International Journal of Operations & Production Management

Strategic Planning for Production Capacity

R.D. Jack Hammesfahr James A. Pope Alireza Ardalan
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R.D. Jack Hammesfahr James A. Pope Alireza Ardalan, (1993),"Strategic Planning for Production Capacity", International
Journal of Operations & Production Management, Vol. 13 Iss 5 pp. 41 - 53
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 Strategic
Strategic Planning for Planning
Production Capacity
R.D. Jack Hammesfahr, James A. Pope and Alireza Ardalan
Old Dominion University, Norfolk, Virginia, USA 41
Received March 1992
Revised July 1992
Introduction
American manufacturing, once the world leader in producing high quality and
reliable goods, has suffered many reversals since the 1960s. This problem has
been dissected and analysed from almost every conceivable position in recent
years, resulting in many improved manufacturing techniques. Yet, improvements
in manufacturing technology alone, although slowing the decline, have not
returned American manufacturing to the domestic and global competitive
dominance which it once enjoyed. Research tends to confirm that improvements
in operations have limitations relative to gains in a firm's overall competitive
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position. Manufacturing strategy, in support of a firm's corporate and marketing

strategies, is an important step in overcoming these limitations. Unfortunately,
the literature is all but silent on the role of production capacity relating to the
development of a comprehensive manufacturing strategy in support of overall
corporate objectives.
Strategic planning for production capacity is one of the dominant issues which
should be resolved in the development of the overall strategic plan for manufacturing
firms. Production capacity decisions for new, expanding, and existing facilities
impact directly on a firm's competitive position and resulting profitability. Therefore
capacity decisions require careful analysis and consideration at the highest level
of planning to provide the maximum opportunity for a manufacturer to achieve
his strategic objectives. Decisions providing excess capacity will result in higher
overhead costs, reducing a firm's ability to compete by increasing break-even
points, and decreasing unit profits. Under-capacity decisions will generate lost
sales, possible lost customers, and could result in a decreased market share for
a firm's products.
We propose an approach to strategic capacity planning which enables
manufacturers to provide for sufficient capacity throughout product life cycles,
yet limit exposure to over-capacity, while attaining production levels to meet
existing product demand. The strategy provides for control over operational
costs, including overheads, while adjusting to existing marketing conditions,
providing a firm with the best attainable competitive position. To accomplish
this, the strategic plan should limit initial fixed capacity below anticipated levels International Journal of Operations
of product demand. In this article we discuss this problem more fully, review the & Production Management, VoL 13
No. 5,1993, pp. 41-53.© MCB
literature, and propose a model for strategic capacity planning. University Press, 0144-3577
 IJOPM Plant Capacity and Product Competitiveness
13,5 Ideally, production is most efficient when operating at full capacity, where there
is sufficient idle capacity to provide for the resolution of problems which might
develop during production runs, including unscheduled maintenance. Full capacity
production planning and control are a somewhat straightforward process. Raw
materials, labour, equipment, and machine requirements are predictable and
42 Work in Process (WIP) inventories are controllable. Production runs, set-up times,
and preplanned maintenance required to produce finished goods inventories are
also predictable. In addition, fixed and variable costs of production can be directly
allocated to each unit produced. In other words, the major elements of production
become known and are relatively constant. However, it is rare indeed to have
market conditions in balance with full capacity production. This results in two
primary product demand-related problems. Either there is unsatisfied demand
for the product, or demand is "soft" and finished goods inventories accumulate
beyond preplanned levels. To illustrate how these two problems relate to strategic
capacity planning and a firm's product competitiveness, we will first consider
the problem associated with lost sales which have occurred owing to limited
capacity. Then we will discuss the effect of over-capacity, as it relates to reduced
product competitiveness in the marketplace.
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Full Capacity Production, Profitability and Lost Sales

