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Chapter 5, Part A

Facility Capacity and Location

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Overview
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Facility Planning Long-Range Capacity Planning Facility Location Wrap-Up: What World-Class Companies Do

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Facility Planning
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HOW MUCH long range capacity is needed WHEN additional capacity is needed WHERE the production facilities should be located WHAT the layout and characteristics of the facilities should be

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Facility Planning
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The capital investment in land, buildings, technology, and machinery is enormous A firm must live with its facility planning decisions for a long time, and these decisions affect: Operating efficiency Economy of scale Ease of scheduling Maintenance costs … Profitability!
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Long-Range Capacity Planning

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Steps in the Capacity Planning Process
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Estimate the capacity of the present facilities. Forecast the long-range future capacity needs. Identify and analyze sources of capacity to meet these needs. Select from among the alternative sources of capacity.

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Definitions of Capacity
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In general, production capacity is the maximum production rate of an organization. Capacity can be difficult to quantify due to … Day-to-day uncertainties such as employee absences, equipment breakdowns, and materialdelivery delays Products and services differ in production rates (so product mix is a factor) Different interpretations of maximum capacity
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Definitions of Capacity
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The Federal Reserve Board defines sustainable practical capacity as the greatest level of output that a plant can maintain … within the framework of a realistic work schedule taking account of normal downtime assuming sufficient availability of inputs to operate the machinery and equipment in place
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Measurements of Capacity
Output Rate Capacity For a facility having a single product or a few homogeneous products, the unit of measure is straightforward (barrels of beer per month) For a facility having a diverse mix of products, an aggregate unit of capacity must be established using a common unit of output (sales dollars per week)
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Measurements of Capacity
Input Rate Capacity Commonly used for service operations where output measures are particularly difficult Hospitals use available beds per month Airlines use available seat-miles per month Movie theatres use available seats per month
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Measurements of Capacity
Capacity Utilization Percentage Relates actual output to output capacity Example: Actual automobiles produced in a quarter divided by the quarterly automobile production capacity Relates actual input used to input capacity Example: Actual accountant hours used in a month divided by the monthly account-hours available
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Measurements of Capacity
Capacity Cushion an additional amount of capacity added onto the expected demand to allow for: greater than expected demand demand during peak demand seasons lower production costs product and volume flexibility improved quality of products and services
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Forecasting Capacity Demand
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Consider the life of the input (e.g. facility is 10-30 yr) Understand product life cycle as it impacts capacity Anticipate technological developments Anticipate competitors’ actions Forecast the firm’s demand

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Other Considerations
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Resource availability Accuracy of the long-range forecast Capacity cushion Changes in competitive environment

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Expansion of Long-Term Capacity
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Subcontract with other companies Acquire other companies, facilities, or resources Develop sites, construct buildings, buy equipment Expand, update, or modify existing facilities Reactivate standby facilities

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Reduction of Long-Term Capacity
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Sell off existing resources, lay off employees Mothball facilities, transfer employees Develop and phase in new products/services

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Economies of Scale
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Best operating level - least average unit cost Economies of scale - average cost per unit decreases as the volume increases toward the best operating level Diseconomies of scale - average cost per unit increases as the volume increases beyond the best operating level

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Economies and Diseconomies of Scale
Average Unit Cost of Output ($)

Economies of Scale

Diseconomies of Scale

Best Operating Level Annual Volume (units)
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Economies of Scale
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Declining costs result from: Fixed costs being spread over more and more units Longer production runs result in a smaller proportion of labor being allocated to setups Proportionally less material scrap … and other economies
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Diseconomies of Scale
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Increasing costs result from increased congestion of workers and material, which contributes to: Increasing inefficiency Difficulty in scheduling Damaged goods Reduced morale Increased use of overtime … and other diseconomies
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Two General Approaches to Expanding Long-Range Capacity
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All at Once – build the ultimate facility now and grow into it Incrementally – build incrementally as capacity demand grows

