CAPACITY PLANNING CAPACITY PLANNING

FOR PRODUCTS AND SERVICESFOR PRODUCTS AND SERVICES

What kindWhat kind of capacity is needed? How muchHow much capacity is needed to match demand? WhenWhen more capacity is needed? WhereWhere facilities should be located (location) HowHow facilities should be arranged (layout)

Facility planning answers:

FFACILITY PLANNINGACILITY PLANNING

CAPACITY (DEFINITION OF)CAPACITY (DEFINITION OF)

The number of units a facility can hold, receive, store or produce in a period of time

It is the upper limit or ceiling on the load that an operating unit can handle. It includes equipment, space, employee skills

STRATEGIC CAPACITY PLANNINGSTRATEGIC CAPACITY PLANNING

Goal To achieve a match between the long-term supply

capabilities of an organization and the predicted level of long-run demand OvercapacityOvercapacity operating costs that are too

high UndercapacityUndercapacity strained resources and

possible loss of customers

CAPACITY PLANNING QUESTIONSCAPACITY PLANNING QUESTIONS Key Questions:Key Questions:

What kind of capacity is needed?How much capacity is needed to match demand?When is it needed?

Related Questions:Related Questions:How much will it cost?What are the potential benefits and risks?Are there sustainability issues?Should capacity be changed all at once, or through several smaller changesCan the supply chain handle the necessary changes?

ISSUES TO BE CONSIDERED IN ISSUES TO BE CONSIDERED IN STRATEGY FORMULATIONSTRATEGY FORMULATION

Capacity strategyDemand patternsGrowth rate and variabilityFacilities (Cost of the building and operating)Technological changes (Rate and direction of technology changes)Behavior of competitorsAvailability of capital and other inputs.

TYPES OF PLANNING OVER A TYPES OF PLANNING OVER A TIME HORIZONTIME HORIZON

Add FacilitiesAdd long lead time equipment

Schedule Jobs* Schedule Personnel AllocateMachinery

Sub-ContractAdd EquipmentAdd Shifts

Add PersonnelBuild or Use Inventory

Long Range Planning

Intermediate Range Planning

Short Range Planning

Modify Capacity Use Capacity

*

*

*Limited options exist

1. impact the ability of the organization to meet future demands2. affect operating costs3. affect lead time responsiveness4. are a major determinant of initial costs5. involve long-term commitment of resources6. affect competitiveness7. affect ease of management8. are more important and complex due to globalization9. need to be planned for in advance due to their consumption

of financial and other resources

IMPORTANCE OF CAPACITY IMPORTANCE OF CAPACITY DECISIONSDECISIONS

CAPACITY MEASURESCAPACITY MEASURES

Design capacityDesign capacity

Maximum output rate or service capacity an operation, process, or facility is designed for

Effective capacityEffective capacity

Capacity a firm can expect to attain given its product mix, methods of scheduling, maintenance and standards of quality. Design capacity minus allowances such as personal time, maintenance and scrap

CAPACITY RELATED CONCEPTSCAPACITY RELATED CONCEPTS

Actual outputActual output

Rate of output actually achieved—cannot exceed effective capacity

UtilizationUtilization

Actual output as a percent of design capacity EfficiencyEfficiency

Actual output as a percent of effective capacity

Measure of how well a facility or machine is performing when used

EfficiencyActual output

Effective Capacity=

EFFICIENCYEFFICIENCY

(expressed as a percentage)

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

UtilizationActual Output

Design Capacity=

UTILIZATIONUTILIZATION

(expressed as a percentage)

Actual output = 36 units/day Efficiency = =

90% Effective capacity 40 units/ day

Utilization = Actual output = 36 units/day =

72% Design capacity 50 units/day

EXAMPLE- EFFICIENCY/UTILIZATIONEXAMPLE- EFFICIENCY/UTILIZATION

Design capacity = 50 trucks/day

Effective capacity = 40 trucks/day

Actual output = 36 units/day

DETERMINANTS OF EFFECTIVE DETERMINANTS OF EFFECTIVE CAPACITYCAPACITY

FacilitiesProduct and Service FactorsProcess FactorsHuman FactorsPolicy FactorsOperational FactorsSupply Chain FactorsExternal Factors

STRATEGY FORMULATIONSTRATEGY FORMULATION

Strategies are typically based on assumptions and predictions about:Long-term demand patternsTechnological changeCompetitor behavior

SPECIAL REQUIREMENTS FOR SPECIAL REQUIREMENTS FOR MAKING GOOD CAPACITY MAKING GOOD CAPACITY

DECISIONSDECISIONS

Forecasting the demand accurately Understanding the technology and capacity

increments Finding the optimal operating level (volume) Building for change

KEY DECISIONS IN CAPACITY KEY DECISIONS IN CAPACITY PLANNINGPLANNING

Amount of capacity needed Timing of changes (frequency of capacity additions) Extent of flexibility of facilities External sources of capacity Need to maintain balance

