Capacity Planning PDF

CAPACITY PLANNING 5 Intended Learning Outcomes By the end of the learning experience, students must be able to: 1. Explain the importance of capacity planning. 2. Discuss ways of defining and measuring capacity. 3. Describe the factors that determine effective capacity alternatives...

CAPACITY PLANNING 5 Intended Learning Outcomes By the end of the learning experience, students must be able to: 1. Explain the importance of capacity planning. 2. Discuss ways of defining and measuring capacity. 3. Describe the factors that determine effective capacity alternatives. 4. Discuss the major considerations related to developing capacity alternatives. 5. Briefly describe approaches that are useful for evaluating capacity alternatives. IMPORTANCE OF CAPACITY DECISIONS a. Capacity decisions have a real impact on the ability of the organisation to meet future demands for products and services; capacity essentially limits the rate of output possible. Having capacity to satisfy demand can allow a company to take advantage of tremendous opportunities. b. Capacity decisions affect operating costs. Ideally, capacity and demand requirements will be matched, which will tend to minimize operating costs. In practice, this is not always achieved because actual demand either differs from expected demand or tends to vary (e.g., cyclically). In such cases, a decision might be made to attempt to balance the costs of over and under capacity. c. Capacity is usually a major determinant of initial cost. Typically, the greater the capacity of a productive unit, the greater its cost. This does not necessarily imply a one for-one relationship; larger units tend to cost proportionately less than smaller units. d. Capacity decisions often involve long-term commitment of resources and the fact that, once they are implemented, it may be difficult or impossible to modify those decisions without incurring major costs. e. Capacity decisions can affect competitiveness. If a firm has excess capacity, or can quickly add capacity, that fact may serve as a barrier to entry by other firms. Then too, capacity can affect delivery speed, which can be a competitive advantage. f. Capacity affects the ease of management; having appropriate capacity makes management easier than when capacity is mismatched. DEFINING AND MEASURING CAPACITY Capacity often refers to an upper limit on the rate of output. Even though this seems simple enough, there are subtle difficulties in actually measuring capacity in certain cases. These difficulties arise because of different interpretations of the term capacity and problems with identifying suitable measures for a specific situation. In selecting a measure of capacity, it is important to choose one that does not require updating. Where only one product or service is involved, the capacity of the productive unit may be expressed in terms of that item. However, when multiple products or services are involved, as is often the case, using a simple measure of capacity based on units of output can be misleading. No single measure of capacity will be appropriate in every situation. Rather, the measure of capacity must be tailored to the situation. Two useful definitions of capacity: 1) Design Capacity: the maximum output that can possibly be attained under ideal conditions. 2) Effective Capacity: the maximum possible output given a product mix, scheduling difficulties, machine maintenance, quality factors, and so on. These different measures of capacity are useful in defining two measures of system effectiveness: efficiency and utilization. Efficiency is the ratio of actual output to effective capacity. Utilization is the ratio of actual output to design capacity. Efficiency = Learning Module in Operations Management and TQM Page | 1  Utilization = Sample Problem 5.1: Compute the efficiency and utilization of the vehicle repair department: Design Capacity = 50 trucks per day Effective Capacity = 40 trucks per day Actual Output = 36 trucks per day Solution Efficiency = = = 90% Utilization = = = 72% Sample Problem 5.2: The design capacity for engine repair in our company is 80 trucks per day. The effective capacity is 40 engines per day and the actual output is 36 engines per day. Calculate the utilization and efficiency of the operation. If the efficiency for next month is expected to be 82%, what is the expected output? Solution Efficiency = = = 90% Utilization = = = 45% Expected Output = (Effective capacity)(Efficiency) = (40)(0.82) = 32.8 engines per day DETERMINANTS OF EFFECTIVE CAPACITY a. Facilities. The design of facilities, including size and provision for expansion, is key. Locational factors, such as transportation costs, distance to market, labor supply, energy sources, and room for expansion, are also important. Likewise, layout of the work area often determines how smoothly work can be performed, and environmental factors such as heating, lighting, and ventilation also play a significant role in determining whether personnel can perform effectively or whether they must struggle to overcoat poor design characteristics. b. Products or service. Product or service design can have a tremendous influence on capacity. Generally speaking, the more uniform the output, the more opportunities there are for standardization of methods and materials, which leads to greater capacity. The particular mix of products or services rendered must also be considered since different items will have different rates of output. c. Processes. The quantity capability of a process is an obvious determinant of capacity. A more subtle determinant is the influence of output quality. For instance, if quality of output does not meet standards, the rate of output will be slowed by the need for inspection and rework activities. d. Human considerations. The tasks that make up ajob, 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. In addition, employee motivation has a very basic relationship to capacity, as do absenteeism and labor turnover. e. Operations. Scheduling problems may occur when an organization has differences in equipment capabilities among alternative pieces of equipment or differences in job requirements. Inventory stocking decisions, late deliveries, acceptability of purchased materials and parts, and quality inspection and control procedures also can have an impact on effective capacity. Inventory shortages of even one