Chapter 5 Learning Objectives Name the three key questions in capacity planning Explain the importance of capacity planning Describe ways of defining and measuring capacity Name several determinants of effective capacity ID: 247609
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Slide1
Strategic Capacity Planning
Chapter 5Slide2
Learning Objectives
Name the three key questions in capacity planning
Explain the importance of capacity planning
Describe ways of defining and measuring capacity
Name several determinants of effective capacity
Perform
cost-volume analysisSlide3
Capacity Planning
Capacity
The upper limit or ceiling on the load that an operating unit can handle
Capacity needs include
Equipment
Space
Employee skills
Strategic Capacity Planning
To achieve a match between the
long-term
supply capabilities of an organization and the predicted level of
long-term
demand
Over-capacity
operating costs that are too high
Under-capacity strained resources and possible loss of customersSlide4
Capacity Planning Questions
Key Questions:
What kind
of capacity is needed?
How much
is needed to match demand?
When
is it needed?
Related Questions:
How much will it cost?
What are the potential benefits and risks?
Are there sustainability issues?
Should capacity be changed all at once, or through several smaller changes
Can the supply chain handle the necessary changes?Slide5
Capacity Decisions Are Strategic
Capacity decisions:
impact the ability of the organization to meet future
demands
http://
www.microsoft.com/Investor/EarningsAndFinancials/Earnings/SegmentResults/S2/FY14/Q1/Performance.aspx
affect
operating costs
major
determinant of initial cost
(often) involve long-term commitment of resources
affect competitiveness
affect
the ease of managementSlide6
Demand Management Strategies
Strategies used to offset capacity limitations and that are intended to achieve a closer match between supply and demand
Appointments
Pricing
Promotions
Discounts
Other tactics to shift demand from peak periods into slow periodsSlide7
Defining and Measuring Capacity
Design capacity
Maximum
output rate or service capacity an operation, process, or facility is
designed for
.
Effective capacity
Design capacity
minus
inefficiencies
such as operational factors, personal time, maintenance, scrap etc. -
cannot exceed design capacity
.
Actual output
Rate of output
actually achieved
—cannot exceed effective capacity.Slide8
Capacity: Illustration
These are
design capacity
from Boeing.
But you typically won’t get to reach this design capacity because some seats are taken out for, say,
extra room for
emergency exit. That’s why you have
effective capacity
.
Actual
output
would be equal of less than the effective capacity because you don’t always have that many passengers on the plane.Slide9
Measuring System Effectiveness
Efficiency
(Measured as percentages)
Utilization
(Measured as percentages
)
Efficiency
=
Actual output
Effective capacity
Utilization
=
Actual output
Design capacitySlide10
Example: Efficiency
and Utilization
Design Capacity = 50 trucks per day
Effective Capacity = 40 trucks per day
Actual Output = 36 trucks per day
Efficiency
=
Actual output
=
36
= 90%
Effective capacity
40
Utilization
=
Actual output
=
36
= 72%
Design capacity
50Slide11
Determinants of Effective Capacity
Facilities
Size, expansions, layout, transportation costs, distance to market, labor supply, energy sources
Product and service factors
(non) uniformity of output, product/service mix
Process factors
Productivity, quality, setup-time
Human factors
Tasks, variety of activities, training, skills, learning, experience, motivation, labor turnoverSlide12
Determinants of Effective Capacity
Policy factors
Overtime, second/third shifts
Operational factors
Scheduling, inventory, purchasing, materials, quality assurance/control, breakdowns, maintenance
Supply chain factors
Suppliers, warehousing, transportation, distributors
External factors
Product standards, minimum quality, safety, environment, regulations, unionsSlide13
Capacity Strategies
Leading
Build capacity in
anticipation
of future demand increases
E.g., let’s expand the restaurant because we
expect
to serve more customers in the
next year
Following
Build capacity when demand exceeds current capacity
E.g., let’s expand the restaurant because we have been full up all the time in the
past
year
Tracking
Similar to the following strategy, but adds capacity in
relatively small increments
to keep pace with increasing demand
E.g., let’s expand the restaurant because we have been full up all the time in the past monthSlide14
Capacity Cushion/Safety
Capacity
Capacity Cushion / Safety Capacity
Extra capacity used to offset demand uncertainty
Capacity cushion = Capacity – expected demand
Capacity cushion strategy
Organizations that have greater
demand uncertainty
typically use greater capacity cushion
Organizations that have
standard products and services
generally use smaller capacity cushionSlide15
Forecasting Capacity Requirements
Long-term
considerations relate to
overall
level
of capacity requirements
Require
forecasting demand
over a time horizon and
converting
those needs
into capacity requirements
E.g., Our hotel expect to serve 10 thousand customers next year.
