MAN3506 Strategic Capacity Planning for Products and Services


Operations Management

Midterm Exam Notes


Strategic Capacity Planning for Products and Services

Strategic Capacity

Capacity Planning- refers to an upper limit or ceiling on the load that an organization can handle. Capacity needs include: equipment, space, and employee skills.

Goals: achieve match between long-term supply capabilities and the predicted level of long-term demand.

Overcapacity: causes operating costs that are too high

Undercapacity: causes strained resources and possible loss of customers.

Key Questions in Capacity Planning:

What kind is needed? Types: Input capacity/ Output capacity

How much is needed to match demand?

When is it needed?

Other Questions:

How much will it cost, how will it be funded, what is the expected ROI

Benefits & Risks

Are there Sustainability issues that need to be addressed?

Timeline of change, all at once? Small changes (“Hedge their bets”)?

Can Supply Chain handle it?

Capacity Decisions are Important because:

Availability: ability to meet demand for products/goods and services

Operating cost: minimized when capacity and demand match

Initial (installation) cost: greater the capacity, greater the cost (subject to economies of scale)

Long term commitment of resources: difficult/costly to modify (especially if excess capacity is reduced)

Competitiveness: A available capacity or ability to quickly expand allows quicker delivery and can be barriers to entry

Globalization of markets: Complicates capacity decisions

Globalization Supplies: is also a capacity challenge

Capacity takes time to build: and resources (financial and others) and planning to build...more important, it takes likelihood of mismatch with demand is greater

Is not a one time decision:

Defining & Measuring Capacity

Select a measure of capacity that does not require updating, such as measure of availability inputs

Poor measurements:

Dollar amounts:

Units of outputs, where there is multiple products

Design capacity: The maximum output rate or service capacity an operation, process, or facility is designed for. (Under Ideal conditions)

Capital utilization- the ratio of actual output to design capacity

Utilization = Actual Output / Effective capacity

Effective capacity: Design Capacity - allowances such as personal time and maintenance. (real, always less than design because of changing product mix, maintenance, equipment, lunch breaks, problems in scheduling…

Actual Output- cannot exceed effective capacity because of machine breakdowns, shortages, quality problems, as well as factors outside the control.

Efficiency = Actual Output / Effective capacity

*Key to improving Capacity utilization is to increase effective capacity by correcting quality problems, maintain good equipment in good condition, fully trained employees, and fully utilizing bottleneck equipment.

Determinants of Effective Capacity


Design: Size and provision for expansion

Location: transportation cost, labor supply, energy sources



Product and Service Factors:

Design: the more uniform the output the more opportunities for standardization of methods and materials

Product or Service mix: consider different items will have different rates of output

Process factors

Quantity capabilities

Quality Capabilities: if it does not meet standards rate of output will be slowed

Human Factors

Job Content

Job design

Training and experience



Learning rates

Absenteeism and labor turnover

Policy Factors

Mgmt Policy: overtime or second or third shifts

Operational Factors


Materials Management

Quality assurance

Maintenance policies

Equipment breakdowns

Supply chain factors

External Factors

Product standards

Safety regulations


Pollution control standards

Strategy formulations:

3 Primary Strategies:

Leading - builds capacity in anticipation of future demand increases. Best option if capacity increases involve a long lead time.

Following -builds capacity when demand exceeds current capacity.

Tracking - adds capacity in relatively small increments to keep pace with increasing demand

Assumptions & Predictions about long-term demand patterns, tech changes & competitors behavior

Growth rate and variability:

Cost of building & operating facilities of different sizes

Rate & direction of technological innovation

Likely behavior of competitors

Availability of capital & other inputs

Building Capacity

Capacity Cushion or buffer- Extra capacity used to offset demand uncertainty. Capacity cushion = capacity –expected demand

By how much and when:

Optimistic or Lead Strategy: Build & they will come

Pessimistic or Lag strategy: wait & See

Steps in Capacity Planning Process

Estimate future capacity requirements

Evaluate existing capacity and facilities and identify gaps.

Identify alternatives for meeting requirements

Conduct financial analyses of each alternative

Assess key qualitative issues for each alternative

Select the alternative to pursue that will be best in the long term.

Implement the selected alternative

Monitor results

Forecasting Capacity Requirements

Long-term Considerations:

Overall level of capacity: facility size

Forecast the demand over a time horizon and then convert those forecasts into capacity requirements

Cycles and Trends:

Identify the trends: how long will it lasts, slope of the trend, appropriate length of the cycles and the amplitude of the cycles (deviation from average)

Short term considerations:

(Variability): seasonal, Random, & irregular fluctuations in demand. Resulting in a strain on meeting demand or in an idle capacity

Probable variations in capacity requirements created by such things as seasonal,

When time intervals are too short to have seasonal variations the analysis can often describe the variations by probability distributions such as normal, uniform, or poisson distribution. Ex. The amount of coffee served at a luncheonette by a normal distribution with a certain mean and standard deviation.

Manufacturing systems are more likely to experience less variations because of typical isolation from customers and uniform nature of production.

Analyzing service systems: useful to use waiting line models and simulation models.

Irregular variations: are the most troublesome. Impossible to predict. Since they are created by such diverse forces as major equipment breakdowns, freak storms, foreign political turmoil.

Marketing can supply: customer contracts, demographic analyses, and forecasts

In-house- or outsourceOnce capacity is determined. Organization must determine to do the product or service in house or outsource. (Outsource/ Offshore/ Near Shore/ Rear Shore)

Reasons To Outsource:

Not enough capacity

Lacks Expertise

Higher quality from specialist firms

The nature of demand: Fluctuating or small orders

Not Cost effective in-house

Reasons NOT To Outsource:

You may Risks (Control of operations, intellectual property, liability, & Quality)

Prepare to deal with capacity “chunks”

Capacity changes in chunks so there will be excess/shortage even as capacity is being changed

Developing Capacity Strategies

Design Flexibility into systems

If future expansion of a restaurant seems likely, water lines, power hook ups, and waste disposal lines can be put in place initially so if expansion becomes a reality, modification to the existing structure can be minimized.

Take Stage of life cycle into account

Introduction- difficult to know market size

Growth- increasing output require increasing capacity therefore increasing investment and complexity.

Maturity- Size of market levels off

Decline Phase- decline demand causes underutilization of capacity, eliminate excess capacity or introduce new products/services

Take a “big-picture” systems approach to capacity changes. Increasing rooms in a hotel, look at the big picture, like increased demand in parking, entertainment, food, suppliers…

Bottleneck Operation- An unbalanced system in suppliers, transporters, distributors is the existence of a bottleneck operation. It is an operation in a sequence of operations whose capacity is lower than that of the other operations. A consequence, the capacity of the bottleneck limits the system capacity.

Smooth Capacity required by “complementary products” Products with complementary demand patterns. Identify products that offset each other such as demand for water skis and demand for snow skis.

Identify the optimal operating level

Economies of scale: If output is less than the optimal level increasing the output rate will result in decreasing average unit cost.

Reasons for economies of scale:

Fixed cost over many units

Construction costs increase at a slower rate

Process standardization

Diseconomies of scale- if output is increased beyond the optimal level, average unit cost would become increasingly larger.

Traffic congestion leads to increase on distribution costs

Increased complexity increases costs, and control communication are problematic

Inflexibility and bureaucracy slows work down and change orders

Process Selection & Facility Layout            



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