L5 Strategic Capacity Planning For Products and Services - Feu PDF

5-1 Capacity Planning
What should be the

seating capacity of a
concert hall?
How many customers

per day should Viking be
able to serve?
How large should a

Frito-Lay plant be able
to produce 75,000 bags
of Ruffles in an 8-hour
shift?
LECTURE
5 For Products and Services
Learning Roadmap
Be aware of
Examine the the
major approaches
Describe the considerations
useful for
factors that related to evaluating
Know the
Understand determine developing capacity
ways of
the goals and effective capacity alternatives.
defining and
strategic capacity alternatives. .
measuring
importance of alternatives.
capacity.
capacity
planning.
Capacity Planning
• Capacity planning is a key
strategic component in
designing the system
• Aims to achieve a match

between the long-term
supply capabilities of an
organization and the
predicted long-term demand
Planning Over a Time Horizon
Time Horizon
Options for Adjusting Capacity
Long-range Add facilities

planning
Intermediate-
Add long lead time equipment *
range Subcontract Add personnel
planning Add equipment Build or use inventory
(aggregate Add shifts
planning)
Schedule jobs
Short-range
planning
(scheduling)
* Schedule personnel
Allocate machinery
Modify capacity Use capacity

* Difficult to adjust capacity as limited options exist
TO© BE
2014 CONT.
Pearson Education, Inc. S7 - 6
Three Inputs to Capacity Decision
How much
is needed?
What kind
When it is
of capacity
needed?
is needed?
Capacity
Planning
What is the strategic importance of

capacity decisions?
Strategic Importance of
Capacity Decisions
Capacity Defined
• the upper limit on the load that an operating unit can
handle.
Capacity Defined
• the upper limit on the load that an operating unit can
handle.
• load – no. of physical units produced or no. of services
performed
• operating unit - a plant, department, machine, store, or
worker
• capacity needs – equipment, space and employee skills
Common Measures of Capacity

Business Output Input
Auto manufacturing No. of cars per hr./shift/ day Labor hrs./machine hrs.
Steel mill Tons per day Furnace size
Oil refinery Gallons/barrels per day Refinery size
Restaurant ? No. of tables, seating
cap.
Theater ? No. of seats
Retail stores ? Square feet of floor size
• No single measure of capacity will be appropriate in

every situation, it must be tailored to the situation
Design and Effective Capacity
► Design capacity: the maximum theoretical
output of a system; expressed as a rate
► Effective capacity: the capacity a firm expects
to achieve given current operating constraints
► Often lower than design capacity
• Actual output
the rate of output actually achieved due to machine
breakdowns, absenteeism, shortage of materials;
not exceeding effective capacity
© 2014 Pearson Education, Inc. S7 - 13

Measure of Capacity

Utilization and Efficiency
Utilization is the percent of design
capacity actually achieved
Utilization = Actual output/Design capacity
Efficiency is the percent of effective

capacity actually achieved
Efficiency = Actual output/Effective capacity

Bakery Example
Zurich Bakery has a plant for processing Deluxe
breakfast rolls and wants to better understand its
capability. Last week the facility produced 148,000
rolls. The effective capacity is 175,000 rolls. The
production line operates 7 days per week, with three
8-hour shifts per day. The line was designed to
process the nut-filled, cinnamon-flavored Deluxe roll
at a rate of 1,200 per hour. Determine the design
capacity, utilization, and efficiency for this plant when
producing this Deluxe roll.

