Chapter 9– Capacity &

Location Decisions

Operations Management
by
R. Dan Reid & Nada R. Sanders
4th Edition © Wiley 2010

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 Learning Objectives
 Define capacity planning
 Define location analysis
 Describe relationship between capacity
planning and location, and their importance
 Explain the steps involved in capacity
planning and location analysis

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 Learning Objectives – con’t
 Describe the decision support tools used for
capacity planning
 Identify key factors in location analysis
 Describe the decision support tools used for
location analysis

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 Capacity planning
 Capacity is the maximum output rate of a facility
 Capacity planning is the process of establishing the
output rate that can be achieved at a facility:
 Capacity is usually purchased in “chunks”

 Strategic issues: how much and when to spend

capital for additional facility & equipment

 Tactical issues: workforce & inventory levels, &

day-to-day use of equipment

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 Measuring Capacity Examples
 There is no one best way to measure capacity
 Output measures like kegs per day are easier to understand
 With multiple products, inputs measures work better

Input Measures of Output Measures

Type of Business
Capacity of Capacity
Car manufacturer Labor hours Cars per shift
Hospital Available beds Patients per month
Pizza parlor Labor hours Pizzas per day
Floor space in
Retail store Revenue per foot
square feet

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 Measuring Available Capacity
 Design capacity:
 Maximum output rate under ideal conditions
 A bakery can make 30 custom cakes per day
when pushed at holiday time
 Effective capacity:
 Maximum output rate under normal (realistic)
conditions
 On the average this bakery can make 20
custom cakes per day

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Measuring Effectiveness of
Capacity Use
 Measures how much of the available
capacity is actually being used:

Utilizatio n 
actual output rate
100%
capacity

 Measures effectiveness
 Use either effective or design capacity in
denominator

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 Example of Computing Capacity Utilization: A bakery’s
design capacity is 30 custom cakes per day. Currently the bakery is
producing 28 cakes per day. What is the bakery’s capacity
utilization relative to both design and effective capacity?

actual output 28
Utilizatio n effective  (100%)  (100%)  140%
effective capacity 20

actual output 28
Utilizatio n design  (100%)  (100%)  93%
design capacity 30

 The current utilization is only slightly below its design

capacity and considerably above its effective capacity
 The bakery can only operate at this level for a short period
of time

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 Capacity Considerations
 The Best Operating Level is the output that results in
the lowest average unit cost
 Economies of Scale:
 Where the cost per unit of output drops as volume of output
increases
 Spread the fixed costs of buildings & equipment over multiple
units, allow bulk purchasing & handling of material
 Diseconomies of Scale:
 Where the cost per unit rises as volume increases
 Often caused by congestion (overwhelming the process with too
much work-in-process) and scheduling complexity

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 Best Operating Level and Size

 Alternative 1: Purchase one large facility, requiring one large

initial investment
 Alternative 2: Add capacity incrementally in smaller chunks as
needed
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Other Capacity Considerations
 Focused factories:
 Small, specialized facilities with limited
objectives
 Plant within a plant (PWP):
 Segmenting larger operations into smaller
operating units with focused objectives
 Subcontractor networks:
 Outsource non-core items to free up
capacity for what you do well

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 Making Capacity Planning
Decisions
The three-step procedure for making
capacity planning decisions is as
follows:
1. Identify Capacity Requirements
2. Develop Capacity Alternatives
3. Evaluate Capacity Alternatives

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 Identifying capacity
requirements
 Forecasting Capacity:
 Long-term capacity requirements based on future demand

 Identifying future demand based on forecasting

 Forecasting, at this level, relies on qualitative forecast models

 Executive opinion

 Delphi method

 Forecast and capacity decision must included strategic implications

 Capacity cushions
 Plan to underutilize capacity to provide flexibility
 Strategic Implications
 How much capacity a competitor might have
 Potential for overcapacity in industry a possible hazard

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 Developing & Evaluating Capacity
Alternatives
 Capacity alternatives include
 Could do nothing,
 expand large now (may included
capacity cushion), or
 expand small now with option to add
later
 Use decision support aids to evaluate
decisions (decision tree most popular)
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 Decision trees
Diagramming technique which uses
 Decision points – points in time when decisions
are made, squares called nodes
 Decision alternatives – branches of the tree off
the decision nodes
 Chance events – events that could affect a
decision, branches or arrows leaving circular
chance nodes
 Outcomes – each possible alternative listed

