Capacity Management

Capacity has a cost, whether it is used

or not

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Capacity

Capacity is the maximum output or producing

ability of a machine, person, factory, etc.
Capacity can be measured in physical terms
Measure of the amount of work done
Capacity is the measure of the maximum amount
of work that can be done in a given time

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Capacity

Capacity = R * T
R is the rate of output per unit of time
T is the maximum amount of time available
Capacity has a cost
Cost to acquire or rent the facility, machine,
operating costs, wages, utilities, insurance, etc.
The cost is incurred even if capacity is underused

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Measuring the Cost of Capacity

Traditional measures do not reflect the cost of

capacity usage or over capacity
Costs are part of overhead and allocated to
production
Focus is on inventory valuation, not managing capacity
Allocation base is chosen from five alternatives
Theoretical
Maximum output when operating continuously at
maximum efficiency

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Measuring the Cost of Capacity
Practical
Level of output under current conditions, allowing for
normal downtime for setups, maintenance,
vacations, etc.
Normal
Average level of output achieved or anticipated over
several years
Budget
Level of output anticipated for the current year
Actual
Level of output actually achieved in the current year
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Measuring the Cost of Capacity
Amount of capacity-related overhead charged to the output
depends on the allocation base chosen

A stamping machine costs $400,000 per year to operate.

The machine can produce 200 stampings per hour.
The runs 24 hours per day.
The company does not work on weekends (104 days) or holidays (10 days)
Downtime for maintenance, setups, etc. averages 15 days per year.
The machine is idle because of lack of materials for an average of 5 days per year.
The equivalent of 8 days of production is lost each year because of defects
produced by the machine.
Management expects to produce an average of 1,000,000 stampings per year
over the next five years.
Planned output for the current year was 1,050,000 stampings.
Actual output for the current year was 1,032,000 stampings, requiring 215 days.
If successfully negotiated, a new contract with a customer would increase demand
for the stampings by 24,000 units per year.

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Measuring the Cost of Capacity
Traditional cost allocation measures
Operating Cost per
Output cost unit
Theoretical capacity
Units per hour 200
Hours per day * 24
Days per year * 365
Theoretical capacity = 1,752,000 $400,000 $0.228

Practical capacity
Units per hour 200
Hours per day * 24
Operating days per year* * 231
Practical capacity = 1,108,800 $400,000 $0.361
* 365-104-10-15-5=231 days

Normal capacity
Expected 5 year average output 1,000,000 $400,000 $0.400

Budget capacity
Planned output for the current year 1,050,000 $400,000 $0.381

Actual capacity
Actual output for the current year 1,032,000 $400,000 $0.388

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Measuring the Cost of Capacity

CAM-I capacity model focuses on the cost of

used and unused capacity
Capacity is divided into four categories
Rated capacity
Same as theoretical capacity
Productive capacity
Capacity used to produce usable output

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Measuring the Cost of Capacity
Nonproductive capacity
Capacity that does not result in usable output
Downtime for maintenance, setups, lack of
materials, etc.
Productive time lost due to waste, scrap, rework,
etc.
Idle capacity
Capacity that is not available due to policy decisions
or market reasons such as holidays, lack of orders,
etc.

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Measuring the Cost of Capacity
Cost is attached to the capacity categories based on
the theoretical cost per unit
Output Cost per
Capacity category Days (4,800 units per day) unit Capacity cost
Rated 365 1,752,000 $0.228 $ 400,000
Productive 215 1,032,000 $0.228 235,616
Nonproductive
Setups 15 72,000 $0.228 $ 16,438
Standby 5 24,000 $0.228 5,479
Defects 8 38,400 $0.228 8,767
Subtotal 28 134,400 $0.228 30,685
Idle
Weekends, holidays 114 547,200 $0.228 $ 124,932
Marketable 5 24,000 $0.228 5,479
Not marketable 3 14,400 $0.228 3,288
Subtotal 122 585,600 $0.228 133,699
Total 365 1,752,000 $0.228 $ 400,000

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Measuring the Cost of Capacity
Capacity utilization can be shown graphically

Nonproductive
capacity

Idle capacity

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Managing Capacity Costs

Management can use the information from

the CAM-I model to understand the financial
impact under-utilizing the available capacity
The cost impact of changes in the utilization rates
can also be calculated

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Managing Capacity Costs
Operating Cost per
Capacity category cost Volume stamping
Rated $ 400,000 1,752,000 $ 0.228

Productive $ 400,000 1,032,000 $ 0.388

If the new order is received

Current productive 1,032,000
Productive capacity from new order 24,000
New total productive capacity $ 400,000 1,056,000 $ 0.379

If defects can be eliminated and output sold

Current productive 1,032,000
Productive capacity from reduced defects 38,400
New total productive capacity $ 400,000 1,070,400 $ 0.374

If defects and standby can be eliminated and output sold

Current productive 1,032,000
Productive capacity from reduced defects 38,400
Productive capacity from reduced standby 24,000
New total productive capacity $ 400,000 1,094,400 $ 0.365

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Managing Capacity Costs

Capacity costs may be fixed, but can still be

managed
Reduction of idle capacity
Increasing sales to use unused capacity
Renting unused capacity to others
Reduction in days off

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Managing Capacity Costs
Reduction of nonproductive capacity
Reduction of setup time, defects, etc.

Reduction of rated capacity

Replace the asset with one having less capacity
Lower capacity asset can be more fully utilized

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Implications of the CAM-I Model

Illustrates the reasons for idle and

nonproductive capacity
Improves accountability
Illustrates the cost of idle and nonproductive
capacity
Helps management prioritize capacity
utilization efforts

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Practical Considerations in
Measuring Capacity
How is capacity defined?
Worker, machine, factory, etc.
Higher-level capacity (process, factory, etc.) is
determined by the lowest capacity component

Capacity may change over time

Assets slowing with age
Technological improvements to assets

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Practical Considerations in
Measuring Capacity
Capacity may depend on the mix of work
processed on the asset
The machine may take longer to stamp one type
of product than it takes to stamp another type
What costs should be included?
Operating costs?
Sunk costs?
Financing costs?
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