5 Capacity Planning

Operations
Management

S7 - 1
 Process Strategies

The objective of a process strategy is

to build a production process that
meets customer requirements and
product specifications within cost
and other managerial constraints

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 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
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 Planning Over a Time
Horizon
Options for Adjusting Capacity

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

* Difficult to adjust capacity as limited options exist

Figure S7.1
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 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

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 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

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 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

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 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

© 2011 Pearson Education, Inc. publishing as Prentice Hall S7 - 8

 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%

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 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%

© 2011 Pearson Education, Inc. publishing as Prentice Hall 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

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

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

© 2011 Pearson Education, Inc. publishing as Prentice Hall 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

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

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

© 2011 Pearson Education, Inc. publishing as Prentice Hall 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
Efficiency = 84.6%
Efficiency of new line = 75%

Expected Output = (Effective Capacity)(Efficiency)

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

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 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

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 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

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 Capacity Considerations

1. Forecast demand accurately

2. Understand the technology and
capacity increments
3. Find the optimum
operating level
(volume)
4. Build for change

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 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
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 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 complementary
demand patterns

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 Complementary Demand
Patterns

4,000 –
Sales in units

3,000 –

2,000 –
Jet ski
1,000 – engine
sales

JFMAMJJASONDJFMAMJJASONDJ
Time (months)
Figure S7.3
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 Complementary Demand
Patterns

4,000 –
Sales in units

Snowmobile
3,000 – motor sales

2,000 –
Jet ski
1,000 – engine
sales

JFMAMJJASONDJFMAMJJASONDJ
Time (months)
Figure S7.3
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 Complementary Demand
Patterns
Combining both
demand patterns
reduces the
variation
4,000 –
Sales in units

Snowmobile
3,000 – motor sales

2,000 –
Jet ski
1,000 – engine
sales

JFMAMJJASONDJFMAMJJASONDJ
Time (months)
Figure S7.3
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 Tactics for Matching
Capacity to Demand
1. Making staffing changes
2. Adjusting equipment
 Purchasing additional machinery
 Selling or leasing out existing equipment
3. Improving processes to increase throughput
4. Redesigning products to facilitate more
throughput
5. Adding process flexibility to meet changing
product preferences
6. Closing facilities

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 Demand and Capacity
Management in the
Service Sector
 Demand management
 Appointment, reservations, FCFS rule
 Capacity
management
 Full time,
temporary,
part-time
staff
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 Bottleneck Analysis and
Theory of Constraints
 Each work area can have its own unique
capacity
 Capacity analysis determines the
throughput capacity of workstations in a
system
 A bottleneck is a limiting factor or
constraint
 A bottleneck has the lowest effective
capacity in a system

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 Process Times for Stations,
Systems, and Cycles
 The process time of a station is the
time to produce a unit at that single
workstation
 The process time of a system is the
time of the longest process in the
system … the bottleneck The
mig se
 The process cycle time is the h t be tit
time wo
diff qui
takes for a product to go through ere the
nt! te
production process with no waiting

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 A Three-Station
Assembly Line QuickTime™ and a
decompressor
are needed to see this picture.

A B C

2 min/unit 4 min/unit 3 min/unit

Figure S7.4

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 Process Times for Stations,
Systems, and Cycles
 The system process time is the
process time of the bottleneck after
dividing by the number of parallel
operations
 The system capacity is the inverse
of the system process time
 The process cycle time is the total
time through the longest path in the
system

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 Capacity Analysis
 Two identical sandwich lines
 Lines have two workers and three operations
 All completed sandwiches are wrapped

Bread Fill Toast

15 sec/sandwich 20 sec/sandwich 40 sec/sandwich
Order Wrap
30 sec/sandwich 37.5 sec/sandwich
Bread Fill Toast
15 sec/sandwich 20 sec/sandwich 40 sec/sandwich

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 Capacity Bread Fill Toast

Analysis
15 sec 20 sec 40 sec
Order Wrap
30 sec 37.5 sec
Bread Fill Toast
15 sec 20 sec 40 sec

 Toast work station has the longest processing

time – 40 seconds
 The two lines each deliver a sandwich every 40
seconds so the process time of the combined
lines is 40/2 = 20 seconds
 At 37.5 seconds, wrapping and delivery has the
longest processing time and is the bottleneck
 Capacity per hour is 3,600 seconds/37.5
seconds/sandwich = 96 sandwiches per hour
 Process cycle time is 30 + 15 + 20 + 40 + 37.5 =
142.5 seconds

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 Capacity Analysis
 Standard process for cleaning teeth
 Cleaning and examining X-rays can happen
simultaneously

