Risks and Strategic effects – Capacity plans

Many important effects of alternative capacity plans can be represented in an expanded decision tree. For example, if a technological breakthrough can be assigned a probability of perhaps p= 0.30, then a branch in the tree can be structured for “no breakthrough”(p=0.70) and breakthrough”(p=0.30). Other risks can be handled similarly in the formal decision tree analysis.

Many strategic effects, however, must be evaluated through managerial trade-off. If the most economical plan involves lost sales and possibly a decline in market share, the manager must weigh the lower expected costs against the loss of market share. Specific capacity plans might have an impact on competition, flexibility of operations, market locations, labor policies, market share, and so on.

Framework for analyzing capacity planning decisions:

This similarity is not surprising since capacity expansion often involves technological choices and contingencies. We will use the same simple format structure alternatives, set horizon and criterion, evaluate alternatives and decide but adapt it to the special nature of capacity planning.

Structuring Alternatives:

Capacity expansion involves extremely important strategic issues that must be addressed before the balance of the planning process can proceed. These issues involve existing industry capacity, where it is located, the nature and strength of the competition, the status of technology in the industry including the potential for technological change within the industry, and so on. These factors have a strong influence on whether or not to pursue an expansion at all well as on the structuring of alternatives for expansion.

Given a “go” signal for the capacity planning process, alternatives need to be structured around different locations that may competitive advantages, the process technology that can be used including the impact of future technological improvements or even radical changes and the nature of the product and its markets. One of the outcomes will be in terms of the nature of the risk of the situation with regards to both the product and its markets (mature or new and risky), and the anticipation of chance occurrences or developments, usually involving technological choices. If the product and its markets are mature and stable and the technology is also stable, then the alternatives are usually straightforward and simple involving large versus smaller units, economies of scale, the use of alternative sources of capacity, alternative locations and so on. On the other hand if the situation is risky for any of the reasons discussed, there are probably chance events that need to be taken into account and a decision tree will prove valuable in analyzing the alternatives. As with the analysis of technological choice, a “do nothing” alternative should be included in the structure of alternatives.

Horizon and choice of criteria for decision:

Capacity expansion invariably involves the creation of assets that have value over long periods. the building and the process equipment normally involve the largest assets of an enterprise and since the alternatives may involve expenditures and revenues with differing timings, present values should be used to place all of the monetary values on a common basis for comparison. But if we are dealing with risky situations that require decision-tree analysis then probabilities must be taken into account and expected monetary values become the criteria as was true with our framework for analyzing technological choice.

Evaluation of Alternatives and Decisions:

Although the economic criteria are of great significant in the basic decision to expand capacity, they may yield to qualitative differences in the selection of an alternative. Questions of location and timing may depend on qualitative criteria that cannot be reflected in the economic analysis. Competitive factors among the alternatives may be of extreme importance and may outweigh economic differences among the alternatives in the minds of the decision makers. As with the analysis of technological alternatives, decision makers can make trade-offs between economic and subjective values, thereby “pricing” the subjective advantages. Although most capacity decision problems involve multiple criteria.