Strategic Capacity Planning For Products and Services: Overview: Learning Objectives

MODULE 6
Strategic capacity planning for products and services
Learning Objectives:
OVERVIEW:
• Explain the importance of capacity planning.
Capacity planning is important as its a key strategic • Describe ways of defining and measuring capacity
component in designing the system. Measurement of • Discuss the major considerations related to
capacity, how capacity requirements are determined, developing capacity alternatives.
and the development and evaluation of capacity • Describe the steps that are used to resolve
alternatives are the main points in this topic. constraint issues
6.1. Defining and measuring capacity
Capacity may be referred as an upper limit on the rate of output. Proper representation of measurement of a capacity
may involve difficulty especially when a firm has multiple products. The choice of measurement should also be the one
which doesn’t need updating. It is important to note however, that no single measure of capacity will be appropriate in
every situation. Rather, the measure of capacity must be tailored to the situation. (Refer to table 5.1 in reference book, for
examples of capacity measures)
Definition of Capacity
▪ Design capacity— The maximum output rate or service capacity an operation, process, or facility is designed for.
▪ Effective capacity— Design capacity minus allowances such as personal time, equipment maintenance, delays due
to scheduling problems, and changing the mix of products.
Measures of system effectiveness

▪ Efficiency is the ratio of actual output to effective capacity
▪ Capacity utilization is the ratio of actual output to design capacity
6.2. Determinants of effective capacity
Decisions on systems design have an impact on a firm’s capacity. Other factors that affects or contributes to the capacity
involves:
a) Facilities
b) Product and service factors
c) Process factors
d) Human factors
e) Policy factors
f) Operational factors
g) Supply Chain Factors
h) External factors
6.3. Strategy Formulation
Manages must be aware of the effects of capacity decisions on the overall business organization. Strategies must be
formulated in order to have efficient operations. Capacity strategy are formulated based on assumptions and predictions
about long-term demand patterns, technological changes, and the behavior of its competitors. Three primary strategies
are: leading capacity strategy (builds capacity in anticipation of future demand increases), following strategy (builds
capacity when demand exceeds current capacity), tracking strategy (similar to a following strategy, but adds capacity in
relatively small increments to keep pace with increasing demand).
Steps in the Capacity Planning Process

1. Estimate future capacity requirements.
2. Evaluate existing capacity and facilities and identify gaps.
3. Identify alternatives for meeting requirements.
4. Conduct financial analyses of each alternative.
5. Assess key qualitative issues for each alternative.
6. Select the alternative to pursue that will be best in the long term.
7. Implement the selected alternative.
8. Monitor results.
❖ Calculating Processing Requirements

To determine the capacity requirements of products that will be processed, there should be a reasonably accurate
information on the demand forecasts for each product and the standard processing time per unit for each product,
the number of workdays per year, and the number of shifts that will be used.
6.4. Developing capacity alternatives
1. Design flexibility into systems

⎯ The long-term nature of many capacity decisions and the risks inherent in long-term forecasts suggest
potential benefits from designing flexible systems
2. Take stage of life cycle into account
⎯ Capacity requirements are often closely linked to the stage of the life cycle that a product or service
is in
3. Take a “big picture” approach to capacity changes
⎯ When developing capacity alternatives, it is important to consider how parts of the system interrelate
4. Prepare to deal with capacity “chunks”
⎯ Capacity increases are often acquired in fairly large chunks rather than smooth increments, making it
difficult to achieve a match between desired capacity and feasible capacity.
5. Attempt to smooth out capacity requirements
⎯ Unevenness in capacity requirements also can create certain problems.
6. Identify the optimal operating level
⎯ Production units typically have an ideal or optimal level of operation in terms of unit cost of output.
7. Choose a strategy if expansion is involved
⎯ Consider whether incremental expansion or single step is more appropriate.
6.5. Constraint Management
One thing that may hinder the utilization of capacity is the presence of constraint. A constraint is something that limits
the performance of a process or system in achieving its goals. Constraint issues can be resolved by using the following five
steps:
1) Identify the most pressing constraint. If it can easily be overcome, do so, and return to Step 1 for the next
constraint. Otherwise, proceed to Step 2.
2) Change the operation to achieve the maximum benefit, given the constraint. This may be a short-term solution.
3) Make sure other portions of the process are supportive of the constraint (e.g., bottleneck operation).
4) Explore and evaluate ways to overcome the constraint.
5) Repeat the process until the level of constraints is acceptable.
❖ Cost–Volume Analysis
Cost–volume analysis focuses on relationships between cost, revenue, and volume of output. The purpose of cost–
volume analysis is to estimate the income of an organization under different operating conditions. It is particularly
useful as a tool for comparing capacity alternatives. The main use of CVP analysis is the determination of breakeven
point or the volume of output at which total cost and total revenue are equal.
(See illustration of Cost-Volume Analysis, Break-even point and Indifference point in Production Operations Management
Chapter 5 by William J. Stevenson)
Reference used:
William J. Stevenson, Production Operations Management
Additional Readings:
Production Operations Management Chapter 5 by William J. Stevenson

Exercise 1
Determine the utilization and the efficiency for each of these situations:
a) A loan processing operation that processes an average of 7 loans per day. The operation has a design capacity of
10 loans per day and an effective capacity of 8 loans per day.
b) A furnace repair team that services an average of four furnaces a day if the design capacity is six furnaces a day
and the effective capacity is five furnaces a day.
c) Would you say that systems that have higher efficiency ratios than other systems will always have higher
utilization ratios than those other systems? Explain.
Exercise 2
In a job shop, effective capacity is only 50 percent of design capacity, and actual output is 80 percent of effective
output. What design capacity would be needed to achieve an actual output of eight jobs per week?
Exercise 3
A producer of pottery is considering the addition of a new plant to absorb the backlog of demand that now exists. The
primary location being considered will have fixed costs of $9,200 per month and variable costs of 70 cents per unit
produced. Each item is sold to retailers at a price that averages 90 cents.
a) What volume per month is required in order to break even?
b) What profit would be realized on a monthly volume of 61,000 units? 87,000 units?
c) What volume is needed to obtain a profit of $16,000 per month?
d) What volume is needed to provide a revenue of $23,000 per month?
e) Plot the total cost and total revenue lines.

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MODULE 6

Strategic capacity planning for products and services

6.1. Defining and measuring capacity

Measures of system effectiveness

6.2. Determinants of effective capacity

6.3. Strategy Formulation

Steps in the Capacity Planning Process

❖ Calculating Processing Requirements

6.4. Developing capacity alternatives

1. Design flexibility into systems

William J. Stevenson, Production Operations Management

Production Operations Management Chapter 5 by William J. Stevenson

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