1. Strategic Capacity Planning5
Strategic Capacity Planning
Slides prepared by
Laurel Donaldson
Douglas College

2. LO 1
Define capacity, explain the importance of long-term capacity, know how to measure capacity and understand two related performance measures, and describe factors influencing effective capacity. Describe the strategic capacity planning process in organizations, know how to forecast demand and calculate capacity requirements, and discuss major considerations for developing capacity alternatives, Describe the break-even analysis approach for evaluating capacity alternatives, and use it to solve problems.
LO 2
LO 3

3. What is capacity?
Measuring capacity
Factors influencing capacity
Developing capacity alternatives
Evaluating alternatives

4. What is capacity?
Capacity is the upper limit on the load that an operating unit can handle.
The basic questions in capacity handling are:
What kind of capacity is needed?
How much is needed?
When is it needed?

5. Importance of Long-Term Capacity
Impacts ability to meet future demands
Affects operating costs
Major determinant of initial costs
Involves long-term commitment
Affects competitiveness

6. Measuring capacity Design capacity Effective capacity Actual output
maximum obtainable output under ideal conditions
Effective capacity
Maximum capacity given delays, product mix, scheduling difficulties, and other realities.
Actual output
rate of output actually achieved—cannot exceed effective capacity.
p142

7. Common Measures of Capacity
Business
Inputs
Outputs
Auto manufacturing
Number of cars per shift
Steel mill
Tonnes of steel per day
Oil refinery
Barrels of crude oil used per day
Barrels of gasoline per day
Farming
Number of acres
Bushels of grain per acres per year, litres of milk per day
Restaurant
Number of tables, number of seats
Number of meals / day
Theatre
Number of seats
Number of tickets sold per day
Retail sales
Square metres of floor space, sales per sq. ft.
Revenue generated per day
Table 5-1 p142

8. Efficiency and Utilization
p143

9. Efficiency/Utilization Example
Design capacity = 50 trucks/day Effective capacity = 40 trucks/day Actual output = 36 units/day
Example 1 from p143

10. Example: Capacity Actual production last week = 32,000 units
Effective capacity = 35,000 units
Design capacity = 250 units per hour
Factory operates 7 days/week, hour shifts
Design capacity = (7 x 3 x 8) x (250) = 42,000 units
New example
What is the design capacity for one week?
Calculate the efficiency and utilization rates.

11. Example: Capacity Utilization = 32,000/42,000 = 76.2%
Actual production last week = 32,000 units
Effective capacity = 35,000 units
Design capacity = 250 units per hour
Factory operates 7 days/week, hour shifts
Design capacity = (7 x 3 x 8) x (250) = 42,000 units
Utilization = 32,000/42,000 = 76.2%

12. Example: Capacity Utilization = 32,000/42,000 = 76.2%
Actual production last week = 32,000 units
Effective capacity = 35,000 units
Design capacity = 250 units per hour
Factory operates 7 days/week, hour shifts
Design capacity = (7 x 3 x 8) x (250) = 42,000 units
Utilization = 32,000/42,000 = 76.2%
Efficiency = 32,000/35,000 = 91.4%

13. Factors Influencing Capacity
Facilities
Floor space, layout
Products or services
Limited menu in a restaurant
Human
Training, skills and experience
Planning and Operational
No of shifts per day, inventory, quality control
External
Pollution standards, paper work
p144

14. Factors Influencing Capacity
Facilities
Products or services
Human
Planning and Operational
External
P144
Facilities
Floor space, layout
Products or services
Limited menu in a restaurant
Human
Training, skills and experience
Planning and Operational
No of shifts per day, inventory, quality control
External
Pollution standards, paper work

15. Capacity planning process
1. Forecast demand one to five years ahead
2. Determine capacity requirements
3. Measure the capacity now and decide how to bridge the gap
a) Generate feasible alternatives
b) Evaluate alternatives considering economic and non economic aspects
c) Choose the best alternative and implement it P

16. Some Possible Growth Patterns
Volume
Time
Growth
Decline
Cyclical
Stable
Figure 5-1 p145

17. Calculating Capacity Requirements
A department works one eight hour shift, 250 days a year, and has these figures for products, their demand, and usage of a type of machine that is currently being considered. How many machines would be needed to handle the required volume?
Product
Annual Demand
Standard Processing time per unit (hr.)
Processing time needed (hr.) #1
400
5.0
2,000 #2
300
8.0
2,400 #3
700
2.0
1,400

