CHAPTER 4

PROCESS SELECTION AND CAPACITY PLANNING

PROCESS SELECTION
What is process?
A process is any part of an organization that takes inputs and transforms them into outputs that, it
is hoped, are of greater value to the organization than the original inputs. Automobile
assembling companies’ assembling plants take in parts and components that have
been fabricated for the plant. Using labor, equipment along an assembly line, and energy,
these parts and components are transformed into automobiles. McDonald’s at each of
its restaurants, uses inputs such as hamburger meat, lettuce, tomatoes, and potatoes. To
these inputs, trained labor is added in the form of cooks and orders takers, and capital equipment
is used to transform the inputs into hamburgers, French fries, and other foods.

In both of these examples, the process produces products as output. However, the
outputs of many processes are services. In a hospital, for example, specialized equipment and
highly trained doctors, nurses, and technicians are combined with other inputs, the
patients. The patient is transformed through proper treatment and care into a healthy patient. An
airline is another example of a service organization. The airplanes, ground equipment, flight
crews, ground crews, reservation personnel, and fuel to transport customers between locations all
over the world. Based on some criteria, processes are classified into different types, and there has
to be good match between the selected product and the process to be selected from the different
alternatives.

Process Selection

Process selection refers to the way an organization chooses to produce its goods or provide its
services. Essentially it involves the choice of technology and related issues, and it has
major implications for capacity planning, layout of facilities, equipment, and design
of work systems. Process selection occurs as a matter of course when new products or
services are being planned. However, it also occurs periodically due to technological
changes in equipment.

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Importance of Process Selection Decisions

Process selection decisions are important in that they are strategic in nature. They
require a long-term perspective and a great deal of cross- functional coordination,
since marketing, finance, human resource, and operations issues are all important. Process
selection decisions tend to be capital intensive and cannot be easily changed. Therefore, a firm
has to be committed to the process choice and is bound by these decisions for years to come.

How an organization approaches process selection is determined by the organization’s

process strategy.

The major and key aspects that operations process strategy addresses include:

a. Make or buy decisions: The extent to which the organization will produce goods or
provide services in-house as opposed to relying on outside organizations to produce or
provide them.

The very first 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 service. A manufacturer might
decide to purchase certain parts rather than make them; sometimes all parts are
purchased, with the manufacturer simply performing assembly operations. Many firms
contract out janitorial services, and some contract for repair services. If a decision is
made to buy or contract, this lessens or eliminates the need for process selection.

In make or buy decisions, a number of factors are usually considered:

 Available capacity: If an organization has available the equipment, necessary

skills, and time, it often makes sense to produce an item or perform a service
in-house. The additional costs would be relatively small compared with those required to
buy items or subcontract services.
 Expertise: If a firm lacks the expertise to do a job satisfactorily, buying might be a
reasonable alternative.
 Quality considerations: Firms that specialize can usually offer higher quality than an
organization can attain itself. Conversely, special quality requirements or the
ability to closely monitor quality may cause an organization to perform a job
itself.

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  The nature of demand: When demand for an item is high and steady, the organization
is often better off doing the work itself. However, wide fluctuations in demand or
small orders are usually better handled by specialists who are able to combine
orders from multiple sources, which results in higher volume and tend to offset
individual buyer fluctuations.
 Cost: Any cost savings achieved from buying or making must be weighed against the
preceding factors. Cost savings might come from the item itself or from transportation
cost savings. If there are fixed costs associated with making an item that cannot be
reallocated if the item is purchased, that has to be recognized in the analysis. If the
organization decides to perform some or all of the processing, then the issue of process
selection becomes important.
b. Degree of automation/Capital Intensity: The mix of equipment and labor that will be used
by the organization.
c. Process Flexibility: The degree to which the system can be adjusted to changes in
processing requirements due to such factors as changes in product or service
design, changes in volume processed, and changes in technology.

TYPES OF PROCESSES
I. Continuous and Semi-Continuous Processes
a. Continuous Processes:
 Continuous processes are employed when a highly uniform product or service is
produced or rendered.
Continuous processes are characterized by:
 Perfect product standardization  Products are continuous rather than
 Very high product volume discrete.
 Specialized purpose or function  Shut-downs and start-ups are costly
 Expensive process equipment’s  High vulnerable to shutdowns
 Logical arrangement of the  Low personnel skills required
equipment’s  Wide span of supervision

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b. Semi-continuous Processes:
 Semi-continuous processes also called repetitive processes are employed to produce
outputs that allow for some variety
 Products are highly similar but not identical
 Typically, these products are produced in discrete units
 High volume products
 Relatively low skills
 Relatively greater product variety
II. Intermittent Processes
o Processes used to produce a variety of products with different processing requirements in
lower volumes
o Volume is much lower than in continuous and semi-continuous systems
o The equipment’s are general purpose
o Workers are semi-skilled and skilled
o Span of supervision is narrow
a. Batch Processes: are intermittent processes that are used when companies need to produce
moderate volumes of similar products. Batch manufacturing companies make a batch of one
product, then switch over (set up) the equipment and make a batch of another item.
b. Job shops: are also intermittent processes that are used to produce small lots, low volume
products. Equipment’s involved are general purpose, and the need for skilled workers to
operate and supervise such highly flexible equipment’s is tremendously high. What
distinguishes the job shop operation from batch processing is that the job requirements often
vary considerably from job to job.

