Capacity Planning

Module 4
 Capacity Planning

Capacity planning is the process of determining the production capacity needed by an

organisation to meet changing demands for its products.
 Defining Capacity

Capacity is the productive capability of a facility. Capacity is defined under three categories

1) Design capacity,

2) Effective capacity

3) Actual output / Actual capacity

The utilization of resources in the operations and the efficiency of its processes can be calculated
using these concepts.
 Defining Capacity

Design Capacity

Design capacity is the output that an operation can produce continuously, at maximum rate
without stopping for any shift changeovers, maintenance or any other delays.

In other words, it is the capacity that can be made available or what the process is capable
of producing under perfect conditions. In some cases, this might be interpreted as
maximum capacity.
 Defining Capacity
Effective Capacity

This considers how the operation will run on a long term, basis, how it will be staffed and how
it will be maintained. All planned stoppages under the normal working time frame are taken
into consideration.

This can also be known as available capacity. These stoppages may include shift changeovers,
lunch breaks, set up times and many other operational factors.

Actual capacity

This is the same as effective capacity but contains unplanned losses as well as planned
ones. These could include poor work rate, absenteeism or new staff training time etc.
 Efficiency and utilisation

Actual Output Actual Output

Efficiency = ----------------------- Utilisation = --------------------
Effective Capacity Design Capacity

Example
Design Capacity = 50 trucks per month
Effective Capacity = 40 trucks per month
Actual output = 36 trucks per month

36 units 36 units
Efficiency = ------------- = 90% Utilisation = ------------ = 72%
40 units 50 units
 Measures of Capacity

When measuring capacity the unit of measurement can be either an input or output.
1) Input Measures of Capacity
2) Output Measures of Capacity

Where the input is more complicated to measure then output is a more suitable
option.
 Measures of Capacity
Input Measure of Capacity

When using input measures of capacity, the measure selected is defined by the key input into
the process.

Where the provision of capacity is fixed, it is often easier to measure capacity by inputs, for
example; rooms available in a hotel or seats at a conference venue.

Input measures are most appropriate for small processes or where capacity is relatively fixed,
or for highly customized or variable outputs such as complicated services.
 Measures of Capacity
Output Measure of Capacity

The output measures count the finished units from the process such as mobile phones produced in
a day or cars manufactured per week.

This measure is best used where there is low variety in the product mix or limited customization.
Measures of Capacity
Capacity can be measured from looking at the operation as a whole and then
calculated on the resources and facilities available and process time
Production / Service Measure of Capacity
Process Input Output

Automobile Number of machine hours Number of vehicle produced

Manufacturing available per unit time
Steel Production Number of machine hours Tons of Steel produced per
available month
Power Generation & Number of machine hours Megawatts of electricity
Transmission available generated per week
Milk Bottling Number of machine hours Bottles filled per day
available
Airlines Operation Number of seats available Number of passengers per day
Hotel Operation Number of rooms available Number of guests per week
Hospital Operation Number of beds available Number of patients per week
 Calculating Capacity
Example

A fitness instructor works an eight hour day, takes two fifteen minute coffee breaks
and has a half hour lunch break. He spends 70 minutes with each customer (10
minutes for the consultation and booking and 1 hour for the gym session), how many
clients could the instructor process during a five day week?

Capacity = (Time available)/ (Time of task)

(5 days a week) x (7 hours a day) x (60 minutes per hour)
Capacity = ------------------------------------------------------------------------
(70 minutes/client)

= (5 x 7 x 60 )/70 = 30 clients per week

30 clients / week can be expressed as the capacity of the fitness operation
 Calculating Capacity - Example
A department works on 8-hour shift, 250 days a year, and has the following figures
for usage of a machine which is currently being considered.

How many such machines will be needed assuming that one single machine can do
the processing of all types of products?
Calculating Capacity - Example

Capacity available for one machine = 250 x 8 = 2000

Number of machines required = 5800/2000 = 2.9 -> 3

 Calculating Capacity
The earlier examples are simplified ones. In most of the practical cases there will be
multiple activities under a process and interlinking processes.
Here the operation will have to consider the capacity of the whole process and not
individual constituent processes.
The individual process durations may differ and there can be bottlenecks.

Bottleneck operation - An operation in a

sequence of operations whose capacity is
lower than that of the other operations.
 Calculating Capacity
If the first part of the process takes 10 minutes but stage 2 takes 20 minutes and stage three
takes 10 minutes, then a backlog will appear at stage 2.

