Unit 2 Management of Conversion System Chapter 5: Capacity DesignLesson 16:- Capacity strategiesLearning ObjectivesAfter reading this lesson you will be able to understand Capacity cushion and its importance Various capacity strategiesToday we will discuss various strategic issues related to capacity. These are:Sizing capacity cushions,Timing and sizing expansion,Linking capacity andOther operating decisionsSo, let’s start with capacity cushions.The capacity cushion is the amount of reserve capacity that a firmmaintains to handle sudden increases in demand or temporary losses ofproduction capacity. It measures the amount by which the average utilization(in terms of effective capacity) falls below 100 percent. Specifically, Capacity cushion = 100% - Utilization rate (%)
The appropriate size of the cushion varies by industry. In the capital-intensive paper industry, where machines can cost hundreds of millions ofrupees each, cushions less than 10 percent are preferred. The less capital-intensive hotel industry breaks even with a 60 to 70 percent utilization (40 to30 percent cushion, and begins to suffer customer-service problems whencushion drops to 20 percent.The second issue of capacity is when to expand and by how much.There are two extreme strategies,i.e.the expansionist strategy,( which involves large, infrequent jumps in capacity,) andthe wait-and-see strategy,( which involves smaller, more frequent jumps.)Figure 5.7 illustrates these strategies.The timing and sizing of expansion are related. If demand is increasing andthe time between increments increases, the size of the increments must alsoincrease. The expansionist strategy, which stays ahead of demand,minimizes the chance of sales lost to insufficient capacity. The wait-and –see strategy lags behind demand, relying on short-term options such as:-use of overtime,temporary workers,subcontractors,stockouts, andpostponement of preventive maintenance to meet any shortfalls.Friends, what could be the possible benefits of the expansionist strategy?Anyone in the class?Well, let me elaborate.
Advantages of the expansionist strategyThere are some advantages of the expansionist strategy.Expansion may result in economies of scale and a faster rate of learning,thus helping a firm reduce its costs and compete on price. This strategymight increase the firm’s market share or act as a form of preemptivemarketing. The conservative wait-and-see strategy is to expand in smallerincrements, such as by renovating existing facilities rather than building newones. Because the wait-and-see strategy follows demand, it reduces the risksof over expansion based on overly optimistic demand forecasts, obsoletetechnology, or inaccurate assumptions regarding the competition.Now we will discuss the important issue of linking capacity with otherdecisions.When managers make decisions about location, resource flexibility, andinventory, they must consider the impact on capacity cushions. Capacitycushions buffer the organization against uncertainty, as do resourceflexibility, inventory, and longer customer lead times. If a system is wellbalanced and a change is made in some other decision area, the capacitycushion may need change to compensate. Following are some examples oflinkage of strategies and capacity decisions. Competitive priorities Faster deliveries for a process requires a larger capacity cushion to allow for quick response, if holding finished goods inventory is infeasible or uneconomical Quality management Paying proper attention to appropriate qualitative issues Capital intensity
Smaller capacity cushion Resource flexibility Larger capacity cushion to compensate for the operation overloads Inventory Larger capacity cushion to meet increased demands SchedulingA change to a more stable environment allows a smaller cushion becauseproducts or services can be scheduled with more assurance.A Systematic approach to capacity Decisions consists primarily of the fourmain steps. These are: Step 1: Estimate capacity requirementsThe long term capacity need is determined on the basis of forecasts ofdemand, productivity, competition, and technological changes that extendwell into the future. The demand forecast has to be converted to a numberthat can be compared directly with the capacity measure being used.Suppose that capacity is expressed as the number of available machines at anoperation. When just one product is being processed, the number ofmachines required, M, is Number of machines required = Pr oces sin g hours required for years demand Hours available from one machine per year, after deducting desired cushion DpM= N [1 − (c / 100)]Where D = number of units (customers) forecast per year
p = processing time (in hours per unit or customers) N = total number of hours per year during which the process operates C = desired capacity cushion If multiple products or services are involved, extra time is needed tochange over from one product or service to the next. Setup time is the timerequired to change a machine from making one product or service to makinganother. The total setup time is found by dividing the number of unitsforecast per year, D, by the number of units made in each lot, which givesthe number of setups per year, and then multiplying by the time per setup.For example, if the annual demand is 1200 units and the average lot size is100, there are 1200/100 = 12 setups per year. Accounting for bothprocessing and setup time when there are multiple products (services), wegetNumber of machines required =Pr oces sin gandsetuphoursrequiredforyear sdemand , summedoverallproducts Hoursavailablefromonemachineperyear , afterdeductingdesiredcushion [ Dp + ( D / Q) s ] product1 + [ Dp + ( D / Q) s ] product 2 + ..... + [ Dp + ( D / Q) s ] productnM= N [1 − (c / 100)]where Q = number of units in each lot s = setup time (in hours) per lotIt is better to round up the fractional part unless it is cost efficient to useshort-term options such as overtime or stockouts to cover any shortfalls.
