CAPACITY
MANAGEMENT
BACK TO THE FUTURE
Using this capacity model can bridge the
communication gap
between operations and management people, while enabling all levels of your business
to effectively evaluate and manage their capacity, and do things better.
by Alan J. Stratton, cma
"Back of reliable cost methods has, in the past, been
responsible for much of the uncertainty so prevalent in our industrial policies; but with
a definite and reliable cost method, which enables us to differentiate between what is
lost in manufacturing and what is lost in business, it will usually become easy to define
clearly the proper business policy."1
H.L.Gantt (1861-1919), a well-known industrial engineer,
made the foregoing statement in 1915. Has the situation he describes improved in the past
80 years? Or, has the situation deteriorated further with additional global competition,
communication advances, and government regulations? Do your cost methods yield results
that do not relate to what you see happening in your business?
Perhaps we should examine some of our basic assumptions to
see which are inhibiting our ability to improve cost methods, especially as they relate to
capacity management. Gantt also described our current cost methods for capacity
management. "The view of costs so largely held, namely, that the product of a
factory, however small, must bear the total expense, however large, is responsible for
much of the confusion about costs and hence leads to unsound business policies."
 Here, Gantt described an application of
accounting principles which dictate that costs must be matched to, and be allocated fairly
to, the output being produced. In general, the application of these principles associates
expenses incurred in a period of time to the product produced during the same period of
time. When discussed theoretically, no one can dispute this principle. However, its
practical application produces the effect described by Gantt. The effect of these
principles is that the cost of a product will be higher in periods when production output
is lower. Conversely, the cost of a product will be lower in periods when production
output is near capacity. This occurs even though nothing about the actual product has
changed.
Perhaps it is not the matching principles that have
problems. Perhaps the real issue is what we are matching to the costs. Those people
familiar with activity-based cost will recognize the axiom: activities consume
resources and products consume activities. Turning the axiom around, one could say
that the products in Gantt's statement did not consume the costs. The activities required
to make the products used the resources and the products used activities. Therefore, the
correct application of the matching principles would be to match the expenses of the
period to the activities performed in the period.
One key attribute of any activity is its capacity to
produce the output intended. On this basis we should be looking at the ability of the
activity to produce its capacity. Further, the expenses should be matched to the
activity's capacity. This is the approach taken by the CAM-I (Consortium for Advanced
Manufacturing -- International) Capacity Model. The CAM-I Capacity Model is the subject of
a soon-to-be-published book, Capacity: A Manager's Primer. The primer is the output
of a CAM-I cost management systems workgroup. (See figure 1.)
 The capacity model approaches capacity
management in a manner similar to Gantt's. First, all uses and non-uses of capacity are
analysed into activities. The activities are defined by the primary cause of the activity.
For example, yield and scrap define the waste capacity activity. Production of good
product at rated speed defines the productive capacity activity. The analysis of how all
time is spent in these activities becomes the time template. The template accounts for 100
per cent of the time. This means 24 hours a day, seven days a week, 52 weeks a year. The
requirement to account for 100 per cent of time makes the model a closed loop. Nothing can
be left out; all uses of time are assigned to a meaningful and appropriate activity.
Second, all expenses associated with the capacity are
assigned to the appropriate activities based on cause and effect. Different types of cost
are assigned to different capacity activities. This becomes the economic template.
These two templates are the basis for other specialized
templates. The various templates are different views of the model data. The different
views are used to communicate capacity issues to both management teams and operation
teams.
 The capacity model has three principal
categories of capacity use: productive, nonproductive and idle. Rated capacity is 100 per
cent or 24 hours a day, seven days a week. If a particular machine is being measured, it
is the full productive speed as rated by the manufacturer without allowance for repair,
setup and other downtime. Rated capacity = productive capacity + nonproductive capacity +
idle capacity
Productive capacity is used producing good product, as well
as in process and product improvement efforts.
Non-productive capacity includes uses of capacity where the
uses do not produce good product, or are not in one of the specific idle definitions.
These activities are: set-ups; maintenance; waste, and standby.
Idle capacity includes capacity that is not marketable, not
in demand, or off limits due to legal, contractual or management concerns.
The primary objective of the capacity model is to bridge
the communication gap between operations and management. The typical problem is that the
operations team works with measures of time, units, pounds and other expressions of
throughput. At the same time the management team is using financial expressions of profit,
cashflow and return on investment. It is almost like each team is using a different
language to communicate with each other. Neither understands the language being used by
the other team. The capacity model time template uses operations measures to analyse how
the total time is spent. At the same time, the economic model is applying financial
measures to the uses of capacity. These two templates make the translation that bridges
the gap between the two teams.
The capacity model enables analysis of both idle and
non-productive capacity. Companies may use the model to focus on either type or both types
depending on the circumstances in which the company finds itself. In fact, as the CAM-I
workgroup started developing the capacity model, the companies represented on the
workgroup had significant excess capacity. The primary question before the group was what
to do with the idle capacity and how to account for it. However, as work on the capacity
model progressed, the economic situation changed for some of the companies represented.
They began experiencing capacity shortages. The question turned to how to find more
capacity without having to invest huge amounts of capital.
 The members of the workgroup found that by
focusing on non-productive uses of capacity, their companies could save enormous sums of
money. The capacity model became the tool to identify, measure, and value these uses of
capacity.
With both idle and non-productive uses of capacity included
in the same model, responsibility can be assigned for the improvement of capacity
utilization by the operations and management teams. The operations team has the primary
responsibility to reduce non-productive capacity and convert it to idle capacity. The
management team has the responsibility to reduce idle capacity by either disposing of it
or by selling it as additional product.
Gantt's concerns in 1915 with appropriate product cost are
also quickly resolved by the capacity model. The idle capacity is identified and costed.
The company may recognize that idle capacity cost is not the cost of current production.
However, this cost is the cost of production not currently needed and it should not be
charged to the current products but rather to period expense. Once this appears on a
company's profit and loss statement, one can imagine the management activities to quickly
utilize or dispose of the capacity generating this cost.
In summary, implementing the capacity model requires
careful analysis and a thorough understanding of the operation of the business, its
processes, and the underlying causes for the use or non-use of capacity. Costs are
assigned appropriately to the capacity categories according to the cause of capacity and
type of cost. Analysis results are presented in a variety of templates that are used to
communicate the information to both operations and management teams. The resulting
communication enables all levels of the business to take appropriate action to optimize
their capacity investment and to achieve the ultimate objective of improving their ABILITY
TO DO THINGS. cma
 Alan Stratton, cpa, cma, of Dynamic
Management Associates, Portland Oregon, and an associate of Focused Management Information
Inc., Oakville, Ontario, has over 20 years of experience in cost management and has been a
significant contributor to the field of ABC/ABM.
1 Gantt, H.L.; "The Relation Between Production and
Costs;" proceedings of the spring meeting of ASME; June 1915.
Reprinted from the CMA
magazine with permission from The Society of Management Accountants of Canada. |
