MS 492

OPERATIONS MANAGEMENT

Capacity Planning for products

and services
Yousaf Ali Khan
Department of Management Sciences and Humanities
GIK Institute of Engineering Sciences and Technology

Capacity
Capacity can be defined as the ability to hold, receive,
store, or accommodate.
Capacity is the maximum output rate of a production
or service facility.
Capacity is the upper limit or ceiling on the load that
an operating unit can handle.
Capacity also includes
Equipment
Space
Employee skills

Capacity planning
Capacity planning is the process of determining
the production capacity needed by an organization
to meet changing demand for its products.
Strategic capacity planning is an approach for
determining the overall capacity level of capital
intensive resources, including facilities,
equipment, and overall labor force size
The basic questions in capacity handling are:

What kind of capacity is needed?

How much is needed?
When is it needed?

Supply & Demand

Operations &
Supply Chains

Supply

Sales & Marketing

>

Demand

Supply

<

Demand

Supply

Demand

Wasteful
Costly

Opportunity Loss
Customer
Dissatisfaction

Ideal

Measuring Capacity Examples

Importance of Capacity Decisions

Capacity decisions
impact the ability of the organization to meet future
demands
affect operating costs
Capacity is a major determinant of initial cost
can affect competitiveness
affect the ease of management
are more important and complex due to globalization
need to be planned for in advance due to their consumption
of financial and other resources

CAPACITY MEASURES
Capacity: The maximum output of a system in a given
period.
Designed capacity: The maximum capacity that can be
achieved under ideal conditions.
Design capacity is the maximum theoretical output of a
system. A bakery can make 30 custom cakes per day when
pushed at holiday time
Effective capacity: Maximum output rate under normal
(realistic) conditions.
Design capacity minus allowances such as personal time,
maintenance, and scrap
Actual output: rate of output actually achieved, cannot
exceed effective capacity.

Utilization and Efficiency

Efficiency is the percent of effective capacity
achieved
Utilization is the percent of design capacity achieved

Efficiency =

Utilization =

Actual output
Effective capacity
Actual output

Design capacity

Bakery Example
Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts
Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Bakery Example
Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts
Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Utilization = 148,000/201,600 = 73.4%

Bakery Example
Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts
Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Utilization = 148,000/201,600 = 73.4%

Efficiency = 148,000/175,000 = 84.6%

Bakery Example
Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts
Efficiency = 84.6%
Efficiency of new line = 75%
Expected Output = (Effective Capacity)(Efficiency)
= (175,000)(.75) = 131,250 rolls

EFFICIENCY/UTILIZATION
Design capacity = 50 trucks/day
Effective capacity = 40 trucks/day
Actual output = 36 units/day

Eefficiency/Utilization
Design capacity = 50 trucks/day
Effective capacity = 40 trucks/day
Actual output = 36 units/day
Actual output

Efficiency =

Utilization =

36 units/day

Effective capacity

Actual output
Design capacity

40 units/ day

36 units/day
50 units/day

= 90%

= 72%

Determinants of Effective Capacity

Facilities (design, location, layout, environment)
The design of facilities, including size and provision for expansion, is key.
Location factors, such as transportation costs, distance to market, labor
supply, energy sources and room for expansion are also important.
Likewise, layout of the work area and environmental factors also play a
significant role.
Product and service factors (design, product mix)
Process factors (quantity capacity, quality capacity)
Human factors (job content, job design, training & experience, motivation,
learning rate, absenteeism and turnover)
Operational factors (scheduling, materials management, maintenance,
breakdown)
Supply chain factors
External factors (standard, safety regulation, unions, pollution control
standard)

Strategy Formulation
Capacity strategy for long-term demand patterns
involve;
Growth rate and variability of demand
Cost of building and operating facilities of
various size
Rate and direction of technology changes
Behavior of competitors
Availability of capital and other inputs

Forecasting Capacity Requirements

Long-term vs. short-term capacity needs
Long-term relates to overall level of capacity
such as facility size, trends, and cycles
Short-term relates to variations from seasonal,
random, and irregular fluctuations in demand

In-House or Outsourcing
(Make or Buy)
Outsourcing: Obtaining a good or service from an
external provider
Decide on outsourcing by considering

Available capacity
Expertise
Quality considerations
The nature of demand: Stability
Cost
Risk: Loss of control over operations with outsourcing; loss
of know-how. Loss of revenue.

Optimal Rate of Output

Average cost per unit

Production units have an optimal rate of output for minimal

cost.
Minimum average cost per unit

Minimum
cost

Rate of output

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

Average unit cost

(dollars per room per night)

Economies and Diseconomies of

Scale

25 - Room
Roadside Motel

50 - Room
Roadside Motel

Economies
of scale

25

75 - Room
Roadside Motel

Diseconomies of
scale

50
Number of Rooms

75

Evaluating Alternatives
Cost-volume analysis
Break-even point

Financial analysis
Cash flow
Present value

Decision theory
Waiting-line analysis

Cost-Volume Relationships
Cost volume analysis focuses on relationship between
cost, revenue and volume of output. The purpose of
cost-volume analysis is to estimate the income of an
organization under different operating condition.

Fixed Costs Cost that do not vary with

production or activity levels

Rental Cost;
Insurance;
Equipment capital recovery;
Property taxes

A Cost Revenue Model Approach

Variable cost: Costs that vary with the level of
activity; e.g. direct labor wages, materials,
marketing, advertising, warranty. Etc.
Variable Costs change with the level of activity;
More activity greater variable costs;
Less activity lower variable costs;
Variable costs are impacted by efficiency of
operation, improved designs, quality, safety, and
higher sales volume.

Total Costs

Total Cost = Fixed Costs + Variable Costs;

TC = FC + VC;
Profit Relationships;
Profit = Revenue Total Cost
P = R TC
P = R {FC + VC}.

Cost Revenue Relationships

Linear Models;
Non-linear models;

Cost-Volume Relationships

Cost-Volume Relationships
Break-even point:The breakeven point, QBE is the point where the revenue
and total cost relationships intersect:

For non-linear forms, it is possible to have more than one QBE point.

Break-Even Problem with Step

Fixed Costs

Calculation for QBEP

Profit = TR-TC=R x Q (FC + v x Q)
P = Q(R v) FC
The required volume quantity, Q
Q = P + FC/R - v
QBEP = FC/ R-v