Chapters 5 and 6

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Chapters 5 and 6

• Process selection and capacity planning

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• Process selection strategic decision of
  choosing the way to produce the products or
  services. It addresses issues like
• What type of technology to use
• How to arrange the flow of operations
• Process selection arises naturally when a new
  product/service is planned (remember the phases
  of product development?)
• But it also arises for existing products/services
  due to technological advances and changes in
  customer needs

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• Does firm need to produce all the parts of the
  product in-house?
• Very often firms purchase all/some of the parts
  from outside and do assembly only. Some firms
  even purchase (subcontract) the assembly -
  OUTSOURCING
• The decision make or buy depends on
• Availability of equipment, time and capacity
• Quality considerations
• The nature of demand
• Cost considerations

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Process Selection and the Big Picture
Capacity planning
Demand Forecasts
Facilities and Equipment
Product and service design
Process selection
Layout
Technologicalchange
Work design
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• Process selection is closely related to the
  degree of standardization and output volume of
  the product/service.
• Standardization extent to which there is absence
  of variety in the product/service.
• Standardization means that
• There are fewer parts to deal with in inventory
  and manufacturing
• More routine purchasing, materials handling and
  quality control procedures can be used

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• Standardization can take advantage of risk
  pooling
• But most importantly, standardization allows for
  long production runs (i.e. High output volume)
  and automation in the processes.

? Closely related to the product life cycle of
the product or service
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Life Cycles of Products or Services
Standardization ? as the product moves into
maturity/saturation phase
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Types of Processes

• Continuous processing
• Highly standardized product
• Production is continuous in large volumes
• Costly to shut-down and re-start
• The facility is essentially one big machine
• Ex sugar/oil refinery, beer production
• Repetitive/assembly
• Production in discrete units (semi-contin.)
• High volume, but allows for some variety
• Ex car, TV, computer production

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Types of Processes (Contd)

• Batch processing
• Moderate volume of similar products
• Higher variety, low volume relative to the
  assembly/repetitive processing
• Ex bakery, food processing
• Job shops
• High variety of products (job requirements vary)
• Production in small runs (i.e., low volume)
• Ex ship manufacturing, machine tool shops, print
  shops

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Variety, Flexibility, Volume
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Product-process Lifecycle Matrix
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Guidelines For Process Selection

• Match product requirement with the process
  capabilities- position diagonally
• Positioning off the diagonal is it always a bad
  process choice? Ex Motorola mass-produce
  custom pagers. Where would you place
  this on the matrix?
• MASS CUSTOMISATION
• As product goes thorough its life-cycle,
  processes need to be changed as well.

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Capacity Planning

• Capacity is the upper limit or ceiling on the
  load that an operating unit can handle ? how much
  we can produce
• Planning for capacity
• Long term deals with overall capacity level.
  Also called strategic capacity planning. Ex
  facility size, major expansions
• Short term deals with variations in capacity
  requirements (created by demand fluctuations) Ex
  Workforce-production plans

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Capacity Planning

• The basic questions of strategic capacity
  planning are
• What kind of capacity is needed?
• How much is needed?
• When is it needed?
• Importance of these decisions
• Determine ability to meet future demand and
  therefore remain/be competitive
• Affects cost (operating, investment costs)
• These decisions involve major investments and
  hence are irreversible in the short run.

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Steps in Strategic Capacity Planning

• Calculate current capacity
• Estimate long-term changes in demand and estimate
  future capacity needs
• Identify sources of capacity to meet these needs
• Select among these alternatives

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Definitions of Capacity

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

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Measures of Capacity

• Capacity can be measured w.r.t a plant,
  department, machine or worker
• Different measures are applicable
• Output rate (product based) (cars/year)
• Aggregate output rate When there are multiple
  similar products. For example a steel mill
  producing different cuts and sizes of steel ?
  (tons of steel/month)
• Input Availability ( machine hrs/day, labor
  hours/year)

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Efficiency and Utilization
Actual output Efficiency Effective
capacity Actual output Utilization
Design capacity
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Efficiency/Utilization Example

• Design capacity 50 trucks/day
• Effective capacity 40 trucks/day
• Actual output 36 units/day
• Actual output 36
  units/day
• Efficiency 90
• Effective capacity 40
  units/ day
• Utilization Actual output 36
  units/day
  72
• Design capacity
  50 units/day

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Developing Capacity Alternatives

• Design flexibility into systems (for future
  expansion possibilities)
• Understand the product-life-cycle
• Prepare to deal with capacity chunks
• Consider outside sources of capacity -
  subcontracting, capacity acquisition
• Identify the optimal operating level

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Best Operating Level
Given the design capacity of our production unit,
there is an optimal rate of output for minimal
cost/unit.
Average cost per unit
Minimum cost
0
Rate of output
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Economies/Diseconomies of Scale
Minimum cost optimal operating rate are
functions of size of production unit.

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Selecting among Alternatives

• Decision Approaches
• Break-Even Analysis (BEA)
• Present Value Analysis (NPV)
• Decision Tree Analysis
• Simulation Waiting Line Analysis (primarily for
  service systems)
• Linear Programming
• Internal Rate of Return (IRR)
• Return on Investment (ROI)

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Break-Even Analysis
Total revenue
Amount ()
Total cost VCQ FC
Total variable cost (VCQ)
Fixed cost (FC)
Break Even Point (BEP)
0
Q (volume in units)
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Break Even Analysis
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Break Even Analysis- Example
We want to add a new line of product. The annual
lease for the equipment is 9,000. We estimate
the production cost to be 3/unit. We plan to
sell it at 6/unit. How many units should we
produce and sell to break even?
If our forecast annual demand is 2,500 units,
should we invest in the new line?
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• Capacity investments may require step costs, i.e.
  fixed costs which increase as the desired output
  increases

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Break-Even Problem with Step Fixed Costs
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• Calculate the BEP for each interval

• If estimated annual demand is between 550-650,
  how many machines?

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Example Continued
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Assumptions of Break-Even Analysis

• One product is produced
• The variable cost per unit is constant,
  regardless of the volume
• Revenue per unit is constant, regardless of
  volume
• Fixed cost is either constant or step function

Note that BEA can also be used for Make-or-Buy
analysis
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Present Value Analysis (NPV)

• 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.
• The current value is calculated for a given
  interest rate (discount rate)

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Present Value Analysis

• The basic formula

• Fn Cash Flow received n periods later in the
  future
• i interest rate per period
• P Net Present Value (Worth) of the cash flow

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PV Analysis for a Single Investment

• Determine the useful life of investment (N)
• Estimate the cash flows for each year F0, F1,
  F2, F3 , , FN-1, FN
• Calculate the Present Value (PV)

• If PV gt 0, the investment is a viable
  alternative. Otherwise, reject.

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PV Analysis for Multiple Investments

• Calculate the Net Present Value (NPV) for each
  alternative
• Choose the one with highest NPV (if its above 0)

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Example Continued
? CHOOSE B
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Assumption of the Present Value Method

• Future cash flows associated with the investments
  can be estimated with high degree of certainty
• The interest rate does not change over time
• When there is high uncertainty (e.g. with the
  future demand) other methods should be used -
  such as decision trees.