Operations Management

KRISHNA MURARIKRISHNA MURARI

STRATEGIC CAPACITY MANAGEMENT

CAPACITY MANAGEMENT

Capacity is the rate of production capability of a facility.

Salient points Generally, It is expressed as volume of output

per time period. Sufficient capacity is required to meet the

customers demand. It affects the cost efficiency of operations. It affects ease or difficulty of scheduling output It affects the cost of maintaining the facilities.

Need for Capacity Planning

It is the first step when organisation decides to produce more or a new product.

Once the capacity is evaluated, need for a new or expanded facilities is determined and facility location and process technology occur.

Spare capacity needs exploring the way to utilise or reduce the capacity.

Capacity has direct impact on location. Capacity depends on demand and demand often depends on location. Example : Banks open new branches based on capacity and customers.

Need for Capacity Planning

Capacity planning involves the identification and evaluation of the long term and short term capacity requirement of an organisation and the development plans to satisfy them.

Overestimate or underestimate of capacity requirement adversely affects the organisation's performance.

Insufficient capacity results in dissatisfied customers and switching over to other suppliers.

extra capacity results in unutilized capacity and inventories.

Capacity Planning Decisions

Capacity planning involves following activities:

1. Assessing existing capacity

2. Forecasting capacity needs

3. Identifying of alternate ways to modify capacity

4. Evaluating the financial, economical and technological capacity alternatives.

5. Selecting a capacity alternative most suited to achieve strategic mission.

Measuring Capacity

For some organisations, capacity is simple to measure by output like no. of cars made per day by Maruti Udyog.

but in case of diverse product lines and services like repair shop, it is expressed in input terms like available labour hours etc.

Sometimes, it is difficult to measure realistic capacity due to employees absenteeism, machine break down etc.

Capacity Can be measures by following formula

Capacity = Available time x utilisation x efficiency

Capacity utilisation rate = capacity used/ capacity available x 100 (at which prodn process operates)

Measuring Capacity

Organisation Measure

Automobile

Steel producer

Power Company

Brewery

Cannery

Numbers

Tons of steel

Megawatt of electricity

Barrel of beer

Tons of food

Measured by Output

Measuring Capacity

Organisation Measure

Airlines

Hospital

Movie theater

Restaurant

University

Warehouse

Job shop

No. of seats

No. of beds

No. of seats

No. of tables

No. of students/faculty

Square or cubic feet of storage place

Labour/ machine hrs.

Measured by Input

Estimate Future Capacity Needs

Short Term Requirements

Short term capacity requirements are estimated based on workload on the basis of forecasts of product demands for maximum 12 months .

Long Term Requirements :

This is very difficult to determine as future demand and technology are uncertain. Long term forecasting is risky and difficult task. Long term requirements are based on marketing plans , product development and product life cycle.

Change is technology must be anticipated even for existing product.

Strategy for Modifying Capacity

Short Term Response

Capital intensive process rely on physical facilities and can be modified by using more or less intensively than normal. Cost of setting up, changing over, maintaining, procurement of raw materials, inventory and Scheduling can be changed.

In labour oriented Process, short term changes can be brought by lay off or hiring people, overtime, or by keeping the labour idle.

In case product can be stored, inventory management can be used fro short term response.

Strategy for Modifying Capacity

Long Term Response

• Capacity contraction - selling off exiting facilities, equipment and inventories. If serious decline in demands occur, operation may be terminated.

• Constant capacity – utilizing facilities for other products. Product design, market research play a role in bringing new product and use the existing capacity.

Strategy for Modifying Capacity

Determining capacity Requirements

Steps

1.Forecasting methods are used to find out individual product demands.

2.Equipments and human resource requirements are identified to meet the forecasted demand. In case of multiple products or service, the time required to switch over from one to other product or service is identified.

3.Capacity required and capacity available are compared and gap is identified.

4.Capacity cushion is provided by extra capacity.

