Capacity Management

Capacity has a cost, whether it is used or not

Capacity

Capacity is the maximum output or producing ability of a machine, person, factory, etc. Capacity can be measured in physical terms

Measure of the amount of work done Capacity is the measure of the maximum amount of work that can be done in a given time

Capacity

Capacity = R * T

R is the rate of output per unit of time

T is the maximum amount of time available

Capacity has a cost

Cost to acquire or rent the facility, machine, operating costs, wages, utilities, insurance, etc. The cost is incurred even if capacity is underused
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Measuring the Cost of Capacity

Traditional measures do not reflect the cost of capacity usage or over capacity

Costs are part of overhead and allocated to production

Focus is on inventory valuation, not managing capacity Allocation base is chosen from five alternatives

Theoretical

Maximum output when operating continuously at maximum efficiency

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Measuring the Cost of Capacity

Practical

Level of output under current conditions, allowing for normal downtime for setups, maintenance, vacations, etc. Average level of output achieved or anticipated over several years
Level of output anticipated for the current year Level of output actually achieved in the current year
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Normal

Budget

Actual

Measuring the Cost of Capacity

Amount of capacity-related overhead charged to the output depends on the allocation base chosen

A stamping machine costs $400,000 per year to operate. The machine can produce 200 stampings per hour. The machine runs 24 hours per day. The company does not work on weekends (104 days) or holidays (10 days) Downtime for maintenance, setups, etc. averages 15 days per year. The machine is idle because of lack of materials for an average of 5 days per year. The equivalent of 8 days of production is lost each year because of defects produced by the machine. Management expects to produce an average of 1,000,000 stampings per year over the next five years. Planned output for the current year was 1,050,000 stampings. Actual output for the current year was 1,032,000 stampings, requiring 215 days. If successfully negotiated, a new contract with a customer would increase demand for the stampings by 24,000 units per year.
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Measuring the Cost of Capacity

Traditional cost allocation measures Output Theoretical capacity Units per hour Hours per day Days per year Theoretical capacity Practical capacity Units per hour Hours per day Operating days per year* Practical capacity * 365-104-10-15-5=231 days Normal capacity Expected 5 year average output Budget capacity Planned output for the current year Actual capacity Actual output for the current year 200 24 365 1,752,000 Operating cost Cost per unit * * =

$400,000

$0.228

* * =

200 24 231 1,108,800

$400,000

$0.361

1,000,000

$400,000

$0.400

1,050,000

$400,000

$0.381

1,032,000

$400,000

$0.388

Measuring the Cost of Capacity

CAM-I capacity model focuses on the cost of used and unused capacity

Capacity is divided into four categories

Rated capacity

Same as theoretical capacity

Productive capacity

Capacity used to produce usable output

Measuring the Cost of Capacity

Nonproductive capacity

Capacity that does not result in usable output

Downtime for maintenance, setups, lack of materials, etc.

Productive time lost due to waste, scrap, rework, etc.

Idle capacity

Capacity that is not available due to policy decisions or market reasons such as holidays, lack of orders, etc.
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Measuring the Cost of Capacity

Cost is attached to the capacity categories based on the theoretical cost per unit
Capacity category Rated Productive Nonproductive Setups Standby Defects Subtotal Idle Weekends, holidays Marketable Not marketable Subtotal Total Days 365 215 15 5 8 28 114 5 3 122 365 547,200 24,000 14,400 585,600 1,752,000 Output (4,800 units per day) 1,752,000 1,032,000 72,000 24,000 38,400 134,400 Cost per unit $0.228 $0.228 $0.228 $ $0.228 $0.228 $0.228 $0.228 $ $0.228 $0.228 $0.228 $0.228 Capacity cost $ 400,000 235,616 16,438 5,479 8,767 30,685 124,932 5,479 3,288 $ 133,699 400,000

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Measuring the Cost of Capacity

Capacity utilization can be shown graphically

100%

$30,685

Nonproductive capacity
80%

$133,699

Idle capacity
60%

40%

$235,616
20%

Productive capacity

0%

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Managing Capacity Costs

Management can use the information from the CAM-I model to understand the financial impact under-utilizing the available capacity

The cost impact of changes in the utilization rates can also be calculated

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Managing Capacity Costs

Capacity category Rated Productive If the new order is received Current productive Productive capacity from new order New total productive capacity Operating cost $ 400,000 $ 400,000 Volume 1,752,000 1,032,000 Cost per stamping $ 0.228 $ 0.388

400,000

1,032,000 24,000 1,056,000

0.379

If defects can be eliminated and output sold Current productive Productive capacity from reduced defects New total productive capacity $

400,000

1,032,000 38,400 1,070,400

0.374

If defects and standby can be eliminated and output sold Current productive Productive capacity from reduced defects Productive capacity from reduced standby New total productive capacity $ 400,000

1,032,000 38,400 24,000 1,094,400

0.365

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Managing Capacity Costs

Capacity costs may be fixed, but can still be managed

Reduction of idle capacity

Increasing sales to use unused capacity Renting unused capacity to others Reduction in days off

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Managing Capacity Costs

Reduction of nonproductive capacity

Reduction of setup time, defects, etc.

Reduction of rated capacity

Replace the asset with one having less capacity

Lower capacity asset can be more fully utilized

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Implications of the CAM-I Model

Illustrates the reasons for idle and nonproductive capacity

Improves accountability

Illustrates the cost of idle and nonproductive capacity Helps management prioritize capacity utilization efforts
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Practical Considerations in Measuring Capacity

How is capacity defined?

Worker, machine, factory, etc.

Higher-level capacity (process, factory, etc.) is determined by the lowest capacity component

Capacity may change over time

Assets slowing with age Technological improvements to assets

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Practical Considerations in Measuring Capacity

Capacity may depend on the mix of work processed on the asset

The machine may take longer to stamp one type of product than it takes to stamp another type

What costs should be included?

Operating costs?

Sunk costs?
Financing costs?
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