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2 Facility Capacity and Location Chapter 5, Part A

3 OverviewOverview l Facility Planning l Long-Range Capacity Planning l Facility Location l Wrap-Up: What World-Class Companies Do

4 Facility Planning l HOW MUCH long range capacity is needed l WHEN additional capacity is needed l WHERE the production facilities should be located l WHAT the layout and characteristics of the facilities should be

5 Facility Planning l The capital investment in land, buildings, technology, and machinery is enormous l A firm must live with its facility planning decisions for a long time, and these decisions affect: l Operating efficiency l Economy of scale l Ease of scheduling l Maintenance costs l … Profitability!

6 Long-Range Capacity Planning

7 Steps in the Capacity Planning Process l Estimate the capacity of the present facilities. l Forecast the long-range future capacity needs. l Identify and analyze sources of capacity to meet these needs. l Select from among the alternative sources of capacity.

8 Definitions of Capacity l In general, production capacity is the maximum production rate of an organization. l Capacity can be difficult to quantify due to … l Day-to-day uncertainties such as employee absences, equipment breakdowns, and material- delivery delays l Products and services differ in production rates (so product mix is a factor) l Different interpretations of maximum capacity

9 Definitions of Capacity l The Federal Reserve Board defines sustainable practical capacity as the greatest level of output that a plant can maintain … l within the framework of a realistic work schedule l taking account of normal downtime l assuming sufficient availability of inputs to operate the machinery and equipment in place

10 Measurements of Capacity Output Rate Capacity l For a facility having a single product or a few homogeneous products, the unit of measure is straightforward (barrels of beer per month) l For a facility having a diverse mix of products, an aggregate unit of capacity must be established using a common unit of output (sales dollars per week)

11 Measurements of Capacity Input Rate Capacity l Commonly used for service operations where output measures are particularly difficult l Hospitals use available beds per month l Airlines use available seat-miles per month l Movie theatres use available seats per month

12 Measurements of Capacity Capacity Utilization Percentage l Relates actual output to output capacity l Example: Actual automobiles produced in a quarter divided by the quarterly automobile production capacity l Relates actual input used to input capacity l Example: Actual accountant hours used in a month divided by the monthly account-hours available

13 Measurements of Capacity Capacity Cushion l an additional amount of capacity added onto the expected demand to allow for: l greater than expected demand l demand during peak demand seasons l lower production costs l product and volume flexibility l improved quality of products and services

14 Forecasting Capacity Demand l Consider the life of the input (e.g. facility is yr) l Understand product life cycle as it impacts capacity l Anticipate technological developments l Anticipate competitors’ actions l Forecast the firm’s demand

15 Other Considerations l Resource availability l Accuracy of the long-range forecast l Capacity cushion l Changes in competitive environment

16 Expansion of Long-Term Capacity l Subcontract with other companies l Acquire other companies, facilities, or resources l Develop sites, construct buildings, buy equipment l Expand, update, or modify existing facilities l Reactivate standby facilities

17 Reduction of Long-Term Capacity l Sell off existing resources, lay off employees l Mothball facilities, transfer employees l Develop and phase in new products/services

18 Economies of Scale l Best operating level - least average unit cost l Economies of scale - average cost per unit decreases as the volume increases toward the best operating level l Diseconomies of scale - average cost per unit increases as the volume increases beyond the best operating level

19 Economies and Diseconomies of Scale Average Unit Cost of Output ($) Annual Volume (units) Best Operating Level Economies of Scale Diseconomies

20 Economies of Scale l Declining costs result from: l Fixed costs being spread over more and more units l Longer production runs result in a smaller proportion of labor being allocated to setups l Proportionally less material scrap l … and other economies

21 Diseconomies of Scale l Increasing costs result from increased congestion of workers and material, which contributes to: l Increasing inefficiency l Difficulty in scheduling l Damaged goods l Reduced morale l Increased use of overtime l … and other diseconomies

22 Two General Approaches to Expanding Long-Range Capacity l All at Once – build the ultimate facility now and grow into it l Incrementally – build incrementally as capacity demand grows

23 Two General Approaches to Expanding Long-Range Capacity l All at Once l Little risk of having to turn down business due to inadequate capacity l Less interruption of production l One large construction project costs less than several smaller projects l Due to inflation, construction costs will be higher in the future l Most appropriate for mature products with stable demand

24 Two General Approaches to Expanding Long-Range Capacity l Incrementally l Less risky if forecast needs do not materialize l Funds that could be used for other types of investments will not be tied up in excess capacity l More appropriate for new products

