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Chapter V Capacity Planning for Products and Services
Capacity: Capacity refers to an upper limit on the load that an operating unit can handle. The operating unit can be a plant, department, machine, store, or worker. Importance of Capacity Planning: The goal of strategic capacity planning is to achieve a match between the long-term supply capabilities of an organization and the predicted level of long-term demand. Organizations plans capacity for various reasons. Among the major reasons are changes in demand, changes in technology, changes in environment, and recognized threats or opportunities. A gap between current and desired capacity will result in capacity that is out of balance. Overcapacity causes operating costs that are too high, while undercapacity causes damaged resources and possible loss of customer. For a number of reasons capacity decisions are among the most fundamental of all the design decisions. They are as follows: (i) Capacity decisions have a real impact on the ability of the organization to meet future demands for products and services. Capacity essentially limits the rate of output possible. (ii) Capacity decisions affect operating costs. If the capacity and demand matches, the operating cost decreases. (iii) Capacity is a major determinant of initial cost. The greater the capacity the greater its initial cost. (iv) Capacity decisions involve long-term commitment of resources. Once these decisions are implemented, it may be difficult or impossible to modify them without incurring major cost. (v) Capacity decisions can affect competitiveness. Defining and measuring capacity: In selecting a measure of capacity, it is important to choose one that does not require updating. For example, dollar amounts are often a poor measure of capacity because price changes necessitate updating of that measure. The measure of capacity must be tailored to the situation. Keeping this in mind, we define the capacity by two ways: (i) Design capacity: It is the maximum rate of output achieved under ideal conditions. (ii) Effective capacity: Design capacity minus allowances (such as personal time, maintenance). It is usually less than design capacity owing to realities of changing product mix, the need for periodic maintenance of equipment, lunch break, coffee breaks, etc. Measures of system effectiveness: Above different measures of capacity are useful in defining two measures of system effectiveness: (a) Efficiency: Efficiency is the ratio of actual output to effective capacity. actual output Efficiency = × 100% effective capacity
Increasing utilization depends on being able to increase effective capacity and this requires a knowledge of what is constraining effective capacity.BBN (b) Utilization: Capacity utilization is the ratio of actual output to design capacity. lighting. Design capacity = 50 trucks per day Effective capacity = 40 trucks per day Actual output = 36 tracks per day Solution: Efficiency = actual output 36 = × 100% = 90% effective capacity 40 actual output 36 = × 100% = 72% design capacity 50 Compared to the effective capacity of 40 units per day. layout of the work area often determines how smoothly work can be performed. 36 unit per day is much less impressive although probably more meaningful. However. Human considerations 6. Product and service factors: Product and service design have a tremendous influence on capacity. the ability of the system to produce those items is generally much greater than when successive items differ. Operational factors 2. the variety of activities involved. Product or service process 5. Also. External 1. Human factors: The tasks that make up a job. The main factors relate to 1. 3. and energy sources are important. Facilities: Among the design of facilities location factors such as transportation costs. distance to market. What design capacity would be needed to achieve an actual output of eight jobs per week? Determinants of effective capacity: Many decisions about system design have an impact on capacity. and the training. skill and experience required to perform a job all have an impact on the 2 . The operation has a design capacity of 10 loans per day and an effective capacity of 8 loans per day. effective capacity is only 50% of the design capacity. utilization = Example 2: Determine efficiency and utilization for a loan processing operation that processes an average of 7 loans per day. compared to the design capacity of 50 units per day. Environmental factors such as heating. and ventilation also play an important role in determining whether personnel can perform effectively. actual output utilization = × 100% design capacity Example: Given the information bellow. labor supply. Facilities 4. Supply chain 3. 2. 36 unit per day looks pretty good. Example 3: In a job shop. when items are similar. and actual output is 80% of effective output. compute the efficiency and the utilization of the vehicle repair department. For example.
