Strategic Capacity

Planning for
Products and
Services

McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
 Capacity
 The upper limit or ceiling on the load that an operating
unit can handle
 Capacity needs include
 Equipment
 Space
 Employee skills

Instructor Slides 5-2

Strategic Capacity Planning
 Goal
 To achieve a match between the long-term supply
capabilities of an organization and the predicted level
of long-run demand
 Over-capacity operating costs that are too high
 Under-capacity strained resources and possible loss of
customers
Capacity

Design capacity
 maximum output rate or service capacity an operation, process, or
facility is designed for
Effective capacity
 Design capacity minus allowances such as personal time,
maintenance, and scrap
Actual output
 rate of output actually achieved
 Cannot exceed effective capacity.
Measuring System Effectiveness
 Efficiency actual output
Efficiency 
effective capacity

 Utilization
actual output
Utilization 
design capacity
Measured as percentages
Example– Efficiency and Utilization P. 197

 Design Capacity = 50 trucks per day

 Effective Capacity = 40 trucks per day
 Actual Output = 36 trucks per day

actual output 36
Efficiency    90%
effective capacity 40

actual output 36
Utilizatio n    72%
design capacity 50
Capacity Cushion
 Capacity Cushion
 Extra capacity used to offset demand uncertainty
 Capacity cushion = 100% - Utilization
 Capacity cushion strategy
 Organizations that have greater demand uncertainty
typically have greater capacity cushion
 Organizations that have standard products and services
generally have smaller capacity cushion
Example 2, P 202
A center works one shift (8-hr shift), 250 days a
year, and these figures for a machine that is
current being considered:
Annual Stand Processing Processing
Product Demand Time per Unit (hr) Time Needed
#1 400 5 5 x 400=2000
#2 300 8 8 x 300=2400
#3 700 2 2 x 700=1400
Total: 5800
Example 2, P. 202 (Cont’d)

How many machines do we need to

handle the required volume?

Total Requires 5800 Hrs

8 Hrs/day x 250 days/Yr
5800Hrs
  2.9 machines
2000Hrs
In-House or Outsource?
 Once capacity requirements are determined, the
organization must decide whether to produce a good or
service itself or outsource
 Factors to consider:
 Available capacity
 Expertise
 Quality considerations
 The nature of demand
 Cost
 Risks
Bottle Neck Operation
Complementary Demand Patterns
Optimal Operating Level

Average cost per unit

Minimum
cost

Optimal Rate of output

Output
Rate
 Minimum cost & optimal operating rate are
functions of size of production unit.
Average cost per unit

Small
plant Medium
plant
Large
plant

Output rate

Instructor Slides 5-14

Cost-Volume Analysis
 Cost-volume analysis
 Focuses on the relationship between cost, revenue, and
volume of output
 Fixed Costs (FC)
 tend to remain constant regardless of output volume
 Variable Costs (VC)
 vary directly with volume of output
 VC = Quantity(Q) x variable cost per unit (v)
 Total Cost (TC)
 TC = FC+VC=FC+Q x v
 Total Revenue (TR)
 TR = revenue per unit (R) x Q
Cost-Volume Relationships
Break-Even Point (BEP)
 BEP
 The volume of output at which total cost and total
revenue are equal
 Profit (P) = TR – TC = R x Q – (FC +v x Q)
Profit (P) = Q(R – v) – FC

P  FC FC
Q profit  QBEP 
Rv Rv
Example 3: P. 211
If FC=$6000/Month, VC=$2/pie, Price=$7/pie
 How many pies must be sold to Break Even?

FC 6000
QBEP    1200 Pies / Month
Re venue  VC 7  2

 If 1000 pies sold in a month, What would be the

profit or loss?
Profit=TR-TC=$7(1000)-($6000+$2x1000)= -$1000
Loss $1000
Example 3: P. 211 (Cont’d)

 How many pies must be sold for a profit of $4000?

Pofit  FC 4000  6000

QPr ofit    2000 Pies
R V 72

 If 2000 pies can be sold, a profit goal is $5000, what price

should be charged per pie?
Profit = Q(R-v) – FC
5000 = 2000(R – 2) – 6000
5000 = 2000R – 4000 – 6000
2000R= 15000 R = $7.50, Price = $7.50
Example 4: P. 212
 A manager has the option of purchasing 1,2, or 3
machines. Fixed costs & potential volumes are as
follows:
# Machines Annual FC Range of Output
1 $ 9,600 0 to 300
2 15,000 301 to 600
3 20,000 601 to 900

VC=$10/unit Revenue=$40/unit
Example 4: P. 212 (Cont’d)
 Determine the break-even point for each range.
1 Machine Q(Bep)= 9600/(40-10)=320units (not in range)
2 Machine Q(Bep)=15000/(40-10) =500units
3 Machine Q(Bep)=20000/(40-10)=666.7units

 If projected annual demand is between 580 and

660 units, how machines should the manager
purchase?

Manager should choose 2 machines

Make or Buy

 Available Capacity

 Quality Consideration

 Nature of Demand

 Cost
Example 5: Make or Buy P. 216
MAKE BUY
Annual FC $150000 0
VC/Unit $60 $80
Annual Volume 12000 units 12000 units
 Annual Cost of each alternative:
TC = FC + VC x Q
TCMake=$150000 +$60x12000=$870,000
TCBuy = 0 +$80x12000=$960,000

Alternative Make is better

Example 5: Make or Buy P. 216 (Cont’d)

 There is a possibility that volume could change in the future.

What would be Indifferent Volume between Making & Buying?
TCMake = TCBuy
FC +V*Q = FC+V*Q
150000+60Q = 0 +80Q
150000=80Q - 60Q = 20Q
Q = 7500 units

If Volume >= 7500 units, Choose MAKE

If Volume <= 7500 units, Choose BUY