2. Facility Capacity and Location
Chapter 5, Part A
Facility Capacity and Location

3. Overview Facility Planning Long-Range Capacity Planning
Facility Location
Wrap-Up: What World-Class Companies Do

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

5. Facility Planning
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:
Operating efficiency
Economy of scale
Ease of scheduling
Maintenance costs
… Profitability!

6. Long-Range Capacity Planning

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

8. Definitions of Capacity
In general, production capacity is the maximum production rate of an organization.
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

9. Definitions of Capacity
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

10. 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)

11. 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

12. 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

13. 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

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

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

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

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

18. Economies of Scale 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

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

20. Economies of Scale 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

21. Diseconomies of Scale
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

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

23. Two General Approaches to Expanding Long-Range Capacity
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

24. Two General Approaches to Expanding Long-Range Capacity
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

25. 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

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

27. Economies of Scope
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

28. Analyzing Capacity-Planning Decisions
Break-Even Analysis (Chapter 4 and this chapter)
Present-Value Analysis
Computer Simulation (Chapter 9)
Waiting Line Analysis (Chapter 9)
Linear Programming (Chapter 8)
Decision Tree Analysis (this chapter)

29. Example: King Publishing
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?

30. Example: King Publishing
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

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

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

33. Example: King Publishing
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)
100,000 = 42(20,000) – [125,000 + v(20,000)]
100,000 = 840,000 – 125,000 – 20,000v
20,000v = 615,000
v = $30.75

34. 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

35. Example: Good Eats Café
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 The payoff table showing the profits for the three designs is on the next slide.

36. Example: Good Eats Café
Payoff Table
Average Number of Customers Per Hour
c1 = c2 = c3 = 120
Design A $10, $15, $14,000
Design B $ 8, $18, $12,000
Design C $ 6, $16, $21,000

37. Example: Good Eats Café
Expected Value Approach
Calculate the expected value for each decision. The decision tree on the next slide can assist in this calculation. Here d1, d2, d3 represent the decision alternatives of designs A, B, C, and c1, c2, c3 represent the different average customer volumes (80, 100, and 120) that might occur.

38. Example: Good Eats Café
Decision Tree 1
(.2)
(.4) d1 d2 d3 c1 c2 c3
Payoffs
10,000
15,000
14,000
8,000
18,000
12,000
6,000
16,000
21,000 2 3 4

39. Example: Good Eats Café
Expected Value For Each Decision
Choose the design with largest EV -- Design C.
EV = .4(10,000) + .2(15,000) + .4(14,000)
= $12,600 d1 2
Design A
EV = .4(8,000) + .2(18,000) + .4(12,000)
= $11,600
Design B d2 1 3 d3
Design C
EV = .4(6,000) + .2(16,000) + .4(21,000)
= $14,000 4

40. Facility Location

41. A Sequence of Decisions
Political, social, economic stability;
Currency exchange rates;
National Decision
Regional Decision
Climate; Customer concentrations;
Degree of unionization;
Community Decision
Transportation system availability;
Preference of management;
Site Decision
Site size/cost; Environmental impact;
Zoning restrictions;

42. Factors Affecting the Location Decision
Economic
Site acquisition, preparation and construction costs
Labor costs, skills and availability
Utilities costs and availability
Transportation costs
Taxes

43. Factors Affecting the Location Decision
Non-economic
Labor attitudes and traditions
Training and employment services
Community’s attitude
Schools and churches
Recreation and cultural attractions
Amount and type of housing available

44. Facility Types and Their Dominant Locational Factors
Mining, Quarrying, and Heavy Manufacturing
Near their raw material sources
Abundant supply of utilities
Land and construction costs are inexpensive
Light Manufacturing
Availability and cost of labor
Warehousing
Proximity to transportation facilities
Incoming and outgoing transportation costs
. . . more

45. Facility Types and Their Dominant Locational Factors
R&D and High-Tech Manufacturing
Ability to recruit/retain scientists, engineers, etc.
Near companies with similar technology interests
Retailing and For-Profit Services
Near concentrations of target customers
Government and Health/Emergency Services
Near concentrations of constituents

46. Some Reasons the Facility Location Decision Arises
Changes in the market
Expansion
Contraction
Geographic shift
Changes in inputs
Labor skills and/or costs
Materials costs and/or availability
Utility costs
. . . more

47. Some Reasons the Facility Location Decision Arises
Changes in the environment
Regulations and laws
Attitude of the community
Changes in technology

48. Analyzing Service Location Decisions
Why do customers buy our
products and services?
Consumer Behavior
Research
Market Research
Who are our customers?
What are their characteristics?
Data Gathering for
Each Location Alternative
Where are our customers concentrated?
What are their traffic/spending patterns?
Revenue Projections for
Each Location Alternative
What are the economic projections?
What is the time-phased revenue?
Profit Projections for
Each Location Alternative
What are the projected revenues
less time-phased operating costs?

49. Analyzing Industrial Facility Locations
Factors that tend to dominate the industrial-facility location decision are:
Transportation costs
Labor cost and availability
Materials cost and availability
Utilities cost

50. Analyzing Industrial Facility Locations
Locating a Single Facility
A simple way to analyze alternative locations is conventional cost analysis
Pros – ease of communication and understanding
Cons – time value of money ignored and qualitative factors not considered
Locating Multiple Facilities
More sophisticated techniques are often used:
Linear programming, computer simulation, network analysis, and others

51. Qualitative Factors in Location Decisions
Often-important qualitative factors include
Housing
Climate
Community activities
Education and health services
Recreation
Churches
Union activities
Community attitudes

52. Integrating Qualitative & Quantitative Factors
Managers often wrestle with the task of trading off qualitative factors against quantitative ones
Methods for systematically displaying the relative advantages and disadvantages, both qualitative and quantitative, of each location alternative have been developed
The relative-aggregate-scores approach is one such method

53. Relative-Aggregate-Scores Approach
Quantitative and Qualitative Factors
Location A Location B
Econ Wgt. Econ Wgt.
Factor Weight Data Score Score Data Score Score
Prod.cost/ton .45 $ $
Transp.cost/ton .35 $ $
Labor Avail
Union Activity
Total Score

54. Wrap-Up: World-Class Practice
Outstanding long-range business plans
Long-range capacity studies
Justify investment on how it positions their company to capture market share
Facility location decisions involve worldwide search for sites

55. End of Chapter 5, Part A