Capacity Planning

Abstract

This article is an introduction to capacity planning and basic models used to support capacity planning and expansion decisions. The importance of making good capacity decisions by firms is described followed by definitions of various measures of capacity. The main elements of capacity decisions such as size, timing, and location of capacity additions are discussed. The impact of flexibility of capacity and the level of automation on a firm's productivity, the nature of capacity decisions as a function of the production processes, and implications of interactions between capacity levels at firms in a supply chain are discussed. Some standard deterministic and stochastic models in the literature for making capacity decisions are presented. A key insight from continuous time deterministic models is that it is optimal to add capacity at equal time intervals under several demand and capacity cost scenarios. A basic stochastic capacity expansion model is provided that can be transformed to a deterministic model with a different discount rate under fairly general conditions on the demand process. Finally, a stochastic programming model and heuristic solution approaches are described—this is a flexible approach to model capacity expansion decisions when there is uncertainty in both demand and other parameters.