Facility Capacity and Location Chapter 5, Part A

Facility Planning HOW MUCH long range capacity is needed HOW MUCH long range capacity is needed WHEN additional capacity is needed WHEN additional capacity is needed WHERE the production facilities should be located WHERE the production facilities should be located WHAT the layout and characteristics of the facilities should be WHAT the layout and characteristics of the facilities should be

Facility Planning The capital investment in land, buildings, technology, and machinery is enormous The capital investment in land, buildings, technology, and machinery is enormous A firm must live with its facility planning decisions for a long time, and these decisions affect: 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!

Long-Range Capacity Planning

Steps in the Capacity Planning Process Estimate the capacity of the present facilities. Estimate the capacity of the present facilities. Forecast the long-range future capacity needs. Forecast the long-range future capacity needs. Identify and analyze sources of capacity to meet these needs. Identify and analyze sources of capacity to meet these needs. Select from among the alternative sources of capacity. Select from among the alternative sources of capacity.

Definitions of Capacity In general, production capacity is the maximum production rate of an organization. In general, production capacity is the maximum production rate of an organization. Capacity can be difficult to quantify due to … Capacity can be difficult to quantify due to … –Day-to-day uncertainties such as employee absences, equipment breakdowns, and material-delivery delays –Products and services differ in production rates (so product mix is a factor) –Different interpretations of maximum capacity

Definitions of Capacity The Federal Reserve Board defines sustainable practical capacity as the greatest level of output that a plant can maintain … The Federal Reserve Board defines sustainable practical capacity as the greatest level of output that a plant can maintain … –within the framework of a realistic work schedule –taking account of normal downtime –assuming sufficient availability of inputs to operate the machinery and equipment in place

Measurements 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)

Measurements of Capacity Input Rate Capacity –Commonly used for service operations where output measures are particularly difficult  Hospitals use available beds per month  Airlines use available seat-miles per month  Movie theatres use available seats per month

Measurements of Capacity Capacity Utilization Percentage –Relates actual output to output capacity  Example: Actual automobiles produced in a quarter divided by the quarterly automobile production capacity –Relates actual input used to input capacity  Example: Actual accountant hours used in a month divided by the monthly account-hours available

Measurements of Capacity Capacity Cushion –an additional amount of capacity added onto the expected demand to allow for:  greater than expected demand  demand during peak demand seasons  lower production costs  product and volume flexibility  improved quality of products and services

Forecasting Capacity Demand Consider the life of the input (e.g. facility is yr) Consider the life of the input (e.g. facility is yr) Understand product life cycle as it impacts capacity Understand product life cycle as it impacts capacity Anticipate technological developments Anticipate technological developments Anticipate competitors’ actions Anticipate competitors’ actions Forecast the firm’s demand Forecast the firm’s demand

Other Considerations Resource availability Resource availability Accuracy of the long-range forecast Accuracy of the long-range forecast Capacity cushion Capacity cushion Changes in competitive environment Changes in competitive environment

Expansion of Long-Term Capacity Subcontract with other companies Subcontract with other companies Acquire other companies, facilities, or resources Acquire other companies, facilities, or resources Develop sites, construct buildings, buy equipment Develop sites, construct buildings, buy equipment Expand, update, or modify existing facilities Expand, update, or modify existing facilities Reactivate standby facilities Reactivate standby facilities

Reduction of Long-Term Capacity Sell off existing resources, lay off employees Sell off existing resources, lay off employees Mothball facilities, transfer employees Mothball facilities, transfer employees Develop and phase in new products/services Develop and phase in new products/services

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

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

Economies of Scale Declining costs result from: 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

Diseconomies of Scale Increasing costs result from increased congestion of workers and material, which contributes to: 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

Two General Approaches to Expanding Long-Range Capacity All at Once – build the ultimate facility now and grow into it All at Once – build the ultimate facility now and grow into it Incrementally – build incrementally as capacity demand grows Incrementally – build incrementally as capacity demand grows

Two General Approaches to Expanding Long-Range Capacity All at Once 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

Two General Approaches to Expanding Long-Range Capacity Incrementally 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

Subcontractor Networks 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 –Relying less on backward vertical integration –Requiring less capital for production facilities –More easily varying capacity during slack or peak demand periods

Outsourcing Service Functions –Building maintenance –Data processing –Delivery –Payroll –Bookkeeping –Customer service –Mailroom –Benefits administration –… and more

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

Example: King Publishing Break-Even Analysis Break-Even Analysis King Publishing intends to publish a book in residential landscaping. Fixed costs are $125,000 per year, variable costs per unit are $32, and selling price per unit is $42. A) How many units must be sold per year to break even? B) How much annual revenue is required to break even? C) If annual sales are 20,000 units, what are the annual profits? D) What variable cost per unit would result in $100,000 annual profits if annual sales are 20,000 units?

Example: King Publishing Break-Even Analysis Break-Even Analysis A) How many units must be sold per year to break even? Q = FC/(p-v) = $125,000/(42 – 32) = 12,500 books

Example: King Publishing Break-Even Analysis Break-Even Analysis B) How much annual revenue is required to break even? TR = pQ = 42(12,500) = $525,000 TR = pQ = 42(12,500) = $525,000

Example: King Publishing Break-Even Analysis Break-Even Analysis C) If annual sales are 20,000 units, what are the annual profits? P = pQ – (FC + vQ) P = pQ – (FC + vQ) = 42(20,000) – [125, (20,000)] = 42(20,000) – [125, (20,000)] = 840,000 – 125,000 – 640,000 = 840,000 – 125,000 – 640,000 = $75,000 = $75,000

Example: King Publishing Break-Even Analysis Break-Even Analysis D) What variable cost per unit would result in $100,000 annual profits if annual sales are 20,000 units? P = pQ – (FC + vQ) P = pQ – (FC + vQ) 100,000 = 42(20,000) – [125,000 + v(20,000)] 100,000 = 42(20,000) – [125,000 + v(20,000)] 100,000 = 840,000 – 125,000 – 20,000v 100,000 = 840,000 – 125,000 – 20,000v 20,000v = 615,000 20,000v = 615,000 v = $30.75 v = $30.75

Decision Tree Analysis Structures complex multiphase decisions, showing: 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 Allows objective evaluation of alternatives Incorporates uncertainty Incorporates uncertainty Develops expected values Develops expected values

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

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

l 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