Strategic Capacity Management

SCML 200 - Supply Chain Management & Operations Chapter 4: Strategic Capacity Management 1 Learning Objectives 1. Understand the concept of capacity and how important it is to “manage” capacity. 2. Explain the impact of economies of scale of...

SCML 200 - Supply Chain Management & Operations Chapter 4: Strategic Capacity Management 1 Learning Objectives 1. Understand the concept of capacity and how important it is to “manage” capacity. 2. Explain the impact of economies of scale of a firm. 3. Determine capacity requirements. 4. Understand how to use decision trees to analyze alternatives when faced with the problem of adding capacity. 5. Describe the differences in planning capacity between manufacturing firms and service firms. 2 Capacity Management in Operations  Capacity: the ability to hold, receive, store, or accommodate  Inbusiness, viewed as the amount of output that a system is capable of achieving over a specific period of time  Capacity management needs to consider both inputs and outputs 3 Capacity Planning Time Durations Long range Greater than one year (acquiring buildings, equipment, Strategic facilities) Intermediate range Monthly or quarterly plans covering the next six to eighteen months (hiring, new tools, minor equipment purchases, Tactical subcontracting) Short range Less than one month (overtime, personnel transfer, Operational alternative production routings) 4 Strategic Capacity Planning  Determining the overall level of capital-intensive resources that best supports the company’s Strategic long-range competitive strategy.  Facilities/Buildings  Equipment/Machinery capacity  Labor force size/Staff size  Capacity planning has high impact on the firm’s response rate, its cost structure, inventory policies 5 Capacity Utilization  Capacity utilization rate  Reveals how well a firm is using its potential capacity  Ratio of capacity used to Best operating level  Best operating level: capacity level for which the process was designed (the output level at which average unit cost is minimized)  If the capacity utilization rate is high (close to 100%), the firm is operating at “full capacity”  If this rate is low, a situation of "excess capacity" exists Capacity used leal Capacity utilization rate = Best Operating Level 6 Example http://www.youtube.com/watch?v=9SiNowSrUPs Question 1: Luxury cakes produces 750 cakes per week, their capacity being 1,200 cakes per week. What is their capacity utilization? Question 2: Using the following information, comment on the effect of increasing output to 900 cakes per week. Price: 10 £ Fixed cost: 4,000 £ Variable cost: 5 £ 7 Economies of Scale  Economies of scale: the cost advantages that businesses obtain as they increase their size.  As a plant gets larger, and volume increases, the average cost per unit drops, because: 1. Fixed cost per unit drops (equipment, etc.) 2. Lower Operating and capital costs 3. Labor becomes more specialized  Specialization economies of scale: division of labor is possible (workers need to focus on less tasks so they become efficient)  Technical economies of scale: Larger companies can make savings by investing in more efficient operations (ex: good IT systems, better distribution systems by delivering in bulk) https://www.youtube.com/watch?v=6ihehRMtRWc 8  Diseconomies of Scale  Diseconomies of scale is the opposite of economies of scale and happen when the plant becomes too large and exceeds the needs of the company, which results in production of goods and services at higher cost per unit. The reasons are:  The company needs high demand volume to keep the large facility busy (to maintain a high demand the firm may be forced to do many discounts so profit decreases)  Larger costs to maintain equipment (Ex: M&M Mars)  Control: It is more difficult to control and monitor workers in a larger company  Communication is slower in large companies (messages get lost, less communication between workers and upper management) 9 Capacity Planning Concepts  Capacity Focus The idea that a production facility works best when it is concentrated on a limited set of production objectives  Focused factory or plant within a plant (PWP) concept. This allows finding best operating level for each PWP.  