Capacity Management

Updated on January 3, 2024
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Capacity Management?

Capacity management refers to the strategy applied by businesses to maximize production efficiency owing to the overall demand for a product or service in the market. Its goals include identifying and eliminating bottlenecks in the manufacturing process and increasing the production speed by optimizing available resources and removing time and capacity constraints.

It helps companies overcome challenges in meeting short- and mid-term customer demand, managing supply chain operations, and formulating long-term organizational plans. In doing so, an organization must analyze the availability of its resources to ensure it achieves the production output within the given period. This practice is common in industries like manufacturing, retail, service, and information technology.

Key Takeaways

Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

How Does Capacity Management Work?

Implementation of best practices in industries has helped businesses achieve growth in terms of market shareMarket ShareMarket share determines the company's contribution in percentage to the total revenue generated within an industry or market in a certain period. It depicts the company's market position when compared to that of its competitors.read more and revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more. In the era of the Industrial Revolution, various industries explored capacity management as a way out to increasing production pressure. But it was during the First World War when the organizations started to consider matching their capacity with the available resources to meet demand.

Market demand keeps changing due to many external factors, such as consumer choices, seasonal changes, macroeconomicsMacroeconomicsMacroeconomics aims at studying aspects and phenomena important to the national economy and world economy at large like GDP, inflation, fiscal policies, monetary policies, unemployment rates.read more, and the industrial revolution. All this may affect the way a business is run and result in loss of capacity. The failure to keep production at maximum efficiency will have a direct impact on profits.

So to achieve maximum efficiency, a business needs to track the data about its human and material resources, inventory, expected profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance.read more, etc. All this combined constitute an effective capacity management strategy. It can use this information to match capacity to demand and efficiently allocate resources to achieve its target. Although there are many resource capacity planning tools to calculate and organize these data, knowing about the strategy behind all this is still a required skill.

Strategic capacity planning in operations management requires businesses to:

  • Determine their goals
  • Understand the sales demands
  • Analyze the opportunities
  • Evaluate their resources
  • Eliminate bottlenecks
  • Review production capacity

For example, if a production line can theoretically assemble 500 goods per hour but assembles only 400 most of the time, there must be a bottleneck.

Capacity Management Strategies

Capacity Management

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Capacity Management (wallstreetmojo.com)

Industrial managers have devised a few strategies to achieve better results to increase the business production capacity. Below are some of the most popular capacity management strategies:

#1 – Lag Strategy

Using this conservative approach, a manager determines the capacity and then waits until there is an actual steady increase in demand. Then, the manager raises the production capabilities to a level to satiate the current market need.

The main drawback of this option is that the business will lose the chance to sell more if the demand goes up too quickly, as increasing production often takes time. Also, a shortage of inventory might result in customer attrition.

#2 – Lead Strategy

Unlike the lag strategy, this strategy is very aggressive and much riskier. The business decides to increase the capacity before there is an actual demand and anticipates that this will suffice if it goes up. It is used in cases where a company expands or in industries where sales demand goes up quickly. So, small firms usually avoid this kind of strategy.

However, there are a few issues with this approach. For instance, if the actual demand does not go up, it could increase the inventory storage costs and the risk of inventory wastage.

#3 – Dynamic Strategy

This forecast-driven strategy focuses on relying on market trends to increase capacity. The manager analyzes the sales forecast data and actual demand and then makes adjustments to production in advance.

It is one of the safest approaches as managers have accurate forecast data that will qualify their capacity targets. Also, it decreases the risk of shortage or wastage of inventory.

#4 – Match Strategy

This strategy mixes up lead and lag strategies. It uses small yet significant additions in the capacity of the company by following the market demand. Whenever it is clear that demand will rise, the company boosts its production in small amounts.

If the demand goes up quickly, the company can at least grow its sales a bit. If it does not, the company will not suffer huge losses. However, the business will never fully enjoy a significant spike in demand or escape unharmed from a sudden recession in the market.

Capacity Management Examples

Todd is the manager of a company that produces paper sheets. He evaluates the company sales and notices that the company is constantly selling 500,000 packages every month, which is its maximum capacity.

So, he decides to use a lead strategy and bets on growth. Todd increases the production to sell 600,000 packages monthly, so the company will not lose the chance to enjoy any spike in demand.

Clair, on the other hand, is the manager of another company in the same industry. Sales here are very different each month, ranging from 300,000 in some months to 500,000 in others. Unlike Todd, she uses a lag strategy. If demand skyrockets, she will upgrade the production. She does not have the same incentives to enhance production so quickly.

The COVID-19 outbreak across the world has affected supply chains of various industries, including healthcare. Moreover, the ramped-up manufacturing and distribution of vaccines in response to the pandemic have posed many challenges before drug manufacturers. But applying capacity management practice could help pharmaceutical companies overcome these challenges to keep vaccine production flowing.


A strong capacity management strategy will bring several benefits to a business. These are some of the main positive aspects that it will change:

  • It will enhance their ability to monitor the costs, especially during growths or recessions. This way, the business will detect shifts in price quickly and can act accordingly.
  • Using capacity management helps plan production cycles ahead of time to maximize production efficiency.
  • It will reduce the overall costs of doing business. As such, a company can identify parts of its business not optimized and remove the bottlenecks.
  • Good capacity management planning will help manage inventory better and deal with problems in the supply chain.
  • It allows better allocation of human and material resources.
  • Finally, it helps to scale a business, for example, having an in-depth understanding of how to operate before opening a new branch.

Recommended Articles

This has been a guide to Capacity Management and its definition. Here we discuss how it works along with its 4 strategies, example, and benefits. You may learn more about financing from the following articles –