This presentation is about capacity planning.

1. Shah Abdul Latif University
Ghotki campus
DEPARTMENT OF BUSINESS
ADMINISTRATION

2. COURSE TITLE
Operations Management
Lecture Topic: Capacity Planning
Course instructor: Nadia Memon
Class: BBA-part IV
Semester: 7th

3. Lecture Outlines
• Capacity
• Managing Demand
• Capacity Planning
• Break-Even Analysis
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1
3
4

4. What Is Capacity?
• Capacity is the throughput or number of units a facility can hold,
receive, store and produce in a period of time.
• In simple words capacity is an ability of given system to produce output
within specific time period, moreover, how much a business is able to
produce with existing resources and if it is adequate in connection with
market requirements and firms own long term objectives? These
questions give hike to capacity planning and decisions.
• Capacity planning is essential in determining optimum utilization of
resource and plays an important role in decision-making process, for
example, extension of existing operations, modification to product lines,
starting new products, etc.

5. What Is Capacity?
• The capacity often determines capital expenditure and large portion of fixed
costs to be incurred.
• If facility is too large, may be some portions of it will sit idle and add extra
cost to production.
• If facility is too small the customer demand will not be satisfied, and market
will be lost.
• Determining size of facility (production system) can be critical, with objective
of achieving high level of utilization and high returns on investment, effective
capacity planning and management can assist organizations to achieve above
objectives.

6. Capacity Planning time horizons
• Capacity planning can be done at three time horizons.
1. Long range capacity planning, greater than one year, requires
adding new facilities and equipment's that have long life.
2. Intermediate range capacity planning, range from 3 to 8
months, requires adding equipment’s, personnel, shifts and
inventory stocks.
3. Short range capacity planning, based on 3 months time period,
requires using existing facility to schedule jobs and allocating
machinery to different jobs.

7. Capacity Planning Time Horizons

8. Design and effective Capacity
• Capacity design is the maximum theoretical output of a system in a given
period of time under ideal conditions.
• Design Capacity normally expressed as a rate, such as number of tons per
week, per month, per year or maximum units produces in a specific time, and
number of beds in a hospital.
• Often organizations operate at a rate less than design capacity to operate
more efficiently because their resources are not utilized to their limits. For
say they utilize 80% of given capacity, this concept is known as effective
capacity.
• Determining capacity is important as it can provide input for present and
future decisions to maximize efficiency, production facility, quality and other
production related issues.

9. Effective capacity
• The capacity a firm
expects to achieve at
given current operating
constraints.
• Such as capacity level
expected for specific
product mix, quality
and method of
scheduling and
maintenance.
Utilization
• Utilization is actual
output expressed as
percentage of design
capacity.
• Actual output/design
capacity = utilization
Efficiency
• Efficiency is measured
as actual output as a
percentage of effective
capacity.
• Actual output/
effective capacity =
efficiency

10. Determining capacity utilization and efficiency
• A facility produced 148,000 rolls last week, effective capacity is 175,000 rolls. The production line operates
7 days a week, with three 8-hour shift per day. The facility designed to process 1,200 rolls per hour, the
firm must compute design capacity and then utilization and efficiency.
• Design capacity = ( 7 days x 3 shifts x 8 hours ) x ( 1,200 per hour ) = 201,600 rolls per week
• or simply (168 hours in a week ) x ( 12,00 per hour ) = 201,600 per week
• Utilization = actual output/ design capacity, 148,000/201,600 = 0.734 0r 73.4%
• Efficiency = actual output/effective capacity, 148,000/175000 = 0.845 or 84.5%
• Expected output = (effective capacity) (efficiency) (175000) x (0.845) = 147, 875

11. Capacity considerations
• Capacity decisions require considering various issues related with
production, quality and market requirements. There are four major areas
need to be focused for good capacity decisions.
• Accurate forecast of demand: accurate forecast of demand is crucial,
determining how much new and existing products can add into demand, how
much volume is needed it helps to determine effective capacity.
• Understand the technology and capacity increment: technology related
capacity decision can be reviewed by evaluating cost, quality and reliability
and weather capacity increment really can add value or simply increase cost
for firm. Because for some firms as automobile, computers, adopting new
technology can be less profitable, capacity increment must tied with demand
and profitability.

12. Capacity considerations
• Find the optimum operating level (Volume): This is important to decide
that what will be the size of facility(system, plant) that will be adequate and
large enough to cover fixed cost and must be appropriate enough to be
managed and supervised easily and do not prove burdensome for firm.
• Build for change: change is inevitable in this world, operation manager
must plan for future and build a facility with flexibility keeping in view
upcoming product changes and trends.

13. Managing Demand
• Managing and forecasting demand often warrants the effective capacity
planning that results in production success but sometimes even good
forecasting results in poor match between facility and actual demand as,
• Demand exceeds capacity: In case firm have to increase capacity for long-
term and raising prices and scheduling long shifts for short-term.
• Capacity Exceeds Demand: In case of decreased demand firm may reduce
prices and apply aggressive marketing tactics and product changes, layoffs
and closing of plant may be necessary in this condition.
• Adjusting to seasonal demand: Seasonal and cyclical patterns in demand
requires firm to offer complementary products to utilize its facility and
personnel in seasonal downturn of demand.

14. Tactics for Matching capacity to Demand
• When demand does not match with capacity it can create worrying situation
for firm, cost of production may increase and facility may be over or
underutilized. There are many options for adjusting capacity with accruing
demand as:
1. Making staff changes or schedule shifts.
2. Adjusting equipment’s ( purchasing or selling)
3. Improving processes to increase output.
4. Redesigning products to facilitate output.
5. Adding process flexibility to meet changing product preferences.
6. Closing plant (facility).