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Two General Approaches to Expanding Long-Range Capacity
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All at Once Little risk of having to turn down business due to inadequate capacity Less interruption of production One large construction project costs less than several smaller projects Due to inflation, construction costs will be higher in the future Most appropriate for mature products with stable demand
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Two General Approaches to Expanding Long-Range Capacity
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Incrementally Less risky if forecast needs do not materialize Funds that could be used for other types of investments will not be tied up in excess capacity More appropriate for new products
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Subcontractor Networks
A viable alternative to larger-capacity facilities is to develop subcontractor and supplier networks. “Farming out” or outsourcing your capacity needs to your suppliers Developing long-range relationships with suppliers of parts, components, and subassemblies Relying less on backward vertical integration Requiring less capital for production facilities More easily varying capacity during slack or peak demand periods
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Outsourcing Service Functions
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Building maintenance Data processing Delivery Payroll Bookkeeping Customer service Mailroom Benefits administration … and more
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Economies of Scope
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The ability to produce many product models in one flexible facility more cheaply than in separate facilities Highly flexible and programmable automation allows quick, inexpensive product-to-product changes Economies are created by spreading the automation cost over many products

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Analyzing Capacity-Planning Decisions
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Break-Even Analysis (Chapter 4 and this chapter) Present-Value Analysis Computer Simulation (Chapter 9) Waiting Line Analysis (Chapter 9) Linear Programming (Chapter 8) Decision Tree Analysis (this chapter)

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Example: King Publishing
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Break-Even Analysis King Publishing intends to publish a book in residential landscaping. Fixed costs are $125,000 per year, variable costs per unit are $32, and selling price per unit is $42. A) How many units must be sold per year to break even? B) How much annual revenue is required to break even? C) If annual sales are 20,000 units, what are the annual profits? D) What variable cost per unit would result in $100,000 annual profits if annual sales are 20,000 units?
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Example: King Publishing
Break-Even Analysis A) How many units must be sold per year to break even?
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Q = FC/(p-v) = $125,000/(42 – 32) = 12,500 books

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Example: King Publishing
Break-Even Analysis B) How much annual revenue is required to break even?
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TR = pQ = 42(12,500) = $525,000

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Example: King Publishing
Break-Even Analysis C) If annual sales are 20,000 units, what are the annual profits?
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P = pQ – (FC + vQ) = 42(20,000) – [125,000 + 32(20,000)] = 840,000 – 125,000 – 640,000 = $75,000

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Example: King Publishing
Break-Even Analysis D) What variable cost per unit would result in $100,000 annual profits if annual sales are 20,000 units?
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P = pQ – (FC + vQ) 100,000 = 42(20,000) – [125,000 + v(20,000)] 100,000 = 840,000 – 125,000 – 20,000v 20,000v = 615,000 v = $30.75

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Decision Tree Analysis
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Structures complex multiphase decisions, showing: What decisions must be made What sequence the decisions must occur Interdependence of the decisions Allows objective evaluation of alternatives Incorporates uncertainty Develops expected values
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Example: Good Eats Café
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Decision Tree Analysis Good Eats Café is about to build a new restaurant. An architect has developed three building designs, each with a different seating capacity. Good Eats estimates that the average number of customers per hour will be 80, 100, or 120 with respective probabilities of 0.4, 0.2, and 0.4. The payoff table showing the profits for the three designs is on the next slide.

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Example: Good Eats Café
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Payoff Table Average Number of Customers Per Hour c1 = 80 c2 = 100 c3 = 120 Design A Design B Design C $10,000 $ 8,000 $ 6,000 $15,000 $18,000 $16,000 $14,000 $12,000 $21,000

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Example: Good Eats Café
Expected Value Approach Calculate the expected value for each decision. The decision tree on the next slide can assist in this calculation. Here d1, d2, d3 represent the decision alternatives of designs A, B, C, and c1, c2, c3 represent the different average customer volumes (80, 100, and 120) that might occur.
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Example: Good Eats Café
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Decision Tree
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Payoffs
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(.2) (.4) (.4) (.2) (.4) (.4) (.2) (.4)

10,000 15,000 14,000 8,000 18,000 12,000 6,000 16,000 21,000 38

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c2 c3 c1 c2 c3

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Example: Good Eats Café
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Expected Value For Each Decision
d1 Design A
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EV = .4(10,000) + .2(15,000) + .4(14,000) = $12,600

Design B

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EV = .4(8,000) + .2(18,000) + .4(12,000) = $11,600

Design C

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EV = .4(6,000) + .2(16,000) + .4(21,000) = $14,000

Choose the design with largest EV -- Design C.

