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Product and service choices, process selection, capacity planning, and choices about
location and layout are among the most basic decisions managers must make because
those decisions have long-term consequences for the organization.


Process refers to the way an organization chooses to produce its goods or provide its
services. Essentially it involves choice of technology and related issue, and it has major
implications for capacity planning, layout facilities, equipment, and design of work systems.

Make or buy.
In make of buy decisions, a number of factors are usually considered.
1. Available capacity (usually, contractual works are more costly).
2. Expertise.
3. Quality considerations (some specialized companies may provide higher quality;
otherwise, if a strict quality control is essential, self-production may become the
4. The nature of demand (if steady do yourself; wide fluctuations or small orders may
require subcontracting, however).
5. Cost (the most important factor, linked to all of the above).

Type of processes <to remind>

Continuous and Repetitive/Assembly. (As a rule, products from these systems are made
for inventory than customer order).
Batch and job shops (intermittent processing). (Products/services are, sometimes, made
for inventory, but usually are designed to meet custom consumer needs. Marketing
efforts in these systems are often directed toward promoting system processing
capabilities or customized services).
Projects. (Customized solutions only).

Match the Process and the Product.

Product variety High Moderate Low Very low
Equipment High Moderate Low Very low
Low volume Job Shop
Moderate Batch
High volume Repetitive
Very high Continuous
volume flow

Poor match would suggest the potential for improvement.

Over a product life cycle, volume requirements change. This must be taken into account
when planning/changing processes.

Automation is the substitution of machinery for human labor.

Besides obvious advantages <discuss>, automation also has drawbacks:
- costly (requires high volumes of output to offset the costs);
- less flexible than humans;
- social issues (workers see automation as a potential for loosing jobs).

Computer-aided manufacturing (CAM).

Numerically controlled machines (N/C) are programmed to follow a set of processing
instructions based on mathematical relationships that tell the machine the details of the
operations to be performed. (Such equipment can be very expensive).
Individual machines may have their own computer (computerized numerical control
One computer may control a number of N/C machines, which is referred to as direct
numerical control (DNC).

Robots consist of three parts: mechanical arm, power supply, and a controller
<advantages of robots; read more about robots from other sources>.
Japanese manufacturing firms are major users of robots.

Robots differentiate by task complexity:

- follow instruction;
- programmable robots, going a sequence of tasks;
- computer-operated robots;
- robots with object recognition and simple decision-making.

Flexible manufacturing system (FMS) is a group of machines that include supervisory

computer control, automatic material handling, and robots or other automated equipment.
Reprogrammable controllers enable these systems to produce a variety of similar
FMS are designed to handle intermittent processing equipment with some of the benefits
of automation and some of the flexibility of individual, or stand-alone, machines (N/C
machines). (i.e. Flexibility of a job shop processing and the productivity of repetitive
processing systems).
FMS requires longer planning and development time (i.e. cost).

Computer-integrated manufacturing (CIM) is a system of linking a broad range of

manufacturing activities through an integrating computer system, including engineering
design, flexible manufacturing systems, and production planning and control (not all
elements are absolutely necessary).
Complex systems can link scheduling, purchasing, inventory control, shop control, and
Generally, CIM integrates information from other areas of an organization with

To conclude.
Process selection requires engineering expertise.
In the long run, the solution is to hire and promote managers who have both managerial
and technical skills and expertise.
In the short run, managers must work with technical experts, asking questions and
increasing their understanding of the benefits and limitations of sophisticated processing
equipment and technology, and ultimately make decisions themselves.
Thus, there is a real need for management of technology.

The proportion of total costs represented by fixed costs is becoming larger, and the
proportion of variable costs is becoming smaller. This means that the volume of output has
a decreasing effect on total cost, a situation that can be particularly burdensome during
periods of slow demand. Also, automation creates additional requirements for the
maintenance and repair of highly specialized equipment.
Managers must proceed cautiously with decisions to automate, carefully weighing the
benefits and risks before making what are usually long-term commitments.

