Generation of Alternative Capacity Plans

When capacity gaps have been identified, alternative plans can be considered. These alternatives may involve the size and timing of added capacity, the use of overtime and multiple shifts, the use of outside capacity sources, the absorption of lost sales, or the location of new capacity.

Large or Small Capacity Increments:

When an enterprise enjoys stable demand growth, the issues are centered on how and when to provide the capacity rather than if capacity should be added. Taking the data fro expected capacity requirements, there is linear growth in capacity requirements of 1000 units per year. One issue is whether capacity should be added more often in smaller increments to keep up with demand or less often in larger increments.

Both figures assume that demand will be met through production, so there will be slack capacity immediately after an addition. The slack capacity declines as requirements increase and it falls to zero just before the next increment to capacity is installed, if the timing is perfect. Whether smaller or larger increments of capacity will be more economical depends on the balance of incremental capital and the operating costs of a particular organization and on whether or not economies of scale exist. A unit of capacity added now may cost less than a unit added later, yet the slack capacity must be carried as additional overhead until it is actually productive.

Alternative Sources of Capacity:

Another issue in generating capacity plans is whether or not alternative capacity sources can be used near a capacity limit. Figure assumes that demand is met through regular productive capacity. Figure assumes that the timing of the increments to capacity makes it necessary to use overtime, multiple shifts, and subcontracting where they are feasible. The cost effects of using alternative sources of capacity are the trade off of some of the costs of carrying slack capacity against the costs of overtime and multiple shifts, productivity losses resulting from pushing capacity beyond normal limits, and the extra costs of subcontracting units of output.

Again whether or not the use of alternative sources of capacity will be more economical for a particular organization depends on the balance of incremental capital and operating costs.

Lost sales:

Another alternative to meeting demand through regular productive capacity or alternative capacity sources is to absorb some lost sales. This is a risky strategy because it is possible that market share could be lost permanently. On the other hand, near capacity limits, contribution decline because of overtime and multiple shift premiums and productivity losses. Thus, absorbing lost sales could be more economical in some situations, yet managers hesitate to take the risk of losing market share. They may be forced into absorbing lost sales at capacity limits, but they would resist the idea of planning to absorb lost sales as a part of a capacity planning strategy.

The question of the location of new capacity is strategically important and involves assessments of market location, system distribution costs, and other factors.

Cost behavior in relation to Volume:

We are particularly interested in cost behavior at the capacity limits of first and second shifts because this is the condition that prevails when capacity is added. Near capacity limits, variable costs increase as a result of the increased use of overtime and subcontracting and because of congestion when facilities are maximally utilized.

On the other hand, when new capacity is first installed, it is not fully utilized unless the expansion is long overdue. Therefore, variable costs for the new capacity are likely to be relatively high, reflecting poor utilization of labor and other resources. But the new capacity relieves the stress on existing facilities, making it possible to eliminate overtime and/or multiple shifts.

The combination of new and existing capacity then reflects a variable cost structure that will improve as the new capacity becomes loaded. The fixed costs of existing capacity are spread over a larger and larger number of units as the volume is driven through the new capacity limits to second and even third shift levels. The fixed cost per unit declines as existing facilities become more fully utilized. New capacity that is relatively poorly utilized will have high fixed costs per unit.