Strategic Capacity Management Dr. Ron Lembke Operations Management

Ideal Capacity of a Process 50/hr 20/hr 10/hr 40/hr What is the capacity of the system? Should we add any capacity? How should we run the system? Where should we keep inventory?

Ideal Capacity of a Process 6 min 5 min 4 min 5 min What is the capacity of the system?

Productivity Productivity = Outputs / Inputs Partial: Output/Labor or Output/Capital Multifactor: Output / (Labor + Capital + Energy ) Total Measure: Output / Inputs

Automotive Productivity Book Data: Jaguar: 14 cars/employee Volvo: 29 cars/employee Mini: 39 cars/employee

Growth of Service Economy

US Productivity Growth

Improving Productivity Develop productivity measurements– you can’t improve what you can’t measure Identify and Improve bottleneck operations first Establish goals, document and publicize improvements

U.S. Work and Productivity Source: International Labor Organization, 1999

What Would Henry Say? Ford introduced the $5 (per day) wage in 1914 He introduced the 40 hour work week “so people would have more time to buy” It also meant more output: 3*8 > 2*10 “Now we know from our experience in changing from six to five days and back again that we can get at least as great production in five days as we can in six, and we shall probably get a greater, for the pressure will bring better methods. Crowther, World’s Work, 1926

Forty Hour Week Ernst Abbe, Karl Zeiss optics 1896: as much done in 9 as in 8.

Marginal Output of Time As you work more hours, your productivity per hour goes down Eventually, it goes negative. Chapman, 1909

“Crunch Mode” Ea_spouse: 12/04 “Pre-crunch” SO was working 7 * 13: 91 per week! Maybe time off at 6pm Saturday $5k signing bonus, couldn’t quit Class action: April ‘06 $14.9m Igda.org “Why Crunch Mode Doesn’t Work: 6 Lessons”

Learning Curves time/unit goes down consistently Down by 10% as output doubles We can use Logarithms to approximate this If you ever need this, email me, and we can talk as much as you want

Example 3.3 Paul’s 1 2 3 4 5 Bottles 60 100 150 200 250 Bags 100 200 300 400 500 Newman’s Bottles 75 85 95 97 98 Bags 200 400 600 650 680

Example 3.3 Bottles 135 185 245 297 348 Bags 300 600 900 1,050 1,180 3 bottle machines 150k each/yr = 450k 5 bag machines, 250k each/yr = 1,250k

Example 3.3 Bottles 135 185 245 297 348 Machines 1 2 2 2 3 Mach. usage 0.9 1.23 1.63 1.98 2.32 Workers 1.8 2.46 3.27 3.96 4.64 Bags 300 600 900 1,050 1,180 Machines 2 3 4 5 5 Mach Usage 1.2 2.4 3.6 4.2 4.7 Workers 3.6 7.2 10.8 12.6 14.1

Capacity Tradeoffs Can we make combinations in between? 120,000 4-door cars 150,000 Two-door cars Can we make combinations in between?

How much do we have? We can only sustain so much effort. “Best Operating Level” Output level process designed for Lowest cost per unit Capacity utilization = capacity used best operating level Hard to run > 1.0 for long

Time Horizons Long-Range: over a year – acquiring, disposing of production resources Intermediate Range: Monthly or quarterly plans, hiring, firing, layoffs Short Range – less than a month, daily or weekly scheduling process, overtime, worker scheduling, etc.

Service Differences Arrival Rate very variable Can’t store the products - yesterday’s flight? Service times variable Serve me “Right Now!” Rates change quickly Schedule capacity in 10 minute intervals, not months How much capacity do we need?

Capacity Levels in Service =100% Zone of non-service < =70% Mean arrival rate,  Critical Zone Zone of service Mean service rate, 

Adding Capacity Expensive to add capacity A few large expansions are cheaper (per unit) than many small additions Large expansions allow of “clean sheet of paper” thinking, re-design of processes Carry unused overhead for a long time May never be needed Small expansions may “pave the cow path”

Capacity Planning How much capacity should we add? Conservative Optimistic Forecast possible demand scenarios (Chapter 10) Determine capacity needed for likely levels Determine “capacity cushion” desired

Reengineering “Business Process Reengineering” (Hammer and Champy) Companies grow over time, adding plants, lines, facilities, etc. Growth may not end in optimal form Re-design processes from ground up

Capacity Sources In addition to expanding facilities: Two or three shifts Outsourcing non-core activities Training or acquisition of faster equipment

Decision Trees Consider different possible decisions, and different possible outcomes Compute expected profits of each decision Choose decision with highest expected profits, work your way back up the tree.

