Operations

Management
Capacity Planning
Supplement 7

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 Outline
 CAPACITY
 Defining Capacity
 Capacity and Strategy
 Capacity Considerations
 Managing Demand
 CAPACITY PLANNING
 BREAKEVEN ANALYSIS
 Single-Product Case
 Multiproduct Case

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 Outline - Continued

 APPLYING DECISION TREES TO CAPACITY

DECISIONS
 STRATEGY DRIVEN INVESTMENTS
 Investment, Variable Cost, and Cash Flow
 Net Present Value

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 Learning Objectives
When you complete this supplement, you should be
able to :
Identify or Define:
 Capacity
 Design Capacity
 Effective Capacity
 Utilization

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 Learning Objectives
When you complete this supplement, you should be
able to:
Explain:
 Capacity Considerations
 Net Present Value Analysis
 Breakeven Analysis
 Financial Considerations
 Strategy-Driven Investments

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 “Too little capacity loses
customers and too much capacity
is expensive. Capacity needs to
be just right.”

 What should be the seating capacity of a concert hall? or a

sport stadium for the Olympic games 2021?
 How many customers per day should a Starbucks Café be
able to serve?
 How many rooms should a hospital provide considering the
increasing number of Covid-19 patients?
 How large should a Nike plant be to produce 1,000 pairs of
shoes in an 8-hour shift?

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 Facility Planning

Facility planning answers:

 How much long-range capacity is needed
 When more capacity is needed
 Where facilities should be located (location)
 How facilities should be arranged (layout)

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 Capacity Planning Process

Develop Quantitative
Forecast
Alternative Factors
Demand
Plans (e.g., Cost)

Compute Evaluate Qualitative

Rated Capacity Factors
Capacity Plans (e.g., Skills)

Compute Select Best

Implement
Needed Capacity
Best Plan
Capacity Plan

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 Types of Planning Over a Time
Horizon
Long Range
Planning: Add Facilities
> 1 year Add long lead time equipment *

Intermediate Sub-Contract Add Personnel

Range Planning: Add Equipment Build or Use Inventory
3-18 months Add Shifts

Schedule Jobs
Short Range * Schedule Personnel
Planning: Allocate Machinery
Up to 3 months
Modify Capacity Use Capacity
*Limited options exist
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 Definition and Measures of Capacity
Capacity: The “throughput,” or number of units a facility can
hold, receive, store, or produce in a period of time.
Design The maximum theoretical output of a system in a given
(theoretical) period under ideal conditions.
capacity:
Effective Capacity a firm can expect to receive given its product
capacity: mix, methods of scheduling, maintenance, and
standards of quality (current operating constraints).

Utilization: The percent of design capacity actually achieved.

Efficiency: The percent of effective capacity actually achieved.

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 Utilization
Measure of planned or actual capacity usage of a
facility, work center, or machine

Actual Output
Utilization = Equation (1)
Design Capacity
Planned hours to be used
=
Total hours available

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 Efficiency
Measure of how well a facility or machine is performing
when used
Actual output
Efficiency = Equation (2)
Effective Capacity
Actual output in units
=
Standard output in units
Average actual time
=
Standard time
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 Case Study
 Sara James Bakery has a plant for processing Deluxe breakfast rolls and wants to better understand its capability. Determine the design capacity, utilization,
and efficiency for this plant when producing the Deluxe roll!
 Approach: Last week the facility produced 148,000 rolls. The effective capacity is 175,000 rolls. The production line operates 7 days/week with 8-hour
shifts/day. The line was designed to process the nut-filled, cinnamon-flavored Deluxe roll at a rate of 1,200 per hour. The firm first computes the design
capacity then uses the Equation (1) to determine utilization and Equation (2) to determine efficiency.
 Solution:
Design capacity = (7 days x 3 shifts x 8 hours) x (1,200 rolls/hour) = 201,600 rolls
Utilization = actual output/design capacity = 148,000/201,600 = 73.4%
Efficiency = actual output/effective capacity = 148,000/175,000 = 84.6%
 Insight: The bakery has now information necessary to evaluate efficiency.

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 Actual or Expected Output
Design capacity, utilization, and efficiency are all important measures for an operations
managers. But managers often need to know the expected output of a facility or process.
To do this, we solve for actual (or in this care, future or expected) output.

Actual (or Expected) Output = (Effective Capacity)(Efficiency)

Equation (3)

Expected output is sometimes referred to as rated capacity. With a

knowledge of effective capacity and efficiency, a manager can find the
expected output of a facility.

