ES2B2.

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ES2B2.051| Capacity Management

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Introduction
Providing sufficient capability to satisfy current and future demand is a fundamental
responsibility of operations management. Capacity planning and control is also sometimes
referred to as aggregate planning and control. This is because, at this level of planning and
control, demand and capacity calculations are usually performed on an aggregated basis
which does not discriminate between the different products and services that an operation
might produce. The essence of the task is to reconcile, at a general and aggregated level, the
supply of capacity with the level of demand which it must satisfy.

What is Capacity Management?

The capacity of an operation is the maximum level of value-added activity over a period of
time that the process can achieve under normal operating conditions. Any measure of
capacity should reflect the ability of an operation or process to supply demand.

Many organizations operate at below their maximum processing capacity, either because
there is insufficient demand completely to ‘fill’ their capacity, or so that the operation can
respond quickly to every new order.

The capacity of an overall product or service is limited to the capacity of each stage. Unless
extra resources are provided to increase the capacity of the micro-operation, it could
constrain the capacity of the whole operation.

Planning and Controlling Capacity

Capacity planning and control is the task of setting the effective capacity of the operation so
that it can respond to the demands placed upon it. This includes deciding how the operation
should react to fluctuations in demand.

Long-term capacity strategy is the approach to changes in demand and alternative capacity
for major increments of physical capacity.

In this chapter, the strategies are discussed for shorter timescales, where decisions are largely
made within the constraints of the physical capacity limits set by the operations long-term
capacity strategy.

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MEDIUM & SHORT-TERM CAPACITY

After deciding the long-term capacity, the medium term capacity must be considered. This
usually involves assessing the demand forecast for the next 2-18 months. However, as
forecasts are not reliable, it is important to be able to respond to quicker acting changes in
demand.

AGGREGATE DEMAND & CAPACITY

An important part of capacity management is setting capacity levels in the medium and short
terms (aggregated). Aggregated describes a mixture of different products and services in
order to get a broad view of demand and capacity – therefore is quite approximate.

OBJECTIVES OF CAPACITY MANAGEMENT

The decisions taken by operations managers in devising their capacity plans will affect several
different aspects of performance:

• Costs are affected by the balance between capacity and demand. If Capacity levels
exceed demand this could be under-utilization of capacity, therefore high unit costs.

• Revenues are affected by the balance between capacity and demand, but in the
opposite way. Capacity levels equal to or higher than demand at any point in time will
ensure that all demand is satisfied and no revenue lost.

• Working capital will be affected if an operation decides to build up finished goods

inventory prior to demand. This might allow demand to be satisfied, but the
organization will have to fund the inventory until it can be sold.

• Quality of goods/services may be affected by a capacity plan involving large

fluctuations in capacity levels, (e.g. hiring temporary staff). The new staff and the
disruption to the regular operation could increase the probability of errors.

• Speed of response to customer demand could be enhanced, either by the build-up of

inventories (allowing customers to be satisfied directly from the inventory rather than
having to wait for items to be manufactured) or by the deliberate provision of surplus
capacity to avoid queuing.

• Dependability of supply will also be affected by how close demand levels are to
capacity. The closer demand gets to the operation’s capacity ceiling, the less able it is
to cope with any unexpected disruptions and the less dependable its deliveries of
goods and services could be.

• Flexibility, especially volume flexibility, will be enhanced by surplus capacity. If

demand and capacity are in balance, the operation will not be able to respond to any
unexpected increase in demand.

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STEPS OF CAPACITY MANAGEMENT

Typically, operations managers are faced with a forecast of demand which is unlikely to be
either certain or constant. They will also have some idea of their own ability to meet this
demand. Nevertheless, before any further decisions are taken, they must have quantitative
data on both capacity and demand.

1. Measure the aggregate demand and capacity levels for the planning period.
2. Identify the alternative capacity plans which could be adopted in response to the
demand fluctuations.
3. Choose the most appropriate capacity plan for their circumstances.

How is Capacity Measured? (Forecasting Demand Fluctuations)

Capacity forecasts are important in order to make effective plans for future events. There are
three requirements for a demand forecast;

• Expressed in terms which are useful for capacity management – monetary terms give
no indication of capacity demands. Demand must have the same units as capacity.

• It is as accurate as possible. Demand can change instantaneously, but there is a lag for
changing capacity. Therefore, the output must be decided based on the forecast.
• It gives an indication of relative uncertainty. It is important to understand the forecast
levels of demand, and to predict how much the actual demand could realistically differ
from this.
o Price-sensitive markets may require a risk-avoiding cost-minimization plan
which does not always meet peak demand,
o Responsive/Service Quality markets may have a more generous capacity.

