Operations

Management
Capacity Planning
Supplement 7
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 Outline
 CAPACITY
 Defining Capacity
 Capacity and Strategy
 Capacity Considerations
 Managing Demand
 CAPACITY PLANNING
 BREAKEVEN ANALYSIS
 Single-Product Case
 Multiproduct Case

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Principles of Operations Management, 5e, and Operations S7-2
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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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Principles of Operations Management, 5e, and Operations S7-3
Management, 7e
 Learning Objectives
When you complete this supplement, you should
be able to :
Identify or Define:
 Capacity
 Design Capacity
 Effective Capacity
 Utilization

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Principles of Operations Management, 5e, and Operations S7-4
Management, 7e
 Learning Objectives
When you complete this supplement, you should
be able to:
Explain:
 Capacity Considerations
 Net Present Value Analysis
 Breakeven Analysis
 Financial Considerations
 Strategy-Driven Investments

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Principles of Operations Management, 5e, and Operations S7-5
Management, 7e
 Facility Planning

Facility planning answers:

 How much long-range capacity is needed
 When more capacity is needed
 Where facilities should be located (location)
 How facilities should be arranged (layout)

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Principles of Operations Management, 5e, and Operations S7-6
Management, 7e
 Capacity Planning Process

Develop Quantitative
Forecast
Alternative Factors
Demand
Plans (e.g., Cost)

Compute Evaluate Qualitative

Rated Capacity Factors
Capacity Plans (e.g., Skills)

Compute Select Best

Implement
Needed Capacity
Best Plan
Capacity Plan

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Principles of Operations Management, 5e, and Operations S7-7
Management, 7e
 Types of Planning Over a Time
Horizon

Long Range Add Facilities

Planning Add long lead time equipment *

Intermediate Sub-Contract Add Personnel

Range Planning Add Equipment Build or Use Inventory
Add Shifts

Schedule Jobs
Short Range * Schedule Personnel
Planning Allocate Machinery

*Limited options exist Modify Capacity Use Capacity

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Principles of Operations Management, 5e, and Operations S7-8
Management, 7e
Definition and Measures of Capacity
Capacity: The “throughput,” or number of units a facility
can hold, receive, store, or produce in a period
of time.

Effective Capacity a firm can expect to receive given its

capacity: product mix, methods of scheduling,
maintenance, and standards of quality.

Utilization: Actual output as a percent of design capacity.

Efficiency: Actual output as a percent of effective capacity.

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Principles of Operations Management, 5e, and Operations S7-9
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 Actual or Expected Output

Actual (or Expected) Output =

(Effective Capacity)(Efficiency)

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Principles of Operations Management, 5e, and Operations S7-10
Management, 7e
 Utilization
Measure of planned or actual capacity usage of a
facility, work center, or machine

Actual Output
Utilization =
Design Capacity
Planned hours to be used
=
Total hours available

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Principles of Operations Management, 5e, and Operations S7-11
Management, 7e
 Efficiency
Measure of how well a facility or machine is
performing when used
Actual output
Efficiency =
Effective Capacity
Actual output in units
=
Standard output in units
Average actual time
=
Standard time
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Principles of Operations Management, 5e, and Operations S7-12
Management, 7e
Implications of Capacity Changes

Changes in:
• Sales
• Cash flow
• Quality
• Supply chain
• Human resources
• Maintenance

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Principles of Operations Management, 5e, and Operations S7-13
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 Special Requirements for Making
Good Capacity Decisions

 Forecast demand accurately

 Understanding the technology and capacity
increments
 Finding the optimal operating level (volume)
 Build for change

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Principles of Operations Management, 5e, and Operations S7-14
Management, 7e
Cost Structure for a Roadside Motel

25 room 75 room
roadside motel 50 room roadside motel
roadside motel

Economies of Diseconomies
Scale of Scale

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Principles of Operations Management, 5e, and Operations S7-15
Management, 7e
 Strategies for Matching Capacity
to Demand
1. Making staffing changes (increasing or
decreasing the number of employees)
2. Adjusting equipment and processes – which
might include purchasing additional machinery
or selling or leasing out existing equipment
3. Improving methods to increase throughput;
and/or
4. Redesigning the product to facilitate more
throughput
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Principles of Operations Management, 5e, and Operations S7-16
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 Approaches to Capacity
Expansion
Expected Demand Expected Demand

New Capacity New Capacity

Demand
Demand

Time in Years Time in Years

Capacity leads demand with an incremental expansion Capacity leads demand with a one-step expansion

Expected Demand Expected Demand

New Capacity
New Capacity
Demand

Demand

Time in Years Time in Years

Capacity lags demand with an incremental expansion
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Management, 7e
Attempts to have an average capacity, with
an incremental expansion
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S7-17
 Approaches to Capacity
Expansion
Expected Demand

New Capacity
Demand

Time in Years

Capacity leads demand with an incremental expansion

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Principles of Operations Management, 5e, and Operations S7-18
Management, 7e
 Approaches to Capacity
Expansion
Expected Demand

New Capacity
Demand

Time in Years
Capacity leads demand with a one-step expansion

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Principles of Operations Management, 5e, and Operations S7-19
Management, 7e
 Approaches to Capacity
Expansion
Expected Demand
New Capacity
Demand

