Capacity Management

• Capacity is the potential or capability,  of a set of resources to do work of some type to create value for the customer.
• Levels of capacity for organization consideration

            * Theoretical -  Maximum possible (not practical)

            *  Practical -  Downward adjustment of theoretical to                      
                            make allowance for unavoidable capacity losses

            *  Normal - Average output over past 3-5 years

            *  Budgeted - Expected in upcoming year

            *  Actual - Work actually done during current year

•  Goal of capacity management is to manage fixed costs (plant assets)   in a manner that spreads costs over the largest possible volume

• A very difficult area of management because it involves long-range planning

A Capacity Manaagement Example

Company A and Company B each manufacture one product that is very similar in nature.  Company A recently invested in modern machinery (new technology) that reduces its manufacturing labor cost.  Company B continues to be labor intensive using its older machinery.  Accordingly, Company A has much more fixed factory overhead annually than Company B ($ 1,500,000 compared to $ 600,000).  The respective selling price and variable costs per unit are as follows:
    Company A       Company B

                             Selling Price                         $ 20.00                         $  20.00

                             Direct Materials                  $  2.00                           $    2.00
                             Direct Labor                         $  1.00                           $   6.00
                             Variable Overhead               $  1.00                          $    1.00

Required:    Compute the gross margins on the product of each company assuming an annual volume of production and sales of 100,000 units;  then 200,000 units.

Solution:             (100,000 units)
                                       Cost:
                                            Variable Costs/Unit     $  4.00                       $  9.00
                                             Fixed Cost/Unit             15.00    6.00
                                             Total Cost/Unit            $19.00                       $ 15.00

                                       Selling Price                       $20.00                       $ 20.00

                                    Total Gross Margin            $100,000                 $ 500,000

                           (200,000 units)
                                      Only change is Fixed
                                               costs per unit             $ 7.50                          $ 3.00

                                  Total Gross Margin             $ 1,700,000             $ 1,600,000