OPM Topic 3 Capacity

Operations&ProductionManagement
1/31/2015
Operations &
Production Management
(OPM)
Dr. Muhammad Wasif
Visiting Faculty, IBA.
3 - Capacity Planning
Resource Person : Dr. Muhammad Wasif
Operations & Production Management
ResourcePerson:Dr.MuhammadWasif
1/31/2015
Section 3.1
Capacity
33
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
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1/31/2015
Capacity
Capacity also includes

Equipment
Space
Employee
skills
The basic questions in capacity handling are:

What
How
kind of capacity is needed?
much is needed?
When
is it needed?
10
Calculating Processing Requirements

Standard
processing time
per unit (hr.)
Processing time
needed (hr.)
Product
Annual
Demand
#1
400
5.0
2,000
#2
300
8.0
2,400
#3
700
2.0
1,400
5,800
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
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Planning Over a Time Horizon

Long-range
planning
Add facilities
Add long lead time equipment
Intermediate
-range
planning
Subcontract
Add equipment
Add shifts
More than 1 yr
3 to 18 months
*
Add personnel
Build or use inventory
Short-range
planning
Upto 3 months
Modify capacity
Schedule jobs
Schedule personnel
Allocate machinery
Use capacity
* Limited options exist
10
Capacity of Doha Airports

Capacity
4.2 million
passengers
Capacity
24 million
passengers
50 million in 2015
12times larger
Longest (4850m)
international
runway for airbus
A380-800
85m high control
tower
600km2 area
150km2
maintenance area
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Design and Effective Capacity
Design capacity is the maximum output rate or

service capacity an operation, process, or facility
is designed for
Effective capacity is the capacity a firm expects

to achieve given current operating constraints
Design capacity minus allowances such as

personal time, maintenance, and scrap
Actual output is the rate of output actually

achieved--cannot exceed effective 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
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1/31/2015
Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 x 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls
Utilization = 148,000/201,600 = 73.4%
Efficiency = 148,000/175,000 = 84.6%
10
Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts
Efficiency = 84.6%
Efficiency of new line = 75%

Expected Output = (Effective Capacity)(Efficiency)
= (175,000)(.75) = 131,250 rolls
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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 organizations mission and strategy
10
Capacity Considerations
Forecast demand accurately
Understand the technology and capacity

increments
Find the optimum operating level

(volume)
Build for change
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Average unit cost

(dollars per room per night)
Economies and Diseconomies of Scale
25 - room
roadside motel
50 - room
roadside motel
Economies
of scale
25
75 - room
roadside motel
Diseconomies
of scale
50
Number of Rooms
75
10
Managing Demand
Demand exceeds capacity
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 complementary demand patterns
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Complementary Demand Patterns

Jet ski sale high in or before summer
Add snowmobile using same engine
technology, differs in application.
Snowmobile sale is high in and
before winter .
10
Tactics for Matching Capacity to Demand

1.
Making staffing changes
2.
Adjusting equipment
3.
Improving processes to increase throughput
4.
Redesigning products to facilitate more throughput
5.
Adding process flexibility to meet changing product

preferences
6.
Closing facilities
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1/31/2015
Demand and Capacity Management in the Service Sector
Demand management
Appointment, reservations, FCFS rule
Capacity management
Full
time, temporary, part-time
staff
10
Section 3.2
Capacity Planning
20
33
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1/31/2015
Approaches to Capacity Expansion

New
capacity
Demand
(a) Leading demand with

incremental expansion
Expected
demand
2
3
Time (years)
10
(b) Leading demand with

one-step expansion
New
capacity
Demand
Expected
demand
2
3
Time (years)
10
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New
capacity
Expected
demand
Demand
(c) Capacity lags demand

with incremental expansion
2
3
Time (years)
10

New
capacity
Expected
demand
Demand
(d) Attempts to have an

average capacity with
incremental expansion
2
Time (years)
10
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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
10
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
10
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Break-Even Analysis
Assumptions
Costs and revenue are linear functions

Generally
We actually know these costs

Very
not the case in the real world
difficult to accomplish
There is no time value of money
10
Break-Even Analysis
Total revenue line
900
800
Cost in dollars
700
Total cost line
Break-even point
Total cost = Total revenue
600
500
Variable cost
400
300
200
100
Fixed cost
|
|
|
|
|
|
|
|
|
|
|
0 100 200 300 400 500 600 700 800 900 1000 1100
|
Volume (units per period)