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Facility Location

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A Sequence of Decisions
National Decision Political, social, economic stability; Currency exchange rates; . . . . . Climate; Customer concentrations; Degree of unionization; . . . . . Transportation system availability; Preference of management; . . . . . Site size/cost; Environmental impact; Zoning restrictions; . . . . .
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Regional Decision

Community Decision

Site Decision

Factors Affecting the Location Decision
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Economic Site acquisition, preparation and construction costs Labor costs, skills and availability Utilities costs and availability Transportation costs Taxes
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Factors Affecting the Location Decision
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Non-economic Labor attitudes and traditions Training and employment services Community’s attitude Schools and churches Recreation and cultural attractions Amount and type of housing available
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Facility Types and Their Dominant Locational Factors
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Mining, Quarrying, and Heavy Manufacturing Near their raw material sources Abundant supply of utilities Land and construction costs are inexpensive Light Manufacturing Availability and cost of labor Warehousing Proximity to transportation facilities Incoming and outgoing transportation costs . . . more
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Facility Types and Their Dominant Locational Factors
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R&D and High-Tech Manufacturing Ability to recruit/retain scientists, engineers, etc. Near companies with similar technology interests Retailing and For-Profit Services Near concentrations of target customers Government and Health/Emergency Services Near concentrations of constituents
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Some Reasons the Facility Location Decision Arises
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Changes in the market Expansion Contraction Geographic shift Changes in inputs Labor skills and/or costs Materials costs and/or availability Utility costs . . . more
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Some Reasons the Facility Location Decision Arises
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Changes in the environment Regulations and laws Attitude of the community Changes in technology
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Analyzing Service Location Decisions
Consumer Behavior Research Market Research Why do customers buy our products and services? Who are our customers? What are their characteristics?

Data Gathering for Where are our customers concentrated? Each Location Alternative What are their traffic/spending patterns? Revenue Projections for What are the economic projections? Each Location Alternative What is the time-phased revenue? Profit Projections for What are the projected revenues Each Location Alternative less time-phased operating costs?
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Analyzing Industrial Facility Locations
Factors that tend to dominate the industrial-facility location decision are: Transportation costs Labor cost and availability Materials cost and availability Utilities cost
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Analyzing Industrial Facility Locations
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Locating a Single Facility A simple way to analyze alternative locations is conventional cost analysis Pros – ease of communication and understanding Cons – time value of money ignored and qualitative factors not considered Locating Multiple Facilities More sophisticated techniques are often used: Linear programming, computer simulation, network analysis, and others
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Qualitative Factors in Location Decisions
Often-important qualitative factors include Housing Climate Community activities Education and health services Recreation Churches Union activities Community attitudes
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Integrating Qualitative & Quantitative Factors
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Managers often wrestle with the task of trading off qualitative factors against quantitative ones Methods for systematically displaying the relative advantages and disadvantages, both qualitative and quantitative, of each location alternative have been developed The relative-aggregate-scores approach is one such method

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Relative-Aggregate-Scores Approach
Quantitative and Qualitative Factors
Location A Location B Econ. Wgt. Econ. Wgt. Weight Data Score Score Data Score Score .45 .35 .15 .05 $65 .923 $18 1.000 .700 .450 .415 .350 .105 .023 .893 $60 1.000 $21 .857 .500 .750 .450 .300 .075 .038 .863
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Factor

Prod.cost/ton Transp.cost/ton Labor Avail. Union Activity Total Score

Wrap-Up: World-Class Practice
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Outstanding long-range business plans Long-range capacity studies Justify investment on how it positions their company to capture market share Facility location decisions involve worldwide search for sites
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End of Chapter 5, Part A

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