Capacity Planning

Outline
 CAPACITY  Defining Capacity  Capacity and Strategy  Capacity Considerations  Managing Demand  CAPACITY PLANNING  BREAKEVEN ANALYSIS  Single-Product Case  Multiproduct 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

Learning Objectives
When you complete this supplement, you should be able to :

Identify or Define:
    Capacity Design Capacity Effective Capacity Utilization

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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Facility Planning
 Facility planning answers: capacity is needed How much long-range  When more capacity is needed  Where facilities should be located (location)  How facilities should be arranged (layout)

Capacity Planning Process

Forecast Demand Compute Rated Capacity Compute Needed Capacity Develop Alternative Plans Evaluate Capacity Plans Select Best Capacity Plan Quantitative Factors (e.g., Cost) Qualitative Factors (e.g., Skills) Implement Best Plan

Types of Planning Over a Time Horizon

Long Range Planning Intermediate Range Planning Short Range Planning
*Limited options exist

Add Facilities Add long lead time equipment Sub-Contract Add Equipment Add Shifts

Add Personnel Build or Use Inventory Schedule Jobs Schedule Personnel Allocate Machinery

* Modify Capacity

Use Capacity
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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:

Capacity a firm can expect to receive given its product mix, methods of scheduling, maintenance, and standards of quality.
Actual output as a percent of design capacity.

Utilization:

Efficiency:

Actual output as a percent of effective capacity.

Actual or Expected Output

Actual (or Expected) Output = (Effective Capacity)(Efficiency)

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Utilization
Measure of planned or actual capacity usage of a facility, work center, or machine Actual Output = Design Capacity Planned hours to be used = Total hours available
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Utilization

Efficiency
Measure of how well a facility or machine is performing when used Efficiency Actual output = Effective Capacity Actual output in units = Standard output in units Average actual time = Standard time
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Implications of Capacity Changes

Changes in: Sales Cash flow Quality Supply chain Human resources Maintenance
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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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Cost Structure for a Roadside Motel

25 room roadside motel

50 room roadside motel

75 room roadside motel

Economies of Scale

Diseconomies of Scale
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Number of Rooms

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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Approaches to Capacity Expansion

Expected Demand New Capacity Demand Demand Expected Demand New Capacity

Time in Years Capacity leads demand with an incremental expansion Expected Demand New Capacity Demand Demand

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

Time in Years Capacity lags demand with an incremental expansion

Time in Years Attempts to have an average capacity, with an incremental expansion

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Approaches to Capacity Expansion

Expected Demand New Capacity Demand

Time in Years Capacity leads demand with an incremental expansion

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Approaches to Capacity Expansion

Expected Demand New Capacity Demand

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

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Approaches to Capacity Expansion

Expected Demand New Capacity Demand

Time in Years Capacity lags demand with an incremental expansion

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

Loss

Fixed cost

Volume (units/period)
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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 25

Cost of Wrong Process Found Via Breakeven Analysis

$ Fixed cost
Low volume, high variety process

Variable cost

$ Fixed cost

Variable cost

Variable cost Fixed cost

High volume, low variety process

Repetitive process

Total cost for low volume high variety

B1 B3 A B B2

Total cost for repetitive process Total cost for high volume, low variety process

Volume
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Decision Tree and Capacity Decision

-$14,000 $18,000 $13,000
Market favorable (0.4) Market unfavorable (0.6) Market favorable (0.4) Market unfavorable (0.6) Market favorable (0.4) Market unfavorable (0.6) $100,000 -$90,000 $60,000 -10,000 -5,000 $40,000 $0
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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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Net Present Value

F = future value P = present value I = interest rate N = number of years

P!

F (i  1)
N

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NPV in a More Convenient Present Form value of $1.00

P! F (i  1)
N

Year 1 2 3 4 5 6 7 8 9

5% 0.952 0.907 0.864 0.823 0.784 0.746 0.711 0.677 0.645

6%

7%

8% 0.857 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500

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0.943 0.935 0.890 0.873 0.840 0.816 0.792 0.763 0.747 0.713 0.705 0.666 0.665 0.623 0.627 0.582 0.592 0.544

P ! FX 1 where X ! (i  1 ) N

Present Value of an Annuity (S)

 X = Factor from Table 0.95 0.94 0.93 0.92 1 2 3 5 6  S = present value of a series of uniform 2 1.85 1.83 1.80 1.78 annual receipts 9 3 8 3 3 2.72 every year  R = receipts that are received 2.67 2.62 2.57 3 3 4 7 for the life of the investment 3.46 3.38 3.31 4 3.54
6 5 5 4.21 2 4.91 7 5.58 7 4.10 0 4.76 6 5.38 2 3.99 3 4.62 3 31 5.20 Year 5% 6% 7% 8%

S ! RX

4.32 9 5.07 6 5.78

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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 32 not always the case

Extras

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Managing Existing Capacity

j Vary staffing Demand Management j Change equipment j Vary prices & processes j Change methods j Vary promotion j Change lead times j Redesign the product for faster processing (e.g., backorders)

Capacity Management

j Offer complementary products

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Complementary Products
Sales (Units) 5,000 4,000 3,000 2,000 1,000 0
Total Snowmobiles Jet Skis

J M M J S N J M M J S N J Time (Months)
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