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- 1. Operations Management Supplement 7 – Capacity Planning PowerPoint presentation to accompany Heizer/Render Principles of Operations Management, 7e Operations Management, 9e© 2008 Prentice Hall, Inc. S7 – 1
- 2. Outline Capacity Design and Effective Capacity Capacity and Strategy Capacity Considerations Managing Demand Demand and Capacity Management in the Service Sector© 2008 Prentice Hall, Inc. S7 – 2
- 3. Outline – Continued Capacity Planning Break-Even Analysis Single-Product Case Multiproduct Case Applying Decision Trees to Capacity Decisions© 2008 Prentice Hall, Inc. S7 – 3
- 4. Outline – Continued Applying Investment Analysis to Strategy-Driven Investments Investment, Variable Cost, and Cash Flow Net Present Value© 2008 Prentice Hall, Inc. S7 – 4
- 5. Learning Objectives When you complete this supplement, you should be able to: 1. Define capacity 2. Determine design capacity, effective capacity, and utilization 3. Compute break-even analysis 4. Apply decision trees to capacity decisions 5. Compute net present value© 2008 Prentice Hall, Inc. S7 – 5
- 6. Capacity The throughput, or the number of units a facility can hold, receive, store, or produce in a period of time Determines fixed costs Determines if demand will be satisfied Three time horizons© 2008 Prentice Hall, Inc. S7 – 6
- 7. Planning Over a Time Horizon Long-range Add facilities planning Add long lead time equipment * Intermediate- Subcontract Add personnel range Add equipment Build or use inventory planning Add shifts Schedule jobs Short-range planning * Schedule personnel Allocate machinery Modify capacity Use capacity * Limited options exist Figure S7.1© 2008 Prentice Hall, Inc. S7 – 7
- 8. Design and Effective Capacity Design capacity is the maximum theoretical output of a system Normally expressed as a rate Effective capacity is the capacity a firm expects to achieve given current operating constraints Often lower than design capacity© 2008 Prentice Hall, Inc. S7 – 8
- 9. Utilization and Efficiency Utilization is the percent of design capacity achieved Utilization = Actual output/Design capacity Efficiency is the percent of effective capacity achieved Efficiency = Actual output/Effective capacity© 2008 Prentice Hall, Inc. S7 – 9
- 10. Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls© 2008 Prentice Hall, Inc. S7 – 10
- 11. Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls© 2008 Prentice Hall, Inc. S7 – 11
- 12. Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls Utilization = 148,000/201,600 = 73.4%© 2008 Prentice Hall, Inc. S7 – 12
- 13. Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls Utilization = 148,000/201,600 = 73.4%© 2008 Prentice Hall, Inc. S7 – 13
- 14. Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls Utilization = 148,000/201,600 = 73.4% Efficiency = 148,000/175,000 = 84.6%© 2008 Prentice Hall, Inc. S7 – 14
- 15. Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls Utilization = 148,000/201,600 = 73.4% Efficiency = 148,000/175,000 = 84.6%© 2008 Prentice Hall, Inc. S7 – 15
- 16. Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Efficiency = 84.6% Efficiency of new line = 75% Expected Output = (Effective Capacity)(Efficiency) = (175,000)(.75) = 131,250 rolls© 2008 Prentice Hall, Inc. S7 – 16
- 17. Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Efficiency = 84.6% Efficiency of new line = 75% Expected Output = (Effective Capacity)(Efficiency) = (175,000)(.75) = 131,250 rolls© 2008 Prentice Hall, Inc. S7 – 17
- 18. Capacity and Strategy Capacity decisions impact all 10 decisions of operations management as well as other functional areas of the organization Capacity decisions must be integrated into the organization’s mission and strategy© 2008 Prentice Hall, Inc. S7 – 18
