Capacity and Constraint Management PowerPoint presentation to accompany Heizer and Render Operations Management, 10e Principles of Operations Management, 8e PowerPoint slides by Jeff Heyl 08: Ch7S - Capacity(MGMT3102: Fall13)

Outline Capacity Bottleneck Analysis and Theory of Constraints Design and Effective Capacity Capacity and Strategy Capacity Considerations Managing Demand Demand and Capacity Management in the Service Sector Bottleneck Analysis and Theory of Constraints Process Times for Stations, Systems, and Cycles Break-Even Analysis 08: Ch7S - Capacity(MGMT3102: Fall13)

Learning Objectives When you complete this supplement, you should be able to: Define capacity Determine design capacity, effective capacity, and utilization Perform bottleneck analysis Compute break-even analysis 08: Ch7S - Capacity(MGMT3102: Fall13)

Capacity The throughput, or the number of units a facility can hold, receive, store, or produce in a period of time Determines fixed costs Determines if demand will be satisfied Three time horizons This slide provides some reasons that capacity is an issue. The following slides guide a discussion of capacity. 08: Ch7S - Capacity(MGMT3102: Fall13)

Planning Over a Time Horizon Modify capacity Use capacity Intermediate-range planning Subcontract Add personnel Add equipment Build or use inventory Add shifts Short-range planning Schedule jobs Schedule personnel Allocate machinery * Long-range planning Add facilities Add long lead time equipment * Difficult to adjust capacity as limited options exist Options for Adjusting Capacity Figure S7.1 08: Ch7S - Capacity(MGMT3102: Fall13)

Design and Effective Capacity Design capacity is the maximum theoretical output of a system Normally expressed as a rate Effective capacity is the capacity a firm expects to achieve given current operating constraints Often lower than design capacity Points to be made might include: - capacity definition and measurement is necessary if we are to develop a production schedule - while a process may have “maximum” capacity, many factors prevent us from achieving that capacity on a continuous basis. Students should be asked to suggest factors which might prevent one from achieving maximum capacity. 08: Ch7S - Capacity(MGMT3102: Fall13)

Utilization and Efficiency Utilization is the percent of design capacity achieved Utilization = Actual output/Design capacity Efficiency is the percent of effective capacity achieved Efficiency = Actual output/Effective capacity 08: Ch7S - Capacity(MGMT3102: Fall13)

Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls It might be useful at this point to discuss typical equipment utilization rates for different process strategies if you have not done so before. 08: Ch7S - Capacity(MGMT3102: Fall13)

Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls It might be useful at this point to discuss typical equipment utilization rates for different process strategies if you have not done so before. 08: Ch7S - Capacity(MGMT3102: Fall13)

Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls It might be useful at this point to discuss typical equipment utilization rates for different process strategies if you have not done so before. Utilization = 148,000/201,600 = 73.4% 08: Ch7S - Capacity(MGMT3102: Fall13)

Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls It might be useful at this point to discuss typical equipment utilization rates for different process strategies if you have not done so before. Utilization = 148,000/201,600 = 73.4% 08: Ch7S - Capacity(MGMT3102: Fall13)

Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls It might be useful at this point to discuss typical equipment utilization rates for different process strategies if you have not done so before. Utilization = 148,000/201,600 = 73.4% Efficiency = 148,000/175,000 = 84.6% 08: Ch7S - Capacity(MGMT3102: Fall13)

Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls It might be useful at this point to discuss typical equipment utilization rates for different process strategies if you have not done so before. Utilization = 148,000/201,600 = 73.4% Efficiency = 148,000/175,000 = 84.6% 08: Ch7S - Capacity(MGMT3102: Fall13)

Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Efficiency = 84.6% Efficiency of new line = 75% Expected Output = (Effective Capacity)(Efficiency) It might be useful at this point to discuss typical equipment utilization rates for different process strategies if you have not done so before. = (175,000)(.75) = 131,250 rolls 08: Ch7S - Capacity(MGMT3102: Fall13)

Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Efficiency = 84.6% Efficiency of new line = 75% Expected Output = (Effective Capacity)(Efficiency) It might be useful at this point to discuss typical equipment utilization rates for different process strategies if you have not done so before. = (175,000)(.75) = 131,250 rolls 08: Ch7S - Capacity(MGMT3102: Fall13)

Managing Demand Demand exceeds capacity Capacity exceeds demand Curtail demand by raising prices, scheduling longer lead time Long term solution is to increase capacity Capacity exceeds demand Stimulate market Product changes Adjusting to seasonal demands Produce products with complementary demand patterns 08: Ch7S - Capacity(MGMT3102: Fall13)

Complementary Demand Patterns Combining both demand patterns reduces the variation 4,000 – 3,000 – 2,000 – 1,000 – J F M A M J J A S O N D J F M A M J J A S O N D J Sales in units Time (months) Snowmobile motor sales Jet ski engine sales Figure S7.3 08: Ch7S - Capacity(MGMT3102: Fall13)

Demand and Capacity Management in the Service Sector Demand management Appointment, reservations, FCFS rule Capacity management Full time, temporary, part-time staff 08: Ch7S - Capacity(MGMT3102: Fall13)

Break-Even Analysis Objective is to find the point in dollars and units at which cost equals revenue Fixed costs are costs that continue even if no units are produced Depreciation, taxes, debt, mortgage payments Variable costs are costs that vary with the volume of units produced Labor, materials, portion of utilities Assumes - Costs and revenue are linear This chart introduces breakeven analysis and the breakeven or crossover chart. As you discuss the assumptions upon which this techniques is based, it might be a good time to introduce the more general topic of the limitations of and use of models. Certainly one does not know all information with certainty, money does have a time value, and the hypothesized linear relationships hold only within a range of production volumes. What impact does this have on our use of the models? 08: Ch7S - Capacity(MGMT3102: Fall13)

Total cost = Total revenue Break-Even Analysis – 900 – 800 – 700 – 600 – 500 – 400 – 300 – 200 – 100 – | | | | | | | | | | | | 0 100 200 300 400 500 600 700 800 900 1000 1100 Cost in dollars Volume (units per period) Total revenue line Profit corridor Loss corridor Total cost line Break-even point Total cost = Total revenue Variable cost This chart introduces breakeven analysis and the breakeven or crossover chart. As you discuss the assumptions upon which this techniques is based, it might be a good time to introduce the more general topic of the limitations of and use of models. Certainly one does not know all information with certainty, money does have a time value, and the hypothesized linear relationships hold only within a range of production volumes. What impact does this have on our use of the models? Fixed cost Figure S7.5 08: Ch7S - Capacity(MGMT3102: Fall13)

Break-Even Analysis TR = TC F or BEPx = P - V Px = F + Vx BEPx = break-even point in units BEP$ = break-even point in dollars P = price per unit (after all discounts) x = number of units produced TR = total revenue = Px F = fixed costs V = variable cost per unit TC = total costs = F + Vx Break-even point occurs when This chart introduces breakeven analysis and the breakeven or crossover chart. As you discuss the assumptions upon which this techniques is based, it might be a good time to introduce the more general topic of the limitations of and use of models. Certainly one does not know all information with certainty, money does have a time value, and the hypothesized linear relationships hold only within a range of production volumes. What impact does this have on our use of the models? TR = TC or Px = F + Vx BEPx = F P - V 08: Ch7S - Capacity(MGMT3102: Fall13)

Break-Even Analysis BEP$ = BEPx P = P = Profit = TR - TC P - V BEPx = break-even point in units BEP$ = break-even point in dollars P = price per unit (after all discounts) x = number of units produced TR = total revenue = Px F = fixed costs V = variable cost per unit TC = total costs = F + Vx BEP$ = BEPx P = P = F (P - V)/P P - V 1 - V/P Profit = TR - TC = Px - (F + Vx) = Px - F - Vx = (P - V)x - F 08: Ch7S - Capacity(MGMT3102: Fall13)

