Presented by:

Peter Ventura Monterey Avendano Rod Steven Vasquez Charina Rose Ventura
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Capacity Planning
Capacity
The upper limit or ceiling on the load that an operating unit can handle Goal
To achieve a match between the long-term supply capabilities of an organization and the predicted level of long-run demand.

Capacity Planning Questions

Key Questions:
What kind of capacity is needed? How much capacity is needed to match demand? When is it needed?

Related Questions:
How much will it cost? What are the potential benefits and risks? Are there sustainability issues? Should capacity be changed all at once, or through several smaller changes Can the supply chain handle the necessary changes?

Capacity Decisions Are Strategic

impact the ability of the organization to meet future demands affect operating costs are a major determinant of initial cost often involve long-term commitment of resources can affect competitiveness affect the ease of management are more important and complex due to globalization need to be planned for in advance due to their consumption of financial and other resources

Defining and Measuring Capacity

Measure capacity in units that do not require updating
Why is measuring capacity in dollars problematic?

Two useful definitions of capacity

a) Design capacity The maximum output rate or service capacity an operation, process, or facility is designed for b) Effective capacity Design capacity minus allowances such as personal time and maintenance

Measuring System Effectiveness

Actual output
The rate of output actually achieved It cannot exceed effective capacity

Efficiency Utilization

actual output Efficiency effective capacity

actual output Utilizatio n design capacity
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Example 1:
Given the following information, compute the efficiency and the utilization of the vehicle repair department: Design Capacity Effective Capacity Actual Output = 50 trucks per day = 40 trucks per day = 36 trucks per day

Solution:
actual output Efficiency effective capacity

=36 trucks per day 40 trucks per day = 90%

Solution:
actual output Utilizatio n design capacity

=36 trucks per day 50 trucks per day = 72%

Determinants of Effective Capacity FACILITIES

Design Design Location Layout
Environment Product or service mix

PRODUCT/ SERVICE

PROCESS
Quantity capabilities Quality capabilities

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Determinants of Effective Capacity Human Factors

Job content Job design
Training & Experience

POLICY

OPERATIONAL
Scheduling

Materials management
Quality assurance

Motivation
Compensation Learning rates
Absenteeism & labor turnover

Maintenance policies
Equipment breakdowns

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Determinants of Effective Capacity SUPPLY CHAIN EXTERNAL FACTORS

Product Standards Safety regulations Unions
Pollution control standards

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Strategy Formulation
Capacity strategy for long-term demand Demand patterns 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

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Capacity Cushion
Extra capacity used to offset demand uncertainty Capacity cushion = 100% - Utilization Capacity cushion strategy
Organizations that have greater demand uncertainty typically have greater capacity cushion Organizations that have standard products and services generally have greater capacity cushion

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Steps in Capacity Planning

1. Estimate future capacity requirements 2. Evaluate existing capacity and facilities; identify gaps 3. Identify alternatives for meeting requirements 4. Conduct financial analyses 5. Assess key qualitative issues 6. Select the best alternative for the long term 7. Implement alternative chosen 8. Monitor results

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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

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Calculating Processing Requirements

Annual Demand Standard processing time per unit (hr.) Processing time needed (hr.)

Product

#1 #2 #3

400 300 700

5.0 8.0 2.0

2,000 2,400 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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The Challenges of Planning Service Capacity

IMPORTANT FACTORS IN PLANNING SERVICE CAPACITY: 1. The need to be near customers 2. The inability to store services 3. The degree of volatility

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MAKE OR BUY? FACTORS:

1. 2. 3. 4. 5. 6. Available capacity Expertise Quality considerations The nature of demand Cost Risk

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Developing Capacity Alternatives

1. Design flexibility into systems 2. Take stage of life cycle into account
Introduction phase Growth phase Maturity phase Decline phase

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Developing Capacity Alternatives

3. Take a big picture (i.e., systems) approach to capacity changes
Bottleneck operations

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Developing Capacity Alternatives

