Capacity Planning

(TREE + TRANSPORTATION+ NEEDS) Contents 1-What is capacity? Capacity planning? 2- Classification of capacity. 3- Capacity expansion strategies. 4- Economies and diseconomies of scale. 5- The challenges of planning service capacity. 6- capacity planning numerical tools (TREE + TRANSPORTATION+ NEEDS)

1-What is capacity?

It must be over some specified duration What is capacity? Capacity can be defined as: 1- What a manufacturing or service system can produce. 2 - The rate at which output can be produced by an operating unit: a machine, process, facility, or company (The rate of output from an OM system per unit of time, or the rate at which the firm withdraws work from the system.). 3- The work that the system is capable of doing in a period of time, It is normally stated in standard hours of work. 4- The maximum output rate of a production or service facility. 5- The upper limit or ceiling on the load that an operating unit can handle. It must be over some specified duration

What is capacity planning? Capacity planning is an approach for determining the overall capacity level of capital intensive resources, including facilities, equipment, and overall labor force size Capacity planning involves the long and short term planning of the systems potential for transforming resources into outputs demanded by customers within a set time period. Strategic issues: How much and when to spend capital for additional facility & equipment Tactical issues: Workforce & inventory levels, & day-to-day use of equipment

Capacity planning -The basic questions The basic questions in capacity planning are: 1-What kind( and amount) of capacity is needed? (how much long range capacity is needed):- How many machines should be purchased? How many workers should be hired? 2- When additional capacity is needed? 3- How to maintain A BALANCE ? (too high, too low)

Things to keep in mind when planning capacity Design flexibility into systems Take a “big picture” approach to capacity changes Prepare to deal with capacity “chunks” Attempt to smooth out capacity requirements Identify the optimal operating level

2-Classification of capacity

(A)- Design capacity Design (or theoretical, or installed or peak) capacity is the maximum output that can be achieved in a given time period from a particular machine (or plant). It is a theoretical capacity as it does not take into consideration power breakdown, poor planning, non availability of materials, labor absenteeism etc. This capacity is realizable only if certain conditions are satisfied: 1- There are no interruptions of any kind. 2- There is cent per cent utilization of capacity. 3- Men and machine work in ideal conditions. 4- Quality of input and every thing else is according to specifications. In real life situation it is difficult to fulfill these conditions. Therefore design capacity only sets the maximum limit and also serves to judge the actual utilization of plant capacity.

(B)- Effective capacity Effective (demonstrated , or practical , or operating ) capacity is the rate production that can be achieved for extended periods under normal conditions, taking into account the product mix, scheduling methods, employee training, rest periods, scrap, machine breakdowns, rework, sick time, a portion of available hours cannot be worked due to scheduling delays, preventive maintenance, and so on. So the effective capacity is the maximum capacity minus the capacity lost due to these factors.

3- Capacity expansion strategies

Capacity expansion strategies when to expand+ by how much There are three basic strategies for capacity expansion : A- Lead strategy B- Lag strategy C- Average strategy

Capacity expansion strategies Units Capacity Time Demand Capacity lead strategy Units Capacity Time Demand Capacity lag strategy Units Capacity Time Demand Average capacity strategy Incremental vs. one-step expansion Units Incremental expansion Time Demand One-step

(A) Lead strategy: Expand capacity in anticipation of growth stays a head of demand Lead strategy (or demand leading strategy, or proactive strategy) by maintaining excess capacity. The goal of this strategy is to maintain sufficient capacity to minimize the chances of not meeting demand

(A) Lead strategy: Expand capacity in anticipation of growth Benefits: 1- Companies that have excess capacity can often gain market share by satisfying the demand by customers of competitors that are capacity constrained, 2- Since there is always excess capacity, a “cushion” against unexpected demand from large orders or new customers is provided. This cushion also enables the firm to give good customer service, since backorders will rarely occur 3- Allow the company to respond quickly to unexpected increases in demand (Minimizes the chance of sales lost to insufficient capacity) 4- Provide fast delivery to customers without overtime costs or production disruptions. 5- Expansion may result in economies of scale and faster rate of learning, thus helping a firm reduce its costs and compete on price 6- Increase the firm’s market share or act as a form of preemptive marketing

(B) Lag strategy: Increase capacity after increase in growth In lag strategy (or demand trailing strategy, or reactive strategy) capacity expansion lags behind demand (not adding capacity until demand is expected to exceed current capacity over the long term), and results in constant capacity shortage. This strategy usually assumes: (1) A company can increase short-term capacity using overtime work, or possibly subcontracting. (2) That customers will tolerate some delay in delivery.

