Strategic Capacity Planning

Chapter 11

Strategic Capacity Planning

Capacity

The maximum level of output The amount of resource inputs available relative to output requirements at a particular time Capacity is the upper limit or ceiling on the load that an operating unit can handle.

Examples of Capacity Measures

Type of Organization Manufacturer Hospital Airline Restaurant Retailer Theater Measures of Capacity Inputs Outputs Machine hours Number of units per shift per shift Number of beds Number of patients treated Number of planes Number of or seats seat-miles flown Number of seats Customers/time Area of store Sales dollars Number of seats Customers/time

Capacity Planning
The

basic questions in capacity planning are:

What

type of capacity is needed? How much is needed? When is it needed? How does productivity relate to capacity?

Two Capacity Strategies

Planned unused capacity Forecast of capacity needed
Capacity

Forecast of Planned use of short-term options capacity needed

Capacity

Time between increments

Expansionist Strategy

Wait-and-See Strategy

Capacity Utilization
Capacity
rate

used

of output actually achieved

Best

operating level

capacity

for which the process was designed (effective or maximum capacity)

Capacity Used _______________ Best Operating Level

Utilization =

Utilization--Example
Best

operating level = 120 units/week

Actual

output = 83 units/week

Capacity used 83 units/wk = .692 = Utilization = operating ? Best level 120 units/wk Utilization =

Best Operating Level

Average unit cost of output Underutilization Over-utilization Best Operating Level

Volume

Economies & Diseconomies of Scale

Long Run Average Cost Curve

Average unit cost of output

100-unit plant 200-unit plant 300-unit plant 400-unit plant

Volume

Cost-Volume Relationships

Amount ($)

Fixed cost (FC) 0 Q (volume in units)

Cost-Volume Relationships

Amount ($) 0

Q (volume in units)

Cost-Volume Relationships

Amount ($) 0

BEP units Q (volume in units)

Break-Even Problem with Step Fixed Costs

3 machines

2 machines 1 machine Quantity

Step fixed costs and variable costs.

Break-Even Problem with Step Fixed Costs

$
BEP2 TC

BE P 3

TC

3 TC 2 1

Quantity Multiple break-even points

Breakeven Analysis
Breakeven quantity = Fixed Costs Price - Variable Costs

Breakeven example
Thomas Manufacturing intends to increase capacity by overcoming a bottleneck operation through the addition of new equipment. Two vendors have presented proposals as follows:

Proposal A B

Fixed Costs $ 50,000 $ 70,000

Variable Costs $12 $10

The revenue for each product is $20 What is the breakeven quantity for each proposal?

Breakeven Solution
FC BEQ = P- VC

Proposal A BEQ = $ 50,000 $20 - 12 = 6250

Proposal B
BEQ = $ 70,000 $20 - 10 = 7000

Breakeven Analysis
In the previous example, at what capacity would both plans incur the same cost?
Solution -consider total cost

Total cost = Fixed cost + Variable Cost (Q)

$50,000 + $12Q = $70,000 + $10 Q

Q = 10,000

The Experience Curve

As plants produce more products, they gain experience in the best production methods and reduce their costs per unit.

Cost or price per unit

Total accumulated production of units

Capacity Flexibility: Having the ability to respond rapidly to demand volume changes and product mix changes.

Flexible

plants Flexible processes Flexible workers

Capacity Bottlenecks
Operation 1 Raw material 200/hour Operation 2 75/hour Operation 3 200/hour

Bottleneck Operation

Determining Capacity Requirements

Forecast

sales within each individual product line equipment and labor requirements to meet the forecasts equipment and labor availability over the planning horizon

Calculate

Project

Example--Capacity Requirements
A manufacturer produces two lines of ketchup, FancyFine and a generic line. Each is sold in small and family-size plastic bottles. The following table shows forecast demand for the next four years.
Year: FancyFine Small (000s) Family (000s) Generic Small (000s) Family (000s) 1 50 35 100 80 2 60 50 110 90 3 80 70 120 100 4 100 90 140 110

Example of Capacity Requirements: The Product from a Capacity Viewpoint

Question:

Are we really producing two different types of ketchup from the standpoint of capacity requirements?

Answer: No, its the same product just packaged differently.

Example of Capacity Requirements: Equipment and Labor Requirements

Year: Small (000s) Family (000s) 1 150 115 2 170 140 3 200 170 4 240 200

Three 100,000 units-per-year machines are available for small-bottle production. Two operators required per machine.

Two 120,000 units-per-year machines are available for family-sized-bottle production. Three operators required per machine.

31

Question: Identify the Year 1 values for capacity, machine, and labor?

Year: Small (000s) Family (000s)

1 150 115

2 170 140

3 200 170

4 240 200 6 6

Small Mach. Cap. 300,000 Labor Family-size Mach. Cap. 240,000 Labor 150,000/300,000=50% At 1 machine for 100,000, it takes 1.5 machines for 150,000 Small Percent capacity used 50.00% Machine requirement 1.50 Labor requirement 3.00 At 2 operators for Family-size 100,000, it takes 3 Percent capacity used 47.92% operators for 150,000 Machine requirement 0.96 Labor requirement 2.88

The McGraw-Hill Companies, Inc., 2001

32

Question: What are the values for columns 2, 3 and 4 in the table below?

Year: Small (000s) Family (000s) Small Family-size Small Percent capacity used Machine requirement Labor requirement Family-size Percent capacity used Machine requirement Labor requirement

1 150 115 Mach. Cap. Mach. Cap.

