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summary ansWers to Key questIons 151

summary ansWers to Key questIons

What is capacity strategy?
Capacity-related decisions are conventionally divided into three time horizons – long-
term, medium-term and short-term strategic decisions. Strategic decisions are those
concerned with the provision of buildings, facilities and process technology, in all parts
of the business, for at least months and probably years into the future. Capacity strategy
includes a number of interrelated decisions that include defining the overall scale of
the operation, the number and size of the sites between which capacity is distributed,
the specific activities allocated to each site, when capacity levels should be changed,
how big each step change should be and the location of each site.

how much capacity should an operation have?
The starting point in determining overall capacity level will be the demand forecast.
However, actual capacity may not be the same as forecast demand. It may be modified
to account for the relative certainty, or uncertainty, of demand, long-term changes in
expected demand level, the availability of capital needed, the ratio of fixed to variable
costs and general economies of scale. Also, a company may choose to provide more of
one kind of resource (e.g. the size of the physical building) before demand warrants it,
in order to save capital costs in the long run.

how many separate sites should an operation have?
The decision here concerns the choice between many small sites on the one hand,
or fewer larger sites on the other. The geographical distribution of demand, together
with customers’ required service level, will influence this decision, as will the econo-
mies of scale of the operation and the costs associated with supply. If demand is widely
distributed between customers demanding high levels of service, and if there are no
significant economies of scale or costs of supply, then the business is more likely to
operate with many small sites.

What issues are important when changing capacity levels?
Capacity can be introduced to either lead or lag demand. Lead-demand strategies
involve early capital expenditure and underutilisation of capacity but ensure that the
operation is likely to be able to meet demand. Lagging-capacity strategies involve later
capital expenditure and full utilisation of the capacity but fail to fulfil forecast demand.
If inventories are carried over so as to smooth the effects of introducing capacity incre-
ments, it may be possible to achieve both high sales and high utilisation of resources,
and therefore low costs. However, working capital requirements will be higher because
the inventory needs to be funded. Changing capacity in large increments can mini-
mise the costs of changing capacity (closure costs if demand is decreasing and capi-
tal expenditure if demand is increasing), but can also mean a significant mismatch
between capacity and demand at many points in time. Conversely, changing by using
small increments of capacity will match demand and capacity more exactly but require
more frequent changes. Especially when increasing capacity, these changes can be
expensive in capital cost and disruption terms. Often it is the risks of making too large

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