1. Operations Management
Supplement 7 – Capacity Planning
PowerPoint presentation to accompany
Heizer/Render
Principles of Operations Management, 6e
Operations Management, 8e
© 2006 Prentice Hall, Inc.

2. Outline Capacity Capacity Planning Design and Effective Capacity
Capacity and Strategy
Capacity Considerations
Managing Demand
Capacity Planning

3. Outline – Continued Breakeven Analysis
Single-Product Case
Multiproduct Case
Applying Decision Trees to Capacity Decisions

4. Outline – Continued
Applying Investment Analysis to Strategy-Driven Investments
Investment, Variable Cost, and Cash Flow
Net Present Value

5. Learning Objectives
When you complete this supplement, you should be able to:
Identify or Define:
Capacity
Design capacity
Effective capacity
Utilization

6. Learning Objectives
When you complete this supplement, you should be able to:
Describe or Explain:
Capacity considerations
Net present value analysis
Break-even analysis
Financial considerations
Strategy-driven investments

7. Capacity
The throughput, or the number of units a facility can hold, receive, store, or produce in a period of time
Determines fixed costs
Determines if demand will be satisfied
Three time horizons
This slide provides some reasons that capacity is an issue. The following slides guide a discussion of capacity.

8. Planning Over a Time Horizon
Modify capacity
Use capacity
Long-range planning
Add facilities
Add long lead time equipment *
Intermediate-range planning
Subcontract Add personnel
Add equipment Build or use inventory
Add shifts
Short-range planning
Schedule jobs
Schedule personnel
Allocate machinery *
* Limited options exist
Figure S7.1

9. Design and Effective Capacity
Design capacity is the maximum theoretical output of a system
Normally expressed as a rate
Effective capacity is the capacity a firm expects to achieve given current operating constraints
Often lower than design capacity
This slide can be used to frame a discussion of capacity.
Points to be made might include:
- capacity definition and measurement is necessary if we are to develop a production schedule
- while a process may have “maximum” capacity, many factors prevent us from achieving that capacity on a continuous basis.
Students should be asked to suggest factors which might prevent one from achieving maximum capacity.

10. Utilization and Efficiency
Utilization is the percent of design capacity achieved
Utilization = Actual Output/Design Capacity
Efficiency is the percent of effective capacity achieved
Efficiency = Actual Output/Effective Capacity

11. Bakery Example Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, hour shifts
Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls
It might be useful at this point to discuss typical equipment utilization rates for different process strategies if you have not done so before.

12. Bakery Example Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, hour shifts
Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls
It might be useful at this point to discuss typical equipment utilization rates for different process strategies if you have not done so before.

13. Bakery Example Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, hour shifts
Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls
It might be useful at this point to discuss typical equipment utilization rates for different process strategies if you have not done so before.
Utilization = 148,000/201,600 = 73.4%

14. Bakery Example Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, hour shifts
Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls
It might be useful at this point to discuss typical equipment utilization rates for different process strategies if you have not done so before.
Utilization = 148,000/201,600 = 73.4%

15. Bakery Example Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, hour shifts
Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls
It might be useful at this point to discuss typical equipment utilization rates for different process strategies if you have not done so before.
Utilization = 148,000/201,600 = 73.4%
Efficiency = 148,000/175,000 = 84.6%

16. Bakery Example Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, hour shifts
Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls
It might be useful at this point to discuss typical equipment utilization rates for different process strategies if you have not done so before.
Utilization = 148,000/201,600 = 73.4%
Efficiency = 148,000/175,000 = 84.6%

17. Bakery Example Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, hour shifts
Efficiency = 84.6%
Efficiency of new line = 75%
Expected Output = (Effective Capacity)(Efficiency)
It might be useful at this point to discuss typical equipment utilization rates for different process strategies if you have not done so before.
= (175,000)(.75) = 131,250 rolls

18. Bakery Example Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, hour shifts
Efficiency = 84.6%
Efficiency of new line = 75%
Expected Output = (Effective Capacity)(Efficiency)
It might be useful at this point to discuss typical equipment utilization rates for different process strategies if you have not done so before.
= (175,000)(.75) = 131,250 rolls

19. Capacity and Strategy
Capacity decisions impact all 10 decisions of operations management as well as other functional areas of the organization
Capacity decisions must be integrated into the organization’s mission and strategy
You might point out to students that this slide links capacity to work measurement (standard times).

