Capacity Supply and Demand 1/3

• Capacity
- Ability to do work
- The upper limit or ceiling on the load that an operating unit can
handle
- Capacity = f(equipment, space & employee)

• Demand
- The requirement of a given product or service
• In production term, capacity is the maximum production rate of
an organization.
 Capacity Supply and Demand 2/3
• Matching organizational capacity and market demand

• Reasons for matching organizational capability with market

demand
- To avoid over capacity  (idle capacity, unit operating
costs)
- To avoid under capacity  (strained resources and
possible loss of customers)
 Capacity Supply and Demand 3/3
• Key Questions:
– What kind of capacity is needed?
– How much capacity is needed to match demand?
– When is it needed?
• Related Questions:
–How much will it cost?
–What are the potential benefits and risks?
–Are there sustainability issues?
–Should capacity be changed all at once, or
incremental bases?
 Difficult in Quantifying Capacity

• Capacity can be difficult to quantify due to:-

– Day-to-day uncertainties such as employee
absences, equipment breakdowns, and material-
delivery delays
– Products and services differ in production rates (so
product mix is a factor)
– Different interpretations of maximum capacity
 Measurements of Capacity 1/4

Output Rate Capacity – quantity of output

over a given time
– For a facility having a single product or a few
homogeneous products, the unit of measure is
straightforward (eg. cases of soda per month)
– For a facility having a diverse mix of products,
an aggregate unit of capacity must be
established using a common unit of output
(sales in dollars per week)
 Measurements of Capacity 2/4

Input Rate Capacity – number of inputs over

a given time
– Commonly used for service operations where
output measures are particularly difficult
• Hospitals use - available beds per month
• Airlines use - available seats per month
• Movie theatres use - available seats per month
 Measurements of Capacity 3/4

Capacity Utilization Percentage

– Relates actual output to output capacity
• Example: Actual automobiles produced in a
quarter divided by the quarterly automobile
production capacity
– Relates actual input used to input capacity
• Example: Actual number of beds occupied in a
given time per hospital beds capacity.
 Measurements of Capacity 4/4
Capacity Cushion
– an additional amount of capacity (idle capacity)
onto the organizational capacity to allow for:
• greater than expected demand
• lower production costs
• improved quality of products and services
 Design, Effective and Actual Capacities
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, change over time and maintenance time
Actual capacity
– rate of output actually achieved; cannot
exceed effective capacity.
 Strategies for Varying Capacity to
Meet Demand
• Leading
–Build capacity in anticipation of future demand
increase
• Following
–Build capacity when demand exceeds current
capacity
• Tracking
–Similar to the following strategy, but adds
capacity in relatively small increments to keep
pace with increasing demand
 Forecasting Capacity Requirement

• Calculating processing machines requires reasonably accurate

demand forecasts, standard processing times, and available work
time

pD i i
Number of required machines (N) for k products  i 1
T
where,
pi  standard processing time for product i,
Di  demand for product i during the planning horizon,
T  processing time available during the planning horizon
 Long Range Capacity Planning 1/8
• It is the planning of organizational resources to be
used for a period of 1 year or above.
• Involves planning for:-
 Facilities
 Workers (permanent)
 Operating hours in a year).
• Aim: To ensure that sufficient capacity to execute the
sale and operations plan
• It is the planning at organizational level
 Long Range Capacity Planning 2/8

Steps in the Capacity Planning Process

• Estimate the capacity of the present facilities.
• Forecast the long-range future capacity needs.
• Identify and analyze sources of capacity to meet
these needs.
• Select from among the alternative sources of
capacity.
 Long Range Capacity Planning 3/8

Expansion of Long-Term Capacity

• Subcontract other companies
• Acquire other companies or facilities
• Develop sites, construct buildings
• Update, or modify existing facilities
• Reactivate standby facilities
 Long Range Capacity Planning 4/8