Intermittent and Repetitive (continuous and semi-continuous) Operations

Decision Intermittent Operations Repetitive Operations

Product variety Great Small
Degree of standardization Low High
Organization of resources Grouped by function Line flow to accommodate
processing needs
Path of products through In a varied pattern, depending Line flow
facility on product needs
Factor driving production Customer orders Forecast of future demands
Critical resource Labor intensive operation Capital intensive operation

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 (workers skills important) (equipment, automation,
technology important)
Type of equipment General purpose Specialized
Degree of automation Low High
Throughput time Longer Shorter
Work-in- process inventory More Less
Underlying Process Relationship between Volume and Standardization Continuum

CAPACITY PLANNING

Defining Capacity

Capacity is the upper limit or ceiling on the load that an operating unit (a plant, department,
machine, store, or worker) can handle during a specified time period (minute, hour, day,
week, year etc). The capacity of an operating unit is an important piece of information for
planning purposes: It enables managers to quantify production capability in terms of inputs or
outputs, and thereby make other decisions or plans related to those quantities.

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Example: A department works one eight-hour shift, 250 days a year, and has using one
machine in kind, and detailed information regarding processing requirements and
demand size for three different products is presented in the table below:

Product Annual Standard Processing Processing Time

Demand Time per Unit (Hr.) Needed (Hr.)
1 400 5.0 2000
2 300 8.0 2400
3 700 2.0 1400
TOTAL 5800
The question is to determine the number of machines (capacity) that the department has to have
to meet the above demand requirements.

Working one eight-hour shift, 250 days a year provides an annual capacity of 8 X 250 = 2,000
hours per year.

o 5800 Hrs/2000 Hrs Machine = 2.90 MACHINES. Approximately 3 machines are required.

The basic questions in capacity planning of any sort are the following:

 What kind of capacity is needed?

 How much is needed?
 When is it needed?

The question of what kind of capacity is needed depends on the products and services that
management intends to produce or provide. Hence, in a very real sense, capacity planning is
governed by those choices.

The most fundamental decisions in any organization concern the products and/or services it will
offer. Virtually all other decisions pertaining to capacity, facilities, location, and the
like are governed by product and service choices. Thus, a decision to produce
high-quality steel will necessitate certain types of processing equipment and certain kinds of
labor skills, and it will suggest certain types of arrangement of facilities. It will influence the size
and type of building as well as the plant location. Notice how different each of these factors
would be if the choice were to operate a family restaurant, and how still different they would be
if the choice were to operate a hospital.’

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Steps in the Capacity Planning Process

1. Estimate the capacity of the present facilities

2. Forecast the long-range future capacity needs
3. Determine the gap between future capacity requirement and current production capacity
4. Identify and analyze sources of capacity to meet this gap
5. Select from among the alternative sources of capacity

Importance of Capacity Decisions

For a number of reasons, capacity decisions are among the most fundamental of all the design
decisions that managers must make.

1. Capacity decisions have a real impact on the ability of the organization to

meet future demands for products and services; capacity essentially limits the rate of
output possible. Having capacity to satisfy demand can allow a company to take
advantage of tremendous opportunities.
2. Capacity decisions affect operating costs. Ideally, capacity and demand
requirements will be matched, which will tend to minimize operating costs. In practice,
this is not always achieved because actual demand either differs from expected demand
or tends to vary (e.g., cyclically). In such cases, a decision might be made to attempt to
balance the costs of over- and under capacity.
3. Capacity is usually a major determinant of initial cost. Typically, the greater the capacity of a
productive unit, the greater is its cost. This does not necessarily imply a one-for-one
relationship; larger units tend to cost proportionately less than smaller units.
4. Capacity decisions often involve long-term commitment of resources and the fact that, once
they are implemented, it may be difficult or impossible to modify those decisions without
incurring major costs.
5. Capacity decisions can affect competitiveness. If a firm has excess capacity, or can quickly
add capacity, that fact may serve as a barrier against entry by other firms.