(B) Lag strategy: Increase capacity after increase in growth Benefits: 1- Require less investment (expand in smaller increments, such as by renovating existing facilities rather than building new ones) 2- High capacity utilization and thus a higher rate of return on investment 3- Because this strategy follows demand, it reduces the risk of over expansion based on overly optimistic demand forecasts, obsolete technology, or inaccurate assumptions regarding competition

(B) Lag strategy: Increase capacity after increase in growth Limitations: 1- Reduce long-term profitability through overtime and productivity losses that occur as the firm scrambles to satisfy demand.( This strategy keeps capital equipment cost per unit low, but overtime and subcontracting costs can be substantial and there is a high risk of losing sales by not being sufficiently responsive to customer demand) 2- In the long run, such a strategy can lead to a permanent loss of market position. Cannot accommodate new or unexpected demand at peak times Often forced to add capacity during peak of business cycle, when costs of expansion are high High overtime and/or subcontracting costs response and delivery to customers are slow

(C)- Average (neutral )strategy Average strategy is the strategy of matching capacity additions with demand as closely as possible. When the capacity curve is above the demand curve, the firm has excess capacity; when it is below, there is insufficient capacity to meet demand. During periods of capacity shortage, there are several alternatives. The firm can incur lost sales and possibly lose market position, or it can make short-term capacity expansions through subcontracting, overtime, additional shifts, and so forth. The intermediate approach of trying to match capacity to demand is most effective when:- 1- demand can be accurately predicted, 2- growth in demand occurs at a relatively steady rate, and 3- there is no substantial lumpiness in capacity additions. When these conditions exist, this strategy will usually minimize the combined costs of facility underutilization, lost sales due to shortages, and inventories

Capacity expansion : one step or incremental increasing? With all of these strategies, the firm has the option of making frequent small capacity increments or fewer large increments. The choice should be based on careful economic analysis of the cost and risks associated with excess capacity and capacity shortages. There are two general approaches to expand long -range capacity:- 1- All at once : Build the ultimate facility now and grow into it 2- Incrementally : Build incrementally as capacity demand grows

Capacity expansion : one step or incremental increasing? 1- All at once: Less interruption of production Little risk of having to turn down business due to inadequate capacity One large construction project costs less than several smaller projects Due to inflation, construction costs will be higher in the future Most appropriate for mature products with stable demand. 2- Incrementally: Less risky if forecast needs do not materialize Funds that could be used for other types of investments will not be tied up in excess capacity More appropriate for new products

4- Economies and diseconomies of scale

Economies of scale Economies of scale:- Where the cost per unit of output drops as volume of output increases (If the output rate is less than the optimal level, increasing the output rate results in decreasing average unit costs). Reasons for economies of scale include the following 1- Fixed costs are spread over more units, reducing cost per unit 2- Construction costs increase at a decreasing rate with respect to the size of the facility to be built 3- Processing costs decrease as output rate increase because operations become more standardized, which reduces unit costs 4- Quantity discounts are available for material purchases 5- operating efficiency increases as workers gain experience

Best Operating Level and Size The Best Operating Level is the output that results in the lowest average unit cost

Diseconomies of scale Diseconomies of scale:- Where the cost per unit rises as volume increases Reasons for diseconomies of scale 1- Distribution costs increase due to traffic congestion and shipping from one large centralized facility instead of several smaller, decentralized facilities 2- Complexity increases costs; control and communication become more problematic 3- Inflexibility can be an issue (firms are too big to operate effectively) 4- Additional levels of bureaucracy exists, slowing decision making (decisions take too long to make)and approvals for changes 5-Damaged goods 6-Reduced morale 7- Increased use of overtime

5-The challenges of planning service capacity

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6- Calculating capacity needs

Capacity-planning tools Break-Even Analysis. Present-Value Analysis. Computer Simulation. Waiting Line Analysis. Linear Programming. Decision Tree Analysis.

Decision tree analysis Structures complex multiphase decisions, showing: What decisions must be made What sequence the decisions must occur Interdependence of the decisions Allows objective evaluation of alternatives Incorporates uncertainty Develops expected values

Example of a Decision Tree Problem A glass factory specializing in crystal is experiencing a substantial backlog, and the firm's management is considering three courses of action: A) Arrange for subcontracting B) Construct new facilities C) Do nothing (no change) The correct choice depends largely upon demand, which may be low, medium, or high. By consensus, management estimates the respective demand probabilities as 0.1, 0.5, and 0.4. 20

Example of a Decision Tree Problem (Continued): The Payoff Table The management also estimates the profits when choosing from the three alternatives (A, B, and C) under the differing probable levels of demand. These profits, in thousands of dollars are presented in the table below: 21

Step 1. We start by drawing the three decisions 22

Step 2. Add our possible states of nature, probabilities, & payoffs C High demand (0.4) Medium demand (0.5) Low demand (0.1) $90k $50k $10k $200k $25k -$120k $60k $40k $20k 23

Step 3. Determine the expected value of each decision High demand (0.4) Medium demand (0.5) Low demand (0.1) $90k $50k $62k $10k A EVA=0.4(90)+0.5(50)+0.1(10)=$62k 24

Step 4. Make decision $62k $80.5k $46k $90k $50k $10k A $200k $25k B High demand (0.4) Medium demand (0.5) Low demand (0.1) A B C $90k $50k $10k $200k $25k -$120k $60k $40k $20k $62k $80.5k $46k Alternative B generates the greatest expected profit, so our choice is B or to construct a new facility 25