Step 2: Identify Gaps Can you tell me what is a capacity gap? A capacity gap is any difference (positive or negative) betweenprojected demand and current capacity. Identifying gaps requires use of thecorrect capacity measure. Complications arise when multiple operations andseveral resource inputs are involved. (e.g. in 1970 when airline executivestates fly more seats to get more passengers many airlines responded bybuying more jumbo jets, but competitors flying smaller planes were moresuccessful. The correct measure of capacity was the number of departmentsrather than the number of seats.) I think, now is the time to consider an example. of this.Example 5.4A restaurant is experiencing a boom in business. The owner expects to servea total of 80,000 meals this year. Although the kitchen is operating at 100percent capacity, the dining room can handle a total of 1,05,000 dinners peryear. Forecasted demand for the next five years is as follows: Year 1: 90,000 meals Year 2: 1,00,000 meals Year 3: 1,10,000 meals Year 4: 1,20,000 meals Year 5: 1,30,000 mealsWhat are the capacity gaps in the restaurant’s kitchen and dining roomthrough year 5?Dear students, make an honest effort and solve it.Now, tally your answer with the solution given below.
Solution. The kitchen is currently the bottleneck at a capacity of 80,000meals per year. Based on the forecasted demand the capacity gap for thekitchen isYear 1: 90,000 – 80,000 = 10,000Year 2: 1,00,000 – 80,000 = 20,000Year 3: 1,10,000 – 80,000 = 30,000Year 4: 1,20,000 – 80,000 = 40,000Year 5: 1,30,000 – 80,000 = 30,000In year 3 and subsequently, there are capacity gaps for the dining roomYear 3: 1,10,000 – 1,05,000 = 5,000Year 4: 1,20,000 – 1,05,000 = 15,000Year 5: 1,30,000 – 1,05,000 = 25,000 Step 3: Develop alternatives The next step is to develop alternative plans to cope with projected gaps.One alternative is base case, which is do nothing and simply lose ordersfrom any demand that exceeds current capacity. Other alternatives arevarious timing and sizing options for adding new capacity, including theexpansionist and wait-and-see strategies. Step 4: Evaluate the alternatives In this final step, the manager evaluates each alternative bothquantitatively and qualitatively. What are Qualitative concerns?
Qualitative concerns are uncertainties about demand, competitive reaction,technological change, and cost estimates. “What if” analysis allows themanager to get an idea of each alternative’s implication before making afinal choice.And what about the Quantitative concerns?Quantitative concerns are estimates of the change in cash flows for eachalternative over the forecast time horizon compared to the base case. Cashflow is the difference between the flows of funds into and out of anorganization over a period of time, including revenues, costs, and changes inassets and liabilities.Let’s focus now on the Tools for capacity planningTools for capacity planningLong-term capacity planning requires demand forecasts for an extendedperiod of time. Forecast accuracy declines as the forecasting horizonlengthen. Tools that deal more formally with demand uncertainty andvariability are: waiting-line models, simulation, and decision trees.Waiting-line modelsWaiting-line models often are useful in capacity planning. Waiting linesgenerally develop in front of a ticket counter, a machine center, or a centralcomputer. The reason is that the arrival time between jobs or customersvaries and the processing time may vary from one customer to the next.Waiting-line models use probability distributions to provide estimates ofaverage customer delay time, average length of waiting lines, and utilization
of the work center. Managers can use this information to choose the mostcost-effective capacity, balancing customer service and the cost of addingcapacity.SimulationMore complex waiting-line problems can be analysed by simulation. It canidentify the process’s bottlenecks and appropriate capacity cushions, evenfor complex processes with random demand patterns with predictable surgesin demand during a typical day.Decision treesA decision tree can be particularly valuable for evaluating different capacityexpansion alternatives when demand is uncertain and sequential decisionsare involved. For example, the owner of a restaurant may expand therestaurant now, only to discover in year 4 that demand growth is muchhigher than forecasted. In that case, he needs to decide whether to expandfurther. In terms of construction costs and down time, expanding twice islikely to be much more expansive than building a large facility from theoutset. However, making a large expansion now when demand growth is lowmeans poor facility utilization.In the last part, we are now focusing our attention to the issue of Linkingcapacity and other decisions. Let’s see how it develops.Linking capacity and other decisions
Capacity decisions should be closely linked to strategies and processes throughout the organization. When managers make decisions about location, resource flexibility, and inventory, they must consider the impact on capacity cushions.Another crucial linkage is between capacity and location decisions. Ifcapacity is expanding suitable location for new facilities to identified. Ifcapacity is downsizing, it is needed to identify which locations to eliminate.A systematic approach to capacity decisionsThere are four main approaches given below: 1. Estimate future capacity requirements 2. Identify gaps by comparing requirements with available capacity 3. Develop alternative plans for filling the gaps 4. Evaluate each alternative, both qualitatively and quantitatively, and make the final choice.With that, we have come to the end of today’s discussions.Points to ponder