1

Chapter 11
Strategic Capacity Management

OBJECTIVES

Strategic Capacity Planning Defined

Capacity Utilization & Best Operating Level

Economies & Diseconomies of Scale

The Experience Curve

Capacity Focus, Flexibility & Planning

Determining Capacity Requirements

Decision Trees

Capacity Utilization & Service Quality

Strategic Capacity Planning

Capacity can be defined as the ability to

hold, receive, store, or accommodate

Strategic capacity planning is an

approach for determining the overall
capacity level of capital intensive
resources, including facilities,
equipment, and overall labor force size

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

Best Operating Level

Example:
Example:Engineers
Engineersdesign
designengines
enginesand
andassembly
assemblylines
linesto
to
operate
operateat
atan
anideal
idealor
orbest
bestoperating
operatinglevel
levelto
tomaximize
maximize
output
outputand
andminimize
minimizeware
ware

Average
unit cost
of output
Underutilization

Overutilization
Best Operating
Level

Volume

Example of Capacity Utilization

During
During one
one week
week of
of production,
production, aa plant
plant

produced
produced 83
83 units
units of
of aa product.
product. Its
Its
historic
historic highest
highest or
or best
best utilization
utilization
recorded
recorded was
was 120
120 units
units per
per week.
week. What
What
is
is this
this plants
plants capacity
capacity utilization
utilization rate?
rate?

Answer:
Answer:

Capacity
Capacity
Capacityutilization
utilizationrate
rate==
Capacityused
used ..
Best
Best operating
operating level
level
==83/120
83/120
=0.69
=0.69or
or 69%
69%

Economies & Diseconomies of

Scale

Economies
Economiesof
ofScale
Scaleand
andthe
theExperience
ExperienceCurve
Curveworking
working

Average
unit cost
of output

100-unit
plant
200-unit
plant

300-unit
plant

400-unit
plant

Diseconomies
Diseconomiesof
ofScale
Scalestart
startworking
working
Volume

The
Experience
Curve

As
Asplants
plantsproduce
producemore
moreproducts,
products,they
they
gain
gainexperience
experiencein
inthe
thebest
bestproduction
production
methods
methodsand
andreduce
reducetheir
theircosts
costsper
perunit
unit

Yesterday

Cost or
price
per unit

Today
Tomorrow

Total accumulated production of units

Capacity Focus

The concept of the focused factory

holds that production facilities work
best when they focus on a fairly
limited set of production objectives

Plants Within Plants (PWP)

Extend focus concept to operating level

10

Capacity Flexibility

Flexible plants

Flexible processes

Flexible workers

Capacity Planning: Balance

Unbalanced
Unbalancedstages
stagesof
ofproduction
production

Units
per
month

Stage 1

Stage 2

Stage 3

6,000
7,000
5,000
Maintaining System Balance: Output of one stage is
the exact input requirements for the next stage
Balanced
Balancedstages
stagesof
ofproduction
production

Units
per
month

Stage 1

Stage 2

6,000

6,000

Stage 3
6,000

11

12

Capacity Planning

Frequency of Capacity Additions

External Sources of Capacity

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

13

14

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:
FancyFine
Small (000s)
Family (000s)
Generic
Small (000s)
Family (000s)

50
35

60
50

80
70

100
90

100
80

110
90

120
100

140
110

Example of Capacity Requirements

(Continued): Product from a Capacity
Viewpoint

Question:
Question: Are
Are we
we really
really producing
producing two
two

different
different types
types of
of mustards
mustards from
from the
the
standpoint
standpoint of
of capacity
capacity requirements?
requirements?

Answer:
Answer: No,
No, its
its the
the same
same product
product just
just
packaged
packaged differently.
differently.

15

16

Example of Capacity Requirements (Continued) :

Equipment and Labor Requirements
Year:
Small (000s)
Family (000s)

1
150
115

2
170
140

3
200
170

4
240
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.

17

Question:
Question:What
Whatare
arethe
theYear
Year11values
valuesfor
forcapacity,
capacity,machine,
machine,
and
andlabor?
labor?

Year:
Small (000s)
Family (000s)

1
150
115

2
170
140

3
200
170

4
240
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
takes 1.5 machines for 150,000
Percent capacity used
50.00%
Machine requirement
1.50
Labor requirement
3.00
At 2 operators for
Family-size
100,000, it takes 3
operators for 150,000
Percent capacity used
47.92%
Machine requirement
0.96
Labor requirement
2.88
The McGraw-Hill Companies, Inc.,

18

Question:
Question:What
Whatare
arethe
thevalues
valuesfor
forcolumns
columns2,
2,33and
and44in
inthe
thetable
tablebelow?
below?

Year:
Small (000s)
Family (000s)
Small
Family-size
Small
Percent capacity used
Machine requirement
Labor requirement
Family-size
Percent capacity used
Machine requirement
Labor requirement

1
150
115

2
170
140

3
200
170

4
240
200

Mach. Cap.
Mach. Cap.

