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Capacity Planning

Atanu Chaudhuri

Agenda Criticality of capacity decisions Capacity decisions over different time horizons Factors influencing capacity decisions Different approaches to capacity expansion Concept of break-even volumes Decision Trees and Capacity Decisions Estimating required and available capacity A capacity planning problem Why companies fail to meet demand despite having capacity?

Capacity decisions are tricky! --- One of the toughest decisions which business leaders have to takeHolcim-owned cement major ACC expects the cement industry to add 70 million tonnes (mt) of fresh capacity this year, putting pressure on prices. With the new additions, the cumulative installed cement production capacity of the country may cross the 300 million tonnemark. In 2010, we expect an additional capacity of about 70 mt to materialise, more than half of which is coming up in south-west India. Despite a growing demand for cement, these capacity additions may create surpluses in some parts of the country, said Mr N.S. Sekhsaria, Chairman, ACC What started out as stock outs on the iPod touch at Amazon.com started spreading to other retailers and iPod models. Amazon.com, one of Apple's highest volume iPod resellers, has just recently pushed lead times on the 8 GB second-generation iPod touch to three to five weeks from 11 days while the 16 GB model remains at three to five weeks. iPod touch, iPod nano, and even iPod shuffle are seeing shortages on different colors and capacities this week across several retailers including Best Buy, Target, Wal-Mart, and Crutchfield.com.

"Frankly, we find these sell-outs on iPods surprising given how difficult the macroeconomic environment is, putting a crimp on consumer spending," he told clients in a new report Wednesday. "http://www.appleinsider.com/articles/08/12/03/apples_unexpected_ipod_shortage_spr eading.html

Source: http://www.thehindubusinessline.com/2010/03/27/stories/2010032752410200.htm

Capacity decisions have long term implications. An illustration from global chemical industrySignificant capacity investments in East Changing rolesAnnual ethylene capacity additions by region (as a % of 2008 total capacity)

Expected behaviorsChinaNet importer - due to significant demand. However some balance between local production and imports will be set. Net importer and merchant buyer - driven by free market needs. Has potential to influence based on demand. Net exporter - with access to advantaged feedstock. Significant government play in the market. Marginal production - driven by significant excess and older capacity.

China and Middle East contribute to 78% of new capacity during 20092013

India

Middle East

Developed markets

National governments are increasingly playing a role in capacity buildup

Source: CMAI, Deutsche Bank and DTT Chemical Group analysis.

4

Declining capacity investments in chemical industry in the developed worldSignificant asset reductionsAn evaluation of 35 major announced capacity closures by leading players

Lower capacity

Capacity reduction in developed markets 2008-2012 Ethylene and Derivatives1

Developing

Developed

Source: Company Websites, Press releases and news, CMAI, Deutsche Bank, and DTT Chemical Group analysis. (1) Ethylene derivatives include HDPE, LDPE, LLDPE, PVC and Ethylene Glycol.

5

Kt per annum

Indian Auto Component Sector- Some firms are building capacities ahead, some are pegging investment growth to sales growth and some are cutting down investmentsMfg Sales, Capital Employed and Asset Turnover-Bharat Forge2000 1800 1600 1400 1200 1000 800 600 400 200 0 2002 2003 2004 2005 2006Mfg Sales Capital Employed Asset Turnover

Mfg Sales Capital Employed Asset Turnover 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0

Mfg Sales, Capital Employed and Asset turnover-Yuken India90 80 70 60 50 40 30 20 10 0 2002 2003 2004 2005

Mfg Sales Capital Employed Asset Turnover 7 6 5 4 3 2 1 0 2006 Mfg Sales Capital Employed Asset Turover 8 7 6 5 4 3 2 1 0

Mfg sales, capital employed and asset turnover-Talbros Automotive Component160 140 120 100 80 60 40 20 0 2002 2003 2004 2005

Mfg sales, capital employed and asset turnover-Munjal Auto350 300 250 200 150 100 50 0 2002 2003 2004 2005

7 6 5 4 3 2 1 0 2006

2006

Firms in Electronics and Chemicals industries in India also show different patterns in capital investmentsMfg sales, capital employed and asset turnover-TVS Electronics250 200 150 100 50 0 2002 2003 2004 2005 2006 SalesManf CapEmp Asset Turnover 12 10 8 6 4 2 0