Reduction of Long-Term Capacity

• Sell off existing resources and lay off employees
• Mothball facilities and transfer or lay off
employees
• Develop and phase in new products/services
 Long Range Capacity Planning 5/8

Economies of Scale
• Best operating level - least average unit cost
• Economies of scale - average cost per unit
decreases as the volume increases toward the
best operating level
• Diseconomies of scale - average cost per unit
increases as the volume increases beyond the
best operating level
Long Range Capacity Planning 6/8
Average Unit
Cost of Output ($)

Economies Diseconomies
of Scale of Scale

Best Operating Level

Annual Volume (units)

 Long Range Capacity Planning 7/8

Economies of Scale
Declining costs result from:
– Fixed costs being spread over more and more
units
– Longer production
– Proportionally less material scrap
 Long Range Capacity Planning 8/8

Diseconomies of Scale
Increasing costs is a result of increasing
production due to:
– Increasing inefficiency
– Difficulty in scheduling
– Damaged goods
– Increased use of overtime
 Medium Range Capacity Planning 1/2
• It covers week-to-week operation. Mainly for
duration of between 6 months up to one
year.
• The planning is focused on:-
workforce size (temporary)
overtime budgets (shifts)
inventories (material and finished goods), etc
• It is a plan at individual work center or
machine
Medium Range Capacity Planning 2/2

Adding and removing a shift

• An organization has to add or remove a shift
depending on the forecasted demand.
• Factors that determine the adding or removing a
shift:-
 Season
 Country policy
 Capacity of the organization
 Basic Calculations 1/7
Calculating System Effectiveness
• Actual output – amount of output achieved after
undertaking actual production/service delivering

actual output
• Efficiency Efficiency 
effective capacity

actual output
• Utilization Utilization 
design capacity
 Basic Calculations 2/7

Example– Efficiency and Utilization

• Design Capacity = 50 trucks per day
• Effective Capacity = 40 trucks per day
• Actual Output = 36 trucks per day
Efficiency =actual output/effective capacity
=36/40 =90%
Utilization =actual output/designed capacity
=36/50=72%
 Basic Calculations 3/7

Capacity Cushion
– Extra capacity used to offset demand
uncertainty
– Capacity cushion = 100% - Utilization
 Basic Calculations 4/7
Productivity
• The ratio of actual output divided by one or more
inputs used
• Single-Factor Productivity (ρ)
ρ = Output
one factor
- Multi-Factor (Total Factor) Productivity (ρ)
ρ = Output
Labour+ Material+Energy+Capital
• The productivity measure helps managers to know
how well the system is doing
 Basic Calculations 5/7
Cost-Volume Analysis – used to decide which facility to be
acquired
– Focuses on the relationship between cost, revenue, and
volume of output
• 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 = FC +VC
• Total Revenue (TR)
– TR = revenue per unit (R) x Q
 Basic Calculations 6/7

• Break-Even Point (BEP)

– The volume of output at which total cost and total
revenue are equal
– Profit (P) = TR – TC = R x Q – (FC +v x Q)
= Q(R – v) – FC

FC
QBEP 
Rv
 Basic Calculations 7/7
Cost-Volume Analysis Assumptions
• Cost-volume analysis is a viable tool for comparing capacity
alternatives if certain assumptions are satisfied
– One product is involved
– Everything produced are sold
– The variable cost per unit doesn’t change with volume
– Fixed costs do not change with volume changes
– The revenue per unit is the same regardless of volume
– Revenue per unit exceeds variable cost per unit
 Demand Management Strategies

Decision making strategies and techniques

• Strategies used to offset capacity limitations and
that are intended to achieve a closer match between
supply and demand
–Pricing
–Promotions
–Discounts
 Capacity Management Strategies

Decision of either to produce in-House or

Outsource
• Once capacity requirements are determined, the organization must
decide whether to produce a good or service itself or outsource
• Factors to consider:
– Available capacity
– Expertise
– Quality considerations
– Cost
– Risks
 Assignment
• Go and read about short term capacity
planning