Chapter 3.3-3.4.4: Strategic Capacity Planning (BPA-4-1-Group-3)

3.3 Strategic Capacity Planning  Capacity considerations are a critical policy decision area for operations. As with all policy issues, there are trade-o s between investing in productive resources and making.  On the one hand, transformative resources like buildings, technolo...

3.3 Strategic Capacity Planning  Capacity considerations are a critical policy decision area for operations. As with all policy issues, there are trade-o s between investing in productive resources and making.  On the one hand, transformative resources like buildings, technology, and people are often expensive and time-consuming to acquire or produce, so the business wants to make the most use of them.  Materials, knowledge, and e ort may be squandered if they are obtained or converted when there is no need for them, and sales may be lost if outputs are not accessible when customers require them. Capacity challenges a ect all organizations, at all levels. Definition of Capacity  It describes the level of output that the organization can achieve over a specified period.  It also refers to upper limit or ceiling on the load that an operating unit can handle. The operating unit might be a plant, department, machine, store, or worker. The basic questions in capacity planning of any sort are the following: 1. What kind of capacity is needed? 2. How much is needed? 3. When is it needed? 3.3.1 Importance of Capacity Decisions Capacity decisions are among the most fundamental of all the design decisions that managers must make. Capacity decisions e ect an organization's ability to satisfy future demands for products and services, as they limit output rates. Having the ability to meet demand allows a corporation to capitalize on enormous potential. Its considerations influence operational expenses. Matching capacity and demand requirements help reduce operational expenses. However, this is not always the case. accomplished because real demand di ers from planned demand or fluctuates (for example, cyclically). In such instances, a choice may be taken to attempt to balance the costs of excess and undercapacity. 3.3.2 Defining and Measuring Capacity Capacity often refers to an upper limit on the rate of output. It appears straightforward, determining capacity can be tricky in some circumstances. These issues occur because of di ering meanings of the term capacity and challenges in defining appropriate metrics for a given context. For example, dollar amounts are often a poor measure of capacity (e.g. capacity of $30 million a year) because price changes necessitate continual updating of that measure. The following table provides some examples of commonly used measures of capacity: Table 3.1: Measures of capacity Business Inputs Outputs Auto-manufacturing Labor hours, machine hours Number of cars per shift Steel mill Furnace size Tons of steel per day Oil refinery Refinery size Gallons of fuel per day Farming Number of acres, number of Bushels of grain per acre per cows year, gallons of milk per day Restaurant Number of tables, seating Number of meals served per capacity day Theater Number of seats Number of tickets sold per performance Retail sales Square feet of floor space Revenue generated per day Two useful definitions of capacity: 1. Design capacity is the highest amount of output that can be obtained. A facility's designed capacity refers to the projected rate of output under normal or full-scale operating circumstances. 2. System/e ective capacity refers to the maximum production of a certain product or combination that a system of workers and equipment can produce. Producing as a cohesive whole. System capacity is less than or equal to design capacity due to limitations in product mix, quality specifications, and breakdowns. These di erent measures of capacity are useful in defining two measures of system e ectiveness: e iciency and utilization. 1. E iciency is the ratio of actual output to e ective capacity. E iciency = Actual output E ective capacity 2. Utilization is the ratio of actual output to design capacity. Utilization = Actual output Design capacity Given the information below, compute the e iciency and the utilization of the vehicle repair department: Design capacity = 50 trucks per day E ective capacity = 40 trucks per day Actual output= 36 trucks per day E iciency = Actual output 36 trucks per day E ective capacity = 40 trucks per day = 90% Utilization = Actual output 36 trucks per day Design capacity = 50 trucks per day = 72% 3.3.3 Determinants of E ective Capacity The main factors relate to the following:  Facilities Factors - The design of facilities, including size and extension options, is critical. Location variables include transportation costs, market distance, labor supply, energy supplies, and expansion potential.  Products/service Factors - The ability of the system to produce those items is generally much greater than when successive items di er.  Processes Factors - The quantity capability of a process is an obvious determinant of capacity. A more subtle determinant is the influence of output quality.  