What is Strategic Capacity Management? Requirements, Types, Planning, Advantages

What is Strategic Capacity Management?

Capacity refers to the ability of a production unit to produce something using available resources within a given period. The capacity of a production unit depends on the demand for products or services, which is largely influenced by the location where products and services are sold. For example, the demand for fast food is higher in urban areas as compared to rural areas.

The capacity of a production unit is expressed in terms of input or output. For example, the capacity of a car manufacturing organization can be expressed as the number of cars produced per year. In this case, capacity is expressed in terms of the output.

On the other hand, in situations where the output is too complex, the capacity is expressed in terms of the input. For example, the capacity of a hospital is expressed in terms of the total number of beds. Here, you should note that the capacity of a production facility depends on various factors, such as demand, cost, and scale of production.

When it comes to measurement, capacity is easy to measure in some cases, for example, in the case of a car manufacturing organization where it is easier to measure the number of cars (output) produced per day. The concept of aggregation can also be used in these cases.

Aggregation implies using a standard average production rate expressing capacity in terms of the standard product. However, in certain cases, where measuring output is not that easier such as in the case of an airline, the capacity may be expressed by the total number of seats, which are measured in terms of the input.

Future capacity needs can be viewed from a long-term or short-term perspective. The forecast of demand for different products is based on past data and the actual orders received by the firm. The existing capacity is adjusted to meet the demand. When we go for the long-term perspective, the requirements are fetched by either expanding or shredding the extra capacity, and some currently available resources.

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How Capacity is Managed in Production and Operations

Capacity management is all about ensuring whether the available capacity of a production facility is sufficient to meet business requirements effectively. An organization must manage its capacity for the smooth working of its production processes. If the capacity of an organization is not managed properly, it may harm its financial performance. Let us understand the management of capacity in a production facility with the help of an example. Suppose an organization wants to prepare its production schedule.

For this, the production department of the organization needs to determine the available and required capacity of its production facility. The department finds out that the available and required capacity of the organization does not match. Considering the present situation, the production manager needs to decide in such a manner that the organization can run its production process effectively.

The decision by the Production Manager

In this case, the production manager can take any of the following decisions:

Ignore the Issue

The production manager can choose to ignore the imbalance between the required and available capacity. This decision may have two consequences, which are as follows:

• If the available capacity of the production facility is not sufficient to meet business requirements, there would be a pile of pending orders. This would result in undue delay in the delivery of products.
  
  
• If the available capacity is greater than the required capacity, there would be a surplus of finished goods. This would lead to a significant increase in different types of costs, such as the holding cost of inventory and wastage cost.

Introduce Changes in Required or Available Capacity

The production manager needs to make alterations to the existing production plans, master schedules, etc. Apart from this, the production manager can also use the following alternatives to make alterations to the existing capacity of the production facility:

• Preparing an efficient production schedule
  
  
• Using alternate routings, that is, ensuring production from a different workstation instead of the one mentioned in the route sheet
  
  
• Shifting employees from the area having the abundant capacity to the area lacking capacity ‰ Outsourcing manufacturing services
  
  
• Employing contract labor according to the situation
  
  
• Introducing or reducing additional work shifts
  
  
• Purchasing new equipment or maintaining the existing one

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Capacity Management in Operations

Capacity management refers to short-term adjustments made in capacity so that it tallies with the forecast demand. Working time is chosen for this. Overtime is used to increase the capacity and short time to reduce it. There are several ways for ensuring capacity management in operations. These are as follows:

• Working Hours and Shift Management: As per the requirement, management can change working hours and shifts.
  
  
• Part-time Staff: Part-time staff members can be deployed to meet the peak demand.
  
  
• Process Adjustment: The process can be adjusted in such a manner that the setup time is reduced.
  
  
• Adjusting Equipment and Process: Work can be expedited and slowed down by adjusting production processes.
  
  
• Self-service: Customers can be encouraged to do some work, for instance, use ATMs or pack their bags in a hypermarket.

The abovementioned measures are short-term adjustments that incur their own cost. Some of these also affect the manpower adversely. These are temporary measures and should be exercised sparingly.

The capacity management process of an organization begins with determining capacity requirements. Let us discuss how to determine capacity requirements in detail in the next section.

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Determining Capacity Requirements

An organization can determine the capacity requirements of a production facility by converting its production schedule into standard hours. The capacity requirement is determined based on various production schedules.