10 minutes 20 minutes 10 minutes

per unit per unit per unit

6 process per hour 3 process per hour 6 process per hour

Bottle Neck

Output of a process will be constrained by the slowest point

 Calculating Capacity - Example
What is the capacity (attainable output) of this system?
 Calculating Capacity - Example

The attainable output of each line of the system is equal to the output of the slowest
operation.
So, the output of the upper line is 10 units per hour and the output of the lower line is
9 units per hour.
Together the two portions can produce 10 + 9 = 19 units per hour.
Although operation #7 can handle 20 units per hour, only 19 units per hour come from
the two previous portions of the system, so the system output can only be 19 units per
hour.
 Capacity Planning – Evaluating Alternatives
An organization needs to examine alternatives for future capacity from a number of
different perspectives. Most obvious are economic considerations.

Cost–Volume Analysis

Focuses on relationships between cost, revenue, and volume of output.

Identification of all costs related to the production of a given product.

Fixed costs (FC) tend to remain constant for fairly considerable time regardless of
volume of output – Capital cost, house rent, machinery etc.

Variable costs (VC) vary directly with volume of output – Material, Labor etc.
 Capacity Planning – Evaluating Alternatives
Total Cost

TC = FC + VC

VC = Q × v v = variable cost per unit

The total revenue associated with a given quantity of output, Q, is

TR = R × Q

The volume at which total cost and total revenue are equal is referred to as the break-
even point (BEP). Q x R = FC + Q x v
𝐹𝐶
𝑄 𝐵𝐸𝑃 =
𝑅−𝑣
 Capacity Planning – Evaluating Alternatives
Total profit can be computed using the formula

P = TR − TC

= R × Q − (FC + v × Q)

P = Q(R − v) − FC

The difference between revenue per unit and variable cost per unit, R − v, is known as
the contribution margin.

The required volume, Q, needed to generate a specified profit is

Capacity Planning – Evaluating Alternatives
Capacity Planning – Evaluating Alternatives

50 65 100

Indifference point - The quantity that would make two alternatives equivalent

Capacity Planning – Evaluating Alternatives

Revenue TCB

TCA

FCA
Cost

FCB

Vo
 Capacity Planning – Evaluating Alternatives
Example - 1

The owner of Old-Fashioned Berry Pies, S. Simon, 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?
 Capacity Planning – Evaluating Alternatives
FC = $6,000, VC = $2 per pie, R = $7 per pie

QBEP = FC/(R − VC) = $6,000/($7 − $2) = 1,200 pies/month

For Q = 1,000, P = Q(R − v) − FC = 1,000 ($7 − $2) − $6,000 = −$1,000

P = $4,000; solve for Q 
Q = ($4,000 + $6,000)/($7 − $2) = 2,000 pies

Profit = Q(R − v) − FC
$5,000 = 2,000(R − $2) − $6, 000
R = $7.50
 Capacity Planning – Evaluating Alternatives
Capacity alternatives may involve step costs, which are costs that increase stepwise as
potential volume increases. For example, a firm may have the option of purchasing one,
two, or three machines, with each additional machine increasing the fixed cost,
 Capacity Planning – Evaluating Alternatives
Example - 2
A manager has the option of purchasing one, two, or three machines. Fixed costs and
potential volumes are given the table below.
Variable cost is $10 per unit, and revenue is $40 per unit.
a. Determine the break-even point for each range.
b. If projected annual demand is between 580 and 660 units, how many machines
should the manager purchase?
Number of Total Annual Corresponding
Machines Fixed Costs ($) Range of Output
1 9,600 0 to 300
2 15,000 301 to 600
3 20,000 601 to 900
Capacity Planning – Evaluating Alternatives
 Capacity Planning – Evaluating Alternatives
Comparing the projected range of demand to the two ranges for which a break-even
point occurs we can see that the break-even point is 500, which is in the range 301 to
600.
This means that even if demand is at the low end of the range, it would be above the
break-even point and thus yield a profit.
That is not true of range 601 to 900. At the top end of projected demand, the volume
would still be less than the break-even point for that range, so there would be no
profit. Hence, the manager should choose two machines
 Determinants of Effective Capacity
Facilities - The design of facilities, size and provision for expansion
Location - Locational factors, such as transportation costs, distance to market, labor
supply, energy sources, and room for expansion, are also important.
Product and Service Factors - When items are similar, the ability of the system to produce
those items is generally much greater than when successive items differ
Process Factors - Influence of output quality impacts capacity. If quality of output does not
meet standards, the rate of output is slowed due to inspection and rework activities.
Human Factors - The tasks that make up a job, the variety of activities involved, and the
training, skill, and experience required to perform a job all have an impact on the potential
and actual output
 Determinants of Effective Capacity
Policy Factors - Management policy can affect capacity by allowing or not allowing
capacity options such as overtime or second or third shifts.
Operational Factors - Scheduling problems, Inventory stocking decisions, late deliveries,
acceptability of purchased materials can have an impact on effective capacity
Supply Chain Factors - If substantial capacity changes happen management needs to
consider its impact on suppliers, warehousing and transport operators, and distributors?
External Factors - Product standards, especially minimum quality and performance
standards, can restrict management’s options for increasing and using capacity. Thus,
pollution standards on products and equipment often reduce effective capacity.
 Capacity Planning Strategy Folulation
The three primary strategies are
 Leading - A leading capacity strategy builds capacity in anticipation of future demand
increases. If capacity increases involve a long lead time, this strategy may be the best
option.
 Following - A following strategy builds capacity when demand exceeds current capacity.
 Tracking - A tracking strategy is similar to a following strategy, but it adds capacity in
relatively small increments to keep pace with increasing demand.
An organization typically bases its capacity strategy on assumptions and predictions about
long-term demand patterns, technological changes, and the behavior of its competitors
 Capacity Planning Strategy Formlulation
In some instances, a decision may be made to incorporate a capacity cushion, which is an
amount of capacity in excess of expected demand when there is some uncertainty about
demand.

