capacity planning

Capacity Planning

For Products and Services

Prepared By: Gurpreet Singh

Capacity Planning

� Capacity is the upper limit or ceiling on the load that an operating

unit can handle.

� It refers to availability of I/Ps.

� The load might be in terms of the number of physical units produces� The load might be in terms of the number of physical units produces

(E.g. Bicycles assembled per hour) or the number of services

performed (E.g. Computers upgraded per hour) etc.

� Capacity also includes:

� Equipment

� Space

� Employee skills etc.


Capacity Planning…

� Organizations become involved in capacity planning for

various reasons:

� Changes in Demand

� Changes in Technology� Changes in Technology

� Changes in Environment

� Threats or Opportunities etc.

� Overcapacity causes operating costs that are too high, while

undercapacity causes strained resources and possible loss of

customers.



� The basic questions in capacity handling are:

� What kind of capacity is needed?

� Depends upon on the products & services that management intends

to produce or provide.to produce or provide.

� How much is needed?

� When is it needed?

� Forecasting is done for how much and when it is needed.


Importance of Capacity Decisions

1. Impacts ability to meet future demands

2. Affects operating costs (actual dd differs from expected dd)

3. Major determinant of initial costs (greater capacity = high cost)


4. Involves long-term commitment of resources

5. Affects competitiveness (a firm that can add capacity quickly)

6. Affects ease of management (appropriate capacity makes it)

7. Globalization adds complexity (far-flung supply chain/markets )

8. Impacts long range planning (plan in advance)


� Design capacity

� Effective capacity

� Actual output� Actual output


� Design capacity:

� Maximum output rate or service capacity an operation, process, or

facility is designed for i.e. maximum rate of O/P achieved under

ideal conditions.



ideal conditions.

� Effective capacity:

� Design capacity minus allowances such as personal time,

maintenance, and scrap i.e. the capacity which is usually less than

design capacity due to changing product mix, lunch/coffee breaks,

regular equipment maintenance, scheduling problems etc.

� Actual output:

� Rate of output actually achieved i.e. it cannot exceed effective

capacity and is often less than because of machine breakdowns,


absenteeism, shortage of materials and quality problems as well

as factors that are outside the control of the operations managers.


Actual outputEfficiency =

Effective capacity

Efficiency and Utilization

Actual outputUtilization =

Design capacity

Both measures expressed as percentages


Design capacity = 50 trucks/day

Effective capacity = 40 trucks/day

Actual output = 36 units/day

Efficiency/Utilization Example

Actual output = 36 units/dayEfficiency = = 90%

Effective capacity 40 units/ day

Utilization = Actual output = 36 units/day= 72%

Design capacity 50 units/day

Actual output = 36 units/day


A Note

� It is important to recognize that the benefits of high

utilization are realized only in instances where there is

demand for the O/P.

� When demand is not there, focusing exclusively on

utilization can be counterproductive, because excess O/P

not only results in additional variable costs but generates

the costs of having to carry the O/P as inventory.


Determinants of Effective Capacity

� Facilities

� Product and service factors

� Process factors


� Human factors

� Policy factors

� Operational factors

� Supply chain factors

� External factors

Determinants of Effective Capacity…

� Facilities:

� The design of facilities including size and provision for expansion.

� Locational factors like: Transportation costs, Distance to Market, Energy

sources etc.


� Layout of the work area determines how smooth work can be performed.

� Environmental factors like: Heating, Lighting, Ventilation etc.

� Product and service factors:

� More uniform the O/P (standardization) = more opportunities = greater

capacity.

� E.g. A Restaurant that offers a limited menu can usually prepare and serve

meals at a faster rate than a restaurant with extensive menu.


� Process factors:

� Quality O/P increases capacity.

� E.g. If quality of O/P doesn’t meet standards, the rate of O/P will be

slowed by the need for inspection and rework activities.


� Human factors:

� Factors like: Variety of activities involved, Training, Skill, Experience etc.

have an impact on the potential and actual O/P.

� E.g. Employee motivation has a very basic relationship to capacity as do

absenteeism and labor turnover.

� Policy factors:

� Management Policy factors like: Overtime etc. have an impact on capacity


� Operational factors:

� Scheduling problems may occur when an organization has differences in

equipment capabilities among alternative pieces of equipment etc.

� Inventory stocking decisions, Late deliveries, Quality inspection, Control

procedures also have an impact on effective capacity.


procedures also have an impact on effective capacity.

� E.g. Inventory shortage of even 1 component can halt assembly operation.

� Supply chain factors: Also hampers capacity.

� External factors:

� Product standards, Safety regulation, Unions, Pollution control standards

and even paperwork required by govt. regulatory agencies by engaging

employees in nonproductive activities can have an impact on capacity.

Strategy Formulation

� Capacity strategy for long-term demand.

� Demand patterns.

� Growth rate and variability.

Facilities:


� 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:

• Capacity Cushion= (100% - Utilization)

• Extra demand intended to offset uncertainty.

