07s Heiz Om4ce PP 07s

Operations Management: Sustainability
and Supply Chain Management

Fourth Canadian Edition
Supplement 7
Capacity and Constraint
Management
Copyright © 2023 Pearson Canada Inc. S7 - 1

Outline
• Capacity
• Bottleneck Analysis and the Theory of Constraints
• Break-Even Analysis
• Reducing Risk with Incremental Changes
• Applying Expected Monetary Value (EMV) to Capacity
Decisions
• Applying Investment Analysis to Strategy-Driven
Investments

Learning Objectives
When you complete this supplement, you should be

able to:
1. Define capacity
2. Determine design capacity, effective capacity, and
utilization
3. Perform bottleneck analysis
4. Compute break-even
5. Determine expected monetary value of a capacity
decision
6. Compute net present value
Capacity Consideration
• Too little capacity loses customers and too much

capacity is expensive.
• Capacity needs to be “just right.”

Capacity
LO1: Define 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

Time Horizons and Capacity Options
Figure S7.1 Time Horizons and Capacity Options

Economies and Diseconomies of Scale
Figure S7.2 Economies and Diseconomies of Scale

Design and Effective Capacity
LO2: Determine design capacity, effective capacity, and utilization
• 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

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

Bakery Example (1 of 8)
Actual production last week = 148 000 rolls

Effective capacity = 175 000 rolls
Design capacity = 1200 rolls per hour
Bakery operates 7 days/week, three 8-hour shifts
Design capacity = (7 x 3 x 8) x (1200) = 201 600 rolls

• Actual production last week = 148 000 rolls

• Effective capacity = 175 000 rolls
• Design capacity = 1200 rolls per hour
• Bakery operates 7 days/week, three 8-hour shifts
• Design capacity = (7 × 3 × 8) × (1200) = 201 600 rolls


Design capacity = (7 × 3 × 8) × (1200) = 201 600 rolls
Utilization = 148 000/201 600 = 73.4%


Utilization = 148 000/201 600 = 73.4%


Utilization = 148 000/201 600 = 73.4%

Efficiency = 148 000/175 000 = 84.6%

Utilization = 148 000/201 600 = 73.4%
Efficiency = 148 000/175 000 = 84.6%


Efficiency = 84.6%
Efficiency of new line = 75%
Expected Output = (Effective Capacity)(Efficiency)

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

Efficiency = 84.6%
Efficiency of new line = 75%
Expected Output = (Effective Capacity)(Efficiency)

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

Capacity Considerations
1. Forecast demand accurately

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

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
Complementary Demand Patterns
Figure S7.3 By Combining Products That Have Complementary Seasonal Patterns, Capacity Can Be Better Utilized

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

Demand and Capacity Management
in the Service Sector
• Demand management
– Appointment, reservations, FCFS rule
• Capacity management
– Full-time, temporary, part-time staff

Bottleneck Analysis and the Theory
of Constraints
LO3: Perform bottleneck analysis
• 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

Process Times for Stations, Systems,
and Cycles (1 of 2)
• 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 • These two might
be quite different!
• The process cycle time is the
time it takes for a product to go
through the production process
with no waiting

A Three-Station Assembly Line
Figure S7.4 Three-Station Assembly Line

A box represents an operation, a triangle represents inventory, and arrows represent precedence relationships.

Process Times for Stations, Systems,
and Cycles (2 of 2)
• 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

Capacity Analysis (1 of 6)
• Two identical sandwich lines

• Lines have two workers and three operations
• All completed sandwiches are wrapped

• 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

• Standard process for cleaning teeth

• Cleaning and examining X-rays can happen
simultaneously

• 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


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

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

Break-Even Analysis (1 of 6)
LO4: Compute break-even
• 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

• 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
– Labour, materials, portion of utilities
– Contribution is the difference between selling price and
variable cost

• 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

Figure S7.5 Basic Break-Even Point

***

Total fixed cost

Break-even in units  S7-4 
Price  Variable cost

Total fixed cost

Break-even in dollars 
Variable cost
S7-5 
1
Selling price

Break-Even Example (1 of 2)
• The firm first determines that it has fixed costs of

$10,000 this period. Direct labour is $1.50 per unit,
and material is $0.75 per unit. The selling price is
$4.00 per unit.
• SOLUTION: The break-even point in dollars is
computed as follows:
F $10, 000 $10, 000

BEP$     $22,857.14
1  V / P  1  1.50  0.75  /  4.00  0.4375

Break-Even Example (2 of 2)
The break-even point in units is:
F $10, 000
BEPx    5, 714
P  V 4.00  1.50  0.75 
• Note that we use total variable costs (i.e., both

labour and material).

