2 LO 1Define capacity, explain the importance of long-term capacity, know how to measure capacity and understand two related performance measures, and describe factors influencing effective capacity. Describe the strategic capacity planning process in organizations, know how to forecast demand and calculate capacity requirements, and discuss major considerations for developing capacity alternatives, Describe the break-even analysis approach for evaluating capacity alternatives, and use it to solve problems.LO 2LO 3
3 What is capacity?Measuring capacityFactors influencing capacityDeveloping capacity alternativesEvaluating alternatives
4 What is capacity?Capacity is the upper limit on the load that an operating unit can handle.The basic questions in capacity handling are:What kind of capacity is needed?How much is needed?When is it needed?
5 Importance of Long-Term Capacity Impacts ability to meet future demandsAffects operating costsMajor determinant of initial costsInvolves long-term commitmentAffects competitiveness
6 Measuring capacity Design capacity Effective capacity Actual output maximum obtainable output under ideal conditionsEffective capacityMaximum capacity given delays, product mix, scheduling difficulties, and other realities.Actual outputrate of output actually achieved—cannot exceed effective capacity.p142
7 Common Measures of Capacity BusinessInputsOutputsAuto manufacturingNumber of cars per shiftSteel millTonnes of steel per dayOil refineryBarrels of crude oil used per dayBarrels of gasoline per dayFarmingNumber of acresBushels of grain per acres per year, litres of milk per dayRestaurantNumber of tables, number of seatsNumber of meals / dayTheatreNumber of seatsNumber of tickets sold per dayRetail salesSquare metres of floor space, sales per sq. ft.Revenue generated per dayTable 5-1 p142
9 Efficiency/Utilization Example Design capacity = 50 trucks/day Effective capacity = 40 trucks/day Actual output = 36 units/dayExample 1 from p143
10 Example: Capacity Actual production last week = 32,000 units Effective capacity = 35,000 unitsDesign capacity = 250 units per hourFactory operates 7 days/week, hour shiftsDesign capacity = (7 x 3 x 8) x (250) = 42,000 unitsNew exampleWhat is the design capacity for one week?Calculate the efficiency and utilization rates.
11 Example: Capacity Utilization = 32,000/42,000 = 76.2% Actual production last week = 32,000 unitsEffective capacity = 35,000 unitsDesign capacity = 250 units per hourFactory operates 7 days/week, hour shiftsDesign capacity = (7 x 3 x 8) x (250) = 42,000 unitsUtilization = 32,000/42,000 = 76.2%
12 Example: Capacity Utilization = 32,000/42,000 = 76.2% Actual production last week = 32,000 unitsEffective capacity = 35,000 unitsDesign capacity = 250 units per hourFactory operates 7 days/week, hour shiftsDesign capacity = (7 x 3 x 8) x (250) = 42,000 unitsUtilization = 32,000/42,000 = 76.2%Efficiency = 32,000/35,000 = 91.4%
13 Factors Influencing Capacity FacilitiesFloor space, layoutProducts or servicesLimited menu in a restaurantHumanTraining, skills and experiencePlanning and OperationalNo of shifts per day, inventory, quality controlExternalPollution standards, paper workp144
14 Factors Influencing Capacity FacilitiesProducts or servicesHumanPlanning and OperationalExternalP144FacilitiesFloor space, layoutProducts or servicesLimited menu in a restaurantHumanTraining, skills and experiencePlanning and OperationalNo of shifts per day, inventory, quality controlExternalPollution standards, paper work
15 Capacity planning process 1. Forecast demand one to five years ahead2. Determine capacity requirements3. Measure the capacity now and decide how to bridge the gapa) Generate feasible alternativesb) Evaluate alternatives considering economic and non economic aspectsc) Choose the best alternative and implement itP
16 Some Possible Growth Patterns VolumeTimeGrowthDeclineCyclicalStableFigure 5-1 p145
17 Calculating Capacity Requirements A department works one eight hour shift, 250 days a year, and has these figures for products, their demand, and usage of a type of machine that is currently being considered. How many machines would be needed to handle the required volume?ProductAnnual DemandStandard Processing time per unit (hr.)Processing time needed (hr.)#14005.02,000#23008.02,400#37002.01,400