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

Bakery Example

Bakery Example
Utilization = 148,000/201,600 = 73.4%

Bakery Example
Utilization = 148,000/201,600 = 73.4%
Efficiency = 148,000/175,000 = 84.6%

Bakery Example
Utilization = 148,000/201,600 = 73.4%
Efficiency = 148,000/175,000 = 84.6%

Bakery Example
Efficiency = 84.6%
Efficiency of new line = 75%
Expected Output = (Effective Capacity)(Efficiency)
= (175,000)(.75) = 131,250 rolls

Bakery Example
Efficiency = 84.6%
Efficiency of new line = 75%
Expected Output = (Effective Capacity)(Efficiency)
= (175,000)(.75) = 131,250 rolls

Midterm Discussions
Final Discussions
Learning Exercise 1
The manager of Zurich Bakery now needs to increase production of the
increasingly popular Deluxe roll. To meet this demand, he will be
adding a second production line. The second line has the same design
capacity (201,600) and effective capacity (175,000) as the first line;
however, new workers will be operating the second line. Quality
problems and other inefficiencies stemming from the inexperienced
workers are expected to reduce output on the second line to 130,000
(compared to 148,000 on the first). The utilization and efficiency were
73.4% and 84.6%, respectively, on the first line. Determine the new
utilization and efficiency for the Deluxe roll operation after adding the
second line.
A) 68.95 percent; 79.43 percent

B) 69.40 percent; 67.2 percent
C) 87.5 percent; 95.10 percent
D) 73.50 percent; 75.40 percent
Learning Exercise 2
The staff training center at a large regional hospital provides training
sessions in CPR to all employees. Assume that the capacity of this
training system was designed to be 1200 employees per year. Since
the training center was first put into use, the program has become more
complex, so that 1050 now represents the most employees that can be
trained per year. In the past year, 950 employees were trained. The
efficiency of this system is approximately ________ and its utilization is
approximately ________.
A) 79.2 percent; 90.5 percent

B) 90.5 percent; 79.2 percent
C) 87.5 percent; 950 employees
D) 950 employees; 1050 employees
E) 110.5 percent; 114.3 percent
Learning Exercise 3
An executive conference center has the physical ability to
handle 1,100 participants. However, conference
management personnel believe that only 1,000 participants
can be handled effectively for most events. The last event,
although forecasted to have 1,000 participants, resulted in
the attendance of only 950 participants. What are the
utilization and efficiency of the conference facility?
Learning Exercise 3 Solution

Answer: Design Capacity = 1,100 participants
Effective Capacity = 1,000 participants
Actual Output = 950 participants
Efficiency and Utilization (cont.)

• the key to improving capacity utilization
is to increase effective capacity by
- correcting quality problems

- maintaining equipment in good
condition
- fully training employees…
What are the Determinants of

Effective Capacity?
• Facilities
• Product and service
• Process
• Human factors
• Operational
• Supply Chain
• External factors
Facilities
Product/Service
Process
Effective
Human
Capacity
Operational
External
Facilities – design,
location, layout, environment
Product/Service – design
and product/service mix
Process – quantity and

quality capabilities
Human – job content, job
design, training & experience, Effective
motivation, compensation,
learning rates, absenteeism Capacity
Operational – scheduling,
material mgt., quality,
maintenance
External – standards,
safety regulations, unions,
pollution
Capacity Strategy Formulation

• long-term demand patterns, technological changes,
and competitor’s behavior
• It involves
(1) growth rate and variability of demand
(2) cost of building and operating facilities
(3) rate and technological innovation
(4) behavior of competitors
(5) availability of capital and other inputs
Key Decisions of Capacity Planning

1. The amount of capacity needed.
2. The timing of changes.
3. The need to maintain balance throughout the
system
4. The extent of flexibility of facilities and the
workforce.
Capacity Cushion
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.
Determining Capacity Requirements

•• Long-term
- overall level of capacity (e.g. facility size)
- determined by forecasting demand
• Short-term
- variations in capacity requirements
- concerned with seasonal variation
Items with seasonal demand patterns
Period Items
Year toy sales, clothing, vacations, tourism
Month bank transactions
Week retail sales, restaurant meal, hotel
registration
Day telephone calls, public transportation,
retail sales
Determining Capacity Requirements (cont)

Evaluate Existing Capacity

Requirements
▪ Accurate demand forecasts for each product
▪ Standard processing time for each product on

each alternative machine
▪ Number of workdays per year
▪ Number of shifts to be used