- 19. Capacity Considerations Forecast demand accurately Understand the technology and capacity increments Find the optimum operating level (volume) Build for change© 2008 Prentice Hall, Inc. S7 – 19
- 20. Economies and Diseconomies of Scale (dollars per room per night) Average unit cost 25 - room 75 - room roadside motel 50 - room roadside motel roadside motel Economies Diseconomies of scale of scale 25 50 75 Number of Rooms Figure S7.2© 2008 Prentice Hall, Inc. S7 – 20
- 21. Build In Flexibility Percent of North American Vehicles Made on Flexible Assembly Lines 100% – 80% – 60% – 40% – Chrysler 20% – Toyota Nissan Honda Ford GM 0– Figure S7.3© 2008 Prentice Hall, Inc. S7 – 21
- 22. Managing Demand Demand exceeds capacity Curtail demand by raising prices, scheduling longer lead time Long term solution is to increase capacity Capacity exceeds demand Stimulate market Product changes Adjusting to seasonal demands Produce products with complementary demand patterns© 2008 Prentice Hall, Inc. S7 – 22
- 23. Complementary Demand Patterns 4,000 – Sales in units 3,000 – 2,000 – 1,000 – Jet ski engine sales JFMAMJJASONDJFMAMJJASONDJ Time (months) Figure S7.3© 2008 Prentice Hall, Inc. S7 – 23
- 24. Complementary Demand Patterns 4,000 – Sales in units 3,000 – Snowmobile motor sales 2,000 – 1,000 – Jet ski engine sales JFMAMJJASONDJFMAMJJASONDJ Time (months) Figure S7.3© 2008 Prentice Hall, Inc. S7 – 24
- 25. Complementary Demand Patterns Combining both demand patterns reduces the variation 4,000 – Sales in units 3,000 – Snowmobile motor sales 2,000 – 1,000 – Jet ski engine sales JFMAMJJASONDJFMAMJJASONDJ Time (months) Figure S7.3© 2008 Prentice Hall, Inc. S7 – 25
- 26. Tactics for Matching Capacity to Demand 1. Making staffing changes 2. Adjusting equipment Purchasing additional machinery Selling or leasing out existing equipment 3. Improving processes to increase throughput 4. Redesigning products to facilitate more throughput 5. Adding process flexibility to meet changing product preferences 6. Closing facilities© 2008 Prentice Hall, Inc. S7 – 26
- 27. Demand and Capacity Management in the Service Sector Demand management Appointment, reservations, FCFS rule Capacity management Full time, temporary, part-time staff© 2008 Prentice Hall, Inc. S7 – 27
- 28. Approaches to Capacity Expansion (a) Leading demand with (b) Leading demand with incremental expansion one-step expansion New New capacity capacity Demand Demand Expected Expected demand demand (c) Capacity lags demand with (d) Attempts to have an average incremental expansion capacity with incremental New expansion capacity New Demand Expected Demand capacity Expected demand demand Figure S7.5© 2008 Prentice Hall, Inc. S7 – 28
- 29. Approaches to Capacity Expansion (a) Leading demand with incremental expansion New capacity Demand Expected demand 1 2 3 Time (years) Figure S7.5© 2008 Prentice Hall, Inc. S7 – 29
- 30. Approaches to Capacity Expansion (b) Leading demand with one-step expansion New capacity Expected Demand demand 1 2 3 Time (years) Figure S7.5© 2008 Prentice Hall, Inc. S7 – 30
- 31. Approaches to Capacity Expansion (c) Capacity lags demand with incremental expansion New capacity Expected Demand demand 1 2 3 Time (years) Figure S7.5© 2008 Prentice Hall, Inc. S7 – 31
- 32. Approaches to Capacity Expansion (d) Attempts to have an average capacity with incremental expansion New capacity Expected Demand demand 1 2 3 Time (years) Figure S7.5© 2008 Prentice Hall, Inc. S7 – 32
- 33. Break-Even Analysis Technique for evaluating process and equipment alternatives Objective is to find the point in dollars and units at which cost equals revenue Requires estimation of fixed costs, variable costs, and revenue© 2008 Prentice Hall, Inc. S7 – 33