Human Factors - The tasks that make up a job, the variety of activities involved, and the training, skill, and experience required to perform a job all have an impact on the potential and actual output.  Operations Factors - Inventory stocking decisions, late deliveries, acceptability of purchased materials and parts, and quality inspection and control procedures also can have an impact on e ective capacity.  External Factors - Product standards, especially minimum quality and performance standards, can restrict management's options for increasing and using capacity. Developing Capacity Alternatives The considerations to be discussed in this section include the following: 1. Design flexibility into systems - The long-term nature of many capacity decisions and the risks inherent in long-term forecasts suggest potential benefits from designing flexible systems. 2. Take a "big picture" approach to capacity changes - Mature products or services tend to be more predictable in terms of capacity requirements, and they may have limited life spans. 3. Prepare to deal with capacity "chunks” - Capacity increases are often acquired in large chunks rather than smooth increments, making it di icult to achieve a match between desired capacity and feasible capacity. 4. Identify the optimal operating level - Production units typically have an ideal or optimal level of operation in terms of unit cost of output. At the ideal level, cost per unit is the lowest for that production unit; larger or smaller rates of output will result in a higher unit cost. Figure 4.1: Unit costs rise as the rate of output varies from the optimal level. FIGURE -1: Production units have an optimal rate of output for minimum cost The form of the cost curve may be explained by the fact that at low output levels, the costs of facilities and equipment must be absorbed (paid for) by a small number of units. As a result, the unit cost is high. As output increases, more units are available to absorb the "fixed" expenses of buildings and equipment, resulting in lower unit costs. Figure 4.2 Minimum cost and optimal operating rate are functions of size of a production unit. Evaluating Alternatives - Several techniques are useful for evaluating capacity alternatives from an economic standpoint. Calculating Processing Requirements - When assessing capacity choices, an essential component. The capacity requirements of items to be processed with a specific alternative are a source of knowledge. To get this information, relatively accurate demand projections for each product are required, as well as knowledge of the standard processing time per unit for each product on each alternative machine, the number of workdays per year, and the number of shifts that will be employed. A department works one eight-hour shift, 250 days a year, and has these figures for usage of a machine that is currently being considered: Working one eight-hour shift, 250 days a year provides an annual capacity of 8 X 250 = 2,000 hours per year. We can see that three of these machines would be needed to handle the required volume: 5,800 hours 2,000 hours/machine = 2.90 machines Cost-Volume Analysis - It focuses on relationships between cost, revenue, and volume of output. The purpose of cost-volume analysis is to estimate the income of an organization under di erent operating conditions. It is particularly useful as a tool for comparing capacity alternatives. The following data summarizes the symbols used in the cost-volume formulas: The total cost associated with a given volume of output is equal to the sum of the fixed cost and the variable cost per unit time’s volume: TC = FC + VC X Q The total revenue associated with a given quantity of output, Q, is: TR = R X Q The volume at which total cost and total revenue are equal is referred to as the break-even point (BEP). When volume is less than the break-even point, there is a loss rather than a profit; when volume is greater than the break-even point, there is a profit. The greater the deviation from this point, the greater the profit or loss. Total profit can be computed using the formula: P = TR - TC = R X Q - (FC + VC X Q) Rearranging terms, we have P = Q(R - VC) – FC The required volume, Q, needed to generate a specified profit is: A special case of this is the volume of output needed for total revenue to equal total cost. This is the break-even point, computed using the formula: 3.4 Facility Location and Layout Plant location or the facilities location problem - is an important strategic level decision making for an organization. One of the key features of a conversion process (manufacturing system) is the e iciency with which the products (services) are transferred to the customers. Two competitive imperatives:  The need to produce close to the customer due to time-based competition, trade agreements, and shipping costs.  The need to locate near the appropriate labor pool to take advantage of low wage costs and /or high technical skills. 