Stevenson
Capacity Planning
Learning Objectives
Explain the importance of capacity planning.
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
5-2
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
Strategic Capacity Planning
Balancing of long term supply capabilities and
predicted level of long term demand.
Forecasts are a key input.
Changes in demand
Changes in technology
Changes in the environment
Perceived threats and opportunities
5-4
Capacity Planning Considerations
Cost, availability of funds, expected returns
Potential benefits and risks.
Degree of uncertainty in forecasts.
Sustainability issues.
Rate of capacity addition?
All at once?
Incremental (piecemeal)?
Timing of capacity addition?
Leading, following, or tracking?
Supply chain support?
5-5
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 (can be a barrier to
deter potential new entry)
6. Globalization adds complexity
7. Impacts long range planning
5-6
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.
5-7
Efficiency and Utilization
Actual output
Efficiency =
Effective capacity
Actual output
Utilization =
Design capacity
Both measures expressed as percentages
5-8
Efficiency/Utilization Example
Design capacity = 50 trucks/day
Effective capacity = 40 trucks/day
Actual output = 36 units/day
Actual output = 36 units/day
Efficiency = = 90%
Effective capacity 40 units/ day
Utilization = Actual output = 36 units/day
= 72%
Design capacity 50 units/day
5-9
Capacity Utilization Strategy
Key to improving capacity utilization is to increase
effective capacity by correcting quality problems,
maintaining equipment in good operating
condition, fully training employees, and fully
utilizing bottleneck equipment.
5-10
Steps for Capacity Planning
1. Estimate future capacity requirements
2. Evaluate existing capacity
3. Identify alternatives
4. Conduct financial analysis
5. Assess key qualitative issues
6. Select one alternative
7. Implement alternative chosen
8. Monitor results
Capacity planning can be difficult at times due to the
complex influence of market forces and technology.
5-11
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
5-12
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
5-13
Optimal Rate of Output
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
5-14
Economies of Scale
Minimum cost & optimal operating rate are
Average cost per unit functions of size of production unit.
Small
plant Medium
plant Large
plant
0 Output rate
5-15
Factors contributing to
Economies of Scale
Fixed costs and spread over more units (products
or customers), reducing the fixed cost per unit
Construction costs increase at a decreasing rate
with respect to the size of the facility
Processing costs decrease as output increases
because operations become more standardized
(over time) which reduces unit costs
5-16
Evaluating Alternatives
Cost-volume analysis
Break-even point
Financial analysis
Cash flow
Present value
Decision theory
Waiting-line analysis
5-17
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
5-18
Cost-Volume symbols
5-19
Cost-Volume Relationships
5-20
Cost Volume Relationships
BEP – Break Even Point
Volume of output needed for total revenue equaling
total cost
Production below BEP quantity results in loss
Production above BEP quantity results in profit
Production at BEP quantity: no profits, no loss.
Point of Indifference
the quantity at which a decision maker would be
indifferent between two competing alternatives
5-21
Example
The owner of Old-Fashioned Berry Pies is contemplating
adding a new line of pies, which will require leasing new
equipment for a monthly payment of $6,000. Variable
costs would be $2 per pie, and pies would retail for $7
each.
a.How many pies must be sold in order to break even?
b.What would the profit (loss) be if 1,000 pies are made
and sold in a month?
c.How many pies must be sold to realize a profit of $4,000?
d.If 2,000 can be sold, and a profit target is $5,000, what
price should be charged per pie?
5-22
Example
5-23
Break-Even Problem with Step Fixed
Costs
5-24
Example
A manager has the option of purchasing one, two, or three
machines. Fixed costs and potential volumes are as follows:
Variable cost is $10 per unit, and revenue is $40 per unit.
a.Determine the break-even point for each range.
b.If projected annual demand is between 580 and 660 units,
how many machines should the manager purchase?
5-25
Example
b. Projected demand is between 580 and
660 units. BEP for 2 machines is 500, so
2 machines are suitable for demand up
to 600. However, BEP for 3 machine is
666.67, but the annual demand is no
more than 660. So 3 machines is not a
feasible option.
We should opt for 2 machines and supply
up to 600 units.
5-26
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.
5-27
Decision Theory
Helpful tool for financial comparison of
alternatives under conditions of risk or
uncertainty
Suited to capacity decisions
See Chapter 5 Supplement
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
5-29