Short-term
considerations relate to
probable variations
in capacity requirements
Less concerned with cycles and trends than with
seasonal variations and other variations from averageE.g., Our hotel expect to serve 10 thousand customers next year. But the demand will be higher in the summer, lower in the winter, and normal in the spring and fall. Slide16
Common demand patternsSlide17
Calculating Processing Requirements
Calculating processing requirements requires:
reasonably accurate demand forecasts,
standard processing times
available work timeSlide18
Example
If annual capacity is 2,000 hours/machine, then
Units of capacity needed = 5,800 hours ÷ 2,000 hours = 2.90
3 machines
Product
Annual Demand
Standard processing time per unit (hr.)
Processing time needed (hr.)
#1
400
5
2000
#2
300
8
2400
#3
700
2
1400
Total=5800Slide19
Service Capacity Planning
Service capacity planning can present a number of challenges related to:
The need to be near customers
Convenience
The inability to store services
Cannot store services for consumption later
The degree of demand volatility
Volume and timing of demand
Time required to service individual customersSlide20
In-House or
Outsource
Once capacity requirements have been determined, the organization must decide whether
to
produce a good or provide a service itself
,
or to
outsource from
another
organization
.
Factors to consider when deciding whether to operate
in-house or outsource
Available capacity
Expertise
Quality considerationsThe nature of demandCostRisksSlide21
Case Study
How much would an all-American iPhone cost?
NPR Marketplace
http://www.marketplace.org/topics/business/ive-always-wondered/how-much-would-all-american-iphone-cost
Audio (4:33)
Pay attention to:
Logistic efficiency
Cost structure
Components
International
expertise
Consumer base
While listening, take notes on the above 5 items
Use the notes, discuss why/when a company decides to outsource?Slide22
Developing Capacity Strategies
There are a number of ways to enhance development of capacity strategies:
Design flexibility into
systems.
Provision for future
expansion
Take stage of
life cycle
into
account.
Take
a “
big-picture
” (i.e., systems) approach to capacity
changes.
Prepare to deal with capacity “chunks.”
Capacity increments are not usually smooth
Attempt to smooth out capacity
requirements.
Overtime; subcontract; inventory controlIdentify the optimal operating level: economies of scale.Slide23
Product Life Cycle
In the
introduction
phase,
organizations should be cautious in making large and/or inflexible capacity investments.
In the
growth
phase,
organizations should consider their market share, competitors’ moves, and establishing competitive advantages.
In the
maturity
phase,
organizations may still be able to increase profitability by reducing costs and making full use of capacity.
In the
decline
phase, organizations may eliminate the excess capacity by selling it, or by introducing new products or services.Slide24
“Big-Picture ” Approach
Bottleneck Operation
An operation in a sequence of operations whose capacity is lower than that of the other operations
Operation 1
20/hr.
Operation 2
10/hr.
Operation 3
15/hr.
10/hr.
Bottleneck
Maximum output rate
limited by bottleneckSlide25
Optimal Operating Level
Minimum
cost
Average cost per
unit
0
Rate of
output
Minimum average cost per unit
Economies of Scale
If output rate is less than the optimal level, increasing the output rate results in decreasing average per unit costs
Diseconomies of Scale
If the output rate is more than the optimal level, increasing the output rate results in increasing average per unit costsSlide26
Economies of Scale
Economies of Scale
If output rate is less than the optimal level, increasing the output rate results in decreasing average per unit costs
Reasons for economies of scale:
Fixed costs
are spread over a larger number of units
Processing costs decrease due to
standardization
There are two types of economies of scale:
Internal
. These are cost savings that accrue to a firm regardless of the industry, market or environment in which it operates.
It is easier for large firms to carry the overheads of sophisticated research and development (R&D). E.g., pharmaceuticals industry
External
. These are economies that benefit a firm because of the way in which its industry is organized.
