5

Capacity Planning For Products and Services

McGraw-Hill/Irwin

Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objectives
Explain the importance of capacity planning. Discuss ways of defining and measuring capacity. Describe the determinants of effective capacity. Discuss the major considerations related to developing capacity alternatives. Briefly describe approaches that are useful for evaluating capacity alternatives
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Capacity Planning
Capacity is the upper limit or ceiling on the load that an operating unit can handle. Capacity also includes

Equipment Space Employee skills

The basic questions in capacity handling are:

What kind of capacity is needed? How much is needed? When is it needed?

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Importance of Capacity Decisions

1. Impacts ability to meet future demands 2. Affects operating costs 3. Major determinant of initial costs 4. Involves long-term commitment 5. Affects competitiveness 6. Affects ease of management 7. Globalization adds complexity 8. Impacts long range planning
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Capacity
Design capacity

maximum output rate or service capacity an operation, process, or facility is designed for Design capacity minus allowances such as personal time, maintenance, and scrap rate of output actually achieved--cannot exceed effective capacity.

Effective capacity

Actual output

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Efficiency and Utilization

Actual output Efficiency =

Effective capacity
Actual output

Utilization =
Design capacity
Both measures expressed as percentages

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Efficiency/Utilization Example
Design capacity = 50 trucks/day Effective capacity = 40 trucks/day Actual output = 36 units/day

Actual output

36 units/day = 40 units/ day

Efficiency =
90% Effective capacity

Utilization =
72%

Actual output Design capacity

36 units/day 50 units/day =
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Best Operating Level

Example: Engineers design engines and assembly lines to operate at an ideal or best operating level to maximize output and minimize ware

Average unit cost of output

Underutilization

Overutilization
Best Operating Level

Volume

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Determinants of Effective Capacity

Facilities Product and service factors Process factors Human factors Policy factors Operational factors Supply chain factors External factors
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Strategy Formulation
Capacity strategy for long-term demand Demand patterns Growth rate and variability Facilities
Cost of building and operating

Technological changes
Rate and direction of technology changes

Behavior of competitors Availability of capital and other inputs

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Key Decisions of Capacity Planning

1. Amount of capacity needed
Capacity cushion (100% - Utilization)

2. Timing of changes 3. Need to maintain balance 4. Extent of flexibility of facilities

Capacity cushion extra demand intended to offset uncertainty

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Steps for Capacity Planning

1. Estimate future capacity requirements 2. Evaluate existing capacity 3. Identify alternatives 4. Conduct financial analysis 5. Assess key qualitative issues 6. Select one alternative 7. Implement alternative chosen 8. Monitor results
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Forecasting Capacity Requirements

Long-term vs. short-term capacity needs Long-term relates to overall level of capacity such as facility size, trends, and cycles Short-term relates to variations from seasonal, random, and irregular fluctuations in demand

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Calculating Processing Requirements

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

#1 #2 #3

400 300 700

5.0 8.0 2.0

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

If annual capacity is 2000 hours, then we need three machines to handle the required volume: 5,800 hours/2,000 hours = 2.90 machines
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Planning Service Capacity

Need to be near customers
Capacity and location are closely tied

Inability to store services

Capacity must be matched with timing of demand

Degree of volatility of demand

Peak demand periods

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In-House or Outsourcing
Outsource: obtain a good or service from an external provider

1. 2. 3. 4. 5. 6.

Available capacity Expertise Quality considerations Nature of demand Cost Risk

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Developing Capacity Alternatives

1.Design flexibility into systems 2.Take stage of life cycle into account 3.Take a big picture approach to capacity changes 4.Prepare to deal with capacity chunks 5.Attempt to smooth out capacity requirements 6.Identify the optimal operating level
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Economies of Scale
Economies of scale
If the output rate is less than the optimal level, increasing output rate results in decreasing average unit costs

Diseconomies of scale
If the output rate is more than the optimal level, increasing the output rate results in increasing average unit costs

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Optimal Rate of Output

Figure 5.4
Production units have an optimal rate of output for minimal cost. Average cost per unit

Minimum average cost per unit

Minimum cost

Rate of output
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Economies of Scale
Figure 5.5
Minimum cost & optimal operating rate are functions of size of production unit. Average cost per unit

Small
plant

Medium plant

Large plant

Output rate

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Economies & Diseconomies of Scale

Economies of Scale and the Experience Curve working

Average unit cost of output

100-unit plant 200-unit plant 300-unit plant 400-unit plant

Diseconomies of Scale start working Volume

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The Experience Curve

As plants produce more products, they gain experience in the best production methods and reduce their costs per unit

Yesterday

Cost or price per unit

Today

Tomorrow

Total accumulated production of units

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Capacity Focus
The concept of the focused factory holds that production facilities work best when they focus on a fairly limited set of production objectives

Plants Within Plants (PWP)

Extend focus concept to operating level

Capacity Flexibility
Flexible plants

Flexible processes

Flexible workers

Evaluating Alternatives
Cost-volume analysis
Break-even point

Financial analysis
Cash flow Present value

Decision theory Waiting-line analysis

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Cost-Volume Relationships
Figure 5.6a

Amount ($)

Fixed cost (FC) 0 Q (volume in units)

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Cost-Volume Relationships
Figure 5.6b

Amount ($)

Q (volume in units)
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Cost-Volume Relationships
Figure 5.6c

Amount ($) 0

BEP units Q (volume in units)

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Break-Even Problem with Step Fixed Costs Figure 5.7a

3 machines

2 machines 1 machine Quantity

Step fixed costs and variable costs.
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Break-Even Problem with Step Fixed Costs Figure 5.7b

$
BEP2
TC 3 BEP
3

TC

TC
2 1

Quantity Multiple break-even points

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Capacity Planning: Balance

Unbalanced stages of production

Units per month

Stage 1 6,000

Stage 2 7,000

Stage 3 5,000

Maintaining System Balance: Output of one stage is the exact input requirements for the next stage
Balanced stages of production

Units per month

Stage 1 6,000

Stage 2 6,000

Stage 3 6,000

Capacity Planning

Frequency of Capacity Additions

External Sources of Capacity

Assumptions of Cost-Volume Analysis

1.One product is involved 2.Everything produced can be sold 3.Variable cost per unit is the same regardless of volume 4.Fixed costs do not change with volume 5.Revenue per unit constant with volume 6.Revenue per unit exceeds variable cost per unit

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Financial Analysis
Cash Flow - the difference between cash received from sales and other sources, and cash outflow for labor, material, overhead, and taxes. Present Value - the sum, in current value, of all future cash flows of an investment proposal.

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Decision Theory
Helpful tool for financial comparison of alternatives under conditions of risk or uncertainty Suited to capacity decisions See Chapter 5 Supplement

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Waiting-Line Analysis
Useful for designing or modifying service systems Waiting-lines occur across a wide variety of service systems Waiting-lines are caused by bottlenecks in the process Helps managers plan capacity level that will be cost-effective by balancing the cost of having customers wait in line with the cost of additional capacity
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Bottleneck Operation
Figure 5.2

Machine #1 Machine #2

10/hr

Bottleneck operation: An operation in a sequence of operations whose capacity is lower than that of the other operations

10/hr

Bottleneck Operation
10/hr 10/hr

30/hr

Machine #3

Machine #4

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Bottleneck Operation
Bottleneck

Operation 1 20/hr.

Operation 2 10/hr.

Operation 3 15/hr.

10/hr.

Maximum output rate limited by bottleneck

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