The problems associated with unsatisfied demand for a product directly affect
a firm's profitability. The primary purpose of the marketing function in business
is to sell products and services. Sales generate revenue, and no business entity
can survive without adequate revenues to cover costs. The real question is just
how, exactly, does a "lost sale" affect profit?
In order to produce additional product to preclude "lost sales" when operating
at full capacity, capacity must be increased. This will change the unit production
costs of all units sold, with a corresponding change in unit profit. The added
capacity may, or may not, improve a firm's overall profitability. One cannot assume
that the profit on each unit "not sold" would be the same as the profit per unit
generated by a facility operating at full capacity. Thus the increased capacity
decision may not have the desired results. Consequently, a decision to increase
capacity is a strategic planning decision and should not be predicated on current
market conditions alone.
Marketing strategies should be coupled with production strategies. Marketing
strategy often calls for the maintenance of some level of finished goods inventory.
If product demand is "strong", these inventory levels tend to decrease. This
situation creates the potential for lost sales and, consequently, lost revenue
opportunities. Product-marketing forecasts should be able to estimate accurately
future inventory levels required to adjust to an increase in demand. This information
should be included in a company's strategic marketing plan. The plan should
also include an assessment of the impact on corporate profitability relating to
meeting demand through increased production capacity, or the maintenance of
current product production capacity.
 A firm should also have a corporate strategic manufacturing plan. This plan Strategic
would include a forecast of production levels required to support the strategic Planning
marketing plan, including all related and identifiable costs to be incurred. Given
these two plans, strategic planners could match relevant forecast revenues with
costs to estimate the impact of a proposed capacity expansion decision on overall
profitability.
43
Excess Production Capacity and Profitability
One problem for manufacturing systems is to determine capacity and production
levels required to satisfy demand at prices which will generate an acceptable
return on the capital invested. All costs, including the cost of excess capacity,
must be profitably absorbed by each unit produced. Should excess capacity be
provided as a part of the planning process, the cost of products increases accordingly.
The cost of excess capacity is, largely, uncontrollable, once production begins.
Now consider the problem of excessive ending inventories when a production
facility is operating at or below full capacity. Given that demand is insufficient
to reduce inventory, the only viable alternative is to reduce the production rate.
When this happens, the production constants referred to above become production
variables. As a consequence, idle capacity is induced into the system and real
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production costs per unit increase. In an attempt to reduce these costs, production
runs are often planned to utilize as much capacity as possible. This leads to
higher finished goods inventories, thus increasing pressures on marketing to
become more competitive to reduce the inventory levels. The result is a decrease
in profit per unit because of increasing production and inventory costs, and
decreasing product sales prices (including rebates and discounts). Ultimately,
when inventories can no longer be reduced at current production rates, production
is cut, increasing unit costs even more and further reducing profitability.
The real challenge is to develop a methodology to control excess capacity and
associated costs. We propose a methodology which assists planners in the
development of capacity plans which will decrease the total cost of production
significantly and thus increase product profitability and competitiveness. We
also believe that the methodology will provide for improved capacity planning
to adjust for higher capacity levels to meet requirements for future growth and
expansion.