25 Subcontractor Networks A viable alternative to larger-capacity facilities is to develop subcontractor and supplier networks. l “Farming out” or outsourcing your capacity needs to your suppliers l Developing long-range relationships with suppliers of parts, components, and subassemblies l Relying less on backward vertical integration l Requiring less capital for production facilities l More easily varying capacity during slack or peak demand periods

26 Outsourcing Service Functions l Building maintenance l Data processing l Delivery l Payroll l Bookkeeping l Customer service l Mailroom l Benefits administration l … and more

27 Economies of Scope l The ability to produce many product models in one flexible facility more cheaply than in separate facilities l Highly flexible and programmable automation allows quick, inexpensive product-to-product changes l Economies are created by spreading the automation cost over many products

28 Analyzing Capacity-Planning Decisions l Break-Even Analysis (Chapter 4 and this chapter) l Present-Value Analysis l Computer Simulation (Chapter 9) l Waiting Line Analysis (Chapter 9) l Linear Programming (Chapter 8) l Decision Tree Analysis (this chapter)

29 Example: King Publishing l Break-Even Analysis King Publishing intends to publish a book in residential landscaping. Fixed costs are $125,000 per year, variable costs per unit are $32, and selling price per unit is $42. A) How many units must be sold per year to break even? B) How much annual revenue is required to break even? C) If annual sales are 20,000 units, what are the annual profits? D) What variable cost per unit would result in $100,000 annual profits if annual sales are 20,000 units?

30 Example: King Publishing l Break-Even Analysis A) How many units must be sold per year to break even? Q = FC/(p-v) = $125,000/(42 – 32) = 12,500 books

31 Example: King Publishing l Break-Even Analysis B) How much annual revenue is required to break even? TR = pQ = 42(12,500) = $525,000 TR = pQ = 42(12,500) = $525,000

32 Example: King Publishing l Break-Even Analysis C) If annual sales are 20,000 units, what are the annual profits? P = pQ – (FC + vQ) P = pQ – (FC + vQ) = 42(20,000) – [125, (20,000)] = 42(20,000) – [125, (20,000)] = 840,000 – 125,000 – 640,000 = 840,000 – 125,000 – 640,000 = $75,000 = $75,000

33 Example: King Publishing l Break-Even Analysis D) What variable cost per unit would result in $100,000 annual profits if annual sales are 20,000 units? P = pQ – (FC + vQ) P = pQ – (FC + vQ) 100,000 = 42(20,000) – [125,000 + v(20,000)] 100,000 = 42(20,000) – [125,000 + v(20,000)] 100,000 = 840,000 – 125,000 – 20,000v 100,000 = 840,000 – 125,000 – 20,000v 20,000v = 615,000 20,000v = 615,000 v = $30.75 v = $30.75

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

35 Example: Good Eats Café l Decision Tree Analysis Good Eats Café is about to build a new restaurant. An architect has developed three building designs, each with a different seating capacity. Good Eats estimates that the average number of customers per hour will be 80, 100, or 120 with respective probabilities of 0.4, 0.2, and 0.4. The payoff table showing the profits for the three designs is on the next slide.

36 l Payoff Table Average Number of Customers Per Hour Average Number of Customers Per Hour c 1 = 80 c 2 = 100 c 3 = 120 c 1 = 80 c 2 = 100 c 3 = 120 Design A $10,000 $15,000 $14,000 Design A $10,000 $15,000 $14,000 Design B $ 8,000 $18,000 $12,000 Design B $ 8,000 $18,000 $12,000 Design C $ 6,000 $16,000 $21,000 Design C $ 6,000 $16,000 $21,000 l Payoff Table Average Number of Customers Per Hour Average Number of Customers Per Hour c 1 = 80 c 2 = 100 c 3 = 120 c 1 = 80 c 2 = 100 c 3 = 120 Design A $10,000 $15,000 $14,000 Design A $10,000 $15,000 $14,000 Design B $ 8,000 $18,000 $12,000 Design B $ 8,000 $18,000 $12,000 Design C $ 6,000 $16,000 $21,000 Design C $ 6,000 $16,000 $21,000 Example: Good Eats Café

37 Expected Value Approach l Expected Value Approach Calculate the expected value for each decision. The decision tree on the next slide can assist in this calculation. Here d 1, d 2, d 3 represent the decision alternatives of designs A, B, C, and c 1, c 2, c 3 represent the different average customer volumes (80, 100, and 120) that might occur. Expected Value Approach l Expected Value Approach Calculate the expected value for each decision. The decision tree on the next slide can assist in this calculation. Here d 1, d 2, d 3 represent the decision alternatives of designs A, B, C, and c 1, c 2, c 3 represent the different average customer volumes (80, 100, and 120) that might occur. Example: Good Eats Café