AMOUNT OF CAPACITY NEEDEDAMOUNT OF CAPACITY NEEDED

STEPS OF CAPACITY PLANNINGSTEPS OF CAPACITY PLANNING

Estimate future capacity requirements Evaluate existing capacity and facilities and

identify gaps Identify alternatives for meeting requirements Conduct financial analysis Assess key qualitative issues Select the best alternative for the long term Implement the alternative chosen Monitor results

Long-term considerations relate to overall level of capacity requirements

Short-term considerations relate to probable variations in capacity requirements

FORECASTING CAPACITY FORECASTING CAPACITY REQUIREMENTS REQUIREMENTS

CALCULATING PROCESSING CALCULATING PROCESSING REQUIREMENTSREQUIREMENTS

Forecast sales within each individual product line

Calculate equipment and labor requirements to meet the forecasts

CALCULATING PROCESSING CALCULATING PROCESSING REQUIREMENTSREQUIREMENTS

Calculating processing requirements requires reasonably accurate demand forecasts, standard processing times, and available work time

horizon planning theduring available timeprocessing

horizon planning theduring product for demand

product for timeprocessing standard

machines required ofnumber

where

1

T

iD

ip

N

T

DpN

i

i

R

k

iii

R

CCALCULATING PROCESSING ALCULATING PROCESSING REQUIREMENTS: EXAMPLE 1 (1 of 2)REQUIREMENTS: EXAMPLE 1 (1 of 2)

P r o d u c tA n n u a l

D e m a n d

S t a n d a r dp r o c e s s i n g t i m e

p e r u n i t ( h r . )P r o c e s s i n g t i m e

n e e d e d ( h r . )

# 1

# 2

# 3

4 0 0

3 0 0

7 0 0

5 . 0

8 . 0

2 . 0

2 , 0 0 0

2 , 4 0 0

1 , 4 0 0 5 , 8 0 0

P r o d u c tA n n u a l

D e m a n d

S t a n d a r dp r o c e s s i n g t i m e

p e r u n i t ( h r . )P r o c e s s i n g t i m e

n e e d e d ( h r . )

# 1

# 2

# 3

4 0 0

3 0 0

7 0 0

5 . 0

8 . 0

2 . 0

2 , 0 0 0

2 , 4 0 0

1 , 4 0 0 5 , 8 0 0

CCALCULATING PROCESSING ALCULATING PROCESSING REQUIREMENTS: EXAMPLE 1 (2 of 2)REQUIREMENTS: EXAMPLE 1 (2 of 2)

If the department works one eight hour shift, 250 days a year, calculate the number of machines that would be needed to handle the required volume.

Solution:

5800/(250)(8) = 2.9 (3 machines are needed)

CAPACITY CUSHIONCAPACITY CUSHION

Capacity Cushion Extra capacity used to offset demand uncertainty Capacity cushion = 100% - Utilization Capacity cushion strategy

Organizations that have greater demand uncertainty typically have greater capacity cushion

Organizations that have standard products and services generally have greater capacity cushion

SERVICE CAPACITY PLANNINGSERVICE CAPACITY PLANNING

Service capacity planning can present a number of challenges related to: The inability to store services The need to be near customer The degree of demand volatility

SERVICE CAPACITY PLANNINGSERVICE CAPACITY PLANNING Time: Inability to store services for later consumption.

Capacity must be available to provide a service when it is needed (capacity must be matched with the timing of demand)

Location: Need to be near customers for convenience. Capacity and location are closely tied. 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) Volume and timing of demand Time required to service individual customers

CCAPACITY UTILIZATION APACITY UTILIZATION & & SSERVICE QUALITYERVICE QUALITY

Best operating point is near 70% of capacity

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

TIMING AND SIZE OF CHANGESTIMING AND SIZE OF CHANGES

(FREQUENCY OF CAPACITY (FREQUENCY OF CAPACITY ADDITIONS)ADDITIONS)

CAPACITY EXPANSIONCAPACITY EXPANSION

Factors to be considered: Volume and certainty of anticipated demand Strategic objectives for growth Costs of expansion and operation Incremental or one-step expansion Frequency of capacity additions

CAPACITY EXPANSION STRATEGIESCAPACITY EXPANSION STRATEGIES (1 of 5) (1 of 5)

Expected Demand Expected Demand

Expected Demand Expected Demand

Time in Years Time in Years

Time in YearsTime in Years

Dem

and

Dem

and

Dem

and

Dem

and

New Capacity

New Capacity New Capacity

New Capacity

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

Capacity lags demand with an incremental expansionAttempts to have an average capacity, with

an incremental expansion

CAPACITY EXPANSION STRATEGIESCAPACITY EXPANSION STRATEGIES (2 of 5) (2 of 5)

