Capacity Strategy

The main objective of capacity planning is to

match company’s production capacity & customer
Supply Chain demand in the most profitable way.

Management
Thus capacity planning should take into

consideration not only facility, production &
distribution costs, but also lost sales due to
inability to supply on time & any revenue gains
Lecture 3 due to quick response.
Chapter 2: Capacity Planning &
Location Decisions
In addition, the capacity strategy should consider
a) Capacity Planning demand patterns as well as supply capabilities.

Strategic Capacity Planning Importance of Capacity Decisions

Strategic capacity planning is an approach for
determining the overall capacity level of capital 1. Impacts ability to meet future demands
intensive resources, including facilities, equipment, and
overall labor force size 2. Affects operating costs

Capacity planning is central to the long term success of 3. Major determinant of initial costs
any strategic plan and the success of the enterprise. 4. Involves long-term commitment
capacity planning and determining the capacity
constraints determines the requirements of other 5. Affects competitiveness
inputs for the program.
6. Affects ease of management

Too much capacity can be as problematic as too little.
7. Globalization adds complexity

The basic questions in capacity planning are: 8. Impacts long range planning
 What kind of capacity is needed?
 How much is needed?
 When is it needed?

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Rationale for Capacity Planning Decisions
1. Design Capacity has linkages with
production facility and cost structure
2. Capacity and location decisions require
large financial investments and long
planning lead times …
3. Capacity availability and location help
companies serve customers quickly and
conveniently – competitive advantage
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

Steps for Capacity Planning In-House or Outsourcing

1. Estimate future capacity requirements Outsource: obtain a good or service from an
external provider
2. Evaluate existing capacity
3. Identify alternatives 1. Available capacity
4. Conduct financial analysis 2. Expertise
5. Assess key qualitative issues 3. Quality considerations
6. Select one alternative 4. Nature of demand
7. Implement alternative chosen 5. Cost
8. Monitor results 6. Risk

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Capacity planning and control Causes of seasonality
Measure aggregate capacity Identify the alternative
and demand capacity plans
Climatic Festive Behavioural Political Financial Social
Choose the most
appropriate capacity plan

Forecast demand
Aggregated output

Education services Travel services

Estimate of current capacity
Beverages (beer, cola) Holidays
Foods (ice-cream, Eid cake) Tax processing
Clothing (sweaters, shoes) Doctors (influenza epidemic)
Gardening items (seeds, fertilizer) Sports services
Fireworks Construction Material

Time

The nature of aggregate capacity

Demand fluctuations in four operations

Aggregate capacity of a hotel:

– rooms per night

– ignores the numbers of guests in each room

Aggregate capacity of an aluminum producer:

– tonnes per month

– ignores types of alloy, gauge and batch

variations

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 Good forecasts are essential for effective How capacity and demand are measured
capacity planning … Actual output
… but so is an understanding of demand uncertainty, because it allows Efficiency =
Effective capacity
you to judge the risks to service level
Only 5% chance of demand Planned loss
being higher than this of 59 hours
Distribution of demand
Design
capacity

Avoidable loss –
Effective
58 hours per
capacity
DEMAND

week
DEMAND

168 hours 109 hours Actual output –

Only 5% chance of demand per week per week 51 hours per
being lower than this
week
TIME TIME
Actual output
Utilization=
When demand uncertainty is high, the risks to service level of under- Design capacity
provision of capacity are high

Operating equipment effectiveness (OEE)

A method of judging the effectiveness of how definitions of capacity
operations equipment is used.
Loading time
Not worked
(unplanned)
Availability rate = a
= total operating time/

Design capacity
loading time
Set-up and
 Maximum output rate or service capacity an
Availability
changeovers operation, process, or facility is designed for
Total operating time
losses Breakdown
failure
Performance rate = p
= net operating time/

Effective capacity
total operating time
Speed Equipment  Design capacity minus allowances such as
Net operating time ‘idling’
losses personal time, maintenance, and scrap
Slow-running
Valuable Quality
equipment Quality rate = q
Actual output
=valuable operating time/
operating
time
losses Quality net operating time  Rateof output actually achieved--cannot
losses
exceed effective capacity.

