POM module 1.pdf

PRODUCTION - is the creation of goods & services OPERATIONS MANAGEMENT (OM) -is the management of systems or processes that create goods and/or services through the transformation of inputs to outputs. It includes planning, designing and operating systems to achieve goals of the organization...

PRODUCTION - is the creation of goods & services OPERATIONS MANAGEMENT (OM) -is the management of systems or processes that create goods and/or services through the transformation of inputs to outputs. It includes planning, designing and operating systems to achieve goals of the organization INPUT PROCESS OUTPUT Examples Why Study OM? 1. Study how people organize themselves for productive enterprise 2. Know how goods and services are produced 3. Understand what operations managers do 4. Because OM is such a costly part of an organization What Operations Managers Do? The management process is the application of planning, organizing, staffing, leading and controlling to the achievement of objectives. 10 OM Strategy Decisions: Design of Goods & Human Resources Services Supply Chain Managing Quality Management Process Strategy Inventory Management Location Strategies Scheduling Layout Strategies Maintenance  Where are the OM Jobs? *OM activities are at the core of all business organizations. *40% or more of all jobs are in OM. *Activities in all other areas of business organizations are all interrelated with OM. OM Jobs Organizing to produce goods & services Organization Finance Operations Marketing Operations Management for a manufacturer Finance/ Marketing Operations Accounting Production Quality Manufacturing Purchasing Control Control Operations Management for an airline Finance/ Marketing Operations Accounting Flight Ground Facility Catering Operations Support Maintenance  3 Basic Functions of Business Organizations Operations Must interact Perform to achieve different but organization’s related goals & activities Finance Marketing objectives Organizational Success = Interface Finance Function  securing resources at favorable prices  allocating resources throughout the organization Finance and Operations Management personnel cooperate by exchanging information and expertise in such activities as: 1. Budgeting 2. Economic Analysis of Investment Proposals 3. Provision of Funds  Marketing Function  Focus is on selling and/or promoting goods or services of the organization  Responsible for assessing customer wants & needs  Communicates to Operations:  Demand Information (purchase mat’ls, schedule work)  Competitor Information (new product design, quality improvement, process enhancement)  Consumer Preferences (lead time, capacity info, manufacturability of design for new product dev’t) Operations Function  goods – oriented  service – oriented Types of Operations Examples Goods Producing………… Farming, Mining, Manufacturing Storage/Transportation… Warehousing, Trucking, Mail Service, Airline Exchange…………………. Retailing, Banking, Leasing, Library Entertainment…………….. Films, radio & TV Communications…………. Newspapers, Telephone, Internet  Essence of Operations Function Value - Added INPUTS Transformation/ Land Conversion Human PROCESS OUTPUTS Cutting, Drilling Raw Materials - Goods Transportation / Storage Equipment Canning, Construction - Services Facilities Farming, Mining Information Mixing, Packing Consulting Feedback Feedback Feedback Control VALUE-ADDED is the term used to describe the difference between the cost of inputs and the value or price of outputs. Non- Profit Organizations - the value of outputs is their value to the society. - the greater the value added , the greater the effectiveness of these operations. Profit Organizations - The value of outputs is measured by the prices that customers are willing to pay for those goods or services. - The greater the value added the greater the amount of funds available for these purposes. Scope of Operations Management SYSTEM DESIGN – involves decisions relating to the system capacity, geographic locations of facilities, arrangement of departments, layout of equipment, product or service planning, and acquisition of equipment. SYSTEM OPERATION – involves management of personnel, inventory planning & control, scheduling, project management, and quality assurance  Responsibilities of the Operations Manager Is responsible for the creation of goods and/or services Plans, coordinates and controls the elements that make up the process (4M’s of Production – Man, Machine, Materials & Method) Is more involved in day-to-day operating decisions than with decisions relating to system design. Has a vital stake in system design because system design essentially determines many of the parameters of system operations, such as cost, space, capacities and quality. DIFFERENTIATING FEATURES of OPERATING SYSTEMS 1. Degree of Standardization 2. Type of Operation 3. Production of Goods versus Service Operations Degree of Standardization Standardized Output high degree of uniformity in goods (ex. computers, canned goods) or services (ex. carwash, commercial airline service) Customized Output product or service is designed for a specific case or individual (ex. cut-to-order glass windows, tailor-fitted suits) Degree of Standardization Systems with Custom Systems Standardized Output  Different jobs  Standardized  More skilled methods workers  Less skilled  Work moves workers slower  Uniform Materials  Work is less  Mechanization susceptible to mechanization  Type of Operation SINGLE, LARGE SCALE PRODUCT CONTINOUS or PROCESS BATCHES SERVICE CUSTOMIZED MASS INDIVIDUAL PRODUCTION UNITS of OUTPUT  PRODUCTION of GOODS versus SERVICE OPERATIONS manufacturing : goods – oriented service : act – oriented Differences involve the ff: 1. Customer contact 