5-1 Capacity Planning

Capacity Planning
For Products and Services
TQM - Week 3
5-2 Capacity Planning

· Capacity is the maximum output rate of a production or

service facility
· The throughput, or the number of units a facility can
hold, receive, store, or produce in a period of time
· The basic questions in capacity handling are:
· What kind of capacity is needed?
· How much is needed?
· When is it needed?
· Capacity needs inlcude:
· Equipment
· Space
· Employee skills
5-3 Capacity Planning

· There is no one best way to measure capacity

· Output measures are easier to understand
· With multiple products, inputs measures work better

Input Measures of Output Measures

Type of Business
Capacity of Capacity
Car manufacturer Labor hours Cars per shift
Hospital Available beds Patients per month
Pizza parlor Labor hours Pizzas per day
Floor space in
Retail store Revenue per foot
square feet
5-4 Capacity Planning

1. Impacts ability to meet future demands

2. Affects operating costs
3. Major determinant of initial costs
4. Involves long-term commitment
5. Affects competitiveness
6. Affects ease of management
7. Globalization adds complexity
8. Impacts long range planning
5-5 Capacity Planning

· Design capacity
· maximum output rate or service capacity an operation, process, or
facility is designed for

· Effective capacity
· Design capacity minus allowances such as personal time,
maintenance, and scrap

· Actual output
· rate of output actually achieved--cannot
exceed effective capacity.
5-6 Capacity Planning

Actual output
Efficiency =
Effective capacity

Actual output
Utilization =
Design capacity

Both measures expressed as percentages

5-7 Capacity Planning
5-8 Capacity Planning
5-9 Capacity Planning
5-10 Capacity Planning
5-11 Capacity Planning
5-12 Capacity Planning
5-13 Capacity Planning

þ Forecast demand accurately

þ Understand the technology and capacity
increments
þ Find the optimum
operating level
(volume)
þ Build for change
5-14 Capacity Planning

· Facilities
· Product and service factors
· Process factors
· Human factors
· Operational factors
· Supply chain factors
· External factors
5-15 Capacity Planning

· Capacity strategy for long-term demand

· Demand patterns

· Growth rate and variability

· Facilities
· Cost of building and operating
· Technological changes
· Rate and direction of technology changes
· Behavior of competitors
· Availability of capital and other inputs
5-16 Capacity Planning

1. Amount of capacity needed

2. Timing of changes
3. Need to maintain balance
4. Extent of flexibility of facilities

Capacity cushion – extra demand intended to offset uncertainty

5-17 Capacity Planning

1. Estimate future capacity requirements

2. Evaluate existing capacity
3. Identify alternatives
4. Conduct financial analysis
5. Assess key qualitative issues
6. Select one alternative
7. Implement alternative chosen
8. Monitor results
5-18 Capacity Planning

· Need to be near customers

· Capacity and location are closely tied
· Inability to store services
· Capacity must be matched with timing of
demand
· Degree of volatility of demand
· Peak demand periods
5-19 Capacity Planning

1. Design flexibility into systems

2. Take stage of life cycle into account
3. Take a “big picture” approach to capacity
changes
4. Prepare to deal with capacity “chunks”
5. Attempt to smooth out capacity requirements
6. Identify the optimal operating level
5-20 Capacity Planning

· Alternatives should be evaluated from varying

perspectives
· Economic
· Cost-volume analysis
· Financial analysis
· Decision theory
· Waiting-line analysis
· Simulation
· Non-economic
· Public opinion
5-21 Capacity Planning

· Cost-volume analysis
· Focuses on the relationship between cost, revenue,
and volume of output
· Fixed Costs (FC)
· tend to remain constant regardless of output volume
· Variable Costs (VC)
· vary directly with volume of output
· VC = Quantity(Q) x variable cost per unit (v)
· Total Cost
· TC = Q x v
· Total Revenue (TR)
· TR = revenue per unit (R) x Q
5-22 Capacity Planning

· BEP
· The volume of output at which total cost and total
revenue are equal
· Profit (P) = TR – TC = R x Q – (FC +v x Q)
= Q(R – v) – FC

FC
Q BEP 
Rv
5-23 Capacity Planning

Figure 5.3
Production units have an optimal rate of output for minimal cost.
Average cost per unit

Minimum average cost per unit

Minimum
cost

0 Rate of output
5-24 Capacity Planning

Figure 5.4
Minimum cost & optimal operating rate are
functions of size of production unit.
Average cost per unit

