1. An Integrated Goods and Services Approach
OPERATIONS MANAGEMENT
An Integrated Goods and Services Approach
CHAPTER 10
Managing Capacity
JAMES R. EVANS
AND
DAVID A. COLLIER
Operations Management/Ch. 10 Managing Capacity
©2007 Thomson South-Western

2. Chapter 10 Learning Objectives
To understand the fundamental decisions that must be made in both the short term and long term, how capacity influences economies and diseconomies of scale, and the impacts of capacity in managing focused and unfocused facilities.
To be able to identify and use different forms of capacity measurement useful to operations managers, to understand the importance of safety capacity, and to make quantitative calculations of capacity, and use capacity measurements in operational planning decisions.
To understand approaches to making long-term capacity decisions and capacity and expansion strategies.

3. Chapter 10 Learning Objectives, Cont.
To understand how firms deal with short-term imbalances between demand and capacity, and to learn strategies for adjusting capacity and influencing demand to achieve better resource use and efficiency.
To identify practical issues associated with revenue management and be able to compute simple overbooking strategies.
To learn the principles and logic of the Theory of Constraints, and better understand how demand, capacity, resource utilization, and process structure are related.

4. Chapter 10 Managing Capacity
Understanding Capacity
Capacity is a measure of the capability of
a manufacturing or service resource such
as a facility, process, workstation, or piece
of equipment to accomplish its purpose
over a specified time period.

5. Chapter 10 Managing Capacity
Understanding Capacity
The resources available to the organization—facilities,
equipment, and labor, how they are organized, and
their efficiency as determined by specific work
methods and procedures determine capacity.
Capacity can be viewed in one of two ways:
As the maximum rate of output per unit of time, or
As units of resource availability.

6. Chapter 10 Managing Capacity
Typical capacity issues to address include:
Can the facility, process, or equipment accommodate new goods and services and adapt to changing demand for existing goods and services?
How large should facility, process, or equipment capacity be?
When should capacity changes take place?

7. Exhibit 10.1
Examples of Short- and Long-Term Capacity Decisions

8. Chapter 10 Managing Capacity
Understanding Capacity
Economies of scale are achieved when the average unit cost of a good or service decreases as the capacity and/or volume of throughput increases.
Diseconomies of scale occur when the average unit cost of the good or service begins to increase as the capacity and/or volume of throughput increases.

9. Exhibit 10.2
Airbus A380 Economies of Scale

10. Chapter 10 Managing Capacity
Understanding Capacity
Focused factory: a way to achieve economies of scale without extensive investments in facilities and capacity by focusing on a narrow range of goods or services, target market segments, and/or dedicated processes to maximize efficiency and effectiveness.
Plant-within-a-plant: a strategy that divides a facility into independent factories, each with its own core competencies.

11. Chapter 10 Managing Capacity
Capacity Measurement
Theoretical capacity (sometimes called design capacity): the maximum output per unit of time the process can achieve for a short period of time under ideal operating conditions.
Effective capacity: the actual output per unit of time that the organization can reasonably be expected to sustain the long run under normal operating conditions.

12. Chapter 10 Managing Capacity
Understanding Capacity
Safety capacity: an amount of capacity reserved for unanticipated events such as demand surges, materials shortages, and equipment breakdowns.
Average Safety Capacity % = 100% —Average Resource Utilization % (Eq. 10.1)

13. Exhibit 10.3
The Demand versus Capacity Problem Structure

14. Chapter 10 Managing Capacity
Capacity Measurement in Job Shops
In a job shop, setup time can be a substantial part of total system capacity.
Capacity Required (Ci) = Setup Time (Si) + Processing Time (Pi) x Order Size (Qi)
= Si + Pi * Qi
(Equation 10.2)

15. Chapter 10 Managing Capacity
Capacity Measurement in Job Shops (continued)
Ham’s Dental Office (Exhibits 10.4 and 10.5) illustrate these calculations using a dental procedure mix.
Setup times normally represent a substantial percentage of the total capacity of most job shops. Every effort must be made to reduce setup time to the lowest possible amount so as to “free up capacity” for creating output.

