Chapter 11 Capacity

Management
WHAT IS CAPACITY MANAGEMENT?
Capacity = the maximum level of value-added activity over a period of time that the
process can achieve under normal operating conditions

Capacity constraints
Many organizations operate at below their maximum processing capacity, either
because there is insufficient demand completely to fill their capacity, or as a
deliberate policy, so that the operation can respond quickly to every new order.
Often, though, organizations find themselves with some parts of the operation
operating below their capacity while others are at their capacity ceiling. It is the
parts that are operating at their capacity ceiling which are the capacity constraints
for the whole operation.

Planning and controlling capacity

Capacity planning and control is the task of setting the effective capacity of the
operation so that it can respond to the demands placed upon it. This usually means
deciding how the operation should react to fluctuations in demand.

Medium- and short-term capacity

Having established a long-term capacity, operations managers must decide how to
adjust the capacity of the operation in the medium term. This usually involves an
assessment of the demand forecasts over a period of 2-18 months ahead, during
which time planned output can be varied. In practice, however, few forecasts are
accurate, and most operations also need to respond to changes in demand which
occur over a shorter timescale. So operations managers also have to make short-
term capacity adjustments, which enables them to flex output for a short period,
either on a predicted basis or at short notice.

Aggregate demand and capacity

The important characteristics of capacity management is that it is concerned with
setting capacity levels over the medium and short term in aggregated terms. That
is, it is making overall, broad capacity decisions, but is not concerned with all of the
detail of the individual products and services offered. This may mean some degree
of approximation, especially if the mix of products or services being produced varies
significantly. As a first step in management, aggregation is necessary (examples,
see book). Money is the ultimate aggregation measure (examples, see book).

The objectives of capacity management

The decisions taken by operations managers in devising their capacity plans will
affect several different aspects of performance:
Costs capacity levels in excess of demand could mean under-utilization of
capacity and therefore high unit-costs
Revenues capacity levels equal to or higher than demand will ensure that all
demand is satisfied and no revenue lost
 Working capital will be affected if an operation decides to build up finished
goods inventory prior to demand, the organization has to fund inventory.
Quality might be affected by a capacity plan which involved large
fluctuations in capacity levels, by hiring temporarily staff for example.
Speed can be enhanced by built up of inventory or by surplus capacity
Dependability affected by how close demand levels are to capacity. The
closer the demand gets to the operations capacity ceiling, the less able it is
to cope with any unexpected disruptions and the less dependable.
Flexibility will be enhanced by surplus capacity. If demand and capacity are
in balance, the operation will not be able to respond to any increase in
demand.

The steps of capacity management

The sequence of capacity management decision which need to be taken by
operations managers:
1. Measure aggregate demand and capacity
2. Identify the alternative capacity plans
3. Chose the most appropriate capacity plan
(see figure 11.2, page 326)

HOW IS CAPCITY MEASURED?

Forecasting demand fluctuations
Demand forecasting is very important to the capacity management decisions.
Without an estimate of the future demand, it is not possible to plan effectively for
future events, only to react on them. It is therefore important to understand the
basic and rationale for these demand forecasts. As far as a capacity planning and
control is concerned, there are three requirements from a demand forecast:
It is expresses in terms which are useful for capacity management
it has to be expressed in the same units as the capacity
It is as accurate as possible - it has to be accurate because there is a lag
between changing capacity and the change taking effect.
It gives an indication of relative uncertainty forecast levels of demand
can differ considerably from actual demand. So of equal importance is an
estimate of how much actual demand could differ from the average.

Seasonality of demand
Most markets are influenced by some kind of seasonality they vary depending on
the time of the year. Sometimes the causes of seasonality are climatic, sometimes
festive, sometimes financial, or social, or political. It may be demand seasonality or
supply seasonality, but in many organizations, capacity management is largely
about coping with these seasonal fluctuations. These fluctuations in demand or
supply may be reasonably forecastable, but some are usually also affected by
unexpected variations of the weather and by changing economic conditions.