Reducing Risk with Incremental
Changes (1 of 4)
Figure S7.6 (a) Four Approaches to Capacity Expansion

Changes (2 of 4)
Figure S7.6 (b)

Changes (3 of 4)
Figure S7.6 (c)

Changes (4 of 4)
Figure S7.6 (d)

Applying Expected Monetary Value
(EMV) to Capacity Decisions (1 of 4)
LO5: Determine expected monetary value of a capacity decision
• Determine states of nature
– Future demand
– Market favourability
• Analyzed using decision trees
– Hospital supply company
– Four alternatives

Northern Hospital Supplies, a company that makes hospital
gowns, is considering capacity expansion.
APPROACH: Northern’s major alternatives are to do
nothing, build a small plant, build a medium plant, or build a
large plant. The new facility would produce a new type of
gown, and currently the potential or marketability for this
product is unknown. If a large plant is built and a favourable
market exists, a profit of $100,000 could be realized. An
unfavourable market would yield a $90,000 loss. However, a
medium plant would earn a $60,000 profit with a favourable
market. A $10,000 loss would result from an unfavourable
market.
A small plant, on the other hand, would return $40,000 with
favourable market conditions and lose only $5,000 in an
unfavourable market. Of course, there is always the option of
doing nothing. Recent market research indicates that there is
a 0.4 probability of a favourable market, which means that
there is also a 0.6 probability of an unfavourable market.
With this information, the alternative that will result in the
highest expected monetary value (EMV) can be selected.

SOLUTION: Compute the EMV for each alternative:
EMV (large plant) = (0.4) ($100,000) + (0.6) (-$90,000) = -$14,000
EMV (medium plant) = (0.4) ($60,000) + (0.6) (-$10,000) = +$18,000
EMV (small plant) = (0.4) ($40,000) + (0.6) (-$5,000) = +$13,000
EMV (do nothing) = $0
Based on EMV criteria, Northern should build a medium

plant.

Applying Investment Analysis to
Strategy-Driven Investments
• Operations may be responsible for return-on-
investment (ROI)
• Analyzing capacity alternatives should include capital
investment, variable cost, cash flows, and net present
value

Summary
1. Capacity calculations and capacity planning is essential

for profitable operations. Other considerations are:
– Accurate forecasting
– Understanding equipment, processes, and capacity
increments
– Finding the optimum operating size
– Ensuring to have flexibility
– Bottleneck and Break-even Analysis are useful techniques

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Operations Management: Sustainability

and Supply Chain Management

Copyright © 2023 Pearson Canada Inc. S7 - 1

Copyright © 2023 Pearson Canada Inc. S7 - 2

When you complete this supplement, you should be

• Too little capacity loses customers and too much

Copyright © 2023 Pearson Canada Inc. S7 - 4

• The throughput, or the number of units a facility can

Copyright © 2023 Pearson Canada Inc. S7 - 5

Figure S7.1 Time Horizons and Capacity Options

Copyright © 2023 Pearson Canada Inc. S7 - 6

Figure S7.2 Economies and Diseconomies of Scale

Copyright © 2023 Pearson Canada Inc. S7 - 7

• Design capacity is the maximum theoretical output of

Copyright © 2023 Pearson Canada Inc. S7 - 8

• Utilization is the percent of design capacity

Copyright © 2023 Pearson Canada Inc. S7 - 9

Actual production last week = 148 000 rolls

Design capacity = (7 x 3 x 8) x (1200) = 201 600 rolls

Copyright © 2023 Pearson Canada Inc. S7 - 11

• Actual production last week = 148 000 rolls

Copyright © 2023 Pearson Canada Inc. S7 - 12

Actual production last week = 148 000 rolls

Design capacity = (7 × 3 × 8) × (1200) = 201 600 rolls

Utilization = 148 000/201 600 = 73.4%

Copyright © 2023 Pearson Canada Inc. S7 - 13

Actual production last week = 148 000 rolls

Design capacity = (7 × 3 × 8) × (1200) = 201 600 rolls

Utilization = 148 000/201 600 = 73.4%

Copyright © 2023 Pearson Canada Inc. S7 - 14

Actual production last week = 148 000 rolls

Design capacity = (7 × 3 × 8) × (1200) = 201 600 rolls

Utilization = 148 000/201 600 = 73.4%

Actual production last week = 148 000 rolls

Copyright © 2023 Pearson Canada Inc. S7 - 16

Actual production last week = 148 000 rolls

Expected Output = (Effective Capacity)(Efficiency)

Actual production last week = 148 000 rolls

Expected Output = (Effective Capacity)(Efficiency)

• Capacity decisions impact all 10 decisions of

Copyright © 2023 Pearson Canada Inc. S7 - 20

1. Forecast demand accurately

Copyright © 2023 Pearson Canada Inc. S7 - 21

• Demand exceeds capacity

Copyright © 2023 Pearson Canada Inc. S7 - 23

Copyright © 2023 Pearson Canada Inc. S7 - 24

Copyright © 2023 Pearson Canada Inc. S7 - 25

Copyright © 2023 Pearson Canada Inc. S7 - 26

Copyright © 2023 Pearson Canada Inc. S7 - 27

Figure S7.4 Three-Station Assembly Line

Copyright © 2023 Pearson Canada Inc. S7 - 28

Copyright © 2023 Pearson Canada Inc. S7 - 29

• Two identical sandwich lines

Copyright © 2023 Pearson Canada Inc. S7 - 30

• Toast work-station has the longest processing time –

Copyright © 2023 Pearson Canada Inc. S7 - 32

• Standard process for cleaning teeth

Copyright © 2023 Pearson Canada Inc. S7 - 33

• All possible paths must be compared

Copyright © 2023 Pearson Canada Inc. S7 - 34

Copyright © 2023 Pearson Canada Inc. S7 - 35

• Five-step process for recognizing and managing

Copyright © 2023 Pearson Canada Inc. S7 - 36