Capacity Planning And Decisions

Capacity planning is one of the key aspects of operations management as it determines the amount of goods or services which can be produced within a given time duration. Too less capacity indicates that customers won’t be satisfied and too much capacity would result in the operation being under-utilized with resultant high fixed costs and also affecting breakeven and profitability. A company, when it has to increase its capacity it has various options to consider, from working overtime to building a new facility or a plant. Forecasting demand is critical to capacity planning and companies can adopt different strategies of capacity planning, to ensure customer satisfaction and maintain the operations well within their budget and other constraints. Short term capacity planning is very important for any company be it a product based or a service based company especially when there are seasonal demands, as those demands are totally unpredictable and there can’t a permanent plan in place for short term capacity planning for seasonal demands. Momentary plans like employee overtime, subcontracting have to be considered and the best among them and that incur least cost have to be selected and implemented and this has been discussed in detail in this project.

Chapter-1 Capacity Planning & Decisions

1.1 Capacity Planning

Firstly, Capacity of any facility is said to be the rate of productive capability of it. Capacity otherwise can be assumed as the rate at which a facility produces or in simple words, it is the ability of a facility to produce a certain level of output within a specific time period.

When a firm decides to produce more of a product or plans to produce altogether a new product, it always starts with deciding how much capacity is needed considering the factors that affect capacity such as number of workers and machines, skill set of workers, defects, suppliers, government regulations…etc. This is termed as Capacity Planning.

1.2 Need for Capacity Planning

A firm can determine its facility location and choose the process technologies only after it has found out a need for new or expanded facilities by evaluating the capacity or capacity planning.

Lack of capacity planning can result in under or over capacity and would incur unnecessary costs in exploring ways to reduce or increase capacity.

Lack of capacity planning can also trigger a series of undesirable events such as poor delivery services, an increase in work-in-process and bring about dissatisfaction in the minds of the sales personnel and the team involved in manufacturing.

Decision making such as producing new products, expanding production…etc can be difficult without proper capacity planning.

1.3 Determinants of Capacity

The determinants of capacity are:

Facilities

Product and Service Factors

Process Factors

Manpower Factors

Operational Factors

Supply Chain Factors

External Factors

1.4 How important are capacity decisions?

Capacity decisions have its impacts on many different verticals of a firm. Firstly it affects the ability to meet future demands, as without capacity planning if not done keeping in mind the future demands leads to a shortage of products. If capacity is underestimated or overestimated it directly affects the operating costs as if capacity is overestimated the operating costs involved would get wasted and if underestimated the measures taken to fix it may cost a lot and so is the way it affects the initial costs too. And all these factors affect many other factors such as the competitiveness, management…etc.

1.5 How are Capacity Decisions made?

Assessment of Existing Capacity

Forecasting Future Capacity Needs

Identification of Ways to Modify Capacity

Evaluation of Financial, Economical, and Technological Capacity Alternatives

Selection of a Capacity Alternative most suited to achieving strategic mission

1.6 Measuring Capacity

Measuring capacity is simple for certain organizations. Reynolds, can use number of ballpoint pens produced per year, Hyundai Motors can use number of automobiles per year. But for organizations whose product lines are more diverse it is difficult to find out a common unit of output.

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As an alternative, capacity can be expressed in terms of input. A consultancy can express its capacity in terms of the number of consultants employed per year. A lathe shop may express capacity in terms of available labor hours or machine hours per week, month, or year. Following table shows some examples of capacity measures.

