1. Long Rang Capacity Planning
Topic-6
Long Rang Capacity Planning

2. Long range capacity planning
Capacity-is the productive capability of a production facility
Capacity measurement: aggregate unit of output/input rate
* single item: output rate
* many items:
aggregate unit of output, or aggregate
unit of input.
In service: input rate
Why capacity planning- matching demand fluctuation.

3. Why Matching Capacity- Matching Demand Fluctuation
Output
Demand
Capacity?
Time

4. Measurement of Capacity
Output rate capacity:
-- For a facility having a single product or a few homogeneous products, the unit of measure is straightforward (barrels of beer per month)
-- For a facility having a diverse mix of products, an aggregate unit of capacity must be established using a common unit of output (sales dollars per week)

5. Measurement of Capacity (II)
Input rate capacity: commonly used for service operations where output measures are particularly difficult.
--Hospital use available beds per month.
--Airline use available seat miles per month.
--Movie theatres use available seats per month.

6. Examples of Capacity Measures
Measures of Capacity
Types of Organizations
Inputs
Outputs
Truck manufacturer
Machine hours per shift
Number of trucks per shift
Hospital
Number of beds
Number of patients treated per day
Airline
Number of planes
Seat-miles flow per week
Restaurant
Number of seats
Customers served per day
Size of display area
Sales dollars per year
Theater
Number of customers per week

7. Design Capacity vs. Maximum Capacity
Design capacity (Q*): the amount of output at which the AUC (average unit cost) of a product facility is minimum.
Practical maximum capacity : the maximum amount of output that a facility can produce (at a higher AUC)
When Q>Q*,then AUC>AUC*
Q<Q*, also AUC>AUC*

8. AVC
AVC Q
(Output Quantity) Q*
Qmax

9. AUC (Average Unit Cost) AUC
Variable Cost
/ Unit
Fixed Cost
/Unit Q*
Qmax
Output Quantity
Q* - Design Capacity Qmax – Practical Maximum Capacity

10. Economies and Diseconomies of Scale
Average
per Unit Cost
Of Output ($)
Diseconomies of scale
Economies of scale
Best Operating Level
Annual
Volume
Units

11. Economies of Scale Best operating level —least average unit cost
Economies of scale —average cost per unit decrease as the volume increases toward the best operating level.
Diseconomies of scale —average cost per unit increase as the volume increase beyond the best operating level

12. Economies of scale Declining costs result from:
--Fixed costs being spread over more and more units.
--Longer production runs result in a smaller proportion of labor being allocated to setups.
--Proportionally less material scrap
--……….and other economies.

13. Economies of scale
Diseconomies of scale: Increasing costs result from increased congestion of workers and materials, which contribute to:
--increasing inefficiency
--difficulty in scheduling
--damaged goods
--reduced morale
--increased use of overtime
--………and other diseconomies

14. Capacity Economy
Economy of scale: Refer to the cost reduction resulting from the increase in production quantity.
“Economies of scale is so vague that it can be used to justify any number of decisions, which all too often turn out to be wrong.”

15. Capacity Economy (II) Plant Des.cap. Act.Prod Proc. Tech AUC A 100 X
Example:
Plant
Des.cap.
Act.Prod
Proc. Tech
AUC A
100 X 10 B 60 12 C
200 5 D Y 2

16. Capacity Economy (III)
AUC(A)< AUC(B)—Volume Economy.
AUC(C)< AUC(A)— Capacity Economy
AUC(D)< AUC(C)—Technology Economy.

17. AUC B A 12 10 C 5 D 2 60
100
200 Q

18. Increases in Incremental Facility Capacity
Average per Unit Cost per Output ($) A B C
Small
Plant
Mid-Sized
Plant
Large
Plant
Annual Volume (Units)

19. Economies and Diseconomies of Scale
Output rate (units per week)
Average unit cost (dollars per unit)
250-unit shop
750-unit shop
500-unit shop
Economies of scale
Diseconomies of scale

20. Three Level Capacity Planning
1.Long range capacity planning: T>1 year.
Decisions: planning for capacity that requires a long time to acquire.
e.g. Plant/building/equipment/high cost facility
2. Intermediate range capacity planning: T(6-18 months).
Decisions: planning for capacity requirement (month or quarterly).
e.g. work force size/new tools/inventory/…..
3. short range capacity planning: T (1-6moth).
Decisions: weekly (or daily) capacity planning.
e.g. overtime use/personnel transfer/alternative routings/……

21. Ways of Changing Long Range Capacity
Expand Capacity
Subcontract with other companies to become suppliers of the expanding firm’s components or entire products
Acquire other companies, facilities, or resources
Develop sites, buildings, buy equipment
Expand, update, or modify existing facilities
Reactivate facilities on standby status
Reduce Capacity
Sell existing facilities, sell inventories, and layoff or transfer employees
Mothball facilities and place on standby status, sell inventories, and layoff of transfer employees
Develop and phase in new products as other products decline

22. Capacity Planning Process
1. Determine capacity requirement:
* long range demand forecasting.
2. Generating alternative capacity plans:
*when should new capacity be added? (timing)
* how much new capacity should be added (sizing)
*what kind capacity should be added? (type)

23. The Timing of Capacity Increments
Policy A: Capacity Leads Demand
Policy B: Capacity lags Demand
Units
Units
Capacity
Demand
Demand
Capacity
Time
Time

24. The Sizing of Capacity Increments{
Units
Time
Demand
Units
Capacity
Increments {
Demand
Time
Should the capacity be added more often in small increments (Option A) or in large increments less frequently (Option B)?

