WHAT IS CAPACITY?

In operations 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. To illustrate this, consider a car park which can hold a maximum of 500 vehicles at any given time. The actual processing capacity of the car park will vary depending on how it is used. For example, if the car park is opened for eight hours a day and will be occupied only by full time office workers, the processing capacity will be 500 vehicles per day. On the other hand, if the car park is opened to shoppers, each averaging two hours, the processing capacity will be up to 2000 vehicles per day. In reality, your business, like many others, does not operate at the maximum processing capacity. This can be either because of insufficient demand, or as a strategic policy, so that the operation can quickly respond to new orders. Usually, you will find that some parts of your operations are operating below capacity while others are at their peak (also referred to as the ceiling'). The parts that are at the ceiling are the areas of concern for your business as they are the capacity constraint for the whole operation and may potentially cause your business to miss valuable opportunities. Hence, it is critical that you ensure that your business at all times, have enough capacity to meet all current and future demands. MEASURING CURRENT CAPACITY Planning long-term capacity is a major task as it involves investing capital in new facilities and equipment. However it is critical to the success of your business. Some of the questions you must consider when selecting a capacity strategy include: How much of a cushion is needed to handle variable or uncertain demand? Should you expand capacity ahead of demand, or wait until demand is more certain? In order to answer these questions, you must be able to measure your current capacity with a systematic approach. Measuring capacity and utilization In general, capacity can be expressed in one of two ways: output measures of capacity and input measures of capacity.

Output measures of capacity are best suited when it is being applied to individual processes within an organization, or if a relatively small number of services and products are offered. For example, a car manufacturing plant would be measured in terms of number of cars produced per day. However, as the amount of customization and variety increases, this method flexible processes. For example, a tailor specializing in custom suits would use this method to express capacity. Utilization refers to the proportion of time a process is in actual use compared to its design capacity. It is measured as the ratio of average output rate to maximum capacity and is expressed as a percent. This formula allows you to determine whether or not you should extra capacity or eliminate unneeded capacity. Utilization = average output rate/maximum capacity X 100% When using this formula, the average output rate and the maximum capacity must be measured in the same terms, that is, time, customers, units or dollars. Maximum capacity refers to the greatest level of output that a process can reasonably sustain for a longer period, using realistic employee work schedules and the equipment currently in place. ECONOMIES OF SCALE A concept known as economies of scale states that the average unit cost of a service or good can be reduced by increasing its output rate. The reason economies of scale can drive costs down when output increases include: Fixed costs are spread over more units Construction costs are reduced Costs of purchased materials are cut Process advantages are found However, at some point, a facility can become so large that diseconomies of scale set in. This is when the average cost per unit increases as the facility's size increases. The reason is that excessive size can bring complexity, loss of focus, and inefficiencies that raise the average unit cost of a service or product. CALCULATING CAPACITY CUSHION One of the things you must consider before making any capacity decisions is the desired amount of capacity cushion you want your operations to have. The capacity cushion is the amount of reserve capacity a process uses to handle sudden increases in demand or temporary losses of production

capacity. It measures the amount by which the average utilization (in terms of total capacity) falls below 100 percent. The formula is: Capacity cushion = 100% - average utilization rate (%) As a general guide, the average utilization rate for any resource should not get too close to 100 percent over the long term, with the exception of some processes from time to time in the short run. When the average utilization rates approach 100 percent, it is usually a signal to increase capacity or decrease order acceptance to avoid declining productivity. Further, if demand keeps increasing over time, you should think about increasing the overall long-term capacity in order to provide some buffer against uncertainties. The appropriate size of the cushion varies by industry. For example, large cushions are ideal for front-office processes where customers expect fast service times. Some other considerations that should be factored into cushion decisions include employee absenteeism and vacations. However, a different perspective is that small cushions are preferable because unused capacity costs money. EXPANDING CAPACITY There are two other issues that should be addressed before making capacity decisions, that is, when to adjust capacity levels and by how much. These two things are related, that is, if demand is increasing and the time between increments increases, the size of the increments must also increase. The following two extreme strategies may be helpful if you are looking to expand your capacity: the expansionist strategy and the wait-and-see strategy. Expansionist strategy The expansionist strategy involves staying ahead of demand and therefore minimizing the chance of sales lost to insufficient capacity. This strategy is often favored as it can result in economies of scale, allowing an organization to reduce its costs and compete on price. Implementing this strategy can either result in increasing your overall market share or act as a form of pre-emptive marketing. For example, if you decide to make a large capacity expansion or at least announce that you have plans to do so, you can pre-empt the expansion of other organizations. As a result, your competitors must sacrifice some of their market share or risk burdening the industry with overcapacity.