Measures of Operating Capacity

Output

Organization

Measure

Automobile Manufacturer

Number of Autos

Brewery

Barrels of Beer

Cannery

Tons of Food

Steel Producer

Tons of Steel

Power Company

Megawatts of electricity

Input

Organization

Measure

Airline

Number of Seats

Hospital

Number of Beds

Job Shop

Labor and/or machine hours

Merchandising

Square Feet of Display or Sales Area

Movie Theatre

Number of Seats

Restaurant

Number of seats or table

Tax Office

Number of Accountants

University

Number of Students and/or faculty

Warehouse

Square or cubic feet of storage space

Source: Productions and Operations Management, Text Book

Day to day variations such as employees being absent or late, breakdowns of machines, downtime required for facility maintenance and repair make it often difficult to measure capacity realistically. A facility can in some cases operate at more than 100% capacity.

Chapter-2 Estimating Future Capacity Needs

2.1 Capacity requirements can be evaluated from two different perspectives viz. short term and long term.

2.1.1 Short-Term Requirements

Managers often use forecasting of product demand for estimating the short term work load the facility should be handling. By looking forward up to 12 months, managers expect output requirements for different products or services following which they compare requirements with currently existing capacity and find out when capacity adjustments are to be made.

2.1.2 Long-Term Requirements

Long term capacity requirements are tougher to determine as future demand and technologies are uncertain. Forecasting five or ten years into the future is a risky and a tough job. A product existing today may not even exist in the future. It is easily visible that long range capacity requirements depend on marketing plans, product development, and the life cycles of the products.

Changes in process technology should also be expected. Even if products remain unchanged, the methods for generating them may change drastically. Capacity planning should be involving forecasting of technology as well as product demand.

2.2 Strategies for Modifying Capacity

After currently existing and the future capacity requirements are determined, alternatives ways of modifying capacity must be found out.

2.2.1 Short Term Responses

For short-term periods of up to one year, basic capacity is fixed. Majority of the facilities are rarely opened or closed on a regular monthly or yearly basis. Many short-term adjustments for increasing or decreasing capacity are possible anyway. The adjustments to be made depend on if the conversion process is mostly labor or capital intensive and if the product is one that can be stored in the inventory.

Capital-intensive processes depend a lot on physical facilities, plant, and equipment. Short term capacity can be modified by operating these facilities more or less intensively than normal. The costs of setting up, changing over, and maintaining facilities, procuring raw materials and manpower, managing inventory, and scheduling can all be modified by making such capacity changes.

2.2.2 Long Term Responses

From World War 2 through the 1960s, the US economy was booming and scaling great heights. Since the 1970s, the United States has faced problems of scarcity of resources and a more competitive economy. Organizations today cannot be constrained into thinking only about expanding the resource base; they must also consider appropriate approaches to contracting it.

Example:

A warehousing operation foresees the need for an additional 100,000 square feet of space by the end of the next five years. One option is to add an additional 50,000 square feet now and another 50,000 square feet after two years. Another option is to add the entire 100,000 square feet now.

Estimating costs for building the entire addition now are $50/square foot. If expanded incrementally, the initial 50,000 square feet will cost $60/square foot. The 50,000 square feet will cost $60/square foot. The 50,000 square feet to be added later are estimated at $80/square foot. Which alternative is better? At a minimum, the lower construction costs plus excess capacity costs of total construction now must be compared with higher costs of deferred construction. The operations manager must consider the costs, benefits, and risks of each option.

Source: Productions and Operations Management by Everett E. Adam, Jr. Ronald J. Ebert

2.3 Classification of Capacity Planning based on Time

Long Term Capacity Planning

Short Term Capacity Planning

2.3.1 Long Term Capacity Planning

Long Term capacity planning solves strategic issues involving the firm’s major production facilities. Also, long-term capacity issues are interrelated to location planning. Technology and the ability to transfer the processes to other products are also interrelated to long-term capacity planning. Long-term capacity planning may come in to the picture when short-term amendments in capacity are scarce. For instance, if a firm adds a third shift to its present two-shift plan and if the output is still insufficient, and also if subcontracting options are unavailable, one practical alternative is adding capital equipment and modifying the layout of the plant. An additional space or constructing an additional facility can also be alternatives.