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 Case Study-continued
 The manager of Sara James now needs to increase production of the increasingly popular Deluxe roll. To meet this demand, she will be adding a
second production line.
 Approach: The manager must determine the expected output of this second line for the sales department. Effective capacity on the second line is the
same as on the first line, which is 175,0000 Deluxe rolls. The first line is operating at an efficiency of 84.6 %, as computed previously. But output on
the second line will be less than the first line because the crew will be primarily new hires, so the efficiency can be expected to be no more that 75%.
What is the expected amount?
 Solution:
Expected output = (Effective Capacity)(Efficiency)
= 175,000 x 75% = 131,250 rolls.
 Insight: The sales department can now be told the expected amount is 131,250 rolls.

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 The capacity of a company not currently being used or the
What about idle component of operable capacity that is not in operation and
capacity? not under active repair, but capable of being placed in
operation

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 Implications of Capacity Changes

Changes in:
• Sales
• Cash flow
• Quality
• Supply chain
• Human resources
• Maintenance

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 Special Requirements for Making
Good Capacity Decisions

 Forecast demand accurately

 Understanding the technology and capacity
increments
 Finding the optimal operating level (volume):
economies and diseconomies of scale.
 Build for change: flexibility into the facility and
equipment due to the inevitable change

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 Cost Structure for a Roadside Motel
(dollars per unit per night)
Average Unit Cost

25 rooms 75 rooms
roadside motel 50 rooms roadside motel
roadside motel

Economies of Diseconomies
Scale of Scale

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 Case Study

Krispy Kreme originally had 8,000-square-foot stores but found them too large
and too expensive for many markets. Then they tried tiny 1,300-square-foot
stores, which required less investment, but such stores were too small to
provide mystique of seeing and smelling Krispy Kreme doughnuts being
made. Krispy Kreme finally got it right with a 2,600-square-foot store. This one
includes a huge glass window to view doughnut production.

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 Managing Demand
1. Demand exceeds capacity: curtail demand by raising
prices, scheduling long lead times, discouraging
marginally profitable business, or in a long term, increase
capacity.
2. Capacity exceeds demand: stimulate demand through
price reductions or aggressive marketing, or
accommodate the market through product change.
3. Adjusting to seasonal demands: offer product with
complementary demand patterns-that is, products for
which the demand is high for one when low for other.

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 Strategies for Matching Capacity to
Demand
1. Making staffing changes (increasing or
decreasing the number of employees)
2. Adjusting equipment and processes – which
might include purchasing additional machinery
or selling or leasing out existing equipment
3. Improving methods to increase throughput;
and/or
4. Redesigning the product to facilitate more
throughput
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 Managing Existing Capacity

Demand Management Capacity Management

 Vary prices  Vary staffing
 Vary promotion  Change equipment
& processes
 Change lead times
 Change methods
(e.g., backorders)
 Redesign the product for
 Offer complementary faster processing
products

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 Complementary Products
Sales (Units)
5,000
Total
4,000
Snow-
3,000 mobiles
2,000
1,000 Jet Skis
0
J M M J S N J M M J S N J
Time (Months)
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 Approaches to Capacity Expansion
Expected Demand Expected Demand

New Capacity New Capacity

Demand
Demand

Time in Years Time in Years

Capacity leads demand with an incremental expansion Capacity leads demand with a one-step expansion

Expected Demand Expected Demand

New Capacity
New Capacity
Demand

Demand

Time in Years Time in Years

Attempts to have an average capacity, with an
Capacity lags demand with an incremental expansion
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 Approaches to Capacity Expansion
Expected Demand

New Capacity
Demand

Time in Years

Capacity leads demand with an incremental expansion

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 Approaches to Capacity Expansion
Expected Demand

New Capacity
Demand

Time in Years
Capacity leads demand with a one-step expansion

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 Approaches to Capacity Expansion

Expected Demand
New Capacity
Demand

Time in Years
Capacity lags demand with an incremental expansion
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 Approaches to Capacity Expansion
Expected Demand
New Capacity
Demand

Time in Years
Attempts to have an average capacity, with an incremental
expansion
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 Bottleneck Analysis
 Capacity analysis: a means of determining the throughput
capacity of workstations in a system and ultimately the
capacity of the entire system.
 Bottleneck: the limiting factor or constraint in a system.
Example:
Arnold Palmer Hospital faced the constraint of bed availability for delivering more babies. The
long-term solution to this bottleneck was to add capacity via a 4-year construction project.
But the hospital staff sought an immediate way to increase capacity of the bottleneck.
Solution: if a woman is ready for discharge and cannot be picked up prior to 5 pm, staffers
drive home the woman and her baby themselves. Not only does this free up a bed for the
next patient, it also creates good will.

