SCML 200 - Supply Chain Management & Operations

Chapter 4: Strategic Capacity Management

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Learning Objectives
1. Understand the concept of capacity and how
important it is to “manage” capacity.
2. Explain the impact of economies of scale of a firm.
3. Determine capacity requirements.
4. Understand how to use decision trees to analyze
alternatives when faced with the problem of adding
capacity.
5. Describe the differences in planning capacity
between manufacturing firms and service firms.

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Capacity Management in Operations
 Capacity: the ability to hold, receive, store, or
accommodate

 In business, viewed as the amount of output that a

system is capable of achieving over a specific
period of time

 Capacity management needs to consider both

inputs and outputs

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Capacity Planning Time Durations
Long range
• Greater than one year (acquiring buildings, equipment, Strategic
facilities)

Intermediate range

• Monthly or quarterly plans covering the next six to twelve

months (hiring & layoff, new tools, minor equipment Tactical
purchases, subcontracting)

Short range

• Daily or weekly (overtime, personnel transfer, alternative

production routings)
Operational

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Strategic Capacity Planning
 Determining the overall level of capital-intensive
resources that best supports the company’s long- Strategic
range competitive strategy.

 Facilities/Buildings

 Equipment/Machinery

 Labor force size/Staff size

 Capacity level has high impact on the firm’s response rate, its
cost structure, inventory policies
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Capacity Utilization
 Capacity utilization rate
 Reveals how well a firm is using its potential capacity
 Ratio of capacity used to Best operating level
 Best operating level: capacity level for which the
process was designed (the output level at which average
unit cost is minimized)
 
Capacity  used
Capacity   utilization  rate=
Best  Operating  Level
 If the capacity utilization rate is high (close to 100%), the firm is
operating at “full capacity”
 If this rate is low, a situation of "excess capacity" exists
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Example
http://www.youtube.com/watch?v=9SiNowSrUPs

Question 1:
Luxury cakes produces 750 cakes per week, their capacity
being 1200 cakes per week. What is their capacity
utilization?
Question 2:
Using the following information, comment on the effect
on increasing output to 900 cakes per week.
Price: 10 £
Fixed cost: 4000£
Variable cost: 5 £

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Economies of Scale
 Economies of scale: the cost advantages that
businesses obtain as they increase their size
 As a plant gets larger, and volume increases,
the average cost per unit drops, because:
1. Fixed cost per unit drops
www.masonmyers.com
2. Lower Operating and capital costs*
3. Labor becomes more specialized
 Specialization economies of scale: division of labor is possible (workers need
to focus on less tasks so they become efficient)
4. Technical economies of scale: Larger companies can make savings by investing
in more efficient operations (ex: IT systems, better distribution system by
delivering in bulk)
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 Diseconomies of Scale
 Diseconomies of scale is the opposite of economies of scale and happen
when the plant becomes too large and exceeds the needs of the company,
which results in production of goods and services at higher cost per unit.
The reasons are:
 The company needs high demand volume to keep the
large facility busy (to maintain a high demand the firm
may be forced to do many discounts so profit decreases)
 Larger costs to maintain equipment (Ex: M&M Mars)
 Control: It is more difficult to control and monitor
workers in a larger company
 Communication is slower in large companies (messages www.investopedia.com
get lost), & coordination is week between functions

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Capacity Planning Concepts
 Capacity Focus
The idea that a production facility works best when it is
concentrated on a limited set of production objectives
 Focused factory or plant within a plant (PWP) concept.

This allows finding best operating level for each PWP

As the two products have

different characteristics, by
separating their production,
this factory can operate
more efficiently
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Capacity flexibility
 Capacity Flexibility – the ability to rapidly increase or
decrease product levels or the ability to shift rapidly from
one product or service to another

Achieved through flexible plants, processes and workers:

 Flexible plants: Ability to quickly adapt to change by using
movable equipment, knockdown walls, reroutable utilities
 Flexible processes: rapid low cost switching from one
product to another. Requires flexible manufacturing
systems and simple, easily setup equipment
 Flexible workers: Ability to switch from one kind of task to
another quickly, Multiple skills (cross training)
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Example – Honda Case
 Read the article about Honda

 How does Honda achieve capacity flexibility?

 In which way can Honda use its capacity flexibility as

strategic competitive dimension?