Capacity Planning Is a Key to Competitiveness

The large, and significantly idle, industrial base available in the USA prior to
World War II provided the foundation for America's worldwide economic dominance
following this global conflict. Totally free from the physical effects of war on its
infrastructure, this country's industrial capacity emerged from the conflict vastly
expanded and intact. Our industrial capacity, formerly dedicated to the war effort
(approximately 60 per cent), was converted to the production of consumer goods
and industrial equipment to meet pent-up demand not only at home, but also
abroad. Even so, capacity was so great relative to demand at prevailing prices
that many industries accumulated excessive inventories during the 1950s. The
 IJOPM emerging industrial output from countries recovering from the destruction of
13,5 war also contributed to growing inventories in the USA during this period.
However, their impact in both foreign and domestic markets was not of great
consequence to American manufacturing at the time. Yet the stage was set to
transform the USA from a net exporter to a net importer nation during the 1970s.
Consider the plight of the American steel industry. By the mid-1960s foreign
44 steel imports were having an alarming impact on American steel production,
primarily because foreign steel could be purchased for less. It has been assumed
foreign steel was less costly to produce because of the newer, more efficient, and
technologically advanced mills located in Japan and West Germany. No one has
noted that these mills at that time were also more efficient, because they were,
mostly, operating at full capacity. Thus one reason why American steel became
increasingly more expensive relative to foreign steel was because the cost of ever-
increasing excess capacity had to be spread over fewer and fewer units of
production. The large capital investment in the modernization of the American
steel industry did not reverse the balance of trade in this industry. The primary
reason for this failure might be that the strategic planning for this modernization
included an ever-present extra capacity for the newer facilities, resulting in
increased production costs.
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Historically, both the Europeans and Asians have made their inroads into
American markets via different marketing strategies. West Germans, for example,
traditionally follow a demand-pull production strategy in many industries.
Translated into a return on their investment, this means, of course, that they
produce to order for both domestic and foreign consumption at a price sufficient
to cover all costs, regardless of capacity. So their production costs can be accurately
forecast and controlled, and they rarely encounter problems with excess inventories.
Some sales are lost in consumer markets pursuing this strategy, but they also
seem willing to accept these forgone profits in favour of predictable returns. They
excel in the industrial markets where long lead-times are a way of life. Production
capacity expansion is, in general, preplanned and acquired, as the back-log for
orders builds.
The Japanese, like the Western Europeans, began to acquire a new industrial
base in the late 1940s. Their challenges, however, were different from those of
other industrialized nations. Japan had a worldwide reputation for cheap, shoddy
goods. Economic planners knew that a healthy and thriving economy depended
on manufacturing for export. The first step towards economic recovery, then,
required the building of a new image for high quality and dependable Japanese
products at competitive prices. Therefore a national economic strategy emerged
to accomplish these objectives. Their success in attaining these goals is evident
worldwide. However, American business response to the ever-increasing Japanese
competitiveness has been, in general, an attempt to emulate "how they do it",
with little focus on "how it was done". A continuation of this policy has little
chance of attaining real competitive advantages for the USA (as many have
already discovered) without modification to our own strategic planning processes.
 It has been the authors' experience with Japanese production facilities in Strategic
America that one key to their gains in the world marketplace might be traced to Planning
their ability to operate many production facilities, most of the time, at or near
full capacity. Assuming aggregate demand for a given product to be finite, the
higher quality, competitively priced units will command ever-increasing shares
for the product, depending on availability, until the total demand is satisfied.
Japanese products, with few exceptions, have seldom been exported in sufficient 45
quantities to satisfy the total demand for them, because, unlike the USA in 1945,
their industrial capacity is still expanding. This may be one of the factors which
enable the Japanese to improve production efficiency through JIT and MRP
concepts and provide workers with long-term, steady employment in production
environments conducive to high quality products. More important perhaps is the
question relating to how American industry will respond to foreign competition
in the coming century.

Facility Planning and Capacity Decisions

There is little relating to the issue of strategic capacity planning in the literature
to assist planners. For example, the Production and Inventory Control Handbook[1]
contains a chapter on "Strategic Manufacturing and Financial Planning". However,
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the discussion relating to capacity planning in a strategic setting is contained in