16. Exhibit 10.4
Ham’s Dental Office Procedures and Times for Today

17. Ham’s Dental Office Demand-Capacity Analysis
Exhibit 10.5
Ham’s Dental Office Demand-Capacity Analysis
*Example computation: C = å(Si + Oi × Qi) = 15 × = 210 minutes, assuming a setup for each patient.

18. Chapter 10 Long-Term Capacity Strategies
In developing a long-range capacity plan, a firm must make the basic economic trade-off between the cost of capacity and the opportunity cost of not having adequate capacity.
Long-term capacity planning must be closely tied to the strategic direction of the organization—what products and services it offers.

19. Chapter 10 Long-Term Capacity Strategies
Complementary goods and services can be produced or delivered using the same resources available to the firm, but whose seasonal demand patterns are out of phase with each other. Complementary goods or services balance seasonal demand cycles and therefore use the excess capacity available, as illustrated in Exhibit 10.6.

20. Exhibit 10.6
Seasonal Demand and Complementary Goods or Services

21. Chapter 10 Capacity Expansion Options
Long-Term Capacity Strategies
Four basic strategies for expanding capacity over some fixed time horizon:
One large capacity increase (Exhibit 10.7a)
Small capacity increases that match average demand (Exhibit 10.7b).
Small capacity increases that lead demand (Exhibit 10.7c).
Small capacity increases that lag demand (Exhibit 10.7d).

22. Exhibit 7.7
Exhibit 10.7
Capacity Expansion Options

23. Exhibit 10.8
Example Decision Tree for Southland’s Capacity Expansion Problem

24. Chapter 10 Short-Term Capacity Management
Short-term capacity adjustments to capacity might include:
Add or share equipment: leasing equipment as needed or a partnership arrangement with capacity sharing. Examples: mainframe computers, CAT scanner, farm equipment.
Sell unused capacity: sell idle capacity to outside buyers and even competitors. Examples: computing capacity, perishable hotel rooms.
Change labor capacity and schedules: short term changes in work force levels. Examples: overtime, under time, temporary employees.
Change labor skill mix: hiring the right people.
Shift work to slack periods:

25. Chapter 10 Managing Capacity
Managing Capacity by Shifting and Stimulating Demand
Vary the price of goods or services: price is the most powerful way to influence demand.
Provide customers information: when to call or visit.
Advertising and promotion: advertising plays a vital role on influencing demand; promotions are strategically distributed to increase demand during periods of low sales or excess capacity.
Add peripheral goods and/or services: change demand during slack periods.
Provide reservations: a promise to provide a good or service at some future time and place.

26. Chapter 10 Revenue Management Systems
Services that are most amenable to revenue management systems (RMS), also called yield management, have one or more of the following characteristics:
Perishability.
Segmented markets.
Advance sales of the service.
High fixed costs relative to variable costs.

27. Exhibit 10.9
Basic Hotel Customer and Economic Information for One Day

28. Chapter 10 Revenue Management Systems
Contribution to profit and overhead ($) = (PB - VC)*DB+(PC -VC)*DC [Equation 10.4]
= ($140 - $20)* ($80 - $20)*700
= $36,000 + $42,000
= $78,000
Hotel Management = (Actual prices for each room night)*(Actual number of room nights rented)/(Maximum legal price for each room night)*(Maximum number of room nights available in hotel)
Using above Equation 10.5 we compute:
Hotel Management = ($140*300 rooms) + ($80*700 rooms) =
Effectiveness (%) ($180*350 rooms) + ($100*800 rooms)
$42,000 + $56,000 = $98,000 = 74.1%
$63,, $80, $143,000

29. Chapter 10 Overbooking Strategies and Analysis
Revenue Management Systems
Overbooking is accepting more reservations than capacity available, assuming that a certain percentage of customers will not show up or cancel prior to using the service.

30. Chapter 10 Overbooking Strategies and Analysis
Revenue Management Example
Zeus Car Company is interested in controlling reservations for midsized cars for one particular day: June 1. Customer no show probabilities are given in Exhibit 10.10, if a car is unused $40 is the lost revenue, if reservation is accepted but no car is available the stockout cost is $150. Zeus has 10 midsized cars available for June 1. How many reservations should Zeus accept, that is should they overbook by 0, 1 or 2 customers?
The highest expected net revenue is when Zeus accepts only 10 reservations and does not overbook at all.