Weekly and daily demand fluctuations

Seasonality of demand occurs over a year, but similar predictable variations in
demand can also occur for some products and services in a shorter cycle. The extent
to which an operation will have to cope with very short-term demand fluctuations is
partly determined by how long its customers are prepared to wait for their products
or services. An operation whose customers are incapable of waiting or unwilling to
wait, will have to plan for very short-term demand fluctuations.
Measuring capacity
The main problem with measuring capacity is the complexity of most operations.
Only when the operation is highly standardized and repetitive is capacity easy to
define unambiguously. For many operations, however, the definition of capacity is
not so obvious. When a much wider range of outputs places varying demands on the
process, for instance, output measures of capacity are less useful. Here input
capacity measures are frequently used to define capacity (see table 11.1, page
329).

Capacity depends on activity mix

Output depends on the mix of activities in which an organization is engaged, and
because some organizations have many different activities, output is difficult to
predict. Certainly it is difficult to compare the capacity of these kinds of operations
which have very different activities.
(Read in book/worked example, page 330)

Design capacity and effective capacity

The theoretical capacity of an operation the capacity which its technical designers
had in mind when they commissioned the operation cannot always be achieved in
practice. The actual capacity which remains, after such losses as maintenance are
accounted for, is called the effective capacity of operation. Not that these causes of
reduction in capacity will be the only losses in the operation. Such factors as quality
problems and machine breakdowns will all take their toll. This means that actual
output of the line will be even lower than the effective capacity.

actual output
Utilization = designcapacity

actual output
Efficiency = effective capacity (See worked example, page 331)

Overall equipment effectiveness

The overall equipment effectiveness (OEE) measure is an increasingly popular
method of judging the effectiveness of operations equipment. It is based on three
aspects of performance:
The time that the equipment is available to operate
The quality of the product or service it produces
The speed, or throughput rate, of the equipment

Overall equipment effectiveness is calculated by multiplying an availability rate by a

performance (or speed) rate multiplied by a quality rate.

total operating time

Availability rate (a) = loading time
 net operating time
Performance rate (p) = total operating time

valuable operating time

Quality rate (q) = net operating time (see figure 11.4, page 332)

OEE = a x p x q
(see worked example, page 333)
COPING WITH DEMAND FLUCTUATION
With an understanding of both demand and capacity, the next step is to consider the
alternative methods of responding to demand fluctuations. There are three pure
options available for coping with such variations
Ignore the fluctuations and keep activity level constant (level capacity plan)
Adjust capacity to reflect the fluctuations in demand (chase demand plan)
Attempt to change demand to fit capacity (demand management)

Level capacity plan

In a level capacity plan, the processing capacity is set at a uniform level throughout
the planning period, regardless of the fluctuations in forecast demand. This means
that the same number of staff operate the same processes and should therefore be
capable of producing the same aggregate output in each period. Where non-
perishable materials are processed, but not immediately sold, they can be
transferred to finished goods inventory in anticipation of sales at a later time.

Level capacity plans of this type can achieve the objectives of stable employment
patterns, high process utilization, and usually also high productivity with low unit
costs. Unfortunately, they can also create considerable inventory which has to be
financed and stored. Perhaps, the biggest problem, is that decisions have to be
taken as to what to produce for inventory rather than for immediate sale. Most firms
operating this plan, therefore give priority to only creating inventory where future
sales are relatively certain and unlikely to be affected by fashion or design.

Low utilization can make level capacity plan prohibitively expensive in many service
operations, but may be considered appropriate when the opportunity costs of
individual lost sales are very high. It is also possible to set the capacity somewhat
below the forecast peak demand level in order to reduce the degree of under-
utilization. While this is far from ideal, the benefits to the organization of stability
and productivity may outweigh the disadvantages of upsetting some customers.

Chase demand plan

The opposite of a level capacity plan is one which attempts to match capacity
closely to the varying levels of forecast demand. This is much more difficult to
achieve than level capacity plan, as the number of different staff, different working
hours, and even different amounts of equipment may be necessary in each period.
For this reason, pure chase demand plans are unlikely to appeal to operation which
manufacture standard, non-perishable products. A pure chase demand plan I more
usually adopted by operations which cannot store their output. It avoids the wasteful
provision of excess staff that occurs with a level capacity plan, and yet should satisfy
customer demand throughout the planned period. Were output can be stored, the
chase demand policy might be adopted in order to minimize or eliminate finished
goods inventory.