2. Uniformity of input 3. Labor content of jobs 4. Uniformity of output 5. Measurement of productivity 6. Simultaneous production & delivery 7. Quality assurance  Characteristic Goods vs Services Output………………………….. Tangible Intangible Uniformity of Output……. High Low Uniformity of Input………. High Low Labor Content………………. Low High Measuring Productivity… Easy Difficult Customer Contact………… Low High Opportunity to correct quality problems before delivery to customer High Low Evaluation…………………….. Easier More Difficult Patentable…………………….. Usually Not usually  Attributes Attributes of of Goods Services Product can be resold. Reselling a service is unusual. Product can be inventoried. Many services cannot be inventoried. Some aspects of quality are Many aspects of quality are measurable. difficult to measure. Selling is distinct from Selling is often part of the production. service. Product is transportable. Provider, not product, is often transportable. Site of facility is important for Site of Facility is important for cost. customer contact. Often easy to automate. Service is often difficult to automate. Revenue is generated primarily Revenue is generated primarily from the intangible services.  Operations Management Chapter 1 – Operations and Productivity Poweroint presentation to accompany Heizer/Render Principles of Operations Management, © 2008 Prentice Hall, Inc. 1–1  Significant Events in OM Figure 1.3 © 2008 Prentice Hall, Inc. 1–2  The Heritage of OM  Division of labor (Adam Smith 1776; Charles Babbage 1852)  Standardized parts (Whitney 1800)  Scientific Management (Taylor 1881)  Coordinated assembly line (Ford/ Sorenson 1913)  Gantt charts (Gantt 1916)  Motion study (Frank and Lillian Gilbreth 1922)  Quality control (Shewhart 1924; Deming 1950) © 2008 Prentice Hall, Inc. 1–3  The Heritage of OM  Computer (Atanasoff 1938)  CPM/PERT (DuPont 1957)  Material requirements planning (Orlicky 1960)  Computer aided design (CAD 1970)  Flexible manufacturing system (FMS 1975)  Baldrige Quality Awards (1980)  Computer integrated manufacturing (1990)  Globalization (1992)  Internet (1995) © 2008 Prentice Hall, Inc. 1–4  Eli Whitney  Born 1765; died 1825  In 1798, received government contract to make 10,000 muskets  Showed that machine tools could make standardized parts to exact specifications  Musket parts could be used in any musket © 2008 Prentice Hall, Inc. 1–5  Frederick W. Taylor  Born 1856; died 1915  Known as ‘father of scientific management’  In 1881, as chief engineer for Midvale Steel, studied how tasks were done  Began first motion and time studies  Created efficiency principles © 2008 Prentice Hall, Inc. 1–6  Taylor’s Principles Management Should Take More Responsibility for:  Matching employees to right job  Providing the proper training  Providing proper work methods and tools  Establishing legitimate incentives for work to be accomplished © 2008 Prentice Hall, Inc. 1–7  Frank & Lillian Gilbreth  Frank (1868-1924); Lillian (1878- 1972)  Husband-and-wife engineering team  Further developed work measurement methods  Applied efficiency methods to their home and 12 children!  Book & Movie: “Cheaper by the Dozen,” book: “Bells on Their Toes” © 2008 Prentice Hall, Inc. 1–8  Henry Ford  Born 1863; died 1947  In 1903, created Ford Motor Company  In 1913, first used moving assembly line to make Model T  Unfinished product moved by conveyor past work station  Paid workers very well for 1911 ($5/day!) © 2008 Prentice Hall, Inc. 1–9  W. Edwards Deming  Born 1900; died 1993  Engineer and physicist  Credited with teaching Japan quality control methods in post- WW2  Used statistics to analyze process  His methods involve workers in decisions © 2008 Prentice Hall, Inc. 1 – 10  Challenges in OM From To  Local or national focus  Global focus  Batch shipments  Just-in-time  Low bid purchasing  Supply chain partnering  Lengthy product  Rapid product development development, alliances  Standard products  Mass customization  Job specialization  Empowered employees, teams © 2008 Prentice Hall, Inc. 1 – 11  Trends in OM Past Causes Future Local or Reliable worldwide Global focus, national communication and moving focus transportation networks production offshore Batch (large) Short product life cycles Just-in-time shipments and cost of capital put performance pressure on reducing inventory Low-bid Supply chain competition Supply chain purchasing requires that suppliers be partners, engaged in a focus on the collaboration, end customer alliances, outsourcing Figure 1.6 © 2008 Prentice Hall, Inc. 1 – 12  New Trends in OM Past Causes Future Lengthy Shorter life cycles, Rapid product product Internet, rapid international development, development communication, computer- alliances, aided design, and collaborative international collaboration designs Standardized Affluence and worldwide Mass products markets; increasingly customization flexible production with added processes emphasis on quality Job Changing socioculture Empowered specialization milieu; increasingly a employees, knowledge and information teams, and lean society production Figure 1.6 © 2008 Prentice Hall, Inc. 1 – 13  New Trends in OM Past Causes Future Low-cost Environmental issues, ISO Environmentally focus 14000, increasing disposal sensitive costs production, green manufacturing, recycled materials, remanufacturing Ethics not Businesses operate more High ethical at forefront openly; public and global standards and review of ethics; opposition social to child labor, bribery, responsibility pollution expected Figure 1.6 © 2008 Prentice Hall, Inc. 1 – 14  New Trends in OM  Global focus  Just-in-time performance  Supply chain partnering  Rapid product development  Mass customization  Empowered employees  Environmentally