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 Theory of Constraints (TOC)
 TOC was first introduced by Goldratt and Cox in their
popular book The Goal: A Process of Ongoing
Improvement.

 TOC is a body of knowledge that deals with anything

that limits or constraints an organization’s ability to
achieve its goals, both physical (e.g., inadequate raw
materials/supplies), and non-physical (e.g., lack of
training, moral, procedure)

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5-step process as the basis of TOC

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4 principles of bottleneck management
 Release work order to the system at the pace set by
the bottleneck’s capacity
 Loss time at the bottleneck represents lost capacity for
the whole system.
 Increasing the capacity of a non-bottleneck station is a
mirage
 Increasing the capacity of a the bottleneck increasing
the capacity for the whole system

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 Breakeven Analysis

 Technique for evaluating process & equipment

alternatives
 Objective: Find the point ($ or units) at which total cost
equals total revenue
 Assumptions
 Revenue & costs are related linearly to volume
 All information is known with certainty
 No time value of money

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 Break-Even Analysis

 Fixed costs: costs that continue even if no units

are produced: depreciation, taxes, debt,
mortgage payments
 Variable costs: costs that vary with the volume of
units produced: labor, materials, portion of utilities

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 Breakeven Chart

Total revenue line

Breakeven point Profit
Total cost = Total revenue
Total cost line
Cost in Dollars

Variable cost

Loss Fixed cost

Volume (units/period)

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 Crossover Chart
Process A: low volume, high variety
Process B: Repetitive
Process C: High volume, low variety
s sA
oce B
-P
r
P r ocess
-
os
t
t a l cost
c To
tal rocess
C
To o s t - P
To tal c

Fixed cost - Process C

Fixed cost - Process B
Fixed cost - Process A

Process A Process B Process C Lowest cost process

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 Cost of Wrong Process Found Via
Breakeven Analysis
Variable Variable
Variable
$ $ cost $ cost
cost

Fixed cost Fixed cost Fixed cost

Low volume, high Repetitive process High volume, low
variety process variety process
Total cost for low
volume high variety
Total cost for repetitive process
B1 Total cost for high volume,
low variety process
B2
B3

A B
Volume
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Decision Tree and Capacity Decision

-$14,000 Market favorable (0.4) $100,000

nt Market unfavorable (0.6)

Pla -$90,000
ge
Lar $18,000 Market favorable (0.4) $60,000
Medium Plant
Sm
all Market unfavorable (0.6)
Pl a -10,000
nt
$13,000 Market favorable (0.4) -5,000
Do
not

Market unfavorable (0.6) $40,000

hin
g

$0
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 Strategy Driven Investment
 Select investments as part of a coordinated strategic plan
 Choose investments yielding competitive advantage
 Consider product life cycles
 Include a variety of operating factors in the financial return
analysis
 Test investments in light of several revenue projections

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 Net Present Value

F = future value
P = present value F
I = interest rate P N
(i  1)
N = number of years

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 NPV in a More Convenient Form
Present value of $1.00
F Year 5% 6% 7% 8%
P N 1 0.952 0.943 0.935 0.857
(i  1)
2 0.907 0.890 0.873 0.857
3 0.864 0.840 0.816 0.794
P  FX 4 0.823 0.792 0.763 0.735
1 5 0.784 0.747 0.713 0.681
where X 
(i  1 ) N 6 0.746 0.705 0.666 0.630
7 0.711 0.665 0.623 0.583
8 0.677 0.627 0.582 0.540
9 0.645 0.592 0.544 0.500
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 Present Value of an Annuity (S)
 X = Factor from Table Year 5% 6% 7% 8%
1 0.952 0.943 0.935 0.926
 S = present value of a
2 1.859 1.833 1.808 1.783
series of uniform annual
3 2.723 2.673 2.624 2.577
receipts
4 3.546 3.465 3.387 3.312
 R = receipts that are
5 4.329 4.212 4.100 3.993
received every year for
6 5.076 4.917 4.766 4.623
the life of the investment
7 5.786 5.582 5.389 5.206
8 6.843 6.210 5.971 5.747
S  RX 9 7.108 6.802 7.024 6.247
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 Limitations of Net Present Value
 Investments with the same present value may
have significantly different project lives and
different salvage values
 Investments with the same net present values
may have different cash flows
 We assume that we know future interest rates -
which we do not
 We assume that payments are always made at
the end of the period - which is not always the
case
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