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**Capacity Planning For Products and Services**

5 Capacity Planning For Products and Services

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**Learning Objectives Explain the importance of capacity planning.**

Discuss ways of defining and measuring capacity. Describe the determinants of effective capacity. Discuss the major considerations related to developing capacity alternatives. Briefly describe approaches that are useful for evaluating capacity alternatives

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Capacity Planning Capacity is the upper limit or ceiling on the load that an operating unit can handle. Capacity also includes Equipment Space Employee skills The basic questions in capacity handling are: What kind of capacity is needed? How much is needed? When is it needed?

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**Importance of Capacity Decisions**

Impacts ability to meet future demands Affects operating costs Major determinant of initial costs Involves long-term commitment Affects competitiveness Affects ease of management Globalization adds complexity Impacts long range planning

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Capacity Design capacity … Effective capacity Actual output

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**Efficiency and Utilization**

Actual output Efficiency = Effective capacity Utilization = Design capacity Both measures expressed as percentages

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**Efficiency/Utilization Example**

Design capacity = trucks/day Effective capacity = 40 trucks/day Actual output = trucks/day Actual output = units/day Efficiency = = Effective capacity units/ day Utilization = Actual output = units/day = Design capacity units/day

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**Determinants of Effective Capacity**

Facilities Product and service factors Process factors Human factors Policy factors Operational factors Supply chain factors External factors

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**Strategy Formulation Capacity strategy for long-term demand**

Demand patterns Growth rate and variability Facilities Cost of building and operating Technological changes Rate and direction of technology changes Behavior of competitors Availability of capital and other inputs

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**Key Decisions of Capacity Planning**

Amount of capacity needed Capacity cushion (100% - Utilization) Timing of changes Need to maintain balance Extent of flexibility of facilities Capacity cushion – extra demand intended to offset uncertainty

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**Forecasting Capacity Requirements**

Long-term vs. short-term capacity needs Long-term relates to overall level of capacity such as facility size, trends, and cycles Short-term relates to variations from seasonal, random, and irregular fluctuations in demand

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**Calculating Processing Requirements**

If annual capacity is 2000 hours, then how many machines do we need to handle the required volume of …. ?

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**Planning Service Capacity**

Need to be near customers Capacity and location are closely tied Inability to store services Capacity must be matched with timing of demand Degree of volatility of demand Peak demand periods

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**In-House or Outsourcing**

Outsource: obtain a good or service from an external provider Available capacity Expertise Quality considerations Nature of demand Cost Risk

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**Developing Capacity Alternatives**

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 out capacity requirements Identify the optimal operating level

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**Bottleneck Operation Machine #1 Machine #2 Bottleneck Operation**

Figure 5.2 Bottleneck operation: An operation in a sequence of operations whose capacity is lower than that of the other operations Bottleneck Operation Machine #1 Machine #3 Machine #4 10/hr 30/hr Machine #2

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**Bottleneck Operation Operation 1 20/hr. Operation 2 10/hr.**

? Which operation is the Bottleneck operation? Maximum output rate limited by bottleneck

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**Economies of Scale Economies of scale Diseconomies of scale**

If the output rate is less than the optimal level, increasing output rate results in decreasing average unit costs Diseconomies of scale If the output rate is more than the optimal level, increasing the output rate results in increasing average unit costs

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**Production units have an optimal rate of output for minimal cost.**

Figure 5.4 Production units have an optimal rate of output for minimal cost. Minimum cost Average cost per unit Rate of output Minimum average cost per unit

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**Economies of Scale Figure 5.5 Small Medium plant Large plant**

Minimum cost & optimal operating rate are functions of size of production unit. Small plant Average cost per unit Medium plant Large plant Output rate

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**Evaluating Alternatives**

Cost-volume analysis Break-even point Financial analysis Cash flow Present value Decision theory Waiting-line analysis

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**Cost-Volume Relationships**

Figure 5.6a Amount ($) Q (volume in units) Total cost = VC + FC Total variable cost (VC) Fixed cost (FC)

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**Cost-Volume Relationships**

Figure 5.6b Amount ($) Q (volume in units) Total revenue

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**Cost-Volume Relationships**

Figure 5.6c Amount ($) Q (volume in units) BEP units Profit Total revenue Total cost

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**Break-Even Problem with Step Fixed Costs**

Figure 5.7a Quantity FC + VC = TC Step fixed costs and variable costs. 1 machine 2 machines 3 machines

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**Break-Even Problem with Step Fixed Costs**

Figure 5.7b $ FC1 FC2 FC3 BEP 2 3 TP Quantity 1 Multiple break-even points TP = (P – VC) Q

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**Assumptions of Cost-Volume Analysis**

One product is involved Everything produced can be sold Variable cost per unit is the same regardless of volume Fixed costs do not change with volume Revenue per unit constant with volume Revenue per unit exceeds variable cost per unit

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Financial Analysis Cash Flow - the difference between cash received from sales and other sources, and cash outflow for labor, material, overhead, and taxes. Present Value - the sum, in current value, of all future cash flows of an investment proposal.

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**Waiting-Line Analysis**

Useful for designing or modifying service systems Waiting-lines occur across a wide variety of service systems Waiting-lines are caused by bottlenecks in the process Helps managers plan capacity level that will be cost-effective by balancing the cost of having customers wait in line with the cost of additional capacity

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