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Capacity Strategy
An operations capacity dictates its potential level of productive activity.It is, the maximum level of value-added activity over a period of timethat the operation can achieve under normal conditions.
Capacity is not same as output.
The capacity strategy of an operation defines its overall scale, the number and
size of different sites between which its capacity is distributed, the specific
activities allocated to each site and the location of each site.
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Issues in capacity strategy
Capacity
Strategy
ConfiguringCapacity
Managing CapacityChange
Type of
Capacity
Overall
Level ofCapacity
Location
ofCapacity
Timing
ofChange
Magnitude
ofChange
Location of
changedcapacity
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Utilization and efficiency measures for two divisions
of a food processing company
Efficiency Actual output
Effective capacity
3724
413490.08%
=
= =
Efficiency Actual output
Effective capacity
4622
543785.01%
=
= =
Ice Cream Division Canned Food Division
TotalCapacity
7896 hrs
PlannedLoss
3762 hrs
EffectiveCapacity
4134 hrs
ActualOutput
3724 hrs
Avoidable
Loss
410hrs
TotalCapacity
7896 hrs
PlannedLoss
2459 hrs
EffectiveCapacity
5437 hrsActualOutput
4622 hrs
AvoidableLoss815hrs
Utilization Actual output
Total capacity
3724
789647.16%
=
= =
Utilization Actual output
Total capacity
4622
789658.54%
=
= =
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Capacity at three levels
Level Time -
Scale
Decisions
concernprovision
of . . .
Span of
decisions
Starting point of
decision
Key questions
Strategic
capacity
Decisions
Years
Months
Buildings and
facilities
Process
technology
All parts of the
process
Probable markets
to be served in
the future
Current capacity
configuration
How much capacity do
we need in total?
How should the
capacity be
distributed?Where should the
capacity be located?
Medium-
term
capacity
decisions
Months
Weeks
Aggregate
number of
people
Degree of
subcontractedresources
Businesssite Market forecasts
Physical capacity
constraints
To what extent
do we keep
capacity level
fluctuate
capacity levels?Should we
change staffing
levels as demand
changes?
Should we
subcontract
off-load
demand?
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Contd .
Level Time - Scale Decisions
concern
provision
of . . .
Span of
decisions
Starting point of
decision
Key questions
Short-term
capacity
decisions
WeeksHours
Minutes
Individual staff
within the
operation
Loading of
individual
facilities
Site
Department
Current
demand
Current
available
capacity
Which
resources
are to be
allocated to
what tasks?
When should
activities be
loaded on
individual
resources?
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The overall level of operations capacity
Forecast level
of demand
Changes in
futuredemand
Uncertainty
of future
demandConsequences
of over/under
supply
Availability
of capital
Cost structure of
capacity
increment
Economies
of scale
Flexibility of
capacity
provisions
Some factors influencing the overall level of capacity
OPERATIONS
RESOURCESMARKET
REQUIREMENTS
Overall level of
capacity
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Cost, Volume profit illustration
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Unit Costs
Total cost = Fixes Cost + variable cost * Demand
Unit cost = Total Cost / output
For example, the theoretical capacity in Figure was based on an assumption that
the operation would be working 112 hours a week (14 shifts a week out of a
possible 21 shifts a week) whereas the operation is theoretically available168
hours a week.
Utilising some of this unused time for production will help to spread further the
fixed costs of the operation but could also incur extra costs.
For example, overtime payments and shift premiums together with incrementallyhigher energy bills may be incurred after a certain level of output.
There may also be less obvious costs of operating above nominal capacity levels.
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Contd
Long periods of overtime may reduce productivity levels, reduced or delayedmaintenance time may increase the chances of breakdown, operating facilities andequipment at a higher rate or for longer periods may also expose problems whichhitherto lay dormant. These diseconomies of over-using capacity can have the effectof increasing unit costs above a certain level of output.
However, all the fixed costs are not usually incurred at one time at the start ofoperations. Rather they occur at many points as volume increases.
Operations managers often have some discretion as to where these fixed-cost breakswill occur.
The factors that go together to reduce costs as volume increases are often calledeconomies of scale.
Those that work to increase unit costs for increased output beyond a certain volumeare called diseconomies of scale.
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Unit Cost Curve
In practice Unit costs are
are capable of being extended
beyond nominal capacity;
often show increases in cost
beyond a certain level of volume;
are best represented by a band
within which the true cost will lie,
rather than a smooth, clean line
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Flexibility of capacity provision
Committing to an investment in a particular level of capacity may be managed in such away as to facilitate later expansion
Effective capacity requires all the required resources and processes to be in place inorder to produce goods and services. This may not necessarily imply that all resourcesand processes are put in place at the same time. It may be possible, for example, to
construct the physical outer shell of an operation without investing in the direct andindirect process technologies which will convert it into productive capacity
One option involves building the whole physical facility (with a larger net cash outflow)but only equipping it to half its potential physical capacity. Only when demand justifiesit would expenditure be made to fully exploit this capacity.
The alternative is to build a fully equipped facility of half the capacity. A furtheridentical capacity increment would then beadded as required. Although this latterstrategy requires a lower initial cash outflow, it shows a lower cumulative cash flow inthe longer term.
