Strategic Capacity Planning 5 Strategic Capacity Planning Slides prepared by Laurel Donaldson Douglas College

LO 1 Define capacity, explain the importance of long-term capacity, know how to measure capacity and understand two related performance measures, and describe factors influencing effective capacity. Describe the strategic capacity planning process in organizations, know how to forecast demand and calculate capacity requirements, and discuss major considerations for developing capacity alternatives, Describe the break-even analysis approach for evaluating capacity alternatives, and use it to solve problems. LO 2 LO 3

What is capacity? Measuring capacity Factors influencing capacity Developing capacity alternatives Evaluating alternatives

What is capacity? Capacity is the upper limit on the load that an operating unit can handle. The basic questions in capacity handling are: What kind of capacity is needed? How much is needed? When is it needed?

Importance of Long-Term Capacity Impacts ability to meet future demands Affects operating costs Major determinant of initial costs Involves long-term commitment Affects competitiveness

Measuring capacity Design capacity Effective capacity Actual output maximum obtainable output under ideal conditions Effective capacity Maximum capacity given delays, product mix, scheduling difficulties, and other realities. Actual output rate of output actually achieved—cannot exceed effective capacity. p142

Common Measures of Capacity Business Inputs Outputs Auto manufacturing Number of cars per shift Steel mill Tonnes of steel per day Oil refinery Barrels of crude oil used per day Barrels of gasoline per day Farming Number of acres Bushels of grain per acres per year, litres of milk per day Restaurant Number of tables, number of seats Number of meals / day Theatre Number of seats Number of tickets sold per day Retail sales Square metres of floor space, sales per sq. ft. Revenue generated per day Table 5-1 p142

Efficiency and Utilization p143

Efficiency/Utilization Example Design capacity = 50 trucks/day Effective capacity = 40 trucks/day Actual output = 36 units/day Example 1 from p143

Example: Capacity Actual production last week = 32,000 units Effective capacity = 35,000 units Design capacity = 250 units per hour Factory operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (250) = 42,000 units New example What is the design capacity for one week? Calculate the efficiency and utilization rates.

Example: Capacity Utilization = 32,000/42,000 = 76.2% Actual production last week = 32,000 units Effective capacity = 35,000 units Design capacity = 250 units per hour Factory operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (250) = 42,000 units Utilization = 32,000/42,000 = 76.2%

Example: Capacity Utilization = 32,000/42,000 = 76.2% Actual production last week = 32,000 units Effective capacity = 35,000 units Design capacity = 250 units per hour Factory operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (250) = 42,000 units Utilization = 32,000/42,000 = 76.2% Efficiency = 32,000/35,000 = 91.4%

Factors Influencing Capacity Facilities Floor space, layout Products or services Limited menu in a restaurant Human Training, skills and experience Planning and Operational No of shifts per day, inventory, quality control External Pollution standards, paper work p144

Factors Influencing Capacity Facilities Products or services Human Planning and Operational External P144 Facilities Floor space, layout Products or services Limited menu in a restaurant Human Training, skills and experience Planning and Operational No of shifts per day, inventory, quality control External Pollution standards, paper work

Capacity planning process 1. Forecast demand one to five years ahead 2. Determine capacity requirements 3. Measure the capacity now and decide how to bridge the gap a) Generate feasible alternatives b) Evaluate alternatives considering economic and non economic aspects c) Choose the best alternative and implement it P144-145

Some Possible Growth Patterns Volume Time Growth Decline Cyclical Stable Figure 5-1 p145

Calculating Capacity Requirements A department works one eight hour shift, 250 days a year, and has these figures for products, their demand, and usage of a type of machine that is currently being considered. How many machines would be needed to handle the required volume? Product Annual Demand Standard Processing time per unit (hr.) Processing time needed (hr.) #1 400 5.0 2,000 #2 300 8.0 2,400 #3 700 2.0 1,400

