5

Capacity Planning
For Products and
Services

McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 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
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 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? 5-3
 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

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 Capacity
 Design capacity
 …

 Effective capacity
…

 Actual output
 …

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 Efficiency and Utilization
Actual output
Efficiency =
Effective capacity

Actual output
Utilization =
Design capacity

Both measures expressed as percentages

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 Efficiency/Utilization Example
Design capacity = 50 trucks/day
Effective capacity = 40 trucks/day
Actual output = 36 trucks/day

Actual output = units/day

Efficiency = =
Effective capacity units/ day

Utilization = Actual output = units/day

=
Design capacity units/day

5-7
 Determinants of Effective
Capacity
 Facilities
 Product and service factors
 Process factors
 Human factors
 Policy factors
 Operational factors
 Supply chain factors
 External factors

5-8
 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
5-9
 Key Decisions of Capacity
Planning
1. Amount of capacity needed
• Capacity cushion (100% - Utilization)
2. Timing of changes
3. Need to maintain balance
4. Extent of flexibility of facilities

Capacity cushion – extra demand intended to offset uncertainty

5-10
 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

5-11
 Calculating Processing
Requirements
Standard
Annual processing time Processing time
Product Demand per unit (hr.) needed (hr.)

#1 400 5.0

#2 300 8.0

#3 700 2.0
Total
Tot

If annual capacity is 2000 hours, then how many machines do we need to

handle the required volume of …. ?

5-12
 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

5-13
 In-House or Outsourcing
Outsource: obtain a good or service
from an external provider

1. Available capacity
2. Expertise
3. Quality considerations
4. Nature of demand
5. Cost
6. Risk

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Developing Capacity Alternatives
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

5-15
 Bottleneck Operation
Figure 5.2 Bottleneck operation: An operation
in a sequence of operations whose
10/hr capacity is lower than that of the
Machine #1 other operations

10/hr
Machine #2
Bottleneck 30/hr
Operation
Machine #3
10/hr

Machine #4 10/hr

5-16
 Bottleneck Operation

Which operation is the Bottleneck operation?

Operation 1 Operation 2 Operation 3

?
20/hr. 10/hr. 15/hr.

Maximum output rate

limited by bottleneck

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 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

5-18
 Optimal Rate of Output
Figure 5.4
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

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 Economies of Scale
Figure 5.5
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

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 Evaluating Alternatives
 Cost-volume analysis
 Break-even point
 Financial analysis
 Cash flow
 Present value
 Decision theory
 Waiting-line analysis

5-21
 Cost-Volume Relationships
Figure 5.6a

Amount ($)

Fixed cost (FC)

0
Q (volume in units)

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 Cost-Volume Relationships
Figure 5.6b

Amount ($)

0
Q (volume in units)

5-23
 Cost-Volume Relationships
Figure 5.6c

Amount ($)

0 BEP units
Q (volume in units)

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 Break-Even Problem with Step
Figure 5.7a Fixed Costs

3 machines

2 machines

1 machine
Quantity
Step fixed costs and variable costs.

5-25
 Break-Even Problem with Step
Figure 5.7b
Fixed Costs

$
BEP
3
FC3
BEP2
FC2
3
FC1
2

1
Quantity
Multiple break-even points
TP = (P – VC) Q
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 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

5-27
 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.

5-28
 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
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