Break-Even Example Fixed costs = $10,000 Material = $.75/unit Direct labor = $1.50/unit Selling price = $4.00 per unit BEP$ = = F 1 - (V/P) $10,000 1 - [(1.50 + .75)/(4.00)] 08: Ch7S - Capacity(MGMT3102: Fall13)

Break-Even Example Fixed costs = $10,000 Material = $.75/unit Direct labor = $1.50/unit Selling price = $4.00 per unit BEP$ = = F 1 - (V/P) $10,000 1 - [(1.50 + .75)/(4.00)] = = $22,857.14 $10,000 .4375 BEPx = = = 5,714 F P - V $10,000 4.00 - (1.50 + .75) 08: Ch7S - Capacity(MGMT3102: Fall13)

Break-Even Example Revenue Break-even point Total costs Fixed costs 50,000 – 40,000 – 30,000 – 20,000 – 10,000 – – | | | | | | 0 2,000 4,000 6,000 8,000 10,000 Dollars Units Revenue Break-even point Total costs Fixed costs 08: Ch7S - Capacity(MGMT3102: Fall13)

∑ 1 - x (Wi) Break-Even Example Multiproduct Case F BEP$ = Vi Pi where V = variable cost per unit P = price per unit F = fixed costs W = percent each product is of total dollar sales i = each product 08: Ch7S - Capacity(MGMT3102: Fall13)

In-Class Problems from the Lecture Guide Practice Problems The design capacity for engine repair in our company is 80 trucks/day. The effective capacity is 40 engines/day and the actual output is 36 engines/day. Calculate the utilization and efficiency of the operation. If the efficiency for next month is expected to be 82%, what is the expected output? 𝑈𝑡𝑖𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛= 𝐴𝑐𝑡𝑢𝑎𝑙 𝑜𝑢𝑡𝑝𝑢𝑡 𝐷𝑒𝑠𝑖𝑔𝑛 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 = 36 80 =45% 𝐸𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦= 𝐴𝑐𝑡𝑢𝑎𝑙 𝑜𝑢𝑡𝑝𝑢𝑡 𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 = 36 40 =90% Expected Output = (Effective capacity)(Efficiency) = (40)(0.82) = 32.8 engines/day 08: Ch7S - Capacity(MGMT3102: Fall13)

In-Class Problems from the Lecture Guide Practice Problems Jack’s Grocery is manufacturing a “store brand” item that has a variable cost of $0.75 per unit and a selling price of $1.25 per unit. Fixed costs are $12,000. Current volume is 50,000 units. The Grocery can substantially improve the product quality by adding a new piece of equipment at an additional fixed cost of $5,000. Variable cost would increase to $1.00, but their volume should increase to 70,000 units due to the higher quality product. Should the company buy the new equipment? Profit = TR – TC Option A: Stay as is: Profit = 50,000*(1.25 - .75) – 12,000 = $13,000 Option B: Add equipment: Profit = 70,000*(1.25 – 1.00) – 17,000 = $500 Therefore the company should continue as is with the present equipment as this returns a higher profit. 08: Ch7S - Capacity(MGMT3102: Fall13)

In-Class Problems from the Lecture Guide Practice Problems What are the break-even points ($ and units) for the two processes considered in Problem S7.5? Using current equipment:  BEP $ = 𝐹 1− 𝑉 𝑃 = 12,000 1− 0.75 1.25 = 12,000 01−0.60 = 12,000 0.40 =$30,000  BEP x = 𝐹 𝑃−𝑉 = 12,000 1.25−0.75 =24,000   Using the new equipment  BEP $ = 𝐹 1− 𝑉 𝑃 = 17,000 1− 1.00 1.25 = 17,000 01−0.80 = 17,000 0.20 =$85,000 BEP x = 𝐹 𝑃−𝑉 = 17,000 1.25−1.00 =68,000 08: Ch7S - Capacity(MGMT3102: Fall13)

In-Class Problems from the Lecture Guide Practice Problems Develop a break-even chart for Problem S7.5. 08: Ch7S - Capacity(MGMT3102: Fall13)