CAPACITY PLANNING

Capacity planning is the process of determining the production Capacity needed by an organization to meet changing demands for its Products. In the context of capacity planning, "capacity" is the maximum amount of work that an organization is capable of completing in a given period of time. The phrase is also used in business computing as a synonym for Capacity management. A discrepancy between the capacity of an organization and the demands of its customers results in inefficiency, either in under-utilized resources or unfulfilled customers. The goal of capacity planning is to minimize this discrepancy. Demand for an organization's capacity varies based on changes in production output, such as increasing or decreasing the production quantity of an existing product, or producing new products. Better utilization of existing capacity can be accomplished through improvements in Overall Equipment Effectiveness (OEE). Capacity can be increased through introducing new techniques, equipment and materials, increasing the number of workers or machines, increasing the number of shifts, or acquiring additional production facilities. Capacity Strategies There are three basic capacity strategies used by different organizations when they consider increased demand; lead capacity strategy, lag capacity strategy and the match capacity strategy. Lead Capacity Strategy As the name suggests, the lead capacity strategy adds capacity before the demand actually occurs. Companies often use this capacity strategy as it allows company to ramp up production at a time when the demands on the manufacturing plant is not so great. If any issues occur during the ramp up process, these can be dealt with so that when the demand occurs the manufacturing plant will be ready. Companies like this approach as it minimizes risk. As customer satisfaction becomes an increasingly important, businesses do not want to fail to meet delivery dates due to lack of capacity. Another advantage of the lead capacity strategy is that it gives companies a competitive advantage. For example, if a toy manufacturer believes a certain item will be a popular seller for the Christmas period, it will increase

capacity prior to the anticipated demand so that it has product in stock while other manufacturers would be playing catch up. However, the lead capacity strategy does have some risk. If the demand does not materialize then the company could quickly find themselves with unwanted inventory as well as the expenditure of ramping up capacity unnecessarily. Lag Capacity Strategy This is the opposite of the lead capacity strategy. With the lag capacity strategy the company will ramp up capacity only after the demand has occurred. Although many companies follow this strategy success is not allows guaranteed. However, there are some advantages of this method. Initially it reduces a companys risk. By not investing at a time of lesser demand and delaying any significant capital expenditure, the company will enjoy a more stable relationship with their bank and investors. Secondly the company will continue to be more profitable than companies who have made the investment with increased capacity. Of course the downside is that the company would have a period where product was unavailable until the capacity was finally increased. Match Capacity Strategy The match capacity strategy is one where a company tries to increase capacity in smaller increments to coincide with the increases in volume. Although this method tries to minimize the over and under capacity of the other two methods, companies also get the worst of the two, were they can find themselves over capacity and under capacity at different periods. Capacity planning is long-term decision that establishes a firms' overall level of resources. It extends over time horizon long enough to obtain resources. Capacity decisions affect the production lead time, customer responsiveness, operating cost and company ability to compete. Inadequate capacity planning can lead to the loss of the customer and business. Excess capacity can drain the company's resources and prevent investments into more lucrative ventures. The question of when capacity should be increased and by how much is the critical decisions.

Capacity Available or Required? From a scheduling perspective it is very easy to determine how much capacity (or time) will be required to manufacture a quantity of parts. Simply multiply the Standard Cycle Time by the Number of Parts and divide by the part or process OEE %. If production is scheduled to produce 500 pieces of product A on a machine having a cycle time of 30 seconds and the OEE for the process is 85%, then the time to produce the parts would be calculated as follows: (500 Parts X 30 Seconds) / 85% = 17647.1 seconds The OEE index makes it easy to determine whether we have ample capacity to run the required production. In this example 4.2 hours at standard versus 4.9 hours based on the OEE index. Repeating this process for all the parts that run through a given machine, it is possible to determine the total capacity required to run production. Capacity Available If you are considering new work for a piece of equipment or machinery, knowing how much capacity is available to run the work will eventually become part of the overall process. Typically, an annual forecast is used to determine how many hours per year are required. It is also possible that seasonal influences exist within your machine requirements, so perhaps a quarterly or even monthly capacity report is required. To calculate the total capacity available, we can use the formula from our earlier example and simply adjust or change the volume accordingly based on the period being considered. The available capacity is difference between the required capacity and planned operating capacity.