E.g., The creation of a better transportation networkSlide27
Diseconomies of Scale
Diseconomies of Scale
If the output rate is more than the optimal level, increasing the output rate results in increasing average per unit costs
Reasons for diseconomies of scale
Congestion (transportation)
Complexity (
customerization
)
Inflexibility
Additional levels of managementSlide28
Evaluating Alternatives
Cost-volume analysis
Break-even point
Indifference point
Financial analysis
Cash flow
Present value
Decision theory
Comparison of alternatives under risk and uncertainty.
Waiting-line analysis
Balance waiting cost and increased capacity cost
Simulation
Evaluate “what-if” scenariosSlide29
Cost-Volume Analysis Assumptions
Cost-volume analysis is a viable tool for comparing capacity alternatives
if
certain
assumptions are satisfied:
One product is involved
Everything produced can be sold
The variable cost per unit is the same regardless of
volume
Fixed costs do not change with volume changes (or they are step changes)
The revenue per unit is the same regardless of volume
Revenue per unit exceeds variable cost per unitSlide30
Cost-Volume Analysis
Focuses on the relationship between
cost
,
revenue
, and
volume
of output
Fixed Costs (FC)
tend to remain constant regardless of output volume
Variable Costs (VC)
vary directly with volume of output
VC = Quantity (Q) x variable cost per unit (v)
Total Cost
TC = FC + VC
Total Revenue (TR)TR = revenue per unit (R) x QSlide31
Break Even Point
Break-Even-Point (BEP)
The volume of output at which
total cost and total revenue are equal
(profit = 0
)
Profit (
P
) = 0 = TR – TC
= (
R
×
Q
) – (FC +
v
× Q)= Q(R – v) – FC
0 =
Q
BEP
(R – v) – FC
P: Profit
Q: Quantity
TR: Total Revenue
TR = revenue per unit (
R
) x
Q
TC: Total Cost
TC = FC + VC
FC: Fixed Costs
VC: Variable Costs
VC =
Q
x variable cost per unit (
v
)Slide32
Cost-volume
relationships
32Slide33
Cost-volume
relationships
33
This line shows the difference between TR and TC.Slide34
Exercise
The owner of Old-Fashioned Berry Pies, S. Simon, is contemplating adding a new line of pies, which will require leasing new equipment for a monthly payment of $6,000. Variable costs would be $2 per pie, and pies would retail for $7 each.
How many pies must be sold in order to break even?
What would the profit (loss) be if 1,000 pies are made and sold in a month?
How many pies must be sold to realize a profit of $4,000?
If 2,000 can be sold, and a profit target is $5,000, what price should be charged per pie?Slide35
Solution
The owner of Old-Fashioned Berry Pies, S. Simon, is contemplating adding a new line of pies, which will require leasing new equipment for a monthly payment of $6,000. Variable costs would be $2 per pie, and pies would retail for $7 each.
How many pies must be sold in order to break even
?
FC = $6000 VC = $2 per pie R = $7 per pie
Q
BEP
= FC / (R
–
VC) = 6000 / (7
–
2) = 1200 pies/monthSlide36
Solution
The owner of Old-Fashioned Berry Pies, S. Simon, is contemplating adding a new line of pies, which will require leasing new equipment for a monthly payment of $6,000. Variable costs would be $2 per pie, and pies would retail for $7 each.
What would the profit (loss) be if 1,000 pies are made and sold in a month?
FC = $6000 VC = $2 per pie R = $7 per pie
For Q = 1000, P = Q(R
–
v)
–
FC = 1000(7 – 2) – 6000 = –1000Slide37
Solution
The owner of Old-Fashioned Berry Pies, S. Simon, is contemplating adding a new line of pies, which will require leasing new equipment for a monthly payment of $6,000. Variable costs would be $2 per pie, and pies would retail for $7 each.
How many pies must be sold to realize a profit of $4,000
?
FC = $6000 VC = $2 per pie R = $7 per pie
Q = (P + FC) / (R
–
v) = (4000 + 6000) / (7
–
2) = 2000 piesSlide38
Solution
The owner of Old-Fashioned Berry Pies, S. Simon, is contemplating adding a new line of pies, which will require leasing new equipment for a monthly payment of $6,000. Variable costs would be $2 per pie, and pies would retail for $7 each.
