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Capacity Management

©The McGraw-Hill Companies, Inc., 2004

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OBJECTIVES
• Strategic Capacity Defined
• Capacity Utilization & Best Operating
Level
• Economies & Diseconomies of Scale
• The Experience Curve
• Capacity Focus, Flexibility & Planning
• Determining Capacity Requirements
• Decision Trees
• Capacity Utilization & Service Quality

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Capacity
• Capacity is the maximum rate of output for
a process.
• The operation manager must provide the
capacity to meet current and future
demand.

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• Long term capacity plan

• Short term capacity plan

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Measures of capacity
• Output Measures
Choice for high volume process
• Input Measures
Choice for low volume flexible process

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Strategic Capacity Planning

Defined
• Capacity can be defined as the ability
to hold, receive, store, or accommodate

• Strategic capacity planning is an

approach for determining the overall
capacity level of capital intensive
resources, including facilities,
equipment, and overall labor force size

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Capacity Utilization

Capacity used
Capacity utilization rate 
Best operating level

• Where is it used
• Capacity used
– rate of output actually achieved
• Best operating level
– capacity for which the process was designed

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Best Operating Level

Example:
Example:Engineers
Engineersdesign
designengines
enginesand
andassembly
assemblylines
linesto
to
operate
operateat
atan
anideal
idealor
or“best
“bestoperating
operatinglevel”
level”to
tomaximize
maximize
output
outputand
andminimize
minimizeware
ware

Average
unit cost
of output
Underutilization Overutilization

Best Operating
Level

Volume ©The McGraw-Hill Companies, Inc., 2004

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Example of Capacity Utilization

•• During
During oneone week
week of
of production,
production, aa plant
plant
produced
produced 83 83 units
units of
of aa product.
product. Its
Its
historic
historic highest
highest or
or best
best utilization
utilization
recorded
recorded waswas 120
120 units
units per
per week.
week. What
What
is
is this
this plant’s
plant’s capacity
capacity utilization
utilization rate?
rate?
 Answer:
Answer:
Capacity
Capacityutilization
utilizationrate
rate== Capacity
Capacityused
used ..
Best
Best operating
operating level
level
==83/120
83/120
=0.69
=0.69or
or 69%
69%
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Economies & Diseconomies of

Scale
Economies
Economiesof
ofScale
Scaleand
andthe
theExperience
ExperienceCurve
Curveworking
working

100-unit
Average plant
unit cost 200-unit
of output plant 400-unit
300-unit
plant
plant

Diseconomies
Diseconomiesof
ofScale
Scalestart
startworking
working

Volume
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The
As
Asplants
plantsproduce
producemore
moreproducts,
products,they
they
Experience gain
gainexperience
experiencein
inthe
thebest
bestproduction
production
methods
methodsandandreduce
reducetheir
theircosts
costsper
perunit
Curve unit

Yesterday

Cost or Today
price Tomorrow
per unit

Total accumulated production of units

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Capacity Flexibility

• Flexible plants

• Flexible processes

• Flexible workers

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Capacity Planning

• Frequency of Capacity Additions

• External Sources of Capacity

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Determining Capacity Requirements

• 1. Forecast sales within each individual

product line

• 2. Calculate equipment and labor

requirements to meet the forecasts

• 3. Project equipment and labor

availability over the planning horizon

©The McGraw-Hill Companies, Inc., 2004

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Example of Capacity Requirements

A manufacturer produces two lines of
mustard, Fancy Fine and Generic line. Each is
sold in small and family-size plastic bottles.

The following table shows forecast demand

for the next four years.
Year: 1 2 3 4
FancyFine
Small (000s) 50 60 80 100
Family (000s) 35 50 70 90
Generic
Small (000s) 100 110 120 140
Family (000s) 80 90 100 110

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Example of Capacity Requirements

(Continued): Product from a Capacity
Viewpoint
•• Question:
Question: AreAre we
we really
really producing
producing two
two
different
different types
types of
of mustards
mustards from
from the
the
standpoint
standpoint of of capacity
capacity requirements?
requirements?
•• Answer:
Answer: No,
No, it’s
it’s the
the same
same product
product just
just
packaged
packaged differently.
differently.

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Example of Capacity Requirements

(Continued) : Equipment and Labor
Requirements
Year: 1 2 3 4
Small (000s) 150 170 200 240
Family (000s) 115 140 170 200
•Three 100,000 units-per-year machines are available
for small-bottle production. Two operators required
per machine.

•Two 120,000 units-per-year machines are available

for family-sized-bottle production. Three operators
required per machine.
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Question:
Question:What
Whatare
arethe
theYear
Year11values
valuesfor
forcapacity,
capacity,machine,
machine,
and
andlabor?
labor?
Year: 1 2 3 4
Small (000s) 150 170 200 240
Family (000s) 115 140 170 200

Small Mach. Cap. 300,000 Labor 6

Family-size Mach. Cap. 240,000 Labor 6
150,000/300,000=50% At 1 machine for 100,000, it
Small takes 1.5 machines for 150,000
Percent capacity used 50.00%
Machine requirement 1.50
Labor requirement 3.00 At 2 operators for
Family-size 100,000, it takes 3
Percent capacity used 47.92% operators for 150,000
Machine requirement 0.96
Labor requirement 2.88 ©The McGraw-Hill Companies, Inc., 2004
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Question:
Question:What
Whatare
arethe
thevalues
valuesfor
forcolumns
columns2,
2,33and
and44in
inthe
thetable
tablebelow?
below?
Year: 1 2 3 4
Small (000s) 150 170 200 240
Family (000s) 115 140 170 200