sensitive production  Ethics © 2008 Prentice Hall, Inc. 1 – 15  Productivity Challenge Productivity is the ratio of outputs (goods and services) divided by the inputs (resources such as labor and capital) The objective is to improve productivity! Important Note! Production is a measure of output only and not a measure of efficiency © 2008 Prentice Hall, Inc. 1 – 16  The Economic System Inputs Processes Outputs Labor, The U.S. economic system Goods capital, transforms inputs to outputs and management at about an annual 2.5% services increase in productivity per year. The productivity increase is the result of a mix of capital (38% of 2.5%), labor (10% of 2.5%), and management (52% of 2.5%). Feedback loop Figure 1.7 © 2008 Prentice Hall, Inc. 1 – 17  Improving Productivity at Starbucks A team of 10 analysts continually look for ways to shave time. Some improvements: Stop requiring signatures Saved 8 seconds on credit card purchases per transaction under $25 Change the size of the ice Saved 14 seconds scoop per drink New espresso machines Saved 12 seconds per shot © 2008 Prentice Hall, Inc. 1 – 18  Improving Productivity at Starbucks A team of 10 analysts continually look for ways to shave time. Some improvements: Operations improvements have helped Starbucks Stop requiring signatures increase Saved yearly 8 seconds revenue per outlet on credit card purchases perby $200,000 to transaction under $25 $940,000 in six years. Change the sizeProductivity of the ice hasSaved improved by 27%, 14 seconds scoop or about 4.5% per peryear. drink New espresso machines Saved 12 seconds per shot © 2008 Prentice Hall, Inc. 1 – 19  Productivity Units produced Productivity = Input used  Measure of process improvement  Represents output relative to input  Only through productivity increases can our standard of living improve © 2008 Prentice Hall, Inc. 1 – 20  Productivity Calculations Labor Productivity Units produced Productivity = Labor-hours used 1,000 = = 4 units/labor-hour 250 One resource input  single-factor productivity © 2008 Prentice Hall, Inc. 1 – 21  Multi-Factor Productivity Output Productivity = Labor + Material + Energy + Capital + Miscellaneous  Also known as total factor productivity  Output and inputs are often expressed in dollars Multiple resource inputs  multi-factor productivity © 2008 Prentice Hall, Inc. 1 – 22  Collins Title Productivity Old System: Staff of 4 works 8 hrs/day 8 titles/day Payroll cost = $640/day Overhead = $400/day Old labor 8 titles/day = productivity 32 labor-hrs © 2008 Prentice Hall, Inc. 1 – 23  Collins Title Productivity Old System: Staff of 4 works 8 hrs/day 8 titles/day Payroll cost = $640/day Overhead = $400/day Old labor 8 titles/day = productivity 32 labor-hrs =.25 titles/labor-hr © 2008 Prentice Hall, Inc. 1 – 24  Collins Title Productivity Old System: Staff of 4 works 8 hrs/day 8 titles/day Payroll cost = $640/day Overhead = $400/day New System: 14 titles/day Overhead = $800/day Old labor 8 titles/day = productivity 32 labor-hrs =.25 titles/labor-hr New labor 14 titles/day = productivity 32 labor-hrs © 2008 Prentice Hall, Inc. 1 – 25  Collins Title Productivity Old System: Staff of 4 works 8 hrs/day 8 titles/day Payroll cost = $640/day Overhead = $400/day New System: 14 titles/day Overhead = $800/day Old labor 8 titles/day = productivity 32 labor-hrs =.25 titles/labor-hr New labor 14 titles/day = =.4375 titles/labor-hr productivity 32 labor-hrs © 2008 Prentice Hall, Inc. 1 – 26  Collins Title Productivity Old System: Staff of 4 works 8 hrs/day 8 titles/day Payroll cost = $640/day Overhead = $400/day New System: 14 titles/day Overhead = $800/day Old multifactor 8 titles/day = productivity $640 + 400 © 2008 Prentice Hall, Inc. 1 – 27  Collins Title Productivity Old System: Staff of 4 works 8 hrs/day 8 titles/day Payroll cost = $640/day Overhead = $400/day New System: 14 titles/day Overhead = $800/day Old multifactor 8 titles/day = =.0077 titles/dollar productivity $640 + 400 © 2008 Prentice Hall, Inc. 1 – 28  Collins Title Productivity Old System: Staff of 4 works 8 hrs/day 8 titles/day Payroll cost = $640/day Overhead = $400/day New System: 14 titles/day Overhead = $800/day Old multifactor 8 titles/day = =.0077 titles/dollar productivity $640 + 400 New multifactor 14 titles/day = productivity $640 + 800 © 2008 Prentice Hall, Inc. 1 – 29  Collins Title Productivity Old System: Staff of 4 works 8 hrs/day 8 titles/day Payroll cost = $640/day Overhead = $400/day New System: 14 titles/day Overhead = $800/day Old multifactor 8 titles/day = =.0077 titles/dollar productivity $640 + 400 New multifactor 14 titles/day = =.0097 titles/dollar productivity $640 + 800 © 2008 Prentice Hall, Inc. 1 – 30  Measurement Problems  Quality may change while the quantity of inputs and outputs remains constant  External elements may cause an increase or decrease in productivity  Precise units of measure may be lacking © 2008 Prentice Hall, Inc. 1 – 31  Productivity Variables  Labor - contributes about 10% of the annual increase  Capital - contributes about 38% of the annual increase  Management - contributes about 52% of the annual increase © 2008 Prentice Hall, Inc. 1 – 32  Key Variables for Improved Labor Productivity  Basic education appropriate for the labor force  Diet of the labor force  Social overhead that makes labor available  Maintaining and enhancing skills in the midst of rapidly changing technology and knowledge © 2008 Prentice Hall, Inc. 1 – 33  Investment and Productivity 10 Percent increase in productivity 8 6 4 2 0 10 15 20 25 30 35 Percentage investment © 2008 Prentice Hall, Inc. 1 – 34  Service Productivity  Typically labor intensive  Frequently focused on unique individual attributes or desires  Often an intellectual task performed by professionals  