2.3.2 Short Term Capacity Planning

In the short term, capacity planning concerns issues related to scheduling, labor shifts, and balancing resource capacities. The goal of short-term capacity planning is to manage unexpected shifts in demand in an efficiently economic way. The time frame for short-term planning is often only a few days but may go on as long as six months. Alternatives for making short-term changes in capacity are numerous and can even take decisions to not meet demand at all. A very easy and most commonly-used method to increase capacity in the short term is working overtime. This is a very flexible and least expensive alternative. While the firm has to pay one and one half times the normal labor rate, it is saved from the expenses of hiring, training, and paying additional benefits. When not used abusively, most workers welcome the opportunity to earn extra wages. If overtime does not provide enough short-term capacity, other alternatives are also available. These include adding shifts, employing casual or part time workers, the use of floating workers, leasing workers, and facilities subcontracting.

Firms may also increase the capacity by improving the use of their resources. The most common alternatives in this category are employee/labor cross training and overlapping or staggering shifts. Most manufacturing firms inventory some output ahead of demand so that any need for a capacity change in future is absorbed by the inventory buffer. From a technical angle, firms may initiate a process design aimed at increasing productivity at work stations. Manufacturers can also shift demand to avoid fluctuations in capacity requirement by backlogging, queuing demand, or lengthening the firm’s lead times. Service firms achieve the same results through scheduling appointments and reservations. A more creative approach is to modify the output. Standardizing the output or offering complimentary services are examples of the same. In services, customers might be allowed to do some of the process work themselves (e.g., self-service fuel pumps and fast-food restaurants). Another alternative reducing quality is an undesirable yet possible trick. Finally, the firm may take steps to modify demand. Changing the price and promoting the product are common. Another alternative is to split demand by initiating a yield or revenue management system. Utilities also report success in shifting demand by the use of “off-peak” pricing.

2.4 When capacity doesn’t meet demand?

When capacity doesn’t equal demand, then in short term capacity planning, it can be managed by temporary measures such as increasing or decreasing the labor force or creating and carrying inventory in the lean period to be used in the peak demand period.

If there happens to be a mismatch between demand and capacity in long term capacity planning, it can be handled by changing or modifying the capacity. If the capacity is short then a new facility can be built or expand the existing facility. In case of an excess capacity then a temporary shutdown/sale/consolidation of facilities would help.

2.5 Best Operating Level

Source: Operations Management by William J Stevenson

The term capacity means an attainable rate of output but mentions nothing about till what point of time that rate can be sustained. Thus, if we say that a given plant has a capacity of x units, we do not know if it is a one-day peak or a six-month average. To avoid this issue, the concept of best operating level is brought into being. This is the level of capacity for which the process was designed and thus is the volume of output at which average unit cost is at a minimum. When the output of the facility falls below this level (underutilization), average unit cost will increase as overhead must be allocated to fewer units. Above this level (overutilization), average unit cost also increases-here due to overtime, increased equipment wear, and heightened defect rates.

2.6 Capacity Planning Models

Present Value Analysis:

It is used to evaluate the time of capital investment and fund flows.

Aggregate Planning Models:

It helps in examining the way of using the existing capacity for short term planning.

Break Even Analysis:

It determines the minimum break down volumes of production.

Linear Programming:

It helps in determining the optimum product mix for maximizing contribution, considering the constraints imposed by capacity.

Computer Simulation:

It is helpful in determining the effects of various scheduling policies.

2.7 Economies of Scale

This well known principle of Economics illustrates the relationship between cost and capacity in an operating system. When output increases in an operating system, the system is likely to experience cost benefits on various factors. Due to the following reasons the average unit cost begins to fall with the rise in output level:

Spreading the fixed costs of capacity over a larger output.

Improved utilization of several resources in the system.

Cost benefit in procurement on account of increased volume.

Efficient use of supervisory and management staff.

