Capacity Planning

1
Operations Management
Supplement 7 Capacity Planning
PowerPoint presentation to accompany
Heizer/Render Principles of Operations
Management, 7e Operations Management, 9e
2
Outline

• Capacity
• Design and Effective Capacity
• Capacity and Strategy
• Capacity Considerations
• Managing Demand
• Demand and Capacity Management in the Service
  Sector

3
Outline Continued

• Capacity Planning
• Break-Even Analysis
• Single-Product Case
• Multiproduct Case
• Applying Decision Trees to Capacity Decisions

4
Outline Continued

• Applying Investment Analysis to Strategy-Driven
  Investments
• Investment, Variable Cost, and Cash Flow
• Net Present Value

5
Learning Objectives

• When you complete this supplement, you should be
  able to

1. Define capacity
2. Determine design capacity, effective capacity,
   and utilization
3. Compute break-even analysis
4. Apply decision trees to capacity decisions
5. Compute net present value

6
Capacity

• The throughput, or the number of units a facility
  can hold, receive, store, or produce in a period
  of time
• Determines fixed costs
• Determines if demand will be satisfied
• Three time horizons

7
Planning Over a Time Horizon
Limited options exist
Figure S7.1
8
Design and Effective Capacity

• Design capacity is the maximum theoretical output
  of a system
• Normally expressed as a rate
• Effective capacity is the capacity a firm expects
  to achieve given current operating constraints
• Often lower than design capacity

9
Utilization and Efficiency
Utilization is the percent of design capacity
achieved
Utilization Actual output/Design capacity
Efficiency is the percent of effective capacity
achieved
Efficiency Actual output/Effective capacity
10
Bakery Example
Actual production last week 148,000
rolls Effective capacity 175,000 rolls Design
capacity 1,200 rolls per hour Bakery operates 7
days/week, 3 - 8 hour shifts
Design capacity (7 x 3 x 8) x (1,200) 201,600
rolls
11
Bakery Example
Actual production last week 148,000
rolls Effective capacity 175,000 rolls Design
capacity 1,200 rolls per hour Bakery operates 7
days/week, 3 - 8 hour shifts
Design capacity (7 x 3 x 8) x (1,200) 201,600
rolls
12
Bakery Example
Actual production last week 148,000
rolls Effective capacity 175,000 rolls Design
capacity 1,200 rolls per hour Bakery operates 7
days/week, 3 - 8 hour shifts
Design capacity (7 x 3 x 8) x (1,200) 201,600
rolls
Utilization 148,000/201,600 73.4
13
Bakery Example
Actual production last week 148,000
rolls Effective capacity 175,000 rolls Design
capacity 1,200 rolls per hour Bakery operates 7
days/week, 3 - 8 hour shifts
Design capacity (7 x 3 x 8) x (1,200) 201,600
rolls
Utilization 148,000/201,600 73.4
14
Bakery Example
Actual production last week 148,000
rolls Effective capacity 175,000 rolls Design
capacity 1,200 rolls per hour Bakery operates 7
days/week, 3 - 8 hour shifts
Design capacity (7 x 3 x 8) x (1,200) 201,600
rolls
Utilization 148,000/201,600 73.4
Efficiency 148,000/175,000 84.6
15
Bakery Example
Actual production last week 148,000
rolls Effective capacity 175,000 rolls Design
capacity 1,200 rolls per hour Bakery operates 7
days/week, 3 - 8 hour shifts
Design capacity (7 x 3 x 8) x (1,200) 201,600
rolls
Utilization 148,000/201,600 73.4
Efficiency 148,000/175,000 84.6
16
Bakery Example
Actual production last week 148,000
rolls Effective capacity 175,000 rolls Design
capacity 1,200 rolls per hour Bakery operates 7
days/week, 3 - 8 hour shifts Efficiency
84.6 Efficiency of new line 75
Expected Output (Effective Capacity)(Efficiency)
(175,000)(.75) 131,250 rolls
17
Bakery Example
Actual production last week 148,000
rolls Effective capacity 175,000 rolls Design
capacity 1,200 rolls per hour Bakery operates 7
days/week, 3 - 8 hour shifts Efficiency
84.6 Efficiency of new line 75
Expected Output (Effective Capacity)(Efficiency)
(175,000)(.75) 131,250 rolls
18
Capacity and Strategy

• Capacity decisions impact all 10 decisions of
  operations management as well as other functional
  areas of the organization
• Capacity decisions must be integrated into the
  organizations mission and strategy

19
Capacity Considerations

• Forecast demand accurately
• Understand the technology and capacity increments
• Find the optimum operating level (volume)
• Build for change

20
Economies and Diseconomies of Scale
Figure S7.2
21
Build In Flexibility
Percent of North American Vehicles Made on
Flexible Assembly Lines
Figure S7.3
22
Managing Demand