20. Managing Demand Demand exceeds capacity Capacity exceeds demand
Curtail demand by raising prices, scheduling longer lead time
Long term solution is to increase capacity
Capacity exceeds demand
Stimulate market
Product changes
Adjusting to seasonal demands
Produce products with complimentary demand patterns

21. Economies and Diseconomies of Scale
Number of Rooms 25 50 75
(dollars per room per night)
Average unit cost
25 - Room Roadside Motel
75 - Room Roadside Motel
50 - Room Roadside Motel
Economies of scale
Diseconomies of scale
Figure S7.2

22. Capacity Considerations
Forecast demand accurately
Understanding the technology and capacity increments
Find the optimal operating level (volume)
Build for change

23. Tactics for Matching Capacity to Demand
Making staffing changes
Adjusting equipment and processes
Purchasing additional machinery
Selling or leasing out existing equipment
Improving methods to increase throughput
Redesigning the product to facilitate more throughput

24. Complementary Demand Patterns
By combining both, the variation is reduced
4,000 –
3,000 –
2,000 –
1,000 –
J F M A M J J A S O N D J F M A M J J A S O N D J
Sales in units
Time (months)
Snowmobile sales
Jet ski sales
Figure S7.3

25. Approaches to Capacity Expansion
(a) Leading demand with incremental expansion
Demand
Expected demand
New capacity
(b) Leading demand with one-step expansion
Demand
New capacity
Expected demand
(c) Capacity lags demand with incremental expansion
Demand
New capacity
Expected demand
(d) Attempts to have an average capacity with incremental expansion
Demand
New capacity
Expected demand
This slide probably requires some discussion or explanation. Perhaps the best place to start is the left hand column where capacity either leads or lags demand incrementally. As you continue to explain the options, ask students to suggest advantages or disadvantages of each.
Figure S7.4

26. Approaches to Capacity Expansion
(a) Leading demand with incremental expansion
Demand
Time (years) 1 2 3
New capacity
Expected demand
This slide probably requires some discussion or explanation. Perhaps the best place to start is the left hand column where capacity either leads or lags demand incrementally. As you continue to explain the options, ask students to suggest advantages or disadvantages of each.
Figure S7.4

27. Approaches to Capacity Expansion
(b) Leading demand with one-step expansion
Demand
Time (years) 1 2 3
New capacity
Expected demand
This slide probably requires some discussion or explanation. Perhaps the best place to start is the left hand column where capacity either leads or lags demand incrementally. As you continue to explain the options, ask students to suggest advantages or disadvantages of each.
Figure S7.4

28. Approaches to Capacity Expansion
(c) Capacity lags demand with incremental expansion
Demand
Time (years) 1 2 3
New capacity
Expected demand
This slide probably requires some discussion or explanation. Perhaps the best place to start is the left hand column where capacity either leads or lags demand incrementally. As you continue to explain the options, ask students to suggest advantages or disadvantages of each.
Figure S7.4

29. Approaches to Capacity Expansion
(d) Attempts to have an average capacity with incremental expansion
Demand
Time (years) 1 2 3
New capacity
Expected demand
This slide probably requires some discussion or explanation. Perhaps the best place to start is the left hand column where capacity either leads or lags demand incrementally. As you continue to explain the options, ask students to suggest advantages or disadvantages of each.
Figure S7.4

30. Break-Even Analysis
Technique for evaluating process and equipment alternatives
Objective is to find the point in dollars and units at which cost equals revenue
Requires estimation of fixed costs, variable costs, and revenue
This chart introduces breakeven analysis and the breakeven or crossover chart. As you discuss the assumptions upon which this techniques is based, it might be a good time to introduce the more general topic of the limitations of and use of models. Certainly one does not know all information with certainty, money does have a time value, and the hypothesized linear relationships hold only within a range of production volumes. What impact does this have on our use of the models?

