CAPACITY PLANNING

• When looking at capacity, operations managers need to look at both resource inputs and product outputs. The reason is that, for planning purposes, real (or effective) capacity depends on what is to be produced.– For example, a firm that makes multiple products

inevitably can produce more of one kind than of another with a given level of resource inputs.

– Thus while the managers of an automobile factory may state that their facility has 10,000 labor hours per available per year, they are also thinking that these labor hours can be used to make either 50,000 two-door cars or 40,000 four-door models, or some other mix.

• Dictionary definition of capacity is “the ability to hold, receive, store, or accommodate”.

• In a general business sense, capacity is most frequently viewed as the amount of output that a system is capable of achieving over a specific period of time.– Service: Number of customers handles in a time

period– Manufacturing: Number of cars per shift

• An operations management view also emphasizes the time dimension of capacity. That is, capacity must also be stated relative to some period of time.

• Finally, capacity planning itself has different meaning to individuals at different levels within the operations management hierarchy:– Vice President, Operations: Aggregate capacity of all the

factories within the firm. Concern relates mainly to financial resources required to support these factories.

– Plant Manager: Capacity if the individual plant. PM must decide how best to use this capacity to meet the anticipated demand for products.

– The first-level supervisor is concerned with capacity of the equipment and staff mix in his department.

• Capacity is relative term; in an operation management context, it may be defined as the amount of resource inputs available relative to output requirements over a period of time.– Note that this definition makes no distinction

between efficient and inefficient use of capacity.

• The objective of strategic capacity planning is to provide an approach for determining the overall capacity level of capital-intensive resources – facilities, equipment, and overall labor force size – that best supports the company’s long-range competitive strategy.

• The capacity level selected has critical impact on the firm’s :– Response rate– Cost structure– Inventory policies– Management– Staff requirements

– If capacity is inadequate, a company may lose customers through slow service or by allowing competitor’s to enter the market.

– If capacity is excessive, a company may have to reduce prices to stimulate demand; underutilize its workforce; carry excess inventory; seek additional, less profitable products to stay in business.

Capacity Planning Concepts• The term capacity implies attainable rate of

output such as 300 cars per day, for example, says nothing about how long that rate can be sustained. – Thus we do not know if this 300 cars per day is one-

day peak or a six-month average.• To avoid this problem, the concept of “Best

Operating Level” is used.– This is the level of capacity for which the process was

designed and thus is the volume of output at which average cost per unit is minimized.

• Determining the best operating level is difficult because it involves a complex trade-off between the allocation of fixed overhead costs and the cost of overtime, equipment wear, defect rate, and other costs.

• An important measure is the capacity utilization rate, which reveals how close a firm is to its best operating point (that is, design capacity).

Capacity utilization rate = (Capacity used/Best operating level)

Capacity Planning• Three important issues that must be

considered when adding capacity are:1. Maintaining system balance2. Frequency of capacity addition3. Use of external capacity

1. Maintaining system balance:– In a perfectly balanced plant, the output of stage 1

provides the exact input requirement for stage 2. Stage 2’s output provides the exact input requirement for stage 3 and so on.

– In practice, however, achieving such a perfect design is not possible. One reason is that best operating levels of each stage generally differ.

– There are various ways of dealing with imbalance:• Add capacity to stages that are bottlenecks. This can be

done by temporary measures such as overtime, leasing equipment, or purchasing additional capacity through subcontracting.• Use buffer inventories in front of the bottlenecks stage

to ensure that it always has something to work on.

2. Frequency of Capacity Additions– There are two types of costs to consider when

adding capacity:• The cost of upgrading too frequently

– Upgrading capacity too frequently is expensive. » Direct cost include removing and replacing old equipment

and training employees on the new equipment. » In addition the new equipment must be purchased, often

for considerable more than the selling price of the old. » Finally, there is the opportunity cost of idling the plant or

service site during the changeover period.

• Cost of upgrading infrequently– Upgrading capacity too infrequently is also expensive– Infrequent expansion means that capacity is purchased in

chunks. Any excess capacity that is purchased must be carried as overhead until it is utilized.

Small chunk Large chunk

Frequent expansionInfrequent expansion

YEARS

VOLUME

3. External Sources of Capacity– In some cases, it may be cheaper not to add

capacity at all, but rather to use some existing external source of capacity.

– Two common strategies used by organizations are outsourcing and sharing capacity.

Determining Capacity Requirements• In determining capacity requirements, we must address

the demands of:– Individual product lines– Individual plant capacities– Allocation of production throughout the plant network

• Typically capacity determination is done according to the following steps:1. Use forecasting techniques to predict sales for individual

products within each product line (outputs).2. Calculate equipment and labor requirements to meet the

product line forecasts (inputs)3. Project equipment and labor availabilities over the planning

horizon (capacity).

– Often the firm then decides on some capacity cushion that will be maintained between the projected requirements and the actual capacity.

– A capacity cushion is an amount of capacity in excess of expected demand. • For example, if the expected annual demand on a

facility is $10 million in products per year and the design capacity is $12 million per year, it has a 20% capacity cushion. A 20% capacity cushion equates to an 83% utilization rate (100%/120%).• When a firm’s design capacity is less than the capacity

required to meet its demand, it is said to have a negative capacity cushion.

Determining Capacity Requirements:The Whitening Company produces two varieties of detergents: Sirf & ExSirf. Each is available in bags and single-serving pouches. Management would like to determine equipment and labor requirements for the next five years.

• Step 1: Use forecasting techniques to predict sales for individual products within each product line.