• Greater the degree of demand uncertainty = greater the amount of


• Greater the degree of demand uncertainty = greater the amount of

cushion used.

2. Timing of changes.

3. Need to maintain balance throughout the system.

4. Extent of flexibility of facilities and the workforce.

Steps for Capacity Planning

1. Estimate future capacity requirements

2. Evaluate existing capacity and facilities and identify gaps

3. Identify alternatives for meeting requirements

4. Conduct financial analysis of each alternative


4. Conduct financial analysis of each alternative

5. Assess key qualitative issues for each alternative

6. Select the alternative to pursue that will be best in the long run

7. Implement the selected alternative

8. Monitor results.

Forecasting Capacity Requirements

� It involves Long-term vs. short-term capacity considerations.

� Long-term considerations relates to overall level of capacity

such as facility size, trends, cycles, etc. i.e. forecasting demand

over a long time horizon.


over a long time horizon.

� Short-term considerations relates to variations in capacity

requirements from seasonal, random, and irregular

fluctuations in demand i.e. forecasting demand over a short

time horizon.

Examples of Seasonal Demand Patterns

� Year: Toy sales, Beer sales, Clothing, Sports/Recreation

Gasoline consumption, Education etc.

� Month: Bank Transactions, Welfare/Social security checks

etc.etc.

� Week: Restaurant meals, Retail sales, Automobile traffic

etc.

� Day: Telephone calls, Power usage, Automobile traffic,

Restaurant meals, Retail sales etc.


Calculating Processing RequirementsA department works one 8-hour shift, 250 days a year and hasthese figures for a usage of a machine:

# 1

# 2

# 3

4 0 0

3 0 0

7 0 0

5 .0

8 .0

2 .0

2 ,0 0 0

2 ,4 0 0

1 ,4 0 0

5 ,8 0 0

If annual capacity is 2000 hours, then we need three machines to handle therequired volume: 5,800 hours/2,000 hours = 2.90 machines


Planning Service Capacity

� Need to be near customers:

� Capacity and location are closely tied i.e. service must be located near

customers. E.g. Hotel rooms must be where customer wants to stay.

� Inability to store services:


Inability to store services:

� Capacity must be matched with timing of demand i.e. services cannot

be produced in one period and stored for use in later period. E.g. Unsold

Airplane/Train/Bus seat cannot be stored for use on a later trip etc.

� Degree of volatility of demand:

� Peak demand periods i.e. higher for services than goods. E.g. Banks

tends to experience high volumes of demand on certain days of the week

and number of transactions etc.

In-House or Outsourcing/Make or Buy

� Organization must decide whether to produce a good/service

itself or to Outsource from another organization.

� Organizations buy parts or contract out services for a variety of

reasons:


reasons:

1. Available capacity

2. Expertise

3. Quality considerations

4. Nature of demand

5. Cost

6. Risk

In-House or Outsourcing/Make or Buy…

1. Available capacity:

� If an organization has the equipment, necessary skills and time

available then produce item or perform a service in-house, which will

result in less additional costs as compare to buy items or subcontract


result in less additional costs as compare to buy items or subcontract

services.

2. Expertise:

� If a firm lacks the expertise to do a job satisfactorily buying might be a

reasonable option.

In-House or Outsourcing/Make or Buy…

3. Quality considerations:

� Firms that specialize can offer higher quality than an org. can attain

itself.

4. Nature of demand:


4. Nature of demand:

� When demand for item is high and steady then perform job itself.

5. Cost:

� Buying or making costs must be weighed against preceding factors.

Cost savings can be from item itself or transportation cost etc.

6. Risk:

� Outsourcing may involve certain risks.

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

7. Choose a strategy if expansion is involved

Developing Capacity Alternatives…

1. Design flexibility into systems:

� E.g. Provisions for future expansion in the original design of a structure

can be obtained at a small price compared to what it would cost to

remodel an existing structure that did not have such a provision.


remodel an existing structure that did not have such a provision.

� E.g. If future expansion of a restaurant seems likely, water lines, power

hookups and waste disposal lines can be put initially so that if expansion

becomes a reality, modification to existing structure can be minimized.


2. Take stage of life cycle into account:

� Introduction phase = Org. should be cautious about making large

and/or inflexible capacity investments.

� Growth phase = Offer different product than competitors.� Growth phase = Offer different product than competitors.

� Maturity phase = Reduce cost and make full use of capacity.

� Decline phase = Sell excess capacity of introduce new products/services

or transfer capacity to a location that has lower labor costs etc.



3. Take a “big picture” approach to capacity changes:

� E.g. When making a decision to increase the number of rooms in

a motel, one should also take into account probable increased

demands for parking, entertainment and food and housekeepingdemands for parking, entertainment and food and housekeeping

i.e. the “big picture”.

� It also results in bottleneck operation:

� An operation in a sequence of operations whose capacity is lower

than the capacities of the other operations in the sequence.


Machine #110/hr


Bottleneck Operation example

Machine #2Bottleneck

OperationMachine #3

Machine #4

10/hr

10/hr

10/hr

30/hr


Bottleneck

Bottleneck Operation example


Operation 120/hr.