The economies of scale cease to occur beyond a level of production or output. This is called “Diseconomies of Scale”. There can be several reasons for this:

Inefficient management due to large size of operation and the resulting lack of coordination.

Overuse of machines and break down of material handling equipments.

Over hiring of employees, or overtime exceeding justifiable limits.

Service slows down due to increasing complexities.

Increase in quality degradations because of mismanagement and lack of focus.

An Example for Economies of Scale:

Economies/Diseconomies of Scale

Source: Microeconomics by Robert S. Pindyck, Daniel L. Rubinfeld, Prem L. Mehta

Chapter-3 Capacity Planning Techniques

3.1 Capacity Planning Techniques

There are four procedures for capacity planning; capacity planning using overall factors (CPOF), capacity bills, resource profiles, and capacity requirements planning (CRP). The first three are roughly cut approaches that involve analysis to identify potential bottlenecks that can be used with or without manufacturing resource planning (MRP) systems. CRP is used along with MRP systems. Capacity using overall factors is a simple and a manual approach to capacity planning that is based on the master production schedule (MPS) and production standards that convert required units of finished goods into historical loads on each work station. Bills of capacity are a procedure based on the MPS. Instead of using historical ratios, it uses the bills of material and routing sheet that shows the sequence or work stations required to produce the part, as well as the setup and run time. Capacity requirements can then be determined by multiplying the number of units required by the MPS by the time required to manufacture each. Resource profiles are the same as bills of capacity, except lead times being included so that workloads fall into the correct periods. Capacity requirements planning (CRP) is applicable only in companies using MRP or MRP II. CRP uses the information from one of the previous rough-cut methods, plus MRP outputs on existing inventories and lot sizing. The result will be a tabular load report for each work station or a graphical load profile for helping plan-production requirements. This will tell where capacity is not adequate or idle, allowing for imbalances to be corrected by shifts in personnel or equipment or the use of overtime or added shifts. Finite capacity scheduling is an extension of CRP that simulates job order stopping and starting to produce a detailed schedule that provides a set of start and finish dates for each operation at each work station. A failure to understand the very nature of managing capacity can lead to disorder and serious customer service issues. If there is a mismatch between available and required capacity, adjustments should be made. However, it should be taken care that firms cannot Have perfectly-balanced material and capacity plans that easily accommodate emergency orders. If flexibility is the company’s competitive priority, excess capacity would be appropriate.

3.2 Utilization and Efficiency

Utilization is the percentage of design capacity achieved.

Utilization = Actual Output/Design Capacity

Efficiency is the percentage of effective capacity achieved.

Efficiency = Actual Output/Effective Capacity

Bakery Example:

Actual production last week = 148,000 rolls

Effective capacity = 175,000 rolls

Design capacity = 1,200 rolls per hour

Bakery operates 7 days/week, 3 – ‘8 hour shifts’

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Utilization = 148,000/201,600 = 73.4%

Efficiency = 148,000/175,000 = 84.6%

Efficiency = 84.6%

Efficiency of new line = 75%

Expected Output = (Effective Capacity)(Efficiency)

= (175,000)(.75) = 131,250 rolls

3.3 Managing Demand

There are three cases in which demand has to be managed and they are:

Demand Exceeding Capacity

Control demand by raising prices, scheduling longer lead time

Long term solution is to increase the capacity

Capacity exceeds demand

Stimulate market

Product changes

Adjusting to “SEASONAL DEMANDS”

Produce products with complimentary demand patterns

Capacity planning in short time or short term capacity planning to meet seasonal demands is explained in detail in the following sections.

Chapter-4 Seasonal Demands

4.1 Seasonal Demands

Seasonal Demands are those demands those cause unusually large ups or downs in demand. Seasonal demand occurs in a number of different scenarios; most frequent of them is listed in the following:

Natural seasonal variations (e.g. greater demand for ice cream in summer and for cold remedies in winter).

Specific calendar linked Events like Diwali (Crackers, sweets), Mother’s Day (e.g. greetings cards and flowers), and Christmas.

