Topic-6Topic-6

Long Rang Capacity PlanningLong Rang Capacity Planning

Long range capacity Long range capacity planningplanning

Capacity-is the productive capability of a production facility

Capacity measurement: aggregate unit of output/input rate

* single item: output rate * many items: aggregate unit of output, or aggregate unit of input. In service: input rateWhy capacity planning- matching demand

fluctuation.

Why Matching Capacity- Why Matching Capacity- Matching Demand FluctuationMatching Demand Fluctuation

Output

Time

Capacity?

Demand

Measurement of CapacityMeasurement of Capacity• Output rate capacity: -- For a facility having a single product or a

few homogeneous products, the unit of measure is straightforward (barrels of beer per month)

-- For a facility having a diverse mix of products, an aggregate unit of capacity must be established using a common unit of output (sales dollars per week)

Measurement of Capacity (II)Measurement of Capacity (II)

• Input rate capacity: commonly used for service operations where output measures are particularly difficult.

--Hospital use available beds per month.--Airline use available seat miles per

month.--Movie theatres use available seats per

month.

Examples of Capacity Examples of Capacity MeasuresMeasuresMeasures of Capacity

Types of Organizations Inputs Outputs

Truck manufacturer Machine hours per shift Number of trucks per shift

Hospital Number of beds Number of patients treated per day

Airline Number of planes Seat-miles flow per week

Restaurant Number of seats Customers served per day

Restaurant Size of display area Sales dollars per year

Theater Number of seats Number of customers per week

Design Capacity vs. Maximum CapacityDesign Capacity vs. Maximum Capacity

• Design capacity (Q*): the amount of output at which the AUC (average unit cost) of a product facility is minimum.

• Practical maximum capacity : the maximum amount of output that a facility can produce (at a higher AUC)

• When Q>Q*,then AUC>AUC*• Q<Q*, also AUC>AUC*

AVCAVC

Q

(Output Quantity)Q* Qmax

Q* Qmax

AUC (Average Unit Cost)

Output Quantity

AUC

Variable Cost/ Unit

Fixed Cost/Unit

Q* - Design Capacity Qmax – Practical Maximum Capacity

Economies and Economies and Diseconomies of ScaleDiseconomies of Scale

Averageper Unit CostOf Output ($)

Economies of scale Dise

conom

ies o

f sca

le

Best Operating Level Annual Volume Units

Economies of ScaleEconomies of Scale• Best operating level —least average

unit cost• Economies of scale —average cost

per unit decrease as the volume increases toward the best operating level.

• Diseconomies of scale —average cost per unit increase as the volume increase beyond the best operating level

Economies of scaleEconomies of scale• Declining costs result from:--Fixed costs being spread over more

and more units.--Longer production runs result in a

smaller proportion of labor being allocated to setups.

--Proportionally less material scrap--……….and other economies.

Economies of scaleEconomies of scale• Diseconomies of scale: Increasing costs

result from increased congestion of workers and materials, which contribute to:

--increasing inefficiency --difficulty in scheduling --damaged goods --reduced morale --increased use of overtime --………and other diseconomies

Capacity EconomyCapacity Economy• Economy of scale: Refer to the cost

reduction resulting from the increase in production quantity.

“Economies of scale is so vague that it can be used to justify any number of decisions, which all too often turn out to be wrong.”

Capacity Economy (II)Capacity Economy (II)• Example:

Plant Des.cap. Act.Prod Proc. Tech AUC

A 100 100 X 10

B 100 60 X 12

C 200 200 X 5

D 200 200 Y 2

Capacity Economy (III)Capacity Economy (III)

• AUC(A)< AUC(B)—Volume Economy.

• AUC(C)< AUC(A)— Capacity Economy

• AUC(D)< AUC(C)—Technology Economy.