31. Break-Even Analysis
Fixed costs are costs that continue even if no units are produced
Depreciation, taxes, debt, mortgage payments
Variable costs are costs that vary with the volume of units produced
Labor, materials, portion of utilities
Contribution is the difference between selling price and variable cost
This chart introduces breakeven analysis and the breakeven or crossover chart. As you discuss the assumptions upon which this techniques is based, it might be a good time to introduce the more general topic of the limitations of and use of models. Certainly one does not know all information with certainty, money does have a time value, and the hypothesized linear relationships hold only within a range of production volumes. What impact does this have on our use of the models?

32. Break-Even Analysis Assumptions Costs and revenue are linear functions
Generally not the case in the real world
We actually know these costs
Very difficult to accomplish
There is no time value of money
This chart introduces breakeven analysis and the breakeven or crossover chart. As you discuss the assumptions upon which this techniques is based, it might be a good time to introduce the more general topic of the limitations of and use of models. Certainly one does not know all information with certainty, money does have a time value, and the hypothesized linear relationships hold only within a range of production volumes. What impact does this have on our use of the models?

33. Total cost = Total revenue
Break-Even Analysis –
900 –
800 –
700 –
600 –
500 –
400 –
300 –
200 –
100 –
| | | | | | | | | | | |
Cost in dollars
Volume (units per period)
Total revenue line
Profit corridor
Loss corridor
Total cost line
Break-even point
Total cost = Total revenue
Variable cost
This chart introduces breakeven analysis and the breakeven or crossover chart. As you discuss the assumptions upon which this techniques is based, it might be a good time to introduce the more general topic of the limitations of and use of models. Certainly one does not know all information with certainty, money does have a time value, and the hypothesized linear relationships hold only within a range of production volumes. What impact does this have on our use of the models?
Fixed cost
Figure S7.5

34. Break-Even Analysis TR = TC F or BEPx = P - V Px = F + Vx
BEPx = Break-even point in units
BEP$ = Break-even point in dollars
P = Price per unit (after all discounts)
x = Number of units produced
TR = Total revenue = Px
F = Fixed costs
V = Variable costs
TC = Total costs = F + Vx
Break-even point occurs when
This chart introduces breakeven analysis and the breakeven or crossover chart. As you discuss the assumptions upon which this techniques is based, it might be a good time to introduce the more general topic of the limitations of and use of models. Certainly one does not know all information with certainty, money does have a time value, and the hypothesized linear relationships hold only within a range of production volumes. What impact does this have on our use of the models?
TR = TC or
Px = F + Vx
BEPx = F
P - V

35. Break-Even Analysis BEP$ = BEPx P = P = Profit = TR - TC P - V
BEPx = Break-even point in units
BEP$ = Break-even point in dollars
P = Price per unit (after all discounts)
x = Number of units produced
TR = Total revenue = Px
F = Fixed costs
V = Variable costs
TC = Total costs = F + Vx
BEP$ = BEPx P
= P = F
(P - V)/P
P - V
1 - V/P
Profit = TR - TC
= Px - (F + Vx)
= Px - F - Vx
= (P - V)x - F
This chart introduces breakeven analysis and the breakeven or crossover chart. As you discuss the assumptions upon which this techniques is based, it might be a good time to introduce the more general topic of the limitations of and use of models. Certainly one does not know all information with certainty, money does have a time value, and the hypothesized linear relationships hold only within a range of production volumes. What impact does this have on our use of the models?

