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Operations Management - Chapter 5.pdf

This document discusses strategic capacity planning. It defines key capacity planning concepts like capacity, effective capacity, and optimal operating level. It outlines the steps in capacity planning which include estimating future capacity needs, evaluating existing capacity, identifying alternatives, and selecting the best alternative. Factors that determine effective capacity and strategies for managing capacity like leading, following, and tracking strategies are also discussed. The document emphasizes the importance of capacity planning for matching supply to demand.

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Strategic Capacity Planning for Products and Services Chapter 5 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
⚫ Capacity ⚫ The upper limit or ceiling on the load that an operating unit can handle ⚫ Capacity needs include ⚫ Equipment ⚫ Space ⚫ Employee skills Capacity Planning 5-2
⚫ Goal ⚫ To achieve a match between the long-term supply capabilities of an organization and the predicted level of long-term demand ⚫ Overcapacity🡪 operating costs that are too high ⚫ Undercapacity🡪 strained resources and possible loss of customers Strategic Capacity Planning 5-3
⚫ Key Questions: ⚫ What kind of capacity is needed? ⚫ How much is needed to match demand? ⚫ When is it needed? ⚫ Related Questions: ⚫ How much will it cost? ⚫ What are the potential benefits and risks? ⚫ Are there sustainability issues? ⚫ Should capacity be changed all at once, or through several smaller changes ⚫ Can the supply chain handle the necessary changes? Capacity Planning Questions 5-4
⚫ Capacity decisions 1. impact the ability of the organization to meet future demands 2. affect operating costs 3. are a major determinant of initial cost 4. often involve long-term commitment of resources 5. can affect competitiveness 6. affect the ease of management 7. have become more important and complex due to globalization 8. need to be planned for in advance due to their consumption of financial and other resources Capacity Decisions Are Strategic 5-5
Capacity Design capacity ⚫ Maximum output rate or service capacity an operation, process, or facility is designed for Effective capacity ⚫ Design capacity minus allowances such as personal time, maintenance, and scrap Actual output ⚫ Rate of output actually achieved--cannot exceed effective capacity. 5-6
Defining and Measuring Capacity ⚫ Measure capacity in units that do not require updating ⚫ Why is measuring capacity in dollars problematic? ⚫ Two useful definitions of capacity ⚫ Design capacity ⚫ The maximum output rate or service capacity an operation, process, or facility is designed for ⚫ Effective capacity ⚫ Design capacity minus allowances such as personal time and maintenance 5-7
⚫ Actual output ⚫ The rate of output actually achieved ⚫ It cannot exceed effective capacity ⚫ Efficiency ⚫ Utilization Measured as percentages Measuring System Effectiveness 5-8
Example– Efficiency and Utilization ⚫ Design Capacity = 50 trucks per day ⚫ Effective Capacity = 40 trucks per day ⚫ Actual Output = 36 trucks per day 5-9
Determinants of Effective Capacity ⚫ Facilities ⚫ Product and service factors ⚫ Process factors ⚫ Human factors ⚫ Policy factors ⚫ Operational factors ⚫ Supply chain factors ⚫ External factors 5-10
Strategy Formulation ⚫ Strategies are typically based on assumptions and predictions about: ⚫ Long-term demand patterns ⚫ Technological change ⚫ Competitor behavior 5-11
Capacity Cushion ⚫ Capacity Cushion ⚫ Extra capacity used to offset demand uncertainty ⚫ Capacity cushion = 100% - Utilization ⚫ Capacity cushion strategy ⚫ Organizations that have greater demand uncertainty typically have greater capacity cushion ⚫ Organizations that have standard products and services generally have greater capacity cushion 5-12
Steps in Capacity Planning 1. Estimate future capacity requirements 2. Evaluate existing capacity and facilities; identify gaps 3. Identify alternatives for meeting requirements 4. Conduct financial analyses 5. Assess key qualitative issues 6. Select the best alternative for the long term 7. Implement alternative chosen 8. Monitor results 5-13
How would you select between alternatives? Example: Getting a line of credit ⚫ Interest rate on the revolver (including monitoring fees, etc.) ⚫ Up Front fees (commitment fees, closing fees, audit fee, etc.) ⚫ Size of the line offered ⚫ Expected Covenant Restrictions ⚫ Advance Rate on Inventory and AR ⚫ Unused line fee ⚫ Default Rate ⚫ Perceived “friendliness” of lender
Rank the decision criteria as to importance to the situation at hand Decision Factor Weight (1-10) Interest Rate on Revolver 8 Up Front Fees 3 Size of Line 7 Covenant Restrictions 7 Advance Rate 5 Unused Line Fee 3 Default Rate 5 Friendliness of Lender 7
Rank each lender as to how they compare in each category. Decision Factor Weight (1-10) Lender 1 Lender 2 Lender 3 Lender 4 Interest Rate on Revolver 8 1 3 2 4 Up Front Fees 3 2 1 3 4 Size of Line 7 3 2 1 4 Covenant Restrictions 7 4 3 2 1 Advance Rate 5 1 2 2 1 Unused Line Fee 3 2 1 1 2 Default Rate 5 2 1 2 1 Friendliness of Lender 7 1 2 3 4
Lender 1 Lender 2 Lender 3 Lender 4 Decision Factor Weight Rank Score Rank Score Rank Score Rank Score Interest Rate on Revolver 8 4 32 2 16 3 24 1 8 Up Front Fees 3 2 6 4 12 3 9 1 3 Size of Line 7 1 7 3 21 4 28 1 7 Covenant Restrictions 7 1 7 2 14 3 21 4 28 Advance Rate 5 4 20 3 15 3 15 4 20 Unused Line Fee 3 3 9 4 12 4 12 3 9 Default Rate 5 2 10 2 10 3 15 4 20 Friendliness of Lender 7 4 28 3 21 2 14 1 7 Total Score 119 121 138 102