component of an assembled item (e.g., computers, refrigerators, automobiles) can cause a temporary halt to assembly operations until new components become available. This can have a major impact on effective capacity. Thus, insufficient capacity in one area can affect overall capacity. f. External forces. Product standards, especially minimum quality and performance standards, can restrict management's options for increasing and using capacity. Thus, Learning Module in Operations Management and TQM Page | 2  pollution standards on products and equipment often reduce effective capacity, as does paperwork required by government regulatory agencies by engaging employees in non-productive activities. A similar effect occurs when a union contract limits the number of hours and type of work an employee may do. Determining Capacity Requirements Capacity planning decisions involve both long-term and short-term considerations. Long-term considerations relate to overall level of capacity, such as facility size; short-term considerations relate to probable variations in capacity requirements created by such things as seasonal, random, and irregular fluctuations in demand. DEVELOPING CAPACITY ALTERNATIVES a. 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. Other considerations in flexible design involve layout of equipment, location, equipment selection, production planning, scheduling, and inventory policies. b. Differentiate between new and mature products or services. Mature products or services tend to be more predictable in terms of capacity requirements, and they may have limited life spans. New products tend to carry higher risk because of the uncertainty often associated with predicting the quantity and duration of demand. That makes flexibility appealing to managers. c. Take a "big picture" approach to capacity changes. When developing capacity alternatives, it is important to consider how parts of the system interrelate. d. Prepare to deal with capacity "chunks." Capacity increases are often acquired in fairly large chunks rather than smooth increments, making it difficult to achieve a match between desired capacity and feasible capacity. e. Attempt to smooth out capacity requirements. Unevenness in capacity requirements also can create certain problems. f. 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. PLANNING SERVICE CAPACITY Three very important factors in planning service capacity are (1) the need to be near customers, (2) the inability to store services, and (3) the degree of volatility of demand. Convenience for customers is often an important aspect of service. Generally, a service must be located near customers. Capacity must also be matched with the timing of demand. Unlike goods, services cannot be produced in one period and stored for use in a later period. Similarly, inventories of goods allow customers to immediately satisfy wants, whereas a customer who wants a service may have to wait. This can result in a variety of negatives for an organization that provides the service. Thus, speed of delivery, or customer waiting time, becomes a major concern in service capacity planning. Demand volatility presents problems for capacity planners. Demand volatility tends to be higher for services than for goods, not only in timing of demand, but also in the time required to service individual customers. EVALUATING ALTERNATIVES a. Calculating Processing Requirements. When evaluating capacity alternatives, a necessary piece of information is the capacity requirements of products that will be processed with a given alternative. To get this information, one must have reasonably accurate demand forecasts for each product, and know 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 used. Samples Problem 5.3 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. Product Annual Demand Standard Processing Time Processing Time Needed (Hr) per Unit (Hr) Learning Module in Operations Management and TQM Page | 3  #1 400 5.0 2,000 #2 300 8.0 2,400 #3 700 2.0 1,400 5,800 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 machines would be needed to handle the required volume: = 2.90 machines b. Cost-Volume Analysis. Cost-volume analysis 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 different operating conditions. It is particularly useful as a tool for comparing capacity alternatives. Use of the technique requires identification of all costs related to the production of a given product. These costs are then designated as fixed costs or variable costs.  Fixed Costs tend to remain constant regardless of volume of output. Examples include rental costs, property taxes, equipment costs, heating and cooling expenses, and certain administrative costs.  Variable costs vary directly with volume of output. The major components of variable costs are generally materials and labor costs. We will assume that variable cost per unit remains the same regardless of volume of output.  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 times volume: TC = FC + VC VC = Q X v Where; TC = Total Cost VC= Variable Cost Q = Quantity of Output v = Variable Cost per Unit  Total Revenue is computed as: TR = R x Q Where; TR = Total Revenue R = Revenue per Unit Q = Quantity of Output  Break-even Point (BEP). 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; 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 + v x Q) P = Q(R – v) – FC Q= QBEP = Sample Problem 5.4: The owner of Old-Fashioned Berry Pies, S. Simon, is contemplating adding a new line of pies, which will require leasing new equipment for a monthly payment of $6,000. Variable cost would be $2.00 per pie, and would retail for $7.00 each. a) How many pies must be sold in order to break even? b) What would the profit (loss) be if 1,000 pies are made and sold in a month? c) How many pies must be sold to realize a profit of $4,000? FC = $6,000; VC = $2 per pie; Rev = $7 per pie Solution a) QBEP = = = 1,200 pies/month b) For Q = 1,000, P = Q(R-v) – FC = 1,000 ($7-$2) - $6,000 = - $1,000 c) P = $4,000; solve for Q: Learning Module in Operations Management and TQM Page | 4  Q= = = 2,000 pies  Cost-volume analysis can be a valuable tool for comparing capacity alternatives if certain assumptions are satisfied: 1. One product is involved. 2. Everything produced can be sold. 3. The variable cost per unit is the same regardless of the volume. 