Operations

Management
Supplement 7 –
Capacity Planning
PowerPoint presentation to accompany
Heizer/Render
Principles of Operations Management, 6e
Operations Management, 8e

© 2006
© 2006 Prentice
Prentice Hall, Inc. Hall, Inc. S7 – 1
 Outline
 Capacity
 Design and Effective Capacity
 Capacity and Strategy
 Capacity Considerations
 Managing Demand
 Capacity Planning

© 2006 Prentice Hall, Inc. S7 – 2

 Outline – Continued
 Breakeven Analysis
 Single-Product Case
 Multiproduct Case
 Applying Decision Trees to
Capacity Decisions

© 2006 Prentice Hall, Inc. S7 – 3

 Outline – Continued

 Applying Investment Analysis to

Strategy-Driven Investments
 Investment, Variable Cost, and
Cash Flow
 Net Present Value

© 2006 Prentice Hall, Inc. S7 – 4

 Learning Objectives
When you complete this supplement,
you should be able to:
Identify or Define:

 Capacity
 Design capacity
 Effective capacity
 Utilization

© 2006 Prentice Hall, Inc. S7 – 5

 Learning Objectives
When you complete this supplement,
you should be able to:
Describe or Explain:
 Capacity considerations
 Net present value analysis
 Break-even analysis
 Financial considerations
 Strategy-driven investments
© 2006 Prentice Hall, Inc. S7 – 6
 Capacity

 The throughput, or the number of

units a facility can hold, receive,
store, or produce in a period of time
 Determines fixed costs
 Determines if demand will be
satisfied
 Three time horizons

© 2006 Prentice Hall, Inc. S7 – 7

 Planning Over a Time
Horizon

Long-range Add facilities

planning Add long lead time equipment
*
Intermediate- Subcontract Add personnel
range Add equipment Build or use inventory
planning Add shifts

Schedule jobs
Short-range
planning
* Schedule personnel
Allocate machinery

Modify capacity Use capacity

* Limited options exist
Figure S7.1

© 2006 Prentice Hall, Inc. S7 – 8

 Design and Effective
Capacity
 Design capacity is the maximum
theoretical output of a system
 Normally expressed as a rate
 Effective capacity is the capacity a
firm expects to achieve given current
operating constraints
 Often lower than design capacity

© 2006 Prentice Hall, Inc. S7 – 9

 Utilization and Efficiency
Utilization is the percent of design capacity
achieved

Utilization = Actual Output/Design Capacity

Efficiency is the percent of effective capacity

achieved

Efficiency = Actual Output/Effective Capacity

© 2006 Prentice Hall, Inc. S7 – 10

 Bakery Example
Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

© 2006 Prentice Hall, Inc. S7 – 11

 Bakery Example
Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

© 2006 Prentice Hall, Inc. S7 – 12

 Bakery Example
Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Utilization = 148,000/201,600 = 73.4%

© 2006 Prentice Hall, Inc. S7 – 13

 Bakery Example
Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Utilization = 148,000/201,600 = 73.4%

© 2006 Prentice Hall, Inc. S7 – 14

 Bakery Example
Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Utilization = 148,000/201,600 = 73.4%

Efficiency = 148,000/175,000 = 84.6%

© 2006 Prentice Hall, Inc. S7 – 15

 Bakery Example
Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Utilization = 148,000/201,600 = 73.4%

Efficiency = 148,000/175,000 = 84.6%

© 2006 Prentice Hall, Inc. S7 – 16

 Bakery Example
Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts
Efficiency = 84.6%
Efficiency of new line = 75%

Expected Output = (Effective Capacity)(Efficiency)

= (175,000)(.75) = 131,250 rolls

© 2006 Prentice Hall, Inc. S7 – 17

 Bakery Example
Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts
Efficiency = 84.6%
Efficiency of new line = 75%

Expected Output = (Effective Capacity)(Efficiency)

= (175,000)(.75) = 131,250 rolls

© 2006 Prentice Hall, Inc. S7 – 18

 Capacity and Strategy

 Capacity decisions impact all 10

decisions of operations
management as well as other
functional areas of the organization
 Capacity decisions must be
integrated into the organization’s
mission and strategy

© 2006 Prentice Hall, Inc. S7 – 19

 Managing Demand
 Demand exceeds capacity
 Curtail demand by raising prices,
scheduling longer lead time
 Long term solution is to increase capacity
 Capacity exceeds demand
 Stimulate market
 Product changes
 Adjusting to seasonal demands
 Produce products with complimentary
demand patterns
© 2006 Prentice Hall, Inc. S7 – 20
 Economies and
Diseconomies of Scale
(dollars per room per night)
Average unit cost

25 - Room 75 - Room
Roadside Motel 50 - Room Roadside Motel
Roadside Motel

Economies Diseconomies
of scale of scale
25 50 75
Number of Rooms
Figure S7.2
© 2006 Prentice Hall, Inc. S7 – 21
 Capacity Considerations

 Forecast demand accurately

 Understanding the technology
and capacity increments
 Find the optimal operating level
(volume)
 Build for change

