Production & Operations Management:

Capacity & Location Planning

Dr. Ravindra Ojha
(9th , 10th, 12th & 13th Jan’ 2023)
 Agenda
• Understanding capacity,
• Tactical Capacity increase,
• Strategies for capacity planning,
• Breakeven analysis,
• Decision tree approach,
• Need for Location Planning,
• Alternatives in Location planning,
• Service location factors.
 Capacity Planning
What do you see?

• Capacity –A facility’s maximum capability to produce or serve, usually

expressed as volume of output / service per period of time.
Examples: Car manufacturer- 1.2 Lac vehicles / month, 180 PGDM student admissions/ year.
• Capacity planning is the first step when an organization decides to produce /
serve more or a new product/service.
Example: No prominent hospitals in Gurgaon around the year 2000. Six with
large capacity (no of beds) got created by 2010 (New Project).
 Capacity Planning

Capacity planning decisions Measuring capacity

• Assessing existing capacity • Output

• 15,000 cars per month
• 2 million tons of steel per year
• Forecasting capacity needs
based on market needs • 20 tons per day of sugar crushing
• Input (installed)
• 500 bedded hospital
• Cinema hall with 150 seats
• Metro having 8 bogies
 Strategy for modifying capacity

Temporary capacity changes can happen through

• Creating Inventories • Work force utilization

• Changing employment levels • Employee training
• Process redesign • Subcontracting
• Evaluating financial, economical & • Delay Maintenance - temporarily
technological capacity alternatives

Long term response- Expansion (Brown or Green field Projects)

Product cost related to facility capacity
•

p1 p2 p3
Output rate

Will the unit output cost reduce unending with increasing output rate? If not why?
 Economy of scale
Economies of Scale and the Learning Curve working

100-unit
Average plant
unit cost 200-unit
of output plant 400-unit
300-unit
plant
plant

Diseconomies of Scale start working

Volume
Strategies for Capacity planning

• Capacity leading demand

• Capacity lagging demand

• Capacity averaging approach

• Multiple / Large step expansion

 Capacity leading demand

capacity expansion
Capacity
Demand curve

Time

What is the key advantage of this strategy?

 Capacity lagging demand

capacity expansion
Capacity
Demand curve

Time

What is the key disadvantage of this Strategy?

 Average Capacity

capacity expansion
Capacity
Demand curve

Time
 Multiple / single large step

single step capacity

Capacity
Demand curve

Time
 Break Even Point

• Fixed cost per year – 100

• 5 units are sold per year
• Selling price / product – 20
• Unit variable cost - 16
• What is the BE volume?
• Break even period?

BEPx= Break-even point (units), BEP$= Break-even point ($) V = Variable costs, TC =Total costs = F + Vx

Then, break-even point occurs when TR = TC

P =Price per unit, x = No. of units produced or Px = F+ Vx.

TR = Total revenue = Px, F = Fixed costs BEPx = F/ (P – V)

Decision tree analysis for Capacity decision

• Decision tree
• A diagram used to structure and analyze a decision problem
• A systematic sequential laying out of decision points,
alternatives and chance events.

• Chance event
• An event leading potentially to several different outcomes, only
one of which will definitely occur, decision maker has no control
over which outcome will occur.
 Decision tree analysis - Steps
1. Tree diagramming
• Identify all decision points and order in which they occur. Represented by a
small square —
• Identify alternative decisions for each decision point
• Identify the chance events that can occur after each decision; represented by a
circle ---
• Develop a tree diagram showing the sequence of decisions and chance events
2. Estimation
• Estimate the probability for each possible outcome of each chance event
• Estimate financial consequences of each possible outcome & decision choice
3. Evaluation and selection
• Calculate the expected value of each decision alternatives
• Select the decision alternative offering the most attractive expected value
4. Make the decision
 Example of a Decision Tree Problem
A glass factory specializing in crystal is experiencing a substantial backlog, and the firm's
management is considering three courses of action:
A) Arrange for subcontracting
B) Construct new facilities
C) Do nothing (no change)
The correct choice depends largely upon demand, which may be low, medium, or high. By
consensus, management estimates the respective demand probabilities as 0.1, 0.5, and 0.4.
The management also estimates the profits when choosing from the
three alternatives (A, B, and C) under the differing probable levels of
demand. These profits, in thousands of dollars are presented in the table A
below: 0.1 0.5 0.4 B
Low Medium High
A 10 50 90
C
B -120 25 200
C 20 40 60
Example of a Decision Tree Problem
High demand (0.4) $90k
Medium demand (0.5) $50k
Low demand (0.1) $10k