Criterion Weight Alternative A Alternative B Alternative C Financial ROI 15% 2 4 10 Payback 10% 3 5 10 NPV 15% 2 4 10 Organizational Alignment with strategic objectives 10% 3 5 8 Likelihood of achieving project’s MOV 10% 2 6 9 Project Availability of skilled team members 5% 5 5 4 Maintainability 5% 4 6 7 Time to develop 5% 5 7 6 Risk 5% 3 5 5 External Customer satisfaction 10% 2 4 9 Increased market share 10% 2 5 8 Total Score 100% 2.65 4.85 8.50 Notes: Risk scores have a reverse scale – i.e., higher scores for risk imply lower levels of risk
Competitive Profile Matrix Company One Company Two Company Three Critical Success Factors Weight Rating Score Rating Score Rating Score Advertising 0.20 1 0.20 4 0.80 3 0.60 Product Quality 0.10 4 0.40 3 0.30 2 0.20 Price Competitiveness 0.10 3 0.30 2 0.20 4 0.40 Management 0.10 4 0.40 3 0.30 3 0.30 Financial Position 0.15 4 0.60 2 0.30 3 0.45 Customer Loyalty 0.10 4 0.40 3 0.30 2 0.20 Global Expansion 0.20 4 0.80 1 0.20 2 0.40 Market Share 0.05 1 0.05 4 0.20 3 0.15 Total 1.00 3.15 2.60 2.70
Forecasting Capacity Requirements ⚫ Long-term considerations relate to overall level of capacity requirements ⚫ Require forecasting demand over a time horizon and converting those needs into capacity requirements ⚫ Short-term considerations relate to probable variations in capacity requirements ⚫ Less concerned with cycles and trends than with seasonal variations and other variations from average 5-24
⚫ Calculating processing requirements requires reasonably accurate demand forecasts, standard processing times, and available work time Calculating Processing Requirements 5-25
Service Capacity Planning ⚫ Service capacity planning can present a number of challenges related to: ⚫ The need to be near customers ⚫ Convenience ⚫ The inability to store services ⚫ Cannot store services for consumption later ⚫ The degree of demand volatility ⚫ Volume and timing of demand ⚫ Time required to service individual customers 5-26
Demand Management Strategies ⚫ Strategies used to offset capacity limitations and that are intended to achieve a closer match between supply and demand ⚫ Pricing ⚫ Promotions ⚫ Discounts ⚫ Other tactics to shift demand from peak periods into slow periods 5-27
In-House or Outsource? ⚫ Once capacity requirements are determined, the organization must decide whether to produce a good or service itself or outsource ⚫ Factors to consider: ⚫ Available capacity ⚫ Expertise ⚫ Quality considerations ⚫ The nature of demand ⚫ Cost ⚫ Risks 5-28
Developing Capacity Alternatives ⚫ Things that can be done to enhance capacity management: ⚫ Design flexibility into systems ⚫ Take stage of life cycle into account ⚫ Take a “big-picture” approach to capacity changes ⚫ Prepare to deal with capacity “chunks” ⚫ Attempt to smooth capacity requirements ⚫ Identify the optimal operating level ⚫ Choose a strategy if expansion is involved 5-29
Capacity Strategies ⚫ Leading ⚫ Build capacity in anticipation of future demand increases ⚫ Following ⚫ Build capacity when demand exceeds current capacity ⚫ Tracking ⚫ Similar to the following strategy, but adds capacity in relatively small increments to keep pace with increasing demand 5-30
Bottleneck Operation ⚫ An operation in a sequence of operations whose capacity is lower than that of the other operations 5-31
Optimal Operating Level Optimal Output Rate 5-32
Economies and Diseconomies of Scale ⚫ Economies of Scale ⚫ If output rate is less than the optimal level, increasing the output rate results in decreasing average per unit costs ⚫ Diseconomies of Scale ⚫ If the output rate is more than the optimal level, increasing the output rate results in increasing average per unit costs 5-33
Economies of Scale ⚫ Economies of Scale ⚫ If output rate is less than the optimal level, increasing the output rate results in decreasing average per unit costs ⚫ Reasons for economies of scale: ⚫ Fixed costs are spread over a larger number of units ⚫ Construction costs increase at a decreasing rate as facility size increases ⚫ Processing costs decrease due to standardization 5-34
Diseconomies of Scale ⚫ Diseconomies of Scale ⚫ If the output rate is more than the optimal level, increasing the output rate results in increasing average per unit costs ⚫ Reasons for diseconomies of scale ⚫ Distribution costs increase due to traffic congestion and shipping from a centralized facility rather than multiple smaller facilities ⚫ Complexity increases costs ⚫ Inflexibility can be an issue ⚫ Additional levels of bureaucracy 5-35
Facility Size and Optimal Operating Level Minimum cost & optimal operating rate are functions of size of production unit. 5-36
Constraint Management ⚫ Constraint ⚫ Something that limits the performance of a process or system in achieving its goals ⚫ Categories ⚫ Market ⚫ Resource ⚫ Material ⚫ Financial ⚫ Knowledge or competency ⚫ Policy 5-37
1. Identify the most pressing constraint 2. Change the operation to achieve maximum benefit, given the constraint 3. Make sure other portions of the process are supportive of the constraint 4. Explore and evaluate ways to overcome the constraint 5. Repeat the process until the constraint levels are at acceptable levels Resolving Constraint Issues 5-38
Evaluating Alternatives ⚫ Alternatives should be evaluated from varying perspectives ⚫ Economic ⚫ Is it economically feasible? ⚫ How much will it cost? ⚫ How soon can we have it? ⚫ What will operating and maintenance costs be? ⚫ What will its useful life be? ⚫ Will it be compatible with present personnel and present operations? ⚫ Non-economic ⚫ Public opinion 5-39
Evaluating Alternatives ⚫ Techniques for Evaluating Alternatives ⚫ Cost-volume analysis ⚫ Financial analysis ⚫ Decision theory ⚫ Waiting-line analysis ⚫ Simulation 5-40
