Strategic Capacity ManagementCapacity Management in Operations:

A definition of capacity is “ the ability to hold, receive, storeor accommodate.” In a general business sense, it is most frequently viewed as the amount of output that a system is capable of achieving over a specific period of time.

When looking at capacity, operations managers needto 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. An operations management view also emphasizes the time dimensions ofcapacity. That is, capacity must also be stated relative to some period of time. ( Refer the chart “Time Horizons for Capacity Planning”)

Capacity planning itself has different meaning to individuals at different levels within the operations management hierarchy.

Capacity is a relative term; in an operations managementcontext, it may be defined as the amount of resource inputsavailable relative to output requirements over a particular period of time.The federal Bureau of Economic Analysis defines as maximum practical capacity ‘that output attained withinthe normal operating schedule of shifts per day and days per week including the use of high-cost inefficient facilities.’

Time Horizons for Capacity PlanningLong-range – greater than one year. Where productive resources take a long time to acquire or dispose of, long-range capacityplanning requires top management participation and approvalIntermediate range – monthly or quarterly plans for the next 6 to 18 months. Capacity may be varied by alternatives as hiring, layoffs, newtools, minor equipment purchases, and sub-contracting.Short range – less than one month. This is tied into daily or weekly scheduling process and involves making adjustments to eliminate the variances between planned and actual output. This include overtime,personnel transfers, and alternative production routings.

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’slong range competitive strategy.

Capacity Planning ConceptsThe term capacity implies an attainable rate of output. The best operating level is the level for which the process was designed and thus is the volume of output at which average cost is minimized. (use of LPP )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 levelThe capacity utilization rate is expressed as a percentageand requires that the numerator and denominator be measured in the same units and time periods.

Economies and Diseconomies of ScaleThe basic notion of economies of scale is that as a plant getslarger and volume increases, the average cost per unit of output drops. This is partially due to lower operating and capital cost, as a piece of equipment with twice the capacityof another piece typically does not cost twice as much to purchase or operate. Plants also gain efficiencies when theybecome large enough to fully utilize dedicated resources fortasks such as material handling, computer equipment, andadministrative support personnel.However, at some point, the size of plant become too large

and diseconomies of scale become a problem. These diseconomies may surface in many different ways. Forexample, maintaining the demand required to keep the large facility may require significant discounting of theproduct. In many cases, the size of a plant may be influenced by factors other than the internal equipment, labor, and other

capital expenditures. A major factor may be the cost of transport raw materials and finished products to and fromthe plant.

The expenditure CurveA well-known concept is the experience curve. As plants produce more, they gain experience in the best productionmethods, which reduce their costs of production in apredictable manner. Every time a plant’s cumulative production doubles, its production costs decline by a specific percentage depending on the nature of the business.The experience curve percentage varies across industries.

It is to be noted that sales volume becomes animportant issue in achieving cost savings. If the firm has a90 % experience curve, costs will fall to 90% of the variablecost, when accumulated production reaches double the volume. Refer the chart of a 70 percentage experiencecurve.

The Experience Curve Note Costs per unit produced fall by a specific percentage each time

cumulative production doubles. This relationship can be expressed through a linear scale as shown below of a 70 % learning curve

300

Cost 250or price 200perunit 150

100

0 400 800 1200 1600 Total accumulated production of units

Where Economies of Scale Meet The Experience CurveLarger plants can have a two-way cost advantage over theircompetitors . Not only does a larger plant gain from economies of scale, but also produce more, giving it experience curve advantage as well. Companies often use this dual advantage as a competitive strategy by first building a large plant with substantial economies of scale, and then using its lower costs to price aggressively and increase sales volume. The increased volume moves down the experience curve more quickly than competitors, allowing the company to lower prices further, gaining still more volume. However, two criteria must be met for this strategy to succeed:

1. The product must fit customers’ needs, and2. The demand must be sufficiently large to support the volume.

Capacity Focus The concept of the focused factory holds that a production facility works best when it focuses on a fairly limited set of production objectives. This means that a firm should not expect to excel in every aspect of manufacturing performance: cost, quality, new product introductions, reliability, short lead times, and low investment. Rather, itshould select a limited set of tasks that contribute the most to corporate objectives. The capacity focus concept can be operationalized throughthe mechanism of plants within the plants-or PWPs, eachof which may have separate sub-organizations, equipment and process policies, workforce management policies, production control methods, etc. even if they are under thesame roof. This, in effect, permits finding the best operatinglevel for each department of the organization and therebycarries the focus concept down to the operating level.

Capacity FlexibilityIt means having the ability to rapidly increase or decrease production levels, or to shift production capacity quickly from one product or service to another. Such flexibility is achieved through flexible plants, processes, and workers,as well as through strategies that use the capacity of other organizations. Flexible plants : zero – change over – timeFlexible processes: Easily set up equipment and flexible

manufacturing systems. They permit rapid low-cost switching from one product line to another, enabling what are referred to as economies of scope.

Flexible workers: They have multiple skills and the ability to switch easily from one kind of task to

another. This require broader training and need managers and staff support to

facilitate quick changes in their work.

Capacity PlanningConsiderations in Adding Capacity:1. Maintaining System BalancesPerfect balance amongst the stages is usually impossible and undesirable. The reason is that the best operating levelfor each stage generally differ.

There are various ways of dealing with imbalance. a) To add capacity to stages that are bottlenecksb) To use buffer inventories in front of the bottleneck stagec) To involve duplicating the facilities of one department

on which another depends2. Frequency of Capacity AdditionsTwo types of costs to add the capacity- the cost of upgradingand upgrading too frequently. The costs include removal and replacing old equipmentand training employees. Cost is higher than old machinery.Opportunity cost of idling the plant or service site duringthe changeover period.

