Strategic Capacity Planning Chapter 11 Strategic Capacity

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Strategic Capacity Planning

• Chapter 11

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Strategic Capacity Planning

• Capacity
• The maximum level of output
• The amount of resource inputs available relative
  to output requirements at a particular time
• Capacity is the upper limit or ceiling on the
  load that an operating unit can handle.

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Examples of Capacity Measures

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Capacity Planning

• The basic questions in capacity planning are
• What type of capacity is needed?
• How much is needed?
• When is it needed?
• How does productivity relate to capacity?

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Two Capacity Strategies

Planned unused capacity
Forecast of capacity needed
Forecast of capacity needed
Planned use of short-term options
Capacity
Capacity
Time between increments
Expansionist Strategy
Wait-and-See Strategy
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Terminology

• Design capacity
• maximum obtainable output
• Effective capacity
• Maximum capacity given product mix, scheduling
  difficulties, and other doses of reality.
• Actual output
• rate of output actually achieved--cannot exceed
  effective capacity.

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Capacity Utilization

• Capacity used
• rate of output actually achieved
• Best operating level
• capacity for which the process was designed
  (effective or maximum capacity)

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Utilization--Example

• Best operating level 120 units/week
• Actual output 83 units/week
• Utilization ?

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Best Operating Level
Average unit cost of output
Underutilization
Over-utilization
Volume
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Economies Diseconomies of Scale
Long Run Average Cost Curve
Average unit cost of output
Volume
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Evaluating Alternatives

Minimum cost optimal operating rate are
functions of size of production unit.
Small plant
Average Cost per unit
Medium plant
Large plant
0
Output rate
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Calculating Processing Requirements
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Cost-Volume Relationships
Amount ()
Total cost VC FC
Total variable cost (VC)
Fixed cost (FC)
0
Q (volume in units)
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Cost-Volume Relationships
Total revenue
Amount ()
0
Q (volume in units)
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Cost-Volume Relationships
Profit
Total revenue
Amount ()
Total cost
0
BEP units
Q (volume in units)
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Break-Even Problem with Step Fixed Costs
FC VC TC
FC VC TC
3 machines
FC VC TC
2 machines
1 machine
Quantity
Step fixed costs and variable costs.
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Break-Even Problem with Step Fixed Costs

BEP
3
TC
BEP
2
TC
3
TC
2
TR
1
Quantity
Multiple break-even points
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Breakeven Analysis
Fixed Costs Price - Variable Costs

• Breakeven quantity

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Breakeven example

• Thomas Manufacturing intends to increase capacity
  by overcoming a bottleneck operation through the
  addition of new equipment. Two vendors have
  presented proposals as follows
• Proposal Fixed Costs Variable Costs
• A 50,000 12
• B 70,000 10
• The revenue for each product is 20
• What is the breakeven quantity for each proposal?

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Breakeven Solution
FC P- VC

• BEQ

Proposal A
Proposal B
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Breakeven Analysis

• In the previous example, at what capacity would
  both plans incur the same cost?

Solution -consider total cost
Total cost Fixed cost Variable Cost (Q)
50,000 12Q 70,000 10 Q
Q 10,000
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The Experience Curve
As plants produce more products, they gain
experience in the best production methods and
reduce their costs per unit.
Cost or price per unit
Total accumulated production of units
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Capacity Flexibility Having the ability to
respond rapidly to demand volume changes and
product mix changes.

• Flexible plants
• Flexible processes
• Flexible workers

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Capacity Bottlenecks

Operation 1
Operation 2
Operation 3
200/hour
75/hour
200/hour
Raw material
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Capacity Planning
Units per month
6,000
7,000
4,500

• Maintaining System Balance

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Determining Capacity Requirements

• Forecast sales within each individual product
  line
• Calculate equipment and labor requirements to
  meet the forecasts
• Project equipment and labor availability over the
  planning horizon

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Capacity Planning Process
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Example--Capacity Requirements
A manufacturer produces two lines of ketchup,
FancyFine and a generic line. Each is sold in
small and family-size plastic bottles. The
following table shows forecast demand for the
next four years.
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Example of Capacity Requirements The Product
from a Capacity Viewpoint

• Question Are we really producing two different
  types of ketchup from the standpoint of capacity
  requirements?

Answer No, its the same product just packaged
differently.
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Example of Capacity Requirements Equipment and
Labor Requirements
Three 100,000 units-per-year machines are
available for small-bottle production. Two
operators required per machine. Two 120,000
units-per-year machines are available for
family-sized-bottle production. Three operators
required per machine.
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Question Identify the Year 1 values for
capacity, machine, and labor?
150,000/300,00050
At 1 machine for 100,000, it takes 1.5 machines
for 150,000
At 2 operators for 100,000, it takes 3 operators
for 150,000

• The McGraw-Hill Companies, Inc., 2001

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Question What are the values for columns 2, 3
and 4 in the table below?
56.67 1.70 3.40
66.67 2.00 4.00
80.00 2.40 4.80
58.33 1.17 3.50
70.83 1.42 4.25
83.33 1.67 5.00