MEASURING CAPACITY

Even though defining capacity seems simple enough, there are subtle difficulties in
actually measuring capacity in certain cases. These difficulties arise because of different

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interpretations of the term capacity and problems with identifying suitable measures for a
specific situation.

In selecting a measure of capacity, it is important to choose one that does not require updating.
For example, dollar amounts are often a poor measure of capacity (e.g. Capacity of $30
million a year); because price changes necessitate continual updating of that measure.

Where only one product or service is involved, the capacity of the productive unit
may be expressed in terms of that item. However, when multiple products or services are
involved, as is often the case, using a simple measure of capacity based on units of output can
be misleading. An appliance manufacturer may produce both refrigerators and freezers. If the
output rates for these two products are different, it would not make sense to simply state capacity
in units without reference to either refrigerators or freezers. The problem is compounded if the
firm has other products. No single measure of capacity is, thus, appropriate in every situation.
Rather, the measure of capacity must be tailored to the situation.

Types of Capacities

Even though defining capacity seems simple enough, there are subtle difficulties in actually
measuring capacity in certain cases. These difficulties arise because of different interpretations
of the term capacity and problems with identifying suitable measures for a specific situation.

a. Design Capacity

b. Effective Capacity

c. Actual Capacity

1. Design Capacity: the maximum output that can possibly be attained. It is the upper
limit on the load an operating unit or production system can handle during a specific time
period under ideal situations.
2. Effective Capacity: the maximum possible output given a product mix, scheduling
difficulties, machine maintenance, quality factors, and so on. What makes effective capacity
different from design capacity is that constraints of the prevailing reality under which the
production unity or system is to work are appreciated and taken into account.
o Effective capacity is usually less than design capacity (it cannot exceed design
capacity) owing to realities of changing product mix, the need for periodic maintenance of

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 equipment, lunch breaks, coffee breaks, problems in scheduling and balancing operations,
and similar circumstances. Actual output cannot exceed effective capacity and is
often less because of machine breakdowns, absenteeism, shortages of materials, and
quality problems, as well as factors that are outside the control of the operations managers.
3. Actual capacity: This is the same as effective capacity but contains unplanned losses as well
as planned ones. These could include poor work rate, absenteeism or new staff training for
example.

These different measures of capacity are useful in defining two measures of system
effectiveness: efficiency and utilization. Efficiency is the ratio of actual output to
effective capacity. Utilization is the ratio of actual output to design capacity.

 Efficiency

 Utilization

It is common for managers to focus exclusively on efficiency, but in many instances, this
emphasis can be misleading. This happens when effective capacity is low compared with
design capacity. In those cases, high efficiency would seem to indicate effective use of
resources when it does not. The following example illustrates this point. Given the information
below, compute the efficiency and the utilization of the vehicle repair department:

 Design capacity = 50 trucks per day

 Effective capacity = 40 trucks per day
 Actual output= 36 trucks per day

Efficiency = Actual output rate/effective capacity

= 36 trucks per day/ 40 trucks per day = 90%

Utilization = Actual output rate/capacity (100%)

=36 trucks per day/ 50 trucks per day = 72%

Thus, compared with the effective capacity of 40 units per day, 36 units per day is looks pretty
good. However, compared with the design capacity of 50 units per day, 36 units per day is much
less impressive although probably more meaningful. Because effective capacity acts as a lid on

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actual output, the real key to improving capacity utilization is to increase effective capacity by
correcting quality problems, maintaining equipment in good operating condition, fully training
employees, and fully utilizing bottleneck equipment.

Hence, increasing utilization depends on being able to increase effective capacity, and this
requires knowledge of what is constraining effective capacity.

The following sections explore some of the main determinants of effective capacity.

a. Facilities Factors: the design of facilities, including size and provision for expansion, is
key. Locational factors, such as transportation costs, distance to market, labor supply, energy
sources, and room for expansion, are also important. Likewise, layout of the work area often
determines how smoothly work can be performed, and environmental factors such as heating,
lighting, and ventilation also play a significant role in determining whether personnel can
perform effectively or whether they must struggle to overcome poor design characteristics.
b. Product/Service Factors: product or service design can have a tremendous
influence on capacity. For example, when items are similar, the ability of the system to
produce those items is generally much greater than when successive items differ. Thus, a
restaurant that offers a limited menu can usually prepare and serve meals at a faster rate than
a restaurant with an extensive menu. Generally speaking, the more uniform the output, the
more opportunities there are for standardization of methods and materials, which leads to
greater capacity.
c. Process Factors: the quantity capability of a process is an obvious determinant
of capacity. A more subtle determinant is the influence of output quality. For
instance, if quality of output does not meet standards, the rate of output will be slowed by the
need for inspection and rework activities.
d. Operational Factors: scheduling problems may occur when an organization has
differences in equipment capabilities among alternative pieces of equipment or
differences in job requirements. Inventory stocking decisions, late deliveries, acceptability
of purchased materials and parts, and quality inspection and control procedures also can
have an impact on effective capacity.
e. External Factors: product standards, especially minimum quality and performance
standards can restrict management’s options for increasing and using capacity. Thus,