Operation 210/hr.

Operation 315/hr.

10/hr.

Maximum output ratelimited by bottleneck



4. Prepare to deal with capacity “chunks”:

� Capacity increases are often acquired in fairly large chunks rather than

smooth increments, making it difficult to achieve a match between

desired capacity and feasible capacity.desired capacity and feasible capacity.

� E.g. The desired capacity of a certain operation may be 55 units per

hour but suppose that machines used for this operation are able to

produce 40 units per hour each. One machine by itself would cause

capacity to be 15 units per hour short of what is needed but two

machines would result in an excess capacity of 25 units per hour.



5. Attempt to smooth out capacity requirements:

� Unevenness in capacity requirements creates problems.

� E.g. During periods of inclement weather public transport ridership

tends to increase substantially relative to periods of pleasant weather.tends to increase substantially relative to periods of pleasant weather.

So the system tends to alternate between underutilization and

overutilization. Increasing the number of buses will reduce the burden

during heavy demand periods but this will result in the problem of

overcapacity at other times as well as cost of operating the system.

� One way to overcome this issue is through the use of overtime work.

� Another way is to subcontract some of the work etc.



6. Identify the optimal operating level:

� Production units have an ideal/optimal level of operation in

terms of unit cost of O/P.

� At the ideal level, cost per unit is the lowest for that production� At the ideal level, cost per unit is the lowest for that production

unit.

� It results in:

� Economies of Scale

� Diseconomies of Scale


• Optimal Rate of Output:

• Production units have an optimal rate of output for minimal cost.

Average cost

Minimum average cost per unit


Minimumcost

cost per unit

0 Rate of outputPrepared By: Gurpreet Singh


6. Identify the optimal operating level:

� Economies of scale:

� If the output rate is less than the optimal level, increasing output

rate results in decreasing average unit costs


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:• Minimum cost & optimal operating rate are functions of size

of production unit.

Ave

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Developing Capacity Alternatives…A

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Smallplant Medium

plant Largeplant

Output rate



� Reasons for Economies of Scale:

� Fixed costs are spread over more units, reducing fixed cost per unit.

� Construction costs increase at a decreasing rate w.r.t. size of facility to be built.

� Processing costs decrease as O/P increase because operations become more

standardized which reduces unit costs.

� Reasons for Diseconomies of Scale:

� Distribution costs increase due to shipping from one large centralized facility

instead of several smaller decentralized facilities.

� Complexity increases costs, control & communication become more problematic.

� Inflexibility can be an issue.



7. Choose a strategy if expansion is involved:

� Consider whether incremental expansion or single step is more

appropriate.

� Decide whether to lead or follow competitors.� Decide whether to lead or follow competitors.


Evaluating Alternatives

� Cost-volume analysis

� Break-even point

� Financial analysis


� Cash flow

� Present value

� Decision theory

� Waiting-line analysis

Evaluating Alternatives…

� Cost-volume analysis:

� It focuses on relationships between Cost, Revenue and Volume of

data.

Its purpose is to estimate the income of an organization under� Its purpose is to estimate the income of an organization under

different operating conditions.

� It includes:

� Break-even Point (BEP):

� The volume of O/P at which total cost and total revenue are

equal.


Am

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($)

Cost-Volume RelationshipsA

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0 Q (volume in units)

Fixed cost (FC)


Cost-Volume Relationships…A

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0


Q (volume in units)

Am

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Cost-Volume Relationships…A

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)

0 BEP unitsQ (volume in units)


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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


� Financial Analysis:

� How to allocate scarce resources? = Financial Analysis i.e.

� To rank investment proposals taking into A/C the time value

of money.


of money.

� 2 important terms are:

� Cash Flow: The difference between cash received from sales (of

goods/services) and other sources (sale of old machinery), 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.


� Financial Analysis: 3 most common methods are:

� Payback

� Present Value (PV)

� Internal Rate of Return (IRR)


� Internal Rate of Return (IRR)

� These techniques are appropriate when there is high

degree of certainty associated with estimates of future cash

flows.


� Decision Theory:

� When the conditions of Risk or Uncertainty are present

Decision Theory if applied i.e. it is a helpful tool for


financial comparison of alternatives under conditions of risk

or uncertainty.

� It is suited to capacity decisions and to wide range of other

decision managers.


� Waiting-Line Analysis:

� It is useful for designing or modifying service systems.

� Waiting-lines occur across a wide variety of service systems


(e.g. Airport ticket counters, hospital emergency rooms etc.).

� 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.

3 machines

Break-Even Problem with Step Fixed Costs


Quantity

Step fixed costs and variable costs.

1 machine

2 machines

3 machines

Break-Even Problem with Step Fixed Costs

$

TC

TCBEP 2

BEP3

TC

TC

Quantity

1

2

3

Multiple break-even points


capacity planning

Documents

service capacity

capacity handling

kind of capacity

trucksday effective

actual outputdesign

service factors

environmental factors

locational factors