Strategic Capacity Planning

Sanjay Jharkharia 1
 Objective of this topic
To understand capacity
To have an understanding of commonly used
strategies for capacity expansion
Analysis of various strategies and recommendations
for different scenarios of capacity expansion
requirements

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Why is capacity strategy important?

Without an appropriate capacity

strategy, operations will always
be struggling to supply markets
in a competitive manner

Getting capacity strategy right is

the starting point for developing
competitive operations

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 What is capacity?
The maximum level of output
The upper limit or ceiling on the load that an
operating unit can handle.

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 Some factors influencing the overall
level of capacity

Forecast
Availability of
level of
capital
demand
Cost structure Changes in
of capacity future
increment demand

OPERATIONS Overall level of MARKET

RESOURCES capacity REQUIREMENTS

Uncertainty
Economie
s of scale of future
demand
Flexibility of Consequences
capacity of over/under-
provisions supply

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 Some factors influencing the number
and size of sites

Economies of Required
scale service level

OPERATIONS Size and MARKET

RESOURCES number of sites REQUIREMENTS

Supply Geographical
costs distribution of
demand

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Capacity Expansion Options

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 Advantages/Disadvantages of each strategy

Advantages Disadvantages

Expansionist Ahead of competition Risky if

No lost sales demand changes

Wait-and-See No unused capacity Rely on short-

Easier to adapt to term options
new technologies

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 Some Short-Term Capacity
Expansion Options
Authorize overtime
Staff second or third shift with temporary workers
Add weekend shifts
Alternate routings, using different work stations
that may have excess capacity
Schedule longer runs to minimize capacity losses
Lease extra space/machines temporarily (for very
expensive items)

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 Some Short-Term Capacity
Options contd

Level output by building up inventory in lean

seasons
Postpone preventive maintenance (risky)
Use multi-skilled workers to alleviate bottlenecks
Allow backorders to increase, extend due date
promises, or have stock-outs.
Subcontract work

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Causes of Industry Overcapacity
Over investment or shortfalls in demand
Shortfall in demand is probably beyond the control
of management
Over investment can, however, be controlled
Over capacity results in waste of resources and
fierce price wars among the competitors
Excess capacity can occur due to a number of
reasons relating to technology, competition, or
environmental factors.
Often competitors go for capacity expansion
simultaneously which results in excess capacity

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 Technological Factors
Scale of economies: Often expansion is done in large
increments in certain sectors such as service, for
example.
Technical change: Introduction of a new lower-cost
production technology often triggers investment by
many producers
Learning curve: Due to experience also the capacity
may increase

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 Competitive Factors
Capacity Share: In services such as air transport,
telecom, hotels etc excess capacity may result in
competitive advantage (e.g. more flight options, more
rooms etc.)
Age of plant: Customers are often attracted to new
facilities instead of old. This also results in excess
capacity
New entrants in the market
Inability to signal intentions: Expansion plan without
taking into consideration the plans of other
competitors
Optimism about demand
Herd approach by the managements
Etc. Sanjay Jharkharia 13
 Other Environmental Factors

Change in financing costs or tax rules: Reduction in

borrowing rates may prompt for new investment
which leads to capacity surplus
Government subsidies: To maintain employment and
promote a key sector government may subsidize
investments in new capacity

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 Capacity Expansion Strategies
The nature of competition is central to the capacity
expansion decisions
How can firms manage the competitors?
A firms optimal strategy depends on the industry
characteristics and expected behaviors of competitors
Long term business strategy and tolerance for risks
are also important

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 Example No. 1
An automobile transmission-assembly factory normally operates two
shifts per day, five days per week. During each shift, 400 transmissions
can be completed under ideal conditions. Under normal operating
conditions, 340 transmissions/shift/day are completed. Over the next
four weeks, the factory has planned shipments according to the
following schedule.
Week 1 2 3 4
Shipments 2,600 2,400 3,200 3,800

a. What is the theoretical monthly capacity @ 4 weeks per month?

b. What is the effective monthly capacity?
c. For this shipment schedule and assuming zero finished goods
inventory at the end of the month, what is the actual utilization rate
(%)?
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 Solution
a. Theoretical capacity = (2 shifts/day)(5 days/week)(400
trans/shift)(4 weeks/month) = 16,000 trans/month

b. Effective capacity = (2 shifts/day)(5 days/week)(340

trans/shift)(4 weeks/month) = 13,600 trans/month

c. Utilization (%) = Resources Demanded or Used/

Resources Available = 12,000/13,600 = 88.2%

Also, note that planned shipments are 111.8 percent

(3,800/3,400) of effective capacity in week 4. So, during
the last week of the month "surge in production" they have
to assemble 3,800 transmissions, very close to their ideal
capacity of 4,000 per week.
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 Example No. 2
A tax assessor has estimated that his office must perform 180
property reevaluations per day. Each staff member assigned to the
reevaluation will work for an eight-hour day including one hour for
breaks and lunch. If it takes a staff member 10 minutes to do a
reevaluation, and the average utilization of any staff member is 75%,
how many staff members must be assigned to this project?
Solution
Service rate = (7 effective hours/day)*(6 reevaluations/hour) = 42
reevaluations/day. We have
Utilization rate of facilities = Output rate / Input Capacity
or 0.75 = 180 reevaluations/day
(42 reevaluations/day)*(Number of Servers)
= 31.5*S = 180 or S = 5.7 or about six staff members.
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Decision Tree in Capacity Decisions

