CHAPTER FIVE

Capacity planning

A dictionary definition of capacity is ‘the ability of hold, receive, store or accommodate’. In a

general business sense, it is most frequently viewed as the amount of output that a system is
capable of achieving over a specified period of time. Capacity can also be defined as the
maximum output that can be produced over a given period of time

In a service setting, this might be the number of customers that can be handled 12 o’clock and 1
o’clock in the afternoon. In, manufacturing this might be the number of automobiles that can be
produced in a single shift.

Capacity is the upper limit or maximum load that an operating unit can handle. The operating
unit might be a plant, department, a machine, a store or a worker. The load can be specified in
terms either inputs or outputs.

Generally, capacity is a relative term, and in an operations management context, may be defined
as the amount of resource inputs available relative to output requirement over a particular period
of time.

Capacity is the maximum output rate of a facility. Capacity planning is the process of
establishing the output rate that can be achieved at a facility:

Strategic issues: how much and when to spend capital for additional facility & equipment

Tactical issues: workforce & inventory levels, & day-to-day use of equipment. Capacity is
usually purchased in “chunks”

What is the Goal of capacity planning?

 To achieve a match between the long-term supply capabilities of an organization and the
predicted level of long-run demand

 A gap between current and desired capacity will result in capacity that is out of balance

 Over capacity causes operating costs that are too high, while under capacity causes
strained resources and possible loss of customers
Why organizations are involved in capacity planning?

 Changes in demand

 Changes in technology

 Changes in environment

 Perceived threats and opportunities

Capacity Planning Questions

Key question

 What kind of capacity is needed? (products/services that management tends to

produce/provide)

 How much capacity is needed to match demand?

 When is it needed? Capacity planning is governed by those choices. Forecasts are key
inputs used to answer the questions of how much capacity is needed and when it is
needed

Factors affecting capacity

Capacity is affected by both internal and external factors.

The external factor includes: government regulations (e.g., working hours, safety, pollution etc.),
union agreement, and suppliers’ capabilities.

The internal factor includes: product and service design, personnel and jobs(worker training,
motivation learning job content and methods), plant lay out and process flow, equipment
capabilities and maintenance, materials management, quality control system, product mix
decision, and management capabilities.

Capacity strategy

How much to increase or decrease capacity and when, is a strategic choice. For manufacturing
firms, there are three major strategies for adding capacity: proactive, neutral and reactive. Each
has its weaknesses and strengths. Which strategy to adopt is dependent, to a large extent, on the
operating characteristics of the facility and the overall strategy of the firm.

Proactive: with a proactive strategy, management anticipates future growth and builds the
facility so that it is up and running when the demand is there. With this strategy, opportunity cost
resulting from lost sales due to an inability to meet demand are minimized, although the firm
does have to allocate fixed costs over a relatively small volume of units during the plant’s initial
period of time. In this case there is capacity cushion (excess capacity) that is used in many
service operations and in the growth stage of the product to ensure that demand can be met from
existing resources. Firms that cannot create an inventory or demand back log must have excess
capacity in order to deal with the extremes of demand.

For example, the fire department in a small town may possess several fire trucks that are seldom,
if ever, on call all at once. Similarly, a bank needs enough teller windows to handle traffic on the
busiest day, like the end of the month which is a pay day for many employees and retirement
systems. A capacity cushion is also useful in the growth stage of product life cycle. Firms that
seek to obtain first mover advantages as well as those that seek to gain the competitive advantage
associated with flexibility, speed and superior services frequently adopt this strategy.

Financially, adding new capacity in anticipation of market growth can be risky. If the demand
does not materialize, or if it is slower to materialize than expected, the fixed cost of the new (or
excess) capacity are not likely to be covered.

Generally, capacity cushion is the amount of reserve capacity that a firm maintains to handle
sudden increases in demand or temporary losses of production capacity. The appropriate size of
the cushion varies by industry. In the capital-intensive industry, where machines can cost
hundreds of millions of dollars each, small cushions (usually less than 10%) are preferred. On
the other hand, large cushion is appropriate: when demand varies, when future demand is
uncertain (particularly if resources are less flexible), and when there is supply uncertainty. The
argument in favor of small cushion is simple: un used capacity costs money.