4. Prepare to deal with capacity chunks

5. Attempt to smooth out capacity requirements

6. Identify the optimal operating level
Economies of Scale Diseconomies of Scale

7. Choose a strategy if expansion is involved

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Evaluating Alternatives
Economic considerations: Will an alternative be economically feasible? How much will it cost? How soon can we have it? What will operating and maintenance cost be? What will its useful life be? Will it be compatible with present personnel and present operations?
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Techniques used for Evaluating Capacity Alternatives

1) Financial Analysis 2) Waiting Line analysis 3) Decision Theory 4) Cost-Volume Analysis

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FINANCIAL ANALYSIS
Important terms:

Cash flow
- refers to the difference between the cash received from sales (of goods of services) and other sources and the cash outflow for labor, materials, overhead and taxes.

Present Value
- expresses in current value the sum of all future
cash flows of a investment proposal.

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FINANCIAL ANALYSIS - Methods a) Payback

- is a simple but widely used method that focuses on the length of time it will take for an investment to return its original cost.
Payback period =

Investment required Net annual cash inflow

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FINANCIAL ANALYSIS - Methods b) Present Value

- method summarizes the initial cost of an investment, its estimated annual cash flows and any expected salvage value in a single value called the equivalent current value, taking into account the time value of money, w/c is the interest rates.

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FINANCIAL ANALYSIS - Methods c) Internal Rate of Return

- summarizes the initial cost, expected annual cash flows, and estimated future salvage of an investment proposal in an equivalent interest rate.

PV factor for the = internal rate of return

Investment required Net annual cash flows

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WAITING-LINE ANALYSIS
Its goal is to minimize the sum of two costs: customer waiting cost and service capacity cost. Analysis of lines is often useful for designing for modifying service systems.

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DECISION THEORY
Is a helpful tool for financial comparison of alternatives under conditions of risk or uncertainty. It is suited to capacity decisions and to a wide range of other decisions managers must make.

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TOOLS FOR ANALYZING DECISION PROBLEM

1) Decision Trees: - a schematic representation of the available alternatives and their possible consequences.

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DECISION THEORY

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TOOLS FOR ANALYZING DECISION PROBLEM

2) Sensitivity Analysis:
Provides a range of probability over which the choice of alternatives would remain the same. Determining the range of probability for which an alternative has the best expected payoff. A graphical solution Makes use of Algebra

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COST VOLUME ANALYSIS

It focuses on relationship between cost and volume of output. Its purpose is to estimate the income of an organization under different operating conditions and its particularly useful as a tool for comparing capacity alternatives.

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COST VOLUME ANALYSIS

Fixed Cost Variable Cost

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TERMS
P = Profit TR = Total Revenue TC = Total Cost R = Revenue Q = Quantity or volume of output FC = Fixed Cost v = Variable cost /unit

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COST VOLUME RELATIONSHIPS

Amount i($)

Fixed Cost (FC)

0 Q (volume in units)

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COST VOLUME RELATIONSHIPS

Amount i($)

TR = R X Q

Q (volume in units)

Total Revenue increases linearly with output

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COST VOLUME RELATIONSHIPS

Amount i($) 0

BEP units Q (volume in units)

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Profit = TR - TC

TOTAL PROFIT
P = TR TC P = R X Q (FC + v X Q) P= Q(R-v)-FC P+FC=Q (R-v) Q=(P+FC)/(R-v)

P = Profit TR = Total Revenue TC = Total Cost R = Revenue Q = Quantity or volume of output FC = Fixed Cost v = Variable cost /unit

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CONTRIBUTION MARGIN
The difference between revenue per unit and variable cost per unit, R v P + FC R-v

Q =

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BREAK-EVEN POINT
The volume of output at which total cost and total revenue are equal. QBEP = FC R-v FC (R v)/R
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QBES =

COST VOLUME RELATIONSHIPS

Amount i($)

Q (volume in units)
0

BEP units

Profit versus Loss

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COST VOLUME RELATIONSHIPS

Amount i($) 0

Point of indifference Q (volume in units)

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Profit of indifference for two alternatives

EXAMPLE
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.