• The McGraw-Hill Companies, Inc., 2001

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Capacity Cushion
Capacity Cushion level of capacity in excess
of the average utilization rate or level of
capacity in excess of the expected demand
. Cushion Best Operating Level
Capacity Used
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Large capacity cushion

• Required to handle uncertainty in demand
• service industries
• high level of uncertainty in demand (in terms of
  both volume and product-mix)
• to permit allowances for vacations, holidays,
  supply of materials delays, equipment breakdowns,
  etc.
• if subcontracting, overtime, or the cost of
  missed demand is very high

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Sources of Uncertainty
Customer Deliveries

• Manufacturing
• Process design
• Product design
• Capacity
• Quality

• Transportation
• Location
• Information

• Supplier Performance
• Responsiveness
• Transportation
• Location
• Quality
• Information

• Customer Demand
• Past performance
• Market research
• Analytical techniques
• Promotions / Incentives

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Small capacity cushion

• Unused capacity still incurs the fixed costs
• highly capital intensive businesses
• time perishable capacity

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Cushion Best operating Level Actual
Demand
Or 1 Cushion Best operating Level
Actual Demand
Utilization Actual Demand Best
operating Level
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Example Target 5 Cushion
cushion Best Operating Level Capacity
Used
- 1
.05 (1800/x) - 1 1.05 (1800/x) 1714.3/1800
.9524 1.05x 1800 x 1714.3
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Capacity Example

• An automobile equipment supplier wishes to
  install a sufficient number of ovens to produce
  400,000 good castings per year. The baking
  operation takes 2.0 minutes per casting, and
  management requires a capacity cushion of 5.
  How many ovens will be required if each one is
  available for 1800 hours (of capacity) per year?

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Solution

• Required system capacity 400,000 good
  units per year
• Number of oven minutes required 400,000 x
  2 min/unit 800,000
• Number of oven minutes available/oven
• (1800 hrs/oven) x(60 minutes/hour) (.9524)
  102,859 minutes/oven
• Number of ovens required
• 800,000 min /102,859 min/oven 7.8 or 8
  ovens

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How does Quality affect capacity?

• Suppose a three operation process is followed by
  an inspection. If the average proportion of
  defectives produced at operations 1, 2, and 3 are
  .04, .01, and .02 respectively, and if the demand
  is 200 units, then what is the required capacity
  for this operation?

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Capacity requirements with Yield Loss

• Notation
• di avg. proportion of defective units at
  operation i
• n number of operations in the production
  process
• M order quantity (good units only or desired
  yield)
• B avg. number of units at the start of the
• production process

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Solution

• Desired yield 200
• Operation Defective rate 1 .04
• 2 .01
• 3 .02
• (1) What is the capacity required?

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Capacity and Quality

• Suppose we have a 6 process assembly line that
  must produce 1000 good products. Each process
  produces only 1 defects. How is capacity
  affected?

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Decision Trees
A glass factory specializing in crystal is
experiencing a substantial backlog, and the
firm's management is considering three courses of
action A) Arrange for subcontracting, B)
Construct new facilities. C) Do nothing (no
change) The correct choice depends largely upon
demand, which may be low, medium, or high. By
consensus, management ranks the respective
probabilities as .10, .50, and .40. A cost
analysis that reveals the effects upon costs is
shown in the following table.
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Payoff Table
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We start with our decisions...
Subcontracting
Construct new facilities
Do nothing
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Then add our possible states of nature,
probabilities, and payoffs
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Determine the expected value of each decision
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Solution
62k
80.5k
46k
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Planning Service Capacity

• Time
• Location
• Volatility of Demand

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Capacity Utilization Service Quality

• Best operating point is near 70 of capacity
• From 70 to 100 of service capacity, what do you
  think happens to service quality? Why?

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Capacity Expansion StrategiesEntrepreneurial
Stage

• Shift resources to different tasks as needed
• Customer co-production

Multisite Rationalization Stage

• Add services to existing site
• Duplicate existing services at additional
  sites
• Relocate

Both?
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Capacity Planning

• Frequency of Capacity Additions
• External Sources of Capacity

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Two Capacity Strategies

Planned unused capacity
Forecast of capacity needed
Forecast of capacity needed
Planned use of short-term options
Capacity
Capacity
Time between increments
Expansionist Strategy
Wait-and-See Strategy
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Advantages/Disadvantages of each strategy
Advantages Disadvantages

• Expansionist ahead of competition
  risky if demand no lost sales changes
• Wait-and-See no unused capacity rely on
  short- easier to adapt to term
  options new technologies

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Some Short-Term Capacity Options

• lease extra space temporarily
• authorize overtime
• staff second or third shift with temporary
  workers
• add weekend shifts
• alternate routings, using different work stations
  that may have excess capacity
• schedule longer runs to minimize capacity
  losses

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Some Short-Term Capacity Options

• level output by building up inventory in slack
  season
• postpone preventive maintenance (risky)
• use multi-skilled workers to alleviate
  bottlenecks
• allow backorders to increase, extend due date
  promises, or have stock-outs.
• subcontract work