Methods of adjusting capacity

The chase demand approach requires that capacity is adjusted by some means.
There are a number of different methods for achieving this, although they may not
all be feasible for all types of operation. Some of these methods are:
Overtime and idle time
Often the quickest and most convenient method of adjusting capacity is by varying
the number of productive hours worked by staff in the operation. When demand is
higher than nominal capacity, overtime is worked. When demand is lower the
amount of time spend by staff on production work can be reduced, they can engage
in some other activity.
Varying the size of the workforce
If capacity is largely governed by workforce size, one way to adjust it is to adjust the
size of the workforce. This is done by hiring staff during high periods of demand and
laying them off as demand falls, or hire and fire. However, there are costs and
ethical implications to be taken into account before adopting such a method.

Using part-time staff

A variation in the previous strategy is to recruit part-time staff; that is, for less than
the normal working day. However, if the fixed costs of employment for each
employee irrespective of how long he or she works, are high, then using this method
may not be worthwhile.

Subcontracting
In periods of high demand, an operation might buy capacity from other
organizations, called subcontracting. This might enable an operation to meet its own
demand without the extra expenses of investing in capacity which will not be
needed after the peak demand has passed. Subcontracting however can be very
expensive. Also a subcontractor may not be motivated to deliver on time or deliver
desired qualities. Or subcontractors might decide themselves to enter the market.

Manage demand plan

The most obvious mechanisms of demand management is to change demand
through price. However, it is less common for products than for services. The
objective is invariably to stimulate off-peak demand and to constrain peak demand,
in order to smooth demand as much as possible. Organizations can also attempt to
increase demand in low periods by appropriate advertising.

Alternative products and services

Sometimes a more radical approach is required to fill periods of low demand, such
as developing alternative products or services which can be produced on existing
processes, but have different demand patterns throughout the year. The apparent
benefits of filling capacity in this way must be weighed against the risks of
damaging the core product or service, and the operation must be fully capable of
serving both markets.

Mixed plans
Each of the three pure plans is applied only when its advantages strongly outweigh
its disadvantages. For many organizations, however, there pure approaches do not
match their required combination of competitive and operational objectives. For this,
operations choose to follow a mixture of the three approaches.

Yield management
In operations which have relatively fixed capacities, it is important to use the
capacity of the operation to maximize its potential to generate profit. One approach
used by such operations is called yield management. It is really a variety of methods
and analytical tools. The term is used in many service operations to mean
techniques that can be used to allocate limited resources, among different
categories of customers. These techniques are used by operations with service that
cannot be stored.
When supplies are short, price goes up; when supply is high; price goes down.
Yield management is especially useful where:
- Capacity is relatively fixed - the service cannot be stored
- The market can be fairly clearly segmented - the service are sold in advance
- The marginal costs of making a sale are relatively low
HOW CAN OPERATIONS PLAN THEIR CAPACITY LEVEL?
Before an operation can decide which of the capacity plans to adopt, it must be
aware of the consequences of adopting each plan in its own set of circumstances.
Two methods are particularly useful in helping to assess the consequences of
adopting particular capacity plans.
Cumulative representation of demand and capacity
Queuing theory

Cumulative representation (see figure 11.10, page 343)

One method of assessing whether a particular level of capacity can satisfy demand
would be to calculate the degree of over-capacity below the graph (areas A and C)
and the degree of under capacity above the graph (area B). If the total over-capacity
is greater than the total under-capacity for a particular level of capacity, then that
capacity could be regarded as adequate to satisfy demand fully, the assumption that
inventory has been accumulated in the periods of over-capacity.

Problems with this approach

Each month shown in figure 11.10 may not have the same amount of
productive time. (vacations)
A capacity level which seems adequate may only be able to supply products
after the demand for them has occurred.

Cumulative plot read book, page 344-345

Comparing plans on cumulative basis

Chase demand plans can also be illustrated on a cumulative representation. Rather
than the cumulative production line having a constant gradient, it would have a
varying gradient representing the production rate at any point in time. If a pure
demand chase plan was adopted, the cumulative production line would match the
cumulative demand line. The gap between the two lines would be zero and hence
inventory would be zero. Although this would eliminate inventory-carrying costs,
there would be costs associated with changing capacity levels.
(read worked example, page 347)

HOW IS CAPACITY PLANNING A QUEUING PROBLEM?

