Capacity: Ending the Confusion

by Dave Garwood

Capacity is an often discussed and almost always misunderstood topic. Yet, effectively managing capacity has a direct bearing on three issues of most importance to an enterprise -- customer satisfaction, financial performance and employee morale. While concepts such as Theory of Constraints and Lean Manufacturing have made contributions to improving some enterprise performances, they have made the capacity topic even more confusing -- unnecessarily.

Aunt Molly’s Peppermint Candy
Aunt Molly made peppermint candy every Christmas for the family. Her homemade recipe was so good that her relative's constant raving lead to her selling it during the holidays to the bank, local motel and the Chevy dealer, bringing in a little Christmas money for Aunt Molly. The word eventually spread all over the county, then the state and eventually to WalMarts worldwide. It is now Aunt Molly’s, Inc. She hired a marketing director, who declared, "We need a complete line of candy." In addition to peppermint, Aunt Molly, Inc. now offers lemon drops, chocolate covered cherries, jelly beans and, well -- you get the picture.

Effectively managing capacity has always been an issue. In the beginning Aunt Molly solved the problem by keeping a few extra pots around and staying up late to make all the candy needed to keep the relatives happy during the holiday season. Now that Aunt Molly, Inc has three factories, two distribution centers and hundreds of products, the capacity management problem is more complex and can’t be solved on the back of an envelope.

The Manufacturing Process
All products are made by purchased material flowing through resources, eventually reaching a finished stage and then shipped to customers. Each resource includes both equipment and people. The resource could be on the factory floor, the engineering department, the software development group or anywhere in a business. Aunt Molly’s single kitchen resource was fairly easy to manage, especially when she had only a single product.

The diagram below depicts a simple, sequential flow of material through three resources.

Sometimes these processes are independent and separated with piles of work-in-process inventory (WIP). Other times they are are tightly linked, forming a work cell or focus factory (or a kitchen!) and separated by small piles (ideally zero) of buffer WIP. Many significant benefits result from linking resources, creating cells and minimizing the buffer WIP. This is a major focus of Lean or Flow Manufacturing initiatives.

As companies grow and offer more products, the number of resources required increases -- so do the stakes when capacity is not effectively managed. The flow can get convoluted to make the multiple products. Material now flows from the first resource to three others loops back or sometimes follows multiple paths before being completed.

Aunt Molly could determine how many pots and how many hours were needed in the kitchen to make 22 batches of peppermint candy with her eyes closed. Aunt Molly, Inc. became more difficult to manage when more products and shared, multiple resources lead to the more complex material flow. In fact, profit margins shrunk, inventory escalated and missed customer deliveries became common.

Again, a major thrust of Lean or Flow Manufacturing efforts is to simplify this flow by creating work cells to produce similar products, drive the buffers down to zero and use kanban to pull products through the cell. Theory of Constraints (TOC) efforts tend to recognize the demand variability, justify the buffers to avoid disruption in the flow and thus "lost" throughput and focus on overcoming the resource bottleneck. Lean or not, TOC or not, capacity in the resources must be managed or there will be a severe price to pay!

What Does Capacity Mean?
Capacity is a term that unfortunately does not have a universally-accepted definition. This is why it is usually difficult to communicate on the subject. Take this quick quiz:

The right definition of capacity is:
A. Hours worked in the resource?
B. Work done (or to be done) in the resource?
C. Output rating of the equipment (see the nameplate) in the resource?

The correct answer is B. Capacity is the work done (or to be done) over a period of time. The unit of measure for "work" could be pounds per hour, gallons per day, pieces per minute, standard hours per shift or whatever. The process to manage capacity is simple in principle. The hard part is getting "believable" numbers and then stepping up to the ugly capacity problems and solving them.

Where to Start: Determine the Required Capacity
Go back to the simple process flow above. The first question we need to answer is how much work do we need to get done in each resource, i.e. the Required Capacity? The answer depends on which products and how many we need to make -- and that depends mostly on the customers. Required Capacity, regardless of whether we have the capability to make that much or not, is derived from the master schedule which is mostly a function of product demand.

Required capacity is almost always variable. At Aunt Molly’s, it goes up and down around Halloween and again in December. As product mix shifts, the required capacity shifts in each resource. Sales promotions that succeed (or fail) cause the required capacity to change. Short supply of key purchase items changes the required capacity in all of the resources. The challenge is to have the tools to quickly recalculate the changing required capacity and communicate it to those who need to respond and adjust the resource capability. Techniques such as Takt time, Capacity Requirements Planning and Rough Cut Capacity Planning are helpful to frequently determine the required capacity once the demand plans change.

