Managing Capacity in Supply Chain

Jishnu Hazra
IIMB

Capacity Strategy
Capacity Strategy

Timing
When should
capacity expansion
be implemented?

Sizing
How much
capacity should
we invest in?

Type
What type of
capacity should it
be?

Location
Where should we
locate the
capacity?

Todays agenda

Capacity Timing Strategies

Volume
(units/year)

Leading capacity
strategy
Lagging
capacity strategy

Demand

Leading, Chasing,
And Timing
Strategies

time

Decisions to make:

Time = when? (lead or lag
or somewhere in between)

Size = by how much? (many
small, one big)

Capacity Addition: Timing

Volume

Demand
Forecast
Capacity
1. When to increase
capacity?
2. How much capacity
to increase?

Time

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Capacity Addition: Reality

Volume

Capacity
shortage

Low
Utilization
Lead time
Trigger Point
Time

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January 28, 2011

TSMC said it currently supplies 60 percent of the
logic chips used in Android-based tablets and 45 percent
of the logic chips used in all smart phones around the world.
The forecast demand from our customers for 2011 outpaces
the supply under our current capacity. We expect to
continue to fully utilize our capacity this year, Chang said.
TSMC plans to spend US$7.8 billion on capacity
expansion, setting a new record after the US$5.94 billion it
spent last year. The new capital spending will help TSMC
increase capacity by 20 percent this year from
last year, Chang said.
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April 28 2011 TSMC utilization rate drops by 5%

With orders from the communications sector slowing down,
Taiwan Semiconductor Manufacturing Company (TSMC)
is expected to generate a 5% drop sequentially in total wafer
starts in the second quarter of 2011, according to industry
sources.
TSMC's average capacity utilization will likely edge down
to 85-90% in the second quarter, the sources said. Utilization
rates for 90nm, 65nm and 40nm nodes may slide to 50%, 70%
and 80-90%, respectively. Broadcom and Qualcomm,
TSMC's main clients in the communications chip market, have
decelerated their pace of orders due to inventory clearance
and parts shortages caused by Japan's recent disasters, the
sources indicated. In addition, the sources speculate that TSMC
may revise downward its capex goal for 2011 to US$6-6.5
billion from the US$7.8 billion previously estimated. The
foundry originally planned to add another 61,000 12-inch
equivalent wafers to production capacity in 2011, but has cut the
target to 43,000 units, the sources claimed.

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April 6 2012 TSMC Faces Acute 28 nm Capacity Shortage

Taiwan Semiconductor Manufacturing Company's (TSMC)
28nm foundry capacity has been drastically short of demand
from Qualcomm, AMD and Nvidia mainly, but the shortage
is expected to relax at the end of the third quarter of 2012,
according to industry sources. Qualcomm, in view of the
shortage, has shifted some orders to United Microelectronics,
but has been unable to meet its clients' demand for processors
for smartphones and tablet PCs, the sources indicated.
AMD launched the 28nm-based Radeon HD 7970 in the first
quarter of 2012, but has actually shipped a relatively small
volume of the GPU due to TSMC's short 28nm capacity, the
sources noted. Nvidia launched only one 28nm-based GPU,
GeForce GTX 680, in late March and has had to delay the launch of
Kepler series GPU models due to the shortage, the sources said.
Though Qualcomm left its sales guidance for the fiscal year unchanged,
executives acknowledged that the 28-nm capacity shortage would have a
negative impact on its outlooks for Qualcomm's fiscal third
and fourth quarters.
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Challenges for Capacity Strategy

Capacity is hard to define: depends on
product mix, demand
Capacity frictions: Lead times, Lumpiness,
Fixed Costs
Capacity requires large and (generally)
irreversible investment
Capacity shortfall cost may be unclear
How large is excess demand?
What is the impact?
Customer wait; Substitution; Lost sale; Loss of
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Cost of Capacity Investment

Linear Capacity Expansion Cost Function:

Monetary Unit C(K)

C ( K ) = c0 + c K K ,

K: amount of Capacity
investment

c0
Capacity Size K

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How Much Capacity to Invest?

Future is Uncertain: Demand has some
Probability Distribution
Trade-off is Investing in Too Much
Capacity versus Too Little
Too Much Capacity: Loss is cK per unit of
Excess Capacity
Too Little Capacity: Loss is Product Margin
plus Shortfall Penalty
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Optimal Capacity Sizing using Newsboy Model

m + cp

Pr( D K ) =

m + c p + cK

m : unit margin
c p : shortfall
c K : marginal
K

: Optimal

Cu

penalty

Co

cost

investment
Capacity

cost
Size
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Expected (Annual) Profit and Optimal Capacity Investment

( K ) = mE ( Sales) c p E ( Lost sales)

= m L( z ) c pL( z )
c

= m 1 1 + p L( z )

Refer to the
Newsvendor Model

cp
Volatility Degradation : 1 + L( z )
m

K*

We have assumed Demand is

z =
Normal with mean and SD

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Monetary Unit

Present Value of Expected Profit

NPV(K*)

*
Optimal Capacity Investment Costs = c0 + cK K

Volatility (CoV)

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Monetary Unit

K* increases with volatility (why?)