• Demand exceeds capacity
• Curtail demand by raising prices, scheduling
  longer lead time
• Long term solution is to increase capacity
• Capacity exceeds demand
• Stimulate market
• Product changes
• Adjusting to seasonal demands
• Produce products with complementary demand
  patterns

23
Complementary Demand Patterns
Figure S7.3
24
Complementary Demand Patterns
Figure S7.3
25
Complementary Demand Patterns
Figure S7.3
26
Tactics for Matching Capacity to Demand

• Making staffing changes
• Adjusting equipment
• Purchasing additional machinery
• Selling or leasing out existing equipment
• Improving processes to increase throughput
• Redesigning products to facilitate more
  throughput
• Adding process flexibility to meet changing
  product preferences
• Closing facilities

27
Demand and Capacity Management in the Service
Sector

• Demand management
• Appointment, reservations, FCFS rule
• Capacity management
• Full time, temporary, part-time staff

28
Approaches to Capacity Expansion
Figure S7.5
29
Approaches to Capacity Expansion
(a) Leading demand with incremental expansion
Figure S7.5
30
Approaches to Capacity Expansion
(b) Leading demand with one-step expansion
Figure S7.5
31
Approaches to Capacity Expansion
(c) Capacity lags demand with incremental
expansion
Figure S7.5
32
Approaches to Capacity Expansion
(d) Attempts to have an average capacity with
incremental expansion
Figure S7.5
33
Break-Even Analysis

• Technique for evaluating process and equipment
  alternatives
• Objective is to find the point in dollars and
  units at which cost equals revenue
• Requires estimation of fixed costs, variable
  costs, and revenue

34
Break-Even Analysis

• Fixed costs are costs that continue even if no
  units are produced
• Depreciation, taxes, debt, mortgage payments
• Variable costs are costs that vary with the
  volume of units produced
• Labor, materials, portion of utilities
• Contribution is the difference between selling
  price and variable cost

35
Break-Even Analysis
Assumptions

• Costs and revenue are linear functions
• Generally not the case in the real world
• We actually know these costs
• Very difficult to accomplish
• There is no time value of money

36
Break-Even Analysis
Figure S7.6
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Break-Even Analysis
Break-even point occurs when
TR TC or Px F Vx
38
Break-Even Analysis
Profit TR - TC Px - (F Vx) Px - F -
Vx (P - V)x - F
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Break-Even Example
Fixed costs 10,000 Material
.75/unit Direct labor 1.50/unit Selling
price 4.00 per unit
40
Break-Even Example
Fixed costs 10,000 Material
.75/unit Direct labor 1.50/unit Selling
price 4.00 per unit
41
Break-Even Example
42
Break-Even Example
Multiproduct Case
where V variable cost per unit P price per
unit F fixed costs W percent each product
is of total dollar sales i each product
43
Multiproduct Example
Fixed costs 3,500 per month
44
Multiproduct Example
Fixed costs 3,500 per month
45
Multiproduct Example
Fixed costs 3,500 per month
46
Decision Trees and Capacity Decision
47
Decision Trees and Capacity Decision
Large Plant
EMV (.4)(100,000) (.6)(-90,000)
EMV -14,000
48
Decision Trees and Capacity Decision
49
Strategy-Driven Investment

• Operations may be responsible for
  return-on-investment (ROI)
• Analyzing capacity alternatives should include
  capital investment, variable cost, cash flows,
  and net present value

50
Net Present Value (NPV)
where F future value P present value i
interest rate N number of years
51
Net Present Value (NPV)
While this works fine, it is cumbersome for
larger values of N
where F future value P present value i
interest rate N number of years
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NPV Using Factors
where X a factor from Table S7.1 defined as
1/(1 i)N and F future value
Portion of Table S7.1
53
Present Value of an Annuity
An annuity is an investment which generates
uniform equal payments
S RX
where X factor from Table S7.2 S present
value of a series of uniform annual
receipts R receipts that are received every
year of the life of the investment
54
Present Value of an Annuity
Portion of Table S7.2
55
Present Value of an Annuity
7,000 in receipts per for 5 years Interest rate
6
From Table S7.2 X 4.212
S RX S 7,000(4.212) 29,484
56
Present Value With Different Future Receipts
Investment As Cash Flow Investment Bs Cash Flow Year Present Value Factor at 8
10,000 9,000 1 .926
9,000 9,000 2 .857
8,000 9,000 3 .794
7,000 9,000 4 .735
57
Present Value With Different Future Receipts
Year Investment AsPresent Values Investment BsPresent Values
1 9,260 (.926)(10,000) 8,334 (.926)(9,000)
2 7,713 (.857)(9,000) 7,713 (.857)(9,000)
3 6,352 (.794)(8,000) 7,146 (.794)(9,000)
4 5,145 (.735)(7,000) 6,615 (.735)(9,000)
Totals 28,470 29,808
Minus initial investment -25,000 -26,000
Net present value 3,470 3,808