6. Estimate future capacity requirements. Conduct financial analysis of each alternative. External (i) Product standard (ii) Safety regulations (iii) Pollution control 3. Asses key qualitative issues for each alternative. 8. 5. power hookups. 3. Facilities: (i) design location (ii) layout (iii) environment 4. 3 . ) that a product or service is in. purchasing requirements. Design flexibility in the systems: Provision for future expansion in the original design of structure frequently can be obtained at a small price compared to what it would cost to remodel an existing structure. inventory stocking decisions. and waste disposal lines are put in place initially.BBN potential and actual output. 4. Supply chain factors: It should be taken into account in capacity planning if substantial capacity changes are involved. Identify alternatives for meeting requirements. will the elements of supply chain be able to handle the increase? 6. External factors: Product standards. Ex. If the capacity increases. Human factors (i) Job content (ii) Training (iii) Motivation Factors that determine effective capacity. Also motivation of employee has an important impact on capacity. Operational (i) Scheduling (ii) Quality assurance (iii) Purchasing 2. Product/ service (i) Design (ii) Product /service mix 5. the modification to this structure can be minimized. Developing capacity alternatives: To improve capacity management the followings can be done: 1. Implement the selected alternative. pollution control have impact on capacity planning. Steps in Capacity planning process: 1. Select one alternative to pursue. maturity phase. safety regulations. Take stages of life cycles into account: Capacity requirements are often closely linked to the stage of the life cycle (introduction phase. Evaluate existing capacity and facilities and identify gaps. growth phase. Monitor results. Example: If water lines. 2. 4. 2. Operational factors: Scheduling. 5. 7. quality inspection and control have impact on effective capacity.
making it difficult to achieve a match between desired capacity and feasible capacity. In growth phase. If we define. Techniques used evaluating capacity alternatives are: (i) Cost-Volume analysis (ii) financial analysis and (iii) decision theory Cost-Volume analysis: It is a relation between cost. This is called economics of scale. In the maturity phase. If the output rate is less than the output level. material cost and labor cost). where v variable cost per unit and Q is the quantity or volume of output. So the organization should be cautious in making inflexible capacity investment. Ex. Take a “big picture” approach to capacity changes: When developing capacity alternatives. But 4 . Less obvious is possible negative public opinion. during bad weather public transportation ridership tends to increase compare to that of good weather. FC. revenue. then TC = FC + VC . Identify the optimal operating level: At the optimal level cost per unit is the lowest for that production unit. So one machine causes 15 unit/hr short but two machine cause 25 units/hr excess.BBN At introduction phase. 5. and volume of output. Step 2: Designate them as fixed (remain constant) cost (Ex. Most obvious are economic considerations. Ex. It is useful as a tool for comparing capacity alternatives. It estimates the income of an organization under different operating conditions. the overall market may experience rapid growth. increasing the output rate will result in decreasing average unit costs. Prepare to deal with capacity “chunks”: Capacity increases are often acquired in large chunks rather than smooth increments. Formulation: Step 1: Identify all costs related to the production of a product. it is difficult to determine both market size and the organization’s share of that market. This is called diseconomies of scales. and total variable cost by TC. VC = Q × v . Attempt to smooth out requirements: Unevenness in capacity requirements create certain problems. Ex. But if the output is increased beyond the optimal level. fixed cost. Total cost = Fixed cost + total variable cost. Evaluating alternatives: An organization needs to examine alternatives for future capacity from different perspectives. VC. the size of the market levels off and the organizations tend to have stable market share. 6. 3. total cost. it is important to consider how parts of the system interrelate? 4. if the desired capacity of an operation is 55 units/ hr but the machine is able to produce 40 units/hr. property taxes) or variable costs (vary with volume of output. average unit costs will be larger. equipment cost.
The break-event (BEP) FC QBEP = R −v Profit TR TC Amount ($) () Loss 0 BEP Units Q (Volume in units) Break-even point (BEP): The volume at which total cost = total revenue. which will require leasing new equipment for a monthly payment of $6. there is a profit. (a) How many pies must be sold in order to break even? (b) What would the profit or loss be if 1. Q = R−v QBEP .000 pies made and sold in a month? (c) How many pies must be sold to realize a profit of $4. Variable costs would be $2 per pie and revenue is $7 per pie. what price should be charged per pie? Solution: 5 .000.000 pies can be sold. When volume is less than the break-even point. is considering adding a new line of pies. Example: The owner of a old-fashioned berry pies. the volume of output at which total cost = total revenue. there is a loss and when volume is greater than the break-even point.BBN TC=VC+FC TR Amount ($) () FC VC Amount ($) () 0 Q (Volume in units) 0 Q (Volume in units) Similarly.000. and a profit target is $5. if revenue per unit is R and total revenue is TR then. Therefore.000? (d) If 2. the required volume P + FC Q needed to generate a specified profit is. TR = R × Q Then profit. P = TR − TC = R × Q − ( FC + v × Q ) = Q( R − v ) − FC .