Conversely, upgrading capacity infrequently is also expensive.3. External Sources of CapacityTwo common strategies- Outsourcing and sharing capacity

Determining Capacity RequirementsThis is done according to the following steps:1. To predict sales for individual products within each product line.2. Calculate equipment and labor requirements to meet product line forecast.3. Project labor and equipment availabilities over the planning horizon.Often the firm then decides on some capacity cushion that

will be maintained between the projected requirementsand the actual capacity. A capacity cushion is an amount of capacity in excess of expected demand and when it is less than than the capacityto meet the demand, then it is negative capacity cushion.

Example:Product: Sprinklers; three types of sprinklers available in both bronze and plastic: (0 degree, 180 degree and 360 degree. 4 operators for plastic and 6 operators for bronze are available.

Forecast for the next four years:Yearly Demand

1(in 000s) 2 (in 000s) 3(in 000s) 4(in 000s)

Plastic 90 32 44 55 56Plastic 180 15 16 17 18Plastic 360 50 55 64 67Bronze 90 7 8 9 10Bronze 180 3 4 5 6Bronze 360 11 12 15 18

Both production lines can produce all the different types of nozzles.Each bronze machine requires two operators and can produce up to12,000 sprinklers. The plastic machine requires four operators and can produce up to 200,000 sprinklers. Three bronze machines and onlyone plastic machine are available. What are the capacity and labor requirements for the next four years?

Solution:1.Calculate equipment and labor requirements to meet product line forecast.

Total product line forecast can be calculated from the tablegiven in the example by adding the yearly demand for plastic and bronze sprinklers as follows:

000s Year

Sprinklers 1 2 3 4

Plastic 97 115 136 141 Bronze 21 24 29 34

We can calculate equipment and labor requirements for year 1. Because the total available capacity for plastic sprinklers is 2,00,000 pieces/year we will be using 97/200 = 0.485 of the available capacity or 0.485 machine. Similarly,we will need 21/3x 12 = 0.583 of the capacity or 0.583x 3 = 1.749 machines.

The labor requirement for year 1’s operation is0.485 x 4 = 1.940 operators (plastic)1.749 x 2 = 3.498 operators (bronze)

Step 2 Project labor and equipment availabilities over the planning

horizon. We repeat the preceding calculations for theremaining years.

Year1 2 3 4

Plastic Operations% capacity utilized 48.5 57.5 68.0 70.4Machine Requirement 0.48 0.575 0.68 0.705Labor Requirement 1.92 2.3 2.72 2.82

Bronze Operations% capacity utilized 58.3 66.0 80.5 94.4Machine Requirement 1.749 1.98 2.415 2.832Labor Requirement 3.498 3.96 4.83 5.66

A positive capacity exists for all four years because theavailable capacity for both operations always exceeds theexpected demand. Also, a positive labor force exists.

AssignmentForecast of demand after intensive market campaign:

Yearly Demand1(in 000s) 2 (in 000s) 3(in 000s) 4(in 000s)

Plastic 90 32 44 55 56Plastic 180 15 16 17 18Plastic 360 50 55 64 67Bronze 90 11 15 18 23Bronze 180 6 5 6 9Bronze 360 15 16 17 20

1.What are the capacity implications of the marketing campaign?2. In anticipation of the ad campaign, the company bought an additional bronze machine. Will this be enough to ensure that enough capacity is available?3. If two bronze machines are added and the total available operators (fully trained for both operations) are 10, what are the labor requirement implications?

Solved Example:A company produces two flavors : Paul’s and Newman’s. Each is available in bottles and plastic bags. Based on the data given, determine equipment and labor requirements for the next five years. Forecasted demand for the next five years:

Year_________________________________1 2 3 4 5

_______________________________________________________Paul’sBottles (000s) 60 100 150 200 250Plastic bags (000s) 100 200 300 400 500

Newman’sBottles (000s) 75 85 95 97 98Plastic bags (000s) 200 400 600 650 680

________________________________________________________

Available Machines and Labor Force Machine No. Capacity No. of operators

per year requiredBottle Packing 3 1,50,000 each 2 per machinePlastic bags Packing 5 2,50,000 each 3 per machineLabor Force:Bottle Packing 6Plastic bags Packing 20

Solution:Total product line forecasts

Year ____________________________

1 2 3 4 5 ______________________________________________

Bottles 135 185 245 297 348Plastic Bags 300 600 900 1050 1180_______________________________________________

Note that a positive capacity cushion exists for all five years

Calculation of equipment and labor requirement for 1 yearEquipment: Bottle Packing : Total available capacity : 4,50,000 per year

(3 x 1,50,000 each) Capacity Used: 450/ 135 =0.3 or 0.3 x 3 = 0.9 machinePlastic Bags : Total available capacity : 12,50,000 per year

(5 x 2,50,000 each)Capacity used: 300/1250 = 0.24 or 0.24 x 5 = 1.2 machine

Labor 0.9 bottle machines x 2 operators = 1.8 operators1.2 bag machines x 3 operators = 3.6 operators

Summary for five years: Year

___________________________________1 2 3 4 5

Bottle OperationPercent Capacity Utilized 30 41 54 66 77Machine requirement 0.9 1.23 1.62 1.98 2.31Labor requirement 1.8 2.46 3.24 3.96 4.62Plastic Bag OperationPercent capacity utilized 24 48 72 84 94Machine requirement 1.2 2.4 3.6 4.2 4.7Labor requirement 3.6 7.2 10.8 12.6 14.1