Often difficult to mechanize  Often difficult to evaluate for quality © 2008 Prentice Hall, Inc. 1 – 35  Productivity at Taco Bell Improvements:  Revised the menu  Designed meals for easy preparation  Shifted some preparation to suppliers  Efficient layout and automation  Training and employee empowerment © 2008 Prentice Hall, Inc. 1 – 36  Productivity at Taco Bell Improvements: Results: Revised the menu  Designed meals for easy preparation  Preparation time cut to 8 seconds  Shifted some preparation to suppliers  Management span of control  Efficient layoutfrom increased and automation 5 to 30  Training and labor  In-store employee empowerment cut by 15 hours/day  Stores handle twice the volume with half the labor  Fast-food low-cost leader © 2008 Prentice Hall, Inc. 1 – 37  2 Product and Service Design Copyright © 2014 by McGraw-Hill Education (Asia). All rights reserved.  Product and Service Design  Important as it affects:  Cost  Quality  Time-to-market  Customer satisfaction  Competitive advantage Product and service design—or redesign—should be closely tied to an organization’s strategy 4-2 Product or Service Design Activities 1. Translate customer wants and needs into product and service requirements 2. Refine existing products and services 3. Develop new products and services 4. Formulate quality goals 5. Formulate cost targets 6. Construct and test prototypes 7. Document specifications 4-3 Reasons for Product or Service Design  Economic  Social and demographic  Political, liability, or legal  Competitive  Cost or availability  Technological 4-4  Objectives of Product and Service Design  Main focus  Customer satisfaction  Understand what the customer wants  Secondary focus  Function of product/service  Cost/profit  Quality  Appearance  Ease of production/assembly  Ease of maintenance/service 4-5  Other Issues in Product and Service Design  Product/service life cycles  Degree of standardization  Mass customization  Product/service reliability  Robustness of design  Degree of newness  Cultural differences  Global Product Design 4-6  Life Cycles of Products or Services Figure 4.1 Saturation Maturity Demand Decline Growth Introduction Time 4-7  Standardization  Standardization  Extent to which there is an absence of variety in a product, service, or process  Standardized products are immediately available to customers 4-8  Advantages of Standardization  Fewer parts to deal with in inventory and manufacturing  Design costs are generally lower  Reduced training costs and time  More routine purchasing, handling, and inspection procedures  Quality is more consistent 4-9  Advantages of Standardization  Orders fillable from inventory  Opportunities for long production runs and automation  Need for fewer parts justifies increased expenditures on perfecting designs and improving quality control procedures 4-10  Disadvantages of Standardization  Designs may be frozen with too many imperfections remaining  High cost of design changes increases resistance to improvements  Decreased variety results in less consumer appeal 4-11  Mass Customization  Mass customization:  A strategy of producing standardized goods or services, but incorporating some degree of customization  Delayed differentiation  Modular design 4-12  Delayed Differentiation  Delayed differentiation or postponement  Producing but not quite completing a product or service until customer preferences or specifications are known 4-13  Modular Design Modular design is a form of standardization in which component parts are subdivided into modules that are easily replaced or interchanged. It allows:  easier diagnosis and remedy of failures  easier repair and replacement  simplification of manufacturing and assembly 4-14  Reliability  Reliability: The ability of a product, part, or system to perform its intended function under a prescribed set of conditions  Failure: Situation in which a product, part, or system does not perform as intended  Normal operating conditions: The set of conditions under which an item’s reliability is specified 4-15  Improving Reliability  Component design  Production/assembly techniques  Testing  backup  Preventive maintenance procedures  User education  System design 4-16  Robust Design Robust design: Design that results in products or services that can function over a broad range of conditions 4-17  Degree of Newness 1. Modification of an existing product/service 2. Expansion of an existing product/service 3. Clone of a competitor’s product/service 4. New product/service 4-18  Cultural Differences  Multinational companies must take into account cultural differences related to the product design. 4-19  Global Product Design  Virtual teams  Uses combined efforts of a team of designers working in different countries  Provides a range of comparative advantages over traditional teams such as:  Engaging the best human resources around the world  Possibly operating on a 24-hr basis  Global customer needs assessment  Global design can increase marketability 4-20  Global Product Design  Original Equipment Manufacturer (OEM)  Designs and manufactures a product based on its own specifications and sells to another company for branding and distribution  Original Design Manufacturer (ODM)  Designs and manufactures a product according to purchaser’s specifications  Original Brand Manufacturer (OBM)  Sells an entire product that is manufactured by a second company under its own brand 4-21  Phases in Product Development Process 1. Idea generation 2. Feasibility analysis 3. Product specifications 4. Process specifications 5. Prototype development 6. Design review 7. Market test 8. Product introduction 9. Follow-up evaluation 4-22  Idea Generation Supply-chain based Ideas Competitor based Research based 4-23  Reverse Engineering Reverse engineering is the dismantling and inspecting of a competitor’s product to discover product improvements. 