3.4.1. Issues in Facility Location Criteria that influence manufacturing plant and warehouse location planning are: 1. Proximity to Customers - A location close to the customer is important because of the ever increasing need to be customer-responsive. 2. Business Climate - A favorable business climate can include the presence of similar sized businesses, the presence of companies in the same industry, and, in the case of international locations, and the presence of other foreign companies. 3. Total Costs - The objective is to select a site with the lowest total cost. This includes regional costs, inbound distribution costs, and outbound distribution costs. Land, construction, labor, taxes, and energy costs comprise the regional costs. 4. Infrastructure - Adequate transportation (road, rail, air, sea) and utilities (energy, telecommunications) are essential. 5. Labor - The availability of skilled labor with the necessary education and willingness to learn is crucial. 6. Suppliers - A competitive supplier base, ideally located nearby for lean production, is advantageous.  7. Other Facilities - Existing facilities within the same company can influence location decisions due to product mix and capacity considerations. 8. Free Trade Zones - These zones o er tax benefits and customs advantages for manufacturers using imported components. 9. Political Risk - The political stability of both the host country and the country of location is a significant factor. 10. Government Barriers - Legislative and cultural barriers can a ect entry and location decisions. 11. Environmental Regulations - Compliance with local environmental regulations is essential and can impact costs and community relations. 12. Host Community - The local community's interest, educational facilities, and quality of life are important considerations. 13. Competitive Advantage - An important decision for multinational companies is the nation in which to locate the home base for each distinct business. 3.4.2 The Strategic Importance of Location Companies must strategically choose where to locate their operations, as location can significantly impact business success. The decision-making process varies based on business type, with cost minimization being a primary goal for industrial operations, revenue maximization for retail and professional services, and a balance of cost and speed for warehouses. Location decisions are typically infrequent and driven by factors like capacity constraints, changes in labor or costs, and shifts in customer demand. Companies have three main options: expanding an existing facility, adding a new facility, or relocating to a di erent location. 3.4.3. Methods of Evaluating Location Alternatives Four major methods are used for solving location problems: the factor-rating method, location break- even analysis, center-of gravity method, and the transportation model. 1. THE FACTOR-RATING METHOD There are many factors, both qualitative and quantitative, to consider in choosing a location. Some of these factors are more important than others, so managers can use weightings to make the decision process more objective. The rating method is popular because a wide variety of factors from education to recreation to labor skills can be included. 2. LOCATIONAL BREAK-EVEN ANALYSIS Location break-even analysis is the use of cost-volume analysis to make an economic comparison of location alternatives. By identifying fixed and variable cost and graphing them for each location, we can determine which one provides the lowest cost. Locational break-even analysis can be done mathematically or graphically. The graphic approach has the advantage of providing the range of volume which each location is preferable. LINEAR PROGRAMMING The transportation method of linear programming can be used to test the cost impact of di erent candidate locations on the entire production-distribution network. Assuming factories in X and Y would be identical in other important respects, the location resulting in the lowest total cost for the network would be selected. This method is easy to use but it does require that at least sub regional locations be identified before a solution can be found. CENTER OF GRAVITY METHOD The center of gravity method is a technique for locating single facilities that considers the existing facilities, the distances between them, and the volumes of goods to be shipped. The technique is often used to locate intermediate or distribution warehouses. In its simplest form, this method assumes that inbound and outbound transportation costs are equal, and it does not include special shipping costs for less than full loads. 3.4.4 Locating Service Facilities While the focus in industrial-sector location analysis is on minimizing cost, the focus in the service sector is on maximizing revenue. This is because manufacturing costs tend to vary substantially between locations, but in service firms’ location often has more impact on revenue than cost. Therefore, for the service firm a specific location often influences revenue more than it does cost. This means that the location focus for service firms should be on determining the volume of business and revenue.