Next question: How much is the resource capable of making?
The capability of the resource is the Demonstrated Capacity.

Demonstrated Capacity = Hours worked x effectiveness of those hours

The historical Demonstrated Capacity is how much work the resource has actually done, ie demonstrated. The future Demonstrated Capacity is how much work we plan to get done in the future and it may be different than the historical number. If the future Demonstrated Capacity is going to be different than in the past, we need a clear plan of how it will be accomplished. Wishing it were different won’t do it. If we do nothing different in the future, the future Demonstrated Capacity will be the same as the historical Demonstrated Capacity, like it or not. Understanding Demonstrated Capacity (see archives for an article on this topic) is critical and often not considered when managing capacity.

Demonstrated Capacity is also variable. For example, as people get sick, quit, advance up the learning curve or equipment wears out, the Demonstrated Capacity changes in the resource. The future Demonstrated Capacity can be greater than the historical Demonstrated Capacity by adding hours with more people, working overtime or adding equipment. However, spending more bucks or adding bodies is usually not the only solution. Effectiveness can also be increased.

What happens during those hours that we scheduled people to work? We would like to believe they are all busy making good product. In reality, we spend those hours on a variety of activities. Here is just a partial list:

Reworking defective product
Replacing scrapped material
Setting up or changing over the equipment
Reporting labor transactions
Looking for material or tooling
Fixing broken equipment
Asking questions about unclear specs
Waiting for material
Talking to expediters
Attending meetings

Notice most of these are not operator controlled. Most of them are due to internal process issues. All of them add cost, not value. Many companies attack and reduce them as part of the Lean Manufacturing effort. Others credit the Total Quality program. Some companies put the effort under the Theory of Constraints (TOC) umbrella. Others say it was ERP. Most companies just do it as good business practice and don’t waste time assigning the credit. It is the reduction in these costly, resource-draining activities that results in cost savings, not the Buzz Word of the Day.

How many different Demonstrated Capacities can a resource have? The answer is infinite. Any change to the hours worked or effectiveness will cause a different Demonstrated Capacity. This why the idea of finite capacity is a myth. There is not a single "capacity" number. It can always be changed.

Non-Negotiable Principle for Capacity Management
Demonstrated Capacity must equal Required Capacity.

When the Demonstrated Capacity is less than the Required Capacity, this is a constraint or bottleneck. Notice: the bottleneck or constraint is always moving, not stationary since both Demonstrated and Required Capacity are variable. You can’t begin by scheduling to the bottleneck. You have to locate the bottleneck first by determining both the Demonstrated and Required Capacity. The "systems" role is to find the bottleneck. Who you gonna call when you got bottlenecks? The bottleneck busters! In this case, the Resource Managers. At the end of the day, effective capacity management depends on people taking cost effective actions to make the two equal.

All capacity constraints can be overcome. It is only a matter of time and money. The challenge is to see the imbalance coming and have enough time to find cost effective solutions. This almost always means having visibility farther into the future than customers place orders. This means an excellent demand planning process is essential for effective capacity management. TOC and to some degree Lean Manufacturing discussions tend to touch this subject very lightly and almost always do not offer any tools to support this critical, essential element. It is almost always swept under the rug!

When demonstrated is less than required capacity, work piles up, material flow slows down and customer deliveries become late. When demonstrated is greater than required capacity, the resource sits idle waiting for more work or more likely people slow down, stretching the work out so as to look busy. The result is costs go up.

Unfortunately, some companies have institutionalized performance measurements that encourage, in fact reward, managers to do the wrong things when they have excess capability. Utilization is a good example. The focus, even the reward system, encourages maximizing utilization. As the resource makes more, needed or not, to increase utilization, more overhead is absorbed into inventory and creates the illusion of more profit. This flaw in the accounting system logic can drive well meaning managers to make more work to drive Demonstrated Capacity above the Required Capacity.

Throughput, as defined in Theory of Constraints, is maximized when all resources are "balanced," i.e. the non-negotiable principle is satisfied. The weak link in most companies is maintaining a valid demand plan to use in determining the Required Capacity, i.e. knowing how much we need to be making and maintaining credibility in the data. Once the resource managers know how much to make (and believe it), they become very resourceful in fixing the problem.