18. Developing Capacity Alternatives
Design flexibility into systems
Differentiate between new and mature products
Take a “big picture” approach to capacity changes
Prepare to deal with capacity “chunks”
Attempt to smooth out capacity requirements
Use capacity cushion
Identify the optimal operating level P

19. Optimal operating level
Minimum cost & optimal operating rate are
functions of size of production unit.
Average cost
per unit
Small
plant
Medium
Large
Output rate

20. Economies and Diseconomies of Scale
What makes the unit cost increase?
Best operating level
Output rate
Average cost per unit
Small Facility
Large Facility
Medium Facility
Economies of scale
Diseconomies of scale

21. Economies and Diseconomies of Scale
Fixed costs (facilities, equipment, management) spread out over more units
Volume purchase discounts
Diseconomies of scale
Worker fatigue, equipment breakdown, less room for error, difficulties in coordination
P148 Note: term “diseconomies of scale” is not in text

22. Evaluating alternatives
Economic considerations
Cost, useful life, compatibility, revenue
Non economic considerations
Public opinion, reactions from employees, community pressure
Techniques used for evaluation:
Break Even Analysis
Payback Period
Net Present Value
p150

23. Break Even Analysis
p152

24. Total revenue = Total cost
Break-Even Analysis
Amount ($)
Q (quantity in units)
Total revenue
Profit
Loss
Total cost
Break-even point
Total revenue = Total cost
Variable cost
p151
Fixed cost

25. Example: Break-Even Fixed costs = $40,000 Material = $1.50/unit
Labour costs = $3/unit Selling price = $10.00 per unit
QBEP = = = 7273 FC
R - VC
$40,000
( )
New example

26. Example: Break-even Analysis
The school cafeteria can make pizza for about $.30 per slice.
Cost for kitchen and labour is $200 per day
The nearby Pizza Den delivers for $9.00 per pizza (8 slices)
Cost for labour reduced to $75 per day
Make or Buy?
New Example See method p153
Do on board, asking class what next?
Make: v = .30 F = 200
Buy: v = 9 / 8 = F = 75
x = point of indifference in slices
Set equal: .3x = 1.125x + 75
.825x = 125
x = 151.5
If demand < 152 slices then buy if more then make

27. Break-Even Problem with Step Fixed Costs
Quantity
FC + VC = TC
Step fixed costs and variable costs.
1 machine
2 machines
3 machines $
p153

28. Multiple Break-Even Points$ TC TR
Quantity 1 2 3
Multiple break-even points

29. Assumptions of Break Even Analysis
One product is involved
Everything produced can be sold
Variable cost per unit is the same regardless of volume
Fixed costs do not change with volume
Revenue per unit constant with volume
Revenue per unit exceeds variable cost per unit
P154 referred to, although not specified in this detail in the text.

30. Further Financial Analysis
Cash Flow
(cash received from sales and other sources) -- (cash outflow for labour, material, overhead, taxes)
Present Value
the sum, in current value, of all future cash flows of an investment proposal.
most used methods of financial analysis:
Payback period
Net present value (NPV)
Internal rate of return (IRR)
This is additional material

31. What is Capacity?
Capacity usually refers to the upper limit of: A) inventories B) demand C) supplies D) rate of output E) finances Ans: D Page: 141

32. What is capacity?
Capacity decisions are mostly long term decisions. Ans: False Page: 141 Stating capacity in dollar amounts generally results in a consistent measure of capacity. Page: 142

33. Capacity performance
The maximum possible output given a product mix, scheduling difficulties, quality factors, and so on, is: A) utilization B) design capacity C) efficiency D) effective capacity E) available capacity Ans: D Page: 142

34. Capacity Performance
Efficiency is defined as the ratio of: A) actual output to effective capacity B) actual output to design capacity C) design capacity to effective capacity D) effective capacity to actual output E) design capacity to actual output Ans: A Page: 143

35. Capacity Performance
Utilization is defined as the ratio of: A) actual output to effective capacity B) actual output to design capacity C) design capacity to effective capacity D) effective capacity to actual output E) design capacity to actual output Ans: B Page: 143

36. Define capacity and identify some common ways it is measured.
Distinguish between efficiency and utilization and be able to calculate them.
Describe factors that influence effective capacity.
Describe the steps of the strategic capacity planning process.
Discuss major considerations for developing capacity alternatives.
Use break-even analysis to solve problems.