Measures of Capacity

• Output rate capacity – Suitable for a single product or a few homogeneous products

• Design capacity - The maximum capacity that can be achieved under ideal conditions

• Effective capacity utilization - The percent of design capacity actually achieved

• Aggregate capacity – Suitable when a common unit of output is used

. . . more

Measures of Capacity

• Rated capacity – Maximum usable capacity of a particular facility

• Input rate capacity – Suitable for service operations

• Percentage utilization of capacity - Relates output measures to inputs available

Capacity Utilization

level operatingBest

usedCapacity nUtilizatio

• Capacity used Rate of output actually achieved

• Best operating level

Capacity for which the process was designed

Capacity Utilization--Example• Best operating level = 120 units/week

• Actual output = 83 units/week

• Utilization = ?

Solution

.692units/wk 120

units/wk 83=

level operatingBest

usedCapacity nUtilizatio

Capacity Cushion• A capacity cushion is an additional amount

of capacity added onto the expected demand to allow for:– greater than expected demand– demand during peak demand seasons– lower production costs– product and volume flexibility– improved quality of products and services

Forecasting Capacity Demand

• Consider the life of the input (e.g. facility is 10-30 yr)

• Understand product life cycle as it impacts capacity

• Anticipate technological developments

• Anticipate competitors’ actions

• Forecast the firm’s demand

Other Considerations• Resource availability

• Accuracy of the long-range forecast

• Capacity cushion

• Changes in competitive environment

How to Determine Capacity Requirements?

• Forecast sales within each individual product line

• Calculate equipment and labour requirements to meet the forecasts

• Project equipment and labour availability over the planning horizon

Expansion of Long-Term Capacity

• Subcontract

• Acquire capacity

• Develop new sites

• Expand current sites

• Reactivate standby facilities

Reduction of Long-Term Capacity

• Sell off existing facilities

• Mothball facilities

• Develop and phase in new products/services

Economy of Scales

Basic theory of economy of scale is that as the size of an operation increases, per unit cost of production is decreases.

Reason is reduction in fixed cost per unit and adoption of efficient process and technology like automation.

When firm expands beyond a point, diseconomies of scale become apparent as expenditure on maintaining large scale becomes uneconomical which includes storage cost, high cost of modification, complexities of the operations.

Economies of Scale

• Best operating level - least average unit cost

• Economies of scale - average cost per unit decreases as the volume increases

• Diseconomies of scale - average cost per unit increases as the volume increases

• Other considerations– Subcontractor and supplier networks– Focused production– Economies of scope

Economies and Diseconomies of ScaleAverage UnitAverage Unit

Cost of Output (Rs)Cost of Output (Rs)

Annual Volume (units)Annual Volume (units)

Best Operating LevelBest Operating Level

EconomiesEconomiesof Scaleof Scale

DiseconomiesDiseconomiesof Scaleof Scale

Economies and Diseconomies of Scale

Average UnitAverage UnitCost of Output (Rs)Cost of Output (Rs)

Annual Volume (units)Annual Volume (units)

100-unitplant

200-unitplant

300-unitplant

400-unitplant

Optimum Plant Size

The Learning Curve Effect

10

20

30

40

50

60

70

80

90

100

0 20 40 60 80 100

Number of repetitions (Volume)

Co

st/T

ime

per

rep

etit

ion

Cost

The Learning Curve Effect

• Observe, that the per unit cost (or price) of the product (or service) declines exponentially as the number of repetitions increases

Analyzing Capacity-Planning Decisions

• Break-even Analysis

• Present-Value Analysis

• Decision Tree Analysis

• Computer Simulation

• Waiting Line Analysis

• Linear Programming

Determining Capacity Requirements

• Forecast sales within each individual product line

• Calculate equipment and labor requirements to meet the forecasts

• Project equipment and labor availability over the planning horizon

Example: Capacity RequirementsA manufacturer produces two lines of ketchup, FancyFine and a generic line. Each is sold in small and family-size plastic bottles. The following table shows forecast demand for the next four years.

