Strategic Capacity Planning

Capacity

- upper limit or ceiling on the load that an operating unit can handle; includes equipment, space and employee skills

Goal of capacity planning

- achieve a match between an organization’s long term supply capabilities and predicted level of long term demand

• Capabilities: kinds of output the organization can provide

Three questions to capacity planning:

1. What kind is needed?

2. How much is needed to match demand?

3. When is it needed?

5.2 Capacity Decisions are Strategic

1. It has the ability to impact meeting future demands. Capacity limits the rate of output possible causing shortages or surplus.

2. Capacity decisions affect operating costs. 

3. Capacity is a major determinant of initial cost; implying that some product units of greater capacity equal greater cost.

4. Decisions involve long term commitment of resources which may be difficult to modify in the long run.

Gap in resources occurs when there is unevenness or mismatch that leads to wasted resources → this signals the need for capacity planning. These gaps can appear in:

• Employment levels – too few or too many workers compared to demand.

• Employee skills – mismatch between required tasks and available competencies.

• Work activities – inefficient allocation or duplication of tasks.

The key question: How efficiently are resources used?

Measures of Capacity:

1. Design Capacity - Maximum output rate/service capacity an operation, process or facility is designed for.

   1. This capacity is under ideal conditions

2. Effective Capacity - Design capacity - allowances (personal time and preventive maintenance).

   1. ALWAYS less than design capacity as it considers realities such as breaks.

3. Actual Output - CANNOT exceed effective capacity due to machine breakdowns. Absenteeism, shortage of materials, and other quality problems.

Measures of Systems Effectiveness:

1. Efficiency - ratio of actual output to effective capacity

   1. Efficiency = Actual Output / Effective Capacity x 100%

2. Capacity Utilization - ratio of actual output to design capacity

   1. Utilization = Actual OutputDesign / Capacity x 100%

Facilities

• Factors to capacity Planning: Size and provision for expansion, Location factors, Transportation costs, Distance to market, labor costs etc.

• Layout determines how smoothly work can be performed along with environmental factors. This also determines whether personnel can perform effectively.

Product and Service 

• The more uniform the output, the more opportunities there are for standardization of methods and materials leading to greater capacity. 

• Different items will have different rates of output.

Process

- processes that improve quality and productivity result in increased capacity

• Quantity capabilities 

• Quality capabilities

Determinants of Effective Capacity 

1. Facilities

   1. Size

   2. Layout

   3. Location

   4. Distance

2. Product and service factors

   1. Level of standardization of outputs

3. Process factors

   1. Quality

   2. Rework

4. Human factors

   1. Training

   2. Skills

   3. Experience

5. Policy factors

   1. Overtime

   2. Shifting

6. Operational factors

   1. Inventory issues

   2. Late deliveries

7. Supply chain factors

   1. Suppliers

   2. Distributors

8. External factors

   1. Government

   2. Environment

   3. Labor Union

Strategy Formulation

Leading Capacity: Builds capacity in anticipation of future demand increases

Following Strategy: Builds capacity when demand exceeds current capacity

Tracking Strategy: adds capacity in relatively small increments to keep pace with increasing demand”

Capacity Cushion - extra capacity to offset demand uncertainty

• Extra capacity to ensure your demand is met when it is unpredictable

• Capacity Cushion = Capacity - Expected Demand

Steps in Capacity Planning

1. Estimate future capacity

• Long term → overall level of capacity, determined by forecasting demand

• Short term → variations in capacity requirements

2. Evaluate existing capacity

• Accurate demand forecasts for each product

• Standard processing time

• Number of workdays per year

• Number of shifts to be used

• Calculating processing requirements = annual capacity + number of machines required

3. Identify alternatives

• In‑house → produce a good or service

• Outsource → supplier chosen if better reasons exist

• Factors: available capacity, expertise, quality, nature of demand, cost, risk (e.g., proprietary info)

4. Conduct financial analysis

• Make or Buy illustration = fixed cost + volume + variable cost per unit

5. Assess qualitative issues
6. Select one alternative
7. Implement chosen alternative
8. Monitor results

Forecasting Capacity Requirements

Long Term capacity relate to overall LEVEL of capacity, while Short Term relates to VARIATION in capacity requirements created by seasonal, random and irregular fluctuations in demand

When time intervals are too short for seasonal variation, we can describe demand using probability distributions like:

• Normal distribution → e.g., average coffee served at lunch with some variation.

• Poisson distribution → e.g., number of customers entering a bank on Monday mornings.

1. Service systems → lots of variability unless requests can be scheduled.

2. Manufacturing systems → usually more stable since production is isolated from customers.

Constraint Management

Constraint - limits performance of a process or system in achieving its goals

Categories of Constraint:

• Market → not enough demand

• Resource → too few workers, equipment, or space

• Material → shortage of materials

• Financial → not enough funds

• Supplier → unreliable, slow, or poor quality suppliers

• Knowledge/Competency → missing skills or know‑how

• Policy → laws or regulations interfere

Steps to manage constraints:

1. Identify the most pressing constraint

   1. If it's easy to fix, do it and repeat.

2. Change operations to get the most benefit despite the constraint (short‑term fix).

3. Support the constraint → make sure other parts of the process don’t make it worse.

4. Explore solutions depending on type:

   1. Low demand → advertising, price change

   2. Capacity issue → overtime, new equipment, outsourcing

   3. Financial issue → improve cash flow, borrow, issue stocks/bonds

   4. Supplier issue → work with them, find new ones, or do in‑house

   5. Knowledge issue → training, consultants, outsourcing

   6. Policy issue → work with lawmakers/regulators

5. Repeat until constraints are at an acceptable level.

Cost Volume Analysis - relationship between cost, revenue and volume of output. Meant to estimate an organization’s income under different operating conditions. 

• Fixed Costs - remains constant regardless of volume of output (e.g rent, property tax, equipment cost, admin costs)

• Variable Costs - vary directly with volume of output.  Mostly material and labor costs. 

  • TC = FC + VC

  • VC = Q x v

  • TR = R x Q

  • P = Q (R - v) - FC

  • Q = P + FC/ R - v

  • Qbep = FC/ R - v

    • FC = Fixed cost

    • VC = Total variable cost

    • v = Variable cost per unit

    • TC = Total cost

    • TR = Total revenue

    • R = Revenue per unit

    • Q = Quantity or volume of output

    • Qpep = Break‑even quantity

    • P = Profit

Financial Analysis

• Cash Flow - difference between cash from sales and other sources + cash outflow for labor, materials, overhead and taxes

• Present Value - the current value of sum of all future cash flows o an investment proposal

  • Methods of Financial Analysis

    • Payback - focus on length of time for an investment to return to its original cost. 

    • Present Value  -Considers the time value of money (interest rates, inflation). Combines Initial cost + Annual cash flows + Salvage value = Produces an equivalent current value.

    • Internal Rate of Return - Summarizes investment in terms of an equivalent interest rate. Finds the rate of return that equates: Future returns + Initial cost

Decision Theory and Waiting Line Analysis

Decision Theory

• Tool for financial comparison of alternatives under risk or uncertainty.

• Useful for capacity decisions and many other managerial choices.

Waiting Line Analysis

• Focuses on lines (queues) in service systems (e.g., airport counters, hospital ERs).

• Lines = symptoms of bottleneck operations.