Production schedules	Production schedule’s unit of measurement	Production units for which the capacity requirement is determined
Production plan	The aggregate number of end items	Organization, Facility
Master Schedule	Number of end items	Organization, Facility
Planned order schedules for parts and assemblies	Number of parts and assemblies	Department
Open order schedules for parts and assemblies	Number of parts and assemblies	Work center/machine

Another important factor for determining a capacity requirement is the level at which the capacity should be defined. For example, the estimation of capacity requirement at the machine level requires detailed information about the machine as compared to the estimation of capacity requirement at the facility level. Therefore, capacity requirements for different levels are determined using different methods based on available information.

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Types of Capacity

Capacity can be of different types, which are as follow:

• Fixed Capacity
  
• Adjusted Capacity
  
• Design Capacity
  
• Theoretical Capacity
  
• System Capacity
  
• Potential Capacity
  
• Immediate Capacity
  
• Effective Capacity
  
• Actual or Utilised Capacity

Fixed Capacity

The capital assets of an organization at a particular time are known as fixed capacity. These assets are not liable to change within the short or intermediate range of production planning.

Adjusted Capacity

It entails the size of the workforce, employee working hours every week and the number of shifts, and the extent of sub-contracting.

Design Capacity

It is the planned rate of the output of goods or services under normal or full-scale operating conditions. It is also known as installed capacity.

Theoretical Capacity

It is a kind of idealized goal that can rarely be achieved practically. It may also be defined as the rate of work to be achieved during the functioning of the machine at its full-rated speed 100 percent of the time.

System Capacity

It refers to the optimal output of certain products or services, or a mix of products and services, which a production system can produce at a given point in time.

Potential Capacity

It is the capacity that can be made available within the decision horizon of the top management. For example, it helps senior management in making decisions about the growth of business, investment, etc.

Immediate Capacity

It is the capacity that can be made available within the current budget period.

Effective Capacity

It is the maximum rate of output that can be practically achieved. Effective capacity is always lesser than the design capacity. It is used within the current budget period. It is also known as practical capacity or operating capacity.

Actual or Utilised Capacity

It is the actual output achieved during a particular period. The actual output may be less than the rated output. The reason for this may be actual demand, employee absenteeism, and low productivity levels.

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Process of Capacity Planning

Capacity planning refers to a process of determining the level of capacity required to manufacture a specific product with a defined quantity. Several factors can affect capacity planning. These factors include the number of workers and their skills, the number of machines, the productivity of employees, the number of suppliers, government regulations, and preventive maintenance.

The process of capacity planning involves several activities to be performed in sequential order.

• Identifying demand
  
  
• Measuring the current capacity of the production plant
  
  
• Determining alternative methods for making alterations in the capacity of the production plant
  
  
• Performing the financial, economic, and technical analysis of the alternative methods
  
  
• Selecting and implementing the best alternative

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Advantages of Capacity Planning

Let us now discuss the major advantages of capacity planning as follows:

• Helps in Meeting the Demands of Customers on Time
  
• Increases the Efficiency of Business Operations
  
• Makes the Scheduling System More Effective
  
• Helps in Monitoring Costs
  
• Helps in Setting Up a New Facility

Helps in Meeting the Demands of Customers on Time

If the demand exceeds a particular period, it can be fulfilled by planning production capacity. More resources can be arranged before the commencement of the production process.

Increases the Efficiency of Business Operations

Advanced capacity planning helps in the smooth functioning of business operations, as the production process gets organized due to capacity planning.

Makes the Scheduling System More Effective

It helps in creating delivery schedules for supplies and shipping schedules for finished goods.

Helps in Monitoring Costs

Carefully planned capacity helps the organization monitor its cost during the growth or recession period.

Helps in Setting Up a New Facility

The needs of facilities and personnel can be more accurately identified by using the data of the capacity planning of the existing facility.

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Types of Capacity Planning

Capacity planning decisions of an organization can be classified into three different categories based on time horizons. These three types are discussed as follows:

• Long-term Capacity Planning
  
• Intermediate-term Capacity Planning
  
• Short-term Capacity Planning

Long-term Capacity Planning

It is concerned with accommodating major changes that affect the overall level of output in the long run. It involves decisions concerning the overall capacity, such as facility size, and acquisition or disposal of equipment, buildings, and facilities.

Long-term capacity decisions are taken when an organization plans to produce a new product or expand the existing product. These decisions may lead to major changes in the overall capacity of the production facility. Therefore, while taking long-term capacity decisions, an organization needs to estimate the demand accurately and implement various strategies for meeting the demand.