Cumulative representations of capacity plans are useful where the operation has the
ability to store its finished goods as inventory. However, for operations where it is
not possible to produce products and services before demand for them has
occurred, capacity and control is best considered using waiting or queuing theory.

Queuing or waiting line management

Looking at an issue as a queuing problem, accepts that, while sometimes demand is
may be satisfied instantly, at other times customers may have to wait. This is
particularly true when the arrival of individual demands on an operation are difficult
to predict, or the time to produce a product or service is uncertain, or both.
Customers arrive according to some probability distribution and wait to be
processed; when they have reached the front of the queue, they are processed by
one of the n parallel servers, after which they leave the operation. (see figure
11.14, table 11.2, page 349)

The source of customers

The source of customers is the source of supply of customers. In queue
management customers are not always human (trucks). The source of customers for
a queuing system can be either finite or infinite. A finite source has a known number
of possible customers. There will be a certain probability that one of the assembly
lines will break down and need repairing. However, if one line really does break
down, the probability of another line needing repair is reduced. Sow with a finite
source of customers, the probability of a customer arriving depends on the number
of customers already being served.

Infinite customers sources assume that there is a large number of potential

customers so that it is always possible for another customer to arrive no matter how
many are being served.
The arrival rate
The rate at which customers needing to be served arrive at the server or servers.
Rarely do customers arrive at a steady and predictable rate. Because of this
variability it is necessary to describe arrival rates in terms of probability
distributions.
The queue
Customers waiting to be served from the queue. If there is relatively little limit on
how many customers can queue at any time, we can assume that, for all practical
purposes, an infinite queue is possible.
Rejecting
If the number of customers in a queue is already at the maximum number allowed
then the customer could be rejected by the system.
Balking
When a customer is a human being with free will he or she may refuse to join the
queue and wait for service if it is judged to be too long.
Reneging
This is similar to baling but here the customer has queued for a certain length of
time and then leaves the queue and therefore the chance of being served.
Queue discipline
Set of rules that determine the order in which customers waiting in the queue are
served.
Servers
The facility that processes the customer in the queue. In any queuing system there
may be any number of servers configured in different ways.

Balancing capacity and demand

The dilemma of managing the capacity of a queuing system is how many servers to
have available at any point in time in order to avoid unacceptably long queuing
times or unacceptably low utilization of servers. When the average capacity of the
operation matches the average demand on the system, both queues an idle time
will occur.
Capacity planning and control problems for queuing operations are often presented
as a trade-off between customer waiting time and system utilization.

Variability in demand or supply

The variability either in demand or capacity, will reduce the effective capacity. The
greater the variability in arrival time or activity time at a process, the more the
process will suffer both high throughput time and reduced utilization. This principle
holds true for whole operations and because long throughout times mean that
queues will build up in the operation, high variability also affects inventory levels.
The greater the variability, the more extra capacity will need to be provided to
compensate for the reduced utilization or available capacity. Operations with high
levels of variability tend to set their base level relatively high.

Customer perceptions of queuing

An important aspect of how people judge the service they receive form a queuing
system is how they perceive the time spent queuing. The management of queuing
systems usually involves attempting to manage customers perception and
expectations in some way.

Time spent idle is perceived as longer than time spent occupied

The wait before a service starts is perceived as more tedious than a wait
within a service process
Anxiety and/or uncertainty heighten the perception that time spent waiting is
long
A wait of unknown duration is perceived as more tedious than a wait whose
duration is known
An unexplained wait is perceived as more tedious than a wait that is
explained
The higher the value of the service for its customer, the longer the wait that
will be tolerated
Waiting on ones own is more tedious than waiting in a group

The dynamics of capacity management

The capacity control process can be seen as a sequence of partially reactive
capacity decisions. At the beginning of each period, operations management
considers its forecasts of demand, its understanding of current capacity and, if
appropriate, how much inventory has been carried forward from the previous period.
Based on all this information, it makes plans for the following periods capacity.
During the next period, demand might or might not be as forecasted and the actual
capacity of the operation might or might not turn out as planned.

The success of capacity management is generally measured by some combination of

costs, revenue, working capital and customer satisfaction. This is influenced by the
actual capacity available to the operation in any period and the demand for that
period.
(see figure 11.6, page 352)