- 34. Break-Even Analysis Fixed costs are costs that continue even if no units are produced Depreciation, taxes, debt, mortgage payments Variable costs are costs that vary with the volume of units produced Labor, materials, portion of utilities Contribution is the difference between selling price and variable cost© 2008 Prentice Hall, Inc. S7 – 34
- 35. Break-Even Analysis Assumptions Costs and revenue are linear functions Generally not the case in the real world We actually know these costs Very difficult to accomplish There is no time value of money© 2008 Prentice Hall, Inc. S7 – 35
- 36. Break-Even Analysis – Total revenue line 900 – r 800 – Break-even point rrido Total cost line o 700 – Total cost = Total revenue f i tc P ro Cost in dollars 600 – 500 – Variable cost 400 – 300 – s 200 – os idor L r r co 100 – Fixed cost | | | | | | | | | | | | – 0 100 200 300 400 500 600 700 800 900 1000 1100 Figure S7.6 Volume (units per period)© 2008 Prentice Hall, Inc. S7 – 36
- 37. Break-Even Analysis BEPx = break- x= number of even point in units units produced BEP$ = break- TR = total even point in dollars revenue = Px P = price F= fixed costs per unit (after all V = discounts) variable cost per unit TC = total Break-even point costs = F + Vx occurs when TR = TC F or BEPx = P-V Px = F + Vx© 2008 Prentice Hall, Inc. S7 – 37
- 38. Break-Even Analysis BEPx = break- x= number of even point in units units produced BEP$ = break- TR = total even point in dollars revenue = Px P = price F= fixed costs per unit (after all V = discounts) variable cost per unit TC = total BEP$ = BEPx P costs = F + Vx F Profit = TR - TC = P-V P = Px - (F + Vx) F = (P - V)/P = Px - F - Vx F = (P - V)x - F = 1 - V/P© 2008 Prentice Hall, Inc. S7 – 38
- 39. Break-Even Example Fixed costs = $10,000 Material = $.75/unit Direct labor = $1.50/unit Selling price = $4.00 per unit F $10,000 BEP$ = = 1 - (V/P) 1 - [(1.50 + .75)/(4.00)]© 2008 Prentice Hall, Inc. S7 – 39
- 40. Break-Even Example Fixed costs = $10,000 Material = $.75/unit Direct labor = $1.50/unit Selling price = $4.00 per unit F $10,000 BEP$ = = 1 - (V/P) 1 - [(1.50 + .75)/(4.00)] $10,000 = = $22,857.14 .4375 F $10,000 BEPx = = = 5,714 P-V 4.00 - (1.50 + .75)© 2008 Prentice Hall, Inc. S7 – 40
- 41. Break-Even Example 50,000 – 40,000 – Revenue Break-even 30,000 – point Total Dollars costs 20,000 – 10,000 – Fixed costs – | | | | | | 0 2,000 4,000 6,000 8,000 10,000 Units© 2008 Prentice Hall, Inc. S7 – 41
- 42. Break-Even Example Multiproduct Case F BEP$ = ∑ 1- Vi Pi x (Wi) where V = variable cost per unit P = price per unit F = fixed costs W = percent each product is of total dollar sales i = each product© 2008 Prentice Hall, Inc. S7 – 42
- 43. Multiproduct Example Fixed costs = $3,500 per month Annual Forecasted Item Price Cost Sales Units Sandwich $2.95 $1.25 7,000 Soft drink .80 .30 7,000 Baked potato 1.55 .47 5,000 Tea .75 .25 5,000 Salad bar 2.85 1.00 3,000© 2008 Prentice Hall, Inc. S7 – 43
- 44. Multiproduct Example Fixed costs = $3,500 per month Annual Forecasted Item Price Cost Sales Units Sandwich $2.95 $1.25 7,000 Soft drink .80 .30 7,000 Baked potato 1.55 .47 Annual 5,000 Weighted Tea Selling Variable .75 .25Forecasted 5,000 Contribution % of Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7) Salad bar 2.85 1.00 3,000 Sandwich $2.95 $1.25 .42 .58 $20,650 .446 .259 Soft drink .80 .30 .38 .62 5,600 .121 .075 Baked 1.55 .47 .30 .70 7,750 .167 .117 potato Tea .75 .25 .33 .67 3,750 .081 .054 Salad bar 2.85 1.00 .35 .65 8,550 .185 .120 $46,300 1.000 .625© 2008 Prentice Hall, Inc. S7 – 44
- 45. Multiproduct Example BEP$ = F ∑ 1 - V x (W ) P i i i Fixed costs = $3,500 per month $3,500 x Forecasted Annual 12 = $67,200 = Item Price Cost .625 Units Sales Sandwich $2.95 $1.25 7,000 Soft drink .80 Daily .30 $67,200 7,000 Baked potato 1.55 sales 312 days = $215.38 = .47 Annual 5,000 Weighted Tea Selling Variable .75 .25Forecasted 5,000 Contribution % of Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7) Salad bar 2.85 1.00 x $215.38 .446 3,000 Sandwich $2.95 $1.25 .42 .58 $20,650 = 32.6 ≈ .259 .446 33 $2.95 sandwiches Soft drink .80 .30 .38 .62 5,600 .121 .075 Baked 1.55 .47 .30 .70 7,750 .167 per day .117 potato Tea .75 .25 .33 .67 3,750 .081 .054 Salad bar 2.85 1.00 .35 .65 8,550 .185 .120 $46,300 1.000 .625© 2008 Prentice Hall, Inc. S7 – 45