⚫ Cost-volume analysis ⚫ Focuses on the relationship between cost, revenue, and volume of output ⚫ Fixed Costs (FC) ⚫ tend to remain constant regardless of output volume ⚫ Variable Costs (VC) ⚫ vary directly with volume of output ⚫ VC = Quantity(Q) x variable cost per unit (v) ⚫ Total Cost ⚫ TC = FC + VC ⚫ Total Revenue (TR) ⚫ TR = revenue per unit (R) x Q Cost-Volume Analysis 5-41
⚫ BEP ⚫ The volume of output at which total cost and total revenue are equal ⚫ Profit (P) = TR – TC = R x Q – (FC +v x Q) = Q(R – v) – FC Break-Even Point (BEP) 5-42
Cost-Volume Relationships 5-43
Cost-Volume Relationships ⚫ Capacity alternatives may involve step costs, which are costs that increase stepwise as potential volume increases. ⚫ The implication of such a situation is the possible occurrence of multiple break-even quantities. 5-44
Cost-Volume Analysis Assumptions ⚫ Cost-volume analysis is a viable tool for comparing capacity alternatives if certain assumptions are satisfied ⚫ One product is involved ⚫ Everything produced can be sold ⚫ The variable cost per unit is the same regardless of volume ⚫ Fixed costs do not change with volume changes, or they are step changes ⚫ The revenue per unit is the same regardless of volume ⚫ Revenue per unit exceeds variable cost per unit 5-45
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 flow of an investment proposal 5-46
Operations Strategy ⚫ Capacity planning impacts all areas of the organization ⚫ It determines the conditions under which operations will have to function ⚫ Flexibility allows an organization to be agile ⚫ It reduces the organization’s dependence on forecast accuracy and reliability ⚫ Many organizations utilize capacity cushions to achieve flexibility ⚫ Bottleneck management is one way by which organizations can enhance their effective capacities ⚫ Capacity expansion strategies are important organizational considerations ⚫ Expand-early strategy ⚫ Wait-and-see strategy ⚫ Capacity contraction is sometimes necessary ⚫ Capacity disposal strategies become important under these conditions 5-47
Decision Theory Supplement 5 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Decision Theory ⚫ A general approach to decision making that is suitable to a wide range of operations management decisions ⚫ Capacity planning ⚫ Product and service design ⚫ Equipment selection ⚫ Location planning 5S-49
Characteristics of Suitable Problems ⚫ Characteristics of decisions that are suitable for using decision theory ⚫ A set of possible future conditions that will have a bearing on the results of the decision ⚫ A list of alternatives from which to choose ⚫ A known payoff for each alternative under each possible future condition 5S-50
Process for Using Decision Theory 1. Identify the possible future states of nature 2. Develop a list of possible alternatives 3. Estimate the payoff for each alternative for each possible future state of nature 4. If possible, estimate the likelihood of each possible future state of nature 5. Evaluate alternatives according to some decision criterion and select the best alternative 5S-51
Payoff Table ⚫ A table showing the expected payoffs for each alternative in every possible state of nature Possible Future Demand Alternatives Low Moderate High Small facility $10 $10 $10 Medium facility 7 12 12 Large Facility (4) 2 16 • A decision is being made concerning which size facility should be constructed • The present value (in millions) for each alternative under each state of nature is expressed in the body of the above payoff table 5S-52
Causes of Poor Decisions ⚫ Decisions occasionally turn out poorly due to unforeseeable circumstances; however, this is not the norm. ⚫ More frequently poor decisions are the result of a combination of ⚫ Mistakes in the decision process ⚫ Bounded rationality ⚫ Suboptimization 5S-53
Decision Process ⚫ Steps: 1. Identify the problem 2. Specify objectives and criteria for a solution 3. Develop suitable alternatives 4. Analyze and compare alternatives 5. Select the best alternative 6. Implement the solution 7. Monitor to see that the desired result is achieved ⚫ Errors ⚫ Failure to recognize the importance of each step ⚫ Skipping a step ⚫ Failure to complete a step before jumping to the next step ⚫ Failure to admit mistakes ⚫ Inability to make a decision 5S-54
Bounded Rationality & Suboptimization ⚫ Bounded rationality ⚫ The limitations on decision making caused by costs, human abilities, time, technology, and availability of information ⚫ Suboptimization ⚫ The results of different departments each attempting to reach a solution that is optimum for that department 5S-55
Decision Environments ⚫ There are three general environment categories: ⚫ Certainty ⚫ Environment in which relevant parameters have known values ⚫ Risk ⚫ Environment in which certain future events have probabilistic outcomes ⚫ Uncertainty ⚫ Environment in which it is impossible to assess the likelihood of various possible future events 5S-56
Decision Making Under Uncertainty ⚫ Decisions are sometimes made under complete uncertainty: No information is available on how likely the various states of nature are. ⚫ Decision Criteria: ⚫ Maximin ⚫ Choose the alternative with the best of the worst possible payoffs ⚫ Maximax ⚫ Choose the alternative with the best possible payoff ⚫ Laplace ⚫ Choose the alternative with the best average payoff ⚫ Minimax regret ⚫ Choose the alternative that has the least of the worst regrets 5S-57
