MGT 563 OPERATIONS STRATEGIES Dr. Aneel SALMAN Department of Management Sciences COMSATS Institute of Information Technology, Islamabad

Recap Lecture 13 Six Sigma Basics Application of six sigma Barriers to implementation Why six sigma is successful DMAIC Methodology Elements of six sigma Application of all these tools (TQM, Six sigma, Lean, BPR)

 What kind of capacity is needed?  How much capacity is needed to match demand?  When more capacity is needed?  Where facilities should be located (location)  How facilities should be arranged (layout) Facility planning answers: FACILITY PLANNING

CAPACITY (DEFINITION OF)  The number of units a facility can hold, receive, store or produce in a period of time  It is the upper limit or ceiling on the load that an operating unit can handle. It includes  equipment,  space,  employee skills

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  Overcapacity  operating costs that are too high  Undercapacity  strained resources and possible loss of customers

CAPACITY PLANNING QUESTIONS  Key Questions:  What kind of capacity is needed?  How much capacity is needed to match demand?  When is it needed?  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?

ISSUES TO BE CONSIDERED IN STRATEGY FORMULATION  Capacity strategy  Demand patterns  Growth rate and variability  Facilities  (Cost of the building and operating)  Technological changes  (Rate and direction of technology changes)  Behavior of competitors  Availability of capital and other inputs.

TYPES OF PLANNING OVER A TIME HORIZON Add Facilities Add long lead time equipment Schedule Jobs * Schedule Personnel AllocateMachinery Sub-Contract Add Equipment Add Shifts Add Personnel Build or Use Inventory Long Range Planning Intermediate Range Planning Short Range Planning Modify CapacityUse Capacity * * * Limited options exist

1.impact the ability of the organization to meet future demands 2.affect operating costs 3.affect lead time responsiveness 4.are a major determinant of initial costs 5.involve long-term commitment of resources 6.affect competitiveness 7.affect ease of management 8.are more important and complex due to globalization 9.need to be planned for in advance due to their consumption of financial and other resources IMPORTANCE OF CAPACITY DECISIONS

CAPACITY MEASURES  Design capacity Maximum output rate or service capacity an operation, process, or facility is designed for  Effective capacity Capacity a firm can expect to attain given its product mix, methods of scheduling, maintenance and standards of quality. Design capacity minus allowances such as personal time, maintenance and scrap

Quality Performance objectives Dependability Supply Networks Process Technology Development and Organization Speed Flexibility Cost Resource Usage Market Competitiveness Decision areas Capacity (configuration) Issues include: Capacity levels Number of sites Size of sites Location

Capacity Strategy Configuring Capacity Managing Capacity Change Type of Capacity Overall Level of Capacity Location of Capacity Timing of Change Magnitude of Change Issues in capacity strategy Location of changed capacity

Forecast level of demand Changes in future demand Uncertainty of future demand Consequences of over/under supply Availability of capital Cost structure of capacity increment Economies of scale Flexibility of capacity provisions Some factors influencing the overall level of capacity OPERATIONS RESOURCES MARKET REQUIREMENTS Overall level of capacity

Issues include….. a LONG-TERM CAPACITY CHANGE STRATEGY NUMBER OF SITES LOCATION OF EACH SITE ALLOCATION OF TASKS TO EACH SITE CAPACITY OF EACH SITE

Questions: “Who should be involved in these decisions?” “How does the company make this type of decision?” NUMBER OF SITES and CAPACITY OF SITES LOCATION OF SITES ALLOCATION OF TASKS TO SITES LONG-TERM CAPACITY CHANGE STRATEGY Many small sites? Few larger sites? QuestionsOptions Supply side dominated? Demand side dominated? All sites make all products/services? Each site focuses on a few products/ services? Capacity leads demand? Capacity lags demand?

Why is capacity strategy important? Without an appropriate capacity strategy operations will always be struggling to supply markets in a competitive manner Getting capacity strategy right is the starting point for developing competitive operations

LONG-TERM CAPACITY CHANGE STRATEGY NUMBER OF SITES LOCATION OF EACH SITE CAPACITY OF EACH SITE ALLOCATION OF TASKS TO SITES What performance measures will all these decisions have a major impact on ? ? How should one judge a capacity strategy ?

