Capacity Planning

For Products and Services

Learning ObjectivesLearning Objectives

Explain 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

Capacity PlanningCapacity Planning

Capacity is the upper limit or ceiling on the load that an operating unit can handle.

Capacity also includes Equipment Space Employee skills

The basic questions in capacity handling are: What kind of capacity is needed? How much is needed? When is it needed?

1. Impacts ability to meet future demands2. Affects operating costs3. Major determinant of initial costs4. Involves long-term commitment5. Affects competitiveness6. Affects ease of management7. Globalization adds complexity8. Impacts long range planning

Importance of Capacity DecisionsImportance of Capacity Decisions

CapacityCapacity

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, and scrap

Actual output Rate of output actually achieved--cannot

exceed effective capacity.

Efficiency and UtilizationEfficiency and Utilization

Actual outputEfficiency =

Effective capacity

Actual outputUtilization =

Design capacity

Both measures expressed as percentages (%)

Actual output = 36 units/day Efficiency = =

90% Effective capacity 40 units/ day

Utilization = Actual output = 36 units/day =

72% Design capacity 50 units/day

Efficiency/Utilization ExampleEfficiency/Utilization Example

Design capacity = 50 trucks/day

Effective capacity = 40 trucks/day

Actual output = 36 units/day

Determinants of Effective Determinants of Effective CapacityCapacity

Facilities (design, location, layout, environment)

Product and service factors (design, product mix)

Process factors (quantity capacity, quality capacity)

Human factors (job content, job design, training & experience, motivation, compensation, learning rate, absenteeism and turnover)

Policy factors Operational factors (scheduling, materials management, QA,

maintenance, breakdown)

Supply chain factors External factors (standard, safety regulation, unions, pollution

control standard)

Strategy FormulationStrategy Formulation

Capacity strategy for long-term demand patterns involve;

Growth rate and variability of demand Cost of building and operating facilities of

various size Rate and direction of technology changes Behavior of competitors Availability of capital and other inputs

Key Decisions of Capacity Key Decisions of Capacity PlanningPlanning

1. Amount of capacity needed• Capacity cushion (100% - Utilization)

2. Timing of changes

3. Need to maintain balance of the system

4. Extent of flexibility of facilities and workforce

Capacity cushion – extra demand intended to offset uncertainty

Steps for Capacity PlanningSteps for Capacity Planning

1. Forecast future capacity requirements

2. Evaluate existing capacity

3. Identify alternatives

4. Conduct financial analysis

5. Assess key qualitative issues

6. Select one alternative

7. Implement alternative chosen

8. Monitor results

Forecasting Capacity Forecasting Capacity RequirementsRequirements

Long-term vs. short-term capacity needs Long-term relates to overall level of capacity

such as facility size, trends, and cycles Short-term relates to variations from

seasonal, random, and irregular fluctuations in demand

Calculating Processing Calculating Processing RequirementsRequirements

P r o d u c tA n n u a l

D e m a n d

S t a n d a r dp r o c e s s i n g t i m e

p e r u n i t ( h r . )P r o c e s s i n g t i m e

n e e d e d ( h r . )

# 1

# 2

# 3

4 0 0

3 0 0

7 0 0

5 . 0

8 . 0

2 . 0

2 , 0 0 0

2 , 4 0 0

1 , 4 0 0 5 , 8 0 0

P r o d u c tA n n u a l

D e m a n d

S t a n d a r dp r o c e s s i n g t i m e

p e r u n i t ( h r . )P r o c e s s i n g t i m e

n e e d e d ( h r . )

# 1

# 2

# 3

4 0 0

3 0 0

7 0 0

5 . 0

8 . 0

2 . 0

2 , 0 0 0

2 , 4 0 0

1 , 4 0 0 5 , 8 0 0

Annual capacity = 2000 hoursMachine required to handle these job = 5,800 /2,000 = 2.90Machine required to handle these job = 3 machines

Working 8-hour shift, 250 day/year

Need to be near customers Capacity and location are closely tied

Inability to store services Capacity must be matched with timing of

demand

Degree of volatility of demand Peak demand periods

Planning Service CapacityPlanning Service Capacity

In-House or OutsourcingIn-House or Outsourcing(Make or Buy)(Make or Buy)

1. Available capacity

2. Expertise

3. Quality considerations

4. Nature of demand

5. Cost

6. Risk

Developing Capacity AlternativesDeveloping Capacity Alternatives 1.Design flexibility into systems2.Take stage of life cycle into account

3.Take a “big picture” approach to capacity changes (to focus bottleneck)

4.Prepare to deal with capacity “chunks”5.Attempt to smooth out capacity

requirements6.Identify the optimal operating level

(economy of scale)