a box in a flow chart labelled "facility and resource evaluation". Most of the
literature concentrates on capacity requirements planning, presuming that the
strategic capacity planning is done correctly. Clarke[2,3], for example, in his
classic reprints from the APICS Proceedings, states: "It is assumed that the
company has a formal business plan". This assumption permeates the literature,
even through the most recent publications[4-8]. Graziano[9] describes a long-term
production capacity-planning system extending one year into the future. Although
he refers to some decisions as "strategic" decisions, they are still tied to loadings
and delivery times which, in effect, make his system an incremental or marginal
planning system. Blackstone refers to strategic capacity planning as resource
requirements planning. He gives a few examples of the impact of doing this
planning incorrectly and then states "... the scope of such decision making falls
in the realms of economics and strategic planning..."[10].
Buffa, addressing problems associated with strategic planning for capacity
and location, points out that excess capacity in industry will result in a cost-price
squeeze because of increased overheads and decreasing prices (except in cases
of explosive and relatively certain increases in demand)[11]. He also proposes
that capacity be added in increments to meet demand when demand is increasing.
That is some lost sales are to be incurred before capacity is expanded, and there
will be some slack capacity afterwards. This results in the acquisition of additional
fixed capacity, with all associated costs.
One major problem in the attempt to develop better strategic capacity-planning
policies is that most research in the area addresses capacity expansion strategies
alone. That is, the literature identified relating to a strategy for decreasing capacity
is sparse. For example, Pannesi defines manufacturing strategy as:
 IJOPM ... a co-ordinated series of decisions which act on the deployment of the firm's manufacturing
resources to provide a competitive advantage in the marketplace in support of the firm's overall
13,5 corporate and market strategy[12].

Then he states that all capacity strategies come under three categories; lead, lag
or tracking. He presents a brief discussion on the merits of each of these, addressing
46 only capacity expansion decisions. His presentation of capacity management
then continues with the assumption that some capacity strategy has been elected,
and that it is consistent with the firm's manufacturing strategy.
Anderson, et al.[l3] observe that, while several researchers have addressed the
problems associated with plant capacity and location decisions, they have, in
general, viewed these decisions as a cost-minimization analysis in the context of
a capital budgeting process[14-19]. They conclude that methods are needed to
integrate this type of quantitative analysis into the strategic planning process
for production capacity decisions. Wheelwright and Hayes provide insight into
the magnitude of the problem with the integration in their discussion of the
strategic role of their four stages in manufacturing[20]. Their contention is that
top managers in the earlier stages in developing manufacturing firms are most
concerned with investment decisions in the area of capital budgeting. Therefore
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these managers minimize their involvement in the company's production facilities

