P
l r
ota o s t
T t a lc
To
ss
- Lo
0 BEP Q (volume in units)
Break-even point (BEP): the quantity of output at
which total cost and total revenue are equal.
Break-Even Problem with Step Fixed Costs
Figure 5.6a
C R
=T T
3
V C 3
+
FC 3
C
=T
2
V C 2
3 machines
+
FC 2
TC
1
= 2 machines
VC
1
+
FC
1
1 machine
Quantity
Multiple break-even points
Assumptions of Cost-Volume Analysis
1. One product is involved
2. Everything produced can be sold
3. Variable cost per unit is the same regardless of
volume
4. Fixed costs do not change with volume
5. Revenue per unit constant with volume
6. Revenue per unit exceeds variable cost per unit
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.
Calculating Processing Requirements
S t a n d a r d
A n n u a pl r o c e s s i n g P t i rm o ce e s s i n g t i m e
P r o d u c D t e m a n d p e r u n i t ( h r .n ) e e d e d ( h r . )
# 1 4 0 0 5 . 0 2 , 0 0 0
# 2 3 0 0 8 . 0 2 , 4 0 0
# 3 7 0 0 2 . 0 1 , 4 0 0
5 , 8 0 0
Q: How many machines are needed? A machine operates 10 hours
per day and 250 days a year.
One machine has total processing time per year:
10 X 250 = 2500.
Number of machines needed is 5800/2500 = 2. 35
THREE machines!
Calculating Processing Requirements cont.
S t a n d a r d
A n n u a pl r o c e s s i n g P t i rm o ce e s s i n g t i m e
P r o d u c D t e m a n d p e r u n i t ( h r .n ) e e d e d ( h r . )
# 1 4 0 0 5 . 0 2 , 0 0 0
# 2 3 0 0 8 . 0 2 , 4 0 0
# 3 7 0 0 2 . 0 1 , 4 0 0
5 , 8 0 0
Q: How many machines are needed? Average utilization of a
machine is 50%.
One machine has total effective processing time per year:
10 X 250 X 50% = 1250.
Number of machines needed is 5800/1250 = 4. 7
FIVE machines!
Recap
Capacity
Capacity cushion
Economy of scale
Diseconomy of scale
Outsource
Break-even point
(BEP)
Cash flow
Present value