Possible Future Demand Alternatives Low Moderate High Small Facility $10 $10 $10 Medium Facility 7 12 12 Large Facility (4) 2 16 Example – Maximin Criterion •The worst payoff for each alternative is Small facility: $10 million Medium facility $7 million Large facility -$4 million •Choose to construct a small facility 5S-58
Possible Future Demand Alternatives Low Moderate High Small Facility $10 $10 $10 Medium Facility 7 12 12 Large Facility (4) 2 16 Example – Maximax Criterion •The best payoff for each alternative is Small facility: $10 million Medium facility $12 million Large facility $16 million •Choose to construct a large facility 5S-59
Possible Future Demand Alternatives Low Moderate High Small Facility $10 $10 $10 Medium Facility 7 12 12 Large Facility (4) 2 16 Example – Laplace Criterion •The average payoff for each alternative is Small facility: (10+10+10)/3 = $10 million Medium facility (7+12+12)/3 = $10.33 million Large facility (-4+2+16)/3 = $4.67 million •Choose to construct a medium facility 5S-60
Possible Future Demand Alternatives Low Moderate High Small Facility $10 $10 $10 Medium Facility 7 12 12 Large Facility (4) 2 16 Example – Minimax Regret •Construct a regret (or opportunity loss) table •The difference between a given payoff and the best payoff for a state of nature Regrets Alternatives Low Moderate High Small Facility $0 $2 $6 Medium Facility 3 0 4 Large Facility 14 10 0 5S-61
Regrets Alternatives Low Moderate High Small Facility $0 $2 $6 Medium Facility 3 0 4 Large Facility 14 10 0 Example – Minimax Regret •Identify the worst regret for each alternative •Small facility $6 million •Medium facility $4 million •Large facility $14 million •Select the alternative with the minimum of the maximum regrets •Build a medium facility 5S-62
Decision Making Under Risk ⚫ Decisions made under the condition that the probability of occurrence for each state of nature can be estimated ⚫ A widely applied criterion is expected monetary value (EMV) ⚫ EMV ⚫ Determine the expected payoff of each alternative, and choose the alternative that has the best expected payoff ⚫ This approach is most appropriate when the decision maker is neither risk averse nor risk seeking 5S-63
Possible Future Demand Alternatives Low (.30) Moderate (.50) High (.20) Small Facility $10 $10 $10 Medium Facility 7 12 12 Large Facility (4) 2 16 Example– EMV EMVsmall = .30(10) +.50(10) +.20(10) = 10 EMVmedium = .30(7) + .50(12) + .20(12) = 10.5 EMVlarge = .30(-4) + .50(2) + .20(16) = $3 Build a medium facility 5S-64
Decision Tree ⚫ Decision tree ⚫ A schematic representation of the available alternatives and their possible consequences ⚫ Useful for analyzing sequential decisions 5S-65
Decision Tree ⚫ Composed of ⚫ Nodes ⚫ Decisions – represented by square nodes ⚫ Chance events – represented by circular nodes ⚫ Branches ⚫ Alternatives– branches leaving a square node ⚫ Chance events– branches leaving a circular node ⚫ Analyze from right to left ⚫ For each decision, choose the alternative that will yield the greatest return ⚫ If chance events follow a decision, choose the alternative that has the highest expected monetary value (or lowest expected cost) 5S-66
⚫ A manager must decide on the size of a video arcade to construct. The manager has narrowed the choices to two: large or small. Information has been collected on payoffs, and a decision tree has been constructed. Analyze the decision tree and determine which initial alternative (build small or build large) should be chosen in order to maximize expected monetary value. Example– Decision Tree 1 2 2 $40 $40 $50 $55 ($10) $50 $70 B u i l d S m a l l Low Demand (.40) Low Demand (.40) High Demand (.60) High Demand (.60) B u i l d L a r g e Do Nothing Cut Prices Do Nothing Overtime Expand 5S-67
Example– Decision Tree 1 2 2 $40 $40 $50 $55 ($10) $50 $70 B u i l d S m a l l Low Demand (.40) Low Demand (.40) High Demand (.60) High Demand (.60) B u i l d L a r g e Do Nothing Cut Prices Do Nothing Overtime Expand EVSmall = .40(40) + .60(55) = $49 EVLarge = .40(50) + .60(70) = $62 Build the large facility 5S-68
⚫ Expected value of perfect information (EVPI) ⚫ The difference between the expected payoff with perfect information and the expected payoff under risk ⚫ Two methods for calculating EVPI ⚫ EVPI = expected payoff under certainty – expected payoff under risk ⚫ EVPI = minimum expected regret Expected Value of Perfect Information 5S-69
Possible Future Demand Alternatives Low (.30) Moderate (.50) High (.20) Small Facility $10 $10 $10 Medium Facility 7 12 12 Large Facility (4) 2 16 Example – EVPI EVwith perfect information = .30(10) + .50(12) + .20(16) = $12.2 EMV = $10.5 EVPI = EVwith perfect information – EMV = $12.2 – 10.5 = $1.7 You would be willing to spend up to $1.7 million to obtain perfect information 5S-70
Regrets Alternatives Low (.30) Moderate (.50) High (.20) Small Facility $0 $2 $6 Medium Facility 3 0 4 Large Facility 14 10 0 Example– EVPI • Expected Opportunity Loss • EOLSmall = .30(0) + .50(2) + .20(6) = $2.2 • EOLMedium = .30(3) + .50(0) + .20(4) = $1.7 • EOLLarge = .30(14) + .50(10) + .20(0) = $9.2 • The minimum EOL is associated with the building the medium size facility. This is equal to the EVPI, $1.7 million 5S-71
Sensitivity Analysis ⚫ Sensitivity analysis ⚫ Determining the range of probability for which an alternative has the best expected payoff 5S-72

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Operations Management - Chapter 5.pdf

  • 1.
    Strategic Capacity Planning for Productsand Services Chapter 5 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
  • 2.
    ⚫ Capacity ⚫ Theupper limit or ceiling on the load that an operating unit can handle ⚫ Capacity needs include ⚫ Equipment ⚫ Space ⚫ Employee skills Capacity Planning 5-2
  • 3.