A High demand (0.4) $200k

B Medium demand (0.5) $25k
Low demand (0.1) -$120k
C
High demand (0.4) $60k
Medium demand (0.5) $40k
Low demand (0.1) $20k
Example of a Decision Tree Problem

High demand (0.4) $90k

Medium demand (0.5) $50k
$62k Low demand (0.1) $10k
A
EVA=0.4(90)+0.5(50)+0.1(10)=$62k
 Example of a Decision Tree Problem

High demand (0.4) $90k

Medium demand (0.5) $50k
$62k Low demand (0.1) $10k

A $80.5k
High demand (0.4) $200k
B Medium demand (0.5) $25k
Low demand (0.1) -$120k
C
High demand (0.4) $60k
$46k Medium demand (0.5) $40k
Low demand (0.1) $20k

Alternative B generates the greatest expected profit, so our choice is B or to construct a new facility
 Summary
• Capacity Planning becomes very critical in a growing market leading to
Brown field or Green field project planning.

• Capacity increase via the lag or lead route of demand is a strategic call
which depends on a number of criteria – utilizing the existing facility to a
stretched level, investment funding, risk taking ability and the product
portfolio.

• Every capacity investment attempts to quickly reach the break-even

volume from a financial health view point.
Location Planning
Where would you locate and why?

• A Green field Steel making manufacturing plant.

• A world class Gym center.

 Need for Location decisions

Addition of new facilities

• Emanating from the marketing strategy to expand,
• Growth in demand leading to expanding existing facilities

Relocation due to
• Depletion of inputs to the system,
• Shift in customer market,
• Cost of doing business.

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 Location Decisions: Strategic call
Location decisions:
• Are closely tied to an organization’s strategies
• Low-cost
• Attract market share / new market
• Technology
• New product
• Impacts on Capacity and Flexibility
• Represent a long-term commitment of resources
• Effect investment requirements, operating costs, revenues & operations
• Implications on the Competitive advantage
• Realigns the importance Supply chain
 Evaluating Location Alternatives

Common techniques:

• Locational Cost-Volume-Profit analysis,

• Factor rating method.

• Center of gravity method.

 Locational Cost-Profit-Volume Analysis
Locational Cost-Profit-Volume Analysis

• Technique for evaluating location choices in economic terms.

• Assumptions - Fixed costs are constant and Variable costs are linear for the
range of probable output. The required level of output can be closely
estimated. Only one product is involved.

Steps:

1. Determine the fixed and variable costs for each alternative

2. Plot the total-cost lines for all alternatives on the same graph
3. Determine the location that will have the lowest total cost (or highest
 Locational Cost-Profit-Volume Analysis
• For a cost analysis, compute the total cost for each alternative location:

Total Cost  FC  v  Q
Example :
Cost details of 4 potential locations
where
Fixed Cost Variable Cost
FC  Fixed cost Location per Year per Unit
v  Variable cost per unit A $250,000 $11
Q  Quantity or volume of output B $100,000 $30
C $150,000 $20
D $200,000 $35
 Example: Cost-Profit-Volume Analysis
What is the locational option you would decide?
Plot of Location Total Costs

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 Example: Cost-Profit-Volume Analysis
• Range approximations Total Cost of C  Total Cost of B
• B Superior (up to 4,999 units) 150,000  20Q  100,000  30Q
50,000  10Q
Q  5,000