Expected Demand

Time in Years

Dem

and

New Capacity

Capacity leads demand with an incremental expansion

CAPACITY EXPANSION STRATEGIESCAPACITY EXPANSION STRATEGIES (3 of 5) (3 of 5)

Expected Demand

Time in Years

Dem

and

New Capacity

Capacity leads demand with a one-step expansion

CAPACITY EXPANSION STRATEGIESCAPACITY EXPANSION STRATEGIES (4 of 5) (4 of 5)

Expected Demand

Time in Years

Dem

and

New Capacity

Capacity lags demand with an incremental expansion

CAPACITY EXPANSION STRATEGIESCAPACITY EXPANSION STRATEGIES (5 of 5) (5 of 5)

Expected Demand

Time in Years

Dem

and

New Capacity

Attempts to have an average capacity, with an incremental expansion

MAKE OR BUY?MAKE OR BUY?

1. Available capacity

2. Expertise

3. Quality considerations

4. Nature of demand

5. Cost

6. Risk

OPTIMAL OPERATING LEVELOPTIMAL OPERATING LEVEL

OPTIMAL OPERATING LEVELOPTIMAL OPERATING LEVELA

vera

ge

cost

per

ro

om

Ave

rag

e co

st p

er r

oo

m

Best operating Best operating levellevel

Economies Economies of scaleof scale

Diseconomies Diseconomies of scaleof scale

250250 500500 10001000

# Rooms# Rooms

ECONOMIES OF SCALEECONOMIES OF SCALE

Economies of scaleEconomies of scale If the output rate is less than the optimal level,

increasing output rate results in decreasing average unit costs

Reasons for economies of scale:Fixed costs are spread over a larger number of

unitsConstruction costs increase at a decreasing rate as

facility size increasesProcessing costs decrease due to standardization

DISECONOMIES OF SCALEDISECONOMIES OF SCALE

Diseconomies of scaleDiseconomies of scale If the output rate is more than the optimal level, increasing

the output rate results in increasing average unit costs

Reasons for diseconomies of scaleDistribution costs increase due to traffic congestion and

shipping from a centralized facility rather than multiple smaller facilities

Complexity increases costs Inflexibility can be an issueAdditional levels of bureaucracy

ECONOMIES OF SCALEECONOMIES OF SCALE

Minimum cost & optimal operating rate are functions of size of production unit.

Ave

rage

cos

t p

er u

nit

0

Smallplant Medium

plant Largeplant

Volume or output rate

ECONOMIES AND DISECONOMIES OF ECONOMIES AND DISECONOMIES OF SCALESCALE

100-unitplant

200-unitplant 300-unit

plant

400-unitplant

Volume

Averageunit costof output

Economies of Scale and the Experience Curve workingEconomies of Scale and the Experience Curve working

Diseconomies of Scale start workingDiseconomies of Scale start working

THE EXPERIENCE

CURVE

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

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

Total accumulated production of units

Cost orpriceper unit

Yesterday

Today

Tomorrow

EXTERNAL SOURCES OF CAPACITYEXTERNAL SOURCES OF CAPACITY

IN-HOUSE OR OURSOURCE?IN-HOUSE OR OURSOURCE?

Once capacity requirements are determined, the organization must decide whether to produce a good or service itself or outsource

Factors to consider:Available capacityExpertiseQuality considerationsThe nature of demandCostRisks

NEED TO MAINTAIN BALANCENEED TO MAINTAIN BALANCE

CAPACITY PLANNING: BALANCECAPACITY PLANNING: BALANCE

Stage 1 Stage 2 Stage 3Unitsper

month6,000 7,000 5,000

Unbalanced stages of productionUnbalanced stages of production

Stage 1 Stage 2 Stage 3Unitsper

month6,000 6,000 6,000

Balanced stages of productionBalanced stages of production

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

BOTTLENECK OPERATIONBOTTLENECK OPERATION

Machine #2Machine #2BottleneckOperation

BottleneckOperation

Machine #1Machine #1

Machine #3Machine #3

Machine #4Machine #4

10/hr

10/hr

10/hr

10/hr

30/hr

Bottleneck operation: An operationin a sequence of operations whosecapacity is lower than that of theother operations

BOTTLENECK OPERATIONBOTTLENECK OPERATION

Operation 120/hr.

Operation 210/hr.

Operation 315/hr.

10/hr.

