Capacity planning

• Capacity


  The level of output that the current system can produce in a specified period
• Capacity is very important to the organization, as it needs to be aware of capability of its production facilities
• Design capacity


  The total achievable capacity if all equipment and processes are working in perfect order
• Effective/Efficient capacity


  The estimated capacity that would result in the efficient operation of the business
• Capacity utilization


  A measure of the percentage of the firm's total capacity that is being used
• Calculating capacity utilization


  Actual output / Maximum capacity
• Importance of capacity utilization


  • Determines if demand can be met
  • Has major implications on the level of fixed costs
  • Results in lower "per unit" fixed costs
  • Idle machinery and equipment can be put to better use to generate revenue
• Demand is less than capacity


  Demand can be met by the firm
• Demand exceeds capacity


  The firm will be unable to meet customer needs, and will result in lost sales
• Total fixed costs incurred

  Positively related to the capacity of the organization
• Capacity utilization is at a high rate


  Average fixed costs will be spread out over many units, unit fixed costs will be relatively low
• Capacity utilization is low


  Fixed costs will have to be borne by fewer units and unit fixed costs will rise
• Factors that may cause a firm to produce below full capacity

  • Deficient demand due to a lack of income or changes in tastes and preferences of consumers
  • Stiff competition and losing market share
  • Seasonal demand
  • Failed marketing campaign
  • Recent increase in capacity
• Risks of having low capacity

  • Higher per unit costs
  • Less likely to breakeven
  • Restricted cash flows
• Methods of increasing capacity utilization

  • Increase sales through promotional activities
  • Redeploy unused resources
  • Employ seasonal or part time workers
  • Outsource aspects of production process
• Calculating stadium capacity


  1. Capacity utilization = Actual attendance / Stadium capacity

  2. Stadium capacity = Actual attendance / Capacity utilization
• Economies of scale


  The cost advantages that enterprises obtain due to increasing their scale (quantity) of operation in the long run
• Diseconomies of scale


  The cost disadvantages that enterprises face due to increasing their scale (quantity) of operation in the long run
• Costs per unit will be falling. Therefore, economies of scale occur when increasing output leads to lower long-run average costs
• Economies of scale


  • If a business has a fixed cost of $10,000, the first unit it produces would bear all the cost plus any variable costs. If the firm expands its production and produces 1,000 units, the fixed cost per unit now become $10. The firm therefore benefitted from its decision to produce more, as its fixed cost per unit fell drastically.
• Internal economies of scale

  The reduction in costs that a firm gains directly as it increase the size/scale of its operations
• External economies of scale

  Where all firms in an industry benefit from lower unit costs as the entire industry increases in size
• Internal economies of scale

  • Purchasing economies
  • Managerial economies
  • Technical economies
  • Financial economies
  • Marketing economies
• Purchasing economies


  Larger firms can afford to buy larger quantities of raw materials and receive better prices and trade discounts
• Managerial economies


  Larger firms can take advantage of specialization of labor instead of one person doing many tasks
• Technical economies


  Larger firms can utilize larger and more efficient machinery and flow production on an assembly line
• Financial economies


  Larger firms have better bargaining power, more collateral, and can access financing more easily at lower interest rates
• Marketing economies


  Larger firms can implement more effective advertising and promotional tools
• External economies of scale

  • Improvement in transport & communication links
  • Training and education
  • Development of auxiliary services
• Diseconomies of scale


  Factors that increase unit costs as a firm's scale of operation increases beyond a certain size
• Causes of diseconomies of scale

  • Poor communication
  • Demotivation
  • Lack of control and coordination
  • Increasing costs of resources
• Poor communication


  Large-scale operations lead to long and bureaucratic communication, poor feedback to workers, and distortion of messages
• Demotivation


  Larger organizations make it more difficult to directly involve every worker and give them a sense of purpose, leading to low motivation and reduced productivity
• Lack of control and coordination

  Business expansion leads to many departments, divisions, and products, making it difficult for management to ensure all employees are working towards the goals of the business
• Increasing costs of resources

  When industries become large and reach capacity, there is a rising demand for factors of production like skilled labor and warehousing space, causing factor prices to increase and average costs to rise