Product Life CycleProduct Life Cycle

Best period to Best period to increase market increase market shareshare

R&D engineering is R&D engineering is criticalcritical

Practical to change Practical to change price or quality price or quality imageimage

Strengthen nicheStrengthen niche

Poor time to Poor time to change image, change image, price, or qualityprice, or quality

Competitive costs Competitive costs become criticalbecome criticalDefend market Defend market positionposition

Cost control Cost control criticalcritical

Introduction Growth Maturity Decline

Co

mp

an

y S

tra

teg

y/Is

sue

sC

om

pa

ny

Str

ate

gy/

Issu

es

InternetInternet

Flat-screen Flat-screen monitorsmonitors

SalesSales

DVDDVD

CD-ROMCD-ROM

Drive-through Drive-through restaurantsrestaurants

Fax machinesFax machines

3 1/2” 3 1/2” Floppy Floppy disksdisks

Color printersColor printers

Product Life CycleProduct Life Cycle

Product designProduct design and and development development criticalcritical

Frequent Frequent product and product and process design process design changeschanges

Short production Short production runsruns

High production High production costscosts

Limited modelsLimited models

Attention to Attention to qualityquality

Introduction Growth Maturity Decline

OM

Str

ate

gy

/Issu

es

OM

Str

ate

gy

/Issu

es

Forecasting Forecasting criticalcritical

Product and Product and process process reliabilityreliability

Competitive Competitive product product improvements improvements and optionsand options

Increase capacityIncrease capacity

Shift toward Shift toward product focusproduct focus

Enhance Enhance distributiondistribution

StandardizationStandardization

Less rapid Less rapid product changes product changes – more minor – more minor changeschanges

Optimum Optimum capacitycapacity

Increasing Increasing stability of stability of processprocess

Long production Long production runsruns

Product Product improvement and improvement and cost cuttingcost cutting

Little product Little product differentiationdifferentiation

Cost Cost minimizationminimization

Overcapacity Overcapacity in the in the industryindustry

Prune line to Prune line to eliminate eliminate items not items not returning returning good margingood margin

Reduce Reduce capacitycapacity

Bottleneck OperationBottleneck Operation

Machine #2Machine #2BottleneckOperation

BottleneckOperation

Machine #1Machine #1

Machine #3Machine #3

Machine #4Machine #4

10/hr

10/hr

10/hr

10/hr

30/hr

Bottleneck operation: An operationin a sequence of operations whosecapacity is lower than that of theother operations

30/hr

Bottleneck OperationBottleneck Operation

Operation 120/hr.

Operation 210/hr.

Operation 315/hr.

10/hr.

Bottleneck

Maximum output ratelimited by bottleneck

Optimal Rate of Output

Minimumcost

Av

era

ge

co

st

per

un

it

0 Rate of output

Production units have an optimal rate of output for minimal cost.

Minimum average cost per unit

Economies of ScaleEconomies of Scale

Economies of scale If the output rate is less than the optimal

level, increasing output rate results in decreasing average unit costs

Diseconomies of scale If the output rate is more than the optimal

level, increasing the output rate results in increasing average unit costs

Economies of ScaleEconomies of Scale

Minimum cost & optimal operating rate are functions of size of production unit.

Av

era

ge

co

st

per

un

it

0

Smallplant Medium

plant Largeplant

Output rate

Evaluating AlternativesEvaluating Alternatives

Cost-volume analysis Break-even point

Financial analysis Cash flow Present value

Decision theory Waiting-line analysis

Cost-Volume RelationshipsCost-Volume Relationships

Am

ou

nt

($)

0Q (volume in units)

Total cost = VC + FC

Total variable cost (V

C)

Fixed cost (FC)

Cost-Volume RelationshipsCost-Volume Relationships

Am

ou

nt

($)

Q (volume in units)0

Total r

evenue

Cost-Volume RelationshipsCost-Volume Relationships

Am

ou

nt

($)

Q (volume in units)0 BEP units

Profit

Total r

even

ue

Total cost

BEP = Break Even Point

Break-Even Problem with Step Break-Even Problem with Step Fixed CostsFixed Costs

Quantity

FC + VC = TC

FC + VC = TC

FC + VC =

TC

Step fixed costs and variable costs.

1 machine

2 machines

3 machines

Break-Even Problem with Step Break-Even Problem with Step Fixed CostsFixed Costs

$

TC

TC

TCBEP2

BEP3

TR

Quantity

1

2

3

Multiple break-even points

1.One product is involved2.Everything produced can be sold3.Variable cost per unit is the same

regardless of volume4.Fixed costs do not change with volume5.Revenue per unit constant with volume6.Revenue per unit exceeds variable cost

per unit

Assumptions of Cost-Volume Assumptions of Cost-Volume AnalysisAnalysis

Financial AnalysisFinancial Analysis

Cash Flow - the difference between cash received from sales and other sources, and cash outflow for labor, material, overhead, and taxes.