and processes. When capacity expansion is required for these companies, they
tend to add large, general-purpose facilities. It is only after a company has matured
and entered into the fourth stage that manufacturing strategy is fully incorporated
into the competitive strategy for the organization. It is our contention that, by
the time a company reaches this final stage of maturity, it has already saddled
itself with enough excess capacity, and the associated cost, significantly to
handicap its competitive posture in an economy facing stiff foreign competition.
In the industrial engineering literature, Pritsker's total capacity management
concepts[21,22] appear to be the leading edge in capacity research. Even here,
the emphasis is on management of the process after the strategic decisions have
been made. The concepts and procedures which we propose in this article could
provide inputs into Pritsker's system.
Although process selection is a part of the strategic decision, the operating
policies are often omitted from the decision. They are left to be dealt with by
following stages of the planning process (i.e. aggregate production planning,
master production scheduling, etc.). Because it is relatively costly to change
production rates, production planners do not always respond to changes in demand
when they should. This results in inventory build-up during periods of low
demand and shortages in periods of high demand. This phenomenon is what
economists call the inventory cycle model extension of the Keynesian business
cycle models. Metzler's model, as described by Ackley[23], makes assumptions
similar to those which we have made about producer behaviour and concludes
that the interaction of inventories and excess capacity will lead to unstable cycles.
 A New Approach Strategic
Capacity planning considers two roles which should be fulfilled by production Planning
facilities. First, enough capacity should be available to satisfy minimum demand.
Second, the system should have adequate flexibility to respond to changes in
demand. The main reason behind the producer's behaviour is that facilities-
planning procedures fail to translate the two roles of facilities to their corresponding
types of facilities. We propose that manufacturers should recognize the different 47
roles which they expect of their facilities and design different facilities to fill these
different roles. One type of facility is intended to fill the minimum demand. If the
company has determined this minimum demand properly, the facility should
operate at full capacity, and thus minimum cost, continuously. This gives the
firm the opportunity to lay out the facility in the most efficient manner and to
simplify materials ordering and handling. Another type of facility should be
designed for flexibility. It should be laid out to accommodate maximum flexibility
in response to variations in demand.
A plan for the firm using the approach which we recommend for strategic
capacity planning (with a two-facility approach) is as follows:
(1) Determine the distribution of forecast demand.
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(2) Determine the long-term base level of demand which will be maintained
through seasonal and cyclical downturns. Whether this is the 80,90,95
or 98 per cent point on the demand curve is a matter which the firm must
decide in its strategic planning.
(3) Plan the minimum sustainable capacity which will support the demand
level in step (2). The facility providing this capacity should operate most
efficiently at full capacity, since the strategic plan should be to operate it
continuously at full capacity.
(4) Plan an auxiliary facility, in which the production rate may be changed
in small increments economically. The capacity of this facility should be
equal to the difference between the maximum demand and the capacity
determined in step (3) above.
If demand does not grow, the firm has protected itself by not over-building
capacity. If demand grows beyond the forecast, the firm may expand production
in the flexible facility along with demand. If demand grows to the point where
another large, full-capacity facility is feasible, the firm may add that facility and
use the flexible facility to continue to absorb fluctuations in demand. The company
would also need to establish policies linking the two facilities. For example, it
may decide to use temporary employees in the flexible facility and move them
to the full capacity facility, as openings become available. In that way they may
remain flexible with the labour aspect of capacity, while still providing advancement
opportunities for the employees in the flexible facility.
A rationale for this approach to strategic capacity planning is developed with
the following illustration. Assume that, during the strategic planning process,
the marketing analysis estimates current demand for a product to be normally
 IJOPM distributed with a mean of 100,000 units, and a standard deviation of 10,000 units
13,5 per month at prices which are competitive. Fixed and variable production costs
projections over this range (70,000 to 130,000 units/month) of forecast demand
indicate an acceptable rate of return per unit over the entire range. However,
economies of scale analysis, including the allocation of fixed cost over more units,
predictably shows decreased production cost per unit in the upper end of the
48 range for demand. Therefore higher profits are anticipated under strong market
conditions. Figure 1 illustrates this demand function. Marketing analysis also
indicates an annual growth rate of 5 per cent for the next five years. This forecast
includes a projected 3 per cent growth rate for the general economy and 2 per
cent for increased market share. Average demand for the product in five years
then is expected to be just under 130,000 per month (127,628).
The five-year projected demand curve imposed over the current forecast demand
curve is shown in Figure 2. At this point, after all the quantitative analysis has
been completed and weighed, the strategic facility capacity decision becomes
essentially an assessment of the propensity to assume risk by the decision makers.
Should they elect to provide for future growth now, as is often the case, there is
a very high probability that the return on investment anticipated for the venture
will never be attainable. For example, assume the marketing analysis for current
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demand to be totally accurate and forecast for future demand to be very reliable.
Then it would not seem unreasonable, even for modest risk takers, to establish
plant capacity at 130,000 units per month, if the costs projections to do so were
acceptable. This capacity will provide for 100 per cent of current demand and
allow for demand growth for the next two and a half years. Yet there is a 0.5
probability that current demand will be less than 100,000 units per month. In
other words, it is highly likely that there will be excess capacity in the system
most of the time. Since the cost of the excess capacity must be spread over existing
 Strategic
Planning

49

units of production, the return per unit is then reduced at any level of production
at current prices. In addition, excess capacity increases the price floor for a
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company's product, which, in turn, adversely affects its competitive position in

