CHAPTER 5 Strategic Capacity Management

Tata McGraw

Chapter 5

Strategic Capacity Management

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OBJECTIVES
Strategic Capacity Planning Defined Capacity Utilization & Best Operating Level Economies & Diseconomies of Scale The Experience Curve Capacity Focus, Flexibility & Planning Determining Capacity Requirements Decision Trees Capacity Utilization & Service Quality

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Strategic Capacity Planning

Capacity can be defined as the ability to hold, receive, store, or accommodate Strategic capacity planning is an approach for determining the overall capacity level of capital intensive resources, including facilities, equipment, and overall labor force size

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Capacity Utilization

Capacity used Capacity utilizatio n rate Best operating level

Where Capacity used

rate of output actually achieved

Best operating level

capacity for which the process was designed

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Best Operating Level

Example: Engineers design engines and assembly lines to operate at an ideal or best operating level to maximize output and minimize ware

Average unit cost of output

Underutilization

Overutilization
Best Operating Level

Volume

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Example of Capacity Utilization

During one week of production, a plant produced 83 units of a product. Its historic highest or best utilization recorded was 120 units per week. What is this plants capacity utilization rate?

Answer:
Capacity utilization rate = Capacity used Best operating level

= 83/120 =0.69 or 69%

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Economies & Diseconomies of Scale

Economies of Scale and the Learning Curve working

Average unit cost of output

100-unit plant 200-unit plant 300-unit plant 400-unit plant

Diseconomies of Scale start working Volume

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As plants produce more products, they gain experience in the best production methods and reduce their costs per unit
The Learning Curve

Yesterday

Cost or price per unit

Today

Tomorrow

Total accumulated production of units

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Capacity Focus

The concept of the focused factory holds that production facilities work best when they focus on a fairly limited set of production objectives Plants Within Plants (PWP)
Extend focus concept to operating level

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Capacity Flexibility

Flexible plants

Flexible processes

Flexible workers

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Capacity Planning: Balance

Unbalanced stages of production

Units per month

Stage 1 6,000

Stage 2 7,000

Stage 3 5,000

Maintaining System Balance: Output of one stage is the exact input requirements for the next stage
Balanced stages of production

Units per month

Stage 1 6,000

Stage 2 6,000

Stage 3 6,000

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Capacity Planning

Frequency of Capacity Additions

External Sources of Capacity

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Determining Capacity Requirements

1. Forecast sales within each individual product line 2. Calculate equipment and labor requirements to meet the forecasts 3. Project equipment and labor availability over the planning horizon

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Example of Capacity Requirements

A manufacturer produces two lines of mustard, FancyFine and Generic line. Each is sold in small and family-size plastic bottles. The following table shows forecast demand for the next four years.
Year: FancyFine Small (000s) Family (000s) Generic Small (000s) Family (000s) 1 50 35 100 80 2 60 50 110 90 3 80 70 120 100 4 100 90 140 110

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Example of Capacity Requirements (Continued): Product from a Capacity Viewpoint

Question: Are we really producing two different types of mustards from the standpoint of capacity requirements? Answer: No, its the same product just packaged differently.

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Example of Capacity Requirements (Continued) : Equipment and Labor Requirements

Year: Small (000s) Family (000s)

1 150 115

2 170 140

3 200 170

4 240 200

Three 100,000 units-per-year machines are available for small-bottle production. Two operators required per machine.

Two 120,000 units-per-year machines are available for family-sized-bottle production. Three operators required per machine.

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Question: What are the Year 1 values for capacity, machine, and labor?

Year: Small (000s) Family (000s) Small Family-size Small Percent capacity used Machine requirement Labor requirement Family-size Percent capacity used Machine requirement Labor requirement

1 150 115 Mach. Cap. Mach. Cap.

2 170 140 300,000 240,000

3 200 170 Labor Labor

4 240 200 6 6

150,000/300,000=50%
50.00% 1.50 3.00 47.92% 0.96 2.88

At 1 machine for 100,000, it takes 1.5 machines for 150,000 At 2 operators for 100,000, it takes 3 operators for 150,000
The McGraw-Hill Companies, Inc., 2004

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Question: What are the values for columns 2, 3 and 4 in the table below?