300,000
240,000

Labor
Labor

6
6

50.00%56.67%
1.501.70
3.003.40

66.67%
2.00
4.00

80.00%
2.40
4.80

58.33%
47.92%
1.17
0.96
3.50
2.88

70.83%
1.42
4.25

83.33%
1.67
5.00

The McGraw-Hill Companies, Inc.,

19

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
new facilities
facilities
C)
C) Do
Donothing
nothing(no
(nochange)
change)
The
Thecorrect
correctchoice
choicedepends
dependslargely
largelyupon
upondemand,
demand,which
which
may
maybe
below,
low,medium,
medium,or
orhigh.
high. By
Byconsensus,
consensus,management
management
estimates
estimatesthe
therespective
respectivedemand
demandprobabilities
probabilitiesas
as0.1,
0.1,0.5,
0.5,
and
and0.4.
0.4.

20

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 from
from the
the three
three alternatives
alternatives (A,
(A,
B,
B, and
and C)
C) under
under the
the differing
differing probable
probable levels
levels of
of
demand.
demand. These
These profits,
profits, in
in thousands
thousands of
of dollars
dollars
are
are presented
presented in
in the
the table
table below:
below:

A
B
C

0.1
Low
10
-120
20

0.5
Medium
50
25
40

0.4
High
90
200
60

21

Example of a Decision Tree Problem

(Continued): Step 1. We start by drawing the
three decisions

A
B
C

22

Example of Decision Tree Problem

(Continued): Step 2. Add our possible states of
nature, probabilities, and payoffs
High demand (0.4)
Medium demand (0.5)
Low demand (0.1)

High demand (0.4)

Medium demand (0.5)

Low demand (0.1)

High demand (0.4)

Medium demand (0.5)
Low demand (0.1)

Rs90k
Rs50k
Rs10k
Rs200k
Rs25k
-Rs120k
Rs60k
Rs40k
Rs20k

23

Example of Decision Tree Problem

(Continued): Step 3. Determine the expected
value of each decision

Rs62k
Rs62k
AA

High
Highdemand
demand(0.4)
(0.4)
Medium
Mediumdemand
demand(0.5)
(0.5)
Low
Lowdemand
demand(0.1)
(0.1)

Rs90k
Rs90k
Rs50k
Rs50k
Rs10k
Rs10k

EV
EVAA=0.4(90)+0.5(50)+0.1(10)=Rs62k
=0.4(90)+0.5(50)+0.1(10)=Rs62k

24

Example of Decision Tree Problem

(Continued): Step 4. Make decision
High demand (0.4)

Rs62k
A
B

Rs80.5k

Medium demand (0.5)

Low demand (0.1)
High demand (0.4)
Medium demand (0.5)
Low demand (0.1)

High demand (0.4)

Rs46k

Medium demand (0.5)

Low demand (0.1)

Rs90k
Rs50k
Rs10k
Rs200k
Rs25k
-Rs120k
Rs60k
Rs40k
Rs20k

Alternative
AlternativeBBgenerates
generatesthe
thegreatest
greatestexpected
expectedprofit,
profit,so
so
our
ourchoice
choiceis
isBBor
orto
toconstruct
constructaanew
newfacility
facility

25

Planning Service Capacity vs.

Manufacturing Capacity

Time: Goods can not be stored for later use

and capacity must be available to provide a
service when it is needed

Location: Service goods must be at the

customer demand point and capacity must be
located near the customer

Volatility of Demand: Much greater than in

manufacturing

26

Capacity Utilization &

Service Quality

Best operating point is near 70% of

capacity

From 70% to 100% of service capacity,

what do you think happens to service
quality?

27

Question Bowl
The objective of Strategic Capacity
Planning is to provide an approach
for determining the overall capacity
level of which of the following?
a. Facilities
b. Equipment
c. Labor force size
d. All of the above
e. None of the above

Answer: d. All of the above

28

Question Bowl
To improve the Capacity Utilization Rate we can do
which of the following?
a.

Reduce capacity used

b.

Increase capacity used

c.

Increase best operating level

d.

All of the above

e.

None of the above

Answer: b. Increase capacity used (This

increases the numerator in the Capacity
Utilization Rate ratio, which is desirable.)

29

Question Bowl
When we talk about Capacity Flexibility which
of the following types of flexibility are
included?
a. Plants
b. Processes
c. Workers
d. All of the above
e. None of the above

Answer: d. All of the above

30

Question Bowl
When adding capacity to existing operations which of
the following are considerations that should be
included in the planning effort?
a.

Maintaining system balance

b.

Frequency of additions

c.

External sources

d.

All of the above

e.

None of the above

Answer: d. All of the above

31

Question Bowl
Which of the following is a term used to describe
the difference between projected capacity
requirements and the actual capacity
requirements?
a.

Capacity cushion

b.

Capacity utilization

c.

Capacity utilization rate

d.

All of the above

e.

None of the above

Answer: a. Capacity cushion

32

Question Bowl
In determining capacity requirements we must do
which of the following?
a.

Address the demands for individual product lines

b.

Address the demands for individual plants

c.

Allocate production throughout the plant network

d.

All of the above

e.

None of the above

Answer: d. All of the above

33

Question Bowl
In a Decision Tree problem used to evaluate
capacity alternatives we need which of the
following as prerequisite information?
a.

Expect values of payoffs

b.

Payoff values

c.

A tree

d.

All of the above

e.

None of the above

Answer: b. Payoff
values (Expected
values are what is
computed, not
prerequisite to the
analysis.)