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5. Strategic

Capacity Planning

Dr. Ron LembkeOperations Management

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Ideal Capacity of a Process

What is the capacity of the system?

Should we add any capacity?

How should we run the system? Where should we keep inventory?

50/hr 20/hr 10/hr 40/hr

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Ideal Capacity of a Process

What is the capacity of the system?

6 min 5 min 4 min 5 min

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What Would Henry Say?

Ford introduced the $5 (per day) wage in 1914

He introduced the 40 hour work week

so people would have more time to buy It also meant more output: 3*8 > 2*10

Now we know from our experience in changing fromsix to five days and back again that we can get at

least as great production in five days as we can in six,and we shall probably get a greater, for the pressurewill bring better methods.

Crowther, Worlds Work, 1926

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Forty Hour Week

Ernst Abbe, Karl Zeissoptics

1896: as much done in9 as in 8.

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How much do we have?

Design capacity: max output designed for

Effective Capacity

We can only sustain so much effort.Output level process designed for

Lowest cost per unit

Efficiency = Actual OutputEffective Capacity

Possible to run > 1.0 for long

Utilization = Actual Output/Design Capacity

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Marginal Output of Time

As you work more hours, your productivityper hour goes down

Eventually, it goes negative.

Chapman, 1909

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Time Horizons

Long-Range: over a yearacquiring,disposing of production resources

Intermediate Range: Monthly or quarterlyplans, hiring, firing, layoffs

Short Rangeless than a month, daily or

weekly scheduling process, overtime,worker scheduling, etc.

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Adding Capacity

Expensive to add capacity

A few large expansions are cheaper (per

unit) than many small additions

Large expansions allow of clean sheet of

paper thinking, re-design of processes

Carry unused overhead for a long time

May never be needed

Small expansions may pave the cow path

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Capacity Planning How much capacity should we add? Conservative Optimistic

Forecast possible demand scenarios(Chapter 10)

Determine capacity needed for likely levels

Determine capacity cushion desired

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Capacity Sources

In addition to expanding facilities:

Two or three shifts

Outsourcing non-core activities

Training or acquisition of faster equipment

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Cost-Volume Analysis

FC = Fixed Cost

v = variable cost per unit

Q = quantity

R = revenue per unit

R-v=contrib. margin

FC+VC*Q

Volume, Q

R*Q

Break-Even

Point

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Cost Volume Analysis

Solve for Break-Even Point

For profit of P,

Q = P + FC

R - v

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Decision Trees

Consider different possible decisions, anddifferent possible outcomes

Compute expected profits of each decision

Choose decision with highest expectedprofits, work your way back up the tree.

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Draw the decision tree

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Working Right to Left, eliminate anyPossible decisions we can.

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Compute Expected Values ofRemaining Decisions

Build small

= 0.4 * $40 + 0.6 * $55= $16 + $33 = $49

Build large= 0.4 * $50 + 0.6 * $70= $20 + $42 = $62

$49

$62

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Decision Trees Example

Computer store thinks demand may grow. Expansion costs $87k, new site $210k, and would cost same if

wait a year New site:

55% chance of profits of $195k. 45% chance of $115k profits.

Expand Current 55% chance of $190k profits 45% chance of $100k profits

Wait and see- enlarge store next year if demand grows If high demand, $190k with expanded store If high demand, $170 with current store If weak demand, $105k with current store

Find the expected profits over 5 years, choose best one.

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Decision Trees

Decision point

Chance events

Outcomes

Calculate expected value of each chanceevent, starting at far right

Working our way back toward thebeginning, choosing highest expectedoutcome at each decision

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Decision Trees

Revenue - Move Cost

Revenue - Move Cost

Revenue Expand Cost

Revenue Expand CostWeak Growth

Weak Growth

Strong Growth

Strong Growth

Move

Expand

Revenue

Rev

Expand Cost

Rev - Expand Cost

0.45

0.55

0.55

0.45

WaitandSee

Weak Growth

Strong Growth0.55

0.45

Expand

Do nothing

HackersComputerStore

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Possible 5 year Revenues

New, growth: 195*5210 = 765

New, low: 115*5210 = 365 Expand, growth: 190*587 = 863

Expand, low: 100*587 = 413

Wait, strong, expand: 170+190*4-87=843 Wait, strong, do nothing: 170*5 = 850

Wait, low, do nothing: 105*5 = 525

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Decision Trees

765

365

863

413Weak Growth

Weak Growth

Strong Growth

Strong Growth

Move

Expand

525

843

850

0.45

0.55

0.55

0.45

WaitandSee

Weak Growth

Strong Growth0.55

0.45

Expand

Do nothing

HackersComputerStore

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Making the Decision

Starting at the far right, look at the Wait

and See option. If demand is strong, we

would obviously not expand. $850k is better than $843.

Eliminate the Expand option

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Decision Trees

765

365

863

413Weak Growth

Weak Growth

Strong Growth

Strong Growth

Move

Expand

525

843

850

0.45

0.55

0.55

0.45

WaitandSee

Weak Growth

Strong Growth0.55

0.45

Expand

Do nothing

HackersComputerStore

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Expected Values

Move:

0.55* 765 + 0.45*365 = $585,000

Wait and See:0.55*850 + 0.45*525 = $703,750

Expand:

0.55 * 863 + 0.45 * 413 = $660,500

Highest expected value is to Wait and see,and either way, do nothing!

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Decision Trees

765

365

863

413Weak Growth

Weak Growth

Strong Growth

Strong Growth

Move

Expand

525

843

850

0.45

0.55

0.55

0.45

WaitandSee

Weak Growth

Strong Growth0.55

0.45

Expand

Do nothing

HackersComputerStore

$585,000

660,500

703,750

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Time Value of Money?

Another criteria to use is to pick the onewith the highest down side.

Under this, do nothing still wins.

We could also consider the expectedvalue of the future cash streams.

PV = $100/(1+r) = $100/(1.16)=$86.27

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Decision Tree-NPV

428,487

166,544

535,116

240,429Weak Growth

Weak Growth

Strong Growth

Strong Growth

Move

Expand

343,801

529,874

556,630

0.45

0.55

0.55

0.45

WaitandSee

Weak Growth

Strong Growth0.55

0.45

Expand

Do nothing

HackersComputerStore

$310,613

402,507

460,857

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Real Options

Assess the value to me of being able tochange my mind in the future

Changed problem slightly -Reduced benefit doing nothing, high demand

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Decision Trees765

365

863

413

Weak

StrongMove

Expand

525

843

820

0.25

0.75

Wait and See

Expand

Do nothing

Hackers

ComputerStore

Weak

Strong0.25

0.75

Weak

Strong0.25

0.75

$465,000

533,000

604,500

820

525Weak

Strong0.25

0.75

Do Nothing

598,750

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Real Options

If we didnt have the wait and see option,

we would Do Nothing.

Option to wait and see is worth $5,750

Move

Expand

Wait and See

465,000

533,000

604,500

Do Nothing 598,750$5,750