As the two products have different characteristics, by separating their production, this factory can operate more efficiently. 10 Capacity flexibility  Capacity Flexibility – the ability to rapidly increase or decrease product levels or the ability to shift rapidly from one product or service to another  Achieved through flexible plants, processes and workers:  Flexible plants: Ability to quickly adapt to change by using movable equipment, knockdown walls, reroutable utilities  Flexible processes: rapid low cost switching from one product to another. Requires flexible manufacturing systems and simple, easily setup equipment  Flexible workers: Ability to switch from one kind of task to another quickly, Multiple skills (cross training) 11 Example – Honda Case  Read the article about Honda on Blackboard  How does Honda achieve capacity flexibility?  In which ways can Honda use its capacity flexibility as strategic competitive dimension? 12 Considerations in Changing Capacity Maintaining System Balance Similar capacities at each operation are desired Manage bottleneck operations Frequency of Capacity Additions upgrading too frequently is expensive (small chunks) upgrading too infrequently is expensive (large chunks) External Sources of Capacity Outsourcing Sharing capacity (e.g. airlines companies sharing same planes) Decreasing Capacity Temporary reductions (scheduling fewer hours) Permanent reductions 13 Frequent versus Infrequent Capacity Expansions 14 Planning Service Capacity Manufacturing Service Capacity Capacity Goods can be stored for Capacity must be available later use when service is needed – cannot be stored Goods can be shipped to Service must be available at other locations customer demand point Volatility of demand is Much higher volatility is relatively low typical 15 Determining Capacity Requirements Use forecasting to Calculate labor Project labor and predict sales for and equipment equipment individual requirements to availability over products meet forecasts the planning horizon 16 Example 4.1: Determining Capacity Requirements  Stewart Company produces two flavors of salad dressing: Paul’s and Newman’s  Each is available in eiher bottles and single-serving bags as packaging  Forecast for the next 5 years is given in the next slide  The company has:  3 machines that can package 150,000 bottles each year (2 operators / machine)  5 machines that can package 250,000 bags per year (3 operators / machine)  What are the capacity and labor requirements for the next five years? 17 Determining Capacity Requirements Step 1:Use forecasting to Year predict sales for individual products 1 2 3 4 5 Bottles (000s) Bottles (000s) 60 100 150 200 250 Paul’s Plastic bags Plastic Bags(000s) (000s) 100 200 300 400 500 Bottles (000s) Bottles (000s) 75 85 95 97 98 Newman’s Plastic bags Plastic Bags(000s) (000s) 200 400 600 650 680 Step 1.1: Calculate Total Year product line forecasts 1 2 3 4 5 Bottles (000s) Bottles (000s) 135 185 245 297 348 Plastic Plastic Bags (000s) bags (000s) 300 600 900 1050 1180 60+75 100+200 18 Determining Capacity Requirements Step 2: Calculate equipment and Year labor requirements 1 2 3 4 5 Bottles Bottles (000s) (000s) 135 185 245 297 348 Plastic Plastic bags (000s) Bags (000s) 300 600 900 1050 1180 Bottling Operation Bagging Operation 3 machines with 150,000 bottles capacity each 5 machines with 250,000 bottles capacity each 2 operators /machine 3 operators /machine Total available capacity = 3 x 150,000 = 450,000 bottles/year Total available capacity = 5 x 250,000 = 1,250,000 bags/year Year 1 Year 1 , ,  Capacity utilization= = 𝟎. 𝟑 = 𝟑𝟎%  Capacity utilization= = 𝟎. 𝟐𝟒 = 𝟐𝟒% , , ,  Machine requirement = 0.3x3=0.9 machines  Machine requirement = 0.24x5=1.2 machines  Labor requirement =0.9x2=1.8 operators  Labor requirement =1.2x3=3.6 operators 19 Determining Capacity Requirements Step 3: Project equipment and Year labor availabilities 1 2 3 4 5 Percentage capacity utilized 30% 41% 54% 66% 77% Bottle Bottles (000s) Machine requirement 0.9 1.23 1.62 1.98 2.31 Operation Labor requirement 1.8 2.46 3.24 3.96 4.62 Percentage capacity utilized 24% 48% 72% 84% 94% Plastic Bags Bag Machine requirement 1.2 2.4 3.6 4.2 4.7 Operation (000s) Labor requirement 3.6 7.2 10.8 12.6 14.1 Excel: Capacity Requirements 20 Conclusions – present situation  Bottling operations  Max. capacity utilization is 77% (year 5), which gives room for addressing unexpected events (fluctuations in demand, machine failures, illness)  Machine requirements: The max. machine requirement is 2.31 machines in year 5. The company has 3 machines, which is above the max. machine requirement.  