Strategic Capacity Planning for Products and Services

Read this summary. Pay attention to the inputs to capacity planning and the determinants and steps in the capacity planning process. This is important to understanding how to use this information to increase the quality of your forecasts. In addition, this helps you understand your organization's capability to meet the forecast needs.

This article examines how important strategic capacity planning is for products and services. The overall objective of strategic capacity planning is to reach an optimal level where production capabilities meet demand. Capacity needs include equipment, space, and employee skills. If production capabilities are not meeting demand, high costs, strains on resources, and customer loss may result. It is important to note that capacity planning has many long term concerns given the long term commitment of resources.

Managers should recognize the broader effects capacity decisions have on the entire organization. Common strategies include leading capacity, where capacity is increased to meet expected demand, and following capacity, where companies wait for demand increases before expanding capabilities. A third approach is tracking capacity which adds incremental capacity over time to meet demand.

Finally, 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. These are calculated by the formulas below:

Efficiency = Actual Output/ Effective Capacity x 100%

Utilization = Actual Output/ Design Capacity x 100%


Capacity Planning for Products and Services

Capacity refers to a system's potential for producing goods or delivering services over a specified time interval. Capacity planning involves long-term and short term considerations. Long-term considerations relate to the overall level of capacity; short-term considerations relate to variations in capacity requirements due to seasonal, random, and irregular fluctuations in demand.

Excess capacity arises when actual production is less than what is achievable or optimal for a firm. This often means that the demand in the market for the product is below what the firm could potentially supply to the market. Excess capacity is inefficient and will cause manufacturers to incur extra costs or lose market share. Capacity can be broken down in two categories: Design Capacity and Effective Capacity. Design Capacity refers to the maximum designed service capacity or output rate. Effective capacity is design capacity minus personal and other allowances. Product and service factors effect capacity tremendously.


Three key inputs to capacity planning are:

  1. The kind of capacity that will be needed
  2. How much capacity will be needed
  3. When will it be needed

Accurate forecasts are critical to the planning process!


Defining And Measuring Capacity

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.


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.

The most important parts of effective capacity are process and human factors. Process factors must be efficient and must operate smoothly, if not the rate of output will dramatically decrease. Human factors must be trained well and have experience, they must be motivated and have a low absenteeism and labor turnover. In resolving constraint issues, all possible alternative solutions must be evaluated. This is possible by using CVP analysis and the Break-Even Point formula.


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

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Last modified: Tuesday, April 9, 2019, 1:48 PM