Small
plant Medium
plant Large
plant

0 Output rate
5-25 Capacity Planning

Figure 5.5a

F C
+ )
Amount ($)

V C C
= t ( V
o st o s
l c e c
t a b l
To a r i a
l v
ta
To
Fixed cost (FC)

0
Q (volume in units)
5-26 Capacity Planning

Figure 5.5b

u e
e n
v
Amount ($)
r e
a l
o t
T

0
Q (volume in units)
5-27 Capacity Planning

Figure 5.5c

u e
n i t
ve f
Amount ($)

e P ro
l r
t a
o st
To ta lc
To

0 BEP units
Q (volume in units)
5-28 Capacity Planning

· Fixed cost = 1000

· Selling price per unit = 15$
· Variable cost per unit= 10$
· Calculate the break even point, and the profit.
· Q= FC/ R-v
· 1000/ 15-10 = 200
· Profit= TR- TC 15*200 – 1000+ 10*200 = zero
· Also calculate the profit when the TR = 6000
· 6000- 3000= 3000
5-29 Capacity Planning

1. One product is involved

2. Everything produced can be sold
3. Variable cost per unit is the same regardless
of volume
4. Fixed costs do not change with volume
5. Revenue per unit constant with volume
6. Revenue per unit exceeds variable cost per
unit
5-30 Capacity Planning

· Cash Flow - the difference between cash

received from sales and other sources, and
cash outflow for labor, material, overhead,
and taxes.
· Present Value - the sum, in current value, of
all future cash flows of an investment
proposal.
5-31 Capacity Planning
5-32 Capacity Planning

 Balance sheet: referred to as statement of financial

position or condition, reports on a company's assets,
liabilities, and net equity as of a given point in time.
 Another definition: is an accountant snapshot of the
firms accounting value on a particular date, as through
the firm stood momentarily still.
 The balance sheet shows what assets the firm controls at
a point in time and how it financed the assets.
 Assets= Liabilities + owners equity
5-33 Capacity Planning

· Income statement: also referred to as Profit and

Loss statement reports on a company's income,
expenses, and profits over a period of time. Profit
& Loss account provide information on the
operation of the enterprise. These include sale
and the various expenses incurred during the
processing state.
· The income statement indicates the flow of sales,
expenses, and earnings during a period of time.
· Revenues- Expenses= Income
5-34 Capacity Planning

· Financial ratios can be used to estimate

systematic risk.
· Financial analysis often assess the firm's:
1. Profitability - its ability to earn income and
sustain growth in both short-term and long-term.
A company's degree of profitability is usually
based on the income statement, which reports on
the company's results of operations;
2. Solvency - its ability to pay its obligation to
creditors and other third parties in the long-term
5-35 Capacity Planning

3.Liquidity - its ability to maintain positive cash

flow, while satisfying immediate obligations;
4. Stability- the firm's ability to remain in
business in the long run, without having to
sustain significant losses in the conduct of its
business. Assessing a company's stability
requires the use of both the income statement
and the balance sheet, as well as other financial
and non-financial indicators.
5-36 Capacity Planning

· The payback, also called pay-off period, is

defined as the period required to recover the
original investment outlay through the
accumulated net profit/loss earned by the project.
· Year+ cumulative net cash flow in previous
period\ Net cash flow in the next period
5-37 Capacity Planning

· The net present value of a project is defined as

the value obtained by discounting, at a constant
interest rate and separately for each year, the
differences of all annual cash outflows and
inflows accruing throughout the life of a project.
· NPV= ∑NCFn\ (1 + r)n
· Accept a project if the NPV is greater than Zero
· Reject a project if the NPV is less than Zero
5-38 Capacity Planning

· The internal rate of return is the discount rate at

which the present value of cash inflows is equal
to the present value of cash outflows.
5-39 Capacity Planning

Decision Theory represents a general

approach to decision making which is
suitable for a wide range of operations
management decisions, including:

capacity product and

planning service design

location equipment
planning selection
39
5-40 Capacity Planning

· Useful for designing or modifying service systems

· Waiting-lines occur across a wide variety of
service systems
· Waiting-lines are caused by bottlenecks in the
process
· Helps managers plan capacity level that will be
cost-effective by balancing the cost of having
customers wait in line with the cost of additional
capacity
5-41 Capacity Planning
5-42 Capacity Planning