Capacity

Capacity

Overview

Capacity management is strategically important because it determines a firm’s ability to meet demand and achieve efficiency goals. Capacity decisions involve trade-offs between cost, responsiveness, and risk.

ELI5

Capacity is like planning a pizza party for your class:

Capacity = How many pizza slices you can make in one hour

Capacity Utilization = How much of your oven space you’re actually using

• If your oven fits 10 pizzas but you only bake 7 = 70% utilization
• High utilization = oven is busy (efficient but can’t handle surprises)
• Low utilization = oven has room (flexible but maybe wasteful)

Chase Strategy = Making exactly enough pizza for each lunch period

• Period 1: 50 kids want pizza → make 50 slices
• Period 2: Only 20 kids → make 20 slices
• Good: No leftover pizza
• Bad: Hiring extra cooks for busy periods, then firing them

Level Strategy = Making the same amount every period

• Make 35 slices every period (the average)
• Good: Same cooks every day, stable schedule
• Bad: Leftover pizza when demand is low, not enough when demand is high

The Tricky Part: Hospitals keep EXTRA capacity (empty beds) on purpose — because emergencies can’t wait!

Quick Navigation

Subtopic	Key Concepts
Capacity Definition	Definition, measurement, strategic planning
Capacity Utilization	Formula, best operating level, economies of scale
Chase Strategy	Matching capacity to demand period by period
Short-term Service Options	Overtime, part-timers, subcontracting, leasing

Key Concepts Summary

Capacity & Utilization

• Capacity: The ability to hold, receive, store, or accommodate; in business, the amount of output a system can achieve over a specific period
• Capacity Utilization Rate: Capacity used ÷ Capacity available
  • Measures how close the firm is to its best operating level
  • High utilization = efficient but less flexible
  • Low utilization = flexible but potentially wasteful
• Strategic Capacity Planning: Determining overall level of capacity-intensive resources (facilities, equipment, labor force) to support long-range competitive strategy

Chase Strategy

• Definition: Produces exactly what is needed each period; sets labor/equipment capacity to satisfy period demands
• Advantage: Minimal inventory, matches demand precisely
• Disadvantage: Constantly changing short-term capacity (hiring/firing, overtime/idle time)
• Best For: Service operations, perishable products, high inventory cost items

Capacity Planning Concepts

Concept	Description	Application
Design Capacity	Maximum output under ideal conditions	Theoretical maximum
Effective Capacity	Maximum output under normal constraints	Realistic maximum
Actual Output	What is actually produced	Always ≤ Effective Capacity
Utilization	Actual Output ÷ Design Capacity	Efficiency measure
Best Operating Level	Output level that minimizes average cost	Economies of scale point

Utilization and Service Quality

The relationship between capacity utilization and service quality is critical:

• Low utilization appropriate when: Uncertainty is high, stakes are high (emergency rooms, fire departments)
• High utilization acceptable when: Demand is predictable, low customer contact (commuter trains, postal sorting)

Examples

From Slides:

• Capacity Utilization Rate: A measure of how close the firm is to its best possible operating level [Chapter 5]
• Chase Plan Example:
  • Period 1: 500 units × 0.64 std / 160 = 2 people (need to fire 16 people)
  • Constantly adjusts workforce to match demand exactly
• Level Plan Example:
  • Production rate = 28,000 units ÷ 7 periods = 4,000 units/period
  • Workforce = (4,000 × 0.64) ÷ 160 = 16 people (constant)

Enriched Examples:

• Restaurant Capacity: A restaurant with 100 seats operating at 70% utilization (70 seats filled) can handle walk-in customers. At 100% utilization, any fluctuation causes delays and poor service.

• Airline Capacity: Airlines deliberately maintain some capacity buffer for irregular operations (weather, mechanical). 100% utilization would mean no recovery from disruptions.

• Amazon Holiday Capacity: Amazon builds capacity for peak (holiday) demand but uses it for non-peak periods through expansion into new services (AWS, advertising) to improve overall utilization.

• Emergency Room: Maintains 30-40% utilization to handle unexpected arrivals. A 90% utilized ER would have dangerous wait times for critical patients.

Formulas

Capacity Utilization Rate = Capacity Used ÷ Capacity Available

Labor Productivity = Output ÷ Labor Input

Revenue per Employee = Total Revenue ÷ Total Employees

Asset Productivity = Output ÷ Assets Employed

Essay Angle

An essay on capacity would likely ask you to recommend a capacity strategy (chase vs. level) for a given scenario or to analyze utilization trade-offs. Framework: (1) define capacity and utilization, (2) analyze demand patterns (predictable vs. uncertain), (3) evaluate chase vs. level trade-offs, (4) recommend strategy with justification based on cost, service, and risk considerations.

MCQ Watch-outs

• Utilization ≠ Efficiency: High utilization doesn’t always mean good performance. In high-uncertainty services (ER, fire department), low utilization is optimal.
• Chase vs. Level: Chase = match demand exactly (constant hiring/firing). Level = constant workforce (build inventory in low periods, draw down in high periods).
• Capacity Planning Timeframe: Strategic capacity planning is LONG-RANGE (facilities, major equipment). Short-term adjustments (overtime, part-time) are tactical.

Memory Aid

CAPACITY = Capacity Available, Plan Appropriate, Yield In Targeted Capacity

• Capacity definition (output per period)
• Availability (design vs. effective)
• Planning horizon (strategic vs. tactical)
• Availability trade-offs (cost vs. flexibility)
• Chase strategy (match demand)
• Inventory relationship (level builds, chase minimizes)
• Throughput (actual output)
• Yield (utilization rate)

Utilization Formula: “Used over Can” — Used ÷ Can (Capacity Used ÷ Capacity Available)

Sources

Chapter5.pptx [Slide 3-8, 17-18, 21-22]