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 pollution standards on products and equipment often reduce effective capacity, as does
paperwork required by government regulatory agencies by engaging employees in
nonproductive activities. A similar effect occurs when a union contract limits the number of
hours and type of work an employee may do. In general, inadequate planning is a major
limiting determinant of effective capacity.
f. Human Factors: the tasks that make up a job, the variety of activities involved, and the
training, skill, and experience required to perform a job all have an impact on the potential
and actual output. In addition, employee motivation has a very basic relationship to capacity,
as do absenteeism and labor turnover.

DEVELOPING AND EVALUATING CAPACITY ALTERNATIVES

Aside from the general considerations about the development of alternatives (i.e.,
conduct a reasonable search for possible alternatives, consider doing nothing, take care
not to overlook non-quantitative factors), some specific considerations are relevant to
developing capacity alternatives. The considerations to be discussed in this section include the
following:

A. Qualitatively
1. Design flexibility into systems: The long-term nature of many capacity decisions and the
risks inherent in long-term forecasts suggest potential benefits from designing flexible
systems. For example, 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.
2. Take a "big picture" approach to capacity changes: A consideration for managers
contemplating capacity increases is whether the capacity is for a new product or service, or a
mature one. Mature products or services tend to be more predictable in terms of capacity
requirements, and they may have limited life spans. The predictable demand
pattern means less risk of choosing an incorrect capacity, but the possible limited life span of
the product or service may necessitate finding an alternate use for the additional capacity at
the end of the life span. New products tend to carry higher risk because of the uncertainty
often associated with predicting the quantity and duration of demand. That makes flexibility
appealing to managers.

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3. Prepare to deal with capacity "chunks: Capacity increases are often acquired in fairly
large chunks rather than smooth increments, making it difficult to achieve a
match between desired capacity and feasible capacity. For instance, the desired
capacity of a certain operation may be 55 units per hour; but suppose that machines used
for this operation are able to produce 40 units per hour each. One machine by itself would
cause capacity to be 15 units per hour short of what is needed, but two machines would result
in an excess capacity of 25 units per hour.
4. Identify the optimal operating level: Production units typically have an ideal or
optimal level of operation in terms of unit cost of output. At the ideal level,
cost per unit is the lowest for that production unit; larger or smaller rates of output
will result in a higher unit cost. A firm realizes economies of scale as long as each
successive unit is produced at a lower cost than it preceding unit.
B. Quantitatively

An organization needs to examine alternatives for future capacity from a number of different
perspectives. Most obvious are economic considerations: Will an alternative be
economically feasible? How much will it cost? How soon can we have it? What will operate and
maintenance costs be? What will its useful life be? Will it be compatible with present
personnel and present operations?

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 tree, and waiting-line analysis.

1. Cost-Volume Analysis: Cost-volume analysis, also called Break-Even Analysis, focuses

on relationships between cost, revenue, and volume of output. The purpose of cost-volume
analysis is to estimate the income of an organization under different operating conditions.

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The variable assuming the horizontal axis is volume of output in units and the vertical line
represents corresponding dollar value of sales. BEP units = break-even units

Assumptions of Cost-Volume Analysis:

a. One product is involved

b. Everything produced can be sold
c. Variable cost per unit is the same regardless of volume
d. Fixed costs do not change with volume
e. Revenue per unit is constant with volume
f. Revenue per unit exceeds variable cost per unit
2. Decision Trees Approach

Decision tree is a quantitative technique evaluating alternatives and structures a complex and
multiphase decisions by showing:

 The decisions that must be made (the candidate alternatives available)

 The sequence in which the decisions must occur
 The interdependence among the decisions (shows main branches and sub-branches

It allows objective evaluation of alternatives incorporates uncertainty and develops expected

(anticipated) values or payoffs.

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3. Financial Analysis

Net Present Value (NPV): is the difference between the sum of the present value
of all the series of future cash flows of an investment proposal of a specific facility with a
specific production capacity and the present value of the investment on it. Net present
value summarizes the initial cost of an investment, its estimated annual cash flows, and
any expected salvage value in a single value called the equivalent current value, taking into
account the time value of money.

4. The waiting line or queue management

It is a critical part of service industry. It deals with issue of treatment of customers in sense
reduce wait time and improvement of service. Queue management deals with cases where the
customer arrival is random; therefore, service rendered to them is also random.

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