BA

C

D

AUC

Q

12

10

5

2

60 100 200

Increases in Incremental Increases in Incremental Facility CapacityFacility Capacity

Average per Unit Cost per Output ($)

Annual Volume (Units)

AB

C

SmallPlant Mid-Sized

PlantLarge Plant

Economies and Economies and Diseconomies of ScaleDiseconomies of Scale

250-250-unit unit shop shop 500-500-unit unit

shop shop

750-750-unit unit shop shop

Economies Economies of scale of scale

Diseconomies Diseconomies of scale of scale

Output rate (units per week)Output rate (units per week)

Av

era

ge

un

it c

os

t A

ve

rag

e u

nit

co

st

(do

llars

pe

r u

nit

)(d

olla

rs p

er

un

it)

Three Level Capacity PlanningThree Level Capacity Planning• 1.Long range capacity planning: T>1 year.• Decisions: planning for capacity that requires a

long time to acquire.• e.g. Plant/building/equipment/high cost facility • 2. Intermediate range capacity planning: T(6-18

months).• Decisions: planning for capacity requirement

(month or quarterly).• e.g. work force size/new tools/inventory/…..• 3. short range capacity planning: T (1-6moth).• Decisions: weekly (or daily) capacity planning.• e.g. overtime use/personnel transfer/alternative

routings/……

Ways of Changing Long Ways of Changing Long Range CapacityRange Capacity

• Expand Capacity– Subcontract with other companies to become suppliers

of the expanding firm’s components or entire products– Acquire other companies, facilities, or resources– Develop sites, buildings, buy equipment– Expand, update, or modify existing facilities– Reactivate facilities on standby status

• Reduce Capacity– Sell existing facilities, sell inventories, and layoff or

transfer employees– Mothball facilities and place on standby status, sell

inventories, and layoff of transfer employees– Develop and phase in new products as other products

decline

Capacity Planning ProcessCapacity Planning Process• 1. Determine capacity requirement: * long range demand forecasting.• 2. Generating alternative capacity plans: *when should new capacity be added?

(timing) * how much new capacity should be

added (sizing) *what kind capacity should be added?

(type)

The Timing of Capacity The Timing of Capacity IncrementsIncrements

Capacity

Demand

Capacity

Demand

Units

Time

Units

Time

Policy A: Capacity Leads Demand Policy B: Capacity lags Demand

The Sizing of Capacity The Sizing of Capacity IncrementsIncrements

Should the capacity be added more often in small increments (Option A) or in large increments less frequently (Option B)?

Capacity Increments

{

Units

Time

Demand

Capacity Increments

{Units

Time

Demand

Planned unused Planned unused capacity capacity

Capacity StrategiesCapacity Strategies

TimeTime

Ca

pac

ity

Ca

pac

ity

Forecast of Forecast of capacity required capacity required

Time between Time between increments increments

Capacity Capacity increment increment

((a) Expansionist strategya) Expansionist strategy

Capacity StrategiesCapacity Strategies

TimeTime

Ca

pac

ity

Ca

pac

ity

((b) Wait-and-see strategyb) Wait-and-see strategy

Forecast of Forecast of capacity required capacity required

Planned use of Planned use of short-term options short-term options

Time between Time between increments increments

Capacity Capacity increment increment

Capacity Planning Process (II)Capacity Planning Process (II)

• 3. Evaluating alternative capacity plans:

*Decision tree *Breakeven analysis4.Selecting best capacity plan under

given objectives5. Locating new capacity (facility

location).

Facility planningFacility planning• How much long range capacity is

need• When additional capacity is need• What the layout and characteristics

of facilities should be • The capital investment in land,

building, technology and machinery is enormous

Facility planningFacility planning• A firm must live with its facility

planning decisions for a long time and these decisions affect:

• Operating efficiency • Economy of scale • Ease of scheduling• Maintenance costs• ……………profitability

Facility planningFacility planning• Steps in the capacity planning process*estimate the capacity of the present

facilities.*forecast the long-range future capacity

needs.*identify and analyze sources of capacity to

meet these needs*Select from among the alternative sources

of capacity

Economies of scopeEconomies of scope• The ability to produce many product

models in one flexible facility more cheaply than in separate facilities

• Highly flexible and programmable automation allows quick, inexpensive products-to-product changes

• Economies are created by spreading the automation cost over many products

Evaluation of Capacity PlansEvaluation of Capacity Plans• Major method:1. Net present value analysis2. Breakeven analysis3. Decision tree model4. Computer simulation5. Queuing Models (Service Capacity

Plan)

Evaluation of Capacity Plans Evaluation of Capacity Plans (II)(II)

• Decision model: a simplified representation of a real world problem. There are many decision models developed in the literature for different problems.

