Download - Operations Management Chapter 5
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Strategic Capacity Planning for
Products and Services
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
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CapacityThe upper limit or ceiling on the load that an operating
unit can handleCapacity needs include
EquipmentSpaceEmployee skills
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GoalTo achieve a match between the long-term supply
capabilities of an organization and the predicted level of long-term demandOvercapacity operating costs that are too highUndercapacity strained resources and possible loss of
customers
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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? Should capacity be changed all at once, or through several
smaller changes Can the supply chain handle the necessary changes?
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Capacity decisions1. impact the ability of the organization to meet future demands2. affect operating costs3. are a major determinant of initial cost4. often involve long-term commitment of resources5. can affect competitiveness6. affect the ease of management7. have become more important and complex due to globalization8. need to be planned for in advance due to their consumption of
financial and other resources
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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.
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Measure capacity in units that do not require updating Why is measuring capacity in dollars problematic?
Two useful definitions of capacity Design capacity
The maximum output rate or service capacity an operation, process, or facility is designed for
Effective capacityDesign capacity minus allowances such as personal time and
maintenance
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Actual outputThe rate of output actually achievedIt cannot exceed effective capacity
Efficiency
Utilization
Measured as percentages
capacity effective
output actualEfficiency
capacitydesign
output actualnUtilizatio
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Design Capacity = 50 trucks per dayEffective Capacity = 40 trucks per dayActual Output = 36 trucks per day
%9040
36
capacity effective
output actualEfficiency
%7250
36
capacitydesign
output actualnUtilizatio
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FacilitiesProduct and service factorsProcess factorsHuman factorsPolicy factorsOperational factorsSupply chain factorsExternal factors
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Strategies are typically based on assumptions and predictions about:Long-term demand patternsTechnological changeCompetitor behavior
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Capacity CushionExtra capacity used to offset demand uncertaintyCapacity cushion = 100% - UtilizationCapacity cushion strategy
Organizations that have greater demand uncertainty typically have greater capacity cushion
Organizations that have standard products and services generally have greater capacity cushion
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1. Estimate future capacity requirements
2. Evaluate existing capacity and facilities; identify gaps
3. Identify alternatives for meeting requirements
4. Conduct financial analyses
5. Assess key qualitative issues
6. Select the best alternative for the long term
7. Implement alternative chosen
8. Monitor results
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Interest rate on the revolver (including monitoring fees, etc.)
Up Front fees (commitment fees, closing fees, audit fee, etc.)
Size of the line offered Expected Covenant Restrictions Advance Rate on Inventory and AR Unused line fee Default Rate Perceived “friendliness” of lender
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Decision Factor
Weight (1-10)
Interest Rate on Revolver 8
Up Front Fees 3
Size of Line 7
Covenant Restrictions 7
Advance Rate 5
Unused Line Fee 3
Default Rate 5
Friendliness of Lender 7
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Decision FactorWeight (1-10) Lender 1 Lender 2 Lender 3 Lender 4
Interest Rate on Revolver 8 1 3 2 4
Up Front Fees 3 2 1 3 4
Size of Line 7 3 2 1 4
Covenant Restrictions 7 4 3 2 1
Advance Rate 5 1 2 2 1
Unused Line Fee 3 2 1 1 2
Default Rate 5 2 1 2 1
Friendliness of Lender 7 1 2 3 4
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Lender 1 Lender 2 Lender 3 Lender 4
Decision Factor Weight Rank
Score Rank Score Rank Score Rank Score
Interest Rate on
Revolver 8 4 32 2 16 3 24 1 8
Up Front Fees 3 2 6 4 12 3 9 1 3
Size of Line 7 1 7 3 21 4 28 1 7
Covenant Restrictio
ns 7 1 7 2 14 3 21 4 28
Advance Rate 5 4 20 3 15 3 15 4 20
Unused Line Fee 3 3 9 4 12 4 12 3 9
Default Rate 5 2 10 2 10 3 15 4 20
Friendliness of Lender 7 4 28 3 21 2 14 1 7
TotalScore 119 121 138 102
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Criterion Weight Alternative A Alternative B Alternative C
Financial
ROI 15% 2 4 10
Payback 10% 3 5 10
NPV 15% 2 4 10
Organizational
Alignment with strategic objectives 10% 3 5 8
Likelihood of achieving project’s MOV 10% 2 6 9
Project
Availability of skilled team members 5% 5 5 4
Maintainability 5% 4 6 7
Time to develop 5% 5 7 6
Risk 5% 3 5 5
External
Customer satisfaction 10% 2 4 9
Increased market share10% 2 5 8
Total Score 100% 2.65 4.85 8.50
Notes: Risk scores have a reverse scale – i.e., higher scores for risk imply lower levels of risk
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Company One Company Two Company Three
Critical Success Factors
Weight Rating Score Rating Score Rating Score
Advertising 0.20 1 0.20 4 0.80 3 0.60
Product Quality 0.10 4 0.40 3 0.30 2 0.20
Price Competitiveness
0.10 3 0.30 2 0.20 4 0.40
