IE 305 BUS 307

CH 5

CAPACITY PLANNING

2006 Prentice Hall, Inc.

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Capacity
The throughput, or the number of units a facility can hold, receive, store, or produce in a period of time Determines fixed costs

Determines if demand will be satisfied

Three time horizons
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Planning Over a Time Horizon

Long-range planning Intermediaterange planning Short-range planning Modify capacity Add facilities Add long lead time equipment Subcontract Add equipment Add shifts

*
Add personnel Build or use inventory Schedule jobs Schedule personnel Allocate machinery Use capacity

* Limited options exist

Figure S7.1
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Design and Effective Capacity

Design capacity is the maximum theoretical output of a system
Normally expressed as a rate

Effective capacity is the capacity a firm expects to achieve given current operating constraints
Often lower than design capacity

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Utilization and Efficiency

Utilization is the percent of design capacity achieved
Utilization = Actual Output/Design Capacity

Efficiency is the percent of effective capacity achieved

Efficiency = Actual Output/Effective Capacity

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Bakery Example
Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

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Bakery Example
Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls Utilization = 148,000/201,600 = 73.4%

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Bakery Example
Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 8 hour shifts Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls Utilization = 148,000/201,600 = 73.4% Efficiency = 148,000/175,000 = 84.6%

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Bakery Example
Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 8 hour shifts Efficiency = 84.6% Efficiency of new line = 75% Expected Output = (Effective Capacity)(Efficiency)

= (175,000)(.75) = 131,250 rolls

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Managing Demand
Demand exceeds capacity
Curtail demand by raising prices, scheduling longer lead time

Long term solution is to increase capacity

Capacity exceeds demand

Stimulate market

Product changes

Adjusting to seasonal demands

Produce products with complimentary demand patterns
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Economies and Diseconomies of Scale

Average unit cost (dollars 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
Figure S7.2
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2006 Prentice Hall, Inc.

Capacity Considerations
Forecast demand accurately
Understanding the technology and capacity increments Find the optimal operating level (volume)

Build for change

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Approaches to Capacity Expansion

(a) Leading demand with incremental expansion
Demand New capacity Expected demand

(b) Leading demand with one-step expansion

Demand New capacity Expected demand

(c) Capacity lags demand with incremental expansion

Demand New capacity Expected demand

(d) Attempts to have an average capacity with incremental expansion

Demand New capacity Expected demand

Figure S7.4
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Break-Even Analysis
Technique for evaluating process and equipment alternatives Objective is to find the point in dollars and units at which cost equals revenue Requires estimation of fixed costs, variable costs, and revenue

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Break-Even Analysis
Fixed costs are costs that continue even if no units are produced
Depreciation, taxes, debt, mortgage payments

Variable costs are costs that vary with the volume of units produced
Labor, materials, portion of utilities
Contribution is the difference between selling price and variable cost
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Break-Even Analysis
Assumptions Costs and revenue are linear functions
Generally not the case in the real world

We actually know these costs

Very difficult to accomplish

There is no time value of money

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Break-Even Analysis
900 800 700 Cost in dollars 600 Total revenue line

Break-even point Total cost = Total revenue

Total cost line

500
400 300 200 100
|

Variable cost

Fixed cost

Figure S7.5
2006 Prentice Hall, Inc.

| | | | | | | | | | | 0 100 200 300 400 500 600 700 800 900 1000 1100

Volume (units per period)

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Break-Even Analysis
BEPx = Break-even point in units BEP$ = Break-even point in dollars P = Price per unit (after all discounts) x = Number of units produced TR = Total revenue = Px F = Fixed costs V = Variable costs TC = Total costs = F + Vx

Break-even point occurs when

TR = TC or Px = F + Vx
2006 Prentice Hall, Inc.

F BEPx = P-V

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Break-Even Analysis
BEPx = Break-even point in units BEP$ = Break-even point in dollars P = Price per unit (after all discounts) x = Number of units produced TR = Total revenue = Px F = Fixed costs V = Variable costs TC = Total costs = F + Vx

BEP$ = BEPx P F P = P-V F = (P - V)/P F = 1 - V/P

2006 Prentice Hall, Inc.

Profit = TR - TC = Px - (F + Vx) = Px - F - Vx = (P - V)x - F

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Break-Even Example
Fixed costs = $10,000 Direct labor = $1.50/unit Material = $.75/unit Selling price = $4.00 per unit

$10,000 F BEP$ = = 1 - [(1.50 + .75)/(4.00)] 1 - (V/P)

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Break-Even Example
Fixed costs = $10,000 Direct labor = $1.50/unit Material = $.75/unit Selling price = $4.00 per unit

$10,000 F BEP$ = = 1 - [(1.50 + .75)/(4.00)] 1 - (V/P)

$10,000 = = $22,857.14 .4375 $10,000 F BEPx = = = 5,714 4.00 - (1.50 + .75) P-V

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Break-Even Example
Multiproduct Case
BEP$ = F

Vi 1x (Wi) Pi

where

V P F W i

= variable cost per unit = price per unit = fixed costs = percent each product is of total dollar sales = each product

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Multiproduct Example
Fixed costs = $3,500 per month

Item Sandwich Soft drink Baked potato Tea Salad bar

Price $2.95 .80 1.55 .75 2.85

Cost $1.25 .30 .47 .25 1.00

Annual Forecasted Sales Units 7,000 7,000 5,000 5,000 3,000

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Multiproduct Example
Fixed costs = $3,500 per month

