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

You should be able to: 1. Summarize the importance of capacity planning 2. Discuss ways of defining and measuring capacity 3. Describe the determinants of effective capacity 4. Discuss the major considerations related to developing capacity alternatives 5. Briefly describe approaches that are useful for evaluating capacity alternatives 5-2 Student Slides

Capacity The upper limit or ceiling on the load that an operating unit can handle It can be measured in terms of input or output Capacity needs include Equipment Space Employee skills Student Slides 5-3

Key Questions: What kind of capacity is needed? How much in total to match demand? How much currently exists? How much in shortage or excess? When to change the capacity? Related Questions: How much will it cost? What are the potential benefits and risks? Are there sustainability issues? Should capacity be changed all at once, or through several smaller changes Can the supply chain handle the necessary changes? Student Slides 5-4

Two useful definitions of capacity Design capacity The maximum output rate or service capacity an operation, process, or facility is designed for Effective capacity Design capacity minus allowances such as personal time and maintenance, and scrap Unit of Measure for capacity Dollars Raw material in lbs. Yields (of output) All are potentially problematic? 5-5 Student Slides

Actual output The rate of output actually achieved It cannot exceed effective capacity Efficiency Utilization Measured as percentages 5-6 Student Slides

1. Estimate future capacity requirements 2. Evaluate existing capacity and facilities; identify gaps 3. Identify alternatives for meeting requirements 4. Conduct financial analyses 5. Assess key qualitative issues 6. Select the best alternative for the long term 7. Implement alternative chosen 8. Monitor results 5-7 Student Slides

Service capacity planning can present a number of challenges related to: The need to be near customers Convenience The inability to store services Cannot store services for consumption later The degree of demand volatility Volume and timing of demand Time required to service individual customers 5-8 Student Slides

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 5-9 Student Slides

Things that can be done to enhance capacity management: 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 capacity requirements Identify the optimal operating level Choose a strategy if expansion is involved 5-10 Student Slides

Best operating level - least average unit cost Economies of scale - average cost per unit decreases as the volume increases toward the best operating level Diseconomies of scale - average cost per unit increases as the volume increases beyond the best operating level

Average Unit Cost of Output ($) Annual Volume (units) Best Operating Level Economies of Scale Diseconomies

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

Increasing costs result from increased congestion of workers and material, which contributes to: Increasing inefficiency Difficulty in scheduling Damaged goods Reduced morale Increased use of overtime … and other diseconomies

Minimum cost & optimal operating rate are functions of size of production unit Student Slides

All at Once – build the ultimate facility now and grow into it Incrementally – build incrementally as capacity demand grows

All at Once Little risk of having to turn down business due to inadequate capacity Less interruption of production One large construction project costs less than several smaller projects Due to inflation, construction costs will be higher in the future Most appropriate for mature products with stable demand

Incrementally Less risky if forecast needs do not materialize Funds that could be used for other types of investments will not be tied up in excess capacity More appropriate for new products

A viable alternative to larger-capacity facilities is to develop subcontractor and supplier networks. “Farming out” or outsourcing your capacity needs to your suppliers Developing long-range relationships with suppliers of parts, components, and subassemblies Requiring less capital for production facilities More easily varying capacity during slack or peak demand periods

Building maintenance Data processing Delivery Payroll Bookkeeping Customer service Mailroom Benefits administration … and more

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 product-to-product changes Economies are created by spreading the automation cost over many products

Break-Even Analysis Present-Value Analysis Computer Simulation Waiting Line Analysis Linear Programming Decision Tree Analysis

Structures complex multiphase decisions, showing: What decisions must be made What sequence the decisions must occur Interdependence of the decisions Allows objective evaluation of alternatives Incorporates uncertainty Develops expected values

Decision Tree Analysis Good Eats Café is about to build a new restaurant. An architect has developed three building designs, each with a different seating capacity. Good Eats estimates that the average number of customers per hour will be 80, 100, or 120 with respective probabilities of 0.4, 0.2, and 0.4. The payoff table showing the profits for the three designs is on the next slide.

Payoff Table Average Number of Customers Per Hour c 1 = 80 c 2 = 100 c 3 = 120 Design A $10,000 $15,000 $14,000 Design B $ 8,000 $18,000 $12,000 Design C $ 6,000 $16,000 $21,000 Payoff Table Average Number of Customers Per Hour c 1 = 80 c 2 = 100 c 3 = 120 Design A $10,000 $15,000 $14,000 Design B $ 8,000 $18,000 $12,000 Design C $ 6,000 $16,000 $21,000

Expected Value Approach l Expected Value Approach Calculate the expected value for each decision. The decision tree on the next slide can assist in this calculation. Here d 1, d 2, d 3 represent the decision alternatives of designs A, B, C, and c 1, c 2, c 3 represent the different average customer volumes (80, 100, and 120) that might occur. Expected Value Approach l Expected Value Approach Calculate the expected value for each decision. The decision tree on the next slide can assist in this calculation. Here d 1, d 2, d 3 represent the decision alternatives of designs A, B, C, and c 1, c 2, c 3 represent the different average customer volumes (80, 100, and 120) that might occur. Example: Good Eats Café

Decision Tree l Decision Tree 11 (.2) (.4) (.4) (.4) (.2) (.4) (.4) (.2) (.4) d1d1d1d1 d2d2d2d2 d3d3d3d3 c1c1c1c1 c1c1c1c1 c1c1c1c1 c2c2c2c2 c3c3c3c3 c2c2c2c2 c2c2c2c2 c3c3c3c3 c3c3c3c3Payoffs10,000 15,000 14,000 8,000 18,000 12,000 6,000 16,000 21, Example: Good Eats Café

Expected Value For Each Decision Expected Value For Each Decision Choose the design with largest EV -- Design C. Choose the design with largest EV -- Design C d1d1d1d1 d2d2d2d2 d3d3d3d3 EV =.4(10,000) +.2(15,000) +.4(14,000) = $12,600 = $12,600 EV =.4(8,000) +.2(18,000) +.4(12,000) = $11,600 = $11,600 EV =.4(6,000) +.2(16,000) +.4(21,000) = $14,000 = $14,000 Design A Design B Design C Example: Good Eats Café

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 = FC + VC Total Revenue (TR) TR = revenue per unit (R) x Q Student Slides 5-29

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) = Q(R – v) – FC Student Slides 5-30