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 Efficiency/Utilization Example
Capacity cushion
Design capacity = 50 trucks/day

Capacity Cushion
Effective capacity = 40 trucks/day
 The amount of reserved capacity that a firm
Actual output = 36 units/day maintains to handle sudden increases in
demand or temporary losses of production
Actual output = 36 units/day capacity.
Efficiency = = 90%
Effective capacity 40 units/ day

Utilization = Actual output = 36 units/day
Capacity Cushion = 1 - Utilization

= 72%
Design capacity 50 units/day

Ways of reconciling capacity and demand

Capacity Utilization
If operated around the clock under ideal conditions, the
fabrications department of an engine manufacturer can
make 100 engines per day.
Management believes that a maximum output rate of only Demand Demand Demand
45 engines per day can be sustained economically over a
long period. Capacity Capacity Capacity
Currently the department is producing an average of 50
engines per day.
What is the utilization of the department relative to peak
Demand
capacity and effective capacity? Level capacity Chase demand
management
Utilization = (Average Output Rate/design Capacity)
Efficiency = (Average Output Rate/Effect. Capacity)

5
 Ways of reconciling capacity and demand

How do you cope with

fluctuations in demand?
Adjust output to match demand

Hire Fire
Absorb Adjust output Change Temporary labor Lay-off
demand to match demand
demand Overtime Short time
Level capacity Demand
management Subcontract Third-party work
Chase demand

Absorb
demand
Have Change demand
excess
capacity Keep output
level Change pattern of demand

Make Develop alternative products

Make to and/or services
customer
stock
wait
Part finished Queues
Finished goods, or Backlogs
Customer inventory

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Moving a peak in demand can make capacity planning easier Capacity Expansion Strategies

1. Demand leading strategy (excess capacity)

2. Demand Trailing strategy (maximum capacity
utilization)
3. Demand matching strategy (Balanced capacity)
4. Steady expansion strategy (steady expansion)

Or
1. Proactive Strategy
2. Neutral strategy
3. Reactive strategy

Graphs Of Capacity Expansion Strategies

Capacity Demand
Cap/Dem
Cap/Dem

Demand Capacity
Time
Capacity Expansion Strategies Demand leading Demand trailing

Demand Demand
Cap/Dem
Cap/Dem

Capacity
.

Capacity

Demand matching Steady expansion

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 Capacity Expansion Strategies..

Demand matching strategy

Demand leading (excess capacity)
+ balances capacity & other costs
+ can accommodate new/unexpected
demand + provides reliable service & responsiveness
+ can provide quick response and delivery - must be able to predict demand well or
+ low overtime & subcontracting costs have constant demand
- high cost of unused capacity
Note: + = advantages Note: (+) => advantages
( - ) => disadvantages
- = disadvantages
Eg.:
Hotel industry (immediate need of rooms; if
substitute exists … can lose sales), Furniture maker
(can people wait?), Restaurant, University

Demand trailing (maximum capacity Steady expansion strategy

utilization) + do not have to outguess competitors
+ minimizes facility & equipment costs
+ price risk from adding capacity during peak
- cannot accommodate new or unexpected demand
- slow response at peak times demand is reduced
- high overtime and/or subcontracting costs
- often forced to add capacity at peaks of business - excess capacity can result if long term
cycles demand falls short of expectations
- Loose sales
Note: (+) => advantages
Note: (+) => advantages ( - ) => disadvantages
( - ) => disadvantages

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 Measure of Capacity Economies of Scale

Output Basis
Economies of scale

Output measure best suited when the company  Ifthe output rate is less than the optimal level,
provides a small number of standardized increasing output rate results in decreasing
product or services or when applied to individual average unit costs
process within the firm.

Diseconomies of scale

Input Basis  Ifthe output rate is more than the optimal
Usual choice for low volume flexible processes. level, increasing the output rate results in
increasing average unit costs

Best Operating Level (Design Capacity) Economies of scale: when a company produces more
Example:
Example:Engineers
Engineersdesign
designengines
enginesand
andassembly
assemblylines
linesto
to
of a similar product, the average cost per unit drops.
operate
operateat
atan
anideal
idealor
or“best
“bestoperating
operatinglevel”
level”to
tomaximize
maximize Producing larger volumes of the same product or very
output
outputand
andminimize
minimizewear
wear similar products may result in economies of scale.