Item Sandwich Soft drink Baked potato Tea Salad bar

Price $2.95 .80 1.55 .75 2.85

Cost $1.25 .30 .47 .25 1.00

Annual Forecasted Sales Units 7,000 7,000 5,000 5,000 3,000

Item (i) Sandwich Soft drink Baked potato Tea Salad bar

Annual Weighted Selling Variable Forecasted % of Contribution Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7) $2.95 .80 1.55 .75 2.85 $1.25 .30 .47 .25 1.00 .42 .38 .30 .33 .35 .58 .62 .70 .67 .65 $20,650 5,600 7,750 3,750 8,550 $46,300 .446 .121 .167 .081 .185 1.000 .259 .075 .117 .054 .120 .625
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2006 Prentice Hall, Inc.

BEP = Multiproduct Example V 1 - P x (W ) F

$ i i i

Fixed costs = $3,500 per month $3,500 x Forecasted Annual 12 = $67,200 = .625 Units Item Price Cost Sales Sandwich $2.95 $1.25 7,000 $67,200 Daily Soft drink .80 .30 7,000 = sales 312 days = $215.38 Baked potato 1.55 .47 Annual 5,000 Weighted % of Tea Selling Variable .75 .25Forecasted 5,000 Contribution Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7) Salad bar 2.85 1.00 x $215.38 3,000 .446 = 33 Sandwich $2.95 $1.25 .42 .58 $20,650 .44632.6 .259 $2.95 sandwiches
Soft drink Baked potato Tea Salad bar .80 1.55 .75 2.85 .30 .47 .38 .30 .33 .35 .62 .70 .67 .65 5,600 7,750 .121 .075 per day .167 .117 .054 .120 .625
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.25 1.00

3,750 8,550 $46,300

.081 .185 1.000

2006 Prentice Hall, Inc.

Strategy-Driven Investment
Operations may be responsible for return-on-investment (ROI) Analyzing capacity alternatives should include capital investment, variable cost, cash flows, and net present value

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Net Present Value (NPV)

F P= (1 + i)N

where

F P i N

= future value = present value = interest rate = number of years

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NPV Using Factors

F P= N = FX (1 + i)
where X = a factor from Table S7.1 defined as = 1/(1 + i)N and F = future value
5% .952 .907 .864 .823 .784 6% .943 .890 .840 .792 .747 7% .935 .873 .816 .763 .713 10% .909 .826 .751 .683 .621
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Portion of Table S7.1

Year 1 2 3 4 5

2006 Prentice Hall, Inc.

Present Value of an Annuity

An annuity is an investment which generates uniform equal payments
S = RX
where X = factor from Table S7.2 S = present value of a series of uniform annual receipts R = receipts that are received every year of the life of the investment

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Present Value of an Annuity

Portion of Table S7.2 Year 1 2 3 4 5 5% .952 1.859 2.723 4.329 5.076 6% .943 1.833 2.676 3.465 4.212 7% .935 1.808 2.624 3.387 4.100 10% .909 1.736 2.487 3.170 3.791

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Process, Volume, and Variety

Figure 7.1

Volume Low Volume Repetitive Process High Volume Mass Customization (difficult to achieve, but huge rewards) Dell Computer Co.

High Variety one or few units per run, high variety (allows customization) Changes in Modules modest runs, standardized modules Changes in Attributes (such as grade, quality, size, thickness, etc.) long runs only
2006 Prentice Hall, Inc.

Process Focus projects, job shops (machine, print, carpentry) Standard Register

Repetitive (autos, motorcycles) Harley Davidson Product Focus (commercial baked goods, steel, glass) Nucor Steel
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Poor Strategy (Both fixed and variable costs are high)

Some Possible Growth Patterns

Volume Volume

Growth

Decline

Time

Time

Cyclical
Volume Volume

Stable

0
2006 Prentice Hall, Inc.

Time

Time
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Developing Capacity Alternatives

Design flexibility into systems
Take a big picture approach to capacity changes Prepare to deal with capacity chunks Attempt to smooth out capacity requirements Identify the optimal operating level

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Planning Service Capacity

Need to be near customers
Capacity and location are closely tied

Inability to store services

Capacity must me matched with timing of demand

Degree of volatility of demand

Peak demand periods
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Measuring Capacity
By units of output ( barrels of beer , # of cars)

Standard time time to produce a product by a qualified operator at a normal pace.

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Levels of Capacity
Must be measured at these three levels
Machine or individual worker

Work center
Plant

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Calculating Processing Requirements

Product Annual Demand Standard processing time per unit (hr.) Processing time needed (hr.)

#1 #2 #3
2006 Prentice Hall, Inc.

400 300 700

5.0 8.0 2.0

2,000 2,400 1,400 5,800

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Determining Capacity Available

Measurement
Demonstrated capacity comes from historical data

Calculation
Calculated or rated capacity is based on available time, utilization and efficiency.

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Capacity Req.
Load determination
1. Determine time needed for each order at each center. 2. Sum the CR for individual orders to obtain a load. Time needed for order
Sum of Setup and Run times
2006 Prentice Hall, Inc.

Example 150 gear shafts with a setup of 1.5 hours and run time of 0.2 hours Standard time = 1.5 + ( 150 x 0.2)
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QUESTIONS???

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