Calculating Processing Requirements

A department works one eight hour shift, 250 days a year,
and below are the figures for usage of a machine that is
being considered:
Standard
Annual processing time Processing time
Product Demand per unit (hr.) needed (hr.) • Annual capacity =
8 × 250 = 2,000
#1 400 5.0 2,000
#2 300 8.0 2,400 • Number of machines

required =
#3 700 2.0 1,400 5,800 ÷ 2,000 = 2.90
5,800
Planning Service Capacity

3 Important Factors:
1. Need to be near customers
• Convenience for customers is imperative
2. Timing of demand
• Capacity must be matched with timing of demand
3. Degree of volatility of demand
• Peak demand periods
Make or Buy
Decision whether to produce a good or provide a service
itself or to outsource from another organization.
Reasons for Outsourcing

1. Available capacity
2. Expertise
3. Quality considerations
4. Nature of demand
5. Cost
6. Risk
Make or Buy Illustration

Crossroad Corporation’s manager must decide
whether to make or buy a certain item used in the
production of vending machine. Cost and volume
estimates are as follows:
Make Buy
Annual fixed cost P150,000 None
Variable cost/unit P 60 P 80
Annual volume (units) P 12,000 12,000
Should the firm buy or make this item?

Make or Buy Illustration

Determine the annual cost of each alternative.
Total Cost = Fixed cost + Volume x Variable cost
Make: P 150,000 + 12,000(P60) = P870,000

Buy: 0 + 12,000(P80) = P960,000
Because the annual cost of making the item is less than

the annual cost of buying it, the manager would
reasonably choose to make the item.
Developing Capacity Alternatives

1. Design flexibility into the system.
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.

(cont.)
• Design flexibility into the system - long-term nature

of many capacity decisions and the risks inherent in long-term
forecasts suggest potential benefits from designing flexible
systems – flexible plants, flexible processes, flexible workers

(cont.)
• Take stage of life cycle into account – capacity

requirements are linked to the stage of the life cycle that a
product or service is in

(cont.)
• Take a “big picture” approach to capacity changes

– the importance of how parts of the system interrelate
• What is the risk of not taking this approach?

(cont.)
• Prepare to deal with capacity “chunks” - capacity

increases are often acquired in fairly large chunks rather than
smooth increments, making it difficult to achieve a match
between desired capacity and feasible capacity

(cont.)
• Attempt to smooth out capacity requirements
 Demand exceeds capacity

 Curtail demand by raising prices, scheduling longer lead time
 Long term solution is to increase capacity
 Capacity exceeds demand

 Stimulate demand
 Product change

(cont.)
• Attempt to smooth out capacity requirements (cont.)

- adjusting to seasonal demands, produce products with
complementary demand patterns

(cont.)
• Identify the optimal operating level

Economies and Diseconomies 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
Economies and
Diseconomies of Scale
(dollars per room per night)
Average unit cost
25 - room 75 - room
roadside motel 50 - room roadside motel
roadside motel
Economies Diseconomies
of scale of scale
25 50 75
Number of Rooms
© 2008 Prentice Hall, Inc. S7 – 58
Evaluating Alternatives
- aims to examine alternatives for future capacity from a
number of different perspectives
Economic consideration
- will an alternative be economically feasible?
- how much it will cost? What will be its useful life?
Negative public opinions

- any option that could disrupt lives and property is bound to
generate hostile reactions
Evaluation Techniques
• Cost-Volume Analysis
• Financial analysis
• Decision theory
• Waiting-line analysis
Cost-Volume Analysis
focuses on relationship among cost, revenue and
volume of output
Purpose: To estimate the income of the organization

under different operating conditions
Method: Identify all costs related to production of a
given product and then designate as fixed or variable
cost
fixed costs tend to remain constant regardless of
volume of production
examples: rental costs, taxes, depreciation
variable costs – vary directly with volume of output

examples: materials and labor costs
FC = fixed cost R = revenue per unit

VC = total variable cost Q = quantity or volume of output
v = variable cost per unit QBEV = Breakeven quantity
TC = total cost P – profit
TR = total revenue
Assumptions of Cost-Volume Analysis