- 46. Decision Trees and Capacity Decision Market favorable (.4) $100,000 Market unfavorable (.6) t -$90,000 plan e Larg Market favorable (.4) $60,000 Medium plant Sm Market unfavorable (.6) all -$10,000 pla nt Do Market favorable (.4) no $40,000 th in g Market unfavorable (.6) -$5,000 $0© 2008 Prentice Hall, Inc. S7 – 46
- 47. Decision Trees and Capacity Decision Market favorable (.4) $100,000 Market unfavorable (.6) t -$90,000 plan e Larg Market favorable (.4) $60,000 Medium plant Large Plant Sm all Market unfavorable (.6) -$10,000 pla nt EMV = (.4)($100,000) Do Market favorable (.4) no $40,000 + (.6)(-$90,000) th in g Market unfavorable (.6) EMV = -$14,000 -$5,000 $0© 2008 Prentice Hall, Inc. S7 – 47
- 48. Decision Trees and Capacity Decision -$14,000 Market favorable (.4) $100,000 Market unfavorable (.6) t -$90,000 plan e Larg $18,000 Market favorable (.4) $60,000 Medium plant Sm Market unfavorable (.6) all -$10,000 pla nt $13,000 Do Market favorable (.4) no $40,000 th in g Market unfavorable (.6) -$5,000 $0© 2008 Prentice Hall, Inc. S7 – 48
- 49. Strategy-Driven Investment Operations may be responsible for return-on-investment (ROI) Analyzing capacity alternatives should include capital investment, variable cost, cash flows, and net present value© 2008 Prentice Hall, Inc. S7 – 49
- 50. Net Present Value (NPV) F P= (1 + i)N where F = future value P = present value i = interest rate N = number of years© 2008 Prentice Hall, Inc. S7 – 50
- 51. Net Present Value (NPV) F P= (1 + i)N While this works where F = future value fine, it is = present value P cumbersome for larger values iof N = interest rate N = number of years© 2008 Prentice Hall, Inc. S7 – 51
- 52. NPV Using Factors F P= = FX (1 + i) N where X= a factor from Table S7.1 defined as = 1/ (1 + i)N and F = future value Year 5% 6% 7% … 10% Portion of 1 .952 .943 .935 .909 Table S7.1 2 .907 .890 .873 .826 3 .864 .840 .816 .751 4 .823 .792 .763 .683 5 .784 .747 .713 .621© 2008 Prentice Hall, Inc. S7 – 52
- 53. Present Value of an Annuity An annuity is an investment which generates uniform equal payments S = RX where X = factor from Table S7.2 S = present value of a series of uniform annual receipts R = receipts that are received every year of the life of the investment© 2008 Prentice Hall, Inc. S7 – 53
- 54. Present Value of an Annuity Portion of Table S7.2 Year 5% 6% 7% … 10% 1 .952 .943 .935 .909 2 1.859 1.833 1.808 1.736 3 2.723 2.676 2.624 2.487 4 4.329 3.465 3.387 3.170 5 5.076 4.212 4.100 3.791© 2008 Prentice Hall, Inc. S7 – 54
- 55. Present Value of an Annuity $7,000 in receipts per for 5 years Interest rate = 6% From Table S7.2 X = 4.212 S = RX S = $7,000(4.212) = $29,484© 2008 Prentice Hall, Inc. S7 – 55
- 56. Present Value With Different Future Receipts Investment A’s Investment B’s Present Value Year Cash Flow Cash Flow Factor at 8% $10,000 $9,000 1 .926 9,000 9,000 2 .857 8,000 9,000 3 .794 7,000 9,000 4 .735© 2008 Prentice Hall, Inc. S7 – 56
- 57. Present Value With Different Future Receipts Investment A’s Investment B’s Year Present Values Present Values 1 $9,260 = (.926)($10,000) $8,334 = (.926)($9,000) 2 7,713 = (.857)($9,000) 7,713 = (.857)($9,000) 3 6,352 = (.794)($8,000) 7,146 = (.794)($9,000) 4 5,145 = (.735)($7,000) 6,615 = (.735)($9,000) Totals $28,470 $29,808 Minus initial investment -25,000 -26,000 Net present value $3,470 $3,808© 2008 Prentice Hall, Inc. S7 – 57

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