Costs / Revenue ($) Volume in thousands of units Forecast demand = 9000 units Cost Revenue Cost, volume, profit illustration

Unit cost (total cost / volume) Volume in thousands of units (a) Nominal capacity limit Unit cost (total cost / volume) Volume in thousands of units (b) Diseconomies of scale kick in Unit cost curve

Physical capacity of facilities Effective Capacity Demand Volume Time Cash flow with extended physical capacity Cash flow with two identical capacity increments Cumulative cash flow Time Expanding physical capacity in advance of effective capacity can bring greater returns in the longer term

Required service level Geographical distribution of demand Economies of scale Supply costs Some factors influencing the number and size of sites OPERATIONS RESOURCES MARKET REQUIREMENTS Size and number of sites

Required service level Suitability of site Image of location Resource costs Land and facilities investment Resource availability Community factors Some factors influencing the location of sites OPERATIONS RESOURCES MARKET REQUIREMENTS Location of sites

CAPACITY RELATED CONCEPTS  Actual output Rate of output actually achieved—cannot exceed effective capacity  Utilization Actual output as a percent of design capacity  Efficiency Actual output as a percent of effective capacity

Measure of how well a facility or machine is performing when used Efficiency Actual output Effective Capacity = EFFICIENCY (expressed as a percentage)

Measure of actual capacity usage of a facility, work center, or machine Utilization Actual Output Design Capacity = UTILIZATION (expressed as a percentage)

Actual output = 36 units/day Efficiency = = 90% Effective capacity 40 units/ day Utilization = Actual output = 36 units/day = 72% Design capacity 50 units/day EXAMPLE- EFFICIENCY/UTILIZATION Design capacity = 50 trucks/day Effective capacity = 40 trucks/day Actual output = 36 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 Strategies are typically based on assumptions and predictions about:  Long-term demand patterns  Technological change  Competitor behavior

SPECIAL REQUIREMENTS FOR MAKING GOOD CAPACITY DECISIONS  Forecasting the demand accurately  Understanding the technology and capacity increments  Finding the optimal operating level (volume)  Building for change

KEY DECISIONS IN CAPACITY PLANNING  Amount of capacity needed  Timing of changes (frequency of capacity additions)  Extent of flexibility of facilities  External sources of capacity  Need to maintain balance

AMOUNT OF CAPACITY NEEDED

STEPS OF CAPACITY PLANNING  Estimate future capacity requirements  Evaluate existing capacity and facilities and identify gaps  Identify alternatives for meeting requirements  Conduct financial analysis  Assess key qualitative issues  Select the best alternative for the long term  Implement the alternative chosen  Monitor results

 Long-term considerations relate to overall level of capacity requirements  Short-term considerations relate to probable variations in capacity requirements FORECASTING CAPACITY REQUIREMENTS

CALCULATING PROCESSING REQUIREMENTS  Forecast sales within each individual product line  Calculate equipment and labor requirements to meet the forecasts

CALCULATING PROCESSING REQUIREMENTS Calculating processing requirements requires reasonably accurate demand forecasts, standard processing times, and available work time

CALCULATING PROCESSING REQUIREMENTS

If the department works one eight hour shift, 250 days a year, calculate the number of machines that would be needed to handle the required volume. Solution: 5800/(250)(8) = 2.9 (3 machines are needed)

CAPACITY CUSHION  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 greater capacity cushion

SERVICE CAPACITY PLANNING  Service capacity planning can present a number of challenges related to:  The inability to store services  The need to be near customer  The degree of demand volatility

SERVICE CAPACITY PLANNING  Time: Inability to store services for later consumption. Capacity must be available to provide a service when it is needed (capacity must be matched with the timing of demand)  Location: Need to be near customers for convenience. Capacity and location are closely tied. Service goods must be at the customer demand point and capacity must be located near the customer  Volatility of Demand: (Much greater than in manufacturing)  Volume and timing of demand  Time required to service individual customers

CAPACITY UTILIZATION & SERVICE QUALITY  Best operating point is near 70% of capacity  From 70% to 100% of service capacity, what do you think happens to service quality?