Capacity investment cost increases with volatility
Expected Profit decreases with volatility
NPV (K*) decreases with volatility

NPV(K*)

Volatility (CoV)

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Lack of manufacturing capacity for Immunexs highly

successful arthritis drug Enbrel cost the company more
than $200 million in lost revenue in 2001
Source: BioPharma Capacity Crunch, McKinsey Qtrly 2002

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Three Keys Drivers of Capacity Sizing

Demand Forecast
Average Demand, Variability

Shortage Cost
Lost sales, Shortage penalty

Safety Capacity Cost

Marginal Cost of Capacity, Capacity vs
Inventory
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Consumer Durable Goods Industry

Bulk of the sales happen in a 3 to 4 month
period.
How should a firm decide on Capacity size?

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Trading Off Capacity with Inventory: An Example

Assume the year has two seasons each of equal

length: Regular and Peak
Suppose in Regular season demand rate is (1-)
and in Peak season demand rate is (1+), where
0 1, and is known
is a measure of inter-seasonal demand
volatility; = 0 corresponds to perfectly stable or
level demand while a value of 1 is a case of
extreme seasonality

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Trading Off Capacity with Inventory: An example

What is the optimal capacity strategy?
Two extreme strategy:
An assemble or build-to-order strategy with no
inventory
A level production strategy that produces at
constant rate throughout the year

Suppose you invest a capacity of K, where

K (1+ )
Annual Production: You need to produce *1
year = units

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Trading Off Capacity with Inventory

Peak
Season
(1+ )

Regular
Season

Cycle Repeats

(1- )
0.5

Time

1 Year: 2 seasons

Demand profile

Average annual demand is

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Trading Off Capacity with Inventory

Capacity = K >
(1+ )
K

Cycle Repeats

(1- )
0.5

Why should K be greater than Average demand, ?

time

Demand profile

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Trading Off Capacity with Inventory

Production Profile
(1+ )
K

Excess Demand

Excess Production

Cycle Repeats
(1- )

Average demand is

0.5

time

Demand profile
Imax
Inventory Buildup
time
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Trading Off Capacity with Inventory

An assemble or build-to-order strategy (No
Inventory) implies

A level production strategy implies

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Trading Off Capacity with Inventory

An assemble or build-to-order strategy (No
Inventory) implies K = (1+)

A level production strategy implies K =

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Trading Off Capacity with Inventory

Level Production

Build-to-Order

Hybrid strategy
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13

Trading Off Capacity with Lead time

Trade-off between Quality of Service and
Cost
The TD AMERITRADE 5-Second Guarantee: When it
comes to order routing, time is of the essence. Our
sophisticated order-routing technology allows us to
dynamically distribute orders to multiple market centers
that seek to fill your order quickly and at the best available
price. Plus, the TD AMERITRADE 5-Second Guarantee
ensures that qualifying S&P 100 Internet equity market
trades that take longer than 5 seconds to execute are
commission-free! We'll automatically waive the
commission for these trades.
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In a fast moving market, the price of a stock could change

between the time you place your order and the time that
order reaches the market. So we don't waste a second.
We measure the time elapsed between when we route an order
to a market center and when that order is executed by the
market center (common measure of execution speed).
http://www.tdameritrade.com/trade/orderexecution/speed.html
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Capacity: 6 trades /second

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Cost of Service Guarantee

$10 per Trade
Expected Cost of Service Guarantee per Trade
92% util:
83% util:
75% util:

T=5

T=2 secs

$0.82
$0.02
$0.00

$3.68
$0.91
$0.18

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Mathematics of Waiting Time

Assume single processor

Demand :
Capacity : K
Ws : Total Delay (Queue + Pr oces sin g )
Utilization :

NOT PART of the COURSE

Pr(Ws > t ) = e

t
K
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Cost of Service Guarantee

How would you do this for a complex process?
You could simulate the process and then vary the
required response time, optimize the process such that
the new response time is gotten at lowest cost.
When you do this repeatedly for various response times,
the associated cost traces the trade-off curve.

Jishnu Hazra
IIMB

Cost of Service Guarantee

What insights do we get from the trade-off curve?
1.Choose the Service Guarantee under the knee
2.What if we improve the service guarantee from
5 sec to 2 sec (for the 83% utilization case)?
Cost would be about 45 times higher! This is a
testament of the strong non-linearity in
performance deterioration.
3.What does an improvement mean here?
Install more capacity, thereby reducing
utilization
Reduce volatility in demand
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IIMB

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Capacity Issues in Services

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Capacity
In Manufacturing, Capacity and Inventory
are Substitutes
In Services, there is no Inventory
Unlike Manufacturing, Capacity issues in
cannot be generalized across Service
Industries
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18