Bottleneck

Maximum output ratelimited by bottleneck

CONSTRAINT MANAGEMENTCONSTRAINT MANAGEMENT ConstraintConstraint

Something that limits the performance of a process or system in achieving its goals

CategoriesMarketResourceMaterialFinancialKnowledge or competencyPolicy

RESOLVING CONSTRAINT ISSUESRESOLVING CONSTRAINT ISSUES Identify the most pressing constraint Change the operation to achieve maximum benefit,

given the constraint Make sure other portions of the process are supportive

of the constraint Explore and evaluate ways to overcome the constraint Repeat the process until the constraint levels are at

acceptable levels

STRATEGIES FOR MATCHING STRATEGIES FOR MATCHING CAPACITY TO DEMANDCAPACITY TO DEMAND

DEMAND MANAGEMENT DEMAND MANAGEMENT STRATEGIESSTRATEGIES

Strategies used to offset capacity limitations and that are intended to achieve a closer match between supply and demand

Pricing Promotions Backorders Offering complementary products Discounts Other tactics to shift demand from peak periods into slow periods

Time (Months)

Sales (Units)

Jet Skis

Snow-mobiles

Total

01,000

2,000

3,000

4,0005,000

J M M J S N J M M J S N J

COMPLEMENTARY PRODUCTSCOMPLEMENTARY PRODUCTS

CAPACITY MANAGEMENT CAPACITY MANAGEMENT STRATEGIESSTRATEGIES

1. Adjusting equipment and processes – which might include purchasing additional machinery or selling or leasing out existing equipment

2. Making staffing changes (increasing or decreasing the number of employees)

3. Improving methods to increase throughput

4. Redesigning the product to facilitate more throughput (for faster processing)

THINGS THAT CAN BE DONE TO THINGS THAT CAN BE DONE TO ENHANCE CAPACITY MANAGEMENTENHANCE CAPACITY MANAGEMENT

1. Design flexibility into systems

2. Take stage of life cycle into account

3. Take a “big picture” approach to capacity changes

4. Prepare to deal with capacity “chunks”

5. Attempt to smooth out capacity requirements

6. Identify the optimal operating level

7. Choose a strategy if expansion is involved

CAPACITY FLEXIBILITYCAPACITY FLEXIBILITY

CAPACITY FLEXIBILITYCAPACITY FLEXIBILITY

Flexible plants

Flexible processes

Flexible workers

EVALUATING ALTERNATIVESEVALUATING ALTERNATIVES Alternatives should be evaluated from varying

perspectivesECONOMIC Cost-volume analysis

Break-even point Financial analysis

Cash flow Present value

Decision theory Waiting-line analysis SimulationNON-ECONOMIC Public opinion

COST-VOLUME RELATIONSHIPS COST-VOLUME RELATIONSHIPS (1 OF 3)(1 OF 3)

Am

oun

t ($

)

0Q (volume in units)

Total cost = VC + FC

Total variable cost (VC)

Fixed cost (FC)

COST-VOLUME RELATIONSHIPS COST-VOLUME RELATIONSHIPS (2 OF 3)(2 OF 3)

Am

oun

t ($

)

Q (volume in units)0

Total rev

enue

COST-VOLUME RELATIONSHIPS COST-VOLUME RELATIONSHIPS (3 OF 3)(3 OF 3)

Am

oun

t ($

)

Q (volume in units)0 BEP units

Profit

Total r

even

ue

Total cost

BREAK-EVEN POINT (BEP)BREAK-EVEN POINT (BEP)

BEPThe volume of output at which total cost and total

revenue are equalProfit (P) = TR – TC = R x Q – (FC +v x Q)

= Q(R – v) – FC

vRQBEP

FC

COST-VOLUME RELATIONSHIPSCOST-VOLUME RELATIONSHIPS

BBREAK-EVEN PROBLEM WITH STEP REAK-EVEN PROBLEM WITH STEP FIXED COSTS (1 of 2)FIXED COSTS (1 of 2)

Quantity

FC + VC = TC

FC + VC = TC

FC + VC = TC

Step fixed costs and variable costs.

1 machine

2 machines

3 machines

BBREAK-EVEN PROBLEM WITH STEP REAK-EVEN PROBLEM WITH STEP FIXED COSTS (2 of 2)FIXED COSTS (2 of 2)

$

TC

TC

TCBEP2

BEP3

TR

Quantity

1

2

3

Multiple break-even points

1. One product is involved2. Everything produced can be sold3. Variable cost per unit is the same regardless of

volume4. Fixed costs do not change with volume5. Revenue per unit is the same regardless of

volume6. Revenue per unit exceeds variable cost per unit

ASSUMPTIONS OF COST-VOLUME ASSUMPTIONS OF COST-VOLUME ANALYSISANALYSIS

FINANCIAL ANALYSISFINANCIAL ANALYSIS

Cash Flow

the difference between cash received from sales and other sources, and cash outflow for labor, material, overhead, and taxes.

Present Value

the sum, in current value, of all future cash flows of an investment proposal.