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SEASONALITY OF DEMAND

Most markets are influenced by seasonality; where they vary depending upon the time of
year. Some causes include climatic (holidays), festive (gift purchases), financial (tax
processing), social, or political. Many of these factors can be forecast, with others affected by
unexpected variations in weather or changing economic conditions.

This can be demand seasonality or supply seasonality – it is important to understand these

fluctuations.

WEEKLY AND DAILY DEMAND FLUCTUATIONS

Seasonality of demand occurs over a year, but similar predictions for variations can occur with
a shorter cycle (e.g. daily or weekly).

The extent to which an organization can cope with a very short-term demand fluctuation
partly depends upon how long the customers are prepared to wait. If the customers are
incapable (or unwilling) to wait, the company will need to plan for these variations.

Measuring Capacity
Most operations are complex, which can cause problems measuring the capacity. When an
operation is highly standardized and repetitive, the capacity is easy to define. For many
operations it can be difficult to define the specific capacity. Almost every type of operation
could use a mixture of both input and output measures (usually only one is investigated).

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Capacity is a function of service/product mix, duration and product service specification.

DESIGN CAPACITY AND EFFECTIVE CAPACITY

The theoretical capacity of an operation is the capacity that the operation was originally
designed for, but this cannot always be achieved in practice. A process cannot always be
carried out at maximum speed, and maintenance will also need to be performed. Therefore,
these losses are caused by the market and technical demands of the operation.

The effective capacity is the capacity after the losses have been accounted for. If you include
quality and failure factors, the capacity will also be reduced, therefore the actual output of
the line will be even lower.

Actual Output
Utilisation =
Design Capacity

Actual Output
Efficiency =
Effective Capacity

OVERALL EQUIPMENT EFFECTIVENESS

The overall equipment effectiveness (OEE) measure is an increasingly popular method for
describing the effectiveness of the operations equipment. It is based on three aspects of
performance;
• Time that the equipment is available to operate
• Quality of the product or service it produces
• Speed of the equipment.

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The overall equipment effectiveness is calculated by multiplying an availability rate by a

performance (or speed) rate multiplied by the quality rate.

OEE = 8 × : × ;

For equipment to operate effectively, it needs to achieve high levels of performance against
each of the three dimensions. All of the losses to the OEE performance can be expressed in
terms of unit time.

Coping with Demand Fluctuations

There are three pure options available to cope with variation;

• Ignore the fluctuations and keep activity levels constant (level-capacity plan)
• Adjust capacity to reflect the fluctuations in demand (chase-demand plan)
• Attempt to change demand to fit the capacity available (demand management)

Most organisations use a mixture of these plans, but one plan may be dominant.

LEVEL CAPACITY PLAN

The aim of the level capacity plan is

to set the processing capacity at a
uniform level throughout the
planning period, ignoring the
fluctuations in forecast demand. For
non-perishable goods, these can be
stored as a finished goods inventory
in anticipation of later sales.

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The advantages of this method are that it can achieve stable employment patterns, high
process utilization, as well as high productivity with low unit costs. However, this does
create a considerable inventory which costs money to store.

Low utilization can create make level capacity plans expensive for most service operations,
as in order to cope with peak demand the same level of capacity is required throughout.

CHASE DEMAND PLAN

The chase demand plan attempts to match the capacity closely to the varying levels of
forecast demand. This is more difficult to achieve (e.g. staffing, equipment). This method
doesn’t suit manufacturing of non-perishable goods due to the irregularity and the large
capital investment in machinery with a capacity for peak demand.

This method is typically used by operations which cannot store their output (e.g. customer
processing or manufacturing perishable products). However, it can be difficult to achieve
large variations in capacity for different periods.

There are a number of different methods for changing the capacity;

• Overtime and idle time

• Varying the size of the workforce – e.g. seasonal staff
• Using part time staff – e.g. evening shifts
• Subcontracting – e.g. for very large increases in demand capacity

MANAGE DEMAND PLAN

The manage demand plan is where the price is changed depending upon the demand. When
demand is low, the price can be reduced to attempt to increase the number of customers.
The objective is to stimulate the off-peak demand as much as possible. This may also be
achieved by using appropriate advertising.

A more radical approach to fill periods of low demand is to develop alternative products or
services which can be produced on the existing processes, but with different demand
patterns throughout the year.

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MIXED PLANS
Most organizations use a mixture of these three plans to match their objectives.

Dynamics of Capacity Management

Capacity management is a dynamic process, involving controlling and reacting to actual
demands and actual capacity as it occurs. The capacity control process is a sequence of
partially reactive capacity decisions.

At the beginning of each period, the demand forecast, current capacity and inventory are
considered. This is then used to make plans for the next period. It is important to consider
the short-term and long-term planning for capacity.