Intermediate-term Capacity Planning

Intermediate-term capacity planning is also known as aggregate planning. It is the process of planning the quantity and timing of output over an intermediate time horizon (3 to 18 months). Within this range, physical facilities are assumed to be fixed for the planning period.

Intermediate-term capacity planning focuses on products in an aggregate manner and not as individuals. Take the example of a paint manufacturer that produces different colors of paint. In the case of intermediate-term capacity planning, the plan will include forecasting demand for the total quantity of paint and not for the different colors of paint separately.

Such type of planning is done by organizations to make more accurate decisions about their capacity as it is often difficult to predict seasonal variations in demand. Thus, the forecasts of product demand in intermediate-term capacity planning are closer to the actual demand for a product in the future.

Intermediate-term capacity planning aims at keeping the costs of operations at a minimum. It matches resources with the expected demand by taking into account a diverse amount of factors, such as decisions on output rates, overtime, employment levels, and changes, inventory levels and changes, back orders, and subcontracting work.

Short-term Capacity Planning

It involves decisions concerning production schedules, workforce levels, and overtime. Such type of planning is done by organizations for a daily, weekly, or quarterly time frame. Generally, the fundamental capacity of a production facility is fixed for short-term durations.

Major facilities of the production facility do not change while small alterations in the capacity are quite possible. Different ways of adjusting capacity based on the varying demands in the short-term time horizon are as follows:

• Use of overtime or idle time
  
• Increasing the number of shifts per day to meet a temporary strong demand
  
• Sub-contracting to another firm

Classification of Capacity Planning

Apart from these three basic types, capacity planning can also be classified as:

• Finite Capacity Planning
  
• Infinite Capacity Planning

Finite Capacity Planning

While fixing the period according to customers’ required delivery date or processing cycle, one can plan backward to accommodate these times. This type of planning is known as finite capacity planning. Time and capacity are two conflicting constraints in finite capacity planning.

Infinite Capacity Planning

If the time of processing is not a constraint, as, in the case of the MTO (Make-to-Stock) production system, a forward plan based on the finite capacity is created. This type of capacity planning is known as infinite capacity planning.

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Capacity Focus

The capacity focus concept is operationalized in a production facility through the ‘Plants within Plants (PWPs)’ system. Such organizations focus on a fairly limited set of production objectives. A capacity-focused production facility may have multiple PWPs, each of which may perform with separate equipment, process policies, workforce, production methods, and so on (even if performing under the same roof).

The focus concept helps in finding the best operating strategy for each unit of the production facility. As each PWP focuses on its production objectives, it does not have to be concerned about excelling in other areas of manufacturing performance. This allows each PWP in specialising in their assigned tasks and accomplishing those tasks most efficiently to meet the objectives of the operation.

Here, you must note that capacity focus can only be used in cases when having the full range of capabilities is not necessary or when the production facility has several sub-facilities (PWPs), each with its methods, policies, and equipment. Only in these cases, the best operating level could be determined for each sub-facility and the focus concept could be carried down to the operational level.

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Capacity Flexibility

Capacity flexibility refers to an ability of an organization to rapidly increase or decrease the production level or revise production capability swiftly from one product to another. In other words, capacity flexibility allows an organization to easily change production levels or switch between product types. Such flexibility in production can be achieved through the following means:

• Flexible Facility
  
• Flexible Processes
  
• Flexible Workers

Flexible Facility

The facility is called flexible if it can decrease the changeover time to zero by using movable equipment and utilities that can be easily accessed and routed. Such facilities can adapt quickly to any changes.

Flexible Processes

An organization is said to have flexible processes when it consists of a flexible manufacturing system and simple and easy set-up equipment. It allows the organization to have low-cost switching between products referred to as the economies of scope (an economy of scope is achieved when multiple products are produced at a lower cost in combination than separately).

Flexible Workers

Flexible workers are employees who possess multiple skills. Employees with a variety of skills can be used to perform different tasks efficiently. Flexible workers can switch from one task to another quickly and competently. Unlike specialized workers, these workers receive a broad level of training that helps them the quicker adaption to changes in their work assignments.

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Planning Service Capacity

Service capacity refers to a service system’s ability to deliver the intended service for meeting customer demand. For example, the total number of beds in a healthcare facility shows the service capacity of the facility. Similarly, the square meter area utilized in a supermarket shows the service capacity of the store. Thus, service capacity is the highest possible amount of output that may be attained in a specific period.