However, in order for this strategy to be successful, you must have the credibility to persuade your competitors that you actually have the resources to go ahead with your proposed expansion and you must announce it before they can act. Wait-and-see strategy The wait-and-see strategy involves lagging behind demand and using shortterm options such as overtime, temporary workers, and subcontractors to deal with any shortfalls. The aim of this strategy is to expand capacity in smaller increments, such as renovating existing facilities rather than building new ones. By following demand, the risk of overexpansion based on overly optimistic demand forecasts, obsolete technology, or inaccurate assumptions regarding your competitors are significantly reduced. However, this is not to say that the wait-and-see strategy does not have any risks of its own. If you decide to adopt this approach, you may be pre-empted by a competitor or may not be able to respond to sudden and unexpected high levels of demand. This strategy is more suited to businesses that are focused on the short-term. As an operations manager, you will have to select the most appropriate strategy for your organizations needs. Although the abovementioned strategies are extreme and may not be suited for everyone, there are other strategies in between that may be adopted. Such a strategy is the follow the leader' strategy, which basically involves expanding capacity when your competitors do so. This way, if they are right, then so are you and nobody gains a competitive advantage, but if they make a mistake, then so do you, which means that everyone has to deal with overcapacity. LONG-TERM CAPACITY DECISIONS Although every business will have different needs when it comes to capacity, the following four-step procedure can be used as a general guide to plan for long-term capacity decisions:[1] Estimate future capacity requirements Identify gaps by comparing requirements with available capacity Develop alternative plans for reducing the gaps Evaluate each alternative, both qualitatively and quantitatively, and make a final choice.

Step 1: Estimate capacity requirements A process's capacity requirement is what its capacity should be for a future period to meet the organizations demand, taking into account the desired capacity cushion.[2] Capacity requirements can be expressed in one of two ways: with an output measure or with an input measure. Step 2: Identify gaps A capacity gap refers to the difference between projected capacity requirements and current capacity, whether it is negative or positive. If multiple operations and several resource inputs are involved, making long-term capacity decision can become a very complex task. For example, if you decide to only expand the capacity of certain operations, your overall capacity may be increased. On the other hand, if one of your operations is constrained, then your overall process capacity will only increase if the constrained operation is also increased. Step 3: Develop alternatives Once you have estimated your organisation's capacity requirements and identify gaps, you should develop alternative plans to cope with projected gaps. One alternative, known as the base case, is to do nothing and simply lose orders from any demand that exceeds current capacity or incur costs because capacity is too large. Other alternatives may include the various timing and sizing options such as the expansionist and wait-and-see strategies. Some alternatives for reducing capacity include the closing of facilities, laying off employees, or reducing the days or hours of operation. Step 4: Evaluate the alternatives The final step involves evaluating each alternative both qualitatively and quantitatively. Qualitatively, you must look at how each alternative fits the overall capacity strategy.. Some of the more important issues to consider include the uncertainties of demand, competitive reaction, technological change, and cost estimates. Having good knowledge and experience will certainly help in this process. You can also use the what-if' analysis to further assess each alternative's implications before making a final choice. Quantitatively, you must estimate the change in cash flow for each alternative over the forecast time horizon compared to the base case. When undertaking this task you should only be concerned with calculating the cash flows attributable to the project.