Capacity Planning for Small Businesses
At some point in time, every organization faces the same dilemma:
How can we use our resources more effectively to reduce costs and thus increase profits?
The journey to answering this question begins from the bottom and it gradually moves up the hierarchy. For some, effective utilization of resources may depend on the effective use of raw materials, while for others it is a question of how productive your workforce really is. In theory, a company strives for production capacity.
Definition of production capacity:the maximum output that a business can produce in a given period with the available resources
However, reaching production capacity is not a process that should be taken lightly. In fact, it is unrealistic to set such expectations for human capital. Production capacity assumes that no matter what, employees will be reaching their maximum output every time they clock-in and out of their work hours. But what if an employee is sick? Or they have an emergency they must attend? Maybe they are simply drained after working overtime during the entire week? Certain factors will inevitably prohibit businesses from reaching production capacity.
How can this be solved? Is there a formula that can be applied to these employees to increase productivity?
There is a two-word solution to this problem: capacity planning.
What exactly is capacity planning?
In simple terms, capacity planning helps a business determine the exact amount of resources it needs to spend in order to create the desired output. Capacity planning is highly beneficial because it establishes a framework through which the business can achieve maximum results in a specific amount of time. For example, a dentist can use capacity planning to determine how many dental implants they will use for the day based on their schedule. In a similar fashion, a dentist can use capacity planning to determine the exact number of hours within which their assistant or administrator is productive.
Effective capacity planning occurs when companies are able to successfully identify the hours needed to finish one project or product. To put it into practice, for labor-intensive companies, organizational capacity is defined as the total number of hours employees spend working. If 20 employees work from 9 to 5, Monday to Friday, this means that your company has 800 hours of work capacity on a weekly basis. For instance, if a project needs a total of 400 hours to be completed, it can be finished in one workweek from 10 employees.
Why is capacity planning important?
For you as a business manager, ensuring that products get out of the company at the expected time and quality is crucial to success. Being aware of productivity levels and the overall production capacity is the first step towards identifying ways to reach maximum capacity. The actual capacity at which the business is functioning is called the Capacity Utilization Rate and it is calculated by:
Capacity Utilization Rate = Actual Output / Potential Output
For instance, if you are a design agency capable of producing 130 designs per week, but you are only producing 95, that means that you are utilizing your capacity at only 73 percent.
The potential output factor is highly subjective and it can be determined in one of three ways:
- Historical data: You know that in the past you managed to pull off 130 designs consistently
- Subjective belief: You believe that your current designers are capable of producing 130 designs per week.
- Competitor Analysis: It has come to your understanding that a competitor has managed to reach that level of production capacity
The last alternative may be difficult to asses, as company size fluctuates a lot. For instance, in the work hour example used earlier, we calculated one employee’s capacity at 8 hours because they are at the office from 9 to 5, and we determined that the total potential output of that company was 800 hours. A good business manager knows that is not the case. During these working hours, employees have at least a one hour break, with additional mini breaks in between. Therefore, in order to determine the exact Capacity Utilization Rate, you must know the exact number of hours employees spend on work tasks. In such circumstances, time tracking is something that you should look into.
Finding a good time tracking app is a process but the structure it establishes is - without a doubt - unmatched. Once everyone embraces the time tracking process, you as a business manager will have an extra layer of information from which you can craft decisions designed to help your business reach a “realistic” production capacity.
You will find that your company’s capacity utilization rate differs from that of another company. Companies with a very high capacity utilization rate are rare, as are those with unusually low capacity rates. The closer your capacity rate to 100%, the closer you are to performing at full capacity. Factors that influence capacity planning vary based on industry, company size, delivery (services, products, or both), the organizational structure, as well as the overall management style. For each of these factors, there is a strategy that will be discussed below.
How to do Strategic Capacity Planning?
Even if your business cannot reach a 100 percent capacity utilization rate, your goal as a business manager should be to meet the current and future demands of your products or services at a minimum level of waste. Waste, in this case, is time wasters, extra breaks, unprecedented leaves, tardiness and more.
There are three levels of planning to consider with regard to strategic capacity planning. These approaches take three forms: risky, conservative and active.
Risky: Planning ahead
This approach, otherwise known Lead capacity planning is the riskiest planning method of the three. That is because lead capacity planning requires the business to increase the capacity within the company as a result of forecasted demand increases. Implementing this strategy means that you are preparing to welcome new customers soon, either from the introduction of a new product or service or due to market trends. If you are planning to use this methodology then you are ready to take a risk. If your forecasts are right then great, you just yielded extra profits but if your forecast is wrong then you have increased waste.
Lead planning is best utilized by companies that have historical data. Forecasting using such data can at least provide a grip to the individual calling the shot.
Conservative: Staying safe
This approach to capacity planning falls on the other side of the spectrum when compared to the risky approach. This type of “safe” planning is highly conservative, meaning your business will increase resources only when you are certain that there is a demand for your product or services. While this strategy ensures that no resources are being wasted if the business is suddenly met with a high wave of customers and it is unable to serve their needs than it is automatically dragged out of its production capacity.
Certain brands use this form of capacity planning to drive the demand for a certain product. For example, limited products that are offered every once in a while - i.e. Popeyes' Chicken Sandwich - are typical examples where companies perform below their production capacity to elicit the demand of that product. Besides global brands, small businesses tend to use lag capacity planning because of resource limitations. Since cash is a highly volatile component for small businesses, we expect them to underperform rather than overperform in the face of risk.
Active: Constant change
One of the more common approaches to capacity planning is known as match capacity planning. This approach requires the business manager to be awake and respond to market changes instantly. Under the matching approach, businesses are adjusting their capacity on an on-going basis to fit the changes presented by the market. To be able to utilize the benefits of this approach, businesses need to be small and agile. A company that is bureaucratic won't be able to adjust its capacity on a need-by basis; thus this approach would not be suitable for them.
In any case, finding the best approach for your business is dependent on numerous factors. If you plan ahead then make sure that your forecasts are as accurate as possible. If you are taking the conservative approach fearing that today’s waste can cost you tomorrow's cash than try to minimize the opportunity cost of foregoing potential clients. In any case, the business is dependent on the market and unless you are small and agile, adjusting to its trends can be challenging.
Handling Cases of Insufficient Capacity
Despite your best efforts to do strategic capacity planning, your business may be faced with projects that require extensive effort which your company cannot meet. This does not always mean you have to reject the project. In these cases, two opportunities arise. The first potential fix or opportunity is to sub-contract third parties. The downside of these contracted services is that they usually take a sizable cut of your profits. The second opportunity is expanding the capacities of your business by adding extra human capital. This, however, can be challenging if the project must be delivered in a short period of time because of the hiring process. Additionally, if the company does not need this additional labor after the project is over, then unwanted costs will incur.
Fortunately, by following these tips, situations like this are rare. Capacity planning prepares your business to effectively use its resources and to be ready for unexpected situations.