10
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Break-Even Analysis
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
F
V
TC
=
=
=
=
total revenue = Px
fixed costs
variable cost per unit
total costs = F + Vx
Break-even point occurs

when
TR = TC
or
Px = F + Vx
BEPx =
F
P-V
10
Break-Even Analysis
BEPx = break-even point in
units
BEP$ = break-even point in
dollars
P = price per unit (after all
discounts)
BEP$ = BEPx P
FP
=
P-V
F
=
(P - V)/P
F
=
1 - V/P
x = number of units produced

TR
F
V
TC
=
=
=
=
total revenue = Px
fixed costs
variable cost per unit
total costs = F + Vx
Profit = TR - TC
= Px - (F + Vx)
= Px - F - Vx
= (P - V)x - F
10
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Break-Even Analysis - Example
10
Break-Even Example
Multiproduct Case
where
V
P
F
W
i
= variable cost per unit

= price per unit
= fixed costs
= percent each product is of total dollar sales
= each product
10
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1/31/2015
Break-Even Example
Fixed costs = $3,500 per month
Item
Sandwich
Soft drink
Baked potato
Tea
Salad bar
Price
$2.95
.80
1.55
.75
2.85
Cost
$1.25
.30
.47
.25
1.00
Annual Forecasted
Sales Units
7,000
7,000
5,000
5,000
3,000
10
Break-Even Example
Annual Forecasted
Item
Price
Cost
Sales Units
Sandwich
$2.95
$1.25
7,000
Soft drink
.80
.30
7,000
Baked potato
1.55
.47 Annual 5,000 Weighted
% of Contribution
Tea Selling Variable .75
.25Forecasted 5,000
Item (i)
Price (P) Cost (V) (V/P) 1 - (V/P) Sales $
Sales (col 5 x col 7)
Salad bar
2.85
1.00
3,000
Sandwich
Soft drink
Baked
potato
Tea
Salad bar
$2.95
.80
1.55
$1.25
.30
.47
.42
.38
.30
.58
.62
.70
$20,650
5,600
7,750
.446
.121
.167
.259
.075
.117
.75
2.85
.25
1.00
.33
.35
.67
.65
3,750
8,550
$46,300
.081
.185
1.000
.054
.120
.625
10
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1/31/2015
Break-Even Example
Annual Forecasted
Item
Price
Cost
Sales Units
Sandwich
$2.95
$1.25
7,000
Soft drink
.80
.30
7,000
Baked potato
1.55
.47 Annual 5,000 Weighted
% of Contribution
Tea Selling Variable .75
.25Forecasted 5,000
Item (i)
Price (P) Cost (V) (V/P) 1 - (V/P) Sales $
Sales (col 5 x col 7)
Salad bar
2.85
1.00
3,000
Sandwich
Soft drink
Baked
potato
Tea
Salad bar
$2.95
.80
1.55
$1.25
.30
.47
.42
.38
.30
.58
.62
.70
$20,650
5,600
7,750
.446
.121
.167
.259
.075
.117
.75
2.85
.25
1.00
.33
.35
.67
.65
3,750
8,550
$46,300
.081
.185
1.000
.054
.120
.625
10
Decision Trees and Capacity Decision

Market favorable (.4)
Market unfavorable (.6)

Medium plant

$100,000
-$90,000
$60,000
-$10,000
$40,000
-$5,000
$0
10
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1/31/2015


Medium plant
Large Plant
EMV = (.4)($100,000)
+ (.6)(-$90,000)
EMV = -$14,000
$100,000
-$90,000
$60,000
-$10,000
$40,000
-$5,000
$0
10

-$14,000
$100,000
-$90,000
$18,000
Medium plant
$60,000
-$10,000
$13,000
$40,000
-$5,000
$0
10
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1/31/2015
Strategy-Driven Investment
Operations may be responsible for returnon-investment (ROI)
Analyzing capacity alternatives should

include capital investment, variable cost,
cash flows, and net present value
10
Net Present Value
P=
where
F
P
i
N
F
(1 + i)N
= future value
= present value
= interest rate
= number of years
10
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1/31/2015
Net Present Value

