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Chapter 5, Part A

Facility Capacity and Location

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 Overview

● Facility Planning
● Long-Range Capacity Planning
● Facility Location
● Wrap-Up: What World-Class Companies Do

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 Facility Planning

● HOW MUCH long range capacity is needed

● WHEN additional capacity is needed
● WHERE the production facilities should be located
● WHAT the layout and characteristics of the facilities
should be

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 Facility Planning

● The capital investment in land, buildings, technology,

and machinery is enormous
● A firm must live with its facility planning decisions
for a long time, and these decisions affect:
●
Operating efficiency
●
Economy of scale
●
Ease of scheduling
●
Maintenance costs
●
… Profitability!

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 Long-Range
Capacity Planning

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 Steps in the Capacity Planning Process

● Estimate the capacity of the present facilities.

● Forecast the long-range future capacity needs.
● Identify and analyze sources of capacity to meet these
needs.
● Select from among the alternative sources of
capacity.

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 Definitions of Capacity

● In general, production capacity is the maximum

production rate of an organization.
● Capacity can be difficult to quantify due to …
●
Day-to-day uncertainties such as employee
absences, equipment breakdowns, and material-
delivery delays
●
Products and services differ in production rates (so
product mix is a factor)
●
Different interpretations of maximum capacity

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 Definitions of Capacity

● The Federal Reserve Board defines sustainable

practical capacity as the greatest level of output that a
plant can maintain …
●
within the framework of a realistic work schedule
●
taking account of normal downtime
●
assuming sufficient availability of inputs to operate
the machinery and equipment in place

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 Measurements of Capacity

Output Rate Capacity

●
For a facility having a single product or a few
homogeneous products, the unit of measure is
straightforward (barrels of beer per month)
●
For a facility having a diverse mix of products, an
aggregate unit of capacity must be established
using a common unit of output (sales dollars per
week)

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 Measurements of Capacity

Input Rate Capacity

●
Commonly used for service operations where
output measures are particularly difficult
Hospitals use available beds per month
●

Airlines use available seat-miles per month

●

Movie theatres use available seats per month

●

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 Measurements of Capacity

Capacity Utilization Percentage

●
Relates actual output to output capacity
Example: Actual automobiles produced in a
●

quarter divided by the quarterly automobile

production capacity
●
Relates actual input used to input capacity
Example: Actual accountant hours used in a
●

month divided by the monthly account-hours

available

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 Measurements of Capacity

Capacity Cushion
●
an additional amount of capacity added onto the
expected demand to allow for:
greater than expected demand
●

demand during peak demand seasons

●

lower production costs

●

product and volume flexibility

●

improved quality of products and services

●

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 Forecasting Capacity Demand

● Consider the life of the input (e.g. facility is 10-30 yr)

● Understand product life cycle as it impacts capacity
● Anticipate technological developments
● Anticipate competitors’ actions
● Forecast the firm’s demand

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 Other Considerations

● Resource availability
● Accuracy of the long-range forecast
● Capacity cushion
● Changes in competitive environment

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 Expansion of Long-Term Capacity

● Subcontract with other companies

● Acquire other companies, facilities, or resources
● Develop sites, construct buildings, buy equipment
● Expand, update, or modify existing facilities
● Reactivate standby facilities

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 Reduction of Long-Term Capacity

● Sell off existing resources, lay off employees

● Mothball facilities, transfer employees
● Develop and phase in new products/services

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 Economies of Scale

● Best operating level - least average unit cost

● Economies of scale - average cost per unit decreases
as the volume increases toward the best operating
level
● Diseconomies of scale - average cost per unit
increases as the volume increases beyond the best
operating level

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 Economies and Diseconomies of Scale
Average Unit
Cost of Output ($)

Economies Diseconomies
of Scale of Scale

Best Operating Level

Annual Volume (units)

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 Economies of Scale

● Declining costs result from:

●
Fixed costs being spread over more and more units
●
Longer production runs result in a smaller
proportion of labor being allocated to setups
●
Proportionally less material scrap
●
… and other economies

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 Diseconomies of Scale

● Increasing costs result from increased congestion of

workers and material, which contributes to:
●
Increasing inefficiency
●
Difficulty in scheduling
●
Damaged goods
●
Reduced morale
●
Increased use of overtime
●
… and other diseconomies

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 Two General Approaches
to Expanding Long-Range Capacity
● All at Once – build the ultimate facility now and
grow into it
● Incrementally – build incrementally as capacity
demand grows