4-24 Research & Development (R&D)  Organized efforts to increase scientific knowledge or product innovation, and may involve:  Basic Research: advances knowledge about a subject without near-term expectations of commercial applications.  Applied Research: achieves commercial applications.  Development: converts results of applied research into commercial applications. 4-25  Service Design  Service is an act  Service delivery system  Facilities  Processes  Skills  Many services are bundled with products 4-26  Service Design  Service design involves  The physical resources needed  The goods that are purchased or consumed by the customer, or provided with the service  Explicit services  Implicit services 4-27  Example  Explicit services: The benefits that are readily observable by the senses and that consist of the essential feature of the service; such as absence of pain after a tooth is repaired/ extracted.  Implicit services: psychological benefits that the customer may sense only vaguely, or the intrinsic feature of the services; such as cheerful flight attendant. 4-28  Service Design  Service  Something that is done to or for a customer  Service delivery system  The facilities, processes, and skills needed to provide a service  Product bundle  The combination of goods and services provided to a customer  Service package  The physical resources needed to perform the service 4-29  Product Bundle  McDonalds Value Meals  automobiles with features such as AC,sunroofs and geographical systems  Computer Package Cross – industry bundling  airline ticket with credit card 4-30  Service Package  4-31  4-32  Differences Between Product and Service Design  Tangible – intangible  Services created and delivered at the same time  Services cannot be inventoried  Services highly visible to customers  Services have low barrier to entry and exit  Location is important to service design  Range of service systems  Demand variability 4-33  Phases in Service Design 1. Conceptualize 2. Identify service package components 3. Determine performance specifications 4. Translate performance specifications into design specifications 5. Translate design specifications into delivery specifications 4-34  Service Blueprinting  Service blueprinting  A method used in service design to describe and analyze a proposed service  A useful tool for conceptualizing a service delivery system 4-35  Major Steps in Service Blueprinting 1. Establish boundaries 2. Identify sequence of customer interactions  Prepare a flowchart 3. Develop time estimates 4. Identify potential failure points 4-36 Characteristics of Well-Designed Service Systems 1. Consistent with the organization mission 2. User friendly 3. Robust 4. Easy to sustain 5. Cost-effective 6. Value to customers 7. Effective linkages between back operations 8. Single unifying theme 9. Ensure reliability and high quality 4-37  Challenges of Service Design 1. Variable requirements 2. Difficult to describe 3. High customer contact 4. Service – customer encounter 4-38  Guidelines for Successful Service Design 1. Define the service package 2. Focus on customer’s perspective 3. Consider image of the service package 4. Recognize that designer’s perspective is different from the customer’s perspective 5. Make sure that managers are involved 6. Define quality for tangible and intangibles elements 7. Make sure that recruitment, training, and rewards are consistent with service expectations 8. Establish procedures to handle exceptions 9. Establish systems to monitor service 4-39  What Operations Managers Do? 10 OM Strategy Decisions: 10 Decision Areas: Design of Goods & Services service & product design Managing Quality quality management Process Strategy process & capacity design Location Strategies location layout design Layout Strategies human resources & job design Human Resources supply chain management Supply Chain Management inventory, MRP, and J-I-T Inventory Management intermediate, short-term, Scheduling and project scheduling Maintenance maintenance  Scope of Operations Management  SYSTEM DESIGN – involves decisions relating to the system capacity, geographic locations of facilities, arrangement of departments, layout of equipment, product or service planning, and acquisition of equipment.  SYSTEM OPERATION – involves management of personnel, inventory planning & control, scheduling, project management, and quality assurance  Capacity  the maximum amount that something can contain  the ability or power to do, experience, or understand something. Synonyms: volume, size, magnitude, dimensions, measurements, proportions  Capacity Decisions  Most fundamental of all design decisions that operations managers must make  With long-term consequences for the organization Affect a large portion of fixed cost Determine if demand will be met or if facilities will be idle  Answer basic capacity planning questions on What kind of capacity is needed? How much is needed? When is it needed?  