CAPACITY PLANNING

Capacity planning
Chapter 5 and
Luehrman Article (Course pack)

CAPACITY PLANNING

Learning Objectives
• Strategic capacity planning,
Efficiency and Utilization
• Optimal capacity level
• Selection among capacity alternatives • Capacity Planning under Uncertainty
• Multi-stage Decision Making

CAPACITY PLANNING

Capacity Planning
• Capacity is the upper limit or ceiling on the load that an operating unit (e.g. plant, dept., store. m/c, worker, etc.) can handle
 how much we can produce (measured in terms of output rates)
• Planning for capacity:
– Long term: deals with overall capacity level. Also called strategic capacity planning.
Ex: facility size, major expansions
– Short term: deals with variations in capacity requirements (created by demand fluctuations)
Ex: Workforce-production plans

CAPACITY PLANNING

Capacity Planning
• The basic questions of strategic capacity planning are:
–
–
–

•

What kind of capacity is needed?
How much is needed?
When is it needed?

Importance of these decisions:
–
–
–
–

Determine ability to meet future demand and therefore remain/be competitive
Excess capacity or ability to add capacity quickly can deter new competitors
Affects cost (operating, investment costs)
These decisions involve major investments and hence are irreversible in the short run.

CAPACITY PLANNING

Steps in Strategic Capacity Planning
• Calculate current capacity
• Estimate long-term changes in demand and estimate future capacity needs
• Identify sources of capacity to meet these needs • Select among these alternatives

CAPACITY PLANNING

Definitions of Capacity
• Design capacity
–

maximum obtainable output under ideal conditions

• Effective capacity
–

maximum capacity given current product mix, scheduling difficulties, and other doses of reality.
(NORMAL operating conditions)

• Actual output
–

rate of output actually achieved—often less than the effective capacity.

CAPACITY PLANNING

Efficiency and Utilization

Efficiency =

Utilization =

Actual output
Effective capacity
Actual output
Design capacity

CAPACITY PLANNING

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

Efficiency =

Utilization =

Actual output
Effective capacity

=

Actual output
Design capacity

36 units/day
40 units/ day

= 90%

36 units/day
=

50 units/day

= 72%

Note that in this example, both efficiency and utilization are less than 100%. What does it mean?

CAPACITY PLANNING

Best Operating Level
Average cost per unit

Given the design capacity of our production unit, there is an optimal rate of output for minimal cost/unit.

Economies of Scale

Diseconomies of Scale

Minimum cost 0
Rate of output

CAPACITY PLANNING

Selecting among Alternatives
• Decision Approaches:
– Break-Even Analysis (BEA)
– Present Value Analysis (NPV)
– Real Options Analysis
– Simulation & Waiting Line Analysis
(primarily for service systems)
– Linear Programming

CAPACITY PLANNING

Amount ($)

Break-Even Analysis

0

t= s co l ta o T

*Q
C
V

+

FC

ev r l

e u en

a t )
To
Q
*
C
(V
t os c e l b a i r va l ta o
T
Fixed cost (FC)

Q (volume in units)

Break Even
Point (BEP)

CAPACITY PLANNING

Break Even Analysis

TC  FC  VC* Q
TR  R  Q

(TOTAL COST)
(TOTAL REVENUE)

To make profit, we need TR  TC
R * Q  FC  VC  Q
 ( R  VC ) Q  FC
FC
 Q 
 Q BEP
R  VC

CAPACITY PLANNING

Break Even Analysis- Example
We want to add a new line of product. The annual lease for the equipment is $ 9,000. We estimate the production cost to be 3$/unit. We plan to sell it at $6/unit. How many units should we produce and sell to break even?

FC 9000, VC 3, R 6
FC
9000

3000 units/year
QBEP 
R  VC 6  3
If our forecast annual demand is 2,500 units, should we invest in the new line?

CAPACITY PLANNING
• Capacity investments may require step costs, i.e. fixed costs which increase as the desired output increases:
# of MC

Annual Fixed C.

Output

1

9,600

0-300