Capacity Planning – Outline Estimate capacity required Capacity and scale Make-or-buy analysis Sizing and timing

Estimate capacity required

Capacity and scale

Make-or-buy analysis

Sizing and timing

Fundamentals of Capacity Planning Capacity (or capacity rate): the maximum rate of output of a resource (a process or a system) Capacity decisions Make or buy Sizing and timing of capacity expansion

Capacity (or capacity rate): the maximum rate of output of a resource (a process or a system)

Capacity decisions

Make or buy

Sizing and timing of capacity expansion

A Systematic Approach Estimate future capacity requirements Identify gaps by comparing requirements with available capacity Develop alternative plans for reducing the gaps Evaluate each alternative, and make a final choice

Estimate future capacity requirements

Identify gaps by comparing requirements with available capacity

Develop alternative plans for reducing the gaps

Evaluate each alternative, and make a final choice

Determine Capacity Required To meet future demand over an appropriate planning horizon Utilization = Capacity cushions are the amount of reserved capacity a process uses to handle sudden changes Capacity cushion = 100% – Utilization rate (%) Average output rate Capacity rate  100%

To meet future demand over an appropriate planning horizon

Utilization =

Capacity cushions are the amount of reserved capacity a process uses to handle sudden changes

Capacity cushion = 100% – Utilization rate (%)

Requirement for a resource over a period of one year, M D = demand forecast for the year p = processing time (in hours) per unit of demand N = total # operation hours per year C = capacity cushion (expressed as a percent) Capacity Required – Single Product/Service Capacity requirement = M = D p N [1 – ( C /100)] Total hours required for a year’s demand Total hours available from a resource per year, excluding capacity cushion

Requirement for a resource over a period of one year, M

D = demand forecast for the year

p = processing time (in hours) per unit of demand

N = total # operation hours per year

C = capacity cushion (expressed as a percent)

Setup times may be required between production lots Multiple Products/Services where Q = number of units in each lot s = setup time (in hours) per lot M = [ D p + ( D / Q )* s ] product 1 + [ D p + ( D / Q )* s ] product 2 + … + [ D p + ( D / Q )* s ] product n N [1 – ( C /100)] Capacity requirement = Processing and setup hours required for year’s demand, summed over all services or products Hours available from a single resource per year, excluding capacity cushion

Setup times may be required between production lots

Example: Estimating Capacity Required A copy center in an office building prepares bound reports for two clients. The center makes multiple copies (the lot size) of each report. The processing time to run, collate, and bind each copy depends on, among other factors, the number of pages. The center operates 250 days per year, with one 8-hour shift. Management believes that a capacity cushion of 15 percent (beyond the allowance built into time standards) is best. It currently has three copy machines. Based on the following table of information, determine how many machines are needed at the copy center. Item Client X Client Y Annual demand forecast ( D ) 2,000 6,000 Standard processing time ( p ) 0.5 0.7 Average lot size ( Q ) 20 30 Standard setup time ( s , in hours) 0.25 0.40

A copy center in an office building prepares bound reports for two clients. The center makes multiple copies (the lot size) of each report. The processing time to run, collate, and bind each copy depends on, among other factors, the number of pages. The center operates 250 days per year, with one 8-hour shift. Management believes that a capacity cushion of 15 percent (beyond the allowance built into time standards) is best. It currently has three copy machines. Based on the following table of information, determine how many machines are needed at the copy center.

Make or Buy If a given increment of capacity must be added “ make” – add in-house production capacity “ buy” – outsource production Factors that affect make-buy decision Costs Quality Intellectual property, core competencies, strategic direction Uncertainty in financial markets, Supply chain (risk of disruption, coordination effort, etc.) Flexibility (quantity, technology) Market perception (labeling v. production) Union considerations

If a given increment of capacity must be added

“ make” – add in-house production capacity

“ buy” – outsource production

Factors that affect make-buy decision

Costs

Quality

Intellectual property, core competencies, strategic direction

Uncertainty in financial markets,

Supply chain (risk of disruption, coordination effort, etc.)

Flexibility (quantity, technology)

Market perception (labeling v. production)

Union considerations

Break-even Analysis To find the break-even quantity, Q , at which the total “make” cost equals the total “buy” cost c b = variable cost (per unit) of the buy option c m = variable cost (per unit) of the make option F = fixed cost of capacity expansion Cost Number of units, x F 0 Cost to make = F + c m x Cost to buy = c b x Q

To find the break-even quantity, Q , at which the total “make” cost equals the total “buy” cost

c b = variable cost (per unit) of the buy option

c m = variable cost (per unit) of the make option

F = fixed cost of capacity expansion

(cont’d) The break-even quantity is If capacity required < Q , then “buy” If capacity require > Q , then “make”

The break-even quantity is

If capacity required < Q , then “buy”

If capacity require > Q , then “make”

Exercise: Laptop Computer Production A manufacturer is planning to introduce a new laptop computer. The manufacturer has two options: (i) upgrading an existing capacity and produce in-house (MAKE), and (ii) outsourcing to a supplier (BUY). The costs of the two options are MAKE: $1.2M for upgrading the capacity; $400 per unit for production BUY: the cost per computer (including shipping) will be $500. What is the minimum demand, Q 1 , that will justify production in-house at unit price $500? Now, suppose the manufacturer negotiates a price of $450 per unit supplied by the supplier, but with a promise of buying 25,000 or more What’s the manufacturer’s break-even Q 2 if the manufacturer were not constrained by this promise? Under this promise, will the manufacturer make or buy if the estimate of the demand is 23,000?

A manufacturer is planning to introduce a new laptop computer. The manufacturer has two options: (i) upgrading an existing capacity and produce in-house (MAKE), and (ii) outsourcing to a supplier (BUY). The costs of the two options are

MAKE: $1.2M for upgrading the capacity; $400 per unit for production

BUY: the cost per computer (including shipping) will be $500.

What is the minimum demand, Q 1 , that will justify production in-house at unit price $500?

Now, suppose the manufacturer negotiates a price of $450 per unit supplied by the supplier, but with a promise of buying 25,000 or more

What’s the manufacturer’s break-even Q 2 if the manufacturer were not constrained by this promise? Under this promise, will the manufacturer make or buy if the estimate of the demand is 23,000?

Capacity and Scale Economies of scale Spreading fixed costs Reducing construction costs Cutting costs of purchased materials Finding process advantages Diseconomies of scale Complexity Loss of focus Inefficiencies

Economies of scale

Spreading fixed costs

Reducing construction costs

Cutting costs of purchased materials

Finding process advantages

Diseconomies of scale

Complexity

Loss of focus

Inefficiencies

Example: Hospital Capacity Alternatives 250-bed hospital 500-bed hospital 750-bed hospital Output rate (patients per week) Average unit cost (dollars per patient) Economies of scale Diseconomies of scale

Capacity Timing and Sizing Wait-and-see Strategy Planned use of short-term options Time Capacity Time between increments Capacity increment Forecast of capacity required

Wait-and-see Strategy

(cont’d) Timing and Sizing Expansionist Strategies Planned unused capacity Time Capacity Forecast of capacity required Time between increments Capacity increment

Expansionist Strategies