Decision Trees Example 3.4, p.65 Computer store thinks demand may grow. Expansion costs $87k, new site $210k, and would cost same if wait a year New site: 55% chance of profits of $195k. 45% chance of $115k profits. Expand Current 55% chance of $190k profits 45% chance of $100k profits Wait and see- enlarge store next year if demand grows If high demand, $190k with expanded store If high demand, $170 with current store If weak demand, $105k with current store Find the expected profits over 5 years, choose best one.

Decision Trees Decision point Chance events Outcomes Calculate expected value of each chance event, starting at far right Working our way back toward the beginning, choosing highest expected outcome at each decision

Decision Trees Strong Growth Revenue - Move Cost Move 0.55 Weak Growth 0.45 Strong Growth Revenue – Expand Cost Hackers’ Computer Store 0.55 Expand Weak Growth Revenue – Expand Cost 0.45 Expand Rev – Expand Cost Wait and See Strong Growth Do nothing 0.55 Rev - Expand Cost Weak Growth Revenue 0.45

Possible 5 year Revenues New, growth: 195*5 – 210 = 765 New, low: 115*5 – 210 = 365 Expand, growth: 190*5 – 87 = 863 Expand, low: 100*5 – 87 = 413 Wait, strong, expand: 170+190*4-87=843 Wait, strong, do nothing: 170*5 = 850 Wait, low, do nothing: 105*5 = 525

Decision Trees Strong Growth 765 Move 0.55 Weak Growth 365 0.45 863 Hackers’ Computer Store 0.55 Expand Weak Growth 413 0.45 Expand 843 Wait and See Strong Growth Do nothing 0.55 850 Weak Growth 525 0.45

Making the Decision Starting at the far right, look at the “Wait and See” option. If demand is strong, we would obviously not expand. $850k is better than $843. Eliminate the “Expand option”

Decision Trees Strong Growth 765 Move 0.55 Weak Growth 365 0.45 863 Hackers’ Computer Store 0.55 Expand Weak Growth 413 0.45 Expand 843 Wait and See Strong Growth Do nothing 0.55 850 Weak Growth 525 0.45

Expected Values Move: Wait and See: Expand: 0.55* 765 + 0.45*365 = $585,000 Wait and See: 0.55*850 + 0.45*525 = $703,750 Expand: 0.55 * 863 + 0.45 * 413 = $660,500 Highest expected value is to Wait and see, and either way, do nothing!

Decision Trees $585,000 660,500 703,750 Strong Growth 765 Move 0.55 Weak Growth 365 0.45 660,500 Strong Growth 863 Hackers’ Computer Store 0.55 Expand Weak Growth 413 0.45 Expand 703,750 843 Wait and See Strong Growth Do nothing 0.55 850 Weak Growth 525 0.45

Other considerations Another criteria to use is to pick the one with the highest down side. Under this, do nothing still wins. We could also consider the expected value of the future cash streams. PV = $100/(1+r) = $100/(1.16)=$86.27

Present Values - p.377 At 16%, Next year is worth 0.862 =(1+rate)^(-years) Year 2: 0.743 Year 3: 0.641 Year 4: 0.552 Year 5: 0.476 195 per year for 5 years: 195 * (3.274)

Decision Tree-NPV $310,613 402,507 460,857 Strong Growth 428,487 Move 0.55 Weak Growth 166,544 0.45 402,507 Strong Growth 535,116 Hackers’ Computer Store 0.55 Expand Weak Growth 240,429 0.45 Expand 460,857 529,874 Wait and See Strong Growth Do nothing 0.55 556,630 Weak Growth 343,801 0.45

Real Options Assess the value to me of being able to change my mind in the future Changed problem slightly - Reduced benefit doing nothing, high demand

Decision Trees $465,000 533,000 604,500 598,750 0.25 Strong 765 Move 0.75 Weak 365 Hackers’ Computer Store 533,000 0.25 Strong 863 Expand 0.75 Weak 413 Expand 843 604,500 0.25 Strong Wait and See Do nothing 820 0.75 Weak 525 598,750 0.25 Strong 820 Do Nothing 0.75 Weak 525

Real Options If we didn’t have the wait and see option, we would Do Nothing. Option to wait and see is worth $5,750 604,500 Wait and See $5,750 Do Nothing 598,750 Expand 533,000 Move 465,000