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Strategic Capacity Planning for Products and Services McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

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Instructor Slides Capacity The upper limit or ceiling on the load that an operating unit can handle Capacity needs include Equipment Space Employee skills 5-2

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Strategic Capacity Planning Goal To achieve a match between the long-term supply capabilities of an organization and the predicted level of long-run demand Over-capacity operating costs that are too high Under-capacity strained resources and possible loss of customers

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Capacity Design capacity maximum output rate or service capacity an operation, process, or facility is designed for Effective capacity Design capacity minus allowances such as personal time, maintenance, and scrap Actual output rate of output actually achieved Cannot exceed effective capacity.

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Measuring System Effectiveness Efficiency Utilization Measured as percentages

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Example– Efficiency and Utilization P. 191 Design Capacity = 50 trucks per day Effective Capacity = 40 trucks per day Actual Output = 36 trucks per day

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Capacity Cushion Extra capacity used to offset demand uncertainty Capacity cushion = 100% - Utilization Capacity cushion strategy Organizations that have greater demand uncertainty typically have greater capacity cushion Organizations that have standard products and services generally have smaller capacity cushion

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Example 2, P 196 A center works one shift (8-hr shift), 250 days a year, and these figures for a machine that is current being considered: Annual Stand Processing Processing Product Demand Time per Unit (hr) Time Needed # x 400=2000 # x 300=2400 # x 700=1400 Total: 5800

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Example 2, P. 196 (Cont’d) How many machines do we need to handle the required volume?

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In-House or Outsource? Once capacity requirements are determined, the organization must decide whether to produce a good or service itself or outsource Factors to consider: Available capacity Expertise Quality considerations The nature of demand Cost Risks

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Bottle Neck Operation

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Complementary Demand Patterns

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Optimal Operating Level Optimal Output Rate

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Instructor Slides Minimum cost & optimal operating rate are functions of size of production unit. 5-14

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Cost-Volume Analysis Cost-volume analysis Focuses on the relationship between cost, revenue, and volume of output Fixed Costs (FC) tend to remain constant regardless of output volume Variable Costs (VC) vary directly with volume of output VC = Quantity(Q) x variable cost per unit (v) Total Cost (TC) TC = FC+VC=FC+Q x v Total Revenue (TR) TR = revenue per unit (R) x Q

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Cost-Volume Relationships

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Break-Even Point (BEP) BEP The volume of output at which total cost and total revenue are equal Profit (P) = TR – TC = R x Q – (FC +v x Q) Profit (P) = Q(R – v) – FC

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Example 3: P. 206 If FC=$6000/Month, VC=$2/pie, Price=$7/pie How many pies must be sold to Break Even? If 1000 pies sold in a month, What would be the profit or loss? Profit=TR-TC=$7(1000)-($6000+$2x1000)= - $1000 Loss $1000

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Example 3: P. 206 (Cont’d) How many pies must be sold for a profit of $4000? If 2000 pies can be sold, a profit goal is $5000, what price should be charged per pie? Profit = Q(R-v) – FC 5000 = 2000(R – 2) – = 2000R – 4000 – R= R = $7.50, Price = $7.50

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Example 4: P. 206 A manager has the option of purchasing 1,2, or 3 machines. Fixed costs & potential volumes are as follows: # Machines Annual FC Range of Output 1 $ 9,600 0 to , to , to 900 VC=$10/unitRevenue=$40/unit

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Example 4: P. 206 (Cont’d) Determine the break-even point for each range. 1 Machine Q(Bep)= 9600/(40-10)=320units (not in range) 2 Machine Q(Bep)=15000/(40-10) =500units 3 Machine Q(Bep)=20000/(40-10)=666.7units If projected annual demand is between 580 and 660 units, how machines should the manager purchase? Manager should choose 2 machines

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Make or Buy Available Capacity Quality Consideration Nature of Demand Cost

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Example 5: Make or Buy P. 210 MAKE BUY Annual FC $ VC/Unit $60 $80 Annual Volume units units Annual Cost of each alternative: TC = FC + VC x Q TC Make =$ $60x12000=$870,000 TC Buy = 0 +$80x12000=$960,000 Alternative Make is better

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Example 5: Make or Buy P. 210 (Cont’d) There is a possibility that volume could change in the future. What would be Indifferent Volume between Making & Buying? TC Make = TC Buy FC +V*Q = FC+V*Q Q = 0 +80Q =80Q - 60Q = 20Q Q = 7500 units If Volume >= 7500 units, Choose MAKE If Volume <= 7500 units, Choose BUY

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