    ⚫ Goal ⚫ Toachieve a match between the long-term supply capabilities of an organization and the predicted level of long-term demand ⚫ Overcapacity🡪 operating costs that are too high ⚫ Undercapacity🡪 strained resources and possible loss of customers Strategic Capacity Planning 5-3
  • 4.
    ⚫ Key Questions: ⚫What kind of capacity is needed? ⚫ How much is needed to match demand? ⚫ When is it needed? ⚫ Related Questions: ⚫ How much will it cost? ⚫ What are the potential benefits and risks? ⚫ Are there sustainability issues? ⚫ Should capacity be changed all at once, or through several smaller changes ⚫ Can the supply chain handle the necessary changes? Capacity Planning Questions 5-4
  • 5.
    ⚫ Capacity decisions 1.impact the ability of the organization to meet future demands 2. affect operating costs 3. are a major determinant of initial cost 4. often involve long-term commitment of resources 5. can affect competitiveness 6. affect the ease of management 7. have become more important and complex due to globalization 8. need to be planned for in advance due to their consumption of financial and other resources Capacity Decisions Are Strategic 5-5
  • 6.
    Capacity Design capacity ⚫ Maximumoutput rate or service capacity an operation, process, or facility is designed for Effective capacity ⚫ Design capacity minus allowances such as personal time, maintenance, and scrap Actual output ⚫ Rate of output actually achieved--cannot exceed effective capacity. 5-6
  • 7.
    Defining and MeasuringCapacity ⚫ Measure capacity in units that do not require updating ⚫ Why is measuring capacity in dollars problematic? ⚫ Two useful definitions of capacity ⚫ Design capacity ⚫ The maximum output rate or service capacity an operation, process, or facility is designed for ⚫ Effective capacity ⚫ Design capacity minus allowances such as personal time and maintenance 5-7
  • 8.
    ⚫ Actual output ⚫The rate of output actually achieved ⚫ It cannot exceed effective capacity ⚫ Efficiency ⚫ Utilization Measured as percentages Measuring System Effectiveness 5-8
  • 9.
    Example– Efficiency andUtilization ⚫ Design Capacity = 50 trucks per day ⚫ Effective Capacity = 40 trucks per day ⚫ Actual Output = 36 trucks per day 5-9
  • 10.
    Determinants of EffectiveCapacity ⚫ Facilities ⚫ Product and service factors ⚫ Process factors ⚫ Human factors ⚫ Policy factors ⚫ Operational factors ⚫ Supply chain factors ⚫ External factors 5-10
  • 11.
    Strategy Formulation ⚫ Strategiesare typically based on assumptions and predictions about: ⚫ Long-term demand patterns ⚫ Technological change ⚫ Competitor behavior 5-11
  • 12.
    Capacity Cushion ⚫ CapacityCushion ⚫ Extra capacity used to offset demand uncertainty ⚫ Capacity cushion = 100% - Utilization ⚫ Capacity cushion strategy ⚫ Organizations that have greater demand uncertainty typically have greater capacity cushion ⚫ Organizations that have standard products and services generally have greater capacity cushion 5-12
  • 13.
    Steps in CapacityPlanning 1. Estimate future capacity requirements 2. Evaluate existing capacity and facilities; identify gaps 3. Identify alternatives for meeting requirements 4. Conduct financial analyses 5. Assess key qualitative issues 6. Select the best alternative for the long term 7. Implement alternative chosen 8. Monitor results 5-13
  • 14.
    How would youselect between alternatives? Example: Getting a line of credit ⚫ Interest rate on the revolver (including monitoring fees, etc.) ⚫ Up Front fees (commitment fees, closing fees, audit fee, etc.) ⚫ Size of the line offered ⚫ Expected Covenant Restrictions ⚫ Advance Rate on Inventory and AR ⚫ Unused line fee ⚫ Default Rate ⚫ Perceived “friendliness” of lender
  • 15.
    Rank the decisioncriteria as to importance to the situation at hand Decision Factor Weight (1-10) Interest Rate on Revolver 8 Up Front Fees 3 Size of Line 7 Covenant Restrictions 7 Advance Rate 5 Unused Line Fee 3 Default Rate 5 Friendliness of Lender 7
  • 16.
    Rank each lenderas to how they compare in each category. Decision Factor Weight (1-10) Lender 1 Lender 2 Lender 3 Lender 4 Interest Rate on Revolver 8 1 3 2 4 Up Front Fees 3 2 1 3 4 Size of Line 7 3 2 1 4 Covenant Restrictions 7 4 3 2 1 Advance Rate 5 1 2 2 1 Unused Line Fee 3 2 1 1 2 Default Rate 5 2 1 2 1 Friendliness of Lender 7 1 2 3 4
  • 17.
    Lender 1 Lender2 Lender 3 Lender 4 Decision Factor Weight Rank Score Rank Score Rank Score Rank Score Interest Rate on Revolver 8 4 32 2 16 3 24 1 8 Up Front Fees 3 2 6 4 12 3 9 1 3 Size of Line 7 1 7 3 21 4 28 1 7 Covenant Restrictions 7 1 7 2 14 3 21 4 28 Advance Rate 5 4 20 3 15 3 15 4 20 Unused Line Fee 3 3 9 4 12 4 12 3 9 Default Rate 5 2 10 2 10 3 15 4 20 Friendliness of Lender 7 4 28 3 21 2 14 1 7 Total Score 119 121 138 102
  • 18.
    Criterion Weight AlternativeA Alternative B Alternative C Financial ROI 15% 2 4 10 Payback 10% 3 5 10 NPV 15% 2 4 10 Organizational Alignment with strategic objectives 10% 3 5 8 Likelihood of achieving project’s MOV 10% 2 6 9 Project Availability of skilled team members 5% 5 5 4 Maintainability 5% 4 6 7 Time to develop 5% 5 7 6 Risk 5% 3 5 5 External Customer satisfaction 10% 2 4 9 Increased market share 10% 2 5 8 Total Score 100% 2.65 4.85 8.50 Notes: Risk scores have a reverse scale – i.e., higher scores for risk imply lower levels of risk
  • 22.
