Section Objectives

1

• Section Objectives
• After completing this section, you should be able
  to
• 1. Explain the importance of capacity planning.
• 2. Discuss ways of defining and measuring
  capacity.
• 3. Describe some of the factors that determine
  effective capacity.
• 4. Discuss the major considerations related to
  developing capacity alternatives.
• 5. Describe approaches that are useful for
  evaluating process selection and capacity
  alternatives.

2

• Significance of Capacity Decisions
• 1. Commitment to satisfy market demand for
  specific outputs
• 2. Commitment to provide employment for labour
  force.
• 3. Major capital investment for the organization.
• 4. Inaccuracy of long-term demand forecasts
  limits capacity decisions.
• 5. Incorrect capacity decisions can be costly to
  the organization.

3

• Capacity
• Definition
• The amount of output generated by a production
  system over some interval of time.
• Defined by
• 1. Resources available - e.g. 2,000 direct labour
  hours per year
• 2. Output capabilities - e.g. 5,000 widgets per
  month
• Capacity depends on
• 1. Resources - input availability
• 2. Product mix - a different mix redefines
  capacity
• 3. Technology - degree of capital investment
• 4. Time frame - capacity is influenced by the
  time frame used to measure it

4

• Difficulties in Measuring Actual Capacity
• 1. Diversity of output mix
• single output - use output measure of capacity.
• multiple outputs - use input measure of capacity
• 2. Specification of time interval representing
  real capacity
• maximum capacity
• normal capacity
• short-range, intermediate-range and long-range
  capacity
• 3. Day-to-day variation
• employee absenteeism
• equipment breakdown
• maintenance and repair
• work setups / changeovers
• employee vacations

5
Measuring Capacity Illustration 1
A grocery store has five regular checkout lines
and one express line (12 items or less). Based
on a sampling study, it takes 11 minutes on
average for a customer to go through the regular
line and 4 minutes to go through an express line.
The store is open from 9 a.m. to 9 p.m. daily,
seven days a week. A) What is the stores
maximum capacity? B) What is the capacity if
the number of regular checkout lines operating
is according to the following schedule?
(The express line is always open.) Hour /
Day Mon. Tue. Wed. Thur. Fri. Sat. Sun. 9 -
12 1 1 1 1 3 5 2 12
- 4 2 2 2 2 3 5 4
4 - 6 3 3 3 3 5 3 2
6 - 9 4 4 4 4 5 3 1
6
Measuring Capacity - Illustration 2
A roller coaster at Treasure Island Amusement
Park consists of 15 cars, each of which can
carry up to 3 passengers. If each run takes 1.5
minutes and the time to unload and load riders is
3.5 minutes, what is the maximum capacity of the
system in number of passengers per hour? Would
the actual capacity observed actually equal this
value? Explain.
Measuring Capacity - Illustration 3
An automobile transmission-assembly plant
normally operates one shift per day, 5 days a
week. During each shift, 400 transmissions can
be completed. Over the next 4 weeks, the plant
has planned shipments according to the following
schedule Week 1 2 3 4
Shipments 1800 1700 2200 2100
a. What is the normal capacity? b. At what
percent of capacity is the plant actually
operating?
7
Measuring Capacity - Illustration 4
A company manufactures 4 products on 3 machines.
Production for the next six months is given
below Product Jan Feb Mar Apr
May June 1 200 0 200 0 200 0 2 100 100
100 100 100 100 3 50 50 50 50
50 50 4 100 0 100 0 100 0
The number of hours each product requires on each
machine is given in the following table
Product
Machine 1 2 3 4 1 0.25 0.15 0.15 0.25
2 0.33 0.20 0.30 0.50
3 0.20 0.30 0.25 0.10
Setup times are 20 of operation times. The
number of machine hours available in next 6
months are
Machine Jan Feb Mar Apr May June
1 120 60 60 60 60 60 2 180 60 180 60 180 60
3 120 60 120 60 120 60
Determine if there is enough capacity to meet
product demand.
8

• Definitions of Long-Range Capacity
• 1. Production Capacity - The maximum production
  of an organization.
• 2. Maximum Practical Capacity - that output
  attained within the normal operating schedule of
  shifts per day and days per week while bringing
  in high-cost, inefficient facilities.
• 3. Output Rate Capacity - a measure of production
  capacity based on an organizations outputs. e.g.
  automobiles per month.
• 4. Aggregate Unit of Capacity - a measure of
  production capacity that is used when an
  organizations outputs are diverse. e.g. sales
  dollars per month, tons per month, or other
  measures of capacity.
• 5. Input Rate Capacity - a measure of production
  capacity based on an organizations inputs. e.g.
  available seat-miles per month.
• 6. Percentage of Capacity Utilization - a measure
  of production capacity based on the relative
  outputs generated per inputs required in some
  time period. e.g. actual number of automobiles
  produced divided by the quarterly automobile
  production capacity, or the number of
  labour-hours used during the month divided by the
  number of labour-hours available in the work
  force.