• The marketing department, which is now running a promotional campaign for ExSirf, provided the following forecast demand values (in thousands) for the next five years. The campaign is expected to continue for the next two years.

Years

1 2 3 4 5

Sirf

Bags (000s) 60 100 150 200 250

Pouches (000s) 100 200 300 400 500

ExSirf

Bags (000s) 75 85 95 97 98

Pouches (000s) 200 400 600 650 680

• Step 2: Calculate the equipment and labor requirements to meet product line forecasts.– Currently , 3 machines can package up to 150,000 bags each per year

are available.– Each machine require 2 operators and can produce bags of Sirf and

ExSirf. • 6 bag machine operators are available.

– 5 machines that can package up to 250,000 pouches each per year are available.

– 3 operators are required for each machine, which can produce pouches of both Sirf and ExSirf. • Currently, 20 pouching machine operators are available.

• The total product line forecasts can be calculated from the preceding table by adding the yearly demand for bags and pouches as follows:

• We can now calculate equipment and labor requirements for the current year (year 1).

• Because the total capacity for bags available for the current year is 450,000/year (3 machines x 150,000 each), we will be using 135/450 = 0.3 of the available capacity for the current year, or 0.3 x 3 = 0.9 machine.

• Similarly, we will need 300/1250 = 0.24 of the available capacity for pouches for the current year, or 0.24 x 5 = 1.2 machines

• The number of crew required to support our forecast demand for the first year will consist of the crews required for the bags and the pouch machines.

Years

1 2 3 4 5

Bags (000s) 135 185 245 297 348

Pouches (000s) 300 600 900 1050 1180

• The labor requirement for year 1’s bag operation is :0.9 bag machine x 2 operators = 1.8 operators1.2 pouch machine x 3 operators = 3.6 operators

Step 3: Project labor and equipment availabilities over the planning horizon. We repeat the preceding calculations for the remaining years:

Years

1 2 3 4 5

POUCH OPERATION

% capacity utilized 24% 48% 72% 84% 94%

Machine requirement 1.2 2.4 3.6 4.2 4.7

Labor requirement 3.6 7.2 10.8 12.8 14.1

BAG OPERATION

% capacity utilized 30% 41% 54% 66% 77%

Machine requirement 0.9 1.23 1.62 1.98 2.31

Labor requirement 1.8 2.46 3.24 3.96 4.62

• A positive cushion exists for all five years because the available capacity for both operations always exceeds expected demand.

• The whitening company can now begin to develop the intermediate-range or sales and operations plans for the two production lines.

USING DECISION TREES TO EVALUATE CAPACITY ALTERNATIVES

• A convenient way to lay out the steps of a capacity problem is through the use of decision trees. The tree format helps not only in understanding the problem but also in finding a solution.

• A decision tree is a schematic model of the sequence of steps in a problem and the conditions and consequences of each step.

• Decision trees are composed of decision nodes and chance events.– Squares to represent decision nodes– Circles to represent chance event

• Branches from decision points show the choices available to the decision maker; branches from chance events show the probabilities for their occurrence.

• ExampleThe owner of Hackers Computer Store is considering what to do with his business over the next 5 years. Sales growth over the past couple of years has been good, but sales could grow substantially if a major electronics firm is built in his area as proposed. Hacker’s owner sees three options. The first is to enlarge his current store, the second is to locate at a new site, and the third is to simply wait and do nothing. The decision to expand or move would take little time, and therefore, the store would not lose revenue. If nothing is done the first year and strong growth occurred, then the decision to expand would be reconsidered. Waiting longer than one year would allow competitors to move in and would make expansion no longer feasible.

• The assumptions and conditions are as follows:1. Strong growth as a result of the increased population of computer

fanatics from the new electronics firm has a 55% probability.2. Strong growth with a new site would give annual returns of

Rs.195,000 per year. Weak growth with a new site would mean annual returns of only Rs.115,000.

3. Strong growth with an expansion would give annual returns of Rs.190,000 per year. Weak growth with an expansion would mean annual returns of Rs.100,000

4. At the existing store with no changes, there would be returns of Rs.170,000 per year if there is strong growth and Rs.105,000 per year if growth is weak.

5. Expansion at the current site would cost Rs.87,000.6. The move to new site would cost Rs.210,0007. If growth is strong and the existing site is enlarged during the second

year, the cost would still be Rs.87,000.8. Operating costs for all options are equal.

Hacker’s Computer Store

Move

Expand

Do Nothing

Strong growth

Weak growth

Strong growth

Strong growth

Weak growth

Weak growth

0.55

0.55

0.55

0.45

0.45

0.45

Revenue-Move_Cost = 195,000 x 5 -210,000

Revenue-Move_Cost = 115,000 x 5 -210,000

Revenue-Expansion_Cost = 190,000 x 5 -87,000

Revenue-Expansion_Cost = 100,000 x 5 -87,000

Revenue-Expansion_Cost =170,000 + (190,000 x 4 -87,000)

Revenue

Expand

Do nothing

Hacker’s Computer Store

Move

Expand

Do Nothing

Strong growth

Weak growth

Strong growth

Strong growth

Weak growth

Weak growth

0.55

0.55

0.55

0.45

0.45

0.45

Revenue-Move_Cost =Rs.765,000

Revenue-Move_Cost = Rs.365,000

Revenue-Expansion Cost = Rs.863,000

Revenue-Expansion_Cost = Rs.413,000

Revenue-Expansion_Cost = Rs.843,000

Revenue-Expansion_Cost = Rs.850,000

Revenue = Rs.525,000

Rs.585,000

Rs.660,000

Rs.703,750

Do nothing; Rs.850,000