Strategic Capacity Management

Strategic Capacity Planning

• Strategic capacity planning is an approach for determining
the overall capacity level of capital intensive resources,
including facilities, equipment, and overall labor force size
that best supports companies long term competitive strategy.
• Planning for capacity for a long run
– How much should a plant be able to produce?
– How many customers should a service facility be able to
serve?
– What kind of issues arise as the production system
expands?
 Strategic Capacity Planning

Capacity strategies are formulated keeping in mind;

• The growth rate and variability in demand
• Cost of building and operating facilities of various
sizes
• The rate and direction of technological innovation
• Availability of capital and other resources
Steps involved in Capacity Planning Process

– Estimate future capacity requirements

– Evaluate existing capacity and facilities and identify gaps
– Identify alternatives for meeting requirements.
– Conduct financial analyses of each alternative
– Assess key qualitative issues for each alternative.
– Select one alternative to pursue.
– Implement the selected alternative.
– Monitor results
 Capacity Utilization

Capacity used
Capacity utilization rate 
Best operating level

• Where
• Capacity used
– rate of output actually achieved
• Best operating level
– capacity for which the process was designed
– Volume of output at which average unit cost is minimum
 Examples
Hoosier Manufacturing operates a production
shop that is designed to have the lowest unit
production cost at an output rate of 100 units
per hour. In the month of July, the company
operated the production line for a total of 175
hours and produced 16,900 units of output.
What was its capacity utilization rate for the
month?
 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
 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
 Example of Capacity Requirements
A manufacturer produces two lines of mustard,
FancyFine 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
Example of Capacity Requirements (Continued): Product
from a Capacity Viewpoint

•• Question:
Question:Are
Arewe
wereally
reallyproducing
producingtwo
twodifferent
different
types
typesof
ofmustards
mustardsfromfromthe
thestandpoint
standpointof
of
capacity
capacityrequirements?
requirements?
•• Answer:
Answer:No,
No,it’s
it’sthe
thesame
sameproduct
productjust
justpackaged
packaged
differently.
differently.
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.
 Question:
Question:WhatWhatare
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
Percent capacity used 50.00% takes 1.5 machines for 150,000
Machine requirement 1.50
Labor requirement 3.00
Family-size At 2 operators for
Percent capacity used 47.92% 100,000, it takes 3
Machine requirement 0.96 operators for 150,000
Labor requirement 2.88
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
 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.
Example of a Decision Tree Problem (Continued): The Payoff
Table

The
The management
management also also estimates
estimates the
the profits
profits when
when
choosing
choosing fromfrom thethe three
three alternatives
alternatives (A,
(A, B,
B, and
and C)
C)
under
under the the differing
differing probable
probable levels
levels ofof demand.
demand.
These
These profits,
profits, in
in thousands
thousands ofof dollars
dollars 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
Example of a Decision Tree Problem (Continued): Step 1.
We start by drawing the three decisions

A
B

C
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
Example of Decision Tree Problem (Continued): Step 3.
Determine the expected value of each decision

$90k
$90k
$50k
$50k
$62k
$62k $10k
$10k
A
A
EVAA=0.4(90)+0.5(50)+0.1(10)=$62k
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
 Example of a Decision Tree Problem