Structures complex, multiphase decisions

Allows objective evaluation of alternatives
Incorporates uncertainty
Develops expected values

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 Decision Tree Analysis

1 Define the problem

2 Structure or draw the decision tree
3 Assign probabilities to the states-of-nature
4 Estimate the payoffs for each possible combination of
alternative and state-of-nature
5 Solve the problem by computing expected monetary
values (EMV) for each state-of-nature node

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 Example of a Decision Tree Problem

A glass factory specializing in crystal is experiencing a

substantial backlog, and the firm's management is
considering three courses of action:

A) Arrange for subcontracting

B) Construct new facilities
C) Do nothing (no change)

The correct choice depends largely upon demand, which may

be low, medium, or high. By consensus, management
estimates the respective demand probabilities as 0.1, 0.5,
and 0.4.
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 Example of a Decision Tree Problem
(Continued): The Payoff Table
The management also estimates the profits
when choosing from the three alternatives (A,
B, and C) under the differing probable levels of
demand. These profits, in thousands of dollars
are presented in the table below:

0.1 0.5 0.4

Low Medium High
A 10 50 90
B -120 25 200
C 20 40 60
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 Example of a Decision Tree Problem contd

A
B

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Example of a Decision Tree Problem contd

High demand (0.4) $90k

Medium demand (0.5) $50k
Low demand (0.1) $10k

A High demand (0.4) $200k

B Medium demand (0.5) $25k
Low demand (0.1) -$120k
C
High demand (0.4) $60k
Medium demand (0.5) $40k
Low demand (0.1) $20k
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Example of a Decision Tree Problem contd

High demand (0.4) $90k

Medium demand (0.5) $50k
$62k Low demand (0.1) $10k

A
EVA=0.4(90)+0.5(50)+0.1(10)=$62k

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Example of Decision Tree Problem contd

High demand (0.4) $90k

Medium demand (0.5) $50k
$62k Low demand (0.1) $10k

A High demand (0.4) $200k

$80.5k
B Medium demand (0.5) $25k
Low demand (0.1) -$120k
C
High demand (0.4) $60k
$46k Medium demand (0.5) $40k
Low demand (0.1) $20k
Alternative B generates the highest expected profit
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 Example: Decision Tree
ABC Caf is about to build a new restaurant. An
architect has developed three building designs, each
with a different seating capacity. ABC Caf estimates
that the average number of customers per hour will
be 80, 100, or 120 with respective probabilities of 0.4,
0.2, and 0.4. The payoff table showing the profits for
the three designs is on the next slide.

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Example: Decision Tree Analysis
Payoff Table

Average Number of Customers Per Hour

c1 = 80 c2 = 100 c3 = 120

Design A $10,000 $15,000 $14,000

Design B $ 8,000 $18,000 $12,000
Design C $ 6,000 $16,000 $21,000

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Example: Decision Tree Analysis
Expected Value Approach

Calculate the expected value for each decision. The

decision tree on the next slide can assist in this
calculation. Here d1, d2, d3 represent the decision
alternatives of designs A, B, C, and c1, c2, c3 represent
the different average customer volumes (80, 100, and
120) that might occur.

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Example: Decision Tree Analysis
Decision Tree Payoffs
c1 .4 10,000
c2 .2
2 15,000
c3 .4
d1 14,000
c1 .4
d2 8,000
1 c2 .2
3 18,000
d3 c3 .4
12,000
c1 .4
6,000
c2 .2
4
c3 16,000
.4
21,000
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Example: Decision Tree Analysis
Expected Value For Each Decision
EV = .4(10,000) + .2(15,000) + .4(14,000)
d1 = $12,600
2
Design A
EV = .4(8,000) + .2(18,000) + .4(12,000)
Design B d2 = $11,600
1 3

d3
Design C
EV = .4(6,000) + .2(16,000) + .4(21,000)
= $14,000
4

Choose the design with largest EV -- Design C.

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 Home Work
Solve few more problems based on decision tree
method
Browse internet for the capacity-expansion related
news of companies and try to relate these with our
understanding of the topic

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QUESTIONS?

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