15. Demand and capacity management in service sector
• In a service sector scheduling customers is Demand management and
scheduling work force is capacity management.
• Demand Management: In service-based firms demand can be managed
with appointments, reservations or first-come first-serve basis, each industry
develop its own approach to match demand with capacity.
• Capacity Management: In case when managing demand is not feasible, like
in hospitals then capacity can be matched with demand through changes in
full-time, temporary and part-time workers and professionals.

16. Capacity Planning
• Estimating future capacity requirements can be complicated, because it is based
on future demand. It requires forecasting demand with reasonable degree of
precision that leads to upfront capacity requirement decisions.
• Determining capacity requires “ forecast of future demand with traditional
methods” and using forecast to determine capacity requirement incremental
size of each addition to capacity.
• Demand growth is typically gradual and in small units, while capacity decisions
are rapid(at once) and in large units, this makes capacity expansion a difficult
decision.
• Study reveals four approaches to capacity expansion, portrayed in next slide.

17. 1 2
3
4

18. Capacity Planning
1. As in first approach in first figure, new capacity acquired at the beginning of
the year and it will handle the demand until new year and then new capacity
will be acquired to stay ahead of the future demand, this process continues
for years.
2. In next approach, a large increase in capacity acquired at once to satisfy
demand for more then one year, it offers flexibility and managers can build
inventory to avoid delays that can come with changing environment or
adding new capacity for some time.
3. In third approach management may Lags capacity(using same capacity) and
satisfy demand with overtime and subcontracting with other firms.
4. In last approach, firms straddle demand by building average capacity, based
on upcoming demand and thus, sometime just cover the demand and
sometime lead the demand.

19. Break-Even Analysis
• One of the finest tool for determining capacity that results in profitability is break-
even analysis that is already used for numerous purposes in various fields.
• Break-even analysis is a means of finding the point, in dollars and units, at which
cost equals revenue. Firms must operate above the break-even point to achieve
profitability.
• Break-even analysis requires the estimation of fixed cost, variable cost and revenue.
• Fixed costs: depreciation, taxes, debts, mortgage payments.
• Variable cost: labor, material, utilities vary with production.
• Contribution: the difference between selling price and unit variable cost, it must be
greater than fixed cost to achieve profit.

20. Break-Even Analysis (Graphic Approach)

21. Break-Even Analysis (Algebraic approach)
• BEP = break-even point, TR = total revenue, F= fixed cost, V=unit variable cost
• P= price per unit, TC= total cost, x= number of unit produced
• Break-even point occurs when total revenue equals to total cost as:
• TR = TC or Px = F + Vx
• BEP in units =
𝑭
𝑷−𝑽
• BEP in dollars = BEP in units × 𝑷, 𝑷 =
𝑭
(𝑷−𝑽)÷𝑷
or
• BEP in dollars =
𝑭
𝟏− 𝑽/𝑷
• Profit = Px – F – V or (P – V)x – F

22. Break-Even Analysis (Algebraic approach)
• Example: Stephens Inc. want to determine dollar volume and unit volume
needed at its new facility to break-even.
• Fixed cost for period, 10,000, direct labor, 1.50, material, 0.75 per unit, selling
price is 4.00 per unit.
• BEP in units =
𝑭
𝑷−𝑽
=
𝟏𝟎,𝟎𝟎𝟎
𝟒.𝟎𝟎 −(𝟏.𝟓𝟎+𝟎.𝟕𝟓)
= 5,714
• BEP in dollars =
𝑭
𝟏− 𝑽/𝑷
=
𝟏𝟎,𝟎𝟎𝟎
𝟏−(
𝟐.𝟐𝟓
𝟒
)
=
𝟏𝟎,𝟎𝟎𝟎
𝟎.𝟒𝟑𝟕𝟓
= 22,857.14

23. Break-Even Analysis (Multiproduct case)
Most of the firms have
variety of offerings and
may have different
selling price and variable
cost like restaurants.
Calculation of break-
even for multiproduct
can be tricky by
modifying same formula:

24. Break-Even Analysis (Multiproduct case)
• Determining multiproduct break-even requires calculation product sales as
percentage of total annual sales and weighted contribution of each product.
Item Selling price Variable
cost
V/P 1 – V/P Annual sales
(product)
% of total
sales
Weighted
contribution
(1-v/p x % sales)
Sandwich 2.95 1.25 0.42 0.58 20,650 .446 .259
Soft drink 0.80 0.30 0.38 0.62 5,600 .121 .075
Baked potato 1.55 0.47 0.30 0.70 7,750 .167 .117
tea 0.75 0.25 0.33 0.67 3,750 .081 .054
Salad 2.85 1.00 0.35 0.65 8,550 .185 .120
Total = 46,300 1.000 0.625

25. Break-Even Analysis (Multiproduct case)
• Fore instance: sandwich annual sales = 20,650
• sandwich as percentage of total sale = 20,650 x100/46,300 = 44.6% or 0.446
• Sandwich per dollar contribution = 1- v/p = 0.58
• Sandwich weighted average contribution= 1 −
𝑉
𝑃
𝑋 𝑊𝑖 = 0.446 x 0.58 = 0.259
• In same way total fixed cost of all products is divided with weighted average
contribution of all products in order to get break-even.
• BEP in dollars for restaurant=
𝑎𝑛𝑢𝑎𝑙 𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡
σ[ 1 −
𝑉
𝑃
𝑋 𝑊𝑖 ]
=
42,000
0.625
= 67,200

26. Thank you
Have a great Day!