Production and Capacity Planning

If demand for your product varies, capacity planning is a way of ensuring that you can always fulfill incoming orders without having an excess of inventory. If your company produces its own products, capacity planning is a skill you will need to develop — and sooner is better than later.

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In a nutshell, capacity planning is the process of changing your production output based on changes in demand and based on a firm understanding of your company's efficiency and utilization of existing resources.

In a production environment, capacity is a combination of the capabilities and limitations of your equipment and machinery, your employees and their skills, management and logistics. Logistics begins with getting adequate supplies into your facilities, moving them through the production process and then getting them to your customers.

Properly monitoring your capacity, managing it and effectively planning changes to your output capacity has numerous benefits for your company. Not only does it maximize your utilization of available resources, it can be used to increase the efficiency of your operations. Managing your capacity allows you to increase output when needed while minimizing the risk of having excess inventory. All of this put together will decrease costs while giving you the ability to respond to spikes in demand.

If you're just launching your business or planning to release a new product, capacity planning may seem like guesswork. After all, how can you forecast sales if you don't yet know your likely customers? You can usually get a good idea of what demand for your product will be like by doing some market research.

First, you should know your likely customers and how you will get your product to them, such as with direct sales or using a distribution network of wholesalers, distributors and/or retailers. Talk to potential customers and take surveys, asking them:

• How often do they buy products similar to yours?
• Where do they buy these products?
• How often do they buy these products?
• In what quantities do they buy them?
• When do they usually purchase them? (for seasonal products)

Most industries have people who make a living by gathering data and analyzing factors like market size, demographics, sales history and trends. These may cost a few hundred dollars, but if you use them wisely, they help you turn a wild guess into a highly educated guess, which could save you thousands.

There are three basic strategies you can use to approach capacity planning. Each has its own advantages and disadvantages, so you should examine them carefully to determine which best suits your needs.

1. Leading strategy: Like a runner stepping off first base, lead strategy anticipates an upcoming surge in demand. This can be particularly useful if competitors are vulnerable to inventory shortages in the face of a seasonal increase in demand. This is an aggressive strategy, however, and it can be very costly if demand falls short of your expectations.
   
   
2. Following strategy: Where the lead strategy is aggressive, the lag strategy is conservative. The lag strategy involves waiting for demand to increase before boosting production. Its strength is in not having to worry about the costs of excess inventory. However, if your competitors can fulfill increases in demand quicker than you can, you could lose sales.
   
   
3. Tracking strategy: Also known as match strategy or hybrid strategy, in terms of risk, tracking strategy lays right between lag strategy and lead strategy. Instead of increasing capacity before demand grows or waiting until the orders start pouring in, match strategy involves small increases in production to match increases or expected increases in demand. While this can be a difficult balance, it does reduce the risk of having excess inventory or falling too short when orders begin to spike.

The best-laid plans will come to naught if your strategy is to produce more goods than your company can handle.

• Design capacity: This is the maximum production your company can handle based on systems design. For example, if a bakery has one oven that can bake 10 loaves of bread each hour, then baking around the clock will give you a design capacity of 240 loaves per day. You can think of this as the theoretical maximum capacity.
  
  
• Effective capacity: This is the design capacity reduced as needed for working in the real world. Workers need to take breaks and sleep and systems often need to be shut down for regular maintenance and cleaning. Assuming you have only one baker and he is willing to work 12 hours each day, the theoretical 240 loaves per day would be an effective maximum capacity of 120 loaves. 

While the effective capacity is a more realistic number than the design capacity, it still isn't accurate for most companies, at least not all the time. To zero in on the most accurate numbers, you should also look at your company's efficiency and utilization rates.

Efficiency is a percentage representing your actual production divided by your effective capacity. Utilization represents your actual production divided by your design capacity.

Efficiency = Actual Production / Effective Capacity

Utilization = Actual Production / Design Capacity

So, using the bakery example, suppose you determined after a week that your daily production was 100 loaves of bread. Your effective capacity is 120 loaves, so this means your efficiency rate is 83% (100 / 120 = 0.83). Your utilization rate, however, is only 42% (100 / 240 = 0.416), meaning you are producing less than half of what your oven is technically capable of making.

Once you have identified the best capacity strategy for your operations, understand your design and effective capacity rates and have begun to measure your efficiency and utilization rates, you have the information you need to begin planning for future capacity needs. This is essentially an eight-step process:

1. Estimate your future capacity needs through market research, annual trends in your sales cycle or both. This will also be based on your capacity strategy.
   
   
2. Evaluate your existing capacity to determine your effective and design capacities as well as your current efficiency and utilization rates.
   
   
3. Identify ways to increase your capacity based on your evaluation. This will depend on the weaknesses but could include performance bonuses, retraining or improving workflow practices.
   
   
4. Find alternative methods for meeting capacity requirements, such as hiring more staff, leasing new equipment, subcontracting work to other companies, etc. 
   
   
5. Analyze the financial feasibility of each alternative. Hiring additional full-time staff may not be financially practical, for example, but hiring students or temporary staff for busy periods may be.
   
   
6. Compare the qualitative benefits for each alternative. If you outsourced parts of your production, for example, could you maintain the same quality standards?
   
   
7. Select the best method for increasing capacity based on your financial and qualitative analysis.
   
   
8. Monitor the results of the new system(s) and modify them as needed to ensure you get the output and efficiency rates you require.  

As your business grows, you'll need to go through this process again and possibly on an annual or quarterly basis depending on how fast the market is growing and what your share of that market becomes.