Capacity cushion = capacity − expected demand.

Typically, the greater the degree of demand uncertainty, the greater the amount of
cushion used.
Organizations that have standard products or services generally have smaller capacity
cushions
 Capacity Planning over Time Horizon
When capacity needs to be increased or decreased, the operation must consider
how this is going to be achieved.

Organizations will have to make investment decisions based upon what level of
capacity is to be selected and when it is to be provided.

The timing decisions of how and when to provide capacity need to be determined in
line with demand
 Capacity Planning over Time Horizon
The ability to increase or decrease capacity can be viewed in 3 time phases; short
term, medium term and long term.
Short-term planning –
This is a reactive time scale
Capacity adjustments can be done quickly (within a couple of days to maximum 3
months)
Only the flexible resources can be increased to enhance the capacity.
Example –
Paying overtime to existing workers
Reallocating more workers to the unit where bottle neck has occurred
 Capacity Planning over Time Horizon
Medium-term planning –
 Here the time scale is beyond the immediate management of operations
 Capacity adjustments can be done within a time frame of 3 – 18 months
 More time is available to do the capacity adjustments and hence more significant
than those in short term.
Example –
 Hiring or firing the contract staff
 Leasing in facilities
 Capacity Planning over Time Horizon
Long-term planning –
 Here the planning time scale is beyond 12- 18 months
 Capacity changes are more strategic in nature.
 Changes need longer time and difficult to revert
Example –
 Recruiting or firing full time employees
 Purchase new machinery and set up a new production line
 New technology
 Additional facilities
For each of the above options the adjustment depends on the type of process concerned.
 Capacity Planning – Evaluating Alternatives
Example - 3
A manufacturer of condiments has to decide between Machines A, B and C, three
alternative machines available for final packaging. While the initial fixed costs are high
for machine B and C compared to machine A, their operating costs are lower. The
relevant cost data for each of the machines is given below in the following table.

  Machine A Machine B Machine C

Fixed Cost $20,000 $40,000 $80,000
Variable Cost $5 $4 $3
per unit

What should the manufacturer do?

 Capacity Planning – Evaluating Alternatives
Example - 4

A firm’s manager must decide whether to make or buy a certain item used in the
production of vending machines. Making the item would involve annual lease costs of
$150,000. Cost and volume estimates are as follows:

a. Given these numbers, should the firm buy or make this item?
b. There is a possibility that volume could change in the future. At what volume would
the manager be indifferent between making and buying?
 Capacity Planning – Evaluating Alternatives
Example - 5

A small firm produces and sells automotive items in a five-state area. The firm expects
to consolidate assembly of its battery chargers line at a single location. Currently,
operations are in three widely scattered locations.
The leading candidate for location will have a monthly fixed cost of $42,000 and
variable costs of $3 per charger. Chargers sell for $7 each.
a) Prepare a table that shows total profits, fixed costs, variable costs, and revenues
for monthly volumes of 10,000, 12,000, and 15,000 units.
b) What is the break-even point?
c) Determine profit when volume equals 22,000 units
 Capacity Planning
Example - 6