Average Economies of scope: can be defined as making more

unit cost variety of products in the same factory. It exists when
of output
Underutilization Over-utilization
multiple products can be produced at a lower cost in
combination rather than separately.
Best Operating
Level

Volume

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 Increasing Capacity
Recognize Bottlenecks!

A bottleneck is an operation that has the
lowest effective capacity of any operation
Recognizing Bottleneck in the process and thus limits the system’s
output.

Weaving Printing
Weaving Bleaching etc. Printing
2000 m/hr 2000 m/hr 2000 m/hr
2000 m/hr 2000 m/hr
Bleaching etc.
1000 m/hr

Easy to identify the bottleneck stage(s) by

observing where inventory builds up … Minimizing Capacity Constraints
200 400
100

Outsource during peak periods

Keep bottleneck resources busy

200
200
Use overtime/ part-time employees as

100
short term option

Consider long term capacity expansion
200

400 400

100

10
 Decision Tree Example of a Decision Tree Problem (Continued):
Step 1. We start by drawing the three decisions
AA glass
glassfactory
factoryspecializing
specializinginincrystal
crystal isisexperiencing
experiencingaa
substantial
substantial backlog,
backlog, and
andthe
thefirm's
firm'smanagement
management isisconsidering
considering
three
threecourses
courses of
of action:
action:

A)
A) Arrange
Arrangefor
forsubcontracting
subcontracting A
B)
B) Construct
Constructnew
new facilities
facilities B
C)
C) Do
Donothing
nothing(no
(nochange)
change)
C
The
Thecorrect
correctchoice
choicedepends
dependslargely
largelyupon
upondemand,
demand, which
whichmay may
be
below,
low,medium,
medium,or orhigh.
high. By
Byconsensus,
consensus, management
management
estimates
estimatesthetherespective
respectivedemand
demandprobabilities
probabilitiesas
as0.1,
0.1, 0.5,
0.5,and
and
0.4.
0.4.

Example of a Decision Tree Problem (Continued): Example of Decision Tree Problem (Continued):
The Payoff Table Step 2. Add our possible states of nature,
The
The management
management alsoalso estimates
estimates the
the profits
profits probabilities, and payoffs
when
when choosing
choosing from
from thethe three
three alternatives
alternatives (A,
(A, High demand (0.4) $90k
B,
B, and
and C)
C) under
under the
the differing
differing probable
probable levels
levels of
of Medium demand (0.5) $50k
demand.
demand. These
These profits,
profits, in
in thousands
thousands ofof dollars
dollars Low demand (0.1) $10k
are
are presented
presented in
in the
the table
table below:
below: A High demand (0.4) $200k
0.1 0.5 0.4 B Medium demand (0.5) $25k
Low demand (0.1) -$120k
Low Medium High
C
A 10 50 90 High demand (0.4) $60k
B -120 25 200 Medium demand (0.5) $40k
C 20 40 60 Low demand (0.1) $20k

11
Example of Decision Tree Problem (Continued):
Step 3. Determine the expected value of each decision

High
Highdemand
demand(0.4)
(0.4) $90k
$90k
Medium
Mediumdemand
demand(0.5)
(0.5) $50k
$50k
$62k
$62k Low
Lowdemand
demand(0.1)
(0.1) $10k
$10k
AA
EV
EVAA=0.4(90)+0.5(50)+0.1(10)=$62k
=0.4(90)+0.5(50)+0.1(10)=$62k

Example of Decision Tree Problem (Continued):

Step 4. Make decision
High demand (0.4) $90k
Medium demand (0.5) $50k
$62k Low demand (0.1) $10k

A High demand (0.4) $200k

$80.5k
B Medium demand (0.5) $25k
Low demand (0.1) -$120k
C
High demand (0.4) $60k
$46k Medium demand (0.5) $40k
Low demand (0.1) $20k
Alternative
Alternative BBgenerates
generatesthe
the greatest
greatestexpected
expectedprofit,
profit, so
so
our
ourchoice
choiceisis BBor
orto
to construct
construct aanew
newfacility
facility

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