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Capacity Planning

Chapter 10

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Learning Objectives

Describe methods of measuring capacity, planning capacity and calculating capacity utilization. Explain the impact of economies of scale, diseconomies of scale, and experience curves on capacity.

Explain differences in capacity strategy in terms of the timing and sizing of expansion options.

Describe the benefits of a capacity cushion and the strategic reasons to increase or decrease the cushion.

Understand how to evaluate capacity alternatives.

Discuss how to plan capacity expansions to address gaps between demand and supply.

Explain the importance of special factors for managing service capacity.

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Postmarked Gone

What do the cities of Bridgeport, Connecticut; Newark, New Jersey; and Pasadena, California have in common?

They are all cities that have recently had their postmarks removed by the US Postal Service.

The USPS closed mail processing centers in each of these cities (plus nine others) in an effort to shrink its capacity to better fit demand.

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Discussion Starter

How would you measure capacity?

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Capacity Management
and Its Relationship to Value

Capacity management is a critical component of long-term decision making because it is a fundamental part of all facility investment decisions.
Capacity: the maximum output of an organization, piece of equipment, or worker
There are costs to having too much capacity, just as there are costs to not having enough.

Source: © Image Source/Corbis

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Capacity Measures

There is a high degree of commonality regarding measures of capacity, economies of scale, experience curves, and diseconomies of scale.
Capacity measures must be tailored to fit specific situations.
Utilization increases or decreases as average output is increased or peak or effective capacity is changed.
Capacity can be measured using either input or output measures.

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Figure 10.1: Illustration of Utilization as Related to Average Output and Capacity

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Output/Input Measures & Utilization

Output measures: measures of the units coming out of a process or facility as finished goods or services
Input measures: measures that assess the resources that are put into a supply chain or process
Utilization: the percentage of the available time that equipment, space, or labor is used and adding value

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Peak and Effective Capacity

Peak capacity: the maximum output rate that a process or facility can achieve in the short term under ideal conditions
Effective capacity: the maximum output that a company or process can economically sustain under normal circumstances for an extended time period

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Discussion Starter

If you were a company would you refuse an order if you were at capacity?

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Capacity Factors

There are several factors that affect the estimation of capacity:

Economies of Scale

Experience Curves

Diseconomies of Scale

Source: © Image Source/Corbis

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Economies of Scale

Economies of scale: positive effects that result when large volumes of a product or service are produced together, allowing the producer to spread the fixed costs associated with preparing that product or service over all the units
Economies of scale result from:

the ability to spread setup costs

the ability to obtain quantity purchase discounts

the ability to spread construction costs

various process advantages

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Experience Curves

Experience curves: graphs that display the relationship between total direct labor per unit and the cumulative quantity of product or service produced

a.k.a. learning curves

Show the relationship between productivity and experience

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Figure 10.2: An
Example of a Learning Curve

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Diseconomies of scale

Diseconomies of scale: inefficiencies that occur when an organization has grown so large that the cost of managing and tracking its activities outweighs the benefits associated with size
Increasing size can bring greater complexity, inefficiencies resulting from the need to manage a complex system, and a loss of focus.

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Capacity Strategies

Capacity strategy: a term that refers to several aspects of capacity management, including the timing of expansion (or contraction), the sizing of facilities, and the linkage with marketing/business plans

Two general strategies at either end of the

continuum:

Wait-and-See

Aggressive Expansion

A commonly used tool regardless of strategy is:

Subcontracting/outsourcing: contracting with another company to provide products during a period of excess demand

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Wait and See

Wait-and-see strategy: postponing firm commitments to build expensive new facilities until demand has already exceeded capacity
Typically fits best in industries with slow growth where facilities are very expensive

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Figure 10.3: Wait-and-See
Capacity Strategy

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Capacity at American Express

What are the capacity concerns that American

Express must manage?

Customer statements must be processed and sent

out, either by mail or electronically, once per

month.

Managing capacity for individual transactions is

substantially more challenging.

The computers, phone, and Internet lines and

other equipment that is required to post

transactions across the world have more capacity

than the average demand.

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Aggressive Expansion

Aggressive expansion: a strategy in which capacity is added in large leaps, with the expectation that demand will eventually catch up

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Figure 10.4: An
Aggressive Capacity Strategy

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Blockbuster and
Netflix: Where Does Growth Stop?

Blockbuster Inc. has more than 32 million active customers and stores within 10 minutes of 70 percent of the US population.
Netflix’s capitalization is $1.9 billion vs. Blockbuster’s $775 million.
Blockbuster’s goal was to have 2 million online customers by the end of 2007, up from 1.5 million at the time of the announcement.

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Figure 10.5: Blockbuster and Netflix: Store, Customer, and Revenue Growth

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Capacity Cushion

Capacity cushion: the difference between average utilization and 100 percent capacity

A central component of capacity strategy is the recognition that it is impossible to exactly match capacity to demand

= most companies maintain a capacity cushion of some size

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Figure 10.6: Capacity Cushion
as a Percentage of Design Capacity

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Capacity Cushion

The size of the capacity cushion that a company

wishes to have varies greatly based on a number

of factors:

Organizations that compete based on low cost will generally choose to have fairly small capacity cushions.

Organizations that compete based on quality or flexibility will employ larger cushions.

WHY?
A larger cushion allows the company more room to change an order and/or fix any problems that occur.