• Three major elements of a decision model:

1. Objectives must be measurable2. Decision variables must be controllable3. Constraints and Assumptions.

Decision Tree Model Decision Tree Model • Decision tree model is primarily

developed for problem where:* a series of (multiple) decisions must

be made sequentially* all decisions are interrelated and

interdependent and * Outcomes associated with each

decision are uncertain

Decision Tree Model (II)Decision Tree Model (II)• Assumptions of decision tree model:1. Objective is a single measurement2. All possible outcomes associated with a

decision have a known probability.3. Best plan is represented by the optimal

expected value.

• Tree structure:* Decision point* Even point* Probability of outcome

Capacity DecisionsCapacity Decisions

Decision TreesDecision Trees

Low demand [0.40]Low demand [0.40]

Low demand [0.40]Low demand [0.40]

$70$70

$220$220

$40$40

$148$148

$109$109

$148$148

High demand [0.60]High demand [0.60]

High demand [0.60]High demand [0.60]

$135$135

Don’t expandDon’t expand

ExpandExpand$135$135

$90$90

11

22Small expansion

Small expansion

Large expansion

Large expansion

ExampleExample

Supplement: p. 6-20 - Problem #1

DevelopProduct Sell Idea

Sell Idea

3.0

1.8

2.5

2.1

2.8

2.2

2.6

2.3

EV = 2.5

||

||

1.5

(.5) Large Market

(.5) Marginal Mkt.

EV = 2.5

(.5) Large Market

(.5) Marginal Mkt.EV = 2.45

Company A

Company B

EV = 2.5

||

(.5) Large Market

(.5) Marginal Mkt.

EV = 2.4

(.5) Large Market

(.5) Marginal Mkt.EV = 2.3

Produce &Market

EV = 2.4

||

Lease for Royalty

Payoff($ millions)

SolutionsSolutions

• The company should lease the concept to company A. Notice, however, that other alternatives are very close in their payoffs.

•  •  b. If the company follows your

recommendation, what returns should the company expect to receive?

•  • If the firm's estimates are correct, it will receive

either $2,800,000 or $2,200,000.

•

See Example on your See Example on your Supplementary Supplementary ––

p. 6-17 to 6-19.p. 6-17 to 6-19.

C

D

E

F

G

H

H,p= 0.7, $900 for 6 years

L,p= 0.3, $300 for 6 years

H,p= 0.7, $600 for 6 years

L,p= 0.3, $500 for 6 years

L,p= 0.8, $300 for 6 years

H,p= 0.2, $900 for 6 years

H,p= 0.2, $900 for 6 years

L,p= 0.8, $300 for 6 years

H,p= 0.2, $600 for 6 years

L,p= 0.8, $500 for 6 years

H,p= 0.7, $900 for 6 years

L,p= 0.3, $300 for 6 years

1

A

B

2

3

$520

$3,920

$4,260

$3,520

$3,120

Large plant,Investment = $4,000

Small plantInvestment= $3,400

H,p = 0.6

L,p = 0.4

H,p = 0.6

L,0 = $300

$4,320

Expand,Investment = $800

Do not expand

Expand, Investment = $800

Do not expand

$900

$300

$3,420

$2,520

$3,120

$4,320

$2,520

We evaluated the three from the right-hand side. Investment and income are given in thousands of dollars.

Event C: $900(6)(0.7) + $300 (6)(0.3)= $4,320Event D: $600(6)(0.7) + $500 (6)(0.3)= $3,420Event E: $900(6)(0.2) + $300 (6)(0.8)= $2,520Event F: $600(6)(0.2) + $500 (6)(0.8)= $3,120Event G: $900(6)(0.7) + $300 (6)(0.3)= $4,320Event H: $900(6)(0.2) + $300 (6)(0.8)= $2,520

Decision Point 2:Expand: Income= $4,320- $800 = $3,520Do not expand: Income=…………….....= $3,420

At this point the decision will be to expand the plant because the income for this alternative is larger. Event D will therefore be served.

Decision Point 3:Expand: Income= $42,520- $800 = $1,720Do not expand: Income=…………………= $3,120

At this point the decision will be “do not expand” because the income for this alternative is larger. Event E will therefore be served.

Decision Point 1:Expand: Income= $3,920- $3,400 = $520Do not expand: Income= $4,260- $4,00 = $260

At this point the decision will be to build a small plant. Event B therefore will be served.

Thus, XYZ should initially build a small plant. At the end of one year, if demand is high, the company should expand the plant. If demand is low, the company should not expand the plant. Expected income is $520,000.