Chapter 07s Capacity Planning

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Operations Management
Supplement 7 Capacity Planning
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Outline

• Capacity
• Design and Effective Capacity
• Capacity and Strategy
• Capacity Considerations
• Managing Demand
• Capacity Planning
• Breakeven Analysis
• Single-Product Case
• Multi-product Case

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Outline Continued

• Applying Decision Trees to Capacity Decisions
• Strategy-Driven Investments
• Investment, Variable Cost and Cash Flow
• Net Present Value

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Learning Objectives

• Capacity and Strategy
• Design Effective capacity
• Utilization Efficiency

• Capacity expansions
• Break-even analysis
• Decision Tree
• Net present value analysis
• Strategy-driven investments

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Capacity

• The throughput, or the number of units a facility
  can hold, receive, store, or produce in a period
  of time
• Determines fixed costs
• Determines if demand will be satisfied or if
  facility is set idle
• Three time horizons

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Planning Horizons
Limited options exist
Figure S7.1
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Design and Effective Capacity

• Design capacity is the theoretical maximum output
  of a system in a given period under ideal
  conditions.
• Normally expressed as a rate
• Effective capacity is the capacity a firm expects
  to achieve given current operating constraints
• Often lower than design capacity

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Utilization and Efficiency
Utilization is the percent of design capacity
achieved
Utilization Actual Output / Design Capacity
Efficiency is the percent of effective capacity
achieved
Efficiency Actual Output / Effective Capacity
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Bakery Example
Actual production last week 148,000
rolls Effective capacity 175,000 rolls Design
capacity 1,200 rolls per hour Bakery operates 7
days/week, 3 - 8 hour shifts
Design capacity (7 x 3 x 8) x (1,200) 201,600
rolls
Utilization 148,000/201,600 73.4
Efficiency 148,000/175,000 84.6
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Bakery Example
Actual production last week 148,000
rolls Effective capacity 175,000 rolls Design
capacity 1,200 rolls per hour Bakery operates 7
days/week, 3 - 8 hour shifts Efficiency
84.6 Efficiency of new line 85
Output (expected ) (Effective Capacity)(New
Efficiency)
(175,000)(.85) 148,750 rolls
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Capacity Considerations

• Forecast demand accurately
• Understanding the technology and capacity
  increments
• Find the optimal operating level the right
  volume
• Build for change

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Economies and Diseconomies of Scale
Figure S7.2
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Managing Demand

• Demand exceeds capacity
• Curtail demand by raising prices, scheduling
  longer lead time
• Long term solution is to increase capacity
• Capacity exceeds demand
• Stimulate market
• Product changes
• Adjusting to seasonal (cyclical) demands
• Produce products with complimentary demand
  patterns

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Complementary Demand Patterns
By combining both, the variation is reduced
Snowmobile sales
Jet ski sales
Figure S7.3
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Tactics for Matching Capacity to Demand

• Making staffing changes
• Adjusting equipment and processes
• Purchasing additional machinery
• Selling or leasing out existing equipment
• Improving methods to increase throughput
• Redesigning the product to facilitate more
  throughput

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Approaches to Capacity Expansion
Figure S7.4
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Break-Even Analysis

• Technique for evaluating process and equipment
  alternatives
• Objective is to find the point (in dollars and
  units) at which cost equals revenue
• Requires estimation of fixed costs, variable
  costs, and revenue

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Break-Even Analysis
Figure S7.5
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Break-Even Analysis
P Unit price x of units produced F Fixed
costs V Variable costs/unit TR Total
revenue TC Total costs F Vx
BEPx Break-even point in units BEP Break-even
point in dollars
Break-even point occurs when
TR TC or Px F Vx
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Break-Even Analysis
P Unit price x of units produced F Fixed
costs V Variable costs/unit TR Total
revenue TC Total costs F Vx
BEPx Break-even point in units BEP Break-even
point in dollars
Profit TR - TC Px - (F Vx) Px - F -
Vx (P - V)x - F
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Break-Even Example
Fixed costs 10,000 Material
.75/unit Direct labor 1.50/unit Selling
price 4.00 per unit
Then, what is the profit at 6000 units?
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Break-Even Example
BEP() 22,857.14 BEP(x) 5714 units
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Break-Even Analysis
Assumptions

• Costs and revenue are linear functions
• Generally not the case in the real world
• We know the costs
• Actually very difficult to accomplish
• There is no time value of money

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Multiproduct Break-Even Analysis
Multiproduct Case
where V variable cost per unit P price per
unit F fixed costs W percent each product
is of total dollar sales i each product
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Multiproduct Example
Fixed costs 3,500 per month
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Application of Decision Trees to Capacity Decision

• A decision tree is a graphic display of the
  decision process that indicates decision
  alternatives, states of nature and their
  respective probabilities, and payoffs for each
  combination of decision alternative and state of
  nature

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Decision Trees Example
Table A.1 Decision Table
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Procedure for Decision Trees

• Define the problem
• Structure or draw the decision tree
• Assign probabilities to the states of nature
• Estimate payoffs for each possible combination of
  decision alternatives and states of nature
• By working backward, determine the EMV of each
  branch and prune the tree to find the
  alternative with the best EMV

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Decision Trees Example
EMV
A state of nature node
A decision node
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Complex Decision Tree Example
Figure A.3
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Strategy-Driven Investment

• Operations may be responsible for
  return-on-investment (ROI)
• Analyzing capacity alternatives should include
  capital investment, variable cost, cash flows,
  and net present value

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Net Present Value (NPV)
where F future value P present value i
interest rate N number of years
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NPV Using Factors
Where X a factor from Table S7.1 (defined as
1/(1 i)N)
Portion of Table S7.1
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Present Value of an Annuity
An annuity is an investment which generates
uniform equal payments
S RX
where X factor from Table S7.2 S present
value of a series of uniform annual
receipts R receipts that are received every
year of the life of the investment
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Present Value of an Annuity
Portion of Table S7.2