7

Capacity Planning U
P
P
L
E
M
E
N
T
Alfaisal University
College of Business
OPM 340
Dr. Rahma Lahyani

© 2014
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Pearson
Pearson S7 - 0
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 Outline
► Capacity
► Bottleneck Analysis and the Theory
of Constraints
► Break-Even Analysis
► Reducing Risk with Incremental
Changes
► Applying Expected Monetary Value
(EMV) to Capacity Decisions

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 Learning Objectives
When you complete this supplement
you should be able to :
1. Define capacity
2. Determine design capacity, effective
capacity, and utilization
3. Perform bottleneck analysis
4. Compute break-even

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 Learning Objectives
When you complete this supplement
you should be able to :
1. Determine the expected monetary
value of a capacity decision

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 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

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 Planning Over a Time Horizon
Figure S7.1
Time Horizon
Options for Adjusting Capacity

Long-range Add facilities

planning
Intermediate-
Add long lead time equipment *
range Subcontract Add personnel
planning Add equipment Build or use inventory
(aggregate Add shifts
planning)
Schedule jobs
Short-range
planning
(scheduling)
* Schedule personnel
Allocate machinery

Modify capacity Use capacity

* Difficult to adjust capacity as limited options exist
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 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

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 Utilization and Efficiency
Utilization is the percent of design
capacity actually achieved
Utilization = Actual output/Design capacity

Efficiency is the percent of effective

capacity actually achieved
Efficiency = Actual output/Effective capacity

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 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, 3 shifts - 8 hour shifts

• Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

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 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, 3 - 8 hour shifts

• Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

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 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, 3 - 8 hour shifts

• Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

• Utilization = 148,000/201,600 = 73.4%

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 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, 3 - 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%

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 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, 3 - 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%

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 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, 3 - 8 hour shifts
• Efficiency = 84.6%
• Efficiency of new line = 75%

• Expected Output = (Effective Capacity)(Efficiency)

= (175,000)(.75) = 131,250 rolls

© 2014 Pearson S7 - 0
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 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, 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

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

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 Capacity Considerations

1. Forecast demand accurately

2. Match technology increments and
sales volume
3. Find the optimum operating size
(volume)
4. Build for change

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 Economies and Diseconomies
of Scale Figure S7.2

Av
era
ge 1,300 sq ft 8,000 sq ft
unit store store
cos 2,600 sq ft
t store
(sal
es
per
squ
are
foo Economies Diseconomies
t) of scale of scale
1,300 2,600 8,000
Number of square feet in store
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 Economies and Diseconomies
of Scale
• Fixed costs are spread • Distribution costs increase due to
over a larger number of traffic congestion and shipping from
units a centralized facility rather than
multiple smaller facilities
• Construction costs
increase at a decreasing • Complexity increases costs
rate as facility size
increases • Inflexibility can be an issue

• Processing costs decrease • Additional levels of bureaucracy

due to standardization
• Increase in machine failure and
maintenance cost

• Overtime and overhead costs

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 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
Figure S7.3
Patterns
Combining the
two demand
patterns reduces
4,000 the variation

S Snowmobile
al –
motor sales
e
s 3,000
in
u – Jet ski
ni engine
2,000 sales
ts
JFMAMJJASONDJFMAMJJASONDJ
–
Time (months)
1,000
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 Tactics for Matching Capacity
to Demand
1. Making staffing changes
2. Adjusting equipment
► Purchasing additional machinery
► Selling or leasing out existing 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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 Service-Sector Demand
and Capacity Management
► Demand management
► Appointment, reservations, FCFS rule
► Capacity
management
► Full time,
temporary,
part-time
staff

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 Bottleneck Analysis and the
Theory of Constraints
► Each work area can have its own unique
capacity
► Capacity analysis determines the
throughput capacity of workstations in a
system
► A bottleneck is a limiting factor or constraint
► A bottleneck has the lowest effective capacity
in a system