Year: 1 2 3 4FancyFine

Small (000s) 50 60 80 100Family (000s) 35 50 70 90Generic

Small (000s) 100 110 120 140Family (000s) 80 90 100 110

Example: Capacity Requirements

• The Product from a Capacity Viewpoint– Are we really producing two different types

of ketchup from the standpoint of capacity requirements?

Example: Capacity RequirementsEquipment and Labor Requirements

Year: 1 2 3 4Small (000s) 150 170 200 240Family (000s) 115 140 170 200

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.

Example: Capacity RequirementsEquipment and Labor Requirements

•Total machine capacity available for small-bottle production: 3*100,000=300,000 units/year

•Total machine capacity available for family-sized-bottle production: 2*120,000=240,000 units/year

•Total labor capacity required for small-bottle production: 3*2=6 operators

•Total labor capacity required for family-sized-bottle production: 2*3=6 operators

Example: Capacity Requirements

Year: 1 2 3 4Small (000s) 150 170 200 240Family (000s) 115 140 170 200

Small Mach. Cap. 300,000 Labor 6Family-size Mach. Cap. 240,000 Labor 6

Small

Percent capacity used 50.00% 56.67% 66.67% 80.00%Machine requirement 1.50 1.70 2.00 2.40Labor requirement 3.00 3.40 4.00 4.80Family-size

Percent capacity used 47.92% 58.33% 70.83% 83.33%Machine requirement 0.96 1.17 1.42 1.67Labor requirement 2.88 3.50 4.25 5.00

Capacity planning using decision Tree

• A decision tree is a schematic model of the sequence of steps in a problem and conditions and consequences of each step.

• Decision tree are composed of decision nodes with branches to and from them.

• In solving decision tree we work from end to start of the tree and calculated expected values at each step.

• Finally we select the branch giving the highest expected payoff.

Decision Tree Analysis

• Symbols used in decision tree:– square represent the decision point– Circle represent the chance event.– Branches from the decision point show the

choice available to the decision maker– Branches from the chance event show the

probability of occurrence.

Example

Decision Tree Analysis

• Structures complex, multiphase decisions

• Allows objective evaluation of alternatives

• Incorporates uncertainty

• Develops expected values

Decision Tree Analysis

1 Define the problem

2 Structure or draw the decision tree

3 Assign probabilities to the states-of-nature

4 Estimate the payoffs for each possible combination of alternative and state-of-nature

5 Solve the problem by computing expected monetary values (EMV) for each state-of-nature node

Good Eats Café is about to build a new restaurant. An architect has developed three building designs, each with a different seating capacity. Good Eats estimates that the average number of customers per hour will be 80, 100, or 120 with respective probabilities of 0.4, 0.2, and 0.4. The payoff table showing the profits for the three designs is given in the next slide.

Example : Decision Tree Analysis

• Payoff Table

Average Number of Customers Per Hour

c1 = 80 c2 = 100 c3 = 120

Design A $10,000 $15,000 $14,000

Expense

$5,000

Design B $ 8,000 $18,000 $12,000

Expense

$3,500

Design C $ 6,000 $16,000 $21,000

Expense

$6,000

Example : Decision Tree Analysis

Expected Value Approach

Calculate the expected value for each decision. Say, d1, d2, d3 are the decision alternatives of designs A, B, C, and c1, c2, c3 represent the different average customer volumes (80, 100, and 120) that might occur.