Cleaning

Takes Develops 24 min/unit Check

Check in Dentist
X-ray X-ray out

2 min/unit 2 min/unit 4 min/unit X-ray 8 min/unit 6 min/unit

exam

5 min/unit

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 Capacity Check Takes Develops
Cleaning

24 min/unit Check

Analysis
Dentist
in X-ray X-ray out

2 min/unit 2 min/unit 4 min/unit X-ray 8 min/unit 6 min/unit

exam

5 min/unit

 All possible paths must be compared

 Cleaning path is 2 + 2 + 4 + 24 + 8 + 6 = 46
minutes
 X-ray exam path is 2 + 2 + 4 + 5 + 8 + 6 = 27
minutes
 Longest path involves the hygienist cleaning the
teeth
 Bottleneck is the hygienist at 24 minutes
 Hourly capacity is 60/24 = 2.5 patients
 Patient should be complete in 46 minutes

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 Theory of Constraints
 Five-step process for recognizing and
managing limitations
Step 1: Identify the constraint
Step 2: Develop a plan for overcoming the
constraints
Step 3: Focus resources on accomplishing Step 2
Step 4: Reduce the effects of constraints by
offloading work or expanding capability
Step 5: Once overcome, go back to Step 1 and find
new constraints

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 Bottleneck Management
1. Release work orders to the system at the
pace of set by the bottleneck
2. Lost time at the bottleneck represents
lost time for the whole system
3. Increasing the capacity of a non-
bottleneck station is a mirage
4. Increasing the capacity of a bottleneck
increases the capacity of the whole
system

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 Crossover Charts
Variable
costs
Variable Variable
$ costs $ costs $
Fixed costs Fixed costs
Fixed costs
Low volume, high variety Repetitive High volume, low variety
Process A Process B Process C

t
$ os
st

l c t
cos
co

ta l
To Tot a
tal
To

400,000
300,000
200,000
Fixed cost Fixed cost Fixed cost
Process A Process B Process C
Figure 7.4 (2,857) V1 V2 (6,666) Volume
S7 - 34
 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

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 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

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 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 verify
 Time value of money is often
ignored
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 Break-Even Analysis
–
Total revenue line
900 –

800 – i d or
r Total cost line
Break-even point
cor
700 – Total cost = Total revenue fit
P ro
Cost in dollars

600 –

500 –
Variable cost
400 –

300 –
o ss or
200 – L ri d
r
co
100 – Fixed cost
| | | | | | | | | | | |
–
0 100 200 300 400 500 600 700 800 900 1000 1100
Figure S7.5 Volume (units per period)

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 Break-Even Analysis
BEPx = break- x = number of units
even point in units produced
BEP$ = break- TR = total revenue =
even point in dollars Px
P = price per unit F = fixed costs
(after all discounts) V = variable cost per
unit
TC = total costs = F +
Vx
Break-even point occurs when

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

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 Break-Even Analysis
BEPx = break- x = number of units
even point in units produced
BEP$ = break- TR = total revenue =
even point in dollars Px
P = price per unit F = fixed costs
(after all discounts) V = variable cost per
unit
TC = total costs = F +
BEP$ = BEPx P Vx
F Profit = TR - TC
= P - VP = Px - (F + Vx)
F
= (P - V)/P = Px - F - Vx
F = (P - V)x - F
= 1 - V/P
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 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)]

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 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)

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 Break-Even Example
50,000 –

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

20,000 –

Fixed costs
10,000 –

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

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 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

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 Multiproduct Example
Fixed costs = $3,000 per month
Annual Forecasted
Item Price Cost Sales Units
Sandwich $5.00 $3.00 9,000
Drink 1.50 .50 9,000
Baked potato 2.00 1.00 7,000

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 Multiproduct Example
Fixed costs = $3,000 per month
Annual Forecasted
Item Price Cost Sales Units
Sandwich $5.00 $3.00 9,000
Drink 1.50 .50 9,000
Baked potato 2.00 1.00 7,000

Annual Weighted
Selling Variable Forecasted % of Contribution
Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7)
Sandwich $5.00 $3.00 .60 .40 $45,000 .621 .248
Drinks 1.50 .50 .33 .67 13,500 .186 .125
Baked 2.00 1.00 .50 .50 14,000 .193 .096
potato
$72,500 1.000 .469

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 Multiproduct
BEP Example
=
F
$