F
= FX
(1 + i)N
P=
where
Portion of
Table S7.1
X = a factor from Table S7.1

defined as = 1/(1 + i)N and
F = future value
Year
1
2
3
4
5
5%
.952
.907
.864
.823
.784
6%
.943
.890
.840
.792
.747
7%
.935
.873
.816
.763
.713
10%
.909
.826
.751
.683
.621
10
Net Present Value

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
10
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1/31/2015
Net Present Value

Portion of Table S7.2
Year
1
2
3
4
5
5%
.952
1.859
2.723
4.329
5.076
6%
.943
1.833
2.676
3.465
4.212
7%
.935
1.808
2.624
3.387
4.100
10%
.909
1.736
2.487
3.170
3.791
10
Net Present Value

$7,000 in receipts per for 5 years
Interest rate = 6%
From Table S7.2
X = 4.212
S = RX
S = $7,000(4.212) = $29,484
10
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1/31/2015
Present Value With Different Future Receipts

Investment As
Cash Flow
Investment Bs
Cash Flow
Year
Present Value
Factor at 8%
$10,000
$9,000
.926
9,000
9,000
.857
8,000
9,000
.794
7,000
9,000
.735
10
Present Value With Different Future Receipts

Investment As
Present Values
Investment Bs
Present Values
$9,260 = (.926)($10,000)
$8,334 = (.926)($9,000)
7,713 = (.857)($9,000)
7,713 = (.857)($9,000)
6,352 = (.794)($8,000)
7,146 = (.794)($9,000)
5,145 = (.735)($7,000)
6,615 = (.735)($9,000)
Year
Totals
$28,470
$29,808
Minus initial
investment
Net present
value
-25,000
-26,000
$3,470
$3,808
10
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References
Operations Management, 10th Ed., by J. Heizer &

B. Render
Operations Management, William J. Stevenson.
Operations Management, 7th Ed., N. Slack, A.B.

Jones, R. Johnston.
Cases in Operations Management, S. Chambers, C.

Harland, A. Harison, N. Slack.
59
24

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Operations&ProductionManagement

Resource Person : Dr. Muhammad Wasif

Operations & Production Management

Resource Person : Dr. Muhammad Wasif

Operations & Production Management

The throughput, or the number of units a

Determines fixed costs

Determines if demand will be satisfied

Resource Person : Dr. Muhammad Wasif

Operations & Production Management

Capacity also includes

The basic questions in capacity handling are:

kind of capacity is needed?

Resource Person : Dr. Muhammad Wasif

Operations & Production Management

Calculating Processing Requirements

Operations & Production Management

Planning Over a Time Horizon

* Limited options exist

Resource Person : Dr. Muhammad Wasif

Operations & Production Management

Capacity of Doha Airports

Resource Person : Dr. Muhammad Wasif

Operations & Production Management

Design and Effective Capacity

Design capacity is the maximum output rate or

Effective capacity is the capacity a firm expects

Design capacity minus allowances such as

Actual output is the rate of output actually

Resource Person : Dr. Muhammad Wasif

Operations & Production Management

Utilization and Efficiency

Utilization is the percent of design

Efficiency is the percent of effective

Resource Person : Dr. Muhammad Wasif

Operations & Production Management

Utilization and Efficiency

Actual production last week = 148,000 rolls

Effective capacity = 175,000 rolls

Design capacity = 1,200 rolls per hour

Bakery operates 7 days/week, 3 x 8 hour shifts

Resource Person : Dr. Muhammad Wasif

Operations & Production Management

Utilization and Efficiency

Actual production last week = 148,000 rolls

Effective capacity = 175,000 rolls

Design capacity = 1,200 rolls per hour

Bakery operates 7 days/week, 3 - 8 hour shifts

Efficiency of new line = 75%

Resource Person : Dr. Muhammad Wasif

Operations & Production Management

Capacity and Strategy

Capacity decisions impact all 10 decisions

Capacity decisions must be integrated into

Resource Person : Dr. Muhammad Wasif

Operations & Production Management

Forecast demand accurately

Understand the technology and capacity

Find the optimum operating level

Build for change

Resource Person : Dr. Muhammad Wasif

Operations & Production Management

Average unit cost