Operations Management

Note-11
Prof. Satyanath Mohapatra (Asst. Professor)
Quantitative Finance
Capacity Planning
What Is Capacity Planning?
Capacity planning is the practice of planning/determining production capacity and
workforce needs to make sure your supply chain is equipped to meet demand.
Capacity planning lets businesses know how and when to scale, identify bottlenecks,
create better design capacity, and mitigate risk, within a planned period of time.
A good capacity planning strategy helps adequately plan manufacturing resources.
Excess capacity means the manufacturer’s money is being spent inefficiently, and
this could have been invested elsewhere for a profit instead. On the other hand, low
capacity implies the inability of the manufacturer to produce as per what the customer
wants at a particular period of time.
The 3 Types of Capacity Planning
The three types of capacity planning make sure you have enough, but not too much,
of three major resources for both the long- and short-term. You’ll want to plan weeks,
months, or even a year in advance.
1. Product capacity planning
Product capacity planning ensures you have enough products or ingredients for your
deliverables. For a florist, this would be flowers, vases, and cards. For a pool
maintenance company, this would be things like chlorine that are required to do the
job.
2. Workforce capacity planning
Workforce capacity planning ensures you have enough team members and work
hours available to complete jobs. This type of planning will also show you when you
need to hire more employees and help you determine how far in advance you need to
start recruiting based on the length of your onboarding process.
 3. Tool capacity planning
Tool capacity planning ensures you have enough tools to complete jobs. This includes
any trucks, assembly line components, or machinery you need to manufacture and
deliver your product.
Capacity Planning Strategy Benefits
- Monitor Operations Costs
Capacity Planning Strategies incorporates all relevant aspects including
personnel, facilities, budgets, production schedules and supplies. This can help
manufacturers carefully monitor all production costs especially during periods
of growth and recession. When manufacturers are able to foresee projected
capacity needs, it allows them to accurately budget for upcoming changes, and
apply financial resources where needed. This can also help develop relevant
delivery schedules for supplies and shipping schedules for completed products.
- Ensure Adequate Availability
With a Capacity Planning Strategy in place, manufacturers can ensure they have
the necessary resources to deliver work even before a contract is signed. The
Capacity Planning Strategy guides manufacturers on the scope available to
undertake new projects along with inputs on sufficient resources to cater to the
requirements. Using actionable analytics, manufacturers get access to key data
points which accurately report the possibility of overtime based on current work
schedules.
- Maintain Production Cycles
Manufacturers can maintain proper production levels as per expected business
cycles with a good Capacity Planning Strategy. Seasonal demand fluctuations
can be planned for using historical data and production capacity can be easily
managed to handle the rise in demand. Capacity Planning Strategy also
identifies when the business cycle might deteriorate so that seasonal workers
can be employed accordingly and unnecessary expenses can be avoided.
- Identify Skill Gaps
Adequate capacity planning can help identify the relevant skills required to
deliver key projects and plan for any skill shortages well in advance.
Manufacturers can plan work accordingly and forecast skill requirements and
also make decisions regarding in-house skills vs outsourced skills.
Manufacturers can easily plan employee training needs and decide how projects
will get delivered in the future.
 - Plan New Production Facilities
As your company grows, you may find the need to open new production
facilities. Using your capacity planning information from your existing
locations, you can develop a more accurate projection of needs for facilities and
personnel levels, and of the kind of production that can be expected from the
new location. This is a valuable tool when putting together the business plan
and budgets for your company’s growth.
- Meet Operations Budget:
When manufacturers use appropriate capacity planning tools, they are able to
meet demand with the least amount of waste and increase their utilization rates.
It also helps them meet their budgetary requirements based on their projected
sales or demand forecast and reduce additional expenses.
Capacity Planning strategies can help increase operational performance and
move closer toward achieving output targets. However, if your Capacity
Planning Strategies are not customized to your company’s business model, you
might land into a crisis.
Types of Capacity Planning Strategies
1. Lead Strategy
The Lead Strategy involves an upfront investment in more capacity that is needed
and is one of the most aggressive approaches used. Manufacturers plan to increase
their capacity in advance even before the actual demand increases. This takes care of
anticipated demand increases. Many manufacturers use this strategy to gain market
share against competitors. This is also used when competitors are prone to inventory
shortages especially when demand skyrockets. The Lead Strategy has its own risk
also, as if the actual demand does not match the predicted demand, manufacturers are
left with excess inventory to be stored.
The major benefit of this strategy is that if you do have a sudden uptick in orders, you
will most likely be able to keep all of your customers happy and meet due dates.
2. Lag Strategy
The Lag Strategy is much more conservative than the Lead Strategy as it waits until
the current capacity is stretched to its limits before adding more capacity. In this
strategy, manufacturers respond to an actual increase in demand and boost capacity
after the current operation runs in full steam. Here, manufacturers avoid the problem
of storing excess inventory but might end up losing customers to competition.
If you get a sudden surge in orders or land a large new client who wants fast
turnaround times, lag strategy may prevent you from meeting due dates.
