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When designing a concert hall, management hopes that the forecasted

capacity (the product mix – opera, symphony, and special events – and the
technology needed for these events) is accurate and adequate for operation
above the break-even point.
• How many concertgoers should a facility seat?
• How many customers per day should a Hard Rock Café be able
to service?
• How many computers should Dell’s Nashville plant be able to
produce in an 8-hour shift?

“The ‘throughput’ or number of units a facility can hold,

receive, store, or produce in a period of time.”
CAPACITY determines:
• A large portion of fixed cost.
• If demand will be satisfied or if facilities will be idle.

If the facility is too large, portions of it will sit idle and add
cost to existing production.
If the facility is too small, customers and perhaps entire
markets are lost.

Determining facility size, with an objective of achieving high

levels of utilization and a high return on investment, is critical.
Types of Planning over a Time Horizon

“Three time horizons”

Design and Effective Capacity
Design capacity is the maximum theoretical output of a system
in a given period under ideal conditions.
• Normally expressed as a rate.
• E.g. number of tons of steel that can be produced per week, per month,
or per year.

Effective capacity is the capacity a firm expects to achieve given

the current operating constraints.
• Often lower than design capacity because the facility may have been
designed for an earlier version of the product or a different product
mix than is currently being produced.
Design and Effective Capacity Cont’d..
Utilization is simply the percent of design capacity actually
Efficiency is the percent of effective capacity actually achieved.

Depending on how facilities are used or managed, it may be difficult to

reach 100% of efficiency. Operations managers tend to be evaluated on

“The key to improving efficiency is often found in correcting quality

problems and in effective scheduling, training, and maintenance.”
Utilization and Efficiency are computed below:
Sara James Bakery has a plant for processing breakfast rolls. Last week
the facility produced 148,000 rolls. The effective capacity is 175,000
rolls. The production line operates 7 days per week with three 8-hour
shifts per day. The line was designed to process a nut-filled, cinnamon-
flavored, sugar-coated Deluxe roll at the rate of 1,200 per hour.
Determine the design capacity, utilization, and efficiency for this plant
when producing the Deluxe roll.

Design capacity = (7 days x 3 shifts x 8 hours) x (1,200 rolls per hour) = 201,600 rolls

Utilization = Actual output/Design capacity = 148,000/201,600 = 73.4%

Efficiency = Actual output/Effective capacity = 148,000/175,000 = 84.6%

The manager of Sara James Bakery now needs to increase production of the
increasingly popular Deluxe roll. To meet this demand, the operations manager
will be adding a second production line. The manager must determine the
expected output of this second line for the sales department.

Effective capacity on second line is the same as on first line, which is 175,000
Deluxe rolls. The first line is operating at an efficiency of 84.6%. But output on
the second line will be less than the first line because the crew will be primarily
new hires; so the efficiency can be expected to be no more than 75%.
What is the expected output?

Expected output = (Effective capacity)(Efficiency) = (175,000)(.75) = 131,250 rolls

The sales department should be told the expected output is 131,250 Deluxe rolls.
*If the expected output is inadequate, additional capacity may be needed.
Capacity and Strategy
Sustained profits come from building competitive advantage, not
just from a good financial return on a specific process.
Capacity decisions must be integrated into the organization’s mission
and strategy.
Investments are not to be made as isolated expenditures, but as a
part of a coordinated plan that will place the firm in an advantageous
Will these investments eventually win customers?
What competitive advantage (e.g. process flexibility, speed of delivery,
improved quality, etc) do we obtain?
Capacity Considerations
In addition to tight integration of strategy and investments, there
are four special considerations for a good capacity decision.

1. Forecast demand accurately.

2. Understand the technology and capacity increments.
3. Find the optimum operating level (volume).
4. Build for change.
Managing Demand
Even with good forecasting and facilities built to that forecast, there may be
a poor match between the actual demand that occurs and available capacity.

Demand Exceeds Capacity.

The firm may be able to curtail demand simply by raising prices, scheduling long lead
times (which may be inevitable), and discouraging marginally profitable business.
However, because inadequate facilities reduce revenue below what is possible, the
long-term solution is usually to increase capacity.

Capacity Exceeds Demand

The firm may want to stimulate demand through price reductions or aggressive
marketing, or it may accommodate the market through product changes.

Adjusting to Seasonal Demands

Offer products with complementary demand patterns
- that is, products for which the demand is high for one when
low for the other.
Tactics for Matching Capacity to Demand
Various tactics for matching capacity to demand exist. Internal changes
include adjusting the process to a given volume through:

1. Making staffing changes (increasing or decreasing the number of

2. Adjusting equipment and processes, which may include purchasing
additional machinery or selling or leasing out existing equipment;
3. Improving methods to increase throughput; and/or
4. Redesigning the product to facilitate more throughput.

The foregoing tactics can be used to adjust demand to existing

facilities. The strategic issue is, of course, how
to have a facility of the correct size.
Break-Even Analysis
Break-Even Analysis Cont’d
Break-Even Analysis Cont’d
Single-Product Case
• Applying Decision Trees to Capacity Decisions
• Applying Investment Analysis to Strategy-Driven Investments