Made regularly or infrequently (governed by) Products/services design Stability of demand Rate of technological change in equipment Competitive factors  Importance of Capacity Decisions  Real input on the ability of the organization to meet future demands for products and services  Effect on operating costs (attempt to balance the costs of over- and under capacity)  Major determinant of initial cost  Long-term commitment of resources  Effect on competitiveness (barrier to entry by competition, delivery speed)  Effect on ease of management  Defining Capacity  Capacity – the upper limit or ceiling on the load that an operating unit (plant, department, machine, store, or worker) can handle  Capacity Issues – important for all organizations and at all levels of an organization  important information for planning purposes : to quantify production capability in terms of inputs/outputs make other decisions or plans related to those quantities  The term, “capacity” has different interpretations, leading to difficulties in measuring capacity  Measuring Capacity  Important to choose one that does NOT require updating (ex. dollar amounts)  Basic measure is UNITS of a product OUTPUT ok with single-product operations problems with multi-product operations (product mix will necessitate frequent change in composite index of capacity)  Alternative : refer capacity to AVAILABILITY of INPUTS (e.g. no. of hospital beds, m/c hours available, # of passenger seats)  “No single measure of capacity will be appropriate in every situation.” Rather the measure of capacity must be TAILORED to the SITUATION.  Measures of Capacity Business Inputs Ouputs Auto manufacturing Labor or Machine hours No. of cars per shift Steel Mill Furnace Size Metric tons of steel per day Oil Refinery Refinery Size Barrels of fuels per day Metric tons of grain per Farming No. of hectares, no. of cows hectare/yr, liters of milk /day Restaurant No. of tables, seating capacity No. of meals served /day No. of tickets sold Theater No. of seats /performance Retail Sales Square meters of floor space Revenue generated per day  Useful Definitions of Capacity DESIGN CAPACITY – theoretical maximum output that can be attained by a system in a given period (achieved under ideal conditions) EFFECTIVE CAPACITY – capacity a firm can expect to achieve given its product mix, methods of scheduling, m/c maintenance, standards of quality, and so on Effective Capacity  Design Capacity Actual Output  Effective Capacity (due to realities of m/c breakdowns, absenteeism, shortages of materials, quality problems and outside factors)  Measures of System Effectiveness Efficiency = Actual Output__ Effective Capacity Utilization = Actual Output_ Design Capacity Example : Given the information below, 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 : Actual Output__ 36 trucks per day_ Efficiency = = = 90% Effective Capacity 40 trucks per day Utilization = Actual Output_ = 36 trucks per day_ = 72% Design Capacity 50 trucks per day  Determinants of Effective Capacity I. FACILITIES 1. Design (size and provision for expansion) 3. Layout (smooth work flow) 2. Location (labor supply, energy sources) 4. Environment (ventilation) II. PRODUCTS or SERVICES 1. Design (more uniform output  std. mat’ls & methods  greater capacity) 2. Product or Service Mix (different items  different output rates) III. PROCESSES (Quantity Capabilities : obvious determinant of capacity) (Quality Capabilities : quality  = output rate  due to inspection) IV. HUMAN FACTORS (job content, job design, training & experience, motivation, compensation, learning rates, absenteeism & turnover) V. OPERATIONAL FACTORS (scheduling, materials management, QA, maintenance policies and equipment breakdowns) VI. EXTERNAL FACTORS 1. Product standards 3. Unions 2. Safety Regulations 4. Pollution control standards INADEQUATE PLANNING = major limiting determinant of effective capacity  Determining Capacity Requirements  Capacity Planning Decisions involve Long-term considerations (relate to overall level of capacity, e.g. size) Short-term considerations (relate to probable variations in capacity requirements due to demand fluctuations) Irregular Variations : examples are major equipment breakdown, storms that disrupts normal routine, discovery of health hazard etc….  Link between Marketing and Operations is crucial to a realistic determination of capacity requirements Long-Term Capacity : more on cycles and trends Short-Term Capacity : concerned more with seasonal variations or variations from an average (yearly, monthly, weekly, daily fluctuations  Seasonal Demand Patterns Period Items Year Beer sales, toy sales, airline traffic, clothing, vacations, tourism Month bank trasactions, welfare and security checks Week retail sales, hotel registration, restaurant meals Day telephone calls , classroon utilization, , power usage  Managing Demand Even with good forecasting and facilities built into that forecast,there may be a poor match between actual demand and available capacity  Demand Exceeds Capacity When demand exceeds capacity, the firm may be able to curtail demand by raising prices, scheduling long lead times, and discouraging marginally profitable business.  Capacity Exceeds Demand When capacity exceeds demand, the firm may stimulate demand through price reductions or aggressive marketing, or accommodate product changes.  Adjusting to Seasonal Demands A seasonal or cyclical pattern of demand is another capacity challenge wherein management may find it helpful to offer products with complementary demand patterns. Tactics for Matching Capacity to Demand 1. Making staffing changes (increase/decrease in no. of employees) 2. Adjusting equipment and processes (adding a machine/selling equipment) 3. Improving methods to increase throughput 4. Redesigning the product to facilitate more throughput  Developing Capacity Alternatives 1. Design flexibility into systems (e.g. provision for future expansion) 2. Differentiate between new and mature products or services Mature Products  predictable demand  capacity requirements  limited life spans  find alt. use for additional capacity New Products  higher risk in predicting quantity and duration of demand 3. Take a “big picture” approach to capacity changes (important to consider how parts of the system interrelate) 4. Attempt to smooth out capacity requirements Seasonality Issues  under/over utilization  