the marketplace.
We suggest the other way around might be more profitable to plan for capacity.
That is segregate strategic capacity planning into modules, having a high
probability of achieving the desired return on investment goals. In the example
above there is a probability of 0.98 that demand will exceed 80,000 units per
month. A facility with a maximum capacity of 80,000 units per month could be
reasonably expected to operate at full capacity continuously. Many benefits accrue
in full production situations, including the ability to lead competitors in product
price structures, when adjusting to prevailing economic conditions. This is not
meant to imply that expanding market share and future economic growth are to
be ignored. To the contrary, we propose that the firm acknowledge that capacity
has more than one role. The first role, to provide for base demand, would be
fulfilled by building a facility to provide for the 98 per cent level of demand cited
above. The other role, to provide for increases and decreases in demand, should
be fulfilled by building flexible auxiliary facilities. The exact nature of the auxiliary
flexible facility would depend on the nature of the product or service, but would
have the characteristic of being able to be expanded or contracted in relatively
small increments. In this way, the firm avoids the inventory cycle of overproducing,
when demand is low, and losing sales, when demand is high.
An example of this type approach to capacity in manufacturing may be found
in the Hills Brothers Coffee (now known as Nestle Beverages) plant in Suffolk,
Virginia. The plant roasts, grinds, and packages a variety of coffees. The plant
contains two separate facilities. One facility has a large-capacity, continuous
process line for producing their primary Hills Bros brand. This line has one batch
 IJOPM stage, roasting, but the batches are large enough (measured in 1,000lb) to keep
13,5 the rest of the line running in a continuous process fashion. The other facility is
designed to run small batches of approximately 400lb. This line is designed as
a strict batch-processing operation. The roasters are designed to process 400lbs
at a time; and, instead of feeding into a continuous process operation, the roasted
beans are stored in specially designed hoppers. These hoppers are on wheels, so
50 that, they may be stored as Work in Progress (WIP). These WIP batches are then
scheduled through the grinding and packaging stages according to promised
delivery dates.
Nestle did not design their plant with two separate facilities for strict capacity
reasons. The primary reason was to allow them to run small batches of speciality
coffees for smaller customers. On the other hand, the facility would fit our model
perfectly, if they chose to use it in that fashion. The large continuous process
facility could be designed to produce for the base demand, while the batch facility
could be used to adjust to fluctuations in demand caused by seasonal or cyclical
influences. Although it is more expensive to produce 1lb of coffee on the batch
line than on the continuous process line, producing 1lb of coffee to their actual
schedule of demand is cheaper with the combined facilities compared with the
continuous process facility, because of the flexibility of the small batch line.
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Classic examples in the service industries for this arrangement exist in the
military services. Commissioned officers are individuals who have earned a
baccalaureate degree and have received the appropriate military training. The
armed forces have three sources for commissioned officers. The military academies
are designed to produce the minimum number of officers required for a peacetime
force. They produce approximately the same number of officers year after year.
Changing the number of officers whom they produce would be quite costly, either
increasing through building new facilities or decreasing through leaving facilities
idle. The academies are staffed with military faculty on long-term assignments,
or with civilian instructors in permanent positions. The raw materials are high
school graduates, so production requires a significant amount of "fabrication and
assembly" to add both the baccalaureate degree and military training to the end
product.
Their second facility for producing officers is ROTC. This uses the facilities
at universities around the country and is staffed by the armed forces. Expanding
or contracting production at ROTC facilities is much faster and less expensive
than at the academies. The lead-time for significant changes is two to four years
because of the nature of the programme. Labour (the military instructors) can
be moved about relatively easily compared with the academies, generally involving
a two to four-year lead-time, since most instructors must live on the civilian
economy away from military installations. The raw materials are high school
graduates, but part of the production process - the baccalaureate degree - is
subcontracted out to the host university, while the ROTC staff adds the military
training.
The third type of facility of officer training for the military is their officer
training schools. These are intended to meet the short-term fluctuations in demand
 for military officers. The Air Force's OTS, for example, is a 90-day programme. Strategic
The actual facilities are on existing Air Force bases and they are staffed with Planning
full-time military instructors, who can be transferred in and out easily. The lead-
time for changes is less than a year. The raw materials are college or university
graduates; so OTS is, in effect, performing only the final assembly. The requirement
for baccalaureate degrees is met by acquiring them off the shelf from independent
vendors, and the military training is added at the officer training school. 51
The key is that the three types of facilities produce essentially the same products,
but do it under very different conditions of layout with varying materials and
labour. While the production of military officers is a service industry, there is no
reason why the same concept may not be applied to manufacturing. Whether
any given manufacturer would require two or three or four types of facilities to
allow for fluctuations in demand is irrelevant. What is relevant is that manufacturers
recognize the different roles of capacity and plan strategically to design and build
different types of facilities to meet those different roles.