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
The total cost is equal to the sum of the fixed cost and
the variable cost per unit times volume
TC = FC + VC
VC = Q x v Amount (P)
Fixed cost (FC)
0
Q (volume in units)
Total revenue will have a linear relationship to output
The total revenue associated with a given quantity of
output, Q is:
TR = R x Q Amount (P)
0
Q (volume in units)
Breakeven Point (BEP) TC = TR
Volume < BEP = Loss
Amount
Volume > BEP = Profit
($)
The greater the deviation from
this point, the greater the profit 0 BEP units
or loss Q (volume in units)
Break-Even Analysis
–
Total revenue line
900 –
800 –
Break-even point Total cost line
700 – Total cost = Total revenue
Cost in dollars
600 –
500 –
400 – Variable cost
300 –
200 –
100 – Fixed cost

–
| | | | | | | | | | | |
0 100 200 300 400 500 600 700 800 900 1000 1100
Volume (units per period)
Figure S7.6
© 2008 Prentice Hall, Inc. S7 – 68
Example:
The owners of Hinilawod Pies, is contemplating adding a
new line pies, which will require leasing of new equipment
for a monthly payment of P6,000. Variable costs would be
P2.00 per pie, and pie would retain for P7.00 each.
a. How many pies must be sold in order to breakeven?

b. What should the profit (loss) be if 1,000 pies are
made and sold in a month?
c. How many pies must be sold to realize a profit of
P4,000?
Solution:
FC = P6,000
v = P2/pie
Rev = P7/pie
a. How many pies must be sold in order to breakeven?
QBEV = FC/Rev – v
= 6,000/7-2
QBEV = 1,200 pies/month
Solution:
FC = P6,000
v = P2/pie
Rev = P7/pie
b. What should the profit be if 1,000 pies are made

and sold in a month?
For Q = 1,000,
P = Q(R – v) – FC
= 1,000(7-2) – 6,000
= -1,000
Solution:
FC = P6,000
v = P2/pie
Rev = P7/pie
c. How many pies must be sold to realize a profit
of P4,000?
P + FC
Q = ----------------------
R-v
P = 4,000
4,000 + 6,000
Q = ---------------------- = 2,000 pies
P7 – P2
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.
Financial Analysis
Payback - the length of time it will take for an investment
to return its original cost.
Rule: The better investment is the one with shorter

payback period
Illustration:
Assuming Kalipulako Enterprises considers a project with costs of P100,000
and is expected to return P20,000 annually.
Payback Period = P100,000/20,000

Payback Period = 5 years
2 Drawbacks: 1. It ignores any benefits that occur after the payback period,
and 2. It does not measure profitability.
Financial Analysis
Present value (PV) method - summarizes the initial cost of an

investment, its estimated annual cash flows, and any expected
salvage value in a single value called the equivalent current value,
taking into account the time value of money (i.e., interest rates).
It describes how much a future sum of money is worth

today.
PV = CF/(1+r)n
Where:
CF = cash flow in future period
r = the periodic rate of return/interest/dr
n = number of periods
Financial Analysis
Illustration:
Assume that you would like to put money in an account today to make
sure your child has enough money in 10 years to buy a car. If you
would like to give your child P10,000 in 10 years, and you know you
can get 5% interest per year from a savings account during that time,
how much should you put in the account now? The present value
formula tells us:
PV = P10,000/ (1 + .05)10 = P6,139.13
Thus, P6,139.13 will be worth P10,000 in 10 years if you can earn

