Capacity Planning and Management in Operations

Capacity
Capacity refers to the ability of a production or operation facility to
bring out a given level of output.
Capacity may be more comprehensively assessed in two different ways:

i. In terms of output: Capacity is the maximum volume of output that

can be obtained from a productive facility in a given period of time. For
example, if a factory can produce 10,000 units of hoes in a day, then its
daily capacity is said to be 10,000 units of hoes.
ii. In terms of input: Capacity is the maximum available inputs that the
business has for production purposes. For example, the capacity of a
hospital could be 1,000 beds for in patients, a business school’s intake
of 15,000 students annually, a restaurant with a dinning capacity of 15
clients, a guest house with 50 beds. Etc.
Capacity Management
Capacity management is the process of planning, organizing and
controlling the transformation/conversion process. This involves
evaluating current and future capacity alternatives with regard
to their cost and benefit implications, selecting and implementing
the most favorable alternative(s). Capacity decisions are largely
influenced by current and forecasted demand for a firms output in
the market/environment.
 Capacity planning seeks to answer the following questions.

How much capacity do we need?

How much capacity do we have at present?
How much capacity do we need in the future?
When is additional capacity needed?
Capacity planning and management is therefore concerned with ensuring that resource
requirements are matched with resource availability so that production is not hindered
by lack of resources or the business does not have excess and therefore idle resources. It
seeks to avoid;
Under –capacity. a situation where an organization has limited resources to meet
demand.
Over – Capacity; a situation where by the organization has more resources as compared
to the demand requirements.
But attaining;

Optimum Capacity; a point where resources required economically match resources

available.
Constituents of capacity in an organization
An organization capacity relates to its;

Labour force.
Machines.
Cubic space (floor, Vertical and overhead space)
Stores.
All the facilities and departments that aid production.
Importance of Capacity Planning and Management in Business
The need for optimum capacity, to forestall the limitations of either
under capacity or over capacity makes capacity planning and
management important, thus;
 
 
Under capacity is undesirable because;
 There is inability to produce and deliver the required output on
time, leading to dissatisfied customers, a decline in market share,
low levels of profits and a fall in overall competitiveness.
 Inability to produce in high quantities even when demand supports
such and therefore high unit costs.
 The business will incur high costs in making up for the capacity
deficit through, for example, using overtime or hiring more staff.
Optimum capacity is therefore desirable because;
 There is just available needed capacity to produce the required goods and
services.
 The business can meet its present and future demand for goods and services.
 The business is able to produce the required goods and services in a timely
and dependable manner.
 No shortages due to resource constraints will arise.
 The business will not incur unnecessary operating costs when trying to
acquire additional capacity like hiring employees.
Over capacity on the other hand is better than under capacity but has
these limitations;
 There are idle resources, on which return is foregone, leading to investors
who are not satisfied. Share values on the market will subsequently decline.
 There may be need of paying workers who are idle or working for fewer
hours because demand is low.
 High costs are incurred by the firm to keep large volumes of inventories,
both raw materials and finished goods.
Capacity planning Techniques
Aggregate Capacity Plan (ACP), it basically defines the
capacity required for production at the initial stage in terms
of labor hours/machine hours and storage in totality.
Rough-Cut Capacity Planning (RCCP) happens mid-
process and begins to identify required capacity by
machine and/or work station. Tests the feasibility of the
master production schedule (MPS).
Detail Capacity Planning (DCP) takes place at the end of
the planning process and DCP tests the feasibility of the
Materials Requirement Planning (MRP). As the name
suggests, it is much more detailed than either ACP or RCCP.
Instead of focusing on resources or machine-level capacity,
it addresses the specific manner in which shop floor
activities need to be arranged to reach capacity targets.
Aggregate capacity plan example
Rough-cut capacity plan example
Detailed capacity plan example
Detail Capacity Planning should cover several key
issues:
Order mapping. DCP maps manufacturing orders
against actual capacities.
Order planning. Detail Capacity Planning fine tunes
labor and equipment inputs to accurately match real-
time customer demand. But it also manages work
orders and work center assignments to maintain a
steady flow of production.
Capacity Planning and Management Process
Due to the importance of capacity planning and management,
operations managers need to follow a well-coordinated approach
while performing planning for capacity. The following steps should
be followed and in an iterative manner.
1. Forecasting demand
2. Assessing existing capacity
3. Developing alternative Sources of capacity
4. Selection of an optimal capacity alternative.
1. Forecasting demand
Managers can use both qualitative and quantitative approaches in forecasting
demand.
The Qualitative Approaches may include;