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 Decision tree diagrams
Decision trees developed by
 Drawing from left to right
 Use squares to indicate decision points
 Use circles to indicate chance events
 Write the probability of each chance by the
chance (sum of associated chances = 100%)
 Write each alternative outcome in the right
margin

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Example Using Decision Trees: A restaurant owner has
determined that she needs to expand her facility. The alternatives
are to expand large now and risk smaller demand, or expand on a
smaller scale now knowing that she might need to expand again in
three years. Which alternative would be most attractive? (see notes)

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 Evaluating the Decision Tree
 Decision tree analysis utilizes expected value
analysis (EVA)
 EVA is a weighted average of the chance events
 Probability of occurrence * chance event outcome
 Refer to previous slide
 At decision point 2, choose to expand to maximize
profits ($200,000 > $150,000)
 Calculate expected value of small expansion:
 EVsmall = 0.30($80,000) + 0.70($200,000) = $164,000

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 Evaluating the Decision
Tree con’t
 Calculate expected value of large expansion:
 EVlarge = 0.30($50,000) + 0.70($300,000) =
$225,000
 At decision point 1, compare alternatives &
choose the large expansion to maximize the
expected profit:
 $225,000 > $164,000
 Choose large expansion despite the fact that
there is a 30% chance it’s the worst decision:
 Take the calculated risk!
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 Location Analysis
Three most important factors in real estate:
1. Location
2. Location
3. Location
Facility location is the process of identifying
the best geographic location for a service
or production facility

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Factors Affecting Location
Decisions
 Proximity to source of supply:
 Reduce transportation costs of perishable or bulky
raw materials
 Proximity to customers:
 High population areas, close to JIT partners
 Proximity to labor:
 Local wage rates, attitude toward unions,
availability of special skills (silicon valley)

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 More Location Factors
 Community considerations:
 Local community’s attitude toward the facility (prisons,
utility plants, etc.)
 Site considerations:
 Local zoning & taxes, access to utilities, etc.
 Quality-of-life issues:
 Climate, cultural attractions, commuting time, etc.
 Other considerations:
 Options for future expansion, local competition, etc.

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 Globalization –
Should Firm Go Global?
Globalization is the process of locating facilities
around the world
 Potential advantages:
 Inside track to foreign markets, avoid trade barriers, gain access
to cheaper labor
 Potential disadvantages:
 Political risks may increase, loss of control of proprietary
technology, local infrastructure (roads & utilities) may be
inadequate, high inflation
 Other issues to consider:
 Language barriers, different laws & regulations, different
business cultures

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 Making Location Decisions
Analysis should follow 3 step process:
1. Identify dominant location factors
2. Develop location alternatives
3. Evaluate locations alternatives
Procedures for evaluation location alternatives
include
 Factor rating method
 Load-distance model
 Center of gravity approach
 Break-even analysis
 Transportation method

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Factor Rating Example

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 A Load-Distance Model Example: Matrix Manufacturing is
considering where to locate its warehouse in order to service its four
Ohio stores located in Cleveland, Cincinnati, Columbus, Dayton. Two
sites are being considered; Mansfield and Springfield, Ohio. Use the
load-distance model to make the decision.

 Calculate the rectilinear distance: dAB  30  10  40  15  45 miles

 Multiply by the number of loads between each site and the four cities

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 Calculating the Load-Distance Score
for Springfield vs. Mansfield
Computing the Load-Distance Score for Springfield
 City Load Distance ld
Cleveland 15 20.5 307.5
Columbus 10 4.5 45
Cincinnati 12 7.5 90
Dayton 4 3.5 14
Total Load-Distance Score(456.5)

Computing the Load-Distance Score for Mansfield

City Load Distance ld
Cleveland 15 8 120
Columbus 10 8 80
Cincinnati 12 20 240
Dayton 4 16 64
Total Load-Distance Score(504)

The load-distance score for Mansfield is higher than for

Springfield. The warehouse should be located in Springfield.

