Operations Management Capacity Design

Types of Planning Over a Time Horizon Add Facilities Schedule Jobs Schedule Personnel Allocate Machinery Sub-Contract Add Equipment Add Shifts Add Personnel Build or Use Inventory Long Range Planning Intermediate Range Planning Short Range Planning Modify Capacity Use Capacity

Definition and Measures of Capacity Design Capacity: The maximum “throughput,” or number of units a facility can produce in a period of time. Capacity a firm can expect to achieve given its product mix, methods of scheduling, maintenance, and standards of quality. Effective capacity: Utilization: Actual output as a percent of design capacity. This slide can be used to frame a discussion of capacity. Points to be made might include: - capacity definition and measurement is necessary if we are to develop a production schedule - while a process may have “maximum” capacity, many factors prevent us from achieving that capacity on a continuous basis. Students should be asked to suggest factors which might prevent one from achieving maximum capacity. Efficiency: Actual output as a percent of effective capacity.

Utilization Measure of planned or actual capacity usage of a facility, work center, or machine Actual Output Utilization = Design Capacity It might be useful at this point to discuss typical equipment utilization rates for different process strategies if you have not done so before.

Efficiency Measure of how well a facility or machine is performing when used Actual output Efficiency = Effective Capacity You might point out to students that this slide links capacity to work measurement (standard times).

Example Facility produces breakfast rolls Last week, produced 148,000 rolls Effective capacity is 175,000 rolls Line operates 7 days a week with three 8-hour shifts per day Line designed to produce 1200 rolls per hour Determine Design Capacity Utilization Efficiency You might point out to students that this slide links capacity to work measurement (standard times).

Calculating actual output Same facility adding one more line due to increase in demand for deluxe rolls Effective capacity is 175,000 rolls of this line Efficiency of this second line will be 75% What is the expected output? You might point out to students that this slide links capacity to work measurement (standard times).

Managing Demand Demand exceeds capacity – curtail demand by raising prices, scheduling long lead times, etc Capacity exceeds demand – stimulate demand through price reductions, aggressive marketing, etc Adjusting to seasonal demands – offer products with complementary demand patterns – pdts for which demand is high for one when low for the other

Managing Capacity Making staffing changes (increasing or decreasing the number of employees) Adjusting equipment and processes – which might include purchasing additional machinery or selling or leasing out existing equipment Improving methods to increase throughput; and/or Redesigning the product to facilitate more throughput

Breakeven Analysis Technique for evaluating process & equipment alternatives Objective: Find the point ($ or units) at which total cost equals total revenue Assumptions Revenue & costs are related linearly to volume All information is known with certainty

Break-Even Analysis Fixed costs: costs that continue even if no units are produced: depreciation, taxes, debt, mortgage payments, salaries, etc Variable costs: costs that vary with the volume of units produced: labor wages, materials, portion of utilities

Breakeven Chart Volume (units/period) Total revenue line Profit Breakeven point Total cost = Total revenue Profit Profit Total cost line Cost in Dollars Variable cost Loss Fixed cost Volume (units/period)

Crossover Chart Process A: low volume, high variety Fixed cost - Process A Fixed cost - Process B Fixed cost - Process C Total cost - Process C Total cost - Process B Total cost - Process A Process A: low volume, high variety Process B: Repetitive Process C: High volume, low variety Process C Process B Process A Lowest cost process This slide can be used to introduce the role of breakeven analysis in the process selection decision.

Break Even Contd.. BEPx= FC (units) P-V BEPrs.= FC (amount) 1-(V/P) BEPrs.= FC (multi product) ∑[(1-Vi/Pi)*(Wi)] P=Selling price, V=variable cost FC=fixed cost

BEP Calc. A company has fixed costs of 10000/- this period. Direct costs are 1.5/- per unit and material cost is 0.75/- per unit. The selling price is 4/- per unit. Calculate the BEPs.

BEP Calc. in multi product case ITEM PRICE COST FORECASTED SALES ANNUALLY Sandwich 2.95 1.25 7000 Cola 0.80 0.30 Burger 1.55 0.47 5000 Tea .75 0.25 Salad 2.85 1.00 3000

Item P V V/P 1-(V/P) Forecasted sales % of sales wghtd.contribution sandwich 2.95 1.25 .42 .58 20650 .446 .259 Cola 0.80 .30 .38 .62 5600 .121 .075 Burger 1.55 .47 .70 7750 .167 .117 Tea 0.75 .25 .33 .67 3750 .081 .054 Salad 2.85 1.0 .35 .65 8550 .185 .120 46300 1.00 .625

BEPrs.= FC ∑[(1-Vi/Pi)*(Wi)] If the fixed costs are 3500, BEPrs.= FC ∑[(1-Vi/Pi)*(Wi)] 3500*12 = 67200 0.625

Decision trees application A company is considering capacity expansion. it has 3 alternatives. the new facility would produce new type of product and currently the marketability of the product is unknown. Types of plant favorable mkt. unfavorable mkt. Large plant 100 k -90k Medium plant 60k -10k Small plant 40k -5k The probability of fav and unfav. Markets are 0.4 and 0.6 respectively.

EMV (large plant)=0.4(100k)+(.6)(-90k)=-14k EMV (medium plant)=0.4(60k)+(.6)(-10k)=18k EMV (small plant)=0.4(40k)+(.6)(-5k)=13k Based on Expected market value, the company should build a medium plant

Net Present value A co. having two capacity expansion alternatives A and B have useful lives of 4 years. Initial outlay for A is 25k and that for B is 26k. The cost of capital is 8%.the cash flow pattern is as follows. year A B 1 10k 9k 2 9k 9k 3 8k 9k 4 7k 9k