Management 0.10 4 0.40 3 0.30 3 0.30
Financial Position 0.15 4 0.60 2 0.30 3 0.45
Customer Loyalty 0.10 4 0.40 3 0.30 2 0.20
Global Expansion 0.20 4 0.80 1 0.20 2 0.40
Market Share 0.05 1 0.05 4 0.20 3 0.15
Total 1.00 3.15 2.60 2.70
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Long-term considerations relate to overall level of capacity requirementsRequire forecasting demand over a time horizon and
converting those needs into capacity requirementsShort-term considerations relate to probable variations in capacity requirementsLess concerned with cycles and trends than with
seasonal variations and other variations from average
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Calculating processing requirements requires reasonably accurate demand forecasts, standard processing times, and available work time
horizon planning theduring available timeprocessing
horizon planning theduring product for demand
product for timeprocessing standard
machines required ofnumber
where
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ip
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R
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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 laterThe degree of demand volatility
Volume and timing of demandTime required to service individual customers
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Strategies used to offset capacity limitations and that are intended to achieve a closer match between supply and demandPricingPromotionsDiscountsOther tactics to shift demand from peak periods into
slow periods
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Once capacity requirements are determined, the organization must decide whether to produce a good or service itself or outsource
Factors to consider: Available capacity Expertise Quality considerations The nature of demand Cost Risks
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Things that can be done to enhance capacity management: Design flexibility into systems Take stage of life cycle into account Take a “big-picture” approach to capacity changes Prepare to deal with capacity “chunks” Attempt to smooth capacity requirements Identify the optimal operating level Choose a strategy if expansion is involved
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Leading Build capacity in anticipation of future demand increases
Following Build capacity when demand exceeds current capacity
Tracking Similar to the following strategy, but adds capacity in relatively
small increments to keep pace with increasing demand
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An operation in a sequence of operations whose capacity is lower than that of the other operations
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OptimalOutputRate
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Economies of ScaleIf output rate is less than the optimal level, increasing
the output rate results in decreasing average per unit costs
Diseconomies of ScaleIf the output rate is more than the optimal level,
increasing the output rate results in increasing average per unit costs
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Economies of ScaleIf 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 unitsConstruction costs increase at a decreasing rate as facility
size increasesProcessing costs decrease due to standardization
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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
Distribution costs increase due to traffic congestion and shipping from a centralized facility rather than multiple smaller facilities
Complexity increases costsInflexibility can be an issueAdditional levels of bureaucracy
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Minimum cost & optimal operating rate are functions of size of production unit.
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Constraint Something that limits the performance of a process or system in
achieving its goals Categories
MarketResourceMaterialFinancialKnowledge or competencyPolicy
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1. Identify the most pressing constraint
2. Change the operation to achieve maximum benefit, given the constraint
3. Make sure other portions of the process are supportive of the constraint
4. Explore and evaluate ways to overcome the constraint
5. Repeat the process until the constraint levels are at acceptable levels
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Alternatives should be evaluated from varying perspectivesEconomic
Is it economically feasible?How much will it cost?How soon can we have it?What will operating and maintenance costs be?What will its useful life be?Will it be compatible with present personnel and
present operations?Non-economic
Public opinion
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Techniques for Evaluating AlternativesCost-volume analysisFinancial analysisDecision theoryWaiting-line analysisSimulation
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Cost-volume analysisFocuses on the relationship between cost, revenue,
and volume of outputFixed Costs (FC)
tend to remain constant regardless of output volumeVariable Costs (VC)
vary directly with volume of outputVC = Quantity(Q) x variable cost per unit (v)
Total CostTC = FC + VC
Total Revenue (TR)TR = revenue per unit (R) x Q
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BEPThe volume of output at which total cost and total
revenue are equalProfit (P) = TR – TC = R x Q – (FC +v x Q)
= Q(R – v) – FC
vRQBEP
FC
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Capacity alternatives may involve step costs, which are costs that increase stepwise as potential volume increases.The implication of such a situation is the possible
occurrence of multiple break-even quantities.