Neutral: a neutral strategy for adding capacity simply takes middle –of-the –road approach.
Additional capacity becomes available when demand is about 50% of total capacity. The issue
here, as with reactive strategy, is how best to satisfy demand before the plant is up and operating.
This is the balanced strategy. Firms that compete in the cyclical industries and firms that are in
the maturity stage of the product life cycle are likely to adopt this strategy. Such firms endeavor
to match their capacity as closely as possible to near-term demand. Depending on the economic
climate, they carry either excess capacity or excess demand. During precession, they will tend to
have excess capacity. During economic expansion, they may develop short ages. To such firm,
effectively anticipating changes in the economic cycle is very important, as is flexibility in
capacity. They may prefer to lease rather than own, relay on temporary employees rather than
hire a permanent staff, or find alternative uses for their capacity by developing complementary
businesses.

Reactive: when a reactive strategy is adopted, the plant capacity is not added until all of the
planned output from the facility can be sold. Thus, with this strategy, the plant is not brought on
line until demand equals 100%of its capacity. Operating cost is minimized with this approach, as
the plant is producing at its desired optimal output, beginning with the first day of operations.
This strategy is most conducive to process oriented operations that have very high fixed cost,
regardless of the volume produced and low variable cost. E.g., paper mills, breweries and
refineries.

In this case, there is demand cushion in which fixed cost is more easily covered. Firms that use
this reactive (demand cushion) strategy tend to maintain high inventory levels or large demand
back logs. These firms are less likely than others to try to be first to market with new products
and features and they generally invest less money in aggressive marketing campaigns. Firms
should take care to add new capacity before their demand cushion become too large.

Measures of capacity

No single capacity measure is applicable to all types of situations. For example, a retailer
measure capacity as annual sale dollars generated per square foot, a theater measure capacity as
number of seats, and a job shop measure capacity as number of machine hour.

Important terms used to measure the capacity:

 Design capacity (peak capacity): is the maximum rate of output achieved under
ideal condition. In other words, it is a planned (engineered) rate of output of
goods or services under normal conditions. Peak capacity can be sustained for
 only a short time, such as few hours in a day or a few days in a month. A process
reaches it by using marginal methods of production such as excessive over time,
extra shifts, temporality reduced maintenance activities, over staffing, and
subcontracting. Although they can help with temporary peaks, these options
cannot be sustained for long. Employees do not want to work excessive over time
for extended periods, overtime and night –shifts premium drive-up costs and
quality drops. Generally, overtime soared and exhaustive workers dragged down
productivity. Thus, when operating close to peak capacity, a firm can make
minimal profits or even lose money, despite high sales levels.

 Effective capacity: is the maximum output that a process or firm can

economically sustain under normal conditions. It is the greatest level of output the
firm can reasonably sustain by using realistic employee work schedules and the
equipment currently in place.

It is the maximum possible given predicted problems such as a product mix, problems in
scheduling and balancing operations, machine maintenance, quality factors, and so on. It also
includes lunch breaks, and coffee breaks. It is typically less than or equal to the design capacity.

 Output capacity: is the actual output of a system at a given point in time. It is even less
than effective capacity, for it is affected by unpredicted short range factors such as
equipment break down, absenteeism, shortage of raw materials, productivity, and other
factors that are outside the control of the operations manager.

 Capacity utilization: is the degree to which equipment, space or labor is currently being
used. It the ratio of capacity used during a fixed period of time to the available capacity
during that same time period.

actual capacity ( ¿ capacity used )

Utilization= X 100 %
Designed capacity

actual out put

Efficiency= X 100 %
Effective capacity

 Rated capacity: when capacity is measured relative to equipment alone, the appropriate
measure is rated capacity. It is an engineering assignment of maximum annual output,
 assuming continuous operations except for an allowance for Norman maintenance, and
repair downtime.

Rated capacity=designcapacity X effective capacity X efficiency

Rated capacity will always be less than or equal to effective capacity.

Design (peak )capacity >effective capacity >rated capacity

Example 1

If operated around the clock under ideal conditions, the fabrication department of an engine
manufacturer can make 100engines per days. Management believe that a maximum output rate
of only 45 engines per day can be sustained economically over a long period of time Currently,
the department is producing 50 engines per day. What is the utilization of the department related
to designed capacity? Efficiency capacity

Solutions

Given:

actual output=50 , effective capacity=45 ,∧designed capacity=100 engine

Utilization=50/100 X 100 %=50 %

Efficiency=50 /45 X 100 %=111%

Example 2

A call center might have 1200 work station, but on a given day, only, have 600 of them staffed
with operators. Determine capacity utilization.