Flexibility, besides its importance, does not always offer the best choice in processing
decisions i.e. costs are not outweighed by revenues.
E.g. products in mature stages would not require many changes in design. These
situations would require specialized equipment with no need for flexibility.
Flexibility should be adopted with great care; applications should be matched with
situations in which a need for flexibility clearly exists.
Flexible systems are chosen for either (1) varied demand or (2) uncertain demand. The
second is better to be overcome through improved forecasting.


Capacity is an upper limit on the load that an operating unit can handle. (Operating unit
can be a plant, department, machine, store, or worker).
The load can be specified in terms of either inputs or outputs (which approach to use is a
matter of convenience). (E.g., processing 45 pounds of raw material per hour is input
capacity; producing 18 pieces per hour is output capacity).

Basic questions about capacity are:

1. What kind of capacity is needed? (i.e. related to what products/services?)
2. How much is needed?
3. When is it needed?

All decisions relative to capacity, facilities, location, and the like are governed by product
and service choices.

Importance of capacity decisions.

1. Ability to meet future demands. (Capacity limits the rate of output possible).
2. Balanced choice between the costs of over- and undercapacity. (Operating costs are
minimized given the match [or at least balance] between demand and capacity).
3. Capacity is the major determinant of cost. (Larger units cost more, but have lesser cost
per unit of production).
4. Implemented capacity resources have long-term commitment. (It may be
difficult/impossible to modify those decisions without incurring major costs).

Defining and measuring capacity.
Capacity is the upper limit of the rate of output. (Sounds simple, but difficulties arise on the
interpretations of the term).
- In measures of capacity it is important to choose one that does not require updating
(e.g. dollar measure is inappropriate).
- Given a list of different produced items, number of items as output capacity becomes
misleading (in this case, an input capacity may be a solution).

Dimensions of capacity:
1. Design capacity: the maximum output that can be possibly attained.
2. Effective capacity: the maximum possible output given a product mix, scheduling
difficulties, machine maintenance, quality factors, and so on.
3. Actual output: rate of output actually achieved (which is less than effective capacity due
to breakdowns, defective output, shortage of materials, and similar factors).

Measures of capacity examples

Business Inputs Outputs
Auto manufacturing Labor hours, machine hours Cars per shift
Steel mill Furnace size Tons of steel per day
Oil refinery Refinery size Gallons of fuel per day
Farming Number of acres, # of cows Bushels of grain per acre
per year, gallons of milk per
Restaurant Number of tables, seating Number of meals served per
capacity day
Theater Number of seats Number of tickets sold per
Retail sales Square feet of floor space Revenue per day

Efficiency = Actual output / Effective capacity

Utilization = Actual output / Design capacity

E.g. given
Design capacity = 50 trucks per day;
Effective capacity = 40;
Real capacity = 36;

Efficiency = 36/40 = 90%;

Utilization = 36/50 = 72%.
(i.e. stressing only efficiency is sometimes misleading; stress must be made on increasing
effective capacity).

Determinants of effective capacity

1. Facilities. (Design of facilities [size, provision for expansion], location factors
[transportation, distance to markets, labor supply, energy sources], work area layout,
environmental factors [where personnel either may work efficiently or will struggle to
overcome poor design characteristics]).

2. Product/Service factors. (Generally, the more uniform the output, the greater is capacity
level. Product mix must also be considered to have a coherent production).
3. Process factors. (Besides the direct effect (quantity), quality becomes another
important factor, since not meeting the standards leads to rework, inspections, etc., that
lower the capacity).
4. Human factors. (Tasks that make up a job, variety of activities involved, training, skill,
experience have impact on potential and actual output, as well as absenteeism and
labor turnover).
5. Operation factors. (Scheduling problems due to different equipment capabilities;
inventory stocking decisions, late deliveries, acceptability of purchased materials and
parts, quality inspections and control procedures have impact on effective capacity.
Generally, insufficient capacity in one area may affect the overall capacity!).
6. External factors. (External product standards [minimum quality and performance
standards], pollution standards, paperwork, union contracts [which limits the number of
hours and type of work an employee may do]).
In general, inadequate planning is the major limiting determinant of effective capacity.

Determining capacity requirements.

