Capacity Management

Capacity Management

In this lesson, you’re expected to learn about:
– productive capacity
– the factors that influence capacity planning decisions
– types of capacity management strategies

What is Productive Capacity?

Productive capacity is the maximum volume of value-adding activity that can be reached by a productive unit in normal operating conditions.

Providing the necessary capability to satisfy current and future demand is a fundamental responsibility of operations management.

However, capacity is a determinant of an organization’s performance:
– if you manage to allocate the right capacity, you are likely to be able to meet demand with reduced costs.
– If you get the wrong capacity (i.e. too little or too much), then you are not going to be able to satisfy demand and/or will incur in excessive costs.

Capacity can mean different things for different types of organizations:

– A law firm’s capacity is related to the number of cases it can handle in a certain period, which can be based on the number of employees
– A manufacturing company’s capacity is related to the number of units it can produce in a certain period, which can be based on its machines’ technical capacity.

References: Slack et al. (2010); Chopra & Meindl (2013)

The essence of capacity management lies in matching, at an aggregated level, the supply capacity with the demand that it must satisfy.

Capacity management is sometimes referred as “aggregated planning” as its calculations are performed on an aggregated level, not distinguishing individual products.

References: Slack et al. (2010); Chopra & Meindl (2013)
[Optional] Aggregate Production Planning Strategies
Watch this 4-minute video about aggregate production planning strategies:
Factors Influencing Capacity Planning Decisions
Capacity decisions usually involve large sums of capital, require great anticipation, and are expensive to be reverted

Following the model of strategic operations management that we saw earlier, capacity planning helps in reconciling operations resources with market requirements.

Enlarged version:

Several factors influence capacity decisions:

– From the market side, the demand forecast plays an important role, as well as the consequences of lack of /excess capacity (e.g. can lack of capacity be easily reverted in the short term?)

– From the operations side, influences come from financial decisions, available technology, and the current and future flexibility to increase capacity.

Capacity decisions have different inertia, thus it is necessary to consider various planning horizons

An operations manager needs to consider the time frame of his/her decision. For example:

– Hiring a new employee has a relatively low inertia (the hiring process does not take too long) and it has a short-term impact.

– Building a new plant has a lot of inertia (it takes time to build it) and has long-term effects (it is difficult to revert it).

[Optional] Capacity Planning
Watch this 5-minute video to learn more:
Capacity Management Decisions

Capacity increments can be done in small or large increments

– Small increments may feel ”safer”, from the perspective that immediate capital commitment and idle capacity may be reduced. However, it may not be feasible or desirable in some cases, due to economies of scale or technical matters.

– Large increments are big decisions and may be ”hard to swallow”. However, this strategy is recommended in cases in which decisions have large inertia and imply large economies of scale.

Capacity management also involves deciding whether capacity increments should be installed before of after the demand realization

1) Capacity-leading strategy: increments anticipate demand

– More likely to have capacity to meet demand, maximizing revenues and customer satisfaction.
– However, utilization is relatively lower, which reflects in higher unit costs.
– Risk of overcapacity is higher.
– Capital spending is made earlier.

2) Capacity-lagging strategy: increments react to demand

– Work at full capacity, keeping low unit costs.
– Capital spending is delayed.
– Overcapacity problems are minimized.
– However, it is likely to have insufficient capacity to meet demand, reducing revenues and customer satisfaction.

Smoothing with Inventory

Alternatively, companies can mix strategies by smoothing capacity issues with inventory.

This strategy can be considered a mix of the capacity-leading and capacity-lagging strategies.

Source: adapted from Slack et al. (2010)

It basically uses excess capacity of one period to produce inventory that will supply the under-capacity of another period:

– Demand is more likely to be satisfied than in the capacity-lagging strategy, maximizing revenues and customer satisfaction.

– Capacity utilization is also high, keeping low unit costs.

– However, cost of inventory can be high, as well as the risk of obsolescence of the inventory.

[Optional] Capacity Utilization
Watch this 6-minute video about capacity utilization:
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