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 Bottleneck Analysis and the
Theory of Constraints
► The bottleneck time is the time of the
slowest workstation (the one that takes
the longest) in a production system
► The throughput time is the time it takes
a unit to go through production from start
to end Figure S7.4

A B C

2 min/unit 4 min/unit 3 min/unit

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 Capacity Analysis
-Parellel-
► Two identical sandwich lines
► Lines have two workers and three operations
► All completed sandwiches are wrapped

Bread Fill
15 sec/sandwich 20 sec/sandwich
Order Wrap/
Toaster
Deliver
30 sec/sandwich 20 sec/sandwich
Bread Fill 37.5 sec/sandwich

15 sec/sandwich 20 sec/sandwich

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 Capacity Bread
15 sec
Fill
20 sec

Analysis
Wrap/
Order Toaster
30 sec 20 sec Deliver
37.5 sec
Bread Fill
15 sec 20 sec

► The two identical lines each deliver a

sandwich every 20 seconds
► At 37.5 seconds, wrapping and delivery
has the longest processing time and is the
bottleneck
► Capacity per hour is 3,600 seconds/37.5
seconds/sandwich = 96 sandwiches per
hour
► Throughput time is 30 + 15 + 20 + 20 +
37.5 = 122.5 seconds
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 Capacity Analysis
-Simultaneous-
► Standard process for cleaning teeth
► Cleaning and examining X-rays can happen
simultaneously

Cleaning

24
Takes Develops min/unit Check
Check in Dentist
X-ray X-ray out
2 min/unit 2 min/unit 4 min/unit 8 min/unit 6 min/unit
X-ray
exam
5 min/unit

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 Capacity Check Takes Develops
24
Cleaning

min/unit Check

Analysis
Dentist
in X-ray X-ray out
2 min/unit 2 min/unit 4 min/unit 8 min/unit 6 min/unit
X-ray
exam
5 min/unit

► All possible paths must be compared

► Bottleneck is the hygienist at 24 minutes
► Hourly capacity is 60/24 = 2.5 patients
► X-ray exam path is 2 + 2 + 4 + 5 + 8 + 6 = 27
minutes
► Cleaning path is 2 + 2 + 4 + 24 + 8 + 6 = 46
minutes
► Longest path involves the hygienist cleaning
the teeth, patient should complete in 46
minutes= throughput time
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 Theory of Constraints
► Five-step process for recognizing and
managing limitations
Step 1: Identify the constraints
Step 2: Develop a plan for overcoming the constraints
Step 3: Focus resources on accomplishing Step 2
Step 4: Reduce the effects of constraints by offloading work or
expanding capability
Step 5: Once overcome, go back to Step 1 and find new constraints

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 Bottleneck Management
1. Release work orders to the system at the
pace of set by the bottleneck
2. Lost time at the bottleneck represents lost
time for the whole system
3. Increasing the capacity of a non-bottleneck
station is a mirage
4. Increasing the capacity of a bottleneck
increases the capacity of the whole system

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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

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 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

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 Break-Even Analysis
► Revenue function begins at the
origin and proceeds upward to the
right, increasing by the selling price of
each unit
► Where the revenue function crosses
the total cost line is the break-even
point

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 Break-Even Analysis
–
Total revenue line
900

–
Break-even point Profit Total cost line
800 Total cost = Total revenue corridor
C –
o
s 700
t
i – Variable cost
n 600
d
o – Loss
ll corridor
500
a Fixed cost
r –| | | | | | | | | | | |
s
0 100 200 300 400 500 600 700 800 900
Figure S7.5 400
1000 1100 Volume (units per period)
–
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 Break-Even Analysis
Assumption
s► Costs and revenue are linear
functions
► Generally not the case in the real
world
► We actually know these costs
► Very difficult to verify
► Time value of money is often
ignored

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 Break-Even Analysis
BEPx = break-even point in x = number of units produced
units TR = total revenue = Px
BEP$ = break-even point in F = fixed costs
dollars
V = variable cost per unit
P = price per unit (after all
discounts) TC = total costs = F + Vx