© 2006 Prentice Hall, Inc. S7 – 22

 Tactics for Matching
Capacity to Demand
1. Making staffing changes
2. Adjusting equipment and processes
 Purchasing additional machinery
 Selling or leasing out existing equipment
3. Improving methods to increase
throughput
4. Redesigning the product to facilitate
more throughput

© 2006 Prentice Hall, Inc. S7 – 23

 Complementary Demand
Patterns
By combining
both, the
variation is
reduced
4,000 –
Sales in units

Snowmobile
3,000 – sales

2,000 –
Jet ski
1,000 – sales

JFMAMJJASONDJFMAMJJASONDJ
Time (months)
Figure S7.3

© 2006 Prentice Hall, Inc. S7 – 24

 Approaches to Capacity
Expansion
(a) Leading demand with (b) Leading demand with
incremental expansion one-step expansion
New New
capacity capacity
Demand

Demand
Expected Expected
demand demand

(c) Capacity lags demand with (d) Attempts to have an average

incremental expansion capacity with incremental
New
expansion
capacity New
Demand

Expected Demand capacity Expected

demand demand

Figure S7.4
© 2006 Prentice Hall, Inc. S7 – 25
 Approaches to Capacity
Expansion
(a) Leading demand with incremental
expansion

New
capacity
Demand

Expected
demand

1 2 3
Time (years)
Figure S7.4
© 2006 Prentice Hall, Inc. S7 – 26
 Approaches to Capacity
Expansion
(b) Leading demand with one-step
expansion

New
capacity
Expected
Demand

demand

1 2 3
Time (years)
Figure S7.4
© 2006 Prentice Hall, Inc. S7 – 27
 Approaches to Capacity
Expansion
(c) Capacity lags demand with incremental
expansion

New
capacity

Expected
Demand

demand

1 2 3
Time (years)
Figure S7.4
© 2006 Prentice Hall, Inc. S7 – 28
 Approaches to Capacity
Expansion
(d) Attempts to have an average capacity
with incremental expansion

New
capacity

Expected
Demand

demand

1 2 3
Time (years)
Figure S7.4
© 2006 Prentice Hall, Inc. S7 – 29
 Break-Even Analysis
 Technique for evaluating process
and equipment alternatives
 Objective is to find the point in
dollars and units at which cost
equals revenue
 Requires estimation of fixed costs,
variable costs, and revenue

© 2006 Prentice Hall, Inc. S7 – 30

 Break-Even Analysis
 Fixed costs are costs that continue
even if no units are produced
 Depreciation, taxes, debt, mortgage
payments
 Variable costs are costs that vary
with the volume of units produced
 Labor, materials, portion of utilities
 Contribution is the difference between
selling price and variable cost
© 2006 Prentice Hall, Inc. S7 – 31
 Break-Even Analysis
Assumptions
 Costs and revenue are linear
functions
 Generally not the case in the real
world
 We actually know these costs
 Very difficult to accomplish
 There is no time value of money
© 2006 Prentice Hall, Inc. S7 – 32
 Break-Even Analysis
–
Total revenue line
900 –

800 – i dor
Break-even point orr Total cost line
700 – Total cost = Total revenue it c
r of
P
Cost in dollars

600 –

500 –
Variable cost
400 –

300 –
o ss or
200 – L rid
r
co
100 – Fixed cost
| | | | | | | | | | | |
–
0 100 200 300 400 500 600 700 800 900 1000 1100
Figure S7.5
Volume (units per period)
© 2006 Prentice Hall, Inc. S7 – 33
 Break-Even Analysis
BEPx = Break- x= Number of
even point in units units produced
BEP$ = Break- TR = Total
even point in dollars revenue = Px
P = Price F= Fixed costs
per unit (after all V =
discounts) Variable costs
TC = Total
Break-even point costs = F + Vx
occurs when

TR = TC F
or BEPx =
P-V
Px = F + Vx

© 2006 Prentice Hall, Inc. S7 – 34

 Break-Even Analysis
BEPx = Break- x= Number of
even point in units units produced
BEP$ = Break- TR = Total
even point in dollars revenue = Px
P = Price F= Fixed costs
per unit (after all V =
discounts) Variable costs
TC = Total
BEP$ = BEPx P costs = F + Vx
F Profit = TR - TC
= P-V P
= Px - (F + Vx)
F
= (P - V)/P = Px - F - Vx
F = (P - V)x - F
= 1 - V/P
© 2006 Prentice Hall, Inc. S7 – 35
 Break-Even Example
Fixed costs = $10,000 Material = $.75/unit
Direct labor = $1.50/unit Selling price = $4.00 per unit

F $10,000
BEP$ = =
1 - (V/P) 1 - [(1.50 + .75)/(4.00)]

© 2006 Prentice Hall, Inc. S7 – 36

 Break-Even Example
Fixed costs = $10,000 Material = $.75/unit
Direct labor = $1.50/unit Selling price = $4.00 per unit

F $10,000
BEP$ = =
1 - (V/P) 1 - [(1.50 + .75)/(4.00)]
$10,000
= = $22,857.14
.4375

F $10,000
BEPx = = = 5,714
P-V 4.00 - (1.50 + .75)

