Chapter 5

1. Strategic Capacity
Planning for Products
and Services
Gerlyn Bonus
Agnes Regala
Roselyn Pudao
Mary Grace Ibanez
Matex Carillo
BSBA. Management
Prof. Joey Acuῆa

2. Capacity
 Capacity is the upper limit or ceiling on the
load that an operating unit can handle.
 Capacity also includes:
Equipment
Space
Employee skill
• The basic questions in capacity handling are:
– What kind of capacity is needed?
– How much is needed?
– When is it needed?

3. Design capacity
 maximum output rate or service capacity an
operation, process, or facility is designed for.
Effective capacity
 Design capacity minus allowances such as
personal time, maintenance, and scrap.
Actual output
 rate of output actually achieved--cannot
exceed effective capacity.

4. Efficiency and Utilization

5. Design capacity = 50 trucks/day
Effective capacity = 40 trucks/day
Actual output = 36 units/day
Actual output = 36 units/day
Efficiency = = 90%
Effective capacity 40 units/ day
Utilization = Actual output = 36 units/day
= 72%
Design capacity 50 units/day

6. Determinants of Effective Capacity
FACILITIES
 The design of facilities, including size and provision
for expansion, is key.
 Locational factors, such as transportation costs,
distance to market, labor supply, energy sources and
room for expansion are also important.
 Likewise, layout of the work area and environmental
factors also play a significant role.

7. PRODUCT AND SERVICE FACTORS
 Product and service design can have a tremendous
influence on capacity.
 The more uniform the output, the more
opportunities there are for standardization of
methods and materials.
PROCESS FACTORS
 The quantity capability of a process is an obvious
determinant of capacity but subtle determinant is
the influence of output quality.
 Process improvement that increase quality and
productivity can result in increased capacity.

8. HUMAN FACTORS
 The tasks that make up a job, the variety of activities
involved, also the training, skill and experience
required to perform a job all have an impact on the
potential and actual output.
 Employee motivation has a very basic relationship to
capacity , as do absenteeism.
POLICY FACTORS
 Management policy can affect capacity by allowing
or not allowing capacity options such as overtime or
second or third shifts.

9. OPERATIONAL FACTORS
 Inventory stocking decisions, late deliveries,
purchasing requirements, acceptability of purchased
materials, quality inspection and control procedures
also have an impact on effective capacity.
SUPPLY CHAIN FACTORS
 It must be taken into account in capacity planning if
substantial capacity changes are involved.
EXTERNAL FACTORS
 Product standards , especially minimum quality and
performance standards, can restrict management’s
options for increasing capacity.

10. Strategy Formulation
• An organization typically its base its capacity
strategy on assumption and predictions about
long term demand patterns, technological
changes , and the behavior of its competitors.
Key decisions of capacity planning
• The amount of capacity needed
• The timing of changes
• The need to maintain balance throughout the system
• The extent of flexibility of facilities and the
workforce.

11. • Deciding on the amount capacity
involves consideration of expected
demand and capacity cost.
• Capacity cushion which is an amount
capacity in excess of expected demand
when there is some uncertainty about
demand.
 the greater the degree of demand uncertainty , the greater
the amount cushion used.

12. Steps in the Capacity Planning Process
• Estimate future capacity requirement
• Evaluate existing capacity and facilities and identify
gaps.
• Identify alternative for meeting requirements
• Conduct financial analyses of each alternative
• Assess key qualitative issues for each alternative
• Select the alternative to pursue that will be bests in
long term
• Implement the selected alternative
• Monitor results

13. Forecasting Capacity Requirements
• Long-term vs. Short-term capacity needs
• Long-term relates to overall level of capacity such as
facility size, trends, and cycles.
• Short-term relates to variations from seasonal,
random, and irregular fluctuations in demand
Calculating Processing Requirements
• A department works one 8-hour shift, 250
days a year , and has these figures for usage of
a machine that is currently being considered:

14. Working one 8 hour shift 250 days a year provides an
annual capacity of 8×250=2000 hours per year.
5800 hours/2000 hours/machine=2.90 Machines
Product Annual
demand
Standard
Processing
time per unit
Processing
time needed
1 400 5 2000
2 300 8 2400
3 700 2 1400
5800

15. The Challenge of Planning Service
Capacity
Three Important Factors in planning service capacity
The need to be near customers
• Convenience for customers is often an
important aspects of services. Generally, a
service must be located near customer.
The inability to store service
• Speed of the delivery, or customers waiting time
become a major concern in a service capacity
planning .

16. The degree of volatility
• Demand volatility presents problem for capacity
planners. Demand volatility tend to be higher for
services than goods, not only in timing of demand,
But also in amount of time required to the service
individual customers.
Make Or Buy
• Once capacity requirements have been determined ,
the organization must decide whether to produce a
good or provide a service itself. or outsource (buy)
from another organization.

17. Factors:
Available Capacity
• If an organization has available the equipment,
necessary skills, and time, if often makes sense to
produce an item of perform a service in-house, The
additional cost would be relatively small compared
with those required to buy items or subcontract
services.
Expertise
• If a firm lacks the expertise to do the job satisfactory
buying might be reasonable alternative.

18. Quality Considerations
• Firm that specialize can usually offer higher quality
than an organization can attain itself. Conversely
unique quality requirements or the desire to closely
monitor quality may cause an organization to
perform a job itself.
The nature of Demand
• When demand for an items is high and steady, the
organization is often better off doing the work itself.