BREAK EVEN ANALYSIS

The break-even point is in general the point at which gains equal losses or the point where revenues equal expenses. This is important for any that manages a business since break-even point is the lower limit of the profit when setting prices and determining prices.

In Figure 1, the break-even point illustrates the quantity at which total revenues and total costs are equal; it is the point of intersection for these two totals. Above this quantity, total revenues will be greater than total costs, generating a profit for the company. Below this quantity, total costs will exceed total revenues, creating a loss. To find this break-even quantity, the manager uses the standard profit equation, where profit is the difference between total revenues and total costs. Predetermining the profit to be $0, he/she then solves for the quantity that makes this equation true, as follows: Let TR= Total revenues TC= Total costs P= Selling price F= Fixed costs V= Variable costs

Q= Quantity of output TR=PQ TC=F+VQ TRTC= profit Because there is no profit ($0) at the break-even point, TRTC= 0, and then PQ (F+VQ) = 0. Finally, Q=F(PV). This is typically known as the contribution margin model, as it defines the breakeven quantity (Q) as the number of times the company must generate the unit contribution margin (PV), or selling price minus variable costs, to cover the fixed costs. It is particularly interesting to note that the higher the fixed costs, the higher the break-even point. Thus, companies with large investments in equipment and/or high administrative-line ratios may require greater sales to break even. As an example, if fixed costs are $100, price per unit is $10, and variable costs per unit are $6, then the break-even quantity is 25 ($100 [$10 $6] = $100 $4). When 25 units are produced and sold, each of these units will not only have covered its own marginal (variable) costs, but will have also have contributed enough in total to have covered all associated fixed costs. Beyond these 25 units, all fixed costs have been paid, and each unit contributes to profits by the excess of price over variable costs, or the contribution margin. If demand is estimated to be at least 25 units, then the company will not experience a loss. Profits will grow with each unit demanded above this 25-unit break-even level.

Decision Tree
A decision tree is a decision support tool that uses a tree-like graph or model of decisions and their possible consequences, including chance event outcomes, resource costs, and utility. It is one way to display an algorithm. Decision trees are commonly used in operations research, specifically in decision analysis, to help identify a strategy most likely to reach a goal. Further explaining you with an example:Your company is considering whether it should tender for two contracts (MS1 and MS2) on offer from a government department for the supply of certain components. The company has three options:
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Tender for MS1 only; or Tender for MS2 only; or Tender for both MS1 and MS2.

If tenders are to be submitted the company will incur additional costs. These costs will have to be entirely recouped from the contract price. The risk, of course, is that if a tender is unsuccessful the company will have made a loss. The cost of tendering for contract MS1 only is 50,000. The component supply cost if the tender is successful would be 18,000. The cost of tendering for contract MS2 only is 14,000. The component supply cost if the tender is successful would be 12,000. The cost of tendering for both contracts MS1 and contract MS2 is 55,000. The component supply cost if the tender is successful would be 24,000. For each contract, possible tender prices have been determined. In addition, subjective assessments have been made of the probability of getting the contract with a particular tender price as shown below. Note here that the company can only submit one tender and cannot, for example, submit two tenders (at different prices) for the same contract.

Option

Possible tender prices () 130,000 115,000

Probability of getting contract 0.20 0.85

MS1 only

MS2 only

70,000 65,000 60,000

0.15 0.80 0.95

MS1 and MS2

190,000 140,000

0.05 0.65

In the event that the company tenders for both MS1 and MS2 it will either win both contracts (at the price shown above) and no contract at all.
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What do you suggest the company should do and why? What are the downside and the upside of your suggested course of action?