200 pies per month. (Out side the range 0 – 300. Fixed cost and potential volumes are as follows No. so.50 Example 2: A manager has the option of purchasing 1. (b) If projected annual demand is between 580 to 660 unit.900. R − VC 40 − 10 FC 20000 = = 666.BBN Given.600. This means that even if the demand is at the low end of the range (580 . Determine the break-even point for each range. 2. R − VC 7 − 2 (b) For Q = 1000 . so. how many machines should the manager purchase? Solution: (a) QBEP1 = QBEP 2 = QBEP 3 = FC 9600 = = 320 units.000 301 to 600 3 $20. or 3 machines. This means that even if the demand is at the upper end of the range (580 .67 units. Hence the manager should choose to purchase two machines. and revenue is $40 per unit. a break-even point). the volume would still be less than the break-even point and thus yield no profit.000 pies R−v $7 − $2 (d) P = Q( R − v ) − FC ⇒ 5000 = 2000( R − 2 ) − 6000 ⇒ R = $7. the break-even point is 500 which is in 301 . But in the 3rd range. R − VC 40 − 10 b) From the break-even points we see that in the second range.000. FC = $6. (Inside the range 601– 900.660). of Total Corresponding Machines fixed costs range of output 1 $9. R = $7 per pie. a break-even point). so. the break-even point is 666.67 which is in 601 . 6 . (Inside the range 301 – 600.660). Q = P + FC $4000 + $6000 = = 2. no break-even point). P = Q( R − v ) − FC = 1000( 7 − 2 ) − 6000 = −$1000.000 601 to 900 Variable cost is $10 per unit. (c) For P = $4000 . R − VC 40 − 10 (a) FC 15000 = = 500 units. (a) QBEP = VC = $2 per pie. it would be above the break-even point and thus yield a profit.600 0 to 300 2 $15. FC 6000 = = 1.
At what volume would the manager be indifferent between making and buying? Solution: 7 . and any expected salvage value (save money or recover money) in a single value called equivalent current value taking into account the time value (e. Internal rate of return: It summaries the initial cost. and taxes. Cash flow is the difference between the cash received from sales and the cash outflow for labor. Three common methods in financial analysis are: (i) Payback (ii) present value (iii) internal rate of return Payback: It focuses on the length of time it will take for an investment to return its original cost.000. its estimated annual cash flows. A common approach is to apply financial analysis to rank investment proposals.000 and a monthly net cash flow of $1. Present value: The present value method summaries the initial cost of an investment.g. Decision theory: Decision theory is used for financial comparison of alternatives under conditions of risk or uncertainty. Cost and volume estimates are as follows. Cash flow and present value are two important terms used in financial analysis. Make Buy Annual fixed cost $150. Example: A firm’s manager must decide whether to make or buy a certain item used in the production of vending machines.000 has a payback period of six months. Payback ignores the time value of money.000 12. Present value expresses in current value the sum of all future cash flows of an investment proposal.000 (a) Should the firm buy or make this item? (b) There is a possibility that volume could change in the future. Making would involve annual lease costs of $150. Example: An investment with an original cost of $6.000 None Variable cost per unit $60 $80 Annual volume (units) 12.BBN 3 2 1 300 600 900 Financial analysis: A problem that is universally encountered by managers is how to allocate limited funds. expected annual cash flows and estimated salvage value of an investment proposal in an equivalent interest rate. materials. interest rates) of money.
fixed costs. operations are in three widely scattered locations.000 per month? (iv) What volume is needed to provide a revenue of $23.000 + 12.9. Example: A produces of pottery is considering the addition of a new plant to absorb the backlog of demand that now exists. (i) What volume per month is required in order to break-even? (ii) What profit would be realized on a monthly volume of 61.000 per month? (iii) What volume is needed to obtain a profit of $16.000 × 80 = $960.000. Chargers sell for $7 each. variable costs. and 15. will have fixed costs of $9. The primary location being considered.7 per unit produced. (b) TC make = TC buy ⇒ 150. the manager would choose to make the item.000 units.000 + Q × 60 = 0 + Q × 80 ⇒ Q = 7.200 per month and variable costs of $0.BBN (a) Annual cost to make the item= 150. The leading candidate for location will have a monthly fixed cost of $42.000.000 units. The firm expects to combine assembly of its battery chargers line at a single location.000 Annual cost to buy the item = 0 + 12. and revenues for monthly volumes of 10. Each item is sold at a price that averages $0.000 per month? 8 .000 So. Prepare a table that shows total profits. 12. What is the break-even point? Also determine profit when volume equals 22. Currently.000 × 60 = $870.000 and variable costs of $3 per charger.500 Example: A small firm produces and sells automotive items in a five state area.