Though the planning of service capacity is similar to the planning of manufacturing capacity, there are certainly major differences. In comparison to manufacturing capacity, service capacity is more time and location dependent. Moreover, it is subjected to more volatile demand fluctuations.

Let us discuss these factors in detail:

• Time
  
• Location
  
• Volatility of Demand

Time

Service capacity cannot be inventoried and therefore, it is not possible to store it for further use. Moreover, service capacity cannot be transferred from one customer to another. Thus, the availability of capacity becomes necessary to produce a service when required. For example, you cannot give an unoccupied seat on a previous flight to a passenger if the current flight is full. Thus, in case you do not avail of the service at the specific time, it would perish immediately.

Location

The service capacity requires being located near the customer. A hotel room available in the city ‘A’ would not produce any service to a customer living in city ‘B’. In manufacturing, production may take place at some facility and then the goods may get distributed to customers located at different places. However, this is not possible in the case of services.

A service cannot be differentiated from the facility responsible for providing it. Moreover, services cannot be stored to be distributed later as they are normally produced and utilized at the same time. Thus, a service is produced only when the capacity to deliver the service is distributed to the customer.

Volatility of Demand

The volatility of demand on a service delivery system is usually very high. This happens mainly because services cannot be stored. In manufacturing, an inventory of goods helps an organization maintain a balance between demand and supply.

However, this is not possible in the case of services. Services cannot be saved, stored, or resold. If unconsumed, they simply go to waste. Take an example of an empty seat in an airplane, an unoccupied hospital bed or hotel room, or an hour without a patient on the day of a physician; these all are lost opportunities for the service providers.

Services also face the situation of unpredictable demand due to the reason that customers interact directly with the production system. Moreover, every customer often has different needs and requires different numbers of transactions. This not only generates variability in the processing time needed for each customer but also brings inconsistency in the minimum capacity requirement.

Apart from these two reasons, the third major reason for volatility in service demand is the constant change in consumer behavior. The behavioral pattern of consumers affects the demand for any service to a great extent. For example, it is not easy to book a hotel room at some hill station during summer as at that time the demand for hotel rooms is higher due to summer vacation. However, you can easily get rooms in winter or rainy season due to low or moderate demand.

Thus, an organization, while planning service capacity must consider these factors in detail.

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Capacity Utilisation and Service Quality

Service capacity planning considers a day-to-day relationship between service capacity utilization and service quality. Capacity utilization measures the extent to which the productive capacity of a service is being used. In other words, it can be defined as the percentage of total capacity that is being achieved in a specific period. Capacity utilization can be calculated by using the given formula:

Capacity utilisation (expressed in %) = Actual level of output/maximum possible output × 100

A service organization requires handling its capacity carefully so that the optimum level of capacity utilization is achieved at any given point in time. When capacity utilization exceeds a certain limit, it would negatively affects service quality and customer complaints are bound to happen. This happens because the organization is serving more customers than its capacity.

The possible consequence could be that some customers may remain unserved and thus, it would result in a loss of business opportunities. Apart from this, served customers would not be able to get the full attention of employees and as there would be a long waiting time to serve each customer; the total quality of service would be degraded.

Excessive capacity utilization in terms of human resources and other equipment would result in poor quality services. Service organizations should handle such situations carefully as those may spread dissatisfaction among customers, which could ultimately lead to the erosion of the organization’s customer base.

On the other hand, in the case of low capacity utilization, the service provider could give more attention to every customer and therefore, could focus more on service quality. In such situations, customers receive a higher quality of services as they get minimum waiting time and an opportunity to fully utilize the capacity of the facility.

However, this situation leads to excess production capacity where human resources as well as other equipment remain underutilized. In such a scenario, the production cost per unit would be higher as organizations usually have a fixed cost component. High costs and low revenue may lead the organization to incur a financial loss.

Thus, service organizations should focus on maintaining a balance between capacity utilization and demand. Only this would lead to providing high-quality services to customers at the maximum rate of profit.

However, there are certain exclusions. Many experts believe that low capacity utilization rates are appropriate when both the degree of uncertainty and stakes are high in the business. For example, healthcare emergency rooms and fire stations should aim for low utilization due to the high level of uncertainty and the life-or-death nature of their service activities. Relatively predictable services, such as postal services, restaurants, etc. may plan to operate at a higher rate of capacity utilization.

Service organizations, considering the nature of their business, should focus on understanding demand patterns related to services offered by the organization in a specific period. This could help them in taking measures regarding how to utilize capacity (concerning demand) to reach the optimum level and thereby deliver high-quality services to their customers.