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 Two General Approaches
to Expanding Long-Range Capacity
● All at Once
●
Little risk of having to turn down business due to
inadequate capacity
●
Less interruption of production
●
One large construction project costs less than
several smaller projects
●
Due to inflation, construction costs will be higher
in the future
●
Most appropriate for mature products with stable
demand
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 Two General Approaches
to Expanding Long-Range Capacity
● Incrementally
●
Less risky if forecast needs do not materialize
●
Funds that could be used for other types of
investments will not be tied up in excess capacity
●
More appropriate for new products

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 Subcontractor Networks

A viable alternative to larger-capacity facilities is to

develop subcontractor and supplier networks.
●
“Farming out” or outsourcing your capacity needs
to your suppliers
●
Developing long-range relationships with suppliers
of parts, components, and subassemblies
●
Relying less on backward vertical integration
●
Requiring less capital for production facilities
●
More easily varying capacity during slack or peak
demand periods

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 Outsourcing Service Functions

●
Building maintenance
●
Data processing
●
Delivery
●
Payroll
●
Bookkeeping
●
Customer service
●
Mailroom
●
Benefits administration
●
… and more

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 Economies of Scope

● The ability to produce many product models in one

flexible facility more cheaply than in separate
facilities
● Highly flexible and programmable automation allows
quick, inexpensive product-to-product changes
● Economies are created by spreading the automation
cost over many products

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 Analyzing Capacity-Planning Decisions

●
Break-Even Analysis (Chapter 4 and this chapter)
●
Present-Value Analysis
●
Computer Simulation (Chapter 9)
●
Waiting Line Analysis (Chapter 9)
●
Linear Programming (Chapter 8)
●
Decision Tree Analysis (this chapter)

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 Example: King Publishing

● Break-Even Analysis
King Publishing intends to publish a book in
residential landscaping. Fixed costs are $125,000 per
year, variable costs per unit are $32, and selling price
per unit is $42.
A) How many units must be sold per year to
break even? B) How much annual revenue is
required to break even? C) If annual sales are 20,000
units, what are the annual profits? D) What variable
cost per unit would result in $100,000 annual profits
if annual sales are 20,000 units?

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 Example: King Publishing

● Break-Even Analysis
A) How many units must be sold per year to break even?

Q = FC/(p-v) = $125,000/(42 – 32) = 12,500 books

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 Example: King Publishing

● Break-Even Analysis
B) How much annual revenue is required to break even?

TR = pQ = 42(12,500) = $525,000

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 Example: King Publishing

● Break-Even Analysis
C) If annual sales are 20,000 units, what are the annual
profits?
P = pQ – (FC + vQ)
= 42(20,000) – [125,000 + 32(20,000)]
= 840,000 – 125,000 – 640,000
= $75,000

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 Example: King Publishing

● Break-Even Analysis
D) What variable cost per unit would result in $100,000
annual profits if annual sales are 20,000 units?
P = pQ – (FC + vQ)
100,000 = 42(20,000) – [125,000 + v(20,000)]
100,000 = 840,000 – 125,000 – 20,000v
20,000v = 615,000
v = $30.75

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 Decision Tree Analysis

● Structures complex multiphase decisions, showing:

●
What decisions must be made
●
What sequence the decisions must occur
●
Interdependence of the decisions
● Allows objective evaluation of alternatives
● Incorporates uncertainty
● Develops expected values

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 Example: Good Eats Café

● Decision Tree Analysis

Good Eats Café is about to build a new
restaurant. An architect has developed three building
designs, each with a different seating capacity. Good
Eats estimates that the average number of customers
per hour will be 80, 100, or 120 with respective
probabilities of 0.4, 0.2, and 0.4. The payoff table
showing the profits for the three designs is on the
next slide.

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 Example: Good Eats Café

● Payoff Table

Average Number of Customers Per Hour

c1 = 80 c2 = 100 c3 = 120

Design A $10,000 $15,000 $14,000

Design B $ 8,000 $18,000 $12,000
Design C $ 6,000 $16,000 $21,000

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 Example: Good Eats Café

● Expected Value Approach

Calculate the expected value for each decision.
The decision tree on the next slide can assist in this
calculation. Here d1, d2, d3 represent the decision
alternatives of designs A, B, C, and c1, c2, c3 represent
the different average customer volumes (80, 100, and
120) that might occur.