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EXAMPLE
a. How many pies must be sold in order to break even in units & dollar? 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?
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SOLUTION
a) How many pies must be sold in order to break even in units?
Given: FC: $6,000 VC:$2/pie Rev:$7/pie

QBEP =

FC R-v

= $6,000 $7 - $2 = 1,200 pies/month

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SOLUTION
a) How many pies must be sold in order to break even in dollar?
Given: FC: $6,000 VC:$2/pie Rev:$7/pie

QBES =
=

FC (R v)/R
$6,000
($7 - $2)/$7

= $8,400 pies/month
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SOLUTION:
b. What would the profit (loss) be if 1,000 pies are made and sold in a month?

P= Q(R-v)-FC
= 1,000 ($7-$2)-$6,000
= -$1,000

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SOLUTION:
c. How many pies must be sold to realize a profit of $4,000? Q = P + FC R-v

= $4,000+$6,000 $7-$2 = 2,000 pies

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SOLUTION:
d. If 2,000 can be sold and a profit target is $5,000, what price should be charged per pie?

P= Q(R-v)-FC
$5,000= 2,000 (R-$2)-$6,000
R = $7.50

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EXAMPLE
The Business Owner of a sports good factory in Sialkot is contemplating adding a new line of cricket bats, which will require leasing new equipment for a monthly payment or P60,000. Variable costs would be P200 per bat and bats would sold for P2,000 only.

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EXAMPLE
1. How many bats would be sold in order to break-even? 2. What would be the profit or loss if the 100 bats are made and sold in 1 month? 3. How many bats must be sold to realize a profit of P40,000?

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SOLUTION
1. How many bats would be sold in order to break-even?
Given: FC: P60,000 VC:P200/bat Rev:P2,000/bat

QBEP =
=

FC R-v
P60,000 P2,000 P200 = 33.33 bats
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SOLUTION:
2. What would be the profit or loss if the 100 bats are made and sold in 1 month?

P= Q(R-v)-FC
P= 100(P2,000 P200)-P60,000 P = P120,000
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SOLUTION:
3. How many bats must be sold to realize a profit of P40,000? Q = P + FC R-v

Q= P40,000+P60,000 P2,000-P200 Q = 56 bats

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CAPACITY ALTERNATIVES:
Step Cost:
- which are costs that increase stepwise as potential volume increases.
FC
2 machines

FC
3 machines

FC
1 machine

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CAPACITY ALTERNATIVES:
Multiple Break-Even:
3

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EXAMPLE:
A manager has the option of purchasing one, two or three machines. Fixed costs and potential volumes are as follows:
Number of Machines Total Annual Fixed Costs Corresponding Range of Output

1 2
3

$9,600 15,000
20,000

0 to 300 301 to 600

601 to 900

VC = $10/unit

Rev = $40/unit
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Problem & Solution

a) Determine the break-even point for each range.
Number of Machines

Computation

Answer

QBEP = $9,600 $40-$10 QBEP = $15,000 $40-$10

320 units 500 units

QBEP = $20,000 $40-$10

666.67 units

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Problem & Solution:

b) If projected annual demand is between 580 and 660 units, how many machines should the manager purchase?
Number of Machines 2 Total Annual Fixed Costs 15,000 Corresponding Range of Output 301 to 600

P = TR TC P = Q(R-v)-FC P = 580($40-$10)-$15,000 P = $2,400

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Problem & Solution:

b) If

projected annual demand is between 580 and 660 units, how many machines should the manager purchase?
Number of Machines 3 Total Annual Fixed Costs 20,000 Corresponding Range of Output 601 to 900

P = TR TC P = Q(R-v)-FC P = 660($40-$10)-$20,000 P = ($200)

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Problem & Solution:

b) If projected annual demand is between 580 and 660 units, how many machines should the manager purchase? 2M- P = $2,400 3M P= ($200)

