Chapter 5 and
Luehrman Article (Course pack)
• Strategic capacity planning,
Efficiency and Utilization
• Optimal capacity level
• Selection among capacity alternatives • Capacity Planning under Uncertainty
• Multi-stage Decision Making
• Capacity is the upper limit or ceiling on the load that an operating unit (e.g. plant, dept., store. m/c, worker, etc.) can handle
how much we can produce (measured in terms of output rates)
• Planning for capacity:
– Long term: deals with overall capacity level. Also called strategic capacity planning.
Ex: facility size, major expansions
– Short term: deals with variations in capacity requirements (created by demand fluctuations)
Ex: Workforce-production plans
• The basic questions of strategic capacity planning are:
What kind of capacity is needed?
How much is needed?
When is it needed?
Importance of these decisions:
Determine ability to meet future demand and therefore remain/be competitive
Excess capacity or ability to add capacity quickly can deter new competitors
Affects cost (operating, investment costs)
These decisions involve major investments and hence are irreversible in the short run.
Steps in Strategic Capacity Planning
• Calculate current capacity
• Estimate long-term changes in demand and estimate future capacity needs
• Identify sources of capacity to meet these needs • Select among these alternatives
Definitions of Capacity
• Design capacity
maximum obtainable output under ideal conditions
• Effective capacity
maximum capacity given current product mix, scheduling difficulties, and other doses of reality.
(NORMAL operating conditions)
• Actual output
rate of output actually achieved—often less than the effective capacity.
Efficiency and Utilization
Design capacity = 50 trucks/day
Effective capacity = 40 trucks/day
Actual output = 36 units/day
40 units/ day
Note that in this example, both efficiency and utilization are less than 100%. What does it mean?
Best Operating Level
Average cost per unit
Given the design capacity of our production unit, there is an optimal rate of output for minimal cost/unit.
Economies of Scale
Diseconomies of Scale
Minimum cost 0
Rate of output
Selecting among Alternatives
• Decision Approaches:
– Break-Even Analysis (BEA)
– Present Value Analysis (NPV)
– Real Options Analysis
– Simulation & Waiting Line Analysis
(primarily for service systems)
– Linear Programming
t= s co l ta o T
ev r l
e u en
a t )
t os c e l b a i r va l ta o
Fixed cost (FC)
Q (volume in units)
Break Even Analysis
TC FC VC* Q
TR R Q
To make profit, we need TR TC
R * Q FC VC Q
( R VC ) Q FC
Break Even Analysis- Example
We want to add a new line of product. The annual lease for the equipment is $ 9,000. We estimate the production cost to be 3$/unit. We plan to sell it at $6/unit. How many units should we produce and sell to break even?
FC 9000, VC 3, R 6
R VC 6 3
If our forecast annual demand is 2,500 units, should we invest in the new line?
• Capacity investments may require step costs, i.e. fixed costs which increase as the desired output increases:
# of MC
Annual Fixed C.