19. Cost
• Any cost savings achieved from buying of making
must weighed against the preceding factors. Cost
savings might come from the item itself or from
transportation cost savings. If there are fixed cost
associated with making an item that cannot be
reallocated if the service or product outsourced, that
has to recognized in the analysis.
Risk
• Outsourcing may involved certain risks. One is loss of
control over operations. Another is the need to
disclosed proprietary information.

20. Developing Capacity Alternatives
Design Flexibility into system.
o Provisions for Future Expansion in the original
design.
Take Stage of life cycle into account
o Capacity requirements are often closely linked to the
stage of the life cycle that a product or service is in.

21. Take a “Big Picture” approach to capacity
changes
o When developing capacity alternatives, it is important
to consider how parts of the system interrelate.
o Bottleneck Operation
Bottleneck
Operation
Machine #1
Machine #3
Machine #4
10/hr
10/hr
10/hr
10/hr
30/hr
Machine #2

22. Prepare to deal with capacity “chunks.”
o no machine comes in continuous capacities.
Attempt to smooth out capacity requirements.
o Unevenness in capacity requirements also can create
certain problems.
Identify the optimal operating level.
o Production units typically have an ideal or optimal
level of operation in terms of unit cost of output.
Economies of Scale
o If the output rate is less than the optimal level,
increasing the output rate results in decreasing
average unit costs.

23. Diseconomies of scale
o If the output rate is more than the optimal level,
increasing the output rate results in increasing
average unit costs.
Choose a strategy if expansion is involved.
o Consider whether incremental expansion or single
step is more appropriate.

24. Cost-Volume Analysis
o Focuses on relationships between cost, revenue and
volume of output.
FC= Fixed Cost
VC= Total variable cost
v= variable cost per unit
TC= Total Cost
TR= Total revenue
R= Revenue per unit
Q= Quantity or Volume of output
QBEP= Break even quantity P=Profit

25. • Fixed Costs (FC)
– tend to remain constant regardless of output
volume
• Variable Costs (VC)
– vary directly with volume of output
– VC = Quantity(Q) x variable cost per unit (v)
• Total Cost
– TC = Q x v
• Total Revenue (TR)
– TR = revenue per unit (R) x Q
Profit (P) = TR – TC = R x Q – (FC +v x Q)
= Q(R – v) – FC
Q=P+FC/R-v ; QBEP=FC/R-V

26. Examples:
• The owner of Old-Fashioned Berry Pies, Simon Chen, is
contemplating adding a new line of pies, which will
require leasing new equipment for a monthly payment
of $6000. Variable costs would be $ 2.00 per pie, and
pies would retail for $7.00.
a) How many pies must be sold in order to break-even?
b) What would the profit be if 1000 pies are made and
sold in a month?
c) How many pies must be sold to realize a profit of
$4000?
d) If 2000 can be sold, and a profit target is $5000,
what price should be charged per pie?

27. Solution:
FC=$6000 VC=$2 per pie REV=$7 per pie
a) QBEP= FC/R-V =$6000/$7-$2 =1200 pies/month
b)For Q=1000; P=Q(R-V)-FC =1000($7-$2)-$6000= $1000
c) P=$4000; SOLVE for Q using Q=P+FC/R-V
Q=$4000+$6000/$7-$2 = 2000 pies
d) Profit=Q(R-V)-FC
$5000=$2000(R-$2)-$6000
R=$7.50

28. • A manager has the option of purchasing one, two, or
three machines. Fixed costs and potential volumes
are as follows:
VC is $10 per unit and R is $40 per unit.
a) Determine the break-even point for each range.
b) If projected annual demand is between 580 and 660
units, how many machines should the manager
purchase?
Number of
Machines
Total annual
Fixed Costs
Corresponding
range of output
1 $9 600 0-300
2 15000 301-600
3 20000 601-900

29. I. Solution:
a) For one machine:
QBEP= $9600/$40 per unit-$10 per unit
= 320 units( not in range, so there is no BEP)
b) For two machines:
QBEP= $15000/$40 per unit- $10 per unit
=500 units
c) For three machines:
QBEP= $20000/$40 per unit- $10 per unit
=666.67 units

30. B. Comparing the projected range of demand to the
two ranges for which a break-even point occurs,
you can see that the break-even point is 500,
which is in the range 301-600. this means that
even if demand is at the low end of the range, it
would be above the break-even point and thus
yield a profit. At the top end of projected
demand, the volume would still be less than the
break-even point for that range, so there would
be no profit.

31. Assumptions of Cost-Volume Analysis
• One product is involved.
• Everything produced can be sold.
• The variable cost per unit is the same regardless of
the volume.
• Fixed costs do not change with volume changes, or
they are step changes.
• The revenue per unit is the same regardless of
volume.
• Revenue per unit exceeds variable cost per unit.

32. Financial Analysis
• Cash flow
– The difference between cash received from
sales and other sources, and cash outflow
for labor, material, overhead, and taxes
• Present value
– The sum, in current value, of all future cash
flow of an investment proposal

33. Decision Theory
• represents a general approach to decision making
which is suitable for a wide range of operations
management decisions, including:
capacity
planning
product and
service design
product and
service design
equipment
selection
location
planning