Chapter 5: Strategic Capacity Planning for Products and Services

Suman Niranjan

Capacity Planning
Capacity
It is the upper limit on the load that an operating unit can handle

Capacity planning plays an strategic role in designing of systems

Example 1: How many machines do you need, are they sufficient Example 2: How many servers do we need in a restaurant

The idea behind strategic capacity planning is the long term supply capabilities with the long term demand
Internal supply (manufacturing) External supply (purchase)
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Capacity Planning

Basic questions in capacity planning

What kind of capacity is needed?
Depends on products and services that the management intends to produce or provide

How much capacity is needed?

Forecasts are the key input

When is it needed?

Factors that influence the choices of capacity:The stability of demand The rate of technological changes in equipment and product design Competitiveness When a style of a product or service changes

Capacity Decisions are Strategic

Decisions

involving capacity can be termed as the most critical for a organization:

Impact

on ability of an organization to meet future demands of the products and services

When Microsoft released Xbox in 2005 there were insufficient supplies resulting lost sales and customers

Capacity

costs

decisions affect the operating is the major determinant of cost

Balancing the cost of over- and under capacity

Capacity

Greater the capacity, greater is the productivity, greater the cost

Capacity Decisions are Strategic

Capacity decisions can affect the competiveness
Having excess capacity or quickly add capacity

Capacity affects the ease of management

Appropriate capacity capacity mismatched

Globalization affects the capacity

Supply chains and distant markets add to the uncertainty of capacity need

Capacity decisions are usually long-term decisions

Amount of investment and other resources involved Change in demand over the period of time
It takes years to construct a power plant, the estimated demand at the time the project starts - time when it is completed

Defining and Measuring Capacity

Capacity refers to upper limit on the rate of output Difficulty in measuring capacity
Actually measuring Different interpretations of term capacity Identifying suitable measures for specific situation Single Vs. multiple product or service
Example of appliance manufacturer

Measure of capacity can be number of available inputs

Service industry hospitals Manufacturing industry- number of machine hours available
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Defining and Measuring Capacity

Design capacity
Maximum output rate or service capacity an operation, process, or facility is designed for

Effective capacity
Design capacity minus allowances such as personal time, maintenance, and scrap

Actual output
Rate of output actually achieved--cannot exceed effective capacity.

Efficiency and Utilization

Actual output Efficiency = Effective capacity Actual output Utilization = Design capacity
Both measures expressed as percentages
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Efficiency/Utilization Example
Design capacity = 50 trucks/day Effective capacity = 40 trucks/day Actual output = 36 units/day
Efficiency= Utilization=
capacity Actual output Effective capacity Actual output 50 units/day = 36 units/day = 90% 40 units/ day

= 36 units/day = 72% Design

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Determinants of Effective Capacity

Many decisions about system design and operating decisions have an impact on capacity Factors which influence these decisions are:
Facilities
Size, location, expansion

Product and service factors

Similar items Vs. different items Different rates of output

Process factors
Influence on quality of output, rework, inspection etc.

Human factors
Experience required, motivation, fatigue

Policy factors
Overtime, second and third shifts

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Determinants of Effective Capacity

Factors which influence these decisions are:

Operational factors
Equipment capabilities, differences in job requirements Importance of a every single component

Supply chain factors

What will impact the suppliers, warehousing, transportation, and distributers

External factors
Maintaining minimum quality and standard Pollution standards on product or equipment Union contract limits

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Strategy Formulation

Capacity strategies are usually assumed on:

Long-term demand pattern 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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Key Decisions of Capacity Planning

Amount of capacity needed
Capacity cushion (100% - Utilization)

Timing of changes
Availability of capital, lead time, and expected demand

Need to maintain balance

Proportional changes in capacity to all related areas

Extent of flexibility of facilities

Uncertainty in demand
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Steps in Capacity Planning

1. 2. 3. 4. 5. 6. 7. 8. Estimate future capacity requirements Evaluate existing capacity Identify alternatives Conduct financial analysis Assess key qualitative issues Select one alternative Implement alternative chosen 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

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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Bottleneck Operation

Machine #1 Machine #2

10/hr

Bottleneck operation: An operation in a sequence of operations whose capacity is lower than that of

10/hr

Machine #3

Bottleneck Operation
10/hr 10/hr

30/hr

Machine #4

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Bottleneck Operation
Bottlene ck

Operation 1 20/hr.