Solution

600 X 100 %
In this case, the call center would be working at or 50% capacity utilization that
1200
day.

Example 3
The Sara James Bakery has a plant for processing breakfast rolls. The facility has an efficiency
of 90%, and the effective capacity is 80%. Three process lines are used to produce the rolls. The
line operates 7 days a week and three 8 hours shift per day. Each line was designed to process
120 standard rolls per hour. What is designed capacity? Rated capacity?

Solution

Number of lines=3 , number of hours =7 days X 24 hrs per day=168 hrs , number of rolls/hrs=120

Designed capacity =number of lines X number of hours X number of roles per hour

¿ 3 X 168 X 120

¿ 60,480 rolls per week .

Rated capacity=60480 rolls per week X 0.8 X 0.9

¿ 43546 rolls per week

designed capacity −actual capacity

Capacity cushion= X 100 %
Actual capacity

Example: if the expected annual demand on a facility is birr 10 million worth of products per
year and the design capacity is 12 million birr per year, find the capacity cushion.

¿ 12,000,000−10,000,000
Capacity cushion X 100 %=20 %
10,000,000

3.5 Work System Design

Designing a work system is part of developing an operations strategy; Effective operations

strategy provides structure for company productivity. The work system includes: Job design,
Work method, and Work measurements.

Job Design: One of the operation manager tasks is managing the work forces in the
organization. Peoples are the heart of the organization. Managing employee in the organization is
a challenging task. The objectives of managing people in the organization are to achieve
productivity. Job design refers to the way that a set of tasks, or an entire job, is organized.
Job design involves specifying the content and methods of jobs. Job designers focus on what will
be done in a job, who will do the job, how the job will be done, and where the job will be done.
The objectives of job design include productivity, safety, and quality of work life.

Job design helps to determine:

 What tasks are done,

 How the tasks are done,

 How many tasks are done, and

 In what order the tasks are done.

Job design involves administrative areas such as:

Job enlargement means giving a worker a larger portion of the total task. This constitutes
horizontal loading —the additional work is on the same level of skill and responsibility as the
original job. The goal is to make the job more interesting by increasing the variety of skills
required and by providing the worker with a more recognizable contribution to the overall
output. For example, a production worker’s job might be expanded so that he or she is
responsible for a sequence of activities instead of only one activity.

Job rotation means having workers periodically exchange jobs. A firm can use this approach to
avoid having one or a few employees stuck in monotonous jobs. It works best when workers can
be transferred to more interesting jobs; there is little advantage in having workers exchange one
boring job for another. Job rotation allows workers to broaden their learning experience and
enables them to fill in for others in the event of sickness or absenteeism.

Job enrichment involves an increase in the level of responsibility for planning and coordination

tasks. It is sometimes referred to as vertical loading. An example of this is to have stock clerks in
supermarkets handle reordering of goods, thus increasing their responsibilities. The job
enrichment approach focuses on the motivating potential of worker satisfaction. Job enlargement
and job enrichment are also used to workers are cross-trained to be able to perform a wider
variety of tasks and given more authority to manage their jobs. The importance of these
approaches to job design is that they have the potential to increase the motivational power of jobs
by increasing worker satisfaction through improvement in the quality of work life.

Job design determines the content of a job, and methods analysis determines how a job is to be
performed. Work measurement is concerned with determining the length of time it should take
to complete the job. Job times are vital inputs for capacity planning, workforce planning,
estimating labor costs, scheduling, budgeting, and designing incentive systems. Moreover, from
the workers’ standpoint, time standards reflect the amount of time it should take to do a given job
working under typical conditions. The standards include expected activity time plus allowances
for probable delays.

A standard time is the amount of time it should take a qualified worker to complete a specified
task, working at a sustainable rate, using given methods, tools and equipment, raw material
inputs, and workplace arrangement. Whenever a time standard is developed for a job, it is
essential to provide a complete description of the parameters of the job because the actual time to
do the job is sensitive to all of these factors; changes in any one of the factors can materially
affect time requirements. For instance, changes in product design or changes in job performance
brought about by a methods study should trigger a new time study to update the standard time.
As a practical matter, though, minor changes are occasionally made that do not justify the
expense of restudying the job. Consequently, the standards for many jobs may be slightly
inaccurate. Periodic time studies may be used to update the standards.