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 Example: Good Eats Café

●
Decision Tree Payoffs
c1 (.4) 10,000
c2 (.2)
2 15,000
c3 (.4)
d1 14,000
c1 (.4)
d2 8,000
1 c2 (.2)
3 18,000
d3 c3 (.4)
12,000
c1 (.4)
6,000
c2 (.2)
4
c3 16,000
(.4)
21,000
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 Example: Good Eats Café

● Expected Value For Each Decision

EV = .4(10,000) + .2(15,000) + .4(14,000)
d1 = $12,600
2
Design A
EV = .4(8,000) + .2(18,000) + .4(12,000)
Design B d2 = $11,600
1 3

d3
Design C
EV = .4(6,000) + .2(16,000) + .4(21,000)
= $14,000
4

Choose the design with largest EV -- Design C.

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Facility Location

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 A Sequence of Decisions

Political, social, economic stability;

National Decision
Currency exchange rates; . . . . .

Climate; Customer concentrations;

Regional Decision
Degree of unionization; . . . . .

Transportation system availability;

Community Decision
Preference of management; . . . . .

Site size/cost; Environmental impact;

Site Decision
Zoning restrictions; . . . . .

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 Factors Affecting
the Location Decision
● Economic
●
Site acquisition, preparation and construction costs
●
Labor costs, skills and availability
●
Utilities costs and availability
●
Transportation costs
●
Taxes

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 Factors Affecting
the Location Decision
● Non-economic
●
Labor attitudes and traditions
●
Training and employment services
●
Community’s attitude
●
Schools and churches
●
Recreation and cultural attractions
●
Amount and type of housing available

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 Facility Types and Their
Dominant Locational Factors
● Mining, Quarrying, and Heavy Manufacturing
●
Near their raw material sources
●
Abundant supply of utilities
●
Land and construction costs are inexpensive
● Light Manufacturing
●
Availability and cost of labor
● Warehousing
●
Proximity to transportation facilities
●
Incoming and outgoing transportation costs
● . . . more
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 Facility Types and Their
Dominant Locational Factors
● R&D and High-Tech Manufacturing
●
Ability to recruit/retain scientists, engineers, etc.
●
Near companies with similar technology interests
● Retailing and For-Profit Services
●
Near concentrations of target customers
● Government and Health/Emergency Services
●
Near concentrations of constituents

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 Some Reasons the
Facility Location Decision Arises
● Changes in the market
●
Expansion
●
Contraction
●
Geographic shift
● Changes in inputs
●
Labor skills and/or costs
●
Materials costs and/or availability
●
Utility costs
● . . . more
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 Some Reasons the
Facility Location Decision Arises
● Changes in the environment
●
Regulations and laws
●
Attitude of the community
● Changes in technology

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 Analyzing Service Location Decisions

Consumer Behavior Why do customers buy our

Research products and services?

Who are our customers?

Market Research
What are their characteristics?

Data Gathering for Where are our customers concentrated?

Each Location Alternative What are their traffic/spending patterns?

Revenue Projections for What are the economic projections?

Each Location Alternative What is the time-phased revenue?

Profit Projections for What are the projected revenues

Each Location Alternative less time-phased operating costs?
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 Analyzing Industrial Facility Locations

Factors that tend to dominate the industrial-facility

location decision are:
●
Transportation costs
●
Labor cost and availability
●
Materials cost and availability
●
Utilities cost

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 Analyzing Industrial Facility Locations

● Locating a Single Facility

●
A simple way to analyze alternative locations is
conventional cost analysis
Pros – ease of communication and understanding
●

Cons – time value of money ignored and

●

qualitative factors not considered

● Locating Multiple Facilities
●
More sophisticated techniques are often used:
Linear programming, computer simulation,
●

network analysis, and others

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 Qualitative Factors in Location Decisions

Often-important qualitative factors include

●
Housing
●
Climate
●
Community activities
●
Education and health services
●
Recreation
●
Churches
●
Union activities
●
Community attitudes

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Integrating Qualitative & Quantitative Factors

● Managers often wrestle with the task of trading off

qualitative factors against quantitative ones
● Methods for systematically displaying the relative
advantages and disadvantages, both qualitative and
quantitative, of each location alternative have been
developed
● The relative-aggregate-scores approach is one such
method

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 Relative-Aggregate-Scores Approach
Quantitative and Qualitative Factors
Location A Location B
Econ. Wgt. Econ. Wgt.
Factor Weight Data Score Score Data Score Score
Prod.cost/ton .45 $65 .923 .415 $60 1.000 .450
Transp.cost/ton .35 $18 1.000 .350 $21 .857 .300
Labor Avail. .15 .700 .105 .500 .075
Union Activity .05 .450 .023 .750 .038
Total Score .893 .863

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 Wrap-Up: World-Class Practice

● Outstanding long-range business plans

●
Long-range capacity studies
● Justify investment on how it positions their company
to capture market share
● Facility location decisions involve worldwide search
for sites

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End of Chapter 5, Part A

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