Chapter 5

1. Strategic Capacity Planning for Products and Services Chapter 5

2. Learning Objectives: • You should be able to: • Summarize the importance of capacity planning • Discuss ways of defining and measuring capacity • Describe the determinants of effective capacity • Discuss the major considerations related to developing capacity alternatives • Briefly describe approaches that are useful for evaluating capacity alternatives Instructor Slides

3. Capacity Planning 5-3 • Capacity • The upper limit or ceiling on the load that an operating unit can handle (rate of output) • Dollar amounts are not good measure (why?) • Capacity needs include: • Equipment • Space • Employee skills

4. Strategic Capacity Planning 5-4 • Goal: • To achieve a match between the long-term supply capabilities and the predicted level of long-term demand • Overcapacity operating costs that are too high • Undercapacity strained resources and possible loss of customers

5. Capacity Planning Questions 5-5 • Key Questions: • What kind of capacity is needed? • How much is needed to match demand? • When is it needed? • Related Questions: • How much will it cost? • What are the potential benefits and risks? • Are there sustainability issues that need to be addressed? • Should capacity be changed all at once, or through several smaller changes? • Can the supply chain handle the necessary changes?

6. Capacity Decisions Are Strategic 5-6 • Capacity decisions: • impact the ability of the organization to meet future demands • affect operating costs • are a major determinant of initial cost • often involve long-term commitment of resources • can affect competitiveness (influence delivery speed) • affect the ease of management • have become more important and complex due to globalization • need to be planned for in advance due to their consumption of financial and other resources

7. Capacity 5-7 • Design capacity • Maximum output rate or service capacity an operation, process, or facility is designed for. • Effective capacity • Design capacity minus allowances such as personal time, maintenance, scrap etc. • Actual output • Rate of output actually achieved—cannot exceed effective capacity.

8. Measuring System Effectiveness 5-8 • Efficiency Measured as percentages • Utilization Measured as percentages

9. Example– Efficiency and Utilization 5-9 Design Capacity = 50 trucks per day Effective Capacity = 40 trucks per day Actual Output = 36 trucks per day

10. Determinants of Effective Capacity 5-10 • Facilities • Size, expansions, layout, transportation costs, distance to market, labor supply, energy sources • Product and service factors • Uniformity of output, product/service mix • Process factors • Productivity, quality, setup-time • Human factors • Tasks, variety of activities, training, skills, learning, experience, motivation, labor turnover

11. Determinants of Effective Capacity 5-11 • Policy factors • Overtime, second/third shifts • Operational factors • Scheduling, inventory, purchasing, materials, quality assurance/control, breakdowns, maintenance • Supply chain factors • Impact of capacity change on suppliers, warehousing, transportation, distributors • External factors • Product standards, minimum quality, safety, environment, regulations, unions

12. Capacity Strategies 5-12 • Three primary capacity strategies: • Leading: • build capacity in anticipation of future demand increase (when capacity increase has long lead time). • Following: • build capacity when demand exceed current capacity. • Tracking: • similar to Following but in relatively small increments.

13. Capacity Cushion 5-13 • Capacity Cushion • Extra capacity used to offset demand uncertainty • Capacity cushion = Capacity – expected demand • Capacity cushion strategy • Organizations that have greater demand uncertainty typically use greater capacity cushion • Organizations that have standard products and services generally use smaller capacity cushion

14. Calculating Processing Requirements 5-14 • Calculating processing requirements requires: • reasonably accurate demand forecasts, • standard processing times • available work time

15. Calculating Processing Requirements If annual capacity is 2,000 hours, then # machines required = 5,800 hours/2,000 hours = 2.90 ->3 machines

16. Service Capacity Planning 5-16 • Service capacity planning can present a number of challenges related to: • The need to be near customers • Convenience • The inability to store services • Cannot store services for consumption later • The degree of demand volatility • Volume and timing of demand • Time required to service individual customers

17. Demand Management Strategies 5-17 • Strategies used to offset capacity limitations and that are intended to achieve a closer match between supply and demand • Pricing • Promotions • Discounts • Other tactics to shift demand from peak periods into slow periods

18. Evaluating Alternatives 5-18 • Techniques for Evaluating Alternatives • Cost-volume analysis • Break-even point • Financial analysis • Cash flow • Present value • Decision theory • Comparison of alternatives under risk and uncertainty. • Waiting-line analysis • Balance waiting cost and increased capacity cost • Simulation • Evaluate “what-if” scenarios

19. Cost-Volume Analysis Assumptions 5-19 • Cost-volume analysis is a viable tool for comparing capacity alternatives if certain assumptions are satisfied: • One product is involved • Everything produced can be sold • The variable cost per unit is the same regardless of volume • Fixed costs do not change with volume changes (or they are step changes) • The revenue per unit is the same regardless of volume • Revenue per unit exceeds variable cost per unit

20. Cost-Volume Analysis 5-20 • Cost-volume analysis • Focuses on the relationship between cost, revenue, and volume of output • Fixed Costs (FC) • (tend to) remain constant regardless of output volume • Variable Costs (VC) • vary directly with volume of output • VC = Quantity(Q) x variable cost per unit (v) • Total Cost • TC = FC + VC • Total Revenue (TR) • TR = revenue per unit (R) x Q

21. Break-Even Point (BEP) 5-21 • BEP • The volume of output at which total cost and total revenue are equal • Profit (P) = TR – TC = R x Q – (FC +v x Q) = Q(R – v) – FC 0 = QBEP(R – v) – FC

22. Cost-Volume Relationships 5-22

23. Indifference Point (Profit) Two (multiple) Alternatives • The quantity at which a decision maker would be indifferent between two competing alternatives Choose A Choose B

24. Example - Indifference Point (Cost) • A manufacturer has 3 options: • Use process A with FC=$80,000 and VC=$75/unit • Use process B with FC=$200,000 and VC=$15/unit • Purchase for $200/units 80,000+75Q=200Q QPA=640 units 80,000+75Q=200,000+15Q QAB=2,000 units Choose lowest cost: 0-640 units : Purchase 640-2,000 units: Process A Above 2,000 units: Process B

25. Average cost per unit Minimum cost 0 Rate of output Optimal Rate of Output Production units have an optimal rate of output for minimal cost. • Diseconomies of Scale • If the output rate is more than the optimal level, increasing the output rate results in increasing average per unit costs • Economies of Scale • If output rate is less than the optimal level, increasing the output rate results in decreasing average per unit costs Minimum average cost per unit

26. Economies of Scale 5-26 • Economies of Scale • If output rate is less than the optimal level, increasing the output rate results in decreasing average per unit costs • Reasons for economies of scale: • Fixed costs are spread over a larger number of units • Processing costs decrease due to standardization

27. Diseconomies of Scale 5-27 • Diseconomies of Scale • If the output rate is more than the optimal level, increasing the output rate results in increasing average per unit costs • Reasons for diseconomies of scale • congestion (transportation) • Complexity • Inflexibility • Additional levels of bureaucracy