Capacity Decisions
Peak load rather than average load drives capacity
level
Congestion effects limit capacity loading: must
keep excess capacity
Lack of control over demand limits scheduling
efficiency
Economies of scale: Depends

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People Supply Chain: Process Flow

RAMP - DOWNS
BUSINESS UNIT
BENCH

RELEASE

RAMP-DOWN
POOL
PROJECT
READY
POOL

RECRUITMENT

PROJECTS

NEW
RECRUIT
POOL
DEMAND
ATTRITION

ATTRITION

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People Supply Chain: Make or Buy Decision

Campus
Make Hires

Training
Bench
Projects
(billed)

Buy

Lateral
Hires

Training

Projects
(unbilled)

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Trade-offs

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Trade-offs
Cost
Versus
Revenues

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Trade-offs
Cost
Versus
Revenues
Question: What is the Right balance?
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People Supply Chain

Fresh Hiring

Resource
Portfolio
(skills)

Demand
fulfillment

demand

supply

Lateral Hiring

Utilization
Indent
Redeployment

Bulge

Attrition
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People Supply Chain

Fresh Hiring

Resource
Portfolio
(skills)

Demand
fulfillment

demand

supply

Lateral Hiring

Growth

Utilization
Indent
Redeployment

Bulge

Attrition
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Bulge

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Year 1
Onsite
Offshore
Total

Onsite Salaries
Offshore salaries

Other costs
Op Profits
Operating Margins

Employees
175
525
700

175
825
1000

Rate
9000
3800

Rs/$
63
63

Amount
992,25,000
1256,85,000
2249,10,000

6500
1111

63
63

783,27,113
631,14,438
1414,41,550
500,00,000
334,68,449.58
15%

70% utilization
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Year 3
Onsite
Offshore
Total

Employees
175
525
700

Onsite Salaries
Offshore salaries

175
825
1000

Rate
9000
3800

Rs/$
63
63

Amount
992,25,000
1256,85,000
2249,10,000

6896
1344

63
63

830,99,041
763,50,859
1594,49,900

Other costs
Op Profits
Operating Margins

500,00,000
154,60,099.60
7%

70% utilization
3% annual increase (onsite); 10% offshore

Jishnu Hazra
IIMB

THE PYRAMID MODEL

As these companies continue to
hire and train armies of fresh
engineering graduates who can be
billed to customers within months,
they are realizing the pyramid
model has problems. "There's fat
in the pyramid," said the HR head
at one of the top Indian software
companies.
Source: Automation drive in IT industry: Middle managers face an uncertain future
20 January 2015, Economic Times

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IIMB

24

And recently, some mid-managers were sacked by TCS,

which denied any mass layoffs were underway. The
company emphasized that 'involuntary attrition' was less
than 1% of its total workforce, but the alarm bells have
started ringing. "If you don't reskill, you're gone. What got
you here will not take you forward," said Saurabh Govil,
head of HR at Wipro.
For now, though, the mid-life crisis for software managers
in the industry looms large. The problem is that many of
such managers have priced themselves out on skills that
are no longer being sought by potential employers.
Source: Automation drive in IT industry:
Middle managers face an uncertain future
20 January 2015, Economic Times

Jishnu Hazra
IIMB

TCS Story
It's not a very happy start to the New Year for over 1,500 odd
employees working in Tech giant Tata Consultancy Services
(TCS) who have been reportedly served the pink slip.
According to industry experts, one of the reasons the
retrenchments have been made is to bring in new talent
with fresh skills and perspective. Plus, new recruits cost a
lot less than employees with some experience. Also,
experienced employees, who are not learning new skills and
thus cannot be inducted in to leadership or project management
roles, add no new value.
Source: TCS lays off over 1500 employees, stung employees to petition PM Narendra Modi
DNA 3 January 2015
http://www.dnaindia.com/money/report-tcs-lays-off-over-1500-employees-stung-employees-to-petition-pm-narendra-modi-2049290

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25

Source: Automation drive in IT industry:

Middle managers face an uncertain future
20 January 2015, Economic Times

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IIMB

Many of these mid-managers have 6-12 years of experience, and

have grown into roles involving allocating engineers for projects,
managing software quality and training fresh hires.
Unfortunately, most of such managerial roles are no more
required; these functions are now getting automated and even
eliminated in a world where software training has moved out of
physical classrooms and is being rendered online on platforms such
as Coursera.
An executive at a software company based in India cited a recent
example that highlighted the crisis. "We found a project manager
was pushing to get re-assigned to a role involving managing a team
of software testers. He seemed unaware that testing is the first
function to get automated," he said.
Source: Automation drive in IT industry:
Middle managers face an uncertain future
20 January 2015, Economic Times

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IIMB

26

Linear versus Non-linear growth

Responsiveness in
Fulfilling Resources

Moving on a Curve
Shifting the Curve

Utilization

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Linear versus Non-linear growth

Moving on a Curve
Shifting the Curve
Responsiveness in
Fulfilling Resources

Improvement

Utilization

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IIMB

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