    Competitive Profile Matrix CompanyOne Company Two Company Three Critical Success Factors Weight Rating Score Rating Score Rating Score Advertising 0.20 1 0.20 4 0.80 3 0.60 Product Quality 0.10 4 0.40 3 0.30 2 0.20 Price Competitiveness 0.10 3 0.30 2 0.20 4 0.40 Management 0.10 4 0.40 3 0.30 3 0.30 Financial Position 0.15 4 0.60 2 0.30 3 0.45 Customer Loyalty 0.10 4 0.40 3 0.30 2 0.20 Global Expansion 0.20 4 0.80 1 0.20 2 0.40 Market Share 0.05 1 0.05 4 0.20 3 0.15 Total 1.00 3.15 2.60 2.70
  • 24.
    Forecasting Capacity Requirements ⚫Long-term considerations relate to overall level of capacity requirements ⚫ Require forecasting demand over a time horizon and converting those needs into capacity requirements ⚫ Short-term considerations relate to probable variations in capacity requirements ⚫ Less concerned with cycles and trends than with seasonal variations and other variations from average 5-24
  • 25.
    ⚫ Calculating processingrequirements requires reasonably accurate demand forecasts, standard processing times, and available work time Calculating Processing Requirements 5-25
  • 26.
    Service Capacity Planning ⚫Service capacity planning can present a number of challenges related to: ⚫ The need to be near customers ⚫ Convenience ⚫ The inability to store services ⚫ Cannot store services for consumption later ⚫ The degree of demand volatility ⚫ Volume and timing of demand ⚫ Time required to service individual customers 5-26
  • 27.
    Demand Management Strategies ⚫Strategies used to offset capacity limitations and that are intended to achieve a closer match between supply and demand ⚫ Pricing ⚫ Promotions ⚫ Discounts ⚫ Other tactics to shift demand from peak periods into slow periods 5-27
  • 28.
    In-House or Outsource? ⚫Once capacity requirements are determined, the organization must decide whether to produce a good or service itself or outsource ⚫ Factors to consider: ⚫ Available capacity ⚫ Expertise ⚫ Quality considerations ⚫ The nature of demand ⚫ Cost ⚫ Risks 5-28
  • 29.
    Developing Capacity Alternatives ⚫Things that can be done to enhance capacity management: ⚫ Design flexibility into systems ⚫ Take stage of life cycle into account ⚫ Take a “big-picture” approach to capacity changes ⚫ Prepare to deal with capacity “chunks” ⚫ Attempt to smooth capacity requirements ⚫ Identify the optimal operating level ⚫ Choose a strategy if expansion is involved 5-29
  • 30.
    Capacity Strategies ⚫ Leading ⚫Build capacity in anticipation of future demand increases ⚫ Following ⚫ Build capacity when demand exceeds current capacity ⚫ Tracking ⚫ Similar to the following strategy, but adds capacity in relatively small increments to keep pace with increasing demand 5-30
  • 31.
    Bottleneck Operation ⚫ Anoperation in a sequence of operations whose capacity is lower than that of the other operations 5-31
  • 32.
  • 33.
    Economies and Diseconomiesof Scale ⚫ Economies of Scale ⚫ If output rate is less than the optimal level, increasing the output rate results in decreasing average per unit costs ⚫ Diseconomies of Scale ⚫ If the output rate is more than the optimal level, increasing the output rate results in increasing average per unit costs 5-33
  • 34.
    Economies of Scale ⚫Economies of Scale ⚫ If output rate is less than the optimal level, increasing the output rate results in decreasing average per unit costs ⚫ Reasons for economies of scale: ⚫ Fixed costs are spread over a larger number of units ⚫ Construction costs increase at a decreasing rate as facility size increases ⚫ Processing costs decrease due to standardization 5-34
  • 35.
    Diseconomies of Scale ⚫Diseconomies of Scale ⚫ If the output rate is more than the optimal level, increasing the output rate results in increasing average per unit costs ⚫ Reasons for diseconomies of scale ⚫ Distribution costs increase due to traffic congestion and shipping from a centralized facility rather than multiple smaller facilities ⚫ Complexity increases costs ⚫ Inflexibility can be an issue ⚫ Additional levels of bureaucracy 5-35
  • 36.
    Facility Size andOptimal Operating Level Minimum cost & optimal operating rate are functions of size of production unit. 5-36
  • 37.
    Constraint Management ⚫ Constraint ⚫Something that limits the performance of a process or system in achieving its goals ⚫ Categories ⚫ Market ⚫ Resource ⚫ Material ⚫ Financial ⚫ Knowledge or competency ⚫ Policy 5-37
  • 38.
    1. Identify themost pressing constraint 2. Change the operation to achieve maximum benefit, given the constraint 3. Make sure other portions of the process are supportive of the constraint 4. Explore and evaluate ways to overcome the constraint 5. Repeat the process until the constraint levels are at acceptable levels Resolving Constraint Issues 5-38
  • 39.
    Evaluating Alternatives ⚫ Alternativesshould be evaluated from varying perspectives ⚫ Economic ⚫ Is it economically feasible? ⚫ How much will it cost? ⚫ How soon can we have it? ⚫ What will operating and maintenance costs be? ⚫ What will its useful life be? ⚫ Will it be compatible with present personnel and present operations? ⚫ Non-economic ⚫ Public opinion 5-39
  • 40.
    Evaluating Alternatives ⚫ Techniquesfor Evaluating Alternatives ⚫ Cost-volume analysis ⚫ Financial analysis ⚫ Decision theory ⚫ Waiting-line analysis ⚫ Simulation 5-40
  • 41.