9

• Facility Planning
• Principle 1 Production units(plants) have an
  optimal rate of output for minimum cost. This is
  frequently known as the best operating level.

Short-Run Average Cost
Volume
Principle 2 Minimum cost and optimal operating
rate are functions of the size of a production
unit. This is known as economies of scale.
Long-Run Average Cost
Volume
10
Short-Term Capacity Adjustment
Increase Capacity
Decrease Capacity
Type of System
Hire Employees Add Shifts Overtime Subcontract Dep
lete Inventory Defer Maintenance Standardize
Output
Layoff Employees Reduce Shifts Reduce
Workweek Shutdown Facilities Lease
Facilities Employee Attrition
Manufacturing Systems
Hire Employees Overlap Shifts Change Workforce
Mix Overtime Offload Activities Defer Maintenance
Standardize Output
Fire / Layoff Employees Reduce Work
Schedules Shutdown Facilities Lease
Facilities Employee Attrition
Service Delivery Systems
11

• Ways of Changing Long-Range Capacity
• Expand Capacity
• 1. Subcontract with other companies to become
  suppliers of the expanding firms components or
  entire products.
• 2. Acquire other companies, facilities or
  resources.
• 3. Develop sites and / or buildings or buy
  equipment.
• 4. Expand, update or modify existing facilities.
• 5. Reactivate facilities that are on a standby
  basis.
• Reduce Capacity
• 1. Sell existing facilities, sell inventories and
  layoff or transfer employees.
• 2. Mothball facilities and place on standby
  status, sell inventories and layoff or transfer
  employees.
• 3. Develop and phase in new products as other
  products decline.

12
Long-Term Capacity Adjustments
Advantages
Disadvantages
Capacity Expansion
- Minimizes Immediate Capital Investment - Less
Risk / Cost of Over-forecasting Demand
- Higher Cost per Sq. Ft. for Construction -
Inflationary Pressures on Future Construction -
Unable to Handle Unexpected Demand - Higher Cost
per Unit of Output(?)
Small Increments
- Lower Cost per Sq. Ft. for Construction -
Absorb Demand Increases Beyond Estimates - Lower
Cost per Unit of Output(?)
- Requires Large Capital Investment - Opportunity
Cost of Investing in Excess Capacity - Higher
Risk / Cost of Over-Forecasting Demand
Large Increments
13
Changing Capacity - Illustration 1
A small firm intends to increase capacity of a
bottleneck operation by adding a new machine.
Two alternatives, A and B, have been identified,
and the associated costs and revenues have been
estimated. Annual fixed costs would be 40,000
for A and 30,000 for B variable costs per unit
would be 10 for A and 12 for B. Revenue per
unit would be 15 for A and 16 for B. a.
Determine each alternatives breakeven point in
units. b. At what volume of output would the two
alternatives yield the same profit? c. If
expected annual demand is 12,000 units, which
alternative would yield the higher profit?
Changing Capacity - Illustration 2
A producer of pottery is considering the addition
of a new plant to absorb the backlog of demand
that exists. The primary location being
considered will have fixed costs of 9,200 per
month and variable costs of 70 cents per unit
produced. Each item is sold to retailers at a
price that averages 90 cents.
a. What volume per month is necessary in order to
break even? b. What profit would be realized on a
monthly volume of(1)61,000 units? (2) 87,000
units?
14
Long-Term Capacity Planning - Illustration 1
The ABC Company has a cost of capital of 10 and
projected sales increases of Year Sales
Growth 1 1,000 2 2,000 3 4,000 4 7,000 5 10,000
The company can either add a single expansion of
24,000 units today or an expansion of 8,000 units
today and another expansion of 16,000 units at
the end of Year 3. The respective costs are
outlined below
Average Operating Cost per Unit per Year
Unit Expansion Investment Cost
A B A B
Year
A B
1 2 3 4 5
24,000 8,000 600,000 260,000 16,000 (end of
Year 3) 470,000
18 17 15 15 12 17 10 12 18 19
Which alternative is preferred?
15
Long-Term Capacity Planning - Illustration 2
The DEF Company has a cost of capital of 14 and
projected annual sales of Year Sales
1 1,000 2 2,000 3 4,000 4 6,500
5 9,500 6 13,000 36,000
The company can add capacity in either two or
three increments with the following costs
Average Operating Cost per Unit per Year
Unit Expansion Investment Cost
A B A B
Year
A B
0 1 2 3 4 5 6
11 12 10 12 11 10 8 10 7 8 8 8
5,250 3,000 200,000 135,000 5,000 275,000
9,750 475,000 7,000 425,000
Which alternative is preferred?