25. Capacity Strategies Forecast of capacity required
Time
Capacity
Planned unused capacity
Forecast of capacity required
Time between increments
Capacity increment
(a) Expansionist strategy

26. Capacity Strategies Forecast of capacity required
Time
Capacity
Forecast of capacity required
Planned use of short-term options
Time between increments
Capacity increment
(b) Wait-and-see strategy

27. Capacity Planning Process (II)
3. Evaluating alternative capacity plans:
*Decision tree
*Breakeven analysis
4.Selecting best capacity plan under given objectives
5. Locating new capacity (facility location).

28. Facility planning How much long range capacity is need
When additional capacity is need
What the layout and characteristics of facilities should be
The capital investment in land, building, technology and machinery is enormous

29. Facility planning
A firm must live with its facility planning decisions for a long time and these decisions affect:
Operating efficiency
Economy of scale
Ease of scheduling
Maintenance costs
……………profitability

30. Facility planning Steps in the capacity planning process
*estimate the capacity of the present facilities.
*forecast the long-range future capacity needs.
*identify and analyze sources of capacity to meet these needs
*Select from among the alternative sources of capacity

31. Economies of scope
The ability to produce many product models in one flexible facility more cheaply than in separate facilities
Highly flexible and programmable automation allows quick, inexpensive products-to-product changes
Economies are created by spreading the automation cost over many products

32. Evaluation of Capacity Plans
Major method:
Net present value analysis
Breakeven analysis
Decision tree model
Computer simulation
Queuing Models (Service Capacity Plan)

33. Evaluation of Capacity Plans (II)
Decision model: a simplified representation of a real world problem. There are many decision models developed in the literature for different problems.
Three major elements of a decision model:
Objectives must be measurable
Decision variables must be controllable
Constraints and Assumptions.

34. Decision Tree Model
Decision tree model is primarily developed for problem where:
* a series of (multiple) decisions must be made sequentially
* all decisions are interrelated and interdependent and
* Outcomes associated with each decision are uncertain

35. Decision Tree Model (II)
Assumptions of decision tree model:
Objective is a single measurement
All possible outcomes associated with a decision have a known probability.
Best plan is represented by the optimal expected value.
Tree structure:
* Decision point
* Even point
* Probability of outcome

36. Capacity Decisions Decision Trees $70 $90 $109 $135 $135 $148 $40 $148
Low demand [0.40]
$70
Don’t expand
$90
Small expansion
High demand [0.60]
$109 2
Expand 1
$135
$135
$148
Large expansion
Low demand [0.40]
$40
High demand [0.60]
$148
$220

37. Supplement: p. 6-20 - Problem #1
Example
Supplement: p Problem #1

38. || Payoff ($ millions) EV = 2.4 3.0 Produce & Market 1.8 Develop
Product
Sell Idea
3.0
1.8
2.5
2.1
2.8
2.2
2.6
2.3
EV = 2.5 ||
1.5
(.5) Large Market
(.5) Marginal Mkt.
EV = 2.45
Company A
Company B
EV = 2.4
EV = 2.3
Produce &
Market
Lease for Royalty
Payoff
($ millions)

39. Solutions
The company should lease the concept to company A. Notice, however, that other alternatives are very close in their payoffs.
 b. If the company follows your recommendation, what returns should the company expect to receive?
If the firm's estimates are correct, it will receive either $2,800,000 or $2,200,000.

40. See Example on your Supplementary – p. 6-17 to 6-19.

41. C 2 D A E 1 3 F G B H $4,320 H,p= 0.7, $900 for 6 years
L,p= 0.3, $300 for 6 years
H,p= 0.7, $600 for 6 years
L,p= 0.3, $500 for 6 years
L,p= 0.8, $300 for 6 years
H,p= 0.2, $900 for 6 years
H,p= 0.2, $600 for 6 years
L,p= 0.8, $500 for 6 years
$3,520
Expand,
Investment
= $800 2
$3,420
Do not
expand
H,p = 0.6
$3,920 A
$2,520
Small plant
Investment
= $3,400
L,p = 0.4
$520
$3,120
Expand,
Investment
= $800 1 3
$3,120
Do not
expand
Large plant,
Investment = $4,000
$4,320
$4,260
H,p = 0.6
$900 B
L,0 = $300
$2,520
$300

42. We evaluated the three from the right-hand side
We evaluated the three from the right-hand side. Investment and income are given in thousands of dollars.
Event C: $900(6)(0.7) + $300 (6)(0.3)= $4,320
Event D: $600(6)(0.7) + $500 (6)(0.3)= $3,420
Event E: $900(6)(0.2) + $300 (6)(0.8)= $2,520
Event F: $600(6)(0.2) + $500 (6)(0.8)= $3,120
Event G: $900(6)(0.7) + $300 (6)(0.3)= $4,320
Event H: $900(6)(0.2) + $300 (6)(0.8)= $2,520

43. Decision Point 2:
Expand: Income= $4,320- $800 = $3,520
Do not expand: Income=…………….....= $3,420
At this point the decision will be to expand the plant because the income for this alternative is larger. Event D will therefore be served.
Decision Point 3:
Expand: Income= $42,520- $800 = $1,720
Do not expand: Income=…………………= $3,120
At this point the decision will be “do not expand” because the income for this alternative is larger. Event E will therefore be served.
Decision Point 1:
Expand: Income= $3,920- $3,400 = $520
Do not expand: Income= $4,260- $4,00 = $260
At this point the decision will be to build a small plant. Event B therefore will be served.
Thus, XYZ should initially build a small plant. At the end of one year, if demand is high, the company should expand the plant. If demand is low, the company should not expand the plant. Expected income is $520,000.