∑ 1 - VP x (W ) i
i
Fixed costs = $3,000 per month i

Annualx Forecasted
$3,000 12
Item Price Cost = Sales Units
= $76,759
.469
Sandwich $5.00 $3.00 9,000
Drink 1.50 .50
Daily 9,000
$76,759
Baked potato 2.00 sales = 312 days
1.00 = $246.02
7,000

Annual Weighted
Selling Variable .621 x $246.02% of Contribution
Forecasted
Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales = 30.6
(col 531
$5.00$ Sales sandwiches
x col 7)
Sandwich $5.00 $3.00 .60 .40 $45,000 .621 per day.248
Drinks 1.50 .50 .33 .67 13,500 .186 .125
Baked 2.00 1.00 .50 .50 14,000 .193 .096
potato
$72,500 1.000 .469

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 Reducing Risk with
Incremental Changes
(a) Leading demand with (b) Capacity lags demand with
incremental expansion incremental expansion
New New
capacity capacity
Demand

Demand
Expected Expected
demand demand

(c) Attempts to have an average

capacity with incremental
expansion
New
Demand

capacity Expected
demand

Figure S7.6
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 Reducing Risk with
Incremental Changes
(a) Leading demand with incremental
expansion

New
capacity
Demand

Expected
demand

1 2 3
Time (years)
Figure S7.6
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 Reducing Risk with
Incremental Changes
(b) Capacity lags demand with incremental
expansion

New
capacity

Expected
Demand

demand

1 2 3
Time (years)
Figure S7.6
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 Reducing Risk with
Incremental Changes
(c) Attempts to have an average capacity
with incremental expansion

New
capacity

Expected
Demand

demand

1 2 3
Time (years)
Figure S7.6
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 Expected Monetary Value
(EMV) and Capacity Decisions

 Determine states of nature

 Future demand
 Market favorability
 Analyzed using decision trees
 Hospital supply company
 Four alternatives

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 Expected Monetary Value
(EMV) and Capacity Decisions
Market favorable (.4)
$100,000

Market unfavorable (.6)

l a nt -$90,000
r gep
La
Market favorable (.4)
$60,000
Medium plant
Sm Market unfavorable (.6)
all -$10,000
pla
nt
Do Market favorable (.4)
no $40,000
t hi
ng
Market unfavorable (.6)
-$5,000

$0

© 2011 Pearson Education, Inc. publishing as Prentice Hall S7 - 53

 Expected Monetary Value
(EMV) and Capacity Decisions
Market favorable (.4)
$100,000

Market unfavorable (.6)

l a nt -$90,000
r gep
La
Market favorable (.4)
$60,000
Medium plant
Large
Sm
all
Plant Market unfavorable (.6)
-$10,000
pla
nt
EMV = (.4)($100,000)
Do Market favorable (.4)
no $40,000
+ (.6)(-$90,000)
th
in
g
Market unfavorable (.6)
EMV = -$14,000 -$5,000

$0

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 Expected Monetary Value
(EMV) and Capacity Decisions
-$14,000
Market favorable (.4)
$100,000

Market unfavorable (.6)

l a nt -$90,000
r gep $18,000
La
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
t hi
ng
Market unfavorable (.6)
-$5,000

$0

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 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

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 Net Present Value (NPV)
In general:
F = P(1 + i)N
where F = future value
P = present value
i = interest rate
N = number of years

Solving for P:
F
P=
(1 + i)N
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 Net Present Value (NPV)
In general:
F = P(1 + i)N
where F = future value
P While
= present valuethis works
i fine, it is
= interest rate
N = numbercumbersome
of years for
larger values of N
Solving for P:
F
P=
(1 + i)N
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 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 6% 8% 10% 12% 14%

Portion of
1 .943 .926 .909 .893 .877
Table S7.1 2 .890 .857 .826 .797 .769
3 .840 .794 .751 .712 .675
4 .792 .735 .683 .636 .592
5 .747 .681 .621 .567 .519

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 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

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 Present Value of an Annuity
Portion of Table S7.2

Year 6% 8% 10% 12% 14%

1 .943 .926 .909 .893 .877
2 1.833 1.783 1.736 1.690 1.647
3 2.676 2.577 2.487 2.402 2.322
4 3.465 3.312 3.170 3.037 2.914
5 4.212 3.993 3.791 3.605 3.433

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 Present Value of an Annuity
$7,000 in receipts per for 5 years
Interest rate = 6%
From Table S7.2
X = 4.212

S = RX
S = $7,000(4.212) = $29,484

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 Limitations
1. Investments with the same NPV may
have different projected lives and
salvage values
2. Investments with the same NPV may
have different cash flows
3. Assumes we know future interest rates
4. Payments are not always made at the
end of a period

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