Example : Decision Tree Analysis

Decision Tree

1111

.2.2

.4.4

.4.4

.4.4

.2.2

.4.4

.4.4

.2.2

.4.4

dd11

dd22

dd33

cc11

cc11

cc11

cc22

cc33

cc22

cc22

cc33

cc33

PayoffsPayoffs

10,00010,000

15,00015,000

14,00014,000

8,0008,000

18,00018,000

12,00012,000

6,0006,000

16,00016,000

21,00021,000

2222

3333

4444

Example : Decision Tree Analysis

Expense

5,000

3,500

6,000

Expected Value For Each DecisionExpected Value For Each Decision

Choose the design with largest EV -- Design B.Choose the design with largest EV -- Design B.

3333

4444

dd11

dd22

dd33

EV = .4(10,000) + .2(15,000) + .4(14,000)EV = .4(10,000) + .2(15,000) + .4(14,000) - 5,000= $ 7,600- 5,000= $ 7,600

EV = .4(8,000) + .2(18,000) + .4(12,000)EV = .4(8,000) + .2(18,000) + .4(12,000) - 3,500 = - 3,500 = $ 8,100$ 8,100

EV = .4(6,000) + .2(16,000) + .4(21,000)EV = .4(6,000) + .2(16,000) + .4(21,000) -6,000 = $8,000-6,000 = $8,000

Design ADesign A

Design BDesign B

Design CDesign C

2222

1 1 1 1

Example : Decision Tree Analysis

Example

Solution

• At decision point 2, choose to expand to maximize profits ($200,000 > $150,000)

• Calculate expected value of small expansion:– EVsmall = 0.30($80,000) + 0.70($200,000) = $164,000

• Calculate expected value of large expansion:– EVlarge = 0.30($50,000) + 0.70($300,000) = $225,000

• At decision point 1, compare alternatives & choose the large expansion to maximize the expected profit:– $225,000 > $164,000

• Choose large expansion despite the fact that there is a 30% chance it’s the worst decision:– Take the calculated risk!

Problem • You are given the following estimates concerning a

Research and development programme

Decsion Di Probability of decision

Out come

Number

Probability of outcome xi at given Di

Payoff value of outcome Xi (Rs.,000)

Develop 0.5 1

2

3

0.6

0.3

0.1

600

-100

0

Do not develop

05 1

2

3

0.0

0.0

1.0

600

-100

0

Problem • A glass factory specialized in crystal is developing a

substantial back log. It is considering three course of action: subcontracting, begin overtime, construct new facilities. Effects are given below: Form decision tree and find out best soln

Demand Probability subcontracting

Begin overtime

Construct

New facilities

Low

Medium

High

0.1

0.5

0.4

10

50

50

-20

60

100

-150

20

200

Planning Service Capacity

Services involve customer participation hence located near the customer like branches of a bank. As services can not be produced in anticipation and kept in inventory, planning should consider when and where capacity is needed.

Service organisation based in one geographical area can not efficiently serve customers in other geographical area.

Some services like hospital, institutes etc tends to increase capacity at one location.

It became easier for some services to operate from one location through internet like retailers.

Master Production Schedule and

capacity planning

Master production schedule (MPS) defines the type and volume of each product that is to be produced within a planned period. It is also used to schedule various stages of production based on the type of operations. Function of MPS are

Translate aggregate plans

Evaluate alternate schedule

Identify material requirements

Generate capacity requirements

Effectively utilize capacity

Master Production Schedule (MPS)

and capacity planning

Material requirement planning (MRP) and Capacity Requirement Planning (CRP) are the two planning activities that are part of master production scheduling process.

CRP determines whether existing production capacity is sufficient to achieve the objectives of MPS.

Master Production Schedule (MPS)

and capacity planning

Preliminary Master Production Schedule

MRP MPC

Does MPS needsAny

Adjustment ?

Final Master Production Schedule

MPS and Capacity Planning

Steps:

Finding out the gross requirement of materials for each products

1.Obtaining the net requirements for each unit of materials taking the inventory into account.

2.Revising the preliminary MPS to accommodate the inadequacy of materials and inventory.

3.Converting adjusted net requirements into planned order releases to determine lot size.

4.Developing load reports

5.Modification the MPS or capacity if required.