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Evaluating Capacity Alternatives

Managing capacity is always a concern:

too much is expensive to maintain

too little results in lost sales opportunities

Key considerations when looking at capacity alternatives:

Incorporating flexibility

Accounting for Life-Cycle Stage

Looking at the Big Picture

Dealing with Capacity Increments

Smoothing Out Capacity Requirements

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Incorporating Flexibility

The long-term nature of capacity planning causes gaps between capacity and demand.
Creating the ability to expand a facility is a key technique.
Flexible equipment or workers who have the flexibility to perform multiple jobs are another way to vary capacity.

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Accounting for Life-Cycle Stage

Life-cycle stage and capacity are tightly linked.
Companies should be careful when making large or inflexible investments in capacity.
The growth phase of the product life cycle is characterized by rapid increases in sales.
The maturity phase of the life cycle is characterized by stable demand.
The final decline phase for a product or service is challenging for many organizations.

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Looking at the Big Picture

When evaluating capacity alternatives, it is important to consider capacity as part of an interrelated system in addition to individual steps in a process.
The goal is to provide a system that is well balanced.
Bottleneck: the step with the slowest cycle time in a given process; this is the limiting step that limits productivity for the process

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Figure 10.7a and 10.7b: Capacity Bottlenecks at an Internet Bookseller

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Figure 10.7c: Capacity
Bottlenecks at an Internet Bookseller

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Dealing with Capacity Increments

Capacity increases often come in large increments rather than small ones, which makes it challenging to match capacity and demand.

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Smoothing Out Capacity Requirements

One approach is to utilize inventory, buying or making large amount in anticipation of future demand.
Two Techniques:

Yield/Revenue Management

Complementary Products

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Figure 10.8: Stockpiling Inventory of Snow Shovels to Meet Anticipated Demand

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Yield/Revenue Management

Yield/revenue management: allocating a perishable product to the right kind of customer so as to maximize revue rather than simply maximizing utilization

Example products: airline seats, restaurant tables, or parking spaces

Seeks to proactively price products or service in order to shape and smooth demand.
Use yield management techniques when:

there is a fixed capacity

demand can be segmented into distinct categories

products are perishable and sold in advance

demand fluctuates substantially

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Grand Luxor Hotel Applies Yield Management to Smooth Demand and Increase Revenue

The Grand Luxor Hotel is a major hotel in a large city in India.
Demand is very high on Monday – Thursday but low on Friday – Sunday.
By changing prices from a standard price of $200 per room per night to a two-tier price of $220 per night on Monday – Thursday and $160 on Friday- Sunday, the hotel can increase revenue while also smoothing demand.

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Figure 10.9: Demand
and Revenue for Grand Luxor

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Complementary Products

Criteria for this technique to work:

The products must balance out seasonal patterns, where the peak period for one product occurs during the slow period for another, and vice versa.

The products can be produced in the same facility.

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Figure 10.10: Complementary
Products Help Balance Demand

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Systematic Capacity Planning

There is a general sequence of steps that is usually followed when planning capacity.
Capacity planning is reviewed on yearly bases or at any time there is a substantial change in market forces or demand or when the organization is faced with a dramatic shortage or excess of capacity.
Capacity planning involves both decisions to expand or contract capacity and decisions on how best to utilize the existing capacity.

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Capacity Planning

Master schedules: a medium-term planning tool that sets the number of end items or products within a specified time period
Capacity requirements planning: the process of determining short-range capacity requirements
Load reports: reports for a department or work center that measure already scheduled and expected future capacity requirements against capacity availability

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Long-Range Planning of Capacity

Steps to assess future capacity needs:

Estimate future capacity requirements.

Identify gaps between existing capacity and projected requirements.

Develop alternative strategies for addressing these gaps.

Choose the most appropriate alternative, based on both qualitative and quantitative assessment.

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Step 1. Estimating Requirements

Setup time: the time associated with changing the machine settings, equipment being used, or personnel from making one product to another

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Step 2. Indentifying Gaps

Capacity gap: a difference (either a surplus or a shortage) between projected demand and current capacity
It is very important to consider the implications and biases associated with the choice of capacity measures.

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Self-Checkout at Home Depot: Reducing Costs While Improving Service

Home improvement stores such as Home Depot or Lowe’s see great variation by day of the week.
The estimated value of self-checkout transactions in the US is expected to rise from $475 billion in 2006 to $1.2 trillion in 2009.

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Figure 10.11: Predicted Demand and Available Capacity at a Home Depot

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Step 3. Developing Alternatives

Options?

Do nothing

This only works if the organization has excess capacity.

If the organization has a significant capacity gap, then plans for adding or deleting capacity should be made.
Outsourcing/Subcontracting

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Step 4. Choosing Alternatives

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Qualitative Factors

Fairly subjective and difficult to measure quantitatively
Managers must consider how capacity expansion plans fit with the overall operations strategy of the business, and other factors that must be considered include:

business climate

uncertainties regarding demand

the actions of competitors

technological change

Technique to measure them:

Make best-case, expected, and worst-case projections for what-if analysis

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Quantitative Factors

Can be analyzed in a straight forward manner to come up with a single assessment
Examples:

Fixed and variable costs of adding or removing capacity

Estimates of potential added revenues

Estimates of total market share

Estimates of competitors’ responses

To calculate an alternative’s potential value, businesses typically employ the concept of:

net present value: the financial impact of an alternative in present-day dollars

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Service Capacity

Capacity planning for services shares many similarities with planning for manufacturing.
Time
Location
Volatility of Demand
Capacity Utilization and Service Quality

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Figure 10.13: Relationship Between Service Utilization and Service Quality