 Delphi method (use of experts who refine their answers over and over to reach best
ones).
 Historical data and nominal group techniques. (method for use among groups of
many sizes, who want to make their decision quickly, as by a vote, but want
everyone's opinions taken into account)
 
Quantitative ones may include;

 Time Series Analysis. (Analysis of data collected over time ...weekly values,
monthly values, quarterly values, yearly values, etc. Usually the intent is to discern
whether there is some pattern in the values collected to date, with the intention of
short term forecasting)
 Experimental Smoothing (trying to predict the effect of various options so as to
choose the best).
2. Assessing Existing Capacity.
This involves measuring the capacity of the existing facilities. In assessing
capacity, capacity gaps need to be identified. This gap is the difference
between projected demand and current capacity. It is vital to identify the gaps
to ensure proper usage of current capacity.
Existing capacity can be assessed using the following methods;

a) When output is tangible and homogeneous, capacity measurement may be

expressed in terms of output units per period of time. (Output approach)
b) When the mix of outputs is diverse, it becomes hard to find a common
measure. Services are in this category. It is common to use the availability of
the limiting resource as the capacity, (Input approach) for example, a
hotel using the maximum number of diners who can be served during
mealtimes, or a university using its annual intake.
c) Multi-product businesses may choose to establish an aggregate unit of
capacity that allows output rates of the various products to be converted to a
common unit, for example tones per hour, or sales per month.
Capacity Gap
This is the difference between the existing or predicted capacity and the
required capacity from the demand point of view.
Take a case where a firm has a predicted capacity requirement of 9,000 tons in
2003, yet the machine shop capacity is 10,000 tonnes. The capacity gap is 1,000
tonnes in 2003 or capacity gap of
10,000 -9,000/10,000 x 100 = 10%
Capacity gaps vary in size, i.e. they may either be large or small and this size
depends on several factors:
i. Type of demand; Stable demand yields small gaps while unstable demand
yields large ones.
ii. Type of suppliers; Reliable suppliers give rise to small gaps as there is less
need of accumulating inventories, and for unreliable suppliers there is need for
inventories, hence a large capacity gap.
iii.Type of management of the firm; this determines the size of the gap
depending on their level of risk preference.
The size of the capacity gap, whether small or large, has advantages and
disadvantages. The business has to decide what capacity size it needs.
A large positive capacity gap for example has the following advantages:
i. Promptness of services to customers even in times of peak demand.
ii. Avoidance of customer queues
iii.When future demand is uncertain, the firm is able to meet its capacity,
especially when it is unable to predict future demand.
A small capacity gap has got the following advantages:
I. Unit costs are kept constant and low because costs associated with
unused capacity are low.
II.The firm has fewer problems in management of capacity when
demand or the firm’s products reaches the maturity stage or the
declining stage In Its product life cycle (PLC).
III.The firm avoids costs of hiding inefficiencies which are rampant in
companies that have large capacity gaps.
3. Developing alternatives
 The productions manager has to come up with various capacity alternatives in terms
of the capacity gap. I.e. keep no gap, maintain a small gap or maintain a large
gap. Etc.
4. Evaluation and Selection of optimal Capacity Management Alternative
Strategies
 Before a capacity alternative can be chosen, all alternatives have to be evaluated by
the Operations Manager so that the best one for the business is chosen.
 Evaluation of capacity alternatives
 There are several statistical and mathematical models that can be used to evaluate
the alternatives:
i. Present value analysis: Since capacity planning deals with future costs over a long
time span, it is necessary to use discounted cash flows to compare with alternative
plans.
ii. Aggregate planning models; these are useful for examining how best to use existing
capacity in the short run. See production planning topic
iii.Break-even analysis: This technique provides the break-even volume required at a
minimum output when various expansion alternatives after being cost against
projected revenue.
 Capacity Adjustment Options
After identifying the size of capacity gap, a firm has to decide
on what adjustments to undertake. These adjustments include:
a) Doing nothing and simply losing the increasing demand if it is
not currently feasible to increase the capacity of the facility.
b)Expansion of the facility at the present location if it is feasible
and there is room for plant expansion.
c) Keeping the present facility and opening up another one
elsewhere. For example, a supermarket opens an additional
branch when demand increases.
d)Closing down the facility on the impossibility of b) and c) and
opening up a facility elsewhere.
Capacity Management Strategies
When the capacity gaps have been identified while assessing the existing capacity,
alternative plans have to be drawn up to enable the firm to cope with the gap. These
strategies can be categorized into the following;
1. Short-Term Strategies
In the short run, capacity is relatively fixed so changes are seldom made. Short-term
strategies cover capacity decisions in respect of the immediate need of the firm.
In the short term, a firm can adjust its use of short-term assets and working capital
aspects as follows:
a) Inventory can be used to manage capacity problems. Produce, store to cover for
increases of demand.
b)Altering the use of the workforce in order to manage demand changes. Options
that can be used in workforce adjustment include;
i. Using overtime when demand is high and use idle time for workers when the
demand is low.
ii. Extra shifts in case of high demand.
iii.Increasing and decreasing staff.
a) Temporary reduction in preventive maintenance (PM). If
demand increased and the machines can work efficiently with
less preventive maintenance, the maintenance should be reduced
till demand falls back to normal levels and the originally planned
preventive maintenance levels should be continued.
b)Backlogs, which is allowing stock outs and asking the clients to
wait for short periods of time while production is undertaken to
build up stock to meet their needs.
Sub-contracting may also be used where the firm contracts
another firm to produce goods and services for its customers
2. Medium-Term Or Intermediate Strategies
These capacity plans are made to cover the intermediate period.
The plans are quarterly or yearly and may cover a period of up to
18 months.
These plans include:

