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Strategic Capacity Management
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What is common?
Have you experienced problems with a service
because of inadequate labor or equipment
capacity?
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Capacity
The ability to hold, receive, store, or
accommodate
Capacity is the capability of a manufacturing or
service resource such as a facility, process,
workstation, or piece of equipment to
accomplish a purpose over a specific period.
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How do you measure capacity?
PAPER MILL HOSPITAL SERVER AUTOMOTIVE
STORAGE PLANT
MAX OUTPUT PER UNITS OF
UNIT TIME RESOURCE
AVAILABILITY
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Examples of Short- and Long-Term Capacity
Decisions
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Capacity Planning Concepts
• Capacity utilization rate: a measure of how close
the firm is to its best possible operating level
– 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 𝑈𝑡𝑖𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 =
• Economies of scale: the idea that as a planet gets
larger and volume increases, the average cost per
unit tends to drop
• Diseconomies of scale: at some point, the plant
becomes too large and average cost per unit
begins to increase
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Capacity Management Concepts
Focus
Flexibility
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Capacity Focus
• A few key products
• A specific technology
• A certain process design and capability
• A specific competitive priority objective such
as next day delivery
• Particular market segments or customers and
associated volumes
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Capacity Flexibility
Flexible •Ability to quickly adapt to change
Plants •Zero-changeover time
Flexible •Flexible manufacturing systems
Processes •Simple, easily set up equipment
Flexible •Ability to switch from one kind of task to another
quickly
Workers •Multiple skills (cross training)
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Considerations in Changing Capacity
Maintaining System Balance
•Similar capacities desired at each operation
•Manage bottleneck operations
Frequency of Capacity Additions
•Cost of upgrading too frequently
•Cost of upgrading too infrequently
External Sources of Capacity
•Outsourcing
•Sharing capacity
Decreasing Capacity
•Temporary reductions
•Permanent reductions
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Frequent versus Infrequent Capacity
Expansions
Exhibit 5.2
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Demand versus Capacity Problem
Structure
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Strategic Capacity Planning
Determining the overall level of capacity- Facilities
intensive resources that best supports Equipment
the company’s long-range competitive Labor force size
strategy
Capacity level selected has a critical Too low and the firm will lose customers and
impact on response rate, it cost structure, encourage competitors
is inventory policies, and management Too high and firm may have to cut costs or
and staff support requirements underutilize its capacity
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Determining Capacity Requirements
Project labor
Use forecasting Calculate labor
and equipment
to predict sales and equipment
availability over
for individual requirements to
the planning
products meet forecasts
horizon
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Determining Capacity Requirements
• Stewart Company produces two flavors of salad dressing
– Paul’s and Newman’s
• Each is available in bottles and single-serving bags
• Have three machines that can package 150,000 bottles
each year
– Each machine requires two operators
• Have five machines that can package 250,000 plastic bags
per year
– Each machine requires three operators
• What are the capacity and labor requirements for the next
five years?
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Step 1: Use Forecast to Predict Sales
for Individual Products
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Step 2: Calculate Equipment and Labor
Requirements
Bottling Operation Bagging Operation
• Capacity: 450,000 • Capacity: 1,250,000
– 150,000 x 3 – 250,000 x 5
• Operators: 6 • Operators: 15
– 2x3 – 3x5
• Year 1 • Year 1
– 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 𝑢𝑡𝑖𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 = = 0.3 – 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 𝑢𝑡𝑖𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 = =
,
0.24
– 𝑀𝑎𝑐ℎ𝑖𝑛𝑒 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡 = 0.3 × 3 = 0.9
– 𝑀𝑎𝑐ℎ𝑖𝑛𝑒 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡 = 0.24 ×
– 𝐿𝑎𝑏𝑜𝑟 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡 = 0.9 × 2 = 1.8 5 = 1.2
– 𝐿𝑎𝑏𝑜𝑟 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡 = 1.2 × 3 =
3.6
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Step 3: Project Equipment and Labor
Availabilities over the Planning Horizon
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Planning Service Capacity
Manufacturing Service
Capacity Capacity
Capacity must be available
Goods can be stored for
when service is needed –
later use
cannot be stored
Goods can be shipped to Service must be available
other locations at customer demand point
Volatility of demand is Much higher volatility is
relatively low typical
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Capacity Utilization and Service Quality
• Capacity = Service Rate X Number of Servers
• The relationship between service capacity utilization and service
quality is critical
– Arrival rate: the average number of customers that come to a facility
during a specific period of time
– Service rate: the average number of customers that can be processed
over the same period of time
– Best operating point is near 70 percent usually
• Optimal levels of utilization are context specific
– Low rates are appropriate when the degree of uncertainty (in demand)
is high and/or the stakes are high (e.g., emergency rooms, fire
departments)
– Higher rates are possible for predictable services or those without
extensive customer contact (e.g., commuter trains, postal sorting)
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Relationship Between the Rate of Service
Utilization and Service Quality
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Exhibit 5.6
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Break-Even Analysis
• Defined as standard approach to choosing among alternative processes or
equipment.
