LECTURE THREE

PROCESS STRATEGY
Process selection

 Is the way an organization chooses to produce its

goods or provides its services.
 Essentially it involves choice of technology and
related issues, and it has major implications for
capacity planning, layout of facilities, equipment
and design of work systems.
 Cont’

MAKE or BUY
 The very important step in Process planning is to
consider whether to make or buy some or all of a
product or to subcontract some or all of a services.
 In make or buy decision, a number of factors are
usually considered;
• Available capacity
• Expertise
• Quality consideration
• The nature of demand
• Cost
 PROCESS STRATEGY
 Another decision of the operations manager is finding
the best way to produce so as not to waste resources.
 Process strategy is an organization approach to
transforming resources into goods and services.
 The objectives of strategy is to build a production
process that meets customer requirements and product
specifications within cost and other managerial
constraints.
 The process selected will have a long term effect on
efficiency and flexibility of production as well as on
cost and quality of goods produced.
 Services process strategy

 Interaction with the customer often affects process

performance adversely. But a vision by its complex
nature implies that some interaction and customization
is needed.
 Services also change with technology. Eg ATM
machines, blood and urine electronic testing, scanners at
airports etc
Types of Process strategies
• Continuous process: Produce large volumes of
highly standardized item continuously (no processing
variety) eg. Sugar production
• Repetitive/assembly line: a process technology
suitable for a narrow range of standardized product
in. large volumes. eg. Automobiles, camera, etc.
• Batch process: variety of products in varying
volumes
• Job shop: Small quantities are produced of many
different product and each require its own unique set
of processing steps
• Project: Non routine job encompassing a complex
set of activities
Capacity of a facility
• Capacity is defined as the maximum output of a system in a
given period.
• OR it is the number of units a facility can hold, receive, store,
or produce in a period of time
• It is normally expressed as a rate, such as the number of tons
of steel that can be produced per week, per month, or per year.
• Effective determining the size of a facility is critical to a firm’s
success.
Cont….
 Capacity needs include
 Equipment
 Space
 Employee skills

 Goal
 To achieve a match between the long-term supply
capabilities of an organization and the predicted level
of long-run demand
 Overcapacity operating costs that are too high
 Under-capacity strained resources and possible
loss of customers
Questions to ask as manager

 Key Questions:
 What kind of capacity is needed?
 How much capacity is needed to match
demand?
 When is it needed?

 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 changes
Cont’….

 Capacity can be difficult to quantify due to

 Day-to-day uncertainties such as employee
absences, equipment breakdowns, and material-
delivery delays
 Products and services differ in production rates
 Different interpretations of maximum capacity
Measurements 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)
Measurements of Capacity

Input Rate Capacity

 Commonly used for service operations where output
measures are particularly difficult
 Hospitals use available beds per month
 Airlines use available seat-miles per month
 Movie theatres use available seats per month
Capacity management

 As it was stated earlier that; Capacity is the

maximum output of a system in a given period.
 It is the maximum number of units that can be
produced in a specific time.
 It is expressed in terms of inputs used or the
output produced.
 For example number of beds (a hospital), active
members (a church), or the number of counselors
(a drug abuse program) or total work time
available.
 Strategic Capacity
Planning
 Strategic Capacity Planning is an approach
for determining the overall capacity level of
capital intensive resources, including facilities,
equipment and overall labour force size.
 Capacity used is the rate of output actually
achieved
 The best operating level is nominally the
capacity of which the process was designed
Capacity Adjustment Strategies
Increase capacity
 Adding extra shifts
 Scheduling overtime or weekend
 Adding equipment a personnel
 Increase loading speed
 Subcontract jobs
 Reschedule maintenance (reduce)
 Acquire other companies, facilities, or resources
 Develop sites, construct buildings, buy equipment
 Expand, update, or modify existing facilities
 Reactivate standby facilities

July 28, 2020

Capacity Adjustment Strategies

Reduce capacity
 Eliminating shifts
 Reduce loading speed
 Reschedule maintenance (increase)
 Reduce or remove shifts
 Lay off workers
 Sell off existing resources, lay off employees
 Mothball facilities, transfer employees
 Develop and phase in new products/services

July 28, 2020

 CAPACITY DECISIONS
a) Design capacity of a facility is the maximum theoretical
capacity that can be achieved under ideal conditions.
• rated capacity is theoretical
• effective capacity includes efficiency and utilization

 Most organizations operate their facilities at a rate less than

the designed capacity.