36. Break-Even Example Fixed costs = $10,000 Material = $.75/unit
Direct labor = $1.50/unit Selling price = $4.00 per unit
BEP$ = = F
1 - (V/P)
$10,000
1 - [( )/(4.00)]

37. Break-Even Example Fixed costs = $10,000 Material = $.75/unit
Direct labor = $1.50/unit Selling price = $4.00 per unit
BEP$ = = F
1 - (V/P)
$10,000
1 - [( )/(4.00)]
= = $22,857.14
$10,000
.4375
BEPx = = = 5,714 F
P - V
$10,000
( )

38. Break-Even Example Revenue Break-even point Total costs Fixed costs
50,000 –
40,000 –
30,000 –
20,000 –
10,000 – –
| | | | | |
0 2,000 4,000 6,000 8,000 10,000
Dollars
Units
Revenue
Break-even point
Total costs
Fixed costs

39. ∑ 1 - x (Wi) Break-Even Example Multiproduct Case F BEP$ = Vi Pi
where V = variable cost per unit
P = price per unit
F = fixed costs
W = percent each product is of total dollar sales
i = each product

40. Multiproduct Example Fixed costs = $3,500 per month Annual Forecasted
Item Price Cost Sales Units
Sandwich $2.95 $1.25 7,000
Soft drink ,000
Baked potato ,000
Tea ,000
Salad bar ,000

41. Multiproduct Example Fixed costs = $3,500 per month Annual Forecasted
Item Price Cost Sales Units
Sandwich $2.95 $1.25 7,000
Soft drink ,000
Baked potato ,000
Tea ,000
Salad bar ,000
Sandwich $2.95 $ $20,
Soft drink ,
Baked ,
potato
Tea ,
Salad bar ,
$46,
Annual Weighted
Selling Variable Forecasted % of Contribution
Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7)

42. Multiproduct Example ∑ 1 - x (Wi) BEP$ = F Vi Pi = = $67,200
= = $67,200
$3,500 x 12
.625
Fixed costs = $3,500 per month
Annual Forecasted
Item Price Cost Sales Units
Sandwich $2.95 $1.25 7,000
Soft drink ,000
Baked potato ,000
Tea ,000
Salad bar ,000
Daily sales
= = $215.38
$67,200
312 days
Sandwich $2.95 $ $20,
Soft drink ,
Baked ,
potato
Tea ,
Salad bar ,
$46,
Annual Weighted
Selling Variable Forecasted % of Contribution
Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7)
.446 x $215.38
$2.95
= 32.6  33
sandwiches
per day

43. Decision Trees and Capacity Decision
-$14,000
-$90,000
Market unfavorable (.6)
Market favorable (.4)
$100,000
Large plant
$18,000
Market favorable (.4)
Market unfavorable (.6)
$60,000
-$10,000
Medium plant
Market favorable (.4)
Market unfavorable (.6)
$40,000
-$5,000
Small plant $0
Do nothing
$13,000

44. Strategy-Driven Investment
Operations may be responsible for return-on-investment (ROI)
Analyzing capacity alternatives should include capital investment, variable cost, cash flows, and net present value
This slide suggests that the process selection decision should be considered in light of the larger strategic initiative

45. Net Present Value (NPV)F
(1 + i)N
where F = future value
P = present value
i = interest rate
N = number of years

46. NPV Using Factors F P = = FX (1 + i)N
where X = a factor from Table S7.1 defined as = 1/(1 + i)N and F = future value
Year 5% 6% 7% … 10%
Portion of Table S7.1

47. Present Value of an Annuity
An annuity is an investment which generates uniform equal payments
S = RX
where X = factor from Table S7.2
S = present value of a series of uniform annual receipts
R = receipts that are received every year of the life of the investment

48. Present Value of an Annuity
Portion of Table S7.2
Year 5% 6% 7% … 10%