© 2006 Prentice Hall, Inc. S7 – 37

 Break-Even Example

50,000 –

Revenue
40,000 –
Break-even
point Total
30,000 –
Dollars

costs

20,000 –

Fixed costs
10,000 –

| | | | | |
0– 2,000 4,000 6,000 8,000 10,000
Units

© 2006 Prentice Hall, Inc. S7 – 38

 Break-Even Example
Multiproduct Case
F
BEP$ =
∑ 1-
Vi
Pi
x (Wi)

where V = variable cost per unit

P = price per unit
F = fixed costs
W = percent each product is of total dollar sales
i = each product

© 2006 Prentice Hall, Inc. S7 – 39

 Multiproduct Example
Fixed costs = $3,500 per month
Annual Forecasted
Item Price Cost Sales Units
Sandwich $2.95 $1.25 7,000
Soft drink .80 .30 7,000
Baked potato 1.55 .47 5,000
Tea .75 .25 5,000
Salad bar 2.85 1.00 3,000

© 2006 Prentice Hall, Inc. S7 – 40

 Multiproduct Example
Fixed costs = $3,500 per month
Annual Forecasted
Item Price Cost Sales Units
Sandwich $2.95 $1.25 7,000
Soft drink .80 .30 7,000
Baked potato 1.55 .47 Annual 5,000 Weighted
Tea Selling Variable .75 .25Forecasted 5,000
% of Contribution
Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7)
Salad bar 2.85 1.00 3,000
Sandwich $2.95 $1.25 .42 .58 $20,650 .446 .259
Soft drink .80 .30 .38 .62 5,600 .121 .075
Baked 1.55 .47 .30 .70 7,750 .167 .117
potato
Tea .75 .25 .33 .67 3,750 .081 .054
Salad bar 2.85 1.00 .35 .65 8,550 .185 .120
$46,300 1.000 .625

© 2006 Prentice Hall, Inc. S7 – 41

 Multiproduct Example BEP$ =
F

∑ 1 - VP x (W ) i
i
i
Fixed costs = $3,500 per month
$3,500
Annualx Forecasted
12
= = $67,200
Item Price Cost .625
Sales Units
Sandwich $2.95 $1.25 7,000
Soft drink .80 Daily
.30 $67,200
7,000
sales = = $215.38
Baked potato 1.55 .47 312
Annual days
5,000 Weighted
Tea Selling Variable .75 .25Forecasted 5,000
% of Contribution
Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7)
Salad bar 2.85 1.00
.446 x $215.38 3,000
Sandwich $2.95 $1.25 .42 .58 $20,650 = 32.6  .259
.446 33
$2.95 sandwiches
Soft drink .80 .30 .38 .62 5,600 .121 .075
per day
Baked 1.55 .47 .30 .70 7,750 .167 .117
potato
Tea .75 .25 .33 .67 3,750 .081 .054
Salad bar 2.85 1.00 .35 .65 8,550 .185 .120
$46,300 1.000 .625

© 2006 Prentice Hall, Inc. S7 – 42

 Decision Trees and
Capacity Decision
-$14,000
Market favorable (.4)
$100,000

Market unfavorable (.6)

l a nt -$90,000
p
arge $18,000
L
Market favorable (.4)
$60,000
Medium plant
Sm Market unfavorable (.6)
all -$10,000
pla
nt $13,000
Do
Market favorable (.4)
no $40,000
th
in
g
Market unfavorable (.6)
-$5,000

$0
© 2006 Prentice Hall, Inc. S7 – 43
 Strategy-Driven Investment

 Operations may be responsible

for return-on-investment (ROI)
 Analyzing capacity alternatives
should include capital
investment, variable cost, cash
flows, and net present value

© 2006 Prentice Hall, Inc. S7 – 44

 Net Present Value (NPV)

F
P=
(1 + i)N

where F = future value

P = present value
i = interest rate
N = number of years

© 2006 Prentice Hall, Inc. S7 – 45

 NPV Using Factors
F
P= = FX
(1 + i) N

where X= a factor from

Table S7.1 defined as =
1/(1 + i)N and F = future
value
Year 5% 6% 7% … 10%
Portion of 1 .952 .943 .935 .909
Table S7.1 2 .907 .890 .873 .826
3 .864 .840 .816 .751
4 .823 .792 .763 .683
5 .784 .747 .713 .621
© 2006 Prentice Hall, Inc. S7 – 46
 Present Value of an Annuity
An annuity is an investment which
generates uniform equal payments

S = RX
where X = factor from Table S7.2
S = present value of a
series of uniform annual
receipts
R = receipts that are
received every year of the life of
the investment

© 2006 Prentice Hall, Inc. S7 – 47

 Present Value of an Annuity
Portion of Table S7.2

Year 5% 6% 7% … 10%
1 .952 .943 .935 .909
2 1.859 1.833 1.808 1.736
3 2.723 2.676 2.624 2.487
4 4.329 3.465 3.387 3.170
5 5.076 4.212 4.100 3.791

© 2006 Prentice Hall, Inc. S7 – 48