Introductory-Operations-Management-Lecture-7-8-Strategic-Capacity-Planning-for-Products-and-Services.pdf

operations management

1. Chapter 5: Strategic
Capacity Planning for
Products and Services
Suman Niranjan

2. 2
Capacity Planning
Capacity
It is the upper limit on the load that an operating
unit can handle
Capacity planning plays an strategic role in
designing of systems
Example 1: How many machines do you need,
are they sufficient
Example 2: How many servers do we need in a
restaurant
The idea behind strategic capacity planning
is the long term supply capabilities with the
long term demand
Internal supply (manufacturing)
External supply (purchase)

3. 3
Capacity Planning
Basic questions in capacity planning
What kind of capacity is needed?
Depends on products and services that the management intends to produce or
provide
How much capacity is needed?
Forecasts are the key input
When is it needed?
Factors that influence the choices of
capacity:-
The stability of demand
The rate of technological changes in equipment
and product design
Competitiveness
When a style of a product or service changes

4. 4
Capacity Decisions are Strategic
Decisions involving capacity can be
termed as the most critical for a
organization:
Impact on ability of an organization to
meet future demands of the products and
services
When Microsoft released Xbox in 2005 there were insufficient supplies resulting
lost sales and customers
Capacity decisions affect the operating
costs
Balancing the cost of over- and under capacity
Capacity is the major determinant of cost
Greater the capacity, greater is the productivity, greater the cost

5. 5
Capacity Decisions are Strategic
Capacity decisions can affect the
competiveness
Having excess capacity or quickly add capacity
Capacity affects the ease of management
Appropriate capacity – capacity mismatched
Globalization affects the capacity
Supply chains and distant markets add to the
uncertainty of capacity need
Capacity decisions are usually long-term
decisions
Amount of investment and other resources
involved
Change in demand over the period of time
It takes years to construct a power plant, the estimated demand at the time the
project starts - time when it is completed

6. 6
Defining and Measuring Capacity
Capacity refers to upper limit on the rate of
output
Difficulty in measuring capacity
Actually measuring
Different interpretations of term “capacity”
Identifying suitable measures for specific
situation
Single Vs. multiple product or service
Example of appliance manufacturer
Measure of capacity can be number of
available inputs
Service industry – hospitals
Manufacturing industry- number of machine
hours available

7. 7
Defining and Measuring Capacity
Design capacity
Maximum output rate or service capacity an
operation, process, or facility is designed for
Effective capacity
Design capacity minus allowances such as
personal time, maintenance, and scrap
Actual output
Rate of output actually achieved--cannot
exceed effective capacity.

8. 8
Efficiency and Utilization
Actual output
Efficiency =
Effective capacity
Actual output
Utilization =
Design capacity
Both measures expressed as
percentages

9. 9
Actual output = 36 units/day
Efficiency= = 90%
Effective capacity 40 units/ day

Utilization= Actual output = 36 units/day
= 72% Design
capacity 50 units/day
Efficiency/Utilization Example
Design capacity = 50 trucks/day
Effective capacity = 40 trucks/day
Actual output = 36 units/day

10. 10
Determinants of Effective Capacity
Many decisions about system design and
operating decisions have an impact on
capacity
Factors which influence these decisions are:
Facilities
Size, location, expansion
Product and service factors
Similar items Vs. different items
Different rates of output
Process factors
Influence on quality of output, rework, inspection etc.
Human factors
Experience required, motivation, fatigue
Policy factors
Overtime, second and third shifts

11. 11
Determinants of Effective Capacity
Factors which influence these decisions are:
Operational factors
Equipment capabilities, differences in job requirements
Importance of a every single component
Supply chain factors
What will impact the suppliers, warehousing, transportation, and distributers
External factors
Maintaining minimum quality and standard
Pollution standards on product or equipment
Union contract limits

12. 12
Strategy Formulation
Capacity strategies are usually assumed on:
Long-term demand pattern
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

13. 13
Key Decisions of Capacity Planning
Amount of capacity needed
Capacity cushion (100% - Utilization)
Timing of changes
Availability of capital, lead time, and expected
demand
Need to maintain balance
Proportional changes in capacity to all related
areas
Extent of flexibility of facilities
Uncertainty in demand

14. 14
Steps in Capacity Planning
1.Estimate future capacity requirements
2.Evaluate existing capacity
3.Identify alternatives
4.Conduct financial analysis
5.Assess key qualitative issues
6.Select one alternative
7.Implement alternative chosen
8.Monitor results

15. 15
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

16. 16
Calculating Processing
Requirements
If annual capacity is 2000 hours, then we need three
machines to handle the required volume: 5,800
hours/2,000 hours = 2.90 machines