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 The Center of Gravity Approach
 This approach requires that the analyst find the center of
gravity of the geographic area being considered
Computing the Center of Gravity for Matrix Manufacturing
Coordinates Load
Location (X,Y) (li) lixi liyi
Cleveland (11,22) 15 165 330
Columbus (10,7) 10 165 70
Cincinnati (4,1) 12 165 12
Dayton (3,6) 4 165 24
Total 41 325 436

 Computing the Center of Gravity for Matrix Manufacturing

X 
 l X 325

i i
 7.9 ; Y 
 l Y 436
  10.6
i i

Is there another possible   lto the41C.G. that

c.g. c.g.
l 41 i i
 warehouse location closer
should be considered?? Why?
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 Break-Even Analysis
 Break-even analysis computes the amount of goods required
to be sold to just cover costs
 Break-even analysis includes fixed and variable costs
 Break-even analysis can be used for location analysis
especially when the costs of each location are known

Step 1: For each location, determine the fixed and

variable costs
Step 2: Plot the total costs for each location on one graph
Step 3: Identify ranges of output for which each location
has the lowest total cost
Step 4: Solve algebraically for the break-even points
over the identified ranges

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 Break-Even Analysis
 Remember the break even equations used for calculation total
cost of each location and for calculating the breakeven
quantity Q.
 Total cost = F + cQ
 Total revenue = pQ
 Break-even is where Total Revenue = Total Cost

Q = F/(p-c)
Q = break-even quantity
p = price/unit
c = variable cost/unit
F = fixed cost

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 Example using Break-even Analysis: Clean-Clothes
Cleaners is considering four possible sites for its new
operation. They expect to clean 10,000 garments. The
table and graph below are used for the analysis.

Example 9.6 Using Break-Even Analysis

Location Fixed Cost Variable Cost Total Cost
A $350,000 $ 5(10,000) $400,000
B $170,000 $25(10,000) $420,000
C $100,000 $40(10,000) $500,000
D $250,000 $20(10,000) $450,000

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 The Transportation Method
 Can be used to solve specific location problems
 Is discussed in detail in the supplement to this text
 Could be used to evaluate the cost impact of
adding potential location sites to the network of
existing facilities
 Could also be used to evaluate adding multiple
new sites or completely redesigning the network

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Capacity Planning & Facility
Location within OM
 Decisions about capacity and location are highly
dependent on forecasts of demand (Ch 8).
 Capacity is also affected by operations strategy (Ch
2), as size of capacity is a key element of
organizational structure.
 Other operations decisions that are affected by
capacity and location are issues of job design and
labor skills (Ch 11), choice on the mix of labor and
technology, as well as choices on technology and
automation (Ch 3).

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 Capacity Planning and Facility
Location Across the Organization
 Capacity planning and location analysis
affect operations management and are
important to many others
 Finance provides input to finalize capacity
decisions
 Marketing impacted by the organizational
capacity and location to customers

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 Chapter 9 Highlights
 Capacity planning is deciding on the
maximum output rate of a facility
 Location analysis is deciding on the best
location for a facility
 Capacity planning and location analysis
decision are often made simultaneously
because the location of the facility is usually
related to its capacity.

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 Chapter 9 Highlights – con’t
 In both capacity planning and location analysis,
managers must follow three-step process to make
good decision. The steps are assessing needs,
developing alternatives, and evaluating
alternatives.
 To choose between capacity planning alternatives
managers may use decision trees, which are a
modeling tool for evaluating independent
decisions that must be made in sequence.
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 Chapter 9 Highlights – con’t
 Key factors in location analysis included proximity
to customers, transportation, source of labor,
community attitude, and proximity to supplies.
Service and manufacturing firms focus on different
factors. Profit-making and nonprofit organizations
also focus on different factors.

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 Chapter 9 Highlights – con’t
 Several tools can be used to facilitate location
analysis. Factor rating is a tool that helps
managers evaluate qualitative factors. The load-
distance model and center of gravity approach
evaluate the location decision based on distance.
Break-even analysis is used to evaluate location
decisions based on cost values. The transportation
method is an excellent tool for evaluating the cost
impact of adding sites to the network of current
facilities.
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 The End
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