Developing Capacity Alternatives Design flexibility into systems Differentiate between new and mature products Take a “big picture” approach to capacity changes Prepare to deal with capacity “chunks” Attempt to smooth out capacity requirements Use capacity cushion Identify the optimal operating level P146-149

Optimal operating level Minimum cost & optimal operating rate are functions of size of production unit. Average cost per unit Small plant Medium Large Output rate

Economies and Diseconomies of Scale What makes the unit cost increase? Best operating level Output rate Average cost per unit Small Facility Large Facility Medium Facility Economies of scale Diseconomies of scale

Economies and Diseconomies of Scale Fixed costs (facilities, equipment, management) spread out over more units Volume purchase discounts Diseconomies of scale Worker fatigue, equipment breakdown, less room for error, difficulties in coordination P148 Note: term “diseconomies of scale” is not in text

Evaluating alternatives Economic considerations Cost, useful life, compatibility, revenue Non economic considerations Public opinion, reactions from employees, community pressure Techniques used for evaluation: Break Even Analysis Payback Period Net Present Value p150

Break Even Analysis p152

Total revenue = Total cost Break-Even Analysis Amount ($) Q (quantity in units) Total revenue Profit Loss Total cost Break-even point Total revenue = Total cost Variable cost p151 Fixed cost

Example: Break-Even Fixed costs = $40,000 Material = $1.50/unit Labour costs = $3/unit Selling price = $10.00 per unit QBEP = = = 7273 FC R - VC $40,000 10.00 - (3 +1.50) New example

Example: Break-even Analysis The school cafeteria can make pizza for about $.30 per slice. Cost for kitchen and labour is $200 per day The nearby Pizza Den delivers for $9.00 per pizza (8 slices) Cost for labour reduced to $75 per day Make or Buy? New Example See method p153 Do on board, asking class what next? Make: v = .30 F = 200 Buy: v = 9 / 8 = 1.125 F = 75 x = point of indifference in slices Set equal: .3x + 200 = 1.125x + 75 .825x = 125 x = 151.5 If demand < 152 slices then buy if more then make

Break-Even Problem with Step Fixed Costs Quantity FC + VC = TC Step fixed costs and variable costs. 1 machine 2 machines 3 machines $ p153

Multiple Break-Even Points $ TC TR Quantity 1 2 3 Multiple break-even points

Assumptions of Break Even Analysis One product is involved Everything produced can be sold Variable cost per unit is the same regardless of volume Fixed costs do not change with volume Revenue per unit constant with volume Revenue per unit exceeds variable cost per unit P154 referred to, although not specified in this detail in the text.

Further Financial Analysis Cash Flow (cash received from sales and other sources) -- (cash outflow for labour, material, overhead, taxes) Present Value the sum, in current value, of all future cash flows of an investment proposal. most used methods of financial analysis: Payback period Net present value (NPV) Internal rate of return (IRR) This is additional material

What is Capacity? Capacity usually refers to the upper limit of: A) inventories B) demand C) supplies D) rate of output E) finances Ans: D Page: 141

What is capacity? Capacity decisions are mostly long term decisions. Ans: False Page: 141 Stating capacity in dollar amounts generally results in a consistent measure of capacity. Page: 142

Capacity performance The maximum possible output given a product mix, scheduling difficulties, quality factors, and so on, is: A) utilization B) design capacity C) efficiency D) effective capacity E) available capacity Ans: D Page: 142

Capacity Performance Efficiency is defined as the ratio of: A) actual output to effective capacity B) actual output to design capacity C) design capacity to effective capacity D) effective capacity to actual output E) design capacity to actual output Ans: A Page: 143

Capacity Performance Utilization is defined as the ratio of: A) actual output to effective capacity B) actual output to design capacity C) design capacity to effective capacity D) effective capacity to actual output E) design capacity to actual output Ans: B Page: 143

Define capacity and identify some common ways it is measured. Distinguish between efficiency and utilization and be able to calculate them. Describe factors that influence effective capacity. Describe the steps of the strategic capacity planning process. Discuss major considerations for developing capacity alternatives. Use break-even analysis to solve problems.