Long-term (trends and cycles) vs. short-term (patterns) capacity planning.
Irregular variations are the most complex to deal with since no forecasting mechanisms
are applicable.
The link between marketing and operations is crucial to realistic determination of capacity

Examples of demand patterns

Year Beer sales, toy sales, airline traffic, clothing, vacations, tourism, power
usage, gasoline consumption, sports and recreation, education
Month Welfare and social security checks, bank transactions
Week Retail sales, restaurant meals, automobile traffic, automobile rentals, hotel
Day Telephone calls, power usage, automobile traffic, public transportation,
retail sales, restaurant meals

Developing capacity alternatives

1. Design flexibility into systems. (Provision for future expansion in the original design
of a structure frequently can be obtained at a small price compared to what it would
cost to remodel an existing structure that did not have such a provision. Flexibility
issues involve layout of equipment, location, equipment selection, production planning,
scheduling, and inventory policies.
Also, new products are less predictable and require higher degree of flexibility; older
products are more predictable, but may have limited life span, what then would require
readjustment of production; consequently, flexibility is an appealing feature).
2. Take a big picture approach to capacity changes. (Changes in operations may
require changes in other elements of a system; e.g. expansion of the number of room
in a hotel would require bigger parking, cooking and dining facilities, etc.).
3. Prepare to deal with capacity chunks. (Capacity solutions are frequently discrete
[e.g. equipment is capable to produce 40 units per hour, the requirement is, say, 55];
the example becomes even more extreme if open-hearth furnaces or airplanes are
considered when providing the desired level of capacity).

4. Attempt to smooth out capacity requirements. (Unevenness of capacity is another
problem. Over- and underutilization are typical problems given fluctuating demand; e.g.
increasing the number of buses for peak periods will lead to underutilization during
periods of mild demand and would add to the cost of operating system. No simple
solution is possible in such cases, but forecasting and heuristics can improve the
choice of a solution.
Besides, companies may find complementary solutions [conditioners and heaters,
snow and water skies] that, sometimes, can be a remedy. <More examples?>
Also, subcontracting works may also resolve the situation).
5. Identify the optimal operating level. (Size of a plant conditions the optimal output
level [which is, normally, higher for bigger plants with lower cost per unit]. <critique the
graph of cost per unit vs. rate of output for a single plant and plants of different sizes).

Evaluating alternatives
1. Economic considerations. (Will an alternative be economically feasible? How much
will it cost? How soon can we have it? What will operating and maintenance costs be?
What will its useful life be? Will it be compatible with present personnel and present
A number of techniques are useful for evaluation of capacity alternatives from an
economic standpoint: cost-volume analysis, financial analysis, decision theory, waiting-
line analysis).
2. Possible negative public opinion. <Examples>

Calculating processing requirements.

When evaluating capacity alternatives, a necessary piece of information is the capacity
requirements of products that will be processed with a given alternative. To get this
information, one must have reasonably accurate demand forecasts for each product, and
know the standard processing time per unit for each product on each alternative machine,
the number of work days per year, and the number of shifts that will be used.

Cost-volume analysis (Break-even point analysis).

Profit = TR TC = R x Q (FC + VC x Q)

The required volume needed to generate a specific profit is:

Volume = (Specific profit + FC) / (R VC)

Capacity alternatives may involve step costs, which are costs that increase stepwise as
potential volume increases. E.g. there is an option to purchase 1, 2, or 3 machines, with
each additional machine increasing fixed cost, although perhaps not linearly.
FC would depend on the number of machines purchased.
Multiple break-even quantities may occur (possibly, one for each range). Total revenue
may not intersect the fixed cost line in a particular range, meaning no BEP for the range.

In order to decide how many machines to purchase, a manager must consider projected
annual demand (volume) relative to the multiple break-even points and choose the most
appropriate number of machines.

Assumptions of cost-volume analysis <discussion>.

Financial analysis (used to rank investment proposals).

Cash flow (difference between cash received from sales and other sources and cash
outflow for labor, materials, etc.)
Present value (expresses in current value the sum of all future cash flows of an
investment proposal).

3 most commonly used methods of financial analysis: payback (ignores time value
money), present value, and internal rate of return.
<read more from other sources>.