Small Mach. Cap. 300,000 Labor 6

Family-size Mach. Cap. 240,000 Labor 6

Small
Percent capacity used 50.00% 56.67% 66.67% 80.00%
Machine requirement 1.50 1.70 2.00 2.40
Labor requirement 3.00 3.40 4.00 4.80
Family-size
Percent capacity used 47.92% 58.33% 70.83% 83.33%
Machine requirement 0.96 1.17 1.42 1.67
Labor requirement 2.88 3.50 4.25 5.00
©The McGraw-Hill Companies, Inc., 2004
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Example of a Decision Tree Problem

AAglass
glassfactory
factoryspecializing
specializingin
incrystal
crystalis
isexperiencing
experiencingaa
substantial
substantialbacklog,
backlog,and
andthe
thefirm's
firm'smanagement
managementis is
considering
consideringthree
threecourses
coursesof ofaction:
action:

A)
A) Arrange
Arrangefor
forsubcontracting
subcontracting
B)
B) Construct
Constructnew
newfacilities
facilities
C)
C) Do
Donothing
nothing(no
(nochange)
change)

The
Thecorrect
correctchoice
choicedepends
dependslargely
largelyupon
upondemand,
demand,which
which
may
maybebelow,
low,medium,
medium,ororhigh.
high. By
Byconsensus,
consensus,management
management
estimates
estimatesthetherespective
respectivedemand
demandprobabilities
probabilitiesas
as0.1,
0.1,0.5,
0.5,
and
and0.4.
0.4.

©The McGraw-Hill Companies, Inc., 2004

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Example of a Decision Tree Problem

(Continued): The Payoff Table
The
The management
management also also estimates
estimates thethe profits
profits
when
when choosing
choosing from
from the
the three
three alternatives
alternatives (A,
(A,
B,
B, and
and C)
C) under
under thethe differing
differing probable
probable levels
levels of
of
demand.
demand. These
These profits,
profits, in
in thousands
thousands are
are
presented
presented in
in the
the table
table below:
below:
0.1 0.5 0.4
Low Medium High
A 10 50 90
B -120 25 200
C 20 40 60
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Example of a Decision Tree Problem

(Continued): Step 1. We start by
drawing the three decisions

A
B

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Example of Decision Tree Problem

(Continued): Step 2. Add our possible
states of nature, probabilities, and payoffs
High demand (0.4) 90k
Medium demand (0.5) 50k
Low demand (0.1) 10k

A High demand (0.4) 200k

B Medium demand (0.5) 25k
Low demand (0.1) -120k
C
High demand (0.4) 60k
Medium demand (0.5) 40k
Low demand (0.1) 20k

©The McGraw-Hill Companies, Inc., 2004

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Example of Decision Tree Problem

(Continued): Step 3. Determine the
expected value of each decision
High
Highdemand
demand(0.4)
(0.4) 90k
90k
Medium
Mediumdemand
demand(0.5)
(0.5) 50k
50k
62k
62k Low
Lowdemand
demand(0.1)
(0.1) 10k
10k
AA
EV
EVAA=0.4(90)+0.5(50)+0.1(10)=62k
=0.4(90)+0.5(50)+0.1(10)=62k

©The McGraw-Hill Companies, Inc., 2004

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Example of Decision Tree Problem

(Continued): Step 4. Make decision
High demand (0.4) 90k
Medium demand (0.5) 50k
62k Low demand (0.1) 10k

A High demand (0.4) 200k

80.5k
B Medium demand (0.5) 25k
Low demand (0.1) -120k
C
High demand (0.4) 60k
46k Medium demand (0.5) 40k
Low demand (0.1) 20k
Alternative
AlternativeBBgenerates
generatesthe
thegreatest
greatestexpected
expectedprofit,
profit,so
so
our
ourchoice
choiceis
isBBor
orto
toconstruct
constructaanew
newfacility
facility
©The McGraw-Hill Companies, Inc., 2004
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Planning Service Capacity vs.

Manufacturing Capacity
• Time: Goods can not be stored for later use
and capacity must be available to provide a
service when it is needed

• Location: Service goods must be at the

customer demand point and capacity must
be located near the customer

• Volatility of Demand: Much greater than in

manufacturing

©The McGraw-Hill Companies, Inc., 2004

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Question Bowl
The objective of Strategic Capacity
Planning is to provide an approach for
determining the overall capacity level of
which of the following?
a. Facilities
b. Equipment
c. Labor force size
d. All of the above
e. None of the above
Answer: d. All of the above
©The McGraw-Hill Companies, Inc., 2004
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Question Bowl
To improve the Capacity Utilization Rate
we can do which of the following?
a. Reduce “capacity used”
b. Increase “capacity used”
c. Increase “best operating level”
d. All of the above
e. None of the above

Answer: b. Increase “capacity used” (This

increases the numerator in the Capacity
Utilization Rate ratio, which is desirable.)
©The McGraw-Hill Companies, Inc., 2004
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Question Bowl
When we talk about Capacity Flexibility
which of the following types of flexibility
are included?
a. Plants
b. Processes
c. Workers
d. All of the above
e. None of the above

Answer: d. All of the above

©The McGraw-Hill Companies, Inc., 2004

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Question Bowl
When adding capacity to existing
operations which of the following are
considerations that should be included
in the planning effort?
a. Maintaining system balance
b. Frequency of additions
c. External sources
d. All of the above
e. None of the above
Answer: d. All of the above

©The McGraw-Hill Companies, Inc., 2004

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Question Bowl
In determining capacity requirements we
must do which of the following?
a. Address the demands for individual
product lines
b. Address the demands for individual
plants
c. Allocate production throughout the
plant network
d. All of the above
e. None of the above
Answer: d. All of the above
©The McGraw-Hill Companies, Inc., 2004