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Considerations in Changing Capacity
Maintaining System Balance

• Similar capacities at each operation are desired

• Manage bottleneck operations

Frequency of Capacity Additions

• upgrading too frequently is expensive (small chunks)

• upgrading too infrequently is expensive (large chunks)

External Sources of Capacity

• Outsourcing
• Sharing capacity (e.g. airlines companies sharing same planes)

Decreasing Capacity

• Temporary reductions (scheduling fewer hours)

• Permanent reductions
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Frequent versus Infrequent Capacity Expansions

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Planning Service Capacity

Manufacturing Service
Capacity Capacity
Capacity must be available
Goods can be stored for later
when service is needed –
use
cannot be stored

Goods can be shipped to Service must be available at

other locations customer demand point

Volatility of demand is Much higher volatility is

relatively low typical

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Determining Capacity
Requirements
Project labor and
Use forecasting to Calculate labor
equipment
predict sales for and equipment
availability over
individual requirements to
the planning
products meet forecasts
horizon

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Example 4.1: Determining Capacity Requirements
 Stewart Company produces two flavors of salad
dressing: Paul’s and Newman’s
 Each is available in bottles and single-serving bags
 Forecast for the next 5 years is given in the next
slide
 The company has:
 3 machines that can package 150 000 bottles each
year (2 operators / machine)
 5 machines that can package 250 000 bags per year

(3 operators/machine)
 What are the capacity and labor requirements for the 17
Determining Capacity
Requirements
Step 1:Use forecasting to predict Year
sales for individual products
1 2 3 4 5

Bottles (000s) 60 100 150 200 250

Paul’s
Plastic bags (000s) 100 200 300 400 500
Bottles (000s) 75 85 95 97 98
Newman’s
Plastic bags (000s) 200 400 600 650 680

Year
Step 1.1: Calculate Total
product line forecasts 1 2 3 4 5

Bottles (000s) 135 185 245 297 348

Plastic bags (000s) 300 600 900 1050 1180

60+75 100+200 18
Determining Capacity Requirements

Step 2: Calculate equipment and Year

labor requirements 1 2 3 4 5
Bottles (000s) 135 185 245 297 348
Plastic bags (000s) 300 600 900 1050 1180

Bottling Operation Bagging Operation

 3 machines with 150000 bottles capacity each 5  machines with 250,000 bottles capacity each
2 operators /machine 3 operators /machine
Total available capacity = 3x150.000=450,000 Total available capacity = 5x250,000=1,250,000
Year 1 Year 1
Capacity utilization= Capacity utilization=

Machine requirement = =0.9 machines Machine requirement = =1.2 machines

Labor requirement =0.9x2=1.8 operators Labor requirement =1.2x3=3.6 operators

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Determining Capacity Requirements

Step 3: Project equipment and Year

labor availabilities 1 2 3 4 5
Percentage capacity utilized 24 48 72 84 94
Plastic Bag
Operation Machine requirement 1.2 2.4 3.6 4.2 4.7
Labor requirement 3.6 7.2 10.8 12.6 14.1
Percentage capacity utilized 30 41 54 66 77
Bottle Machine requirement 0.9 1.23 1.62 1.98 2.31
Operation
Labor requirement 1.8 2.46 3.24 3.96 4.62

Excel: Capacity Req

uirements 20
Conclusions – present situation
 Bottling operations
 Max. capacity utilization is 77% (year 5), which gives

room for addressing unexpected events (fluctuations in

demand, machine failures, illness)
 Machine requirements: The max. machine requirement

is 2.31 machines in year 5. The company has 3

machines, which is above the max. machine
requirement.
 Labor requirements: The max. labor requirement is 4.62
in year 5. The present number of workers is 6, which is
again above the max. labor requirement.

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Conclusions – present situation
 Plastic bags operations
 Max. capacity utilization is 94% (year 5), which might be

tight for addressing unexpected events (fluctuations in

demand, machine failures, illness)
 Machine requirements: The company has 5 machines. The

machine requirement in years 4 and 5 is less than 5 but

above 4 so the company should revise the requirements in
future years to avoid capacity problems.
 Labor requirements: The present number of workers is 15.
Labor requirement in year 5 is less than 15 but above 14 so
the company might consider to hire new employees in
future years to avoid capacity problems.
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Exercise - Higher demand in year 5

 Assume now that the total demand for plastic bags

in year 5 will be 1500000 and not 1180000.
Calculate the machine and labor requirement in
year 5.

 Is the current number of machines (5) and the

current number of operators (15) sufficient to
satisfy all the demand for plastic bags in year 5? If
no, by how much the capacity must be increased?

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Homework Exercises
 Capacity requirement: 4,5,6,7 pg. 111

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Thank you.
Your Questions?

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