Capacity planning may be defined as the exercise of assessing and establishing the production capacity of a manufacturer with a view to matching the production level with the fast-changing demand for its products.
It is a long-term strategic decision, which is required to be taken meticulously and cautiously, taking into consideration all the relevant factors, especially the availability of various resources. The decisions taken in this regard have far-reaching impacts on the financial resources of a business organization.
Definition of Capacity Planning
Some scholars have also defined it as “the study of the level of capacity the organization provides at each stage of the production or service delivery system to meet its objectives.”
For example, in the recent past, the decision to put up an ethylene cracker by a well-known business group or the decision to build a refinery or caustic soda plant by some other industrialists required heavy initial investments as well as the commitment to make further substantial investment in future also. Initial investment in such projects is generally for the acquisition of fixed assets (plants, machinery, equipment, etc.), which are very costly to sustain; in case any change is warranted at a later stage, it becomes prohibitive.
According to the American Production and Inventory Control Society (APICS), “Capacity planning or capacity requirements’ planning is the function of establishing, measuring and adjusting limits or levels of capacity. The term ‘Capacity Requirement Planning in this context is the process of determining how much labor and machine resource requires to accomplish the tasks of production”.
Need for Capacity Planning
Capacity planning is helpful in view of the following factors:
1) One of the objectives of capacity planning is to ascertain the most advantageous level of the facility capacity, with a view to keeping the sum of costs of under-capacity and over-capacity at the lowest possible level.
2) The initial investment in the facility needs to be at a lower level so that a lower break-even volume can be achievable.
3) The facility capacity requires investment on a long-term basis, the reversal of which is rather difficult and expensive.
4) To ensure fulfilling the future demand for products by maintaining the appropriate production level.
Top 7 Objectives of Capacity Planning
The capacity planning process affects various functions, which are as follows:
The relationship between capacity and demand has an impact on overall costs. Surplus capacity levels may lead to higher unit costs on account of under-utilization of resources.
The relationship between capacity and demand also affects revenue. However, this relationship is inversely related. If there is an equal or higher level of capacity, then demand will ensure that demand is fully met and no revenue is lost.
3) Working Capital
Working capital also affects when the firm decides to build up inventory. This may help in the proper handling of demand, but it also leads to higher working capital requirements as the funds requires in the form of goods.
Capacity planning also affects the quality of the goods. If there is a high level of fluctuation in capacity, then it may involve the hiring of temporary staff. Such hiring may disrupt the routine work process, leading to lower efficiency.
Building up inventory is one of the most straightforward ways of meeting the customers’ demand speedily.
If the demand is close to the capacity level of the firm, then the firm will need more margins to deal with unexpected circumstances. It will adversely impact the dependability of the organization.
The surplus capacity leads to higher flexibility, especially volume flexibility. If capacity and demand are in balance, then the set-up may not be able to meet the demands arising due to unexpected circumstances.
Levels of Capacity Planning (as per Organization)
The levels of capacity planning are as follows:
1) Long-Range Capacity Planning
The long term capacity planning is related to the strategic problems of various continuous production systems of the firm. These issues are connected with the location decision of the firm. The technology and transferability of the process to other products are also related to long-term capacity planning. This occurs when the short-term capacity is not working properly. For example, if the firm wants to add a third shift to the present two shifts, then the output does not increase. The subcontracting arrangement must be done in a shorter-range capacity planning so the firm will increase the capital layout and equipment and change the layout of the firm. It needs to add extra plant space or build a new plant.
2) Short-Range Capacity Planning
The short term capacity planning is related to the problem of scheduling, shifts of workers, and balancing resources capacities. Short-term capacity planning aims to manage unanticipated changes in demand in a proper economic situation. The time of short-term planning is for a few days but exists for more than six months.
The changes for doing short-term capacity changes are more and also has the decision not to fulfill the demand. The way to increase the capacity in the short term is by working overtime. This is a very common method which is adjustable and economical. Suppose the firm pays one and a half times the normal labor rate, then it leaves the cost of hiring, training, and giving extra benefits. It acts as a way for increasing the wages of the firm.
The various other resource-increasing methods are present when the overtime method does not work properly. These alternative methods can be increasing the shifts, appointing casual or part-time workers, the application of floating workers, leasing workers, and having the opportunity for subcontracting.