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Expanding physical capacity in advance of effective
capacity can bring greater returns in the longer
term
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Number and size of sites
The decision of how many separate operational sites to have is concernedwith where a business wants to be on the spectrum between many smallsites on one hand and few large sites on the other.
Small Units - If demand for a businesss products or services is widelydistributed. This will be especially true if customers demand high absolutelevels, or immediate service.
Of course, dividing capacity into small units may also increase costsbecause of the difficulty of exploiting the economies of scale possible inlarger units.
A small number of larger units may also be less costly to supply with theirinput resources. There again, in material transformation operations, asingle large unit will bear extra transportation costs in supplying itsdistributed market.
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Some factors influencing the number and size of
sites
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CASE
Suppose a company which stores and distributes books to book shops isconsidering its capacity strategy.
Currently in its European market it has three distribution centres,
one in the UK, one in Franceand one in Germany.
The UK depot looks after the UK and Ireland, the French depot looks after France,Spain, Portugal and Belgium, and the German depot looks after the rest of Europe.
The consultants decide to simulate the alternative operations in order to estimate(a) the cost of running the depots (this includes fixed costs such as rent and localtaxes, heating, wages, security, and working capital charges for the inventory, etc.),
(b) transportation costs of delivering the books to customers, and
(c) the average delivery time in working days between customers requesting booksand them being delivered.
Table 3.2 shows the results of this simulation
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Results
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By moving to one large site it can save 9.1 million per year (the savings on depot costs
easily outweighing the increase in transportation costs). Yet, delivery times will increase
on average by 1.4 days.
Alternatively, moving to six smaller sites would increase costs by 9.3 million per year,
yet gives what looks like a significant improvement in delivery time of 2.5 days.
In practice, however, the decision is probably more sensibly approached by presenting
a number of questions to the companys managers.
Is an increase in average delivery time from 6.3 to 7.7 days likely to result in losses of
business greater than the 9.1 million savings in moving to a large site?
Is the increase in business which may be gained from a reduction in delivery time from6.3 days to 3.8 days likely to compensate for the 9.3 million extra cost of moving to six
smaller sites?
Are either of these alternative positions likely to be superior to its existing profitability?
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One final point:
In evaluating the sizes and number of sites in any operation, it is not just the
increase in profitability which may result from a change in configuration that
needs to be considered, it is whether that increase in profitability is worth the
costs of making the change. Presumably, either option will involve this company in
not only capital expenditure, but also a great deal of management effort anddisruption to its existing business. It may be that these costs and risks outweigh
any increase in profitability.
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Capacity Change
Planning changes easier if it were not for two characteristics ofcapacity:
lead-time
economies of scale.
If capacity could be introduced with zero delay between the
decision to expand and the capacity coming on stream, anoperation could wait until demand clearly warranted the change.
Deciding to Change capacity inevitably involves some degree of risk,but so does delaying the Decision leading to more problems
This means that, when changing capacity levels, there is pressure to
make the change big enough to exploit scale economies Capacity by too little may mean Opportunity risks of tying the
operation in to small, non-economic units of capacity. Put both longlead-times and significant economies of scale together and capacityChange decisions become particularly risky.
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The timing of capacity Change
Forecast level
of demand
Competitor
activity
Uncertainty
of future
demandRequired level
of service
Lead-time of
capacity
changeAbility to
cope with
change
Economiesof scale
Some factors influencing the timings of capacity change
OPERATIONS
RESOURCESMARKET
REQUIREMENTS
Time of
Capacity
Change
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Generic Timings StrategiesThere are three generic strategies for timing capacity change:
Capacity leads demandtiming the introduction of capacity in such a waythat there is always sufficient capacity to meet forecast demand.
Capacity lags demandtiming the introduction of capacity so thatdemand is always equal to or greater than capacity.
Smoothing with inventoriestiming the introduction of capacity so thatcurrent capacity plus accumulated inventory can always supply demand.
(a) Capacity-leading and capacity-lagging strategies; (b) smoothing with inventory means using the excess
capacity of one period to produce inventory which can be used to supply the under-capacity period
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Generic Timings Strategies
The advantages and disadvantages of pure leading, pure lagging and smoothing with inventories
strategies of capacity timing
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The Magnitude of Capacity Change Large units of capacity also have some disadvantages when the capacity of the
operation is being changed to match changing demand.
If an operation where forecast demand is increasing seeks to satisfy all demand byincreasing capacity using large capacity increments, it will have substantial
amounts of over-capacity for much of the period when demand is increasing,
which results in higher unit costs.
However, if the company uses smaller increments, although there will still be some
over-capacity it will be less than that using large capacity increments. This resultsin higher capacity utilisation and therefore lower costs. .
Capacity plans for meeting demand using either 800- or 400-unit capacity plants; (b) smaller-scale capacity
increments allow the capacity plan to be adjusted to accommodate changes in demand
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Balancing Capacity change
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Requiredservice level
Suitability
of site
Image of
location
Resourcecosts
Land and
facilities
investment
Resource
availability
Community
factors
Some factors influencing the location of sites
OPERATIONS
RESOURCES
MARKET
REQUIREMENTS
Location of
sites
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Labour
Transportation
Energy
Resource Cost
government financial or planning assistance
local tax rates
capital movement restrictions
political stability
local amenities (schools, theatres, shops, etc.)
history of labour relations, absenteeism, productivity, etc
environmental restrictions and waste disposal
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