38 Decision Tree l Decision Tree 11 (.2) (.4) (.4) (.4) (.2) (.4) (.4) (.2) (.4) d1d1d1d1 d2d2d2d2 d3d3d3d3 c1c1c1c1 c1c1c1c1 c1c1c1c1 c2c2c2c2 c3c3c3c3 c2c2c2c2 c2c2c2c2 c3c3c3c3 c3c3c3c3Payoffs10,000 15,000 14,000 8,000 18,000 12,000 6,000 16,000 21, Example: Good Eats Café

39 Expected Value For Each Decision Expected Value For Each Decision Choose the design with largest EV -- Design C. Choose the design with largest EV -- Design C d1d1d1d1 d2d2d2d2 d3d3d3d3 EV =.4(10,000) +.2(15,000) +.4(14,000) = $12,600 = $12,600 EV =.4(8,000) +.2(18,000) +.4(12,000) = $11,600 = $11,600 EV =.4(6,000) +.2(16,000) +.4(21,000) = $14,000 = $14,000 Design A Design B Design C Example: Good Eats Café

40 Facility Location

41 A Sequence of Decisions National Decision Regional Decision Community Decision Site Decision Political, social, economic stability; Currency exchange rates;..... Climate; Customer concentrations; Degree of unionization;..... Transportation system availability; Preference of management;..... Site size/cost; Environmental impact; Zoning restrictions;.....

42 Factors Affecting the Location Decision l Economic l Site acquisition, preparation and construction costs l Labor costs, skills and availability l Utilities costs and availability l Transportation costs l Taxes

43 Factors Affecting the Location Decision l Non-economic l Labor attitudes and traditions l Training and employment services l Community’s attitude l Schools and churches l Recreation and cultural attractions l Amount and type of housing available

44 Facility Types and Their Dominant Locational Factors l Mining, Quarrying, and Heavy Manufacturing l Near their raw material sources l Abundant supply of utilities l Land and construction costs are inexpensive l Light Manufacturing l Availability and cost of labor l Warehousing l Proximity to transportation facilities l Incoming and outgoing transportation costs l... more

45 Facility Types and Their Dominant Locational Factors l R&D and High-Tech Manufacturing l Ability to recruit/retain scientists, engineers, etc. l Near companies with similar technology interests l Retailing and For-Profit Services l Near concentrations of target customers l Government and Health/Emergency Services l Near concentrations of constituents

46 Some Reasons the Facility Location Decision Arises l Changes in the market l Expansion l Contraction l Geographic shift l Changes in inputs l Labor skills and/or costs l Materials costs and/or availability l Utility costs l... more

47 Some Reasons the Facility Location Decision Arises l Changes in the environment l Regulations and laws l Attitude of the community l Changes in technology

48 Analyzing Service Location Decisions Consumer Behavior Research Research Market Research Data Gathering for Each Location Alternative Data Gathering for Each Location Alternative Revenue Projections for Each Location Alternative Revenue Projections for Each Location Alternative Why do customers buy our products and services? Who are our customers? What are their characteristics? What are the economic projections? What is the time-phased revenue? Profit Projections for Each Location Alternative Profit Projections for Each Location Alternative What are the projected revenues less time-phased operating costs? Where are our customers concentrated? What are their traffic/spending patterns?

49 Analyzing Industrial Facility Locations Factors that tend to dominate the industrial-facility location decision are: l Transportation costs l Labor cost and availability l Materials cost and availability l Utilities cost

50 Analyzing Industrial Facility Locations l Locating a Single Facility l A simple way to analyze alternative locations is conventional cost analysis l Pros – ease of communication and understanding l Cons – time value of money ignored and qualitative factors not considered l Locating Multiple Facilities l More sophisticated techniques are often used: l Linear programming, computer simulation, network analysis, and others

51 Qualitative Factors in Location Decisions Often-important qualitative factors include l Housing l Climate l Community activities l Education and health services l Recreation l Churches l Union activities l Community attitudes

52 Integrating Qualitative & Quantitative Factors l Managers often wrestle with the task of trading off qualitative factors against quantitative ones l Methods for systematically displaying the relative advantages and disadvantages, both qualitative and quantitative, of each location alternative have been developed l The relative-aggregate-scores approach is one such method

53 Relative-Aggregate-Scores Approach Quantitative and Qualitative Factors Location A Location B Location A Location B Econ. Wgt. Econ. Wgt. Econ. Wgt. Econ. Wgt. Factor Weight Data Score Score Data Score Score Prod.cost/ton.45$ $ Transp.cost/ton.35$ $ Labor Avail Union Activity Total Score

54 Wrap-Up: World-Class Practice l Outstanding long-range business plans l Long-range capacity studies l Justify investment on how it positions their company to capture market share l Facility location decisions involve worldwide search for sites

55 End of Chapter 5, Part A