Mfg Sales, Capital Employed and Asset Turnover-Zicom Electronic Security Systems100 90 80 70 60 50 40 30 20 10 0 2002 2003 2004 2005

SalesManf CapEmp Asset Turnover

2.000 1.800 1.600 1.400 1.200 1.000 0.800 0.600 0.400 0.200 0.000 2006Mfg Sales Capital Employed Asset Turnover

Mfg sales, capital employed and asset turnover-Kavveri Telecom30 25 20 15 10 5 0 2002 2003 2004

SalesManf CapEmp Asset Turnover 8 7 6 5 4 3 2 1 0 2005

Mfg Sales, Capital Employed and Asset TurnoverJubilant Organosys1600 1400 1200 1000 800 600 400 200 0 2003 2004 2005

2.000 1.950 1.900 1.850 1.800 1.750 1.700 2006

Long waiting times for products usually indicate long term capacity planning or aggregate planning problemsWith competition hotting up, this might result in lost sales

Bajaj Auto has a waiting list of three weeks for their top- selling product Pulsar, pushing demand for these bikes up to 80,000 units per month from 55,000 units. Honda Motorcycle & Scooter India (HMSI) has a waiting period of four weeks for their scooters Activa and Deo. Two-wheeler majors clearly did not expect this surge in demand. Since January, demand has surged by 20%.Source: http://economictimes.indiatimes.com/news/news-by-industry/auto/twowheelers/Rising-consumer-optimism-to-drive-bike-demand/articleshow/5895736.cms

Significance of capacity decisions The throughput (quantity to be sold), or the number of units a facility can hold, receive, store, or produce in a period of time Determines fixed costs Determines whether demand will be satisfied or not Planning over three time horizons

Capacity decisions over different time horizons Long term decisions include: When, how much, and in what form to alter capacity

Medium term decisions include: How much inventory to hold Level of manpower required Whether to sub-contract or not? To buy new equipment or not

Short term decisions include: Scheduling specific jobs, orders, allocating resources (manpower, equipment)

Considerations for capacity decisions Forecast demand with reasonable accuracy Understand the technology and capacity increments Find the optimum operating level (volume)

Capacity decisions are influenced by economies and diseconomies of scaleAverage unit cost (Rupees per room per night)

25 - room roadside motel

50 - room roadside motel

75 - room roadside motel

Economies of scale

Diseconomies of scale

25

50 Number of Rooms

75

Companies also need to understand learning effects while planning capacityCapacity should be calculated considering the standard time

0.3 Standard time0.25Processing time per unit in hours

0.20

0 0 100 200 300 400 Cumulative Units Produced

500

Companies can use flexible facilities to address demand variability across productsPercent of North American Vehicles Made on Flexible Assembly Lines

100% 80% 60% 40% Chrysler Toyota Nissan Honda 20% 0 Ford GM

How can companies manage demand? Demand exceeds capacity Curtail demand by raising prices, scheduling longer lead time

Catering to only specific segment Long term solution is to increase capacity

Capacity exceeds demand Stimulate market through product launches, advertising etc Product changes and upgrades

Adjusting to seasonal demands Produce products with complementary demand patterns, if possible

How can companies match capacity with demand?1. Making staffing changes 2. Adjusting equipment Purchasing additional machinery

May not always be necessary, instead balance flow of product/services through the facility

Selling or leasing out existing equipment

3. Closing facilities 4. Improving processes to increase throughput 5. Redesigning products to facilitate more throughput 6. Adding process flexibility to meet changing product preferences

Different approaches to capacity expansion(a) Leading demand with incremental expansionNew capacity Demand Expected demand Demand

(b) Leading demand with one-step expansionNew capacity Expected demand

(c) Capacity lags demand with incremental expansionNew capacity Demand Expected demand

Where will this capacity expansion approach be suitable?(a) Leading demand with incremental expansionNew capacity

Demand

Expected demand

1

2 Time (years)

3

Where will this capacity expansion approach be suitable?(b) Leading demand with one-step expansion

New capacity Demand Expected demand

1

2 Time (years)

3

Where will this capacity expansion approach be suitable?(c) Capacity lags demand with incremental expansionNew capacity Demand Expected demand

1

2 Time (years)

3

Companies should also account for lifecycle stages while evaluating capacity alternativesShould be careful in making large, irreversible investments, need more flexibility

Need of flexibility of Focus on efficient Systematically build utilization of existing equipment and manpower capacity without increases overshooting by large ext