Conclusion
Innovative production techniques, such as JIT and MRP production control
methodologies, obviously aid in the control of costs. Likewise, automation, new
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technologies, improved processes and computer-controlled production also have

potential for reducing cost and increasing production. Yet increased production
potential without adequate product demand is a root cause of the problem.
Productivity improvements are, generally, most efficient, when the production
process is operated at full capacity. When these improved systems are operated
at any level less than full capacity, the result is often increased production costs;
not a decrease in costs, as many manufacturers have belatedly learned. Therefore
facility capacity should be limited to levels which insure full output production
rates to meet current forecast demand levels for any production system to be
most competitive. This means, of course, that strategic planning for improved
production techniques, even for existing facilities, should place limits on capacity.
Capacity should not be expanded until demand forecasts indicate a full capacity
output can be maintained. In the meantime, fluctuations in demand should be
absorbed in a separate, flexible facility.
American industry has inherited a legacy for over-capacity facility planning.
This over-capacity has resulted in substantially higher production cost relative
to our foreign competitors, operating manufacturing facilities at or near maximum
capacity output. Foreign marketing success in the USA indicates, in our opinion,
that we do it wrongly. Our abundant industrial capacity at the close of the Second
World War left us with an unparalleled opportunity to fill pent-up demand
worldwide. However, the cost of this over-capacity, beginning as early as the mid-
1950s, has steadily eroded our competitive position, as foreign manufacturers
gradually increased capacity to take advantage of their less expensive production
costs.
Labour cost, a significant cost of production, has not been addressed in this
article. We will state, however, that American labour is as competitively priced
 IJOPM as that of any of our industrialized foreign competitors. In addition, in modern
13,5 production facilities, direct labour has declined to the point where it is an
insignificant part of total product cost. The real problem is to control all production
costs in order to price our products competitively at acceptable profit levels. The
primary production cost, with no control available at all, is the cost of excess
capacity. This hidden, yet very significant, cost is built into the system by strategic
52 planners before the first unit is produced. If all goes well, and actual demand
eventually brings a facility into full production, some of these costs may be
recovered. The primary result of excess capacity, however, is to raise the break-
even production point, raise the cost of the product, and reduce the return on
investment to figures well below those originally forecast.
There is hope for American industry on the horizon. Evidence suggests that
Japan has finally expanded industrial capacity to levels where they too experience
building ending inventory levels in some area's. The result of these growing
inventories will be, of course, an eventual reduction in production rates, and
increased production costs because of excess capacity (not labour). Events at
some foreign manufacturing facilities located in the USA over the past ten years
clearly reflect like problems building at home. For example, over-capacity at the
Volkswagen production plant in Pennsylvania was a major factor for this facility's
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failure to generate forecast profits and it was eventually closed. Also the Nissan
plant located in Smyrna, Tennesee, was operated in 1983 and is still having
difficulty becoming profitable after eight years of operations with excess capacity.
General Motors' highly automated Saturn plant is experiencing similar problems
which might also be attributed to design for over-capacity.
We are optimistic that American manufacturers can regain some of the
competitive advantages, both in domestic and foreign markets, which they once
enjoyed unchallenged. We also believe that a new and closer look will be necessary
for the strategic planning process, when providing for facility capacity. Modern
production and operations management technology requires full capacity production
to be efficient. Any production level less than full capacity will increase costs
and reduce product competitiveness. Strategic planners should, therefore, provide
just sufficient levels of production capacity to assure a reasonable opportunity
for full capacity output, and provide different, flexible capacity to absorb the
seasonal, cyclical and life-cycle fluctuations in demand for the product.

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