Labor requirements: The max. labor requirement is 4.62 in year 5. The present number of workers is 6, which is again above the max. labor requirement. 21 Conclusions – present situation  Plastic bags operations  Max. capacity utilization is 94% (year 5), which might be tight for addressing unexpected events (fluctuations in demand, machine failures, illness)  Machine requirements: The company has 5 machines. The machine requirement in years 4 and 5 is less than 5 but above 4 so the company should revise the requirements in future years to avoid capacity problems.  Labor requirements: The present number of workers is 15. Labor requirement in year 5 is less than 15 but above 14 so the company might consider to hire new employees in future years to avoid capacity problems. 22 Exercise - Higher demand in year 5  Assume now that the total demand for plastic bags in year 5 will be 1,500,000 and not 1,180,000. Calculate the machine and labor requirement in year 5.  1 75 0 1 21 Is the current number of machines (5) and the current number of operators (15) sufficient to satisfy all the demand for plastic bags in year 5? If no, by how much the capacity must be increased? 1 27 5 6.35 15 95 25 6 35 23 Decision Trees for Capacity Analysis  A decision tree is a schematic model of the sequence of steps in a problem – including the conditions and consequences of each step  Decision trees help analysts understand the problem and assist in identifying the best solution  Decision tree components  Decision nodes – represented with squares  Chance nodes – represented with circles  Paths – links between nodes 24 Decision Trees - Example  The owner of Hackers Computer Store is evaluating three options for the next five years: expand at current site, expand to a new site, do nothing  The decision process includes the following assumptions and conditions  Strong growth has a 55% probability  New site cost is $210,000 Annual returns: $195,000 /year if strong growth and $115,000 /year if weak growth  Expanding current site cost is $87,000 Annual returns : $190,000, /year if strong growth and $100,000 /year if weak growth  Do nothing Annual returns : $170,000 /year if strong growth and $105,000 per year if weak growth 25 Decision Trees - Example  Decisions: Move to a new site Costs: $210,000 IF Strong growth: revenue $195,000/year Weak growth: revenue $115,000/year Expand the company: Costs: $87,000 IF Strong growth: revenue $190,000/year weak growth: revenue $100,000/year Do nothing this year If Strong growth : Revenue: $190,000/year Weak growth Revenue $105,000 26 Decision Trees - Example  Diagram the problem chronologically Events Revenue- Move cost Revenue- Move cost Revenue- Expansion cost Revenue- Expansion cost Revenue Revenue Decision 27 Decision Trees - Example  Calculate the value (profit) of each alternative Alternative Revenue ($) Cost ($) Profit = Revenue-Cost Move, strong growth 195,000 x 5 210,000 765,000 Move, weak growth 115,000 x 5 210,000 365,000 Expand store, strong growth 190,000 x 5 87,000 863,000 Expand store, weak growth 100,000 x 5 87,000 413,000 Do nothing, strong growth 170,000 x 5 0 850,000 Do nothing, weak growth 105,000 x 5 0 525,000 How to calculate profit: Profit = Revenue – Cost = ( 195,000 x 5 ) – 210,000 = $765,000 28 Decision Trees - Example Revenue - Move cost $765,000 Revenue - Move cost $365,000 Revenue - Expansion cost $863,000 Revenue - Expansion cost $413,000 Revenue $850,000 Revenue $525,000 29 Decision Trees - Example Expected profit= $765,000 x 0.55 + $365 000 x 0.45 = $585,000 Revenue - Move cost $765,000 $585,000 Revenue - Move cost $365,000 Revenue - Expansion cost $863,000 $660,500 Revenue - Expansion cost $413,000 Revenue $850,000 $703,750 Revenue $525,000 The decision tree indicates that the best alternative is to do nothing, as this brings the highest expected profit : $703,750 30 Homework Exercises  Capacity requirement:  1,4,5,6,7  page 111  Decision tree:  Problem 8,9  pages 111,112 31 Thank you. Your Questions? 32