overtime, subcontracting, hedging 5. Identify the optimal operating level Choice of Capacity  availability of financial & other resources forecasts of expected demand  Planning Service Capacity 3 Important Factors: 1) Need to be near customers Convenience – important aspect of service (e.g. hotels) Capacity & Location – are closely tied 2) Inability to store services Timing of Demand – must be matched by capacity Speed of Delivery – major concern in capacity planning Service Level – brings into issue the cost of maintaining capacity 3) Degree of volatility of demand Number of individual customers (ex. Banks experiencing days w/ Time to service each customer higher volume of transactions & varying nature of transactions) (Peak Periods – extra workers, outsourcing, pricing & promotion)  Evaluating Capacity Alternatives  Economic Considerations Feasibility – payback, useful life Costs – financing, operations & maintenance Timing – how soon available Compatibility with present operations & people  Public Opinion Environmental concern, relocation issue, technology upgrade repercussions such as termination of jobs  Capacity Evaluation Techniques  Financial Analysis  Decision Theory  Waiting-Line Analysis  Cost-Volume Analysis  Financial Analysis  Need to rank investment proposals due to problem of allocating scarce funds  3 most commonly used methods  Payback = initial cost  net cash flow  Present Value = time value of money  Internal Rate of Return = equivalent interest rate  2 important terms in financial analysis CASH FLOW - refers to the difference between cash received (from sales and from other sources like sales of old equipment) and cash outflow for labor, materials etc. PRESENT VALUE – expresses in current value the sum of all future cash flows of an investment proposal  Net Present Value  Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. NPV is used in capital budgeting and investment planning to analyze the profitability of a projected investment or project.  Net Present Value A means of determining the discounted value of a series of future cash receipts  Consider the time value of money: say investing $100 in a bank at 5% for 1 year: $105 = $100(1 +.05) For the second year: $110.25 = $105(1 +.05) = $100(1 +.05)2 In general, F = P ( 1 + i )N  P = F N = FX (1+i) where X = a factor from PV of $1 Table defined as 1/( 1+ i )N  In situations of where an investment generates an annual series of uniform and equal cash amounts (called annuity) The basic relationship is S = RX , where X = factor from PV of an Annuity of $1 Table S = present value of a series of uniform annual receipts R = receipts every year for the life of the investment (the annuity) Present Value Method Example No. 1 Your boss, Mr. La Forge, has told you to evaluate the cost of two machines. After some questioning, you are assured that they have the following costs. Assume: a) the life of each machine is 3 years, and b) the company thinks it knows how to make 14% on investments no riskier than this one. Machine A Machine B Original cost $ 13,000 $ 20,000 Labor cost per year 2,000 3,000 Floor space per year 500 600 Energy (electricity) per year 1,000 900 Maintenance per year 2,500 500 Total annual cost $ 6,000 $ 5,000 ====== ====== Salvage value $2,000 $7,000  Present Value Method Example No.1 ….con’t Solution : Determine via the present value method which machine to purchase. From PV Machine A Machine B Table of $1 Given P V Given P V Now Expense 1.000 $13,000 $13,000 $20,000 $20,000 Yr. 1 Expense.877 6,000 5,262 5,000 4,385 Yr. 2 Expense.769 6,000 4,614 5,000 3,845 Yr. 3 Expense.675 6,000 4,050 5,000 3,375 Salvage $26,926 $31,605 Yr.3 Revenue.675 $2,000 -$ 1,350 $7,000 -$ 4,725 $25,576  $26,880 ====== ====== Machine A is the low-cost purchase since it has the lower sum of net costs.  Present Value Method Example No.2 Quality Plastics, Inc. is considering two different investment alternatives. Investment A has an initial cost of $25,000, and investment B has an initial cost of $26,000. Both investments have a useful life of 4 years. The cash flows for these investments are shown below. The cost of capital or the interest rate (i) is 8%. Present Value Investment A’s Investment B’s PV of a $1 Year Factor at 8% Cash Flow PV’s Cash Flow Annuity PV’s 1.926 $ 10,000 $ 9,260 $ 9,000 $$ 9,000 8,834 2.857 9,000 7,713 9,000 x 7,713 3.794 8,000 6,352 9,000 7,146 4.735 7,000 5,145 9,000 3.312 6,615 Totals $28,470 $29,808 Minus initial investment - 25,000 - 26,000 Net present value $ 3,470 $ 3,808 Based on the NPV criterion, MORE ATTRACTIVE   Decision Theory and Waiting-Line Analysis  Decision Theory is helpful for financial comparison of alternatives under conditions of risk or uncertainty; applying decision trees to capacity decisions that maximize the expected value of the alternatives arising from states of nature (usually future demand or market favorability) that are assigned probabilities  Waiting-Line Analysis is often used for designing service systems and helpful in choosing a capacity level that is cost-effective through balancing the cost of having customers wait with the cost of providing additional capacity; also aids in the determination of expected costs for various levels of service capacity  Decision Tree Example Southern Hospital Supplies, a company that makes hospital gowns, is considering capacity expansion. Its major alternatives are to do nothing, build a small plant, build a medium plant, or build a large plant. The new facility would produce a new type of gown, and currently the potential or marketability for this product is unknown. If a large plant is built and a favorable market exists, a profit of $100,000 could be realized. An unfavorable market would yield a $90,000 loss. However, a medium plant would earn a $60,000 profit with a favorable market. A $10,000 loss would result from an unfavorable market. A small plant, on the other hand, would return $40,000 with favorable market conditions and lose only $5,000 in an unfavorable market. Of course, there is always the option of doing nothing. Recent market research indicates that there is a 0.4 probability of a favorable market, which means that there is also a 0.6 probability of an unfavorable market. Which alternative is more attractive for Southern?  