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CAPACITY AND LOCATION PLANNING

CAPACITY PLANNING
CAPACITY
 Maximum rate of output for a facility; refers to an upper limit or ceiling on the load that an operation
unit can handle (operating unit might be a plant, department, machine store or worker). The load can be
specified in terms of either inputs or outputs
 According to the dictionary, the ability to hold, receive, store or accommodate
 In general business sense, it is the amount of output that a system is capable of achieving over a specific
period of time

TWO LEVELS OF CAPACITY PLANS

1. LONG TERM CAPACITY PLANS- deal with investments in new facilities and equipment.
Cover at least two years into the future but construction lead times alone can force much longer
time horizons

2. SHORT TERM CAPACITY PLANS- focus on work-force size, overtime budgets, inventories and other types
of decisions

Note: The capacity of an operation unit is an important piece of information for planning purposes. It enables
managers to quantify production in terms of inputs or outputs and thereby make other decisions or plans
related to those qualities.

The basic questions in capacity plans are:

1. What kind of capacity needed?
2. How much is needed?
3. When is it needed?

*the question of what kind of capacity is needed relates to the products and services that management
intends to produce or provide.

CAPACITY PLANNING
- central to the long term success of an organization

MEASURES OF CAPACITY
1. OUTPUT MEASURES
 Usual choice for line flow processes
 As the amount of customization and the variety in the product mix becomes excessive, output-
based capacity measures become less useful
 Best utilized when the firm provides a relatively small number of standardized products and
services
 ex: produce one product

2. INPUT MEASURES
 Usual choice for flexible flow processes
 Demand (can complicate input measures), which invariably is expressed as an output rate, must
be converted to an input measure. Only after making the conversion can a manager compare
demand requirement and capacity on an equivalent basis
 ex: manager of a copy contest must convert its annual demand for copies from different clients
to the number of machines required.

UTILIZATION
-Degree to which equipment, space or labor is currently being used

Average output rate

Utilization= x 100 %
Maximumcapacity

*average output rate and capacity must be measured in the same terms
*utilization rate indicates the need for adding extra capacity or eliminating unneeded capacity

DEFINITIONS OF MAXIMUM CAPACITY

1. DESIGN CAPACITY OR PEAK CAPACITY
 Maximum output that a process or facility can achieve under ideal conditions
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 When capacity is measured relative to equipment alone, the appropriate measure is rated
capacity: an engineering assessment of maximum annual output, assuming continuous
operation except for an allowance for normal maintenance and repair downtime.
 Can be sustained for only a short time (few hours in a day or few days in a month)

Average output rate

Utilization peak= x 100 %
Peak capacity

2. EFFECTIVE CAPACITY
 Maximum output that a process or firm can economically sustain under normal conditions
 CAPACITY- greatest level of output the firm can reasonably sustain by using realistic employee
work schedules and the equipment currently in place

Average output rate

Utilization effective= x 100 %
Effective capacity

3. ACTUAL OUTPUT
 Rate of output actually achieved, cannot exceed effective capacity and it is often less than
effective capacity due to breakdowns, defective output, shortages of materials and etc.

BOTTLENECK- An operation that has the lowest effective capacity of any operation in the facility and thus limits
the system’s output

ECONOMIES OF SCALE
 The average unit cost of a good or service can be reduced by increasing its output rate

4 PRINCIPAL REASONS why it can drive costs down when output increases:
1. Spreading fixed costs
 When the output rate - and therefore the facility’s utilization rate – increases, the average unit
cost drops because fixed costs are spread over more units
2. Reducing construction costs
 Doubling the size of the facility usually doesn’t double construction cost
3. Cutting costs of purchased materials
 Higher volumes can reduce the costs of purchased materials and services. They give the
purchaser a better bargaining position and the opportunity to take advantage of quantity
discounts
4. Finding process advantages
 Firms may be able to justify the expense of more efficient technology or more specialized
equipment

DISECONOMIES OF SCALE
 The average cost per unit increases as the facility’s size increases
 Reason is that excessive size can bring complexity, loss focus and inefficiencies that raise the
average unit cost of a product or service

CAPACITY STRATEGIES
1. Sizing Capacity Cushion
 Average utilization rates should not get too close to 100 percent. That usually is a signal to
increase capacity or decrease order acceptance so as to avoid declining productivity
 Capacity cushion- amount of reserve capacity that a firm maintains to handle sudden increases
in demand or temporary losses of production capacity; it measures the amount by which the
average utilization (in terms of effective capacity) falls below 100%

Capacity cus h ion=100 %−utilization rate( %)

 business find large cushions when demand varies and when future demand is uncertain,
particularly if resource flexibility is low

2. Timing and Sizing Expansion

 When to expand and by how much
 If demand is increasing and the time between increments increases, the size of the increments
must also increase
a. Expansionist strategy
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 involves large, infrequent jumps in capacity

 stays ahead of demand, minimizes the chance of sales lost to insufficient capacity
b. Wait-and-see strategy
 involves smaller, more frequent jumps
 lags behind demand, relying on short-term options (overtime, temporary workers,
subcontractors, stock outs) and postponement of preventive maintenance to meet any
shortfalls
c. Follow-the-leader
 intermediate strategy, expanding when others do
 if others are right, so are you, and nobody gains a competitive advantage
 if they make a mistake and over expand, so have you, but everyone shares in the agony
of over capacity

