Chapter 5 Capacity Planning For Products and Services Ceiling on the amount of load Capacity at NSU

Capacity Planning Capacity is the upper limit or ceiling on the load that an operating unit can handle. Equipment Space Employee skills Capacity also includes What kind of capacity is needed? How much is needed? When is it needed? The basic questions in capacity handling are:

Importance of Capacity Decisions Impacts ability to meet future demands Affects operating costs Major determinant of initial costs Involves long-term commitment Affects competitiveness Affects ease of management Globalization adds complexity Impacts long range planning Read more Find Examples …

Capacity Design capacity Effective capacity Actual output 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.

Efficiency and Utilization Actual output Efficiency = Effective capacity Utilization = Design capacity Both measures expressed as percentages

Efficiency/Utilization Example Design capacity = 50 trucks/day Effective capacity = 40 trucks/day Actual output = 36 units/day Actual output = 36 units/day Efficiency = ----------------------------------- = 90% Effective capacity = 40 units/ day Actual output = 36 units/day Utilization = ----------------------------------- = 72% Design capacity = 50 units/day

Determinants of Effective Capacity Facilities Product and service factors Process factors Human factors Policy factors Operational factors Supply chain factors External factors

Strategy Formulation Capacity strategy for long-term demand Demand patterns Growth rate and variability Facilities Cost of building and operating Technological changes Rate and direction of technology changes Behavior of competitors Availability of capital and other inputs

Key Decisions of Capacity Planning Amount of capacity needed Capacity cushion (100% - Utilization) Timing of changes Need to maintain balance Extent of flexibility of facilities Capacity cushion – extra demand intended to offset uncertainty

Steps for Capacity Planning Estimate future capacity requirements Evaluate existing capacity Identify alternatives Conduct financial analysis Assess key qualitative issues Select one alternative Implement alternative chosen Monitor results

Forecasting Capacity Requirements Long-term vs. short-term capacity needs Long-term relates to overall level of capacity such as facility size, trends, and cycles Short-term relates to variations from seasonal, random, and irregular fluctuations in demand

Calculating Processing Requirements Product Annual Demand Standard processing time per unit (hr.) Processing time needed (hr.) #1 #2 #3 400 300 700 5.0 8.0 2.0 2,000 2,400 1,400 5,800 If annual capacity is 2000 hours, then we need three machines to handle the required volume: 5,800 hours/2,000 hours = 2.90 machines

Planning Service Capacity Need to be near customers Capacity and location are closely tied Inability to store services Capacity must be matched with timing of demand Degree of volatility of demand Peak demand periods

In-House or Outsourcing Available capacity Expertise Quality considerations Nature of demand Cost Risk Outsource: obtain a good or service from an external provider

Developing Capacity Alternatives Design flexibility into systems Take stage of life cycle into account Take a “big picture” approach to capacity changes Prepare to deal with capacity “chunks” Attempt to smooth out capacity requirements Identify the optimal operating level

Bottleneck Operation Machine #1 Machine #2 Bottleneck Operation Bottleneck operation: An operation in a sequence of operations whose capacity is lower than that of the other operations 10/hr Machine #1 10/hr Machine #2 Bottleneck Operation 30/hr Machine #3 10/hr Machine #4 10/hr Figure 5.2

Machine Type A B C D E F Output 40 50 30 40 120 50 700 200 30 50 700 40 50 700 30 40 120 50

Bottleneck Operation Operation 1 20/hr. Operation 2 10/hr. Maximum output rate limited by bottleneck

Economies of Scale Economies of scale Diseconomies of scale If the output rate is less than the optimal level, increasing output rate results in decreasing average unit costs Diseconomies of scale If the output rate is more than the optimal level, increasing the output rate results in increasing average unit costs

Production units have an optimal rate of output for minimal cost. Minimum average cost per unit Average cost per unit Minimum cost Rate of output Figure 5.4

Economies of Scale Figure 5.5 Small Medium Large Output rate Minimum cost & optimal operating rate are functions of size of production unit. Average cost per unit Small plant Medium Large Output rate Figure 5.5 100 250 400

Evaluating Alternatives Cost-volume analysis Break-even point Financial analysis Cash flow Present value Decision theory Waiting-line analysis

Cost-Volume Relationships Amount ($) Q (volume in units) Total revenue Amount ($) Total cost = VC + FC Total variable cost (VC) Fixed cost (FC) Q (volume in units) Figure 5.6

Cost-Volume Relationships Profit Total revenue Amount ($) Total cost BEP units Q (volume in units) Figure 5.6c

BEP Problem with Step Fixed Costs FC + VC = TC FC + VC = TC 3 machines FC + VC = TC 2 machines 1 machine Figure 5.7a 100 200 300 Quantity Step fixed costs and variable costs.

BEP Problem with Step Fixed Costs $ BEP 3 TC BEP 2 TC 3 TC 2 TR 1 Quantity Multiple break-even points Figure 5.7b

Assumptions of Cost-Volume Analysis Simple Solution to our Capacity Problem? One product is involved Everything produced can be sold Variable cost per unit is the same regardless of volume Fixed costs do not change with volume Revenue per unit constant with volume Revenue per unit exceeds variable cost per unit

Financial Analysis Cash Flow - the difference between cash received from sales and other sources, and cash outflow for labor, material, overhead, and taxes. Present Value - the sum, in current value, of all future cash flows of an investment proposal.

Decision Theory Helpful tool for financial comparison of alternatives under conditions of risk or uncertainty Suited to capacity decisions See Chapter 5 Supplement

Waiting-Line Analysis Useful for designing or modifying service systems Waiting-lines occur across a wide variety of service systems Waiting-lines are caused by bottlenecks in the process Helps managers plan capacity level that will be cost-effective by balancing the cost of having customers wait in line with the cost of additional capacity

Chapter 5 Example 4 Purchase 1, 2 or 3 machines BEP for each range? Variable cost 10/unit Revenue 40/piece BEP for each range? Demand 580-660, how many to buy? No. of Machines Total Annual Fixed Cost Corresponding range of output 1 9600 0-300 2 15000 301-600 3 20000 601-900

QBEP = $9600/($40/unit -$10/unit) = 320 unit QBEP = FC/(R-v) QBEP = $9600/($40/unit -$10/unit) = 320 unit QBEP = $15000/($40/unit -$10/unit) = 500 unit QBEP = $20000/($40/unit -$10/unit) = 666.67 unit Answer part B Demand 580-660, how many to buy? No. of Machines Total Annual Fixed Cost Corresponding range of output 1 9600 0-300 2 15000 301-600 3 20000 601-900

Learning Objectives Explain the importance of capacity planning. Discuss ways of defining and measuring capacity. Describe the determinants of effective capacity. Discuss the major considerations related to developing capacity alternatives. Briefly describe approaches that are useful for evaluating capacity alternatives