 They do so because they have found that they can operate

more efficiently when their resources are not stretched to the
limit.

 The expected capacity might be 92% of the designed capacity.

This concept is called utilization.
Cont’

b) Utilization is simply the ratio of actual output and

the designed capacity of the system or facility

Utilization = Actual output/Design capacity

Cont.’

c)Effective capacity Is the maximum capacity a firm can

expect to achieve given its product mix, methods of
scheduling, maintenance, and standards of quality.
 Depending on how facilities are used and managed, it may be
difficult or impossible to reach 100% efficiency.
Efficiency is expressed as a percentage of the effective capacity.
It is a measure of actual output over effective capacity.
 Efficiency and utilization

Efficiency= Actual Output/ Effective capacity

Utilization= Actual Output/ Design Capacity

Both efficiency and utilization are expressed

as a percentage
 Example– Efficiency and Utilization
 Design Capacity = 50 trucks per day
 Effective Capacity = 40 trucks per day
 Actual Output = 36 trucks per day
Efficiency =Actual output/Effective
capacity
=36/40 =90%
Utilization =actual output/designed
capacity
=36/50=72%
Example 2

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

Cont’

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

Cont’

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%

Cont’

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%

Cont’

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%

Cont’

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%

Cont’

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
Cont’

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
Capacity and Strategy

 Capacity decisions impact all decisions of

operations management as well as other
functional areas of the organization
 Capacity decisions must be integrated into
the organization’s mission and strategy
Evaluating alternatives

 A number of techniques are useful for evaluating

capacity alternatives from an economic standpoint.
 Some of the more common are cost-volume
analysis, financial analysis, decision theory and
waiting-line analysis,
Cost Volume Analysis

 Cost-volume analysis focuses on relationship between

cost, revenue and volume of out-put.
 The purpose of cost-volume analysis is to estimate the
income of an organization under different operating
conditions.
 As a tool for comparing capacity alternatives
 Fixed costs – remain constant regardless of volume of
output (e.g. Rental costs, property taxes, equipment costs,
heating and cooling expenses and administrative costs)
Sometimes it is referred as Break Even
Analysis
Objective is to find the point in shillings
and units at which cost equals revenue
Requires estimation of fixed costs,
variable costs, and revenue
 Break-Even Analysis
 Fixed costs are costs that continue
even if no units are produced
 Machines, buildings, 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
 Break-Even Analysis

Assumptions
 Costs and revenue are linear functions
 Generally not the case in the real world
 There is no time value of money
 Break-Even Analysis
–
Total revenue line
900 –

800 – i d or
Break-even point orr Total cost line
c
700 – Total cost = Total revenue
rofit
P
Cost in dollars

600 –

500 –
Variable cost
400 –

300 –
ss
200 – Lo idor
rr
co
100 – Fixed cost

–| | | | | | | | | | | |
0 100 200 300 400 500 600 700 800 900 1000 1100
Volume (units per period)
 Break-Even Analysis

BEPx = break- x= number of units

even point in units produced
BEP$ = break- TR = total
even point in dollars revenue = Px
P = price per F= fixed costs
unit (after all discounts) V = variable
cost per unit
Break-even point occurs when TC = total
costs = F + Vx

TR = TC F
or BEPx =
P-V
Px = F + Vx
 Break-Even Analysis
BEPx = break- x= number of units
even point in units produced
BEP$ = break- TR = total
even point in dollars revenue = Px
P = price per F= fixed costs
unit (after all discounts) V = variable
cost per unit
TC = total
BEP$ = BEPx P costs = F + Vx
F Profit = TR - TC
= P-V P
= Px - (F + Vx)
F
= (P - V)/P = Px - F - Vx
F = (P - V)x - F
= 1 - V/P
Example

 The owner of old- fashioned wears, MSM enterprise, is

contemplating adding a new line producing item, which
will require leasing new equipment of $ 8,000. Variable
costs would be $ 2.5 per item and would retail for $ 7.20
each.
 How many items must be sold in order to break even?
 What would the profit (loss) be if 900 items are made
and sold in a week?
 How many items must be sold to realize a profit of $
3,500 if FC = $6,100, VC = $ 2 per item, R= $7.5 per
item?
Decision tree model

 Another model for evaluating capacity alternatives is decision

tree
 Recall decision tree as discussed in examples of mathematical
models