31. Probabilities of Zeus Customers Showing Up
Exhibit 10.10
Probabilities of Zeus Customers Showing Up
*These probabilities are based on the binomial distribution, namely, the probability that x customers will show up from n reservations, assuming a constant probability of showing up being .80.

32. Chapter 10 Managing Capacity
Theory of Constraints
Theory of Constraints (TOC) is a set of principles that focuses on increasing total process throughput by maximizing the utilization of all bottleneck work activities and workstations.
Throughput: amount of money generated per time period through actual sales.
Constraint: anything that limits an organization from moving toward or achieving its goal.

33. Chapter 10 Managing Capacity
Theory of Constraints
Physical constraint: associated with the capacity of a resource.
Bottleneck work activity: effectively limits capacity of the entire process.
Nonbottleneck work activity: idle capacity exists.
Nonphysical constraint: environmental or organizational policy or procedure.

34. Exhibit 10.12
Theory of Constraint Principles Applied to Different Process Structures

35. Exhibit 10.11
Basic Principles of the Theory of Constraints

36. Chapter 10 Managing Capacity
Solved Problem #1
An automobile transmission-assembly factory normally operates two shifts per day, five days per week. During each shift, 400 transmissions can be completed under ideal conditions. Under normal operating conditions, 340 transmissions/shift/day are completed. Over the next four weeks, the factory has planned shipments according to the following schedule.
Week
Shipments , , , ,800
a. What is the monthly theoretical capacity?
b. What is the monthly effective capacity?
c. For this shipment schedule and assuming zero finished goods inventory at the end of the month, what is the actual utilization rate (%)?

37. Chapter 10 Managing Capacity
Solved Problem #1 Solution
a. Theoretical capacity = (2 shifts/day)(5 days/week)(400 trans/shift)(4 weeks/month) = 16,000 trans/month
b. Effective capacity = (2 shifts/day)(5 days/week)(340 trans/shift)(4 weeks/month) = 13,600 trans/month
c. Utilization (%) = Resources Demanded or Used/ Resources Available = 12,000/13,600 = 88.2%
Also, note that planned shipments are percent (3,800/3,400) of effective capacity in week 4. So, during the last week of the month "surge in production" they assembled 3,800 transmissions, very close to their ideal capacity of 4,000 per week.

38. Chapter 10 Managing Capacity
Solved Problem #2
Mary Johnson, the tax assessor for Yates County, has estimated that her office must perform 180 property reevaluations per day. Each staff member assigned to the reevaluation will work an eight-hour day with one hour for break and lunch. If it takes a staff member 10 minutes to do a reevaluation, and the average utilization of any staff member is 75%, how many staff members must be assigned to this project?
Solution
Service rate = (7 effective hours/day)*(6 reevaluations/hour) = 42 reevaluations/day. Using Equation 7.2, we have
Utilization (U%) = Demand Rate/[Service Rate*Number of Servers] or = 180 reevaluations/day
(42 reevaluations/day)*(Number of Servers)
= 31.5*S = 180 or S = 5.7 or about six staff members.

39. Chapter 10 Solved Problem #3
Mama Mia’s Pizza must decide on the number of delivery employees to have on Super Bowl Sunday.
DELIVERY CAPACITY
LOW
DEMAND MEDIUM
HIGH 5
$1500 7
$1250
$1800 10
$900
$1600
$2500
Probabilities of demand:
P (low) = 0.5
P (medium) = 0.3
P (high) = 0.2
How many deliveries should he plan for?

40. Exhibit 10.13
Decision Tree for Solved Problem #3

41. A decisions tree for this situation is shown in Exhibit 10.13.
Chapter 10 Solved Problem #3
A decisions tree for this situation is
shown in Exhibit
5 Drivers: $1500
7 Drivers: $1525
10 Drivers: $1430
Even though the most likely level of demand is low, the store manager should plan a capacity level of 7 drivers.