4. Fixed costs do not change with volume changes, or they are step changes. 5. The revenue per unit is the same regardless of volume. 6. Revenue per unit exceeds variable cost per unit. c. Financial Analysis. Aproblem that is universally encountered by managers is how to allocate scarce funds. A common approach is to use financial analysis to rank investment proposals. Two Important Terms in Financial Analysis:  Cash Flow refers to the difference between the cash received from sales (of goods or services) and other sources (e.g., sale of old equipment) and the cash outflow for labor, materials, overhead, and taxes.  Present value expresses in current value the sum of all future cash flows of an investment proposal. Three Most Commonly Used Methods of Financial Analysis:  Payback is a crude but widely used method that focuses on the length of time it will take for an investment to return its original cost.  The present value (PV) method summarizes the initial cost of an investment, its estimated annual cash flows, and any expected salvage value in a single value called the equivalent current value, taking into account the time value of money (i.e., interest rates).  The internal rate of return (IRR) summarizes the initial cost, expected annual cash flows, and estimated future salvage value of an investment proposal in an equivalent interest rate. In other words, this method identifies the rate of return that equates the estimated future returns and the initial cost. d. Decision Theory. Decision theory is a helpful tool for financial comparison of alternatives under conditions of risk or uncertainty. It is suited to capacity decisions and to a wide range of other decisions managers must take.  Causes of Poor Decisions. 1. Decision process. Managers may skip a step or not devote enough effort to completing it before jumping to the next step. 2. Bounded rationality. The limitations on decision making caused by costs, human abilities, time, technology, and availability of information. 3. Suboptimization. The result of different departments each attempting to reach a solution that is optimum for that department.  Decision Environments. The three basic categories of decision environment based on the degree of certainty:  Certainty. Environment in which relevant parameters have known values.  Risk. Environment in which certain future events have probable outcomes.  Uncertainty. Environment in which it is impossible to assess the likelihood of various future events.  Decision Making under Certainty. When it is known for certain which of the possible future conditions will actually happen, the decision is usually relatively straightforward: Simply choose the alternative that has the best payoff under that state of nature.  Decision Making under Uncertainty. At the opposite extreme is complete uncertainty: no information is available on how likely the various states of nature are. Under those conditions, four possible decision criteria are maximin, maximax, Laplace, and minimax regret.  Maximin. Choose the alternative with the best of the worst possible payoffs. Learning Module in Operations Management and TQM Page | 5   Maximax. Choose the alternative with the best possible payoff.  Laplace. Choose the alternative with the best possible payoff.  Minimax Regret. Choose the alternative that has the least of the worst regrets. Sample Problem 5.5 Referring to the table below, determine which alternative would be chosen under each of these strategies. a) Maximin b) Maximax c) Laplace Solution: a) Using maximin, the worst payoffs for the alternatives are: Small Facility: $10 million Medium Facility: 7 million Large Facility: - 4 million Hence, since $10 million is the best, choose to build the small facility using maximin strategy. b) Using maximax, the best payoffs are: Small Facility: $10 millon Medium Facility: 12 million Large Facility: 16 million The best overall payoff is $16 million in the third row. Hence, the maximax criterion leads to building a large facility. c) For the Laplace criterion, first find the row totals, and then divide each of those amounts by the number of states of nature (three in this case). Because the medium facility has the highest average, it would be chosen under the Laplace criterion.  Decision Making under Risk. A widely used approach under such circumstances is the expected monetary value criterion. Expected value is the sum of the payoffs for an alternative where each payoff is weighted by the probability for the relevant state of nature. Thus, the approach is:  Expected MonetaryValue (EMV) criterion – determine payoff of each alternative, and choose the alternative that has the best expected payoff. Sample Problem 5.6 Using the expected monetary value criterion, identify the best alternative for the previous payoff table for these probabilities: low =.30, moderate =.50, and high =.20. Find the expected value of each alternative by multiplying the probability of occurrence for each state of nature by the payoff for that state of nature and summing them: EVSMALL =.30($10) +.50($10) +.20($10) = $10 EVMEDIUM =.30($7) +.50($12) +.20($12) = $10.5 EVLARGE =.30(-4) +.50($2) +.20($16) = $3 Hence, choose the medium facility because it has the highest expected value.  Decision Trees. A decision tree is a schematic representation of the alternatives available to a decision maker and their possible consequences. The term gets its name from the treelike appearance of the diagram. The diagram below shows an example of a decision tree: Learning Module in Operations Management and TQM Page | 6  e. Waiting Line Analysis. Analysis of lines is often useful for designing service systems. Waiting lines have tendency to form a wide variety of service systems. The lines are symptoms of bottleneck operations. Analysis is useful in helping managers choose a capacity level that will be cost-effective through balancing the cost of having customers wait with the cost of providing additional capacity. It can be aid in the determination of expected cost for various levels of service capacity. References Stevenson, W.J. 2012. Operations Management. McGraw-Hill Companies Inc. New York, 11th Edition Stevenson, W.J. 2002. Operations Management. McGraw-Hill Companies Inc. New York, 7th Edition Kumar, A. S. & Suresh, N. 2009. Operations Management. New Age International (P) Limited, Publishers. New Delhi Learning Module in Operations Management and TQM Page | 7