Present Value - the sum, in current value, of all future cash flows of an investment proposal.

Decision TheoryDecision Theory

Helpful tool for financial comparison of alternatives under conditions of risk or uncertainty

Suited to capacity decisions

Waiting-Line AnalysisWaiting-Line Analysis

Useful for designing or modifying service systems

Waiting-lines occur across a wide variety of service systems

Waiting-lines are caused by bottlenecks in the process

Helps managers plan capacity level that will be cost-effective by balancing the cost of having customers wait in line with the cost of additional capacity

Decision Theory represents a general approach to decision making which is suitable for a wide range of operations management decisions, including:

Product andservice design

Product andservice design

Equipment selection

Location planning

Capacityplanning

Decision TheoryDecision Theory

A set of possible future conditions exists that will have a bearing on the results of the decision

A list of alternatives for the manager to choose from

A known payoff for each alternative under each possible future condition

Decision Theory ElementsDecision Theory Elements

Identify possible future conditions called states of nature

Develop a list of possible alternatives, one of which may be to do nothing

Determine the payoff associated with each alternative for every future condition

If possible, determine the likelihood of each possible future condition

Evaluate alternatives according to some decision criterion and select the best alternative

Decision Theory ProcessDecision Theory Process

Bounded Rationality

The limitations on decision making caused by costs, human abilities, time, technology, and availability of information

Causes of Poor DecisionsCauses of Poor Decisions

Suboptimization

The result of different departments each attempting to reach a solution that is optimum for that department

Causes of Poor Decisions (Cont’d)Causes of Poor Decisions (Cont’d)

Decision ProcessDecision Process

1. Identify the problem

2. Specify objectives and criteria for a solution

3. Develop suitable alternatives

4. Analyze and compare alternatives

5. Select the best alternative

6. Implement the solution

7. Monitor to see that the desired result is achieved

Certainty - Environment in which relevant parameters have known values

Risk - Environment in which certain future events have probable outcomes

Uncertainty - Environment in which it is impossible to assess the likelihood of various future events

Decision EnvironmentsDecision Environments

Maximin - Choose the alternative with the best of the worst possible payoffs

Maximax - Choose the alternative with the best possible payoff

Laplace - Choose the alternative with the best average payoff of any of the alternatives

Minimax Regret - Choose the alternative that has the least of the worst regrets

Decision Making under UncertaintyDecision Making under Uncertainty

Decision Making Under RiskDecision Making Under Risk

Risk: The probability of occurrence for each state of nature is known

Risk lies between the extremes of uncertainty and certainty

Expected monetary value (EMV) criterion: The best expected value among alternatives Determine the expected payoff of each

alternative, and choose the alternative with the best expected payoff

Decision TreesDecision Trees

Decision tree: a Schematic representation of the available alternatives and their possible consequences.

Useful for analyzing situations that involve sequential decisions

Format of a Decision TreeFormat of a Decision Tree

State of nature 1

B

Payoff 1

State of nature 2

Payoff 2

Payoff 3

2

Choose A’1

Choose A’2

Payoff 6State of nature 2

2

Payoff 4

Payoff 5

Choose A’3

Choose A’4

State of nature 1

Choose A

’

Choose A’2

1

Decision PointChance Event

Example of a Decision TreeExample of a Decision Tree

Low demand (0.4)

B

40M

High demand (0.6)

40M

55M

2

Do nothing

Expand

70MHigh demand (0.6)

2

10M

50M

Do nothing

Reduce price

Low demand (0.4)

Build s

mal

l

Build large

1

Decision PointChance Event

Overtime 50M

Expected Value of Perfect InformationExpected Value of Perfect Information

Expected value of perfect information: the difference between the expected payoff under certainty and the expected payoff under risk

Expected value ofperfect information

Expected payoffunder certainty

Expected payoffunder risk= -

Sensitivity AnalysisSensitivity Analysis

Sensitivity Analysis: Determining the range of probability for which an alternative has the best expected payoff

Useful for decision makers to have some indication of how sensitive the choice of an alternative is to changes in one or more of these values

ExampleExample

ตารางแสดง Payoff ของแต�ละทางเล�อกState of nature

#1 #2

Alternative A 4 12

B 16 2

C 12 8

จงเข�ยนภาพแสดง Sensitivity

Sensitivity AnalysisSensitivity Analysis

16141210 86420

16141210 86420

A

B

C

A bestC bestB best

#1 Payoff #2 Payoff

Sensitivity analysis: determine the range of probability for which an alternative has the best expected payoff