Operation 2 10/hr.

Operation 3 15/hr.

10/hr .

Maximum output rate limited by

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Cost-Volume Analysis
Fixed Cost (FC) tend to remain constant regardless of volume of output Variable Cost (VC) vary directly with the volume of output Examples of fixed cost

Rental costs, property taxes, equipment costs etc.

Examples of variable cost

Material and labor cost

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Cost-Volume Analysis

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Cost-Volume Analysis

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Example 3

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.
a) How many pies must be sold in order to break even? 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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Example 4

A manager has the option of purchasing one, two, or three machines. Fixed costs and potential volumes are as follows:

Variable cost is $10 per unit, and revenue is $40 per unit.
a) Determine the break-even point for each range. b) If projected annual demand is between 580 and 660 units, how many machines should the manager purchase?

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Cost-Volume Relationships

Amount ($)

t To FC

al

t= os c

VC

+ e st co

lv a ot ) T C (V Fixed cost (FC)

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ri a

bl a

Q (volume in units)

Cost-Volume Relationships

ue ot ven l T e Tota r t os c al
L s os

Amount ($)

f ro P it

BEP Q (volume in units units)

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Break-Even Problem with Step Fixed Costs

C+ F TC C= V

1 machine

+ C F TC

VC

VC + FC TC

3 machines

2 machines

Quanti ty Step fixed costs and variable costs.

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Break-Even Problem with Step Fixed Costs

$
BE 2 T P C T C
T 1 R

BEP

T C 3

Quanti ty Multiple break-even points

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Assumptions of Cost-Volume Analysis

1.One product is involved 2.Everything produced can be sold 3.Variable cost per unit is the same regardless of volume 4.Fixed costs do not change with volume 5.Revenue per unit constant with volume 6.Revenue per unit exceeds variable cost per unit

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Planning Service Capacity

Need to be near customers

Capacity and location are closely tied

Inability to store services

Capacity must be matched with timing of demand

Degree of volatility of demand

Peak demand periods

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In-House or Outsourcing

Available capacity Expertise Quality considerations Nature of demand Cost Risk Outsource: obtain a good or service from an external provider
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Developing Capacity Alternatives

Design flexibility into systems Take stage of life cycle into account

Growth phase Maturity phase Decline phase

Take a big picture approach to capacity changes

Bottleneck operations

Prepare to deal with capacity chunks

Discrete increase in capacity
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Developing Capacity Alternatives

Attempt to smooth out capacity requirements

Under utilization or overutilization of capacity Overtime, subcontract Store during period of low demand and draw during high

Identify the optimal operating level

Economies of scale Vs. Diseconomies of scale

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Economies of Scale

Economies of scale
If the output rate is less than the optimal level, increasing output rate results in decreasing average unit costs

Diseconomies of scale
If the output rate is more than the optimal level, increasing the output rate results in increasing average unit costs

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Optimal Rate of Output

Production units have an optimal rate of output for minimal cost. Average cost per unit
Minimum average cost per unit

Minimu m cost

Rate of output

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Economies of Scale
Minimum cost & optimal operating rate are functions of size of production unit. Average cost per unit

S mall

Mediu m plant

Larg e plan

Output rate

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Evaluating Alternatives

Cost-volume analysis
Break-even point

Financial analysis
Cash flow Present value

Decision theory Waiting-line analysis

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Financial Analysis
Cash Flow - the difference between cash received from sales and other sources, and cash outflow for labor, material, overhead, and taxes. Present Value - the sum, in current value, of all future cash flows of an investment proposal.

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Decision Theory
Helpful tool for financial comparison of alternatives under conditions of risk or uncertainty Suited to capacity decisions

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Waiting-Line Analysis
Useful for designing or modifying service systems Waiting-lines occur across a wide variety of service systems Waiting-lines are caused by bottlenecks in the process Helps managers plan capacity level that will be cost-effective by balancing the cost of having customers wait in line with the cost of additional capacity

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