Overview of Strategic Capacity Management

Capacity management is a critical component of long-term decision-making since it is a fundamental part of all facility investment decisions, which are difficult to change or reverse. Choosing the appropriate amount of capacity for an organization is important because businesses with too much capacity will waste resources on equipment and personnel that do not earn a return, while business with a capacity shortage will lose sales as customers find alternative suppliers. Measures of Capacity Capacity measures must be tailored to fit specific situations. Restaurants measure capacity in terms of the number of diners or meals that can be served during a day or specific mealtime. An amusement park assesses the number of patrons that can visit the park per day. A delivery company measures the number of packages that can be delivered per day. A manufacturing company may count the number of units (TVs, bicycles, tables etc.) made per day, or measure its capacity in terms of the number of machine hours available. While each of these methods of assessing capacity is specific to its application, capacity measures can be grouped broadly as either output or input measures. Output measures assess units coming out of the supply chain as finished goods or services. A bicycle manufacturer such as Trek might measure capacity in terms of the total number of bicycles that can be produced in a year. The total capacity might be 150,000 bikes per year. Capacity can be measured in this manner because while Trek makes a number of different models, they are fairly similar in terms of production resources. Businesses that have a wider product range and a greater degree of customization typically have a more challenging time measuring capacity. For example, a fast food restaurant typically offers 40-50 different products and cannot realistically measure capacity individually for each. Thus, capacity might be tracked in terms of total sales (i.e. $3,600 per day), number of customers (1200 per day) or transactions per group (i.e. 1000 sandwiches per day, 900 orders of fries and 800 drinks). Output measures work best when a few fairly standardized products or services are offered. Input measures fit processes with a high degree of customization. For example, capacity in a copy shop might be measured in terms of total machine hours or the number of machines available. A neighborhood bakery might measure the number of baking hours or machines available. Maximum/design/theoretical capacity is the highest output rate that a process or facility can achieve under ideal conditions in the short term. This assumes that all equipment and workers are fully operational (i.e. not sick) and do not take breaks. Effective capacity is the output that a company or process can economically sustain under normal circumstances for an extended time period without suffering adverse impacts in terms of poor quality, worker burnout and/or safety problems.

Capacity Strategies Capacity strategy refers to several aspects of capacity management, including the timing of expansion (or contraction), the sizing of facilities and the linkage with marketing/business plans. While there are an infinite number of specific approaches, we can describe two general strategies that represent the ends of a continuum. Wait-and-See A Wait-and-See strategy typically involves postponing firm commitments to building expensive, new facilities until after demand has already exceeded capacity. Facility expansion typically occurs in a series of small steps that lag behind demand, as shown in Exhibit 4. Organizations utilizing this strategy generally employ short-term tactics such as overtime, postponement of sales, subcontracting, and temporary workers etc. to compensate for any differences between supply and demand. The primary advantage of this approach is that it allows the organization to postpone making large, difficult to reverse investments in new facilities and capacity. However, it does risk losing business if the marketplace expands faster than projected. This approach can also compromise quality and flexibility since it involves working at higher utilization levels.

A Wait-and-See strategy typically fits best in fairly slow growth industries where facilities are very expensive. In this situation, the risk of over-expanding and being saddled with facilities that are under-utilized far outweighs the risk of losing market share. Another factor to consider when choosing a capacity strategy involves the speed of technological change. In an industry where technology changes quickly, it generally is not a good idea to expand too quickly for fear of over-investing in a technology that quickly becomes obsolete. Aggressive Expansion An alternative strategy involves the Aggressive Expansion of facilities wherein capacity is built to exceed projected demand in the short term. Capacity is added in large leaps with the expectation that demand will eventually catch-up. Exhibit 5 illustrates a typical aggressive expansion strategy.

The primary advantage of an aggressive expansion is in a growing market, where excess capacity allows an organization to capture market share through first mover advantages. If an organization maintains acceptable quality and the market grows to match the available capacity, such a first mover advantage can be very difficult to overcome. This strategy helps preempt competition, since customers typically are reluctant to switch from a market share leader as long as reasonable service levels are provided. In addition, an aggressive strategy offers the ability to capitalize on economies of scale since facilities will be built in larger volumes than in a wait-and-see strategy. It is important to remember that there are some significant risks associated with aggressive expansion. The largest is that actual demand will not match projections. There is also a risk of technological obsolescence wherein a facility that is state of the art may be eclipsed by a competitors newer, more up to date facility. An aggressive strategy fits well in situations where a company is in a growing industry, is a market share leader or wants to maintain a high quality of service. Excess capacity helps ensure that a company will be able to be flexible and meet customer demands. In contrast, organizations that compete primarily based on low cost are more likely to follow a wait-and-see strategy.

Capacity Cushion
Capacity cushion is the difference between effective capacity and maximum capacity. If the expected demand for paper products is $480 million per year for Pauls Paper and the manufacturing plant is designed to handle $500 million per year, the capacity cushion is 4%. Capacity Cushion =
MaximumCapacity EffectiveCapacity MaximumCapacity

Systematic Capacity Planning

While every case is unique, there is a general sequence of steps that is typically followed when planning capacity. Capacity planning is typically reviewed on a yearly basis, or any time when there is a substantial change in market forces, demand or the organization is faced with a dramatic shortage/excess of capacity. It is assumed that the organization starts off with an accurate assessment of existing capacity and then estimates future requirements The foundation of capacity planning consists of forecasting capacity requirements for both the short and long term. Companies often forecast demand for three general time periods: short term (less than a year), medium term (one to three years) and long term (three to ten years). Consider a printing shop that is developing an estimate for its capacity requirements for the coming year. Last years total demand was for 13.5 million pages. Each copy machine can produce 3000 pages/hour capability. However, the printing shop has been growing by 20% per year on average. Thus, the estimate for this years demand is 16.2 million pages. To determine the number of machines required at the print shop: Resource Requirements = Forecasted demand for the resource/effective capacity available from 1 resource If the printing shop is open 2,000 hours per year and desires a 20% capacity cushion, then each machine has an effective capacity of 1,600 hours. In this amount of time a machine can produce 4,800,000 pages (1600 hours x 3000 pages/hour). Machines required = 16.2 million pages of demand/4.8 million capacity of 1 machine = 3.375 rounded to 4 machines This type of analysis can be applied to a variety of situations. For example, estimates could be made regarding the requirements for a restaurant, a grocery store, a manufacturer of clothing or a doctors office. While the general steps are the same, each situation calls for specialized measures of demand and capacity