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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
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Cash flowThe difference between cash received from sales and
other sources, and cash outflow for labor, material, overhead, and taxes
Present valueThe sum, in current value, of all future cash flow of an
investment proposal
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Capacity planning impacts all areas of the organization It determines the conditions under which operations will have to function Flexibility allows an organization to be agile
It reduces the organization’s dependence on forecast accuracy and reliability Many organizations utilize capacity cushions to achieve flexibility
Bottleneck management is one way by which organizations can enhance their effective capacities
Capacity expansion strategies are important organizational considerations
Expand-early strategy Wait-and-see strategy
Capacity contraction is sometimes necessary Capacity disposal strategies become important under these
conditions
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Decision Theory
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
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A general approach to decision making that is suitable to a wide range of operations management decisionsCapacity planningProduct and service designEquipment selectionLocation planning
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Characteristics of decisions that are suitable for using decision theoryA set of possible future conditions that will have a
bearing on the results of the decisionA list of alternatives from which to chooseA known payoff for each alternative under each
possible future condition
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1. Identify the possible future states of nature
2. Develop a list of possible alternatives
3. Estimate the payoff for each alternative for each possible future state of nature
4. If possible, estimate the likelihood of each possible future state of nature
5. Evaluate alternatives according to some decision criterion and select the best alternative
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A table showing the expected payoffs for each alternative in every possible state of nature
Possible Future Demand
Alternatives Low Moderate High
Small facility $10 $10 $10
Medium facility 7 12 12
Large Facility (4) 2 16
• A decision is being made concerning which size facility should be constructed
• The present value (in millions) for each alternative under each state of nature is expressed in the body of the above payoff table
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Decisions occasionally turn out poorly due to unforeseeable circumstances; however, this is not the norm.
More frequently poor decisions are the result of a combination ofMistakes in the decision processBounded rationalitySuboptimization
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Steps:1. Identify the problem2. Specify objectives and criteria for a solution3. Develop suitable alternatives4. Analyze and compare alternatives5. Select the best alternative6. Implement the solution7. Monitor to see that the desired result is achieved
Errors Failure to recognize the importance of each step Skipping a step Failure to complete a step before jumping to the next step Failure to admit mistakes Inability to make a decision
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Bounded rationalityThe limitations on decision making caused by costs,
human abilities, time, technology, and availability of information
SuboptimizationThe results of different departments each attempting
to reach a solution that is optimum for that department
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There are three general environment categories:Certainty
Environment in which relevant parameters have known values
RiskEnvironment in which certain future events have
probabilistic outcomesUncertainty
Environment in which it is impossible to assess the likelihood of various possible future events
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Decisions are sometimes made under complete uncertainty: No information is available on how likely the various states of nature are.