Time in Years
Capacity lags demand with an incremental expansion
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Principles of Operations Management, 5e, and Operations S7-20
Management, 7e
 Approaches to Capacity
Expansion
Expected Demand
New Capacity
Demand

Time in Years
Attempts to have an average capacity, with an incremental
expansion
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Principles of Operations Management, 5e, and Operations S7-21
Management, 7e
 Breakeven Analysis

 Technique for evaluating process & equipment

alternatives
 Objective: Find the point ($ or units) at which total
cost equals total revenue
 Assumptions
 Revenue & costs are related linearly to volume
 All information is known with certainty
 No time value of money

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Principles of Operations Management, 5e, and Operations S7-22
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 Break-Even Analysis

 Fixed costs: costs that continue even if no

units are produced: depreciation, taxes, debt,
mortgage payments
 Variable costs: costs that vary with the volume
of units produced: labor, materials, portion of
utilities

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Principles of Operations Management, 5e, and Operations S7-23
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 Breakeven Chart

Total revenue line

Breakeven point Profit
Total cost = Total revenue
Total cost line
Cost in Dollars

Variable cost

Loss Fixed cost

Volume (units/period)

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Principles of Operations Management, 5e, and Operations S7-24
Management, 7e
 Crossover Chart
Process A: low volume, high variety
Process B: Repetitive
Process C: High volume, low variety

Fixed cost - Process C

Fixed cost - Process B
Fixed cost - Process A

Process A Process B Process C Lowest cost process

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Principles of Operations Management, 5e, and Operations S7-25
Management, 7e
 Cost of Wrong Process Found Via
Breakeven Analysis
Variable Variable
Variable
$ $ cost $ cost
cost

Fixed cost Fixed cost Fixed cost

Low volume, high Repetitive process High volume, low
variety process variety process
Total cost for low
volume high variety
Total cost for repetitive process
B1 Total cost for high volume,
low variety process
B2
B3

A B
Volume
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Principles of Operations Management, 5e, and Operations S7-26
Management, 7e
Decision Tree and Capacity Decision

-$14,000 Market favorable (0.4) $100,000

Market unfavorable (0.6)
-$90,000
$18,000 Market favorable (0.4) $60,000

Market unfavorable (0.6) -10,000

$13,000 Market favorable (0.4) -5,000

Market unfavorable (0.6) $40,000

$0
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Principles of Operations Management, 5e, and Operations S7-27
Management, 7e
 Strategy Driven Investment
 Select investments as part of a coordinated strategic
plan
 Choose investments yielding competitive advantage
 Consider product life cycles
 Include a variety of operating factors in the financial
return analysis
 Test investments in light of several revenue
projections

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Principles of Operations Management, 5e, and Operations S7-28
Management, 7e
 Net Present Value

F = future value
P = present value F
I = interest rate P
(i  1)
N

N = number of years

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Principles of Operations Management, 5e, and Operations S7-29
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 NPV in a More Convenient Form
Present value of $1.00
F Year 5% 6% 7% 8%
P 1 0.952 0.943 0.935 0.857
(i  1)
N

2 0.907 0.890 0.873 0.857

3 0.864 0.840 0.816 0.794
P  FX 4 0.823 0.792 0.763 0.735
1 5 0.784 0.747 0.713 0.681
where X 
(i  1 ) N 6 0.746 0.705 0.666 0.630
7 0.711 0.665 0.623 0.583
8 0.677 0.627 0.582 0.540
9 0.645 0.592 0.544 0.500
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Principles of Operations Management, 5e, and Operations S7-30
Management, 7e
 Present Value of an Annuity (S)
 X = Factor from Table Year 5% 6% 7% 8%
1 0.952 0.943 0.935 0.926
 S = present value of a
2 1.859 1.833 1.808 1.783
series of uniform annual
3 2.723 2.673 2.624 2.577
receipts
4 3.546 3.465 3.387 3.312
 R = receipts that are
5 4.329 4.212 4.100 3.993
received every year for
6 5.076 4.917 4.766 4.623
the life of the investment
7 5.786 5.582 5.389 5.206
8 6.843 6.210 5.971 5.747
S  RX 9 7.108 6.802 7.024 6.247
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Principles of Operations Management, 5e, and Operations S7-31
Management, 7e
 Limitations of Net Present Value
 Investments with the same present value may
have significantly different project lives and
different salvage values
 Investments with the same net present values
may have different cash flows
 We assume that we know future interest rates -
which we do not
 We assume that payments are always made at
the end of the period - which is not always the
case
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Principles of Operations Management, 5e, and Operations S7-32
Management, 7e
 Extras
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Principles of Operations Management, 5e, and Operations S7-33
Management, 7e
 Managing Existing Capacity

Demand Management Capacity Management

 Vary prices  Vary staffing
 Vary promotion  Change equipment
& processes
 Change lead times
 Change methods
(e.g., backorders)
 Redesign the product for
 Offer complementary faster processing
products

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Principles of Operations Management, 5e, and Operations S7-34
Management, 7e
 Complementary Products
Sales (Units)
5,000
Total
4,000
Snow-
3,000 mobiles
2,000
1,000 Jet Skis
0
J M M J S N J M M J S N J
Time (Months)
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Principles of Operations Management, 5e, and Operations S7-35
Management, 7e