Choose 2 Machines

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Cost Volume Analysis valuable tool to Capacity Alternatives:

1. One product is involved. 2. Everything produced can be sold. 3. The variable cost per unit is the same regardless of the volume. 4. Fixed cost do not change with volume changes, or they are step changes. 5. The revenue per unit is the same regardless of volume. 6. Revenue per unit exceeds variable cost per unit.
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Operations Strategy
Capacity planning impacts all areas of the organization
It determines the conditions under which operations will have to function Flexibility allows an organization to be agile
It reduces the organizations dependence on forecast accuracy and reliability Many organizations utilize capacity cushions to achieve flexibility

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Operations Strategy
Bottleneck management is one way by which organizations can enhance their effective capacities. Capacity expansion strategies are important organizational considerations
Expand-early strategy Wait-and-see strategy

Capacity contraction is sometimes necessary

Capacity disposal strategies become important under these conditions

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Problem 1:
A firms manager must decide whether to make or buy a certain item used in the production of vending machines. Making the item would involve annual lease costs of $150,000. Cost and volume estimates are as follows: Make Buy Annual fixed cost $150,000 None Variable cost/unit $60 $80 Annual volume (units) 12,000 12,000 a. Given those numbers, should the firm buy or make this item? b. There is possibility that volume could change in the future. At what volume would the manager be indifferent between making and buying?

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Problem 2:
A small firm produces and sells automotive items in a five-state area. The firm expects to consolidate assembly of its battery charges line at a single location. Currently, operations are in three widely scattered locations. The leading candidate for location will have a monthly fixed cost of $42,000 and variable costs of $3 per charger. Charges sell for $7 each. Required: 1. Prepare a table that shows total profits, fixed costs, variable cost, and revenues for monthly volumes of 10,000; 12,000 and 15,000 units. 2. What is the break-even point?

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Problem 3:
A small firm produces and sells automotive items in a five-state area. The firm expects to consolidate assembly of its battery charges line at a single location. Currently, operations are in three widely scattered locations. The leading candidate for location will have a monthly fixed cost of $42,000 and variable costs of $3 per charger. Charges sell for $7 each. Required: Determine profit when volume equals 22,000 units.
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Problem 4:
A manager must decide which type of equipment to buy, Type A or Type B. Type A equipment cost $15,000 each and Type B cost $11,000 each. The equipment can be operated 8 hours a day, 250 days a year. Either a machine can be used to perform two types of chemical analysis, C1 & C2. Annual service requirements and processing times are shown in the following table.

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Problem 4:
Required: Which type of equipments should be purchased, and how many that type will be needed? The goal is to minimize total purchase cost.

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Answer Question no.1:

a. Given those numbers, should the firm buy or make this item? TC= FC+Q(VC) Make = $150,000+12,000($60) = $870,000 Buy = 0+12,000($80) = $960,000

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Answer Question no.1:

b. There is possibility that volume could change in the future. At what volume would the manager be indifferent between making and buying?

TCmake= TCbuy
$150,000 + Q($60) = 0 + Q($80) $80Q-$60Q=$150,000 $20Q=$150,000 Q=$7,500
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Answer Question no.2:

a. Prepare a table that shows total profits, fixed costs, variable cost, and revenues for monthly volumes of 10,000; 12,000 and 15,000 units.
Volume 10,000 12,000 15,000
Total Revenue

$70,000 84,000 105,000

Total VC $30,000 36,000 45,000

Fixed Cost $42,000 42,000 42,000

Total Total Cost Profit $72,000 $(2,000) 78,000 87,000 6,000 18,000

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Answer Question no.2:

b. What is the break-even point?

Q =

P + FC R-v

Q=$42,000 $7-$3 Q=10,500 units per month

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Answer Question no.3:

Determine profit when volume equals 22,000 units.

P= Q(R-v)-FC
P=Q($7-$3)-$42,000 $4(22,000)-$42,000 =$46,000

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