2 170 140 300,000 240,000

3 200 170 Labor Labor

4 240 200 6 6

50.00% 56.67% 1.50 1.70 3.00 3.40 47.92% 58.33% 0.96 1.17 2.88 3.50

66.67% 2.00 4.00 70.83% 1.42 4.25

80.00% 2.40 4.80 83.33% 1.67 5.00

The McGraw-Hill Companies, Inc., 2001

Capacity Cushion
Capacity Cushion = level of capacity in excess of the average utilization rate or level of capacity in excess of the expected demand . Cushion = Best Operating Level Capacity Used

- 1

Large capacity cushion

Required to handle uncertainty in demand

service industries high level of uncertainty in demand (in terms of both volume and product-mix) to permit allowances for vacations, holidays, supply of materials delays, equipment breakdowns, etc. if subcontracting, overtime, or the cost of missed demand is very high

Sources of Uncertainty
Customer Deliveries Transportation Location Information

Manufacturing Process design Product design Capacity Quality

Supplier Performance Responsiveness Transportation Location Quality Information

Customer Demand Past performance Market research Analytical techniques Promotions / Incentives

Small capacity cushion

Unused capacity still incurs the fixed costs
highly

capital intensive businesses time perishable capacity

Example: Target 5% Cushion

cushion = Best Operating Level Capacity Used
.05 = (1800/x) - 1 1.05 = (1800/x) 1.05x = 1800 x = 1714.3

- 1

1714.3/1800 = .9524

Capacity Example
An automobile equipment supplier wishes to install a sufficient number of ovens to produce 400,000 good castings per year. The baking operation takes 2.0 minutes per casting, and management requires a capacity cushion of 5%. How many ovens will be required if each one is available for 1800 hours (of capacity) per year?

Solution
Required system capacity = 400,000 good units per year Number of oven minutes required = 400,000 x 2 min/unit = 800,000 Number of oven minutes available/oven = (1800 hrs/oven) x(60 minutes/hour) (.9524) = 102,859 minutes/oven Number of ovens required = 800,000 min /102,859 min/oven = 7.8 or 8 ovens

How does Quality affect capacity?

Suppose a three operation process is followed by an inspection. If the average proportion of defectives produced at operations 1, 2, and 3 are .04, .01, and .02 respectively, and if the demand is 200 units, then what is the required capacity for this operation?

Capacity requirements with Yield Loss

Notation: di = avg. proportion of defective units at operation i n = number of operations in the production process M = order quantity (good units only or desired yield) B = avg. number of units at the start of the production process

B =

M [(1-d1)(1-d2).(1-dn)]

Solution
Desired yield = 200 Operation Defective rate 1 .04 2 .01 3 .02 (1) What is the capacity required?

B=

200 (1-.04)(1-.01)(1-.02)

= 215

Capacity and Quality

Suppose we have a 6 process assembly line that must produce 1000 good products. Each process produces only 1% defects. How is capacity affected?
1000 Capacity required = = (.99)6 1062 units

Decision Trees
A glass factory specializing in crystal is experiencing a substantial backlog, and the firm's management is considering three courses of action: A) Arrange for subcontracting, B) Construct new facilities. C) Do nothing (no change) The correct choice depends largely upon demand, which may be low, medium, or high. By consensus, management ranks the respective probabilities as .10, .50, and .40. A cost analysis that reveals the effects upon costs is shown in the following table.

Payoff Table
0.1 Low 10 -120 20 0.5 Medium 50 25 40 0.4 High 90 200 60

A B C

We start with our decisions...

Subcontracting A B C Construct new facilities

Do nothing

Then add our possible states of nature, probabilities, and payoffs

High demand (.4) Medium demand (.5) Low demand (.1)

$90k $50k $10k $200k $25k -$120k

A B C

High demand (.4) Medium demand (.5) Low demand (.1) High demand (.4) Medium demand (.5) Low demand (.1)

$60k $40k $20k

Determine the expected value of each decision

High demand (.4) Medium demand (.5)

$62k
A

Low demand (.1)

$90k $50k $10k

EVA=.4(90)+.5(50)+.1(10)=$62k

Solution
High demand (.4) Medium demand (.5)

$62k
A B C

Low demand (.1) High demand (.4) Medium demand (.5)

$90k $50k $10k $200k $25k -$120k

$80.5k

Low demand (.1)

High demand (.4)

$46k

Medium demand (.5) Low demand (.1)

$60k $40k $20k

Planning Service Capacity

Time

Location

Volatility

of Demand

Capacity Utilization & Service Quality

Best

operating point is near 70% of capacity 70% to 100% of service capacity, what do you think happens to service quality? Why?

From

Two Capacity Strategies

Planned unused capacity Forecast of capacity needed
Capacity

Forecast of Planned use of short-term options capacity needed

Capacity

Time between increments

Expansionist Strategy

Wait-and-See Strategy

Advantages/Disadvantages of each strategy

Advantages Expansionist
ahead of competition no lost sales

Disadvantages
risky if demand changes

Wait-and-See

no unused capacity easier to adapt to new technologies

rely on shortterm options

Some Short-Term Capacity Options

lease extra space temporarily authorize overtime staff second or third shift with temporary workers add weekend shifts alternate routings, using different work stations that may have excess capacity schedule longer runs to minimize capacity losses

Some Short-Term Capacity Options

level

output by building up inventory in slack season postpone preventive maintenance (risky) use multi-skilled workers to alleviate bottlenecks allow backorders to increase, extend due date promises, or have stock-outs. subcontract work