AA logistics
logistics provider
provider plans
plans to to have
have aa newnew warehouse
warehouse built built
to
to handle
handle increasing
increasing demands
demands for for its
its services.
services. Although,
Although,
the
the company
company isis unsure
unsure of of how
how much
much demand
demand there there will
will
be,
be, itit must
must decide
decide nownow on on the
the size
size (large
(large or or small)
small) ofof the
the
warehouse.
warehouse. Preliminary
Preliminary estimates
estimates are are that
that ifif aa small
small
warehouse
warehouse isis built built and
and demand
demand isis low, low, the the monthly
monthly
income
income willwill be
be$700,000.
$700,000. IfIf demand
demandisis high,high, itit will
will have
have toto
either
either expand
expand the the facility
facility oror lease
lease additional
additional space.
space.
Leasing
Leasing will
will result
result inin aa monthly
monthly income
income of of $100,000
$100,000 whilewhile
expanding
expanding will will result
result inin aa monthly
monthly income
income of of $500,000.
$500,000. IfIf
the
the large
large warehouse
warehouse isis built built and
and demand
demand isis low, low, monthly
monthly
income
income willwill be
be only
only $40,000,
$40,000, whilewhile ifif the
the demand
demand isis high,
high,
monthly
monthlyincome
incomewill willbe
be$2million.
$2million. What
What should
shouldbe be done?
done?
AA firm
firm must
must decide
decide howhow manymany machines
machines of of aa certain
certain type
type to to
buy.
buy. The The machines
machines will will bebe used
used to
to manufacture
manufacture aa new new geargear
for
for which
which there
there isis increased
increased demand.
demand. The The manager
manager has has
narrowed
narrowedthe thedecision
decisionto totwo
twoalternatives:
alternatives:buybuyone
onemachine
machineor or
buy
buy [Link]. IfIf only
only one
one machine
machine isis purchased
purchased and and demand
demand isis
more
morethan thanititcan
canhandle,
handle,aasecondsecondmachine
machinecan canbe bepurchased
purchased
atataalater
latertime.
[Link],
However,the thecost
costper
permachine
machinewouldwouldbe belower
lower
ifif the
the two
two machines
machines were were purchased
purchased at at the
the same
same time.
time. TheThe
estimated
estimated probability
probability of of the
the low
low demand
demand isis 0.30,
0.30, and
and the the
estimated
estimated probability
probability of of high
high demand
demand isis 0.70.
0.70. The
The net
net present
present
value
valueassociated
associatedwith withthethepurchase
purchaseof oftwo
twomachines
machinesinitially
initiallyisis
$75,000
$75,000 ififdemand
demandisis low lowand and $130,000
$130,000 ifif the
thedemand
demand [Link].
The
The NPV NPV forfor one
one machine
machine and and low
low demand
demand isis $90,000.
$90,000. IfIf
demand
demand isis high, high, there
there areare three
three options.
options. One
One option
option isis to
to do
do
nothing,
nothing, which
which would
would have have aa NPVNPV of of $90,000.
$90,000. AA secondsecond
option
option isis to
to subcontract,
subcontract, that that would
would have
have aa NPV
NPV of of $110,000.
$110,000.
The
Thethird
thirdoption
optionisisto topurchase
purchaseaasecondsecondmachine.
[Link] Thisoption
option
would
would have have aa NPV
NPV of of $100,000.
$100,000. HowHow many
many machines
machines should
should
the
themanager
managerpurchase
purchaseinitially?
initially?
A manager must decide on the size of a video arcade to
construct. The manager has narrowed the choices to two: large
or small. Information has been collected on payoffs, and the
following decision tree has been constructed. Analyze the
decision tree and determine which initial alternative (build small
or build large) should be chosen in order to maximize expected
monetary value.
AA small
small firm
firm intends
intends to to increase
increase thethe capacity
capacity of of aa
bottleneck
bottleneck operation
operation by by adding
adding aa new new machine.
machine.
Two
Two alternatives,
alternatives, AA and
and B, B, have
have been
been identified,
identified,
and
and the
the associated
associated costs
costs and
and revenues
revenues havehave been
been
estimated.
estimated. Annual
Annual fixed
fixed costs
costs would
would be be Rs.
Rs. 40,000
40,000
for
for AA and
and Rs.
Rs. 30,000
30,000 forfor B,
B, Variable
Variable costs
costs per
per unit
unit
would
would be be Rs.
Rs. 10
10 for
for AA and
and Rs.
Rs. 11
11 for
for B;
B; and
and revenue
revenue
per
per unit
unit would
would bebe Rs.
Rs. 15
15 for
for AA and
and Rs.
Rs. 12
12 for
for B.
B.
–– At
At what
what volume
volume of
of output
output would
would the
the two
two alternatives
alternatives
yield
yieldthe
thesame
sameprofit?
profit?
–– IfIf expected
expected annual
annual demand
demand isis 12,000
12,000 units,
units, which
which
alternative
alternative would
would yield
yield the
the higher
higher profit?
profit? What
What isis
profit?
profit?
Consider
Consider the
the following
following process
process flow
flow diagram.
diagram. Process
Process BB can
can be
be
performed
performed either
either through
through Automatic
Automatic operations
operations oror through
through manual
manual
operations.
operations. The
The setup
setup time
time and
and run
run time
time (IN
(IN MINUTES)
MINUTES) forfor each
each
process
processisisgiven
givenin
inthe
thetable
tablebelow.
below.

For
For what
what range
range of
of production
production volume
volume would
would you
you choose
choose Automatic
Automatic
operations
operationsover
overmanual
manualoperations
operationsfor
forprocess
processB.
B.

B Process Setup Run

Automatic time time

A 35 2
C D
A B(AUTOMATIC) 40 5

B(MANUAL) 20 10
B C 5 2
(Manual)
D 3 1
AA small
small firm
firm intends
intends to to increase
increase thethe capacity
capacity of of aa
bottleneck
bottleneck operation
operation by by adding
adding aa new new machine.
machine.
Two
Two alternatives,
alternatives, AA and
and B, B, have
have been
been identified,
identified,
and
and the
the associated
associated costs
costs and
and revenues
revenues havehave been
been
estimated.
estimated. Annual
Annual fixed
fixed costs
costs would
would be be Rs.
Rs. 40,000
40,000
for
for AA and
and Rs.
Rs. 30,000
30,000 forfor B,
B, Variable
Variable costs
costs per
per unit
unit
would
would be be Rs.
Rs. 10
10 for
for AA and
and Rs.
Rs. 11
11 for
for B;
B; and
and revenue
revenue
per
per unit
unit would
would bebe Rs.
Rs. 15
15 for
for AA and
and Rs.
Rs. 12
12 for
for B.
B.
–– At
At what
what volume
volume of
of output
output would
would the
the two
two alternatives
alternatives
yield
yieldthe
thesame
sameprofit?
profit?
–– IfIf expected
expected annual
annual demand
demand isis 12,000
12,000 units,
units, which
which
alternative
alternative would
would yield
yield the
the higher
higher profit?
profit? What
What isis
profit?
profit?