Total Cost of A  Total Cost of C

• C Superior (>5,000 to 11,111 units)
250,000  11Q  150,000  20Q
100,000  9Q
Q  11,111 .11
• A superior (11,112 units and up)
 Factor Rating
Factor Rating
• Approach to evaluating locations that includes quantitative & qualitative
inputs
Procedure:
1. Determine which factors are relevant
2. Assign a weight to each factor that indicates its relative importance
compared with all other factors. Weights typically sum to 1.
3. Decide on a common scale for all factors, and set a minimum acceptable
score, if necessary
4. Score each location alternative.
5. Multiply the factor weight by the score for each factor, and sum the results
for each location alternative
6. Choose the alternative that has the highest composite score, unless it fails
to meet the minimum acceptable score
 Example: Factor Rating
• A photo-processing company intends to open a new branch store. The following
table contains information on two potential locations. Which is better?
Scores
(Out of 100) Weighted Scores
Factor Weight Alt 1 Alt 2 Alt 1 Alt 2
Proximity to
.10 100 60 .10(100) = 10.0 .10(60) = 6.0
existing source
Traffic volume .05 80 80 .05(80) = 4.0 .05(80) = 4.0
Rental costs .40 70 90 .40(70) = 28.0 .40(90) = 36.0
Size .10 86 92 .10(86) = 8.6 .10(92) = 9.2
Layout .20 40 70 .20(40) = 8.0 .20(70) = 14.0
Operating Cost .15 80 90 .15(80) = 12.0 .15(90) = 13.5
1.00 70.6 82.7
 Center of Gravity Method
Center of Gravity Method
• Method for locating a distribution center that minimizes distribution costs
• Treats distribution costs as a linear function of the distance and the quantity
shipped
• The quantity to be shipped to each destination is assumed to be fixed
• The method includes the use of a map that shows the locations of destinations
• The map must be accurate and drawn to scale
• A coordinate system is overlaid on the map to determine relative locations

a) Map showing destinations b) Coordinate system added c) Center of gravity

 Center of Gravity Method
• If quantities to be shipped to every location are equal, you can obtain the coordinates of the
center of gravity by finding the average of the x-coordinates & the average of the y-coordinates
x Destination x y
x
n
i

D1 2 2 x
x i

18
 4.5
y
 yi n 4
n D2 3 5
where D3 5 4
xi  x coordinate of destinatio n i
yi  y coordinate of destinatio n i
D4 16 8
4
5
y 
y i

n  Number of destinatio ns 18 16 n 4
• When quantities to be shipped to every location are unequal, you can obtain coordinates of the
center of gravity by finding weighted average of the x-coordinates & average of y-coordinates
x
xQ
Q
i i
Destination x y
Weekly
Quantity
x
 xQ i i

2(800)  3(900)  5(200)  8(100) 6,100
  3.05
Q
i

yQ i i
D1 2 2 800 i 2,000 2,000
y
Q i D2 3 5 900
where D3 5 4 200
Qi  Quantity t o be shipped to destinatio n i
xi  x coordinate of destinatio n i
D4 8 5 100
y
 yQ i
i
2(800)  5(900)  4(200)  5(100) 7,400
i
  3.7
yi  y coordinate of destinatio n i
18 16 2,000
Q i 2,000 2,000
Example: Center of Gravity

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 Service and Retail Locations
Considerations:
• Nearness to raw materials is not usually a consideration
• Customer access is
• Prime consideration for some: restaurants, hotels, etc.
• Not an important consideration for others: service call centers, etc.
• Tend to be profit or revenue driven, and so are
• Concerned with demographics, competition, traffic volume
patterns and convenience
• Clustering
• Similar types of businesses locate near one another: IT offices in
Bangalore, Competitive exam/ JEE coaching centers specific areas
of Delhi / Gurgaon
 Real case : An automotive plant location
• Automotive aggregate manufacturer,
• Product leader with 70% market share in India,
• Major presence: North and South India presence,
• A growing market with multinationals coming in,
• Multi national giant.

Where do we locate our new Plant? GKN

 Summary
• Location issues have become more prominent in recent years on account of
globalization (markets and sourcing) and expansion.
• Simple qualitative methods are useful for quickly screening an initial set of
candidates and narrowing down the choice to one or two.
• Location planning in the overall context of just-in-time manufacturing
philosophy (suppliers located in the vicinity: 20 – 40 Km radius).
• Availability of good transport infrastructure and recent developments in the
Internet technology suggests that it is possible to have fewer locations and
still provide better customer service
• Service quality depends on responsiveness of service delivery system.
Locating service outlets, close to the demand point is an important
requirement in a service system
• Location decisions in service systems must address the quality of the location
– community, clients, competition, quality of people access and looks.