Where to Start: Five Universal Steps to Effectively Manage Capacity
The business was formed to deliver what customers want when they want it and make a profit doing it. The five-step universal capacity management process focuses on helping meet this goal. The five steps are:

Step 1: Determine the Required Capacity. This must be done far enough into the future to respond cost effectively. The reality is customers don't place orders with enough lead time to do this. A forecast is required. Proven tools are available to translate product requirements into meaningful resource requirements.
Step 2: Measure the Demonstrated Capacity. This can easily be done by "recording" how many (in capacity units of measure) are made each day or week. It may be ugly, but it is true.
Step 3: Compare the Demonstrated and Required capacity. If they are equal, great. If not, go to Step 4.
Step 4: Adjust the Demonstrated capacity. We have two capacity control knobs to increase or decrease the demonstrated capacity -- hours scheduled and effectiveness. Turn one or both until the demonstrated capacity matches the required. If it will take too long or cost too much to make the adjustment, go to Step 5.
Step 5: Adjust the Required Capacity. This means changing the plan to not make as much as you can sell. Obviously, this must be done only as a last resort.

TOC, Lean Manufacturing, MRP II/ERP and Capacity
One of my favorite quotes is "In technology, simplicity is the ultimate sophistication." Effective Capacity management does not have to be confusing or complicated. It does take a focused effort to find and solve the problems.

These "theories" are often presented as "either/or" alternatives. The zealots in each camp claim their approach is the right one and disavow the other two. The problem gets worse when half truths and incorrect claims are made that incorrectly discredit the other two concepts. For example, TOC advocates often claim MRP II/ERP assumes infinite capacity. Not true. Lean Manufacturing advocates insist a Lean factory does not need MRP II/ERP. Again, not true. Some Lean zealots have even implied MRP II/ERP software is responsible for the wrong measurements such as utilization. Unfortunately, these self-serving claims lead to unnecessary confusion for the practitioner who is trying to make their supply chain more effective. Their time gets diluted trying to avoid picking the wrong buzz word horse to ride!

TOC focuses on many of the right issues, but is weak in providing tools to fix them. For example, the cornerstone of TOC’s Five Focusing Steps is to identify the system’s constraint, exploit it, etc. -- sounds like a "buy low and sell high" recommendation from a financial advisor! How can you do this without a good process of integrating sales, distribution, new product launch, manufacturing and financial plans? A business must have a good Sales and Operations Planning (SOP) process. TOC discussions do offer some good ideas to bring focus on adjusting the demonstrated capacity when needed and recognizing the need to deal with the inevitable process variability. However, we don't need to get all tied up in ropes, drum beats and become enamored with formulas to understand the actions needed to meet the business goal -- cost effectively make all we can sell, no more or less.

Lean or Flow Manufacturing also causes focus on many of the right issues such as linking operations to create work cells. The result is less stopping and starting and thus shorter internal lead times. Lean also focuses on eliminating non-value added activities that reduce the demonstrated capacity. Many Lean zealots imply all products can be made to order, eliminating the need for forecasting. Some Lean advocates even imply Lean eliminates the need for planning and software tools. Very seldom true. While some products can be "finished-to-order," most customers won’t wait for delivery until we have time to order material from suppliers and do all of the production work to get the product ready to ship. Again, an effective SOP process is needed. Credible visibility of future capacity requirements is essential and likely cannot be maintained manually.

ERP is simply an evolutionary derivative of MRP II. ERP includes powerful tools to integrate departmental plans and provide visibility of future capacity and material requirements, helping to locate the constraints soon enough to find cost-effective solutions. Unfortunately, ERP is often implemented as a software effort and the critical business processes are not addressed. As with TOC and Lean, the key non-negotiable principles are ignored and the results are disappointing. Bad idea? No, bad implementation and improper use of the tools.

Ending the Confusion
The principles and stakes for effectively managing capacity are totally independent of the product, process or Buzz Word of the Day. While TOC and Lean Manufacturing can enhance the capacity management process, the job can't get done with TOC and Lean Manufacturing alone. It requires ERP tools.

Make your capacity management "sophisticated" -- aka, SIMPLE. Focus on the universal five steps and the non-negotiable principle. Product will flow profitably up the supply chain!