Year: Small (000s) Family (000s) Small Family-size Small Percent capacity used Machine requirement Labor requirement Family-size Percent capacity used Machine requirement Labor requirement

1 150 115 Mach. Cap. Mach. Cap.

2 170 140 300,000 240,000

3 200 170 Labor Labor

4 240 200 6 6

50.00% 1.50 3.00

56.67% 1.70 3.40

66.67% 2.00 4.00 70.83% 1.42 4.25

80.00% 2.40 4.80 83.33% 1.67 5.00

58.33% 47.92% 1.17 0.96 3.50 2.88

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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.

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Example of a Decision Tree Problem (Continued): The Payoff Table

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 below:

A B C

0.1 Low 10 -120 20

0.5 Medium 50 25 40

0.4 High 90 200 60

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Example of a Decision Tree Problem (Continued): Step 1. We start by drawing the three decisions

A B C

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Example of Decision Tree Problem (Continued): Step 2. Add our possible states of nature, probabilities, and payoffs

High demand (0.4) Medium demand (0.5) Low demand (0.1)

$90k $50k $10k $200k $25k -$120k

A B C

High demand (0.4) Medium demand (0.5)

Low demand (0.1)

High demand (0.4) Medium demand (0.5) Low demand (0.1)

$60k $40k $20k

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Example of Decision Tree Problem (Continued): Step 3. Determine the expected value of each decision

High demand (0.4) Medium demand (0.5)

$62k
A

Low demand (0.1)

$90k $50k $10k

EVA=0.4(90)+0.5(50)+0.1(10)=$62k

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Example of Decision Tree Problem (Continued): Step 4. Make decision High demand (0.4) Medium demand (0.5)

$62k
A B C

Low demand (0.1) High demand (0.4) Medium demand (0.5)

$90k $50k $10k $200k $25k -$120k

$80.5k

Low demand (0.1)

High demand (0.4)

$46k

Medium demand (0.5) Low demand (0.1)

$60k $40k $20k

Alternative B generates the greatest expected profit, so our choice is B or to construct a new facility

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Planning Service Capacity vs. Manufacturing Capacity

Time: Goods can not be stored for later use and capacity must be available to provide a service when it is needed Location: Service goods must be at the customer demand point and capacity must be located near the customer Volatility of Demand: Much greater than in manufacturing

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Service Utilization and Service Quality

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Capacity Utilization & Service Quality

Best operating point is near 70% of capacity

From 70% to 100% of service capacity, what do you think happens to service quality?

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Question Bowl

The objective of Strategic Capacity Planning is to provide an approach for determining the overall capacity level of which of the following? a. Facilities b. Equipment c. Labor force size d. All of the above e. None of the above

Answer: d. All of the above

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Question Bowl

To improve the Capacity Utilization Rate we can do which of the following? a. Reduce capacity used b. Increase capacity used c. Increase best operating level d. All of the above e. None of the above Answer: b. Increase capacity used (This increases the numerator in the Capacity Utilization Rate ratio, which is desirable.)

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Question Bowl

When we talk about Capacity Flexibility which of the following types of flexibility are included? a. Plants b. Processes c. Workers d. All of the above e. None of the above Answer: d. All of the above

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Question Bowl

When adding capacity to existing operations which of the following are considerations that should be included in the planning effort? a. Maintaining system balance b. Frequency of additions c. External sources d. All of the above e. None of the above

Answer: d. All of the above

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Question Bowl
Which of the following is a term used to describe the difference between projected capacity requirements and the actual capacity requirements? a. Capacity cushion b. Capacity utilization c. Capacity utilization rate d. All of the above e. None of the above

Answer: a. Capacity cushion

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Question Bowl

In determining capacity requirements we must do which of the following? a. Address the demands for individual product lines b. Address the demands for individual plants c. Allocate production throughout the plant network d. All of the above e. None of the above

Answer: d. All of the above

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Question Bowl

In a Decision Tree problem used to evaluate capacity alternatives we need which of the following as prerequisite information? a. Expect values of payoffs b. Payoff values c. A tree d. All of the above Answer: b. Payoff e. None of the above values (Expected
values are what is computed, not prerequisite to the analysis.)

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End of Chapter 5

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