capacity1

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Capacity Planning

Capacity is the maximum capability to produce. Capacity planning takes place at several levels of detail. We discuss long-term capacity planning in this chapter, intermediate term capacity planning in Chapter 14, and short-term capacity planning in Chapters 15 and 16.

Long-term capacity planning is a strategic decision that establishes a firm’s overall level of resources. It extends over a time horizon long enough to obtain those resources—usually a year or more for building or expanding facilities or acquiring new businesses. Capacity decisions affect product lead times, customer responsiveness, operating costs, and a firm’s ability to compete. Inadequate capacity can lose customers and limit growth. Excess capacity can drain a company’s resources and prevent investments in more lucrative ventures. When to increase capacity and how much to increase it are critical decisions.

Figure 7.1 a, b, and c show three basic strategies for the timing of capacity expansion in relation to a steady growth in demand.

· Capacity lead strategy. Capacity is expanded in anticipation of demand growth. This aggressive strategy is used to lure customers from competitors who are capacity constrained or to gain a foothold in a rapidly expanding market. It also allows companies to respond to unexpected surges in demand and to provide superior levels of service during peak demand periods.

· Average capacity strategy. Capacity is expanded to coincide with average expected demand. This is a moderate strategy in which managers are certain they will be able to sell at least some portion of expanded output, and endure some periods of unmet demand. Approximately half of the time capacity leads demand, and half of the time capacity lags demand.

· Capacity lag strategy. Capacity is increased after an increase in demand has been documented. This conservative strategy produces a higher return on investment but may lose customers in the process. It is used in industries with standard products and cost-based or weak competition. The strategy assumes that lost customers will return from competitors after capacity has expanded.

As demand grows, a lead, lag, or average capacity strategy can be applied.

Capacity can be increased incrementally or in large steps.

Consider higher education’s strategy in preparing for a tripling of the state’s college-bound population in the next decade. An established university, guaranteed applicants even in lean years, may follow a capacity lag strategy. A young university might lead capacity expansion in hopes of capturing students not admitted to the more established universities. A community college may choose the average capacity strategy to fulfill its mission of educating the state’s youth but with little risk.

How much to increase capacity depends on (1) the volume and certainty of anticipated demand; (2) strategic objectives in terms of growth, customer service, and competition; and (3) the costs of expansion and operation.

Capacity can be increased incrementally or in one large step as shown in Figure 7.1d. Incremental expansion is less risky but more costly. An attractive alternative to expanding capacity is outsourcing, in which suppliers absorb the risk of demand uncertainty.

The best operating level for a facility is the percent of capacity utilization that minimizes average unit cost. Rarely is the best operating level at 100% of capacity—at higher levels of utilization, productivity slows and things start to go wrong. Average capacity utilization differs by industry. An industry with an 80% average utilization would have a 20% capacity cushion for unexpected surges in demand or temporary work stoppages. Large-capacity cushions are common in industries in which demand is highly variable, resource flexibility is low, and customer service is important. Utilities, for example, maintain a 20% capacity cushion. Capital-intensive industries with less flexibility and higher costs maintain cushions under 10%. Airlines maintain a negative cushion by overbooking flights. Best operating level can also refer to the most economic size of a facility.

Figure 7.2 shows the best operating level—in this case, the number of rooms for a hotel—as the point at which the economies of scale have reached their peak and the diseconomies of scale have not yet begun.

Economies of scale occur when it costs less per unit to produce or operate at high levels of output. This holds true when:

· Fixed costs can be spread over a larger number of units,

· Production or operating costs do not increase linearly with output levels,

· Quantity discounts are available for material purchases, and

· Operating efficiency increases as workers gain experience.

The electronics industry provides a good case example of economies of scale. The average cost per chip placement for printed circuit-board assembly is 32 cents in factories with a volume of 25 million placements, 15 cents in factories with 200 million placements, and only 10 cents in factories with 800 million placements.1

1“High Volumes Yield Profits for High-Tech Factories.” HE Solutions(April 1996), p. 8.

Capacity decisions provide a framework for further facility decisions, such as where to locate a new facility and how to arrange the flow of work in the facility. Facility location is discussed in the supplement to this chapter. The remainder of the chapter presents various alternatives for laying out a facility.

Kuala Lumpur International (KLIA) is a Green certified airport with spectacular architecture. Shown here, the outside of the terminals resemble Bedouin tents. Inside, trees and other vegetation, along with waterfalls and streams, recreate a rain forest environment. The airport can handle 25 million passengers a year, and is a major cargo hub for the Asian-Pacific region.

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