    ⚫ Cost-volume analysis ⚫Focuses on the relationship between cost, revenue, and volume of output ⚫ Fixed Costs (FC) ⚫ tend to remain constant regardless of output volume ⚫ Variable Costs (VC) ⚫ vary directly with volume of output ⚫ VC = Quantity(Q) x variable cost per unit (v) ⚫ Total Cost ⚫ TC = FC + VC ⚫ Total Revenue (TR) ⚫ TR = revenue per unit (R) x Q Cost-Volume Analysis 5-41
  • 42.
    ⚫ BEP ⚫ Thevolume of output at which total cost and total revenue are equal ⚫ Profit (P) = TR – TC = R x Q – (FC +v x Q) = Q(R – v) – FC Break-Even Point (BEP) 5-42
  • 43.
  • 44.
    Cost-Volume Relationships ⚫ Capacityalternatives may involve step costs, which are costs that increase stepwise as potential volume increases. ⚫ The implication of such a situation is the possible occurrence of multiple break-even quantities. 5-44
  • 45.
    Cost-Volume Analysis Assumptions ⚫Cost-volume analysis is a viable tool for comparing capacity alternatives if certain assumptions are satisfied ⚫ One product is involved ⚫ Everything produced can be sold ⚫ The variable cost per unit is the same regardless of volume ⚫ Fixed costs do not change with volume changes, or they are step changes ⚫ The revenue per unit is the same regardless of volume ⚫ Revenue per unit exceeds variable cost per unit 5-45
  • 46.
    Financial Analysis ⚫ Cashflow ⚫ 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 flow of an investment proposal 5-46
  • 47.
    Operations Strategy ⚫ Capacityplanning impacts all areas of the organization ⚫ It determines the conditions under which operations will have to function ⚫ Flexibility allows an organization to be agile ⚫ It reduces the organization’s dependence on forecast accuracy and reliability ⚫ Many organizations utilize capacity cushions to achieve flexibility ⚫ Bottleneck management is one way by which organizations can enhance their effective capacities ⚫ Capacity expansion strategies are important organizational considerations ⚫ Expand-early strategy ⚫ Wait-and-see strategy ⚫ Capacity contraction is sometimes necessary ⚫ Capacity disposal strategies become important under these conditions 5-47
  • 48.
    Decision Theory Supplement 5 McGraw-Hill/Irwin Copyright© 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
  • 49.
    Decision Theory ⚫ Ageneral approach to decision making that is suitable to a wide range of operations management decisions ⚫ Capacity planning ⚫ Product and service design ⚫ Equipment selection ⚫ Location planning 5S-49
  • 50.
    Characteristics of SuitableProblems ⚫ Characteristics of decisions that are suitable for using decision theory ⚫ A set of possible future conditions that will have a bearing on the results of the decision ⚫ A list of alternatives from which to choose ⚫ A known payoff for each alternative under each possible future condition 5S-50
  • 51.
    Process for UsingDecision Theory 1. Identify the possible future states of nature 2. Develop a list of possible alternatives 3. Estimate the payoff for each alternative for each possible future state of nature 4. If possible, estimate the likelihood of each possible future state of nature 5. Evaluate alternatives according to some decision criterion and select the best alternative 5S-51
  • 52.
    Payoff Table ⚫ Atable showing the expected payoffs for each alternative in every possible state of nature Possible Future Demand Alternatives Low Moderate High Small facility $10 $10 $10 Medium facility 7 12 12 Large Facility (4) 2 16 • A decision is being made concerning which size facility should be constructed • The present value (in millions) for each alternative under each state of nature is expressed in the body of the above payoff table 5S-52
  • 53.
    Causes of PoorDecisions ⚫ Decisions occasionally turn out poorly due to unforeseeable circumstances; however, this is not the norm. ⚫ More frequently poor decisions are the result of a combination of ⚫ Mistakes in the decision process ⚫ Bounded rationality ⚫ Suboptimization 5S-53
  • 54.
    Decision Process ⚫ Steps: 1.Identify the problem 2. Specify objectives and criteria for a solution 3. Develop suitable alternatives 4. Analyze and compare alternatives 5. Select the best alternative 6. Implement the solution 7. Monitor to see that the desired result is achieved ⚫ Errors ⚫ Failure to recognize the importance of each step ⚫ Skipping a step ⚫ Failure to complete a step before jumping to the next step ⚫ Failure to admit mistakes ⚫ Inability to make a decision 5S-54
  • 55.
    Bounded Rationality &Suboptimization ⚫ Bounded rationality ⚫ The limitations on decision making caused by costs, human abilities, time, technology, and availability of information ⚫ Suboptimization ⚫ The results of different departments each attempting to reach a solution that is optimum for that department 5S-55
  • 56.
    Decision Environments ⚫ Thereare three general environment categories: ⚫ Certainty ⚫ Environment in which relevant parameters have known values ⚫ Risk ⚫ Environment in which certain future events have probabilistic outcomes ⚫ Uncertainty ⚫ Environment in which it is impossible to assess the likelihood of various possible future events 5S-56
  • 57.
    Decision Making UnderUncertainty ⚫ Decisions are sometimes made under complete uncertainty: No information is available on how likely the various states of nature are. ⚫ Decision Criteria: ⚫ Maximin ⚫ Choose the alternative with the best of the worst possible payoffs ⚫ Maximax ⚫ Choose the alternative with the best possible payoff ⚫ Laplace ⚫ Choose the alternative with the best average payoff ⚫ Minimax regret ⚫ Choose the alternative that has the least of the worst regrets 5S-57
  • 58.
    Possible Future Demand AlternativesLow Moderate High Small Facility $10 $10 $10 Medium Facility 7 12 12 Large Facility (4) 2 16 Example – Maximin Criterion •The worst payoff for each alternative is Small facility: $10 million Medium facility $7 million Large facility -$4 million •Choose to construct a small facility 5S-58
  • 59.