3. Linking capacity and other decisions

 When managers make decisions about location, resource flexibility, and inventory, they must
consider the impact on capacity cushions
 capacity cushions- buffer the organization against uncertainty
 Examples of links with capacity:
a) Competitive priorities- a change in competitive priorities that emphasizes faster
deliveries requires a larger capacity cushion to allow for quick response and uneven
demand, if holding finished goods inventory is infeasible or uneconomical
b) Quality management- a drive that has obtained higher levels of quality allows for a
smaller capacity cushion because there will be less uncertainty caused by yield losses
c) Capital intensity- an investment in expensive new technologies makes a process more
capital intensive and increases pressure to have a smaller capacity cushion to get an
acceptable return on investment
d) Resource flexibility- a change to less worker flexibility requires a larger capacity cushion
to compensate for the operation overloads that are more likely to occur with a less
flexible workforce
e) Inventory- a change to less reliance on inventory in order to smooth the output rate
requires a larger capacity cushion to meet increased demands during peak periods
f) Scheduling- a change to more stable environment allows a smaller cushion because
products or services can be scheduled with more assurance

STEPS IN CAPACITY PLANNING

1. ESTIMATE CAPACITY REQUIREMENTS
a. When one product/service is being processed
Processing hours required for yea r ' s demand
No .of mac h ines required= after deducting desired cus h ion ¿ ¿
Hours available one mac h ine per year , ¿
¿

Dp
M=
N [1− ( 100C )]
Where: D= number of units (customers) forecast per year
p= processing time
N= total number of hours per year during which the process operates
C= desired capacity cushion

b. When multiple products/services are involved, extra time needed to change over from one product
or service to the next
*Set up time- time required to change a machine from making one product or service to making another

No .of units forecast per year ( D )

total set up time ( s )= x time per set up
number of units made∈eac h lot
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Processing∧set up hours required for

summed
yea r ' s demand , products
all
No .of mac h ines required= after deducting desired cus hion ¿ ¿
Hours available one mac hine per year ,¿
¿

D D D

M=
[ ( )][ ( )]
Dp+
Q
s + Dp+
Q
s + … …+ Dp+
Q
s
[ ( )]
N [1− ( 100C )]
Where: Q= number of units in each lot
s= set up time (in hours) per lot

*ALWAYS round up the fractional part unless it is cost efficient to use short-term options such as
overtime or stockouts to cover any shortfalls

2. IDENTIFY GAPS
*CAPACITY GAPS- any difference (positive or negative) between projected demand and current capacity
Capacity gap=demand−capacity

3. DEVELOP ALTERNATIVES
*BASE CASE- to do nothing and simply lose orders from any demand

4. EVALUATE THE ALTERNATIVES

*QUALITATIVE CONCERNS- manager has to look at how each alternative fits the overall capacity
strategy and other aspects of the business not covered by the financial analysis
*QUANTITATIVE CONCERNS- manager estimates the change in cash flows for ach alternative
*Cash flows- difference between the flow of funds into and out of an organization over a period
of time

TOOLS FOR CAPACITY PLANNING

1. WAITING LINE MODELS- use probability distributions to provide estimates of average customer time,
average length of waiting lines, and utilization of the work center
2. DECISION TREES- can be particularly valuable for evaluating different capacity expansion alternatives
when demand is uncertain and sequential decisions are involved

LOCATION PLANNING
LOCATION is important to:
 Accounting- prepares cost estimates for operating at new locations
 Finance- performs the financial analysis for investments in facilities at new locations and raises funds to
support them
 Human resources- hires and trains employees to support or relocated operations
 Management information system- provides information technologies that link operations at different
locations
 Marketing- assesses how new locations will appeal to customers and possibly open up entirely new
mark
 Operations- locates its facilities where they can meet current customer demand

GLOBALIZATION OF OPERATIONS (most important trend in location patterns)

GLOBALIZATION- describes businesses’ deployment of facilities and operations around the world
- results to more exports to and imports from other countries, often called offshore
sales and import
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REASONS FOR GLOBALIZATION

1. Improved transportation and communication technologies
2. Opened financial systems
3. Increased demand for imports
4. Reduced import quotas and other trade barriers

DISADVANTAGES OF GLOBALIZATION
1. A firm may have to relinquish proprietary technology if it turns over some of its component
manufacturing to offshore suppliers or if suppliers need the firm’s technology to achieve desired quality
and cost goals
2. There may be political risk.
3. Employee skills may be lower in foreign countries, requiring additional training time
4. Customer response times can be longer
*Global markets impose new standards on quality and time

CHALLENGES OF MANAGING GLOBAL OPERATION

1. Other languages
2. Different norms and customs
3. Work force management
4. Unfamiliar laws and regulations
5. Unexpected cost mix

FACTORS AFFECTING LOCATIONS DECISIONS

FACILITY LOCATION- process of determining a geographic site for a firm’s operations

Criteria to be met:
a. Must be sensitive to location
b. Must have a high impact on the company’s ability to meet its goal

DOMINANT FACTORS IN MANUFACTURING

1. Favorable labor climate
2. Proximity to markets
3. Quality of life
4. Proximity to suppliers and resources
5. Proximity to the parent company’s facilities
6. Utilities, taxes, and real estate costs

DOMINANT FACTORS IN SERVICES

1. Proximity to customers
2. Transportation costs and proximity to markets
3. Location of competitors
4. Site-specific factors

 Load distance method- a mathematical model used to evaluate location based on proximity; select a location
that minimizes the total weighted loads moving into and out of the facility
 Euclidian distance- the straight line distance or shortest possible path between two points
 Rectilinear distance- measures distance between two points with a series of 90° turns, as long city blocks
 Transportation method- quantitative approach that can help solve multiple-facility location problems
 Heuristics- solution guidelines or rules of thumb that find feasible but not necessarily the best solutions to
problems
 Simulation- modeling technique that reproduces the behavior of a system
 Optimization- involves procedures to determine the best solution