3. Match/ tracking strategy
Match strategy is the middle ground between lag and lead strategy. Using match
strategy, you do strategic capacity planning more frequently. You closely monitor
true demand, projected demand, and market shifts/trends. Based on this information,
you adjust your capacity management to meet demand in increments. This strategy
offers the most flexibility with less risk than lead strategy, but it has more ability to
scale than lag strategy.
Despite being more complex in nature, this is a safer bet for most manufacturers as it
is much more risk-averse than the other Capacity Planning Strategies.
4. Dynamic strategy
This strategy is a much safer forecast driven strategy. It involves adding capacity
large or small, before it is required, based on actual demand and sales forecast figures.
Since this is data-driven, it proves to be much more accurate for manufacturers to
plan their capacity targets and avoids wastage or shortage of capacity. However, this
type of strategy does depend on good capacity planning tools which can drive
accurate forecasts.
Capacity planning based on the timeline is classified into three main categories
long range, medium range and short range.
- Long Term Capacity: The strategic capacity planning undertaken by
organization for 4 to 5 years of a time frame is referred to as long term capacity
planning.
- Medium Term Capacity: The strategic capacity planning undertaken by
organization for 2 to 3 years of a time frame is referred to as medium term
capacity planning.
- Short Term Capacity: The strategic planning undertaken by organization for
a daily weekly or quarterly time frame is referred to as short term capacity
planning.
Capacity Analysis
When selecting a measure of capacity, it is best to choose one that doesn't need
updating. When dealing with more than one product, it is best to measure capacity in
terms of each product. For example, the capacity of a firm is to either produce 100
microwaves or 75 refrigerators. This is less confusing than just saying the capacity
is 100 or 75. Another method of measuring capacity is by referring to the availability
of inputs. Note that one specific measure of capacity can't be used in all situations; it
needs to tailored to the specific situation at hand.
The two most useful functions of capacity planning are design capacity and effective
capacity. Design capacity refers to the maximum designed service capacity or output
rate and the effective capacity is the design capacity minus personal and other
allowances. These two functions of capacity can be used to find the efficiency and
utilization.
Determinants of Effective Capacity
▪ Facilities: The size and provision for expansion are key in the design of
facilities. Other facility factors include locational factors (transportation costs,
distance to market, labor supply, energy sources). The layout of the work area
can determine how smoothly work can be performed.
▪ Product and Service Factors: The more uniform the output, the more
opportunities there are for standardization of methods and materials. This leads
to greater capacity.
▪ Process Factors: Quantity capability is an important determinant of capacity,
but so is output quality. If the quality does not meet standards, then output rate
decreases because of need of inspection and rework activities. Process
improvements that increase quality and productivity can result in increased
capacity. Another process factor to consider is the time it takes to change over
equipment settings for different products or services.
▪ Human Factors: the tasks that are needed in certain jobs, the array of activities
involved and the training, skill, and experience required to perform a job all
affect the potential and actual output. Employee motivation, absenteeism, and
labor turnover all affect the output rate as well.
▪ Policy Factors: Management policy can affect capacity by allowing or not
allowing capacity options such as overtime or second or third shifts
 ▪ Operational Factors: Scheduling problems may occur when an organization
has differences in equipment capabilities among different pieces of equipment
or differences in job requirements. Other areas of impact on effective capacity
include inventory stocking decisions, late deliveries, purchasing requirements,
acceptability of purchased materials and parts, and quality inspection and
control procedures.
▪ Supply Chain Factors: Questions include: What impact will the changes have
on suppliers, warehousing, transportation, and distributors? If capacity will be
increased, will these elements of the supply chain be able to handle the
increase? If capacity is to be decreased, what impact will the loss of business
have on these elements of the supply chain?
▪ External Factors: Minimum quality and performance standards can restrict
management's options for increasing and using capacity.
▪ Inadequate planning can be a major limiting determining of effective capacity.
Steps in the Capacity Planning Process
1. Estimate future capacity requirements
2. Evaluate existing capacity and facilities and identify gaps
3. Identify alternatives for meeting requirements
4. Conduct financial analyses of each alternative
5. Assess key qualitative issues for each alternative
6. Select the alternative to pursue that will be best in the long term
7. Implement the selected alternative
8. Monitor results
The design capacity and effective capacity functions of capacity can be used to
find the efficiency and utilization.
These are calculated by the formulas below:
Efficiency = Actual Output/ Effective Capacity x 100%
Utilization = Actual Output/ Design Capacity x 100%
Capacity cushion = 100% - Utilization
Example-1
Given the following information, compute the efficiency: Effective capacity = 40
trucks per day, Actual output = 36 trucks per day
Ans: 90%
Example-2
Find the design capacity when utilization = 72 and actual output = 36 trucks per day
Ans: Utilization = [Actual Output/ Design Capacity] x 100
Therefore: [36/x] x 100 = 72
36 x 100x = 72x
36 =0 .72x
x = 50
Example-3
What is Capacity cushion? If utilization is 38%.
Ans: 100%-38%= 62%
Example-4
A department works on 8 hrs shift for 250 days a year. Following is the data of
machine usage.

Determine the number of machines required.