• Model seeks to determine the point in units produced where a company
will start making profit on the process.
• Model seeks to determine the point in units produced where total revenue
and total cost are equal.
Purchase cost of process or equipment
Breakeven Demand
Price per unit - Cost per unit
or
Total fixed costs of process or equipment
Unit price to customer - Variable cost per unit
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• The management of a pizza place would like to add a new
line of small pizza, which will require leasing a new
equipment for a monthly payment of $4,000. Variable costs
would be $4 per pizza, and pizzas would retail for $9 each.
1. How many pizzas must be sold per month in order to break
even?
2. What would the profit (loss) be if 1200 pizzas are made and
sold in a month?
3. How many pizzas must be sold to realize a profit of
$10,000 per month?
4. If demand is expected to be 700 pizzas per month, will this
be a profitable investment?
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[Link] = FC / (r – v) = 4000 / (9 – 4) = 800 pizzas
per month
[Link] revenue – total cost = 1200 x 9 – 1200 x 4
– 4000 = $2000 (i.e. a profit)
3.P = $10000 = Q(r – v) – FC;
Solving for Q will give us: Q = (10000 + 4000) /
(9 – 4) = 2800
[Link] less than 800 (i.e. QBEP) pizzas will
bring in a loss. Since 700 < 800 (QBEP), it is not a
profitable investment.
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Example 7.1: Break-Even Analysis
• Buy for $200
• Make on lathe for $75
• Make on machining center for $15
• Buy has no fixed costs
• Lathe has $80,000 fixed costs
• Machining center has $200,000 fixed costs
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Example 7.1: Total Cost for Each Option
• Purchase
Cost = $200 x Demand
• Produce Using Lathe
Cost = $80,000 + $75 x Demand
• Produce Using Machining Center
Cost = $200,000 + $15 x Demand
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Example 7.1: Costs Shown Graphically
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Example 7.1: Finding Points A and B
Point A
$ 80 , 000 $ 75 Demand $ 200 , 000 $ 15 Demand
$ 80 , 000 $ 60 Demand $ 200 , 000
$ 60 Demand $ 120 , 000
Demand $ 120 , 000 2 , 000
$ 60
Point B
$ 200 Demand $ 80 , 000 $ 75 Demand
$ 125 Demand $ 80 , 000
Demand $ 80 , 000 640
$ 125
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Which location should we go for?
• Community A • Community C
– FC/year = $150000 – FC/year = $500000
– VC/unit = $62 – VC/unit = $24
• Community B • Community D
– FC/year = $300000 – FC/year = $600000
– VC/unit = $38 – VC/unit = $30
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Using Decision Trees to Evaluate Capacity
Alternatives
• A decision tree is a schematic model of the sequence of steps in a
problem – including the conditions and consequences of each step
• Decision trees help analysts understand the problem and assist in
identifying the best solution
• Decision tree components include the following:
– Decision nodes – represented with squares
– Chance nodes – represented with circles
– Paths – links between nodes
• Work from the end of the tree backwards to the start of the tree
• Calculate expected values at each step
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Example 5.2: Decision Trees
• The owner of Hackers Computer Store is evaluating three options for
expansion over the next five years – expand at current site, expand to a
new site, do nothing
• The decision process includes the following assumptions and
conditions
– Strong growth has a 55% probability
– New site cost is $210,000
• Payoffs: strong growth = $195,000; weak growth = $115,000
– Expanding current site cost is $87,000 (in either year 1 or 2)
• Payoffs: strong growth = $190,000; weak growth = $100,000
– Do nothing
• Payoffs: strong growth = $170,000; weak growth = $105,000
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Calculate the value of each
alternative
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Diagram the Problem Chronologically
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Exhibit 5.3
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Calculate Value of Each Branch
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Exhibit 5.4
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Decision Tree Analysis with Net
Present Value Calculations
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Exhibit 5.5
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Group Project guidelines
• Pick any manufacturing or service operation of your
choice
– Describe the transformation process of the chosen
operation
– Estimate the operation’s capacity and analyse its capacity
management strategy
– Map the Process flow and ascertain the bottleneck
resource of the process
– Examine the fitment of the design of the facility layout with
the process characteristics
– Does the process have Inventory? How is inventory
managed?
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