Capacity allocation to existing production

facilities – TelecomOne/ HighOptic

TelecomOne and HighOptic, two manufacturers of telecommunication equipment.
TelecomOne has focused on the eastern half of the United States. It has manufacturing plants
located in Baltimore, Memphis, and Wichita and serves markets in Atlanta, Boston, and
Chicago. HighOptic has targeted the western half of the United States and serves markets in
Denver, Omaha, and Portland from plants located in Cheyenne and Salt Lake City.
We calculate that TelecomOne has a total production capacity of 71,000 units per month and a
total demand of 32,000 units per month, whereas HighOptic has a production capacity of
51,000 units per month and a demand of 24,000 units per month. Each year, managers in both
companies must decide how to allocate the demand to their production facilities as demand
and costs change.
 Models for Demand Allocation and Plant
Location
Capacity, Demand, and Cost Data for TelecomOne and HighOptic
Demand City Production and Transportation Cost per Thousand Units (Thousand $)
Monthly Monthly
Capacity Fixed Cost
(Thousand (Thousand $)
Supply City Atlanta Boston Chicago Denver Omaha Portland Units) K f
Baltimore 1,675 400 985 1,630 1,160 2,800 18 7,650
Cheyenne 1,460 1,940 970 100 495 1,200 24 3,500

Salt Lake 1,925 2,400 1,450 500 950 800 27 5,000

City
Memphis 380 1,355 543 1,045 665 2,321 22 4,100
Wichita 922 1,646 700 508 311 1,797 31 2,200
Monthly 10 8 14 6 7 11 Blank Blank
demand
(thousand
units) Dj
Allocating Demand to Existing Production
Facilities (1 of 8)
• Inputs required
n = number of factory locations
m = number of markets or demand points
Dj = annual demand from market j
Ki = capacity of factory i
cij = cost of producing and shipping one unit from factory i to market j
The goal is to allocate the demand from different markets to the various
plants to minimize the total cost of facilities, transportation, and inventory.
Define the decision variables:
xij = quantity shipped from factory i to market j
yi = 1 if plant i is open, 0 otherwise
Allocating Demand to Existing Production Facilities
(2 of 8)
The problem is formulated as the following linear program:
Objective function

Also we know,

Subject to (constraints)

For both TelecomOne and HighOptic, the demand allocation problem can be
solved using the Solver tool in Excel.
TelecomOne/ HighOptic
Management executives at both TelecomOne and HighOptic have decided to merge the two
companies into a single entity to be called TelecomOptic. Management believes that
significant benefits will result if the two networks are merged appropriately. TelecomOptic
will have five factories from which to serve six markets. Management is debating whether
all five factories are needed. A team was formed to study the network for the combined
company and identify the plants that could be shut down.
Given that taxes and duties do not vary among locations, the team decides to locate
factories and then allocate demand to the open factories to minimize the total cost of
facilities, transportation, and inventory.
The team concludes that it is optimal for TelecomOptic to close the plants in Salt Lake City
and Wichita, while keeping the plants in Baltimore, Cheyenne, and Memphis open. The total
monthly cost of this network and operation is $47,401,000. This cost represents savings of
about $3 million per month compared with the situation in which TelecomOne and
HighOptic operate separate supply chain networks.
Allocating Demand to Existing Production
Facilities (6 of 8)
Cell Formula Equation Copied to

= I 4 times H 14 minus sum, left parenthesis B 14:G 14 right parenthesis

B22 5.1 B23:B26

B29 = B9 − SUM(B14:B18) 5.2 C29:G29

B32 = SUMPRODUCT(B4:G8, B14:G18) + Objective –

SUMPRODUCT(H4:H8, H14:H18) function

Spreadsheet Area for Constraints for TelecomOptic

Problem- Capacity Allocation/ Merger
Hot&Cold and CaldoFreddo are two European manufacturers of home appliances that have
merged. Hot&Cold has plants in France, Germany, and Finland, whereas CaldoFreddo has
plants in the United Kingdom and Italy. The European market is divided into four regions:
north, east, west, and south. Plant capacities (millions of units per year), annual fixed costs
(millions of euros per year), regional demand (millions of units), and variable production and
shipping costs (euros per unit) are as shown in Table 5-14. Each appliance sells for an average
price of 300 euros. All plants are currently treated as profit centers, and thecompany pays
taxes separately for each plant. Tax rates in the various countries are as follows: France, 0.25;
Germany, 0.25; Finland, 0.3; UK, 0.2; and Italy, 0.35.
a. Before the merger, what is the optimal network for each of the two firms if their goal is
to minimize costs? What is the optimal network if the goal is to maximize after-tax
profits?
b. After the merger, what is the minimum cost configuration if none of the plants is shut
down? What is the configuration that maximizes after-tax profits if none of the plants is
shut down?
 Problem- Capacity Allocation/ Merger
c. After the merger, what is the minimum cost configuration if plants can be shut down (assume
that a shutdown saves 100 percent of the annual fixed cost of the plant)? What is the
configuration that maximizes after-tax profits?
Calculation of Economic Order Quantity or
Optimal order quantity (Qopt)
Total annual cost = Annual + Annual + Annual or
purchase cost ordering cost holding cost

where TC = Total annual cost

D = Demand (annual)
C = Cost per unit
Q = Quantity to be ordered (the optimal amount is termed the economic
order quantity— EOQ—or Qopt)
S = Setup cost or cost of placing an order
H = Annual holding and storage cost per unit of average inventory (often,
holding cost is taken as a percentage of the cost of the item, such as H = iC,
where i is the percent carrying cost)
Calculation of Economic Order Quantity or
Optimal order quantity (Qopt)
The total cost is minimal at the point where the slope of the curve is zero. Using
calculus, we take the derivative of total cost with respect to Q and set this equal to zero.

Because this simple model assumes constant demand and lead time, neither
safety stock nor stockout cost is necessary, and the reorder point, R, is simply
Fixed–Order Quantity Model with Safety Stock
The key difference between a fixed–order quantity model where demand is
known and one where demand is uncertain is in computing the reorder point.
The order quantity is the same in both cases. The uncertainty element is taken
into account in the safety stock. The reorder point is then set to cover the
expected demand during the lead time plus a safety stock determined by the
desired service level.
Inventory Model – example