Capacity Planning

Capacity planning is the process of determining the production capacity needed by an organization to meet changing demands for its products. In the context of capacity planning, design capacity is the maximum amount of work that an organization is capable of completing in a given period. Effective capacity is the maximum amount of work that an organization is capable of completing in a given period due to constraints such as quality problems, delays, material handling, etc.

The phrase is also used in business computing and information technology as a synonym for capacity management. IT capacity planning involves estimating the storage, computer hardware, software and connection infrastructure resources required over some future period of time. A common concern of enterprises is whether the required resources are in place to handle an increase in user or number of interactions. Capacity management is concerned about adding central processing units (CPUs), memory and storage to a physical or virtual server. This has been the traditional and vertical way of scaling up web applications, however IT capacity planning has been developed with the goal of forecasting the requirements for this vertical scaling approach.

A discrepancy between the capacity of an organization and the demands of its customers results in inefficiency, either in under-utilized resources or unfulfilled customers. The goal of capacity planning is to minimize this discrepancy. Demand for an organization’s capacity varies based on changes in production output, such as increasing or decreasing the production quantity of an existing product, or producing new products. Better utilization of existing capacity can be accomplished through improvements in overall equipment effectiveness (OEE). Capacity can be increased through introducing new techniques, equipment and materials, increasing the number of workers or machines, increasing the number of shifts, or acquiring additional production facilities.

Capacity is calculated as (number of machines or workers) × (number of shifts) × (utilization) × (efficiency).

Process of capacity planning

After an analysis of current conditions, future demand is predicted. Since the available capacity is known, the alternative capacity plans for the future is prepared. The economic analysis and feasibility of such plans is then done. This process involves following steps:

• Future capacity requirement: Capacity plans are dependent upon forecasting demands for outputs. Usually, mature products are subject to better prediction than fresh launches in the introductory phase of its life cycle.
• Multiple Outputs: There could be many products for which the demand is forecast. All these products may be at various stages of their respective life cycles. Since each product has a different and independent demand, they insure against uncertainties in the market.
• Stable Demand for Mature products: Products such as textiles, cement, health care, electricity, fertilizers are some examples of products that enjoy a constant and stabilized demand.

Capacity planning Strategies

The broad classes of capacity planning are lead strategy, lag strategy, match strategy, and adjustment strategy.

Chase strategy – Companies that use the chase strategy, or demand matching strategy, produce only enough goods to meet or exactly match the demand for goods. Think of this strategy in terms of a restaurant, which produces meals only when a customer orders, therefore matching the actual production with customer demand. The chase strategy has several advantages – ;it keeps inventories low, which frees up cash that otherwise can be used to buy raw materials or components, and reduces inventory carrying costs that are associated with holding inventory in stock. Cost of capital, warehousing, depreciation, insurance, taxes, obsolescence and shrinkage are all inventory carrying costs.

There are three sub strategies of Chase Demand:

• lead – The Lead sub strategy is typically an aggressive, risk-taking, and proactive strategy. Decisions are focused on increasing production in anticipation of expected demand growth.
• lag – The Lag approach is the opposite of the Lead approach. The company ramps up capacity only after demand has increased. The strategy is conservative and reactive.
• average – Average strategy occupies the middle ground between Lead and Lag Chase Demand strategies. It’s an approach that’s favored by service organizations, where demand is more unpredictable and products cannot be inventoried.

Lead strategy is adding capacity in anticipation of an increase in demand. Lead strategy is an aggressive strategy with the goal of luring customers away from the company’s competitors by improving the service level and reducing lead time. It is also a strategy aimed at reducing stockout costs. A large capacity does not necessarily imply high inventory levels, but it can imply higher cycle stock costs. Excess capacity can also be rented to other companies.

Advantage of lead strategy: First, it ensures that the organization has adequate capacity to meet all demand, even during periods of high growth. This is especially important when the availability of a product or service is crucial, as in the case of emergency care or hot new product. For many new products, being late to market can mean the difference between success and failure. Another advantage of a lead capacity strategy is that it can be used to preempt competitors who might be planning to expand their own capacity. Being the first in an area to open a large grocery or home improvement store gives a retailer a define edge. Finally many businesses find that overbuilding in anticipation of increased usage is cheaper and less disruptive than constantly making small increases in capacity. Of course, a lead capacity strategy can be very risky, particularly if demand is unpredictable or technology is evolving rapidly.

Lag strategy refers to adding capacity only after the organization is running at full capacity or beyond due to increase in demand (North Carolina State University, 2006). This is a more conservative strategy and opposite of a lead capacity strategy. It decreases the risk of waste, but it may result in the loss of possible customers either by stockout or low service levels. Three clear advantages of this strategy are a reduced risk of overbuilding, greater productivity due to higher utilization levels, and the ability to put off large investments as long as possible. Organization that follow this strategy often provide mature, cost-sensitive products or services.

Match strategy is adding capacity in small amounts in response to changing demand in the market. This is a more moderate strategy.

Adjustment strategy is adding or reducing capacity in small or large amounts due to consumer’s demand, or, due to major changes to product or system architecture.

Level production – In a manufacturing company that uses a level production strategy, the company continuously produces goods equal to the average demand for the goods. Scheduling consistently arranges the same quantity of goods for production based on the total demand for the goods. So, if for three months a company wants to produce 20,000 units of a certain item and there are a total of 56 working days, it can level production to 358 units per day.

Level strategies have one clear advantage: they create stability in operations in terms of output rates and workforce levels. However, there are some distinct disadvantages associated with using Level strategies. One disadvantage is that Level strategies rely on inventory, which brings added storage costs. Another is that Level strategies are slow to respond to major demand changes.

Make-to-stock – In the make-to-stock environment, goods are produced before customers place orders. The retail environment is an example of make-to-stock as goods are produced and put into inventory at the retailer’s location. The make-to-stock strategy typically allows manufacturers to produce goods in long production runs, taking advantage of production efficiencies. Because the make-to-stock environment produces goods on a consistent basis, a master production schedule determines the exact number of units to produce for each production run.

Make-to-order – Companies that use a make-to-order strategy produce goods after receiving an order from the customer. Most often a company that uses the make-to-order strategy produces one-of-a-kind goods. Examples include custom-tailored clothing, custom machinery and some fine jewelry.

Assemble-to-order – Certain fast-food restaurants use an assemble-to-order strategy. A customer walks in, places an order for a hamburger as per his way; and the hamburger gets assembled from a stock selection of ingredients. This strategy forces the restaurant to carry enough ingredients to make every hamburger combination a customer might request. Automobile manufacturers also use the assemble-to-order strategy. A customer can pick and choose from many features including interior fabrics, exterior paints, and seat, engine, wheel or tire options. Once the dealer places the customer’s order, the manufacturing plant assembles the standard component parts to the customer’s exact specifications. In this environment the production scheduler uses a final assembly timetable.