1. McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 5 Capacity Planning For Products and Services

2. 5-2 Learning Objectives  Explain the importance of capacity planning.  Discuss ways of defining and measuring capacity.  Describe the determinants of effective capacity.  Discuss the major considerations related to developing capacity alternatives.  Briefly describe approaches that are useful for evaluating capacity alternatives

3. 5-3 Capacity Planning  Capacity is the upper limit or ceiling on the load that an operating unit can handle.  Capacity also includes  Equipment  Space  Employee skills  The basic questions in capacity handling are:  What kind of capacity is needed?  How much is needed?  When is it needed?

4. 5-4 1.Impacts ability to meet future demands 2.Affects operating costs 3.Major determinant of initial costs 4.Involves long-term commitment 5.Affects competitiveness 6.Affects ease of management 7.Globalization adds complexity 8.Impacts long range planning Importance of Capacity Decisions

5. 5-5 Capacity  Design capacity  maximum output rate or service capacity an operation, process, or facility is designed for  Effective capacity  Design capacity minus allowances such as personal time, maintenance, and scrap  Actual output  rate of output actually achieved--cannot exceed effective capacity.

6. 5-6 Efficiency and Utilization Actual output Efficiency = Effective capacity Actual output Utilization = Design capacity Both measures expressed as percentages

7. 5-7 Actual output = 36 units/day Efficiency = = 90% Effective capacity 40 units/ day Utilization = Actual output = 36 units/day = 72% Design capacity 50 units/day Efficiency/Utilization Example Design capacity = 50 trucks/day Effective capacity = 40 trucks/day Actual output = 36 units/day

8. 5-8 Determinants of Effective Capacity  Facilities  Product and service factors  Process factors  Human factors  Policy factors  Operational factors  Supply chain factors  External factors

9. 5-9 Strategy Formulation  Capacity strategy for long-term demand  Demand patterns  Growth rate and variability  Facilities  Cost of building and operating  Technological changes  Rate and direction of technology changes  Behavior of competitors  Availability of capital and other inputs

10. 5-10 Key Decisions of Capacity Planning 1.Amount of capacity needed Capacity cushion (100% - Utilization) 2.Timing of changes 3.Need to maintain balance 4.Extent of flexibility of facilities Capacity cushion – extra demand intended to offset uncertainty

11. 5-11 Steps for Capacity Planning 1.Estimate future capacity requirements 2.Evaluate existing capacity 3.Identify alternatives 4.Conduct financial analysis 5.Assess key qualitative issues 6.Select one alternative 7.Implement alternative chosen 8.Monitor results

12. 5-12 Forecasting Capacity Requirements  Long-term vs. short-term capacity needs  Long-term relates to overall level of capacity such as facility size, trends, and cycles  Short-term relates to variations from seasonal, random, and irregular fluctuations in demand

13. 5-13 Calculating Processing Requirements If annual capacity is 2000 hours, then we need three machines to handle the required volume: 5,800 hours/2,000 hours = 2.90 machines

14. 5-14  Need to be near customers  Capacity and location are closely tied  Inability to store services  Capacity must be matched with timing of demand  Degree of volatility of demand  Peak demand periods Planning Service Capacity

15. 5-15 In-House or Outsourcing 1.Available capacity 2.Expertise 3.Quality considerations 4.Nature of demand 5.Cost 6.Risk Outsource: obtain a good or service from an external provider

16. 5-16 Developing Capacity Alternatives 1.Design flexibility into systems 2.Take stage of life cycle into account 3.Take a “big picture” approach to capacity changes 4.Prepare to deal with capacity “chunks” 5.Attempt to smooth out capacity requirements 6.Identify the optimal operating level

17. 5-17 Bottleneck Operation Figure 5.2 Machine #2 Bottleneck Operation Bottleneck Operation Machine #1 Machine #3 Machine #4 10/hr 30/hr Bottleneck operation: An operation in a sequence of operations whose capacity is lower than that of the other operations

18. 5-18 Bottleneck Operation Operation 1 20/hr. Operation 2 10/hr. Operation 3 15/hr. 10/hr. Bottleneck Maximum output rate limited by bottleneck

19. 5-19 Economies of Scale  Economies of scale  If the output rate is less than the optimal level, increasing output rate results in decreasing average unit costs  Diseconomies of scale  If the output rate is more than the optimal level, increasing the output rate results in increasing average unit costs

20. 5-20 Optimal Rate of Output Minimum cost Average cost per unit 0 Rate of output Production units have an optimal rate of output for minimal cost. Figure 5.4 Minimum average cost per unit

21. 5-21 Economies of Scale Minimum cost & optimal operating rate are functions of size of production unit. Average cost per unit 0 Small plant Medium plant Large plant Output rate Figure 5.5

22. 5-22 Evaluating Alternatives  Cost-volume analysis  Break-even point  Financial analysis  Cash flow  Present value  Decision theory  Waiting-line analysis

23. 5-23 Cost-Volume Relationships Amount ($) 0 Q (volume in units) Total cost = VC + FC Total variable cost (VC) Fixed cost (FC) Figure 5.6a

24. 5-24 Cost-Volume Relationships Amount ($) Q (volume in units) 0 Total revenue Figure 5.6b

25. 5-25 Cost-Volume Relationships Amount ($) Q (volume in units) 0 BEP units Profit Total revenue Total cost Figure 5.6c

26. 5-26 Break-Even Problem with Step Fixed Costs Quantity FC + VC = TC Step fixed costs and variable costs. 1 machine 2 machines 3 machines Figure 5.7a

27. 5-27 Break-Even Problem with Step Fixed Costs $ TC BEP 2 3 TR Quantity 1 2 3 Multiple break-even points Figure 5.7b

28. 5-28 1.One product is involved 2.Everything produced can be sold 3.Variable cost per unit is the same regardless of volume 4.Fixed costs do not change with volume 5.Revenue per unit constant with volume 6.Revenue per unit exceeds variable cost per unit Assumptions of Cost-Volume Analysis

29. 5-29 Financial Analysis  Cash Flow - the difference between cash received from sales and other sources, and cash outflow for labor, material, overhead, and taxes.  Present Value - the sum, in current value, of all future cash flows of an investment proposal.

30. 5-30 Decision Theory  Helpful tool for financial comparison of alternatives under conditions of risk or uncertainty  Suited to capacity decisions  See Chapter 5 Supplement

31. 5-31 Waiting-Line Analysis  Useful for designing or modifying service systems  Waiting-lines occur across a wide variety of service systems  Waiting-lines are caused by bottlenecks in the process  Helps managers plan capacity level that will be cost-effective by balancing the cost of having customers wait in line with the cost of additional capacity