5% each year. In other words, the present value of P10,000 in this
scenario is P6,139.13.
Financial Analysis
IRR or internal rate of return - summarizes the initial cost,

expected annual cash flows, and estimated future salvage value of
an investment proposal in an equivalent interest rate.
Internal rate of return is used to evaluate the attractiveness of a project or

investment. If the IRR of a new project exceeds a company’s required rate
of return, that project is desirable. If IRR falls below the required rate of
return, the project should be rejected.
Summary
• Capacity decisions are important because it is a ceiling
on output and a major determinant of operating costs.
• Three key inputs to capacity planning are the kind of

capacity, amount and timing it will be needed.
• Capacity planning decision is strategic which often

involved significant initial investment of capital.
Summary (cont.)
• A variety of factors can interfere with effective capacity.
• Capacity planning involves long-term and short-term

considerations.
• Development of capacity alternatives is enhanced by

taking a system approach to planning, by recognizing
the capacity increments are required in chunks, by
designing flexible systems…
Collaborative Learning Exercise1

Nano merchandise produces and sells novelty items in a five state
area. The firm expects to consolidate assembly of its electric turtle line
at a single location. Currently, operations are in three widely scattered
locations. The leading candidate for location will have a monthly fixed
cost of P42,000 and variable cost of P3 per turtle. Turtles sells for P7
each. Prepare a table that shows total profits, fixed costs, variable
costs, and revenues for monthly volumes of 10,000, 12,000 and
15,000 units
Revenue = P 7 per unit
Variable cost = P 3 per unit
Fixed cost = P 42,000 per month
Profit = Q(R – v) - FC
Total cost = FC + v x Q
Collaborative Learning Exercise 2
Refer to problem 1. Develop an equation that

can be used to compute profit for any volume.
Use that equation to determine profit when
volume equals 22,000 units.
Collaborative Learning Exercise 3

ATX Pottery is considering the addition of a new plant to
absorb the backlog of demand that now exists. The primary
location being considered will have fixed costs of Php9,200
per month and variable costs of 70 centavos per unit
produced. Each item is sold to retailers at a price that
averages 90 centavos.
a. What volume per month is required in order to break even?
b. What profit would be realized on a monthly volume of 61,000 units?
87,000 units?
c. What volume is needed to obtain a profit of P16,000 per month?
d. What volume is needed to provide a revenue of P23,000 per month?

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5-1 Capacity Planning

What should be the

How many customers

How large should a

• Aims to achieve a match

Long-range Add facilities

Modify capacity Use capacity

Three Inputs to Capacity Decision

What is the strategic importance of

Common Measures of Capacity

• No single measure of capacity will be appropriate in

© 2014 Pearson Education, Inc. S7 - 13

© 2014 Pearson Education, Inc. S7 - 14

Efficiency is the percent of effective

© 2014 Pearson Education, Inc. S7 - 16

© 2014 Pearson Education, Inc. S7 - 17

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

© 2014 Pearson Education, Inc. S7 - 18

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

© 2014 Pearson Education, Inc. S7 - 19

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Utilization = 148,000/201,600 = 73.4%

© 2014 Pearson Education, Inc. S7 - 20

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%

© 2014 Pearson Education, Inc. S7 - 21

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%

© 2014 Pearson Education, Inc. S7 - 22

Expected Output = (Effective Capacity)(Efficiency)

= (175,000)(.75) = 131,250 rolls

© 2014 Pearson Education, Inc. S7 - 23

Expected Output = (Effective Capacity)(Efficiency)

= (175,000)(.75) = 131,250 rolls

© 2014 Pearson Education, Inc. S7 - 24

A) 68.95 percent; 79.43 percent

A) 79.2 percent; 90.5 percent

Learning Exercise 3 Solution

Efficiency and Utilization (cont.)

- correcting quality problems

What are the Determinants of

Process – quantity and

Capacity Strategy Formulation

Key Decisions of Capacity Planning

Steps for Capacity Planning

Determining Capacity Requirements

Items with seasonal demand patterns

Determining Capacity Requirements (cont)

Evaluate Existing Capacity

▪ Accurate demand forecasts for each product

▪ Standard processing time for each product on

▪ Number of workdays per year

▪ Number of shifts to be used

Calculating Processing Requirements

#2 300 8.0 2,400 • Number of machines

Planning Service Capacity

Reasons for Outsourcing

Make or Buy Illustration

Should the firm buy or make this item?

Make or Buy Illustration

Total Cost = Fixed cost + Volume x Variable cost