Regular every day Promotions that can happen frequently and semi-randomly throughout a year.

4.2 Impacts and Challenges of Seasonal Demand

Managing seasonal demand getting a good forecast done, planning production and procurement and managing the fulfillment process introduces considerable additional challenges into the process that is already complex. For most manufacturers, the two key and important planning processes are Forecasting & Demand Planning, and Production Planning & Scheduling.

The challenge in Forecasting and Demand Planning is mainly handling the high demand volatility and variability, and unexpected demands. Specifically, promotions & events tend to cause most of the issues, and result in much larger and more frequent demand spikes and dips than natural seasonal variations. If these are not planned well in a timely fashion and introduced into downstream production and distribution plans, the result can be significant reduction in manufacturing and distribution efficiencies, increase in costs, lower customer service levels and satisfaction and all these ultimately can result in a lost business.

In Planning and Scheduling, the greatest of problems is dealing with frequent changes in forecasts and orders. The ability to react swiftly while making the best decision on the way of satisfying demand is often the desired strategy of “Make to Order” manufacturers. For manufacturers who are unable to meet peak demand because of capacity constraints, and for those that “Make to Stock” or use a combined MTO/MTS strategy, tactical planning requires careful tweaking of demand and production in order to plan for a suitable pre-building of inventory and to ensure that the long lead time items are purchased in synchronization with the modified production plans.

Manufacturers, of course, may, to solve some or all of their capacity issues, resort to sub-contracting. The recent upward trend in contract manufacturing, and the increase in virtual manufacturing, that is, purchasing and distributing products from foreign countries significantly add to the overall supply chain complexity. In this, with very long supply lead times, accuracy of forecast is again paramount, and, the ability to give your suppliers precise projections of your requirements in a timely manner is one of the most critical factors.

Despite the push of lean strategies and principles of customer driven supply chain, one of the most common ways of dealing with any type of demand uncertainty in many of the companies of today still appears to be to insure against the uncertainty by holding an extra inventory across the supply chain which is an expensive and unacceptable solution.

4.3 Focus on Customers and Demand

“Getting the demand right” approach benefits every subsequent supply chain planning and execution processes from production planning, through sourcing and procurement to fulfillment and this result in reduced costs as well as improvements in the top line sales and market share. On the other hand, getting the demand wrong adds cost to almost all downstream processes, severely affecting competitiveness and again ultimately results in losing the business.

In forecasting and demand planning, one very much visible guideline is to focus more on the abnormal than the normal. This does not mean not paying attention to natural seasonal variations, but paying more attention on promotions and events as these are the things that almost cause the highest volatility in demand always and are the most tough to handle.

Putting in extra efforts to ensure you understand your customers and the authentic sources of demand can also pay very good dividends. Many manufacturers still use their customers’ demand from on their warehouses but frequently, their customer’s ordering process is not that good and is a poor source of history of demands or demand trends. Wherever possible, it’s a lot better to have eyes on the actual source of demand, namely the consumer. Using their customer’s POS data as part of the demand planning process often gives much better idea of the actual demand.

The ability to maximize and continuously improve forecast accuracy is very important. Increasing sales and market share with the help of improved perfect order performance and influencing and creating demand is equally important. Focusing well on demand and getting nearer to your customers is an essential requirement to achieve these goals.

Chapter-5 Conclusion

Conclusion

Short term capacity planning to meet seasonal demands, thus is critical for any company and proper forecasting of seasonal demands and a proper plan to meet all those seasonal demands should be in place. Any flaw in this, can lead to high inventory costs, employee dissatisfaction, deteriorating customer service levels and high customer dissatisfaction that leads to losing the customers and ultimately losing the business. A firm should be at vigil all the time to see the changes happening in demands and should keep changing its strategies of short term capacity planning and achieve and sustain an outstanding business value.

Appendix