TIMING AND SIZE OF CHANGES (FREQUENCY OF CAPACITY ADDITIONS)

CAPACITY EXPANSION Factors to be considered:  Volume and certainty of anticipated demand  Strategic objectives for growth  Costs of expansion and operation  Incremental or one-step expansion  Frequency of capacity additions

CAPACITY EXPANSION STRATEGIES (1 of 5) Expected Demand Time in Years Demand New Capacity Capacity leads demand with an incremental expansion Capacity leads demand with a one-step expansion Capacity lags demand with an incremental expansion Attempts to have an average capacity, with an incremental expansion

CAPACITY EXPANSION STRATEGIES (2 of 5) Expected Demand Time in Years Demand New Capacity Capacity leads demand with an incremental expansion

CAPACITY EXPANSION STRATEGIES (3 of 5) Expected Demand Time in Years Demand New Capacity Capacity leads demand with a one-step expansion

CAPACITY EXPANSION STRATEGIES (4 of 5) Expected Demand Time in Years Demand New Capacity Capacity lags demand with an incremental expansion

CAPACITY EXPANSION STRATEGIES (5 of 5) Expected Demand Time in Years Demand New Capacity Attempts to have an average capacity, with an incremental expansion

MAKE OR BUY? 1.Available capacity 2.Expertise 3.Quality considerations 4.Nature of demand 5.Cost 6.Risk

OPTIMAL OPERATING LEVEL

Average cost per room Best operating level Economies of scale Diseconomies of scale # Rooms

ECONOMIES OF SCALE  Economies of scale If the output rate is less than the optimal level, increasing output rate results in decreasing average unit costs Reasons for economies of scale:  Fixed costs are spread over a larger number of units  Construction costs increase at a decreasing rate as facility size increases  Processing costs decrease due to standardization

DISECONOMIES OF SCALE  Diseconomies of scale  If the output rate is more than the optimal level, increasing the output rate results in increasing average unit costs Reasons for diseconomies of scale  Distribution costs increase due to traffic congestion and shipping from a centralized facility rather than multiple smaller facilities  Complexity increases costs  Inflexibility can be an issue  Additional levels of bureaucracy

ECONOMIES OF SCALE Minimum cost & optimal operating rate are functions of size of production unit. Average cost per unit 0 Small plant Medium plant Large plant Volume or output rate

THE EXPERIENCE CURVE As plants produce more products, they gain experience in the best production methods and reduce their costs per unit Total accumulated production of units Cost or price per unit Yesterday Today Tomorrow

EXTERNAL SOURCES OF CAPACITY

IN-HOUSE OR OURSOURCE?  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

NEED TO MAINTAIN BALANCE

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

BOTTLENECK OPERATION Operation 1 20/hr. Operation 2 10/hr. Operation 3 15/hr. 10/hr. Bottleneck Maximum output rate limited by bottleneck

CONSTRAINT MANAGEMENT  Constraint Something that limits the performance of a process or system in achieving its goals  Categories  Market  Resource  Material  Financial  Knowledge or competency  Policy

RESOLVING CONSTRAINT ISSUES  Identify the most pressing constraint  Change the operation to achieve maximum benefit, given the constraint  Make sure other portions of the process are supportive of the constraint  Explore and evaluate ways to overcome the constraint  Repeat the process until the constraint levels are at acceptable levels

STRATEGIES FOR MATCHING CAPACITY TO DEMAND

Should capacity lead or lag demand ? Capacity leads demand Volume Time What competitive objectives will be affected? Capacity lags demand Volume Time Demand Capacity

The three options ….. Time Demand Capacity Volume Time Capacity Leading Strategy Demand Capacity Volume Time Capacity Lagging Strategy Demand Capacity Volume Time Capacity Smoothing Strategy

DEMAND MANAGEMENT STRATEGIES  Strategies used to offset capacity limitations and that are intended to achieve a closer match between supply and demand  Pricing  Promotions  Backorders  Offering complementary products  Discounts  Other tactics to shift demand from peak periods into slow periods

CAPACITY MANAGEMENT STRATEGIES 1.Adjusting equipment and processes – which might include purchasing additional machinery or selling or leasing out existing equipment 2.Making staffing changes (increasing or decreasing the number of employees) 3.Improving methods to increase throughput 4.Redesigning the product to facilitate more throughput (for faster processing)

THINGS THAT CAN BE DONE TO ENHANCE CAPACITY MANAGEMENT 1.Design flexibility into systems 2.Take stage of life cycle into account 3.Take a “big picture” approach to capacity changes 4.Prepare to deal with capacity “chunks” 5.Attempt to smooth out capacity requirements 6.Identify the optimal operating level 7.Choose a strategy if expansion is involved