Decision Criteria: 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 Minimax regret
Choose the alternative that has the least of the worst regrets
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Possible Future Demand
Alternatives Low Moderate High
Small Facility $10 $10 $10
Medium Facility 7 12 12
Large Facility (4) 2 16
•The worst payoff for each alternative isSmall facility: $10 millionMedium facility $7 millionLarge facility -$4 million
•Choose to construct a small facility
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Possible Future Demand
Alternatives Low Moderate High
Small Facility $10 $10 $10
Medium Facility 7 12 12
Large Facility (4) 2 16
•The best payoff for each alternative isSmall facility: $10 millionMedium facility $12 millionLarge facility $16 million
•Choose to construct a large facility
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Possible Future Demand
Alternatives Low Moderate High
Small Facility $10 $10 $10
Medium Facility 7 12 12
Large Facility (4) 2 16
•The average payoff for each alternative isSmall facility: (10+10+10)/3 = $10 millionMedium facility (7+12+12)/3 = $10.33 millionLarge facility (-4+2+16)/3 = $4.67 million
•Choose to construct a medium facility
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Possible Future Demand
Alternatives Low Moderate High
Small Facility $10 $10 $10
Medium Facility 7 12 12
Large Facility (4) 2 16
•Construct a regret (or opportunity loss) table•The difference between a given payoff and the best payoff for a state of nature
Regrets
Alternatives Low Moderate High
Small Facility $0 $2 $6
Medium Facility
3 0 4
Large Facility 14 10 0 5S-61
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Regrets
Alternatives Low Moderate High
Small Facility $0 $2 $6
Medium Facility 3 0 4
Large Facility 14 10 0
•Identify the worst regret for each alternative•Small facility $6 million•Medium facility $4 million•Large facility $14 million
•Select the alternative with the minimum of the maximum regrets
•Build a medium facility
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Decisions made under the condition that the probability of occurrence for each state of nature can be estimated
A widely applied criterion is expected monetary value (EMV) EMV
Determine the expected payoff of each alternative, and choose the alternative that has the best expected payoff
This approach is most appropriate when the decision maker is neither risk averse nor risk seeking
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Possible Future Demand
Alternatives Low (.30) Moderate (.50) High (.20)
Small Facility $10 $10 $10
Medium Facility 7 12 12
Large Facility (4) 2 16
EMVsmall = .30(10) +.50(10) +.20(10) = 10EMVmedium = .30(7) + .50(12) + .20(12) = 10.5EMVlarge = .30(-4) + .50(2) + .20(16) = $3
Build a medium facility
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Decision tree A schematic representation of the available alternatives and
their possible consequences Useful for analyzing sequential decisions
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Composed of Nodes
Decisions – represented by square nodes Chance events – represented by circular nodes
Branches Alternatives– branches leaving a square node Chance events– branches leaving a circular node
Analyze from right to left For each decision, choose the alternative that will yield the
greatest return If chance events follow a decision, choose the alternative that
has the highest expected monetary value (or lowest expected cost)
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A manager must decide on the size of a video arcade to construct. The manager has narrowed the choices to two: large or small. Information has been collected on payoffs, and a decision tree has been constructed. Analyze the decision tree and determine which initial alternative (build small or build large) should be chosen in order to maximize expected monetary value.
1
2
2
$40
$40
$50
$55
($10)
$50
$70
Bui
ld S
mal
l
Low Demand (.40)
Low Demand (.40)
High Demand (.60)
High Demand (.60)
Build Large
Do Nothing
Cut Prices
Do Nothing
Overtime
Expand
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1
2
2
$40
$40
$50
$55
($10)
$50
$70
Bui
ld S
mal
l
Low Demand (.40)
Low Demand (.40)
High Demand (.60)
High Demand (.60)
Build Large
Do Nothing
Cut Prices
Do Nothing
Overtime
Expand
EVSmall = .40(40) + .60(55) = $49EVLarge = .40(50) + .60(70) = $62
Build the large facility 5S-68
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Expected value of perfect information (EVPI) The difference between the expected payoff with perfect
information and the expected payoff under risk Two methods for calculating EVPI
EVPI = expected payoff under certainty – expected payoff under risk EVPI = minimum expected regret
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Possible Future Demand
Alternatives Low (.30) Moderate (.50) High (.20)
Small Facility $10 $10 $10
Medium Facility 7 12 12
Large Facility (4) 2 16
EVwith perfect information = .30(10) + .50(12) + .20(16) = $12.2
EMV = $10.5
EVPI = EVwith perfect information – EMV
= $12.2 – 10.5
= $1.7You would be willing to spend up to $1.7 million to obtain perfect information
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Regrets
Alternatives Low (.30) Moderate (.50) High (.20)
Small Facility $0 $2 $6
Medium Facility 3 0 4
Large Facility 14 10 0
• Expected Opportunity Loss
• EOLSmall = .30(0) + .50(2) + .20(6) = $2.2
• EOLMedium = .30(3) + .50(0) + .20(4) = $1.7
• EOLLarge = .30(14) + .50(10) + .20(0) = $9.2
• The minimum EOL is associated with the building the medium size facility. This is equal to the EVPI, $1.7 million
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Sensitivity analysisDetermining the range of probability for which an
alternative has the best expected payoff
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