    Possible Future Demand AlternativesLow Moderate High Small Facility $10 $10 $10 Medium Facility 7 12 12 Large Facility (4) 2 16 Example – Maximax Criterion •The best payoff for each alternative is Small facility: $10 million Medium facility $12 million Large facility $16 million •Choose to construct a large facility 5S-59
  • 60.
    Possible Future Demand AlternativesLow Moderate High Small Facility $10 $10 $10 Medium Facility 7 12 12 Large Facility (4) 2 16 Example – Laplace Criterion •The average payoff for each alternative is Small facility: (10+10+10)/3 = $10 million Medium facility (7+12+12)/3 = $10.33 million Large facility (-4+2+16)/3 = $4.67 million •Choose to construct a medium facility 5S-60
  • 61.
    Possible Future Demand AlternativesLow Moderate High Small Facility $10 $10 $10 Medium Facility 7 12 12 Large Facility (4) 2 16 Example – Minimax Regret •Construct a regret (or opportunity loss) table •The difference between a given payoff and the best payoff for a state of nature Regrets Alternatives Low Moderate High Small Facility $0 $2 $6 Medium Facility 3 0 4 Large Facility 14 10 0 5S-61
  • 62.
    Regrets Alternatives Low ModerateHigh Small Facility $0 $2 $6 Medium Facility 3 0 4 Large Facility 14 10 0 Example – Minimax Regret •Identify the worst regret for each alternative •Small facility $6 million •Medium facility $4 million •Large facility $14 million •Select the alternative with the minimum of the maximum regrets •Build a medium facility 5S-62
  • 63.
    Decision Making UnderRisk ⚫ Decisions made under the condition that the probability of occurrence for each state of nature can be estimated ⚫ A widely applied criterion is expected monetary value (EMV) ⚫ EMV ⚫ Determine the expected payoff of each alternative, and choose the alternative that has the best expected payoff ⚫ This approach is most appropriate when the decision maker is neither risk averse nor risk seeking 5S-63
  • 64.
    Possible Future Demand AlternativesLow (.30) Moderate (.50) High (.20) Small Facility $10 $10 $10 Medium Facility 7 12 12 Large Facility (4) 2 16 Example– EMV EMVsmall = .30(10) +.50(10) +.20(10) = 10 EMVmedium = .30(7) + .50(12) + .20(12) = 10.5 EMVlarge = .30(-4) + .50(2) + .20(16) = $3 Build a medium facility 5S-64
  • 65.
    Decision Tree ⚫ Decisiontree ⚫ A schematic representation of the available alternatives and their possible consequences ⚫ Useful for analyzing sequential decisions 5S-65
  • 66.
    Decision Tree ⚫ Composedof ⚫ Nodes ⚫ Decisions – represented by square nodes ⚫ Chance events – represented by circular nodes ⚫ Branches ⚫ Alternatives– branches leaving a square node ⚫ Chance events– branches leaving a circular node ⚫ Analyze from right to left ⚫ For each decision, choose the alternative that will yield the greatest return ⚫ If chance events follow a decision, choose the alternative that has the highest expected monetary value (or lowest expected cost) 5S-66
  • 67.
    ⚫ A managermust decide on the size of a video arcade to construct. The manager has narrowed the choices to two: large or small. Information has been collected on payoffs, and a decision tree has been constructed. Analyze the decision tree and determine which initial alternative (build small or build large) should be chosen in order to maximize expected monetary value. Example– Decision Tree 1 2 2 $40 $40 $50 $55 ($10) $50 $70 B u i l d S m a l l Low Demand (.40) Low Demand (.40) High Demand (.60) High Demand (.60) B u i l d L a r g e Do Nothing Cut Prices Do Nothing Overtime Expand 5S-67
  • 68.
    Example– Decision Tree 1 2 2 $40 $40 $50 $55 ($10) $50 $70 B u i l d S m a l l Low Demand(.40) Low Demand (.40) High Demand (.60) High Demand (.60) B u i l d L a r g e Do Nothing Cut Prices Do Nothing Overtime Expand EVSmall = .40(40) + .60(55) = $49 EVLarge = .40(50) + .60(70) = $62 Build the large facility 5S-68
  • 69.
    ⚫ Expected valueof perfect information (EVPI) ⚫ The difference between the expected payoff with perfect information and the expected payoff under risk ⚫ Two methods for calculating EVPI ⚫ EVPI = expected payoff under certainty – expected payoff under risk ⚫ EVPI = minimum expected regret Expected Value of Perfect Information 5S-69
  • 70.
    Possible Future Demand AlternativesLow (.30) Moderate (.50) High (.20) Small Facility $10 $10 $10 Medium Facility 7 12 12 Large Facility (4) 2 16 Example – EVPI EVwith perfect information = .30(10) + .50(12) + .20(16) = $12.2 EMV = $10.5 EVPI = EVwith perfect information – EMV = $12.2 – 10.5 = $1.7 You would be willing to spend up to $1.7 million to obtain perfect information 5S-70
  • 71.
    Regrets Alternatives Low (.30)Moderate (.50) High (.20) Small Facility $0 $2 $6 Medium Facility 3 0 4 Large Facility 14 10 0 Example– EVPI • Expected Opportunity Loss • EOLSmall = .30(0) + .50(2) + .20(6) = $2.2 • EOLMedium = .30(3) + .50(0) + .20(4) = $1.7 • EOLLarge = .30(14) + .50(10) + .20(0) = $9.2 • The minimum EOL is associated with the building the medium size facility. This is equal to the EVPI, $1.7 million 5S-71
  • 72.
    Sensitivity Analysis ⚫ Sensitivityanalysis ⚫ Determining the range of probability for which an alternative has the best expected payoff 5S-72