1. Strategic Capacity Management
Dr. Ron Lembke
Operations Management

2. 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?

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

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

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

6. Growth of Service Economy

7. US Productivity Growth

8. 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

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

10. 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

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

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

13. “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”

14. 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, me, and we can talk as much as you want

15. Example 3.3 Paul’s 1 2 3 4 5 Bottles 60 100 150 200 250
Bags
Newman’s
Bottles
Bags

16. Example 3.3
Bottles
Bags ,050 1,180
3 bottle machines 150k each/yr = 450k
5 bag machines, 250k each/yr = 1,250k

17. Example 3.3 Bottles 135 185 245 297 348 Machines 1 2 2 2 3
Mach. usage
Workers
Bags ,050 1,180
Machines
Mach Usage
Workers

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

19. 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

20. 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.

21. 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?

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

23. 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”

24. 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

25. 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

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

27. 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.

28. 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.

29. 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

30. 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

31. 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: *4-87=843
Wait, strong, do nothing: 170*5 = 850
Wait, low, do nothing: 105*5 = 525

32. 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

33. 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”

34. 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

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

36. 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

37. 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

38. 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)

39. 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

40. 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

41. 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

42. 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