Break-even point occurs when

TR = TC F
or BEPx =
P–V
Px = F + Vx

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 Break-Even Analysis
BEPx = break-even point in x = number of units produced
units TR = total revenue = Px
BEP$ = break-even point in F = fixed costs
dollars
V = variable cost per unit
P = price per unit (after all
discounts) TC = total costs = F + Vx

F Profit = TR - TC
BEP$ = BEPx P = P
P–V = Px – (F + Vx)
= Px – F – Vx
= (P - V)x – F

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 Break-Even Example
Fixed costs = $10,000 Material = $.75/unit
Direct labor = $1.50/unit Selling price = $4.00 per unit

F *P $10,000 * 4
BEP$ =
P – =(V) 4 – (1.50 + .75)

= $22,857.14

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 Break-Even Example
Fixed costs = $10,000 Material = $.75/unit
Direct labor = $1.50/unit Selling price = $4.00 per unit

BEP$ = $22,857.14

F $10,000
BEPx = = = 5,714
P–V 4.00 – (1.50 + .75)

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 Break-Even Example
50,000 –

40,000 – Revenu
e
Break-even
30,000 – point Total
D costs
o
ll 20,000 –
a
r 10,000 – Fixed
s costs

–
| | | | | |
0 2,000 4,000 6,000 8,000 10,000
Unit
s
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 Reducing Risk with
Figure S7.6 Incremental Changes
(a) Leading demand with (b) Leading demand with
incremental expansion a one-step expansion
New
New capacity
capacity D
D
e Expected e Expected
demand demand
m m
a a
n n
d d

(c) Lagging demand with (d) Attempts to have an

incremental expansion average capacity with
incremental expansion
New
capacity New
D Expected D capacity Expected
e demand e demand
m m
a a
n n
d d
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 Reducing Risk with
Incremental Changes
(a) Leading demand with incremental
expansion
Figure S7.6

New
capacity

D
e Expected
m demand
a
n
d

1 2 3
Time (years)
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 Reducing Risk with
Incremental Changes
(b) Leading demand with a one-step
expansion
Figure S7.6

New
capacity

D
e Expected
m demand
a
n
d

1 2 3
Time (years)
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 Reducing Risk with
Incremental Changes
(c) Lagging demand with incremental
expansion Figure S7.6

New
capacity

D Expected
e demand
m
a
n
d

1 2 3
Time (years)
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 Reducing Risk with
Incremental Changes
(d) Attempts to have an average capacity with
incremental expansion Figure S7.6

New
capacity

D Expected
e demand
m
a
n
d

1 2 3
Time (years)
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 Applying Expected Monetary
Value (EMV) and Capacity
Decisions
► Determine states of nature
► Future demand
► Market favorability
► Assign probability values to states
of nature to determine expected
value

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 EMV Applied to Capacity
Decision- Example S8
▶ Southern Hospital Supplies capacity
expansion
EMV (large plant) = (.4)($100,000) + (.6)(–$90,000)
= –$14,000
EMV (medium plant) = (.4)($60,000) + (.6)(–$10,000)
= +$18,000
EMV (small plant) = (.4)($40,000) + (.6)(–$5,000)
= +$13,000
EMV (do nothing) = $0

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 For real-life situations
▶ 1. OM in the News: How Airlines Match Capacity to Demand
Many fewer people fly in the winter than during school breaks, major
holidays, and summer vacations. Here we see four suggested OM
strategies that airlines can implement to break the cycle.
http://heizerrenderom.wordpress.com/2012/03/02/om-in-the-news-how-
airlines-match-capacity-to-demand/
▶ 2. OM in the News: What Happens When Disney, Universal,
and Legoland Reach Capacity
This is an interesting story of how different companies deal with
capacity constraints. Universal and Disney’s tactics for managing
operations at full capacity are described here.
http://heizerrenderom.wordpress.com/2012/01/01/om-in-the-news-
what-happens-when-disney-universal-and-legoland-reach-capacity/

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 End of Chapter 7 Supplement

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