If 2,000 can be sold, and a profit target is $5,000, what price should be charged per pie
?
FC = $6000 VC = $2 per pie R = $7 per pie
Profit = Q(R
–
v) – FC
5000 = 2000(R
–
2) – 6000
R = $7.5
R =
(P + FC
– v
×
Q
) /
Q = (5000 + 6000
+ 2
× 2000) / 2000 = 7.5
Alternative approach:Slide39
Indifference Point (Profit)
Two (multiple) Alternatives
The quantity at which a decision maker would be indifferent between two competing
alternatives.
Choose B
Alternative A (in-house)
R >> v
v low
FC high
BEP high
Alternative B (outsource)
R > v
v high
FC low
BEP low
Choose ASlide40
Indifferent Point (Cost)
A manufacturer has 3 options:
Use process
A
with FC=$80,000 and v=$75/unit
Use process
B
with FC=$200,000 and v=$15/unit
P
urchase for $200/units (in other words, FC=$0 and v=$200/unit)
80,000+75Q
=
200,000+15Q
Q
AB
=2,000 units
80,000+75Q
=
200Q
Q
PA
=640 units
Choose
lowest cost:0-640 units : Purchase640-2,000 units: Process A
Above 2,000 units:
Process BSlide41
Exercise
A firm's manager must decide whether to make or buy a certain item used in the production of vending machines. Cost and volume estimates are as follows
:
Given these numbers, should the firm buy or make this item?
There
is a possibility that volume could change in the future. At what volume would the manager be indifferent between making and buying?Slide42
Solution
Given these numbers, should the firm buy or make this item?
Total cost = Fixed cost
+ Volume
× Variable cost
Make: $150,000 + 12,000 × $60 = $870,000
Buy: $0
+ 12,000 ×
$80
=
$960,000
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. Slide43
Solution
There is a possibility that volume could change in the future. At what volume would the manager be indifferent between making and buying?
To determine the volume at which the two choices would be equivalent, set the two total costs equal to each other and solve for volume:
TC
make
= TC
buy
Thus
,
$
150,000 +
Q
($60) = 0 +
Q
($80).
Solving
,
Q
= 7,500 units
.
For lower volumes, the choice would be to buy, and for higher volumes, the choice would be to makeSlide44
Cost-Volume Analysis Assumptions
Cost-volume analysis is a viable tool for comparing capacity alternatives
if
certain
assumptions are satisfied:
One product is involved
Everything produced can be sold
The variable cost per unit is the same regardless of
volume
Fixed costs do not change with volume changes (
or they are step changes
)
The revenue per unit is the same regardless of volume
Revenue per unit exceeds variable cost per unitSlide45
Step Costs
Capacity alternatives may involve step costs, which are costs that increase stepwise as potential volume increases.
The implication of such a situation is the possible occurrence of multiple break-even quantities
.Slide46
Exercise
A manager has options to purchase one, two, or three machines. Fixed costs are as follows:
Variable
cost is $10 per unit, revenue is $40 per unit
Determine the break-even point for each range.
If projected annual demand is between 580 and 660 units, how many machines should the manager purchase
Number of Machines
Total Annual Fixed Cost
Corresponding
Range of output
1
$9,600
0 to 300
2
15,000
301 to 600
3
20,000
601 to 900Slide47
Solution
Determine the break-even point for each range.
Number of Machines
Total Annual Fixed Cost
Corresponding
Range of output
1
$9,600
0 to 300
2
15,000
301 to 600
3
20,000
601 to 900
1 machine: Q
BEP
= $9,600/($40/unit-$10/unit) = 320 units
2 machine: Q
BEP
= $15,000/($40/unit-$10/unit) = 500 units
3 machine: Q
BEP = $20,000/($40/unit-$10/unit) = 666.67 unitsSlide48
Exercise
If projected annual demand is between 580 and 660 units, how many machines should the manager
purchase
Comparing the projected range of demand to the two ranges for which a BEP occurs, you can see that the BEP is 500, which is in the range 301 to 600. This means that even if demand is at the low end of the range, it would be above the BEP and thus yield a profit. That is not true of range 601 to 900. At the top end of projected demand, the volume would still be less than the BEP for that range, so there would be no profit. Hence,
the manager should choose two machines
.