Importance of Capacity Planning

Importance of capacity planning:
Capacity planning is the process of determining the production capacity needed by an organization to
meet changing demands for its products.[1] 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 overall objective of strategic capacity planning is to reach an optimal level where production
capabilities meet demand. Capacity needs include equipment, space, and employee skills. If production
capabilities are not meeting demand, high costs, strains on resources, and customer loss may result. It is
important to note that capacity planning has many long term concerns given the long term commitment
of resources.
Managers should recognize the broader effects capacity decisions have on the entire organization.
Common strategies include leading capacity, where capacity is increased to meet expected demand,
and following capacity, where companies wait for demand increases before expanding capabilities. A
third approach is tracking capacity which adds incremental capacity over time to meet demand.
Finally, The two most useful functions of capacity planning are design capacity and effective
capacity. Design capacity refers to the maximum designed service capacity or output rate and
the effective capacity is the design capacity minus personal and other allowances. These two functions
of capacity can be used to find the efficiency and utilization. These are calculated by the formulas below:
Efficiency = Actual Output/ Effective Capacity x 100%
Utilization = Actual Output/ Design Capacity x 100%

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The capacity decision is strategic and long-term in nature. Capacity planning is described as matching
the capabilities of an organization with the predicted level of future demand. Many organizations
become involved with capacity planning due to changes in demand, technology, the environment, etc.
Organizations have capacities or limits that their system can handle.
Three key inputs to capacity planning:

1. The kind of capacity that will be needed
2. How much capacity will be needed
3. When will it be needed
*Accurate forecasts are critical to the planning process
Determinants of Effective Capacity
 Facilities: The size and provision for expansion are key in the design of facilities. Other facility factors
include locational factors (transportation costs, distance to market, labor supply, energy sources). The
layout of the work area can determine how smoothly work can be performed.
 Product and Service Factors: The more uniform the output, the more opportunities there are for
standardization of methods and materials. This leads to greater capacity.
 Process Factors: Quantity capability is an important determinant of capacity, but so is output quality. If
the quality does not meet standards, then output rate decreases because of need of inspection and
rework activities. Process improvements that increase quality and productivity can result in increased
capacity. Another process factor to consider is the time it takes to change over equipment settings for
different products or services.
 Human Factors: the tasks that are needed in certain jobs, the array of activities involved and the
training, skill, and experience required to perform a job all affect the potential and actual output.
Employee motivation, absenteeism, and labor turnover all affect the output rate as well.
 Policy Factors: Management policy can affect capacity by allowing or not allowing capacity options such
as overtime or second or third shifts
 Operational Factors: Scheduling problems may occur when an organization has differences in
equipment capabilities among different pieces of equipment or differences in job requirements. Other
areas of impact on effective capacity include inventory stocking decisions, late deliveries, purchasing
requirements, acceptability of purchased materials and parts, and quality inspection and control
procedures.
 Supply Chain Factors: Questions include: What impact will the changes have on suppliers, warehousing,
transportation, and distributors? If capacity will be increased, will these elements of the supply chain be
able to handle the increase? If capacity is to be decreased, what impact will the loss of business have on
these elements of the supply chain?
 External Factors: Minimum quality and performance standards can restrict management's options for
increasing and using capacity.
 Inadequate planning can be a major limiting determining of effective capacity.
The most important parts of effective capacity are process and human factors. Process factors must be
efficient and must operate smoothly, if not the rate of output will dramatically decrease. Human factors
must be trained well and have experience, they must be motivated and have a low absenteeism and
labor turnover. In resolving constraint issues, all possible alternative solutions must be evaluated. This is
possible by using CVP analysis and the Break-Even Point formula.
Steps in the Capacity Planning Process

1. Estimate future capacity requirements
2. Evaluate existing capacity and facilities and identify gaps
3. Identify alternatives for meeting requirements
4. Conduct financial analyses of each alternative
5. Assess key qualitative issues for each alternative
6. Select the alternative to pursue that will be best in the long term
7. Implement the selected alternative
8. Monitor results

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Importance of capacity planning:

Efficiency = Actual Output/ Effective Capacity x 100%

Utilization = Actual Output/ Design Capacity x 100%

Three key inputs to capacity planning:

Steps in the Capacity Planning Process

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