17. 17
Bottleneck Operation
Machine #2
Bottleneck
Operation
Machine #1
Machine #3
Machine #4
10/hr
10/hr
10/hr
10/hr
30/hr
Bottleneck operation: An
operation
in a sequence of operations
whose
capacity is lower than that of

18. 18
Bottleneck Operation
Operation
1
20/hr.
Operation
2
10/hr.
Operation
3
15/hr.
10/hr
.
Bottlene
ck
Maximum output
rate
limited by

19. 19
Cost-Volume Analysis
Fixed Cost (FC) tend to remain constant
regardless of volume of output
Variable Cost (VC) vary directly with the
volume of output
Examples of fixed cost
Rental costs, property taxes, equipment costs
etc.
Examples of variable cost
Material and labor cost

20. 20
Cost-Volume Analysis

21. 21
Cost-Volume Analysis

22. 22
Example 3
The owner of Old-Fashioned Berry Pies, S.
Simon, is contemplating adding a new line of
pies, which will require leasing new
equipment for a monthly payment of $6,000.
Variable costs would be $2.00 per pie, and
pies would retail for $7.00 each.
a)How many pies must be sold in order to break
even?
b)What would the profit (loss) be if 1,000 pies are
made and sold in a month?
c)How many pies must be sold to realize a profit
of $4,000?
d)If 2,000 can be sold, and a profit target is
$5,000, what price should be charged per pie?

23. 23
Example 4
A manager has the option of purchasing one,
two, or three machines. Fixed costs and
potential volumes are as follows:
Variable cost is $10 per unit, and revenue is
$40 per unit.
a)Determine the break-even point for each range.
b)If projected annual demand is between 580 and
660 units, how many machines should the
manager purchase?

24. 24
Cost-Volume Relationships
Am
ou
n
t
(
$
)
0
Q (volume in
units)
To
tal
c
o
st =
VC +

FC
Total
var
iabl
e c
o
st
(VC
)
Fixed cost
(FC)

25. 25
Cost-Volume Relationships
Amo
un
t
(
$)
Q (volume in
units)
0 BEP
units
Pr
of
it
T
o
tal

r evenu
e
Total
cost
L
oss

26. 26
Break-Even Problem with Step
Fixed Costs
Quanti
ty
FC +
VC
=
TC
FC
+ VC =
TC
FC +
VC
=
TC
Step fixed costs and variable
costs.
1
machine
2
machines
3
machines

27. 27
Break-Even Problem with Step
Fixed Costs
$
T
C
T
C
T
C
BE
P
2
BEP
3
T
R
Quanti
ty
1
2
3
Multiple break-even
points

28. 28
Assumptions of Cost-Volume Analysis
1.One product is involved
2.Everything produced can be sold
3.Variable cost per unit is the same regardless
of volume
4.Fixed costs do not change with volume
5.Revenue per unit constant with volume
6.Revenue per unit exceeds variable cost per
unit

29. 29
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
Planning Service Capacity

30. 30
In-House or Outsourcing
Available capacity
Expertise
Quality considerations
Nature of demand
Cost
Risk
Outsource: obtain a good or
service
from an external provider

31. 31
Developing Capacity Alternatives
Design flexibility into systems
Take stage of life cycle into account
Growth phase
Maturity phase
Decline phase
Take a “big picture” approach to capacity
changes
Bottleneck operations
Prepare to deal with capacity “chunks”
Discrete increase in capacity

32. 32
Developing Capacity Alternatives
Attempt to smooth out capacity requirements
Under utilization or overutilization of capacity
Overtime, subcontract
Store during period of low demand and draw
during high
Identify the optimal operating level
Economies of scale Vs. Diseconomies of scale

33. 33
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
Diseconomies of scale
If the output rate is more than the optimal level,
increasing the output rate results in increasing
average unit costs

34. 34
Optimal Rate of Output
Minimu
m
cost
A
v
er
a
g
e
co
s
t p
er

u
n
i
t
0
Rate of
output
Production units have an optimal rate of output for
minimal cost.
Minimum average cost per
unit

35. 35
Economies of Scale
Minimum cost & optimal operating rate are
functions of size of production unit.
A
v
er
a
g
e
co
st
p
er

un
it
0
S
mallMediu
m
plant
Larg
e
plan
Output
rate

36. 36
Evaluating Alternatives
Cost-volume analysis
Break-even point
Financial analysis
Cash flow
Present value
Decision theory
Waiting-line analysis

37. 37
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.

38. 38
Decision Theory
Helpful tool for financial comparison of
alternatives under conditions of risk or
uncertainty
Suited to capacity decisions

39. 39
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