18 Developing Capacity Alternatives Design flexibility into systemsDifferentiate between new and mature productsTake a “big picture” approach to capacity changesPrepare to deal with capacity “chunks”Attempt to smooth out capacity requirementsUse capacity cushionIdentify the optimal operating levelP
19 Optimal operating level Minimum cost & optimal operating rate arefunctions of size of production unit.Average costper unitSmallplantMediumLargeOutput rate
20 Economies and Diseconomies of Scale What makes the unit cost increase?Best operating levelOutput rateAverage cost per unitSmall FacilityLarge FacilityMedium FacilityEconomies of scaleDiseconomies of scale
21 Economies and Diseconomies of Scale Fixed costs (facilities, equipment, management) spread out over more unitsVolume purchase discountsDiseconomies of scaleWorker fatigue, equipment breakdown, less room for error, difficulties in coordinationP148 Note: term “diseconomies of scale” is not in text
22 Evaluating alternatives Economic considerationsCost, useful life, compatibility, revenueNon economic considerationsPublic opinion, reactions from employees, community pressureTechniques used for evaluation:Break Even AnalysisPayback PeriodNet Present Valuep150
24 Total revenue = Total cost Break-Even AnalysisAmount ($)Q (quantity in units)Total revenueProfitLossTotal costBreak-even pointTotal revenue = Total costVariable costp151Fixed cost
25 Example: Break-Even Fixed costs = $40,000 Material = $1.50/unit Labour costs = $3/unit Selling price = $10.00 per unitQBEP = = = 7273FCR - VC$40,000( )New example
26 Example: Break-even Analysis The school cafeteria can make pizza for about $.30 per slice.Cost for kitchen and labour is $200 per dayThe nearby Pizza Den delivers for $9.00 per pizza (8 slices)Cost for labour reduced to $75 per dayMake or Buy?New Example See method p153Do on board, asking class what next?Make: v = .30 F = 200Buy: v = 9 / 8 = F = 75x = point of indifference in slicesSet equal: .3x = 1.125x + 75.825x = 125x = 151.5If demand < 152 slices then buy if more then make
27 Break-Even Problem with Step Fixed Costs QuantityFC + VC = TCStep fixed costs and variable costs.1 machine2 machines3 machines$p153
29 Assumptions of Break Even Analysis One product is involvedEverything produced can be soldVariable cost per unit is the same regardless of volumeFixed costs do not change with volumeRevenue per unit constant with volumeRevenue per unit exceeds variable cost per unitP154 referred to, although not specified in this detail in the text.
30 Further Financial Analysis Cash Flow(cash received from sales and other sources) -- (cash outflow for labour, material, overhead, taxes)Present Valuethe sum, in current value, of all future cash flows of an investment proposal.most used methods of financial analysis:Payback periodNet present value (NPV)Internal rate of return (IRR)This is additional material
31 What is Capacity?Capacity usually refers to the upper limit of: A) inventories B) demand C) supplies D) rate of output E) finances Ans: D Page: 141
32 What is capacity?Capacity decisions are mostly long term decisions. Ans: False Page: 141 Stating capacity in dollar amounts generally results in a consistent measure of capacity. Page: 142
33 Capacity performanceThe maximum possible output given a product mix, scheduling difficulties, quality factors, and so on, is: A) utilization B) design capacity C) efficiency D) effective capacity E) available capacity Ans: D Page: 142
34 Capacity PerformanceEfficiency is defined as the ratio of: A) actual output to effective capacity B) actual output to design capacity C) design capacity to effective capacity D) effective capacity to actual output E) design capacity to actual output Ans: A Page: 143
35 Capacity PerformanceUtilization is defined as the ratio of: A) actual output to effective capacity B) actual output to design capacity C) design capacity to effective capacity D) effective capacity to actual output E) design capacity to actual output Ans: B Page: 143
36 Define capacity and identify some common ways it is measured. Distinguish between efficiency and utilization and be able to calculate them.Describe factors that influence effective capacity.Describe the steps of the strategic capacity planning process.Discuss major considerations for developing capacity alternatives.Use break-even analysis to solve problems.