a) Minor equipment purchases.

b)Acquisition or replacement of tools.
c) Permanently varying the size of the workforce by laying off
workers when demand has shown a persistent decline or hiring
new workers permanently when demand is showing a persistent
increment.
3. Long-Term Strategies
These involve the acquisition of new facilities and equipment and
cover periods of over two years and beyond. The strategies here
include:
a) Contraction of capacity; If the firm finds it uneconomically
feasible to expand, owing to the fact that the increase in demand is
not sufficient, it may decide to keep its present capacity till a time
when there is a substantial increase in demand. As a last resort,
capacity contraction may be undertaken. This involves selling off
existing plants, machines, equipment, and inventories, as well as
firing workers. In extreme conditions, the firm may be shut down.
b) Expansion of capacity; in expansion, there are many options
available to a firm. It can decide to do any of the following:
1) Expand the existing plant at the current location.
2) Take up procurement of several small plants.
 In case the option to expand capacity is covered by uncertainty, a firm can
pursue alternative strategies such as;
a) Expansionist strategy (level capacity plan)
 The firm frequently expands its capacity while anticipating that
market demand will follow.
a) Wait-and-see strategy (chase demand plan or chase strategy)
 Here the firm undertakes smaller frequent jumps in capacity by having
smaller production units than one large one. It has a small capacity
gap.
a) Demand management strategy
 Here, the firm tries to influence demand to fit the available capacity.
This may be done as follows:
i. Transferring customer demand from peak hours to quiet periods, e.g.
phone providers having different charges for different periods. This
encourages subscribers to make calls during off-peak hours that are
cheaper.
Changing demand through price and annual bonus plans
Capacity Decision and other functions
While making a capacity decision, a Productions Manager has to
consider its link at strategic level, Link with other functional areas
and Link with other operations decisions in the operations
department.
A)Links at strategic level
 At this level, the firm looks at its overall vision, mission, goals and
objectives. The firm assesses how its capacity decision will be used to
achieve competitive priorities that will help it achieve its missions and
goals.
 Competitive priorities include;
 Quality,
 Cost,
 Dependability,
 Flexibility, and at times speed of delivery.
A)Links with other functional areas
 The effect of the capacity decision has links with the other functional
areas of the business, which include;
 Finance,
 Research and development,
 Human resource management and
 Marketing
 The capacity decision should be properly linked to these areas so as to
ensure sustainability.
A)Links with Other Operational Decisions in the Operations
Department
 The operations department of the business has operational decisions
such as;
 Production system design,
 Plant Location and Layout,
 Workforce management,