SBP 2b: Time-Perishable Capacity

This principle occurs because much or all of the service production cannot occur until after customer inputs are provided. The Unified Services Theory describes the essential nature of customer inputs in service processes.

The perishability of services is often misunderstood. It is not the service product itself that is perishable, but rather the capacity to produce the service. What is capacity? In the production sense, it is the ability to meet a certain amount and type of demand.

Generally, service capacity can only be utilized to meet demand at the given time. This means that today's capacity cannot be used to meet tomorrow's demand. This is unfortunate, since today's demand may be low but tomorrow's demand may be high. Things would be a lot easier if we could meet some of tomorrow's high demand with today's extra capacity. That is what manufacturers do-it is called production smoothing. They simply produce more product today with the extra capacity and store it in inventory for sale tomorrow.

Service companies cannot generally produce with the extra capacity today since major portions of production require first getting inputs from customers. If a service provider wants to use extra capacity on a given day the either have to (a) pursue production activities that do not require additional customer inputs, or (b) convince customers to provide their inputs on the day of extra capacity. This latter option is actually to shift demand to more closely match capacity. For example, a movie theater may offer discounts for non-weekend movies to shift demand to times of lower capacity utilization.

As a result of time-perishable capacity, the capacity utilization service firms can be relatively low, even under good conditions. For example, at the start of 1998, the average airline “passenger load factor” (the seat utilization rate) was 71 percent, up from about 60 percent at the start of the decade.¹⁾ Even though 71 percent utilization is outstanding for service companies, it would be considered quite low for most manufacturing plants. Other services will have even lower utilization. An example is restaurants, where capacity utilization is high during mealtimes but mostly idle during interim times.

If a hypothetical restaurant which is open from 11:00 a.m. until 9:00 p.m. has 100 seats and each customer takes one hour to eat, then the daily capacity is 100 customer x 10 hours / 1 hour per customer = 1000 customers per day. The restaurant will be full from noon to 2:00 and from 6:00 to 9:00, but it will have only a few customers between these two times. The result is a capacity utilization of perhaps 50 percent. To make matters worse, the restaurant may actually turn customers away for dinner, or lose customers due to long wait times. If the restaurant could just serve dinner customers from 2:00 to 6:00, when there is a lot of extra capacity, the overall utilization would be much better. However, it would be a difficult task to convince many people to have dinner between 2:00 and 6:00.

When there is uncertain demand, service companies need to “inventory” capacity for potential demand. This inventory of capacity represents relatively idle resources waiting for customers to present their inputs. For example, most emergency rooms have much more capacity than is typically needed-they keep the extra capacity just in case.

Who pays for the idle capacity? Ultimately the customers! Idle capacity is a form of overhead that needs to be paid for by revenue-generating production.

Capacity scheduling is difficult but essential. This scheduling requires forecasts of demand, not only in aggregate but period by period. Given a forecast, the service provider must still decide on the appropriate capacity to plan for at each time period. Even if the capacity is set exactly at the forecast level, uncertain forecasts can still result in unmet demand or idle capacity. The service provider must decide on the relative importance of avoiding insufficient capacity vs. avoiding idle capacity.

Other decisions include strategies for shifting demand to times of extra capacity.

There are a number of ways to adjust capacity to more closely match demand. For example, companies can employ part-time workers or cross-train employees to help out where demand is higher than expected. Such strategies can make capacity more flexible and thus more able to match uncertain demand.

Various strategies also exist for influencing demand to more closely match capacity. Movie theaters might offer discounts for matinee or non-weekend movies. In some services it is appropriate to have reservation systems to assure that customers will arrive when there is available capacity.

A more complex system known as Yield Management dynamically adjusts capacity and influences demand to maximize revenues. Yield Management is used in situations where customers make reservations for future service where there is relatively fixed capacity (such as hotels or airlines).

Demand is influenced by adjusting price-if demand seems higher than usual then the price can be raised, but if it appears that demand will be below capacity then the price can be lowered. Capacity is adjusted by allocating capacity between service-price categories. For example, a given airplane may have a certain number of seats reserved for business-fare passengers (who typically pay more) and other seats available for coach-fare passengers who are more price conscious. If an extra number of business passengers make reservations, the airline might switch some of the coach-fare seats to be held for other business passengers, thus reducing the number of coach-fare seats. (Yield Management will be revisited in the Price Guessing Service Business Principle.)

(Fitzsimmons2 chapter 13 discusses a number of strategies for managing capacity and demand.)

At a hair salon, capacity is defined by the number of seats and the number of hairstylists. When a customer is not present in a hairstylist's chair, that capacity is lost forever. The hairstylist cannot (or at least should not) cut someone's hair that has not “demanded” to have it done. There are various ways a hair salon might bring capacity and demand more in line. They might have more employees come in during busy times, might offer a price discount during consistently slow days, or have reservation systems.

With an airline, capacity in a given flight is primarily defined by airplane seats. If no one is sitting in a particular seat during a flight, the capacity on that flight cannot be held until later demand. If there are 50 vacant seats on a morning flight to Dallas, but the evening flight were oversubscribed by 50 people, it is impossible to inventory the 50 vacant morning seats for use on the evening flight. Perhaps demand may be moved back from the evening flight to the morning flight, but it is impossible to recover the unused morning capacity to meet strictly evening-flight demand.

With manufacturing, capacity is not time-perishable, for if no demand is present we can still produce and then store the product in inventory for future demand.

1. What happens at our production facility when customers are not present?
2. How does this affect our utilization of capacity? What percent of our capacity do we reasonably expect to be used at different times? (i.e. busy times, slow times, etc.)
3. How does that utilization affect our cost structure? In other words, are customers who utilize capacity subsidizing, or paying for, the times that capacity is not utilized?

Estimate the percent of time service-production resources are idle waiting for customer inputs. List two major resources, such as a particular type of labor, customer seating, a production machine, etc. For each, estimate what percent of the time that resource is producing, and what percent of the time the resource is idle. Comment on why the idleness occurs and what the cost of that idleness might be to the company and to the customers. Also for each of the resources, describe an appropriate strategy for more closely matching capacity and demand, such as by adjusting capacity to meet demand or by influencing demand to meet capacity.

(One example of a airline resource is ticket counter agents. At a typical airport, ticket counter agents probably serve customers 70 percent of the time, implying that they are idle perhaps 30 percent of the time. This idleness occurs because fewer agents would mean longer lines during the busy times, which would upset customers and might make them miss flights. Ticket agent labor costs would be 30 percent higher than if capacity exactly equaled demand and no idleness occurred, but that probably has a relatively small impact on the overall cost of an airline ticket. Airlines could help make capacity more in line with demand by partitioning demand into passengers who simply want to check baggage and those who have other transactions, such as purchasing or changing tickets. The former is likely more cyclical during the day. When numerous flights are nearing departure, and ticket counters may be backed up with customers wanting to check in, employees could be brought in to help with “check baggage only” stations.)