Solution The decision tree for the problem is shown below.

Below we carry out step 1 of the decision tree solution procedure which (for this example) involves working out the total profit for each of the paths from the initial node to the terminal node (all figures in '000). Step 1
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y y

y y

y y

y y

y y

y y

path to terminal node 12, we tender for MS1 only (cost 50), at a price of 130, and win the contract, so incurring component supply costs of 18, total profit 130-50-18 = 62 path to terminal node 13, we tender for MS1 only (cost 50), at a price of 130, and lose the contract, total profit -50 path to terminal node 14, we tender for MS1 only (cost 50), at a price of 115, and win the contract, so incurring component supply costs of 18, total profit 115-50-18 = 47 path to terminal node 15, we tender for MS1 only (cost 50), at a price of 115, and lose the contract, total profit -50 path to terminal node 16, we tender for MS2 only (cost 14), at a price of 70, and win the contract, so incurring component supply costs of 12, total profit 70-14-12 = 44 path to terminal node 17, we tender for MS2 only (cost 14), at a price of 70, and lose the contract, total profit -14 path to terminal node 18, we tender for MS2 only (cost 14), at a price of 65, and win the contract, so incurring component supply costs of 12, total profit 65-14-12 = 39 path to terminal node 19, we tender for MS2 only (cost 14), at a price of 65, and lose the contract, total profit -14 path to terminal node 20, we tender for MS2 only (cost 14), at a price of 60, and win the contract, so incurring component supply costs of 12, total profit 60-14-12 = 34 path to terminal node 21, we tender for MS2 only (cost 14), at a price of 60, and lose the contract, total profit -14 path to terminal node 22, we tender for MS1 and MS2 (cost 55), at a price of 190, and win the contract, so incurring component supply costs of 24, total profit 190-55- 24=111 path to terminal node 23, we tender for MS1 and MS2 (cost 55), at a price of 190, and lose the contract, total profit -55 path to terminal node 24, we tender for MS1 and MS2 (cost 55), at a price of 140, and win the contract, so incurring component supply costs of 24, total profit 140-55- 24=61

path to terminal node 25, we tender for MS1 and MS2 (cost 55), at a price of 140, and lose the contract, total profit -55

Hence we can arrive at the table below indicating for each branch the total profit involved in that branch from the initial node to the terminal node. Terminal node 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Total profit '000 62 -50 47 -50 44 -14 39 -14 34 -14 111 -55 61 -55

We can now carry out the second step of the decision tree solution procedure where we work from the right-hand side of the diagram back to the left-hand side. Step 2
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For chance node 5 the EMV is 0.2(62) + 0.8(-50) = -27.6 For chance node 6 the EMV is 0.85(47) + 0.15(-50) = 32.45

Hence the best decision at decision node 2 is to tender at a price of 115 (EMV=32.45).
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For chance node 7 the EMV is 0.15(44) + 0.85(-14) = -5.3 For chance node 8 the EMV is 0.80(39) + 0.20(-14) = 28.4 For chance node 9 the EMV is 0.95(34) + 0.05(-14) = 31.6

Hence the best decision at decision node 3 is to tender at a price of 60 (EMV=31.6).

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For chance node 10 the EMV is 0.05(111) + 0.95(-55) = -46.7

For chance node 11 the EMV is 0.65(61) + 0.35(-55) = 20.4

Hence the best decision at decision node 4 is to tender at a price of 140 (EMV=20.4). Hence at decision node 1 have three alternatives:
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tender for MS1 only EMV=32.45 tender for MS2 only EMV=31.6 tender for both MS1 and MS2 EMV = 20.4

Hence the best decision is to tender for MS1 only (at a price of 115) as it has the highest expected monetary value of 32.45 ('000).

The downside is a loss of 50 and the upside is a profit of 47.