Decision Tree Solution: The alternative that will result in the highest expected monetary value (EMV) can be selected. -$ 14,000 Market favorable (.4) $100,000 Market unfavorable (.6) -$ 90,000 +$ 18,000 Market favorable (.4) $ 60,000 ? Medium plant Market unfavorable (.6) -$ 10,000 +$ 13,000 Market favorable (.4) $ 40,000 Market unfavorable (.6) -$ 5,000 $0  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.  Required for computation:  demand forecasts for each product  standard processing time per unit of each product on each alternative machine  number of work days per year  Number of shifts that will be used Example: A store works one eight-hour shift, 250 days a year, and has these figures for usage of a machine that is currently being considered: Annual Standard Processing Processing Time Product Demand Time per Unit (Hour) Needed (Hour) #1 400 5.0 2,000 #2 300 8.0 2,400 #3 700 2.0 1,400 Annual capacity 5,800 = ------- 2.90 = 1 m/c working 8 hrs/shift x 1 shift/day x 250 days/yr = 2,000 machines  Calculating Processing Requirements Example No. 2 A manager must decide which type of machine to buy, A, B, or C. Machine costs are: Machine Cost A $40,000 B $30,000 C $80,000 Product forecasts & processing times on the machines are as follows: Annual Processing Time (Minutes) per Unit Product Demand A B C 1 16,000 3 4 2 2 12,000 4 4 3 3 6,000 5 6 4 4 30,000 2 2 1 Assume that only purchasing costs are being considered. Which machine would have the lowest total cost, and how many of that machine would be needed? Machines operate 10 hours a day, 250 days a year.  Calculating Processing Requirements Solution to Example No. 2 Calculate demand in total number of processing minutes per product on each machine: Buy 2 machines of B Product A B C 1 48,000 64,000 32,000 2 48,000 48,000 36,000 3 30,000 36,000 24,000 4 60,000 60,000 30,000 Total Minutes 186,000 208,000 122,000  60 (in Hours) 3,100 3,467 2,033  annual capacity = 10 hours / day x 250 days / yr = 2,500 No. of Machines 1.24  2 1.39  2 0.81  1 Purchase Cost $80,000 $60,000 $80,000 =======  Cost – Volume Analysis  Focuses on relationships between COST, REVENUE and VOLUME of output  Purpose is to estimate income of an organization under different operating conditions  Tool for comparing alternatives under the following ASSUMPTIONS: 1) One product is involved. 2) Everything produced can be sold. 3) The variable cost per unit is the same regardless of 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.  Provides a conceptual framework for integrating cost, revenue and profit estimates into CAPACITY DECISIONS  Cost – Volume Analysis  Fixed Costs ( FC) – constant, regardless of volume of output (e..g. rental, taxes, administrative expenses)  Variable Costs (VC)– change directly with volume of output (generally materials and labor costs); assumes that variable cost per unit () remains the same regardless of volume of output (Q )  Total Cost = Fixed Costs + Variable Costs or TC = FC + VC, where variable cost, VC = Q x  Total Revenue , TR = Q x SP , where SP = selling price per unit or TR = Q x R , where R = revenue per unit  Profit is P = TR – TC = (Q x SP ) - [ FC + (Q x ) ] P = Q ( SP - ) - FC  required volume to Q = P + FC generate a specified profit SP -  Break – Even Analysis  Objective : To find the point, in dollars and units, at which costs equal revenues. TR  Graphic Approach $ Break-Even Point TC TR = TC VC $ BEP$ VC FC FC Volume BEPQ Volume  Algebraic Approach At BEP, TR = TC Break - even in units , BEPQ = FC Q x SP = FC + (Q x ) SP - Break – even in dollars, BEP$ = FC 1 - / SP  Break – Even Analysis Example No. 1 Single-Product Case Jimmy Stephens, Inc. has fixed costs of $10,000 this period. Direct labor is $1.50 per unit and material is $0.75 per unit. The selling price is $4.00 per unit. Determine the break- even point in dollars and units. Solution: = DL + material = 1.50 +.75 = $2.25 BEP$ = FC = $10,000 = $22,857.14 1 - / SP 1 - (2.25 / 4.00) BEPQ = F = $10,000 = 5,714 units SP - c 4.00 - 2.25  Break – Even Analysis Example No. 2 Single-Product Case The owner of Old Fashioned Berry Pies, S. Simon, is contemplating adding a new machine line of pies, which will require leasing new equipment for a monthly payment of $6,000. Variable costs would be $2 per pie, and pies would retail for $7 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? Solution: a) BEPQ = FC = $6,000 = 1,200 pies / month SP - $7 - $2 b) At Q = 1,000 pies, P = Q ( SP - ) - FC = 1000($7 – $2) - $6,000 = -$ 1,000 (loss) c) To make a profit (P) of $4,000 , Q = P + FC = 4,000 + 6,000 = 2,000 SP - 7 -2 pies  Break – Even Analysis Example No. 3 Step Costs / Multiple B-E Points A manager has the option of purchasing one, two, or three machines. Fixed costs and potential volume are as follows: Number of Total Annual Corresponding Machines Fixed Costs Range of Output 1 $ 9,600 0 to 300 2 15,000 301 to 600 3 20,000 601 to 900 Variable cost is $10 per unit, and revenue is $40 per unit. a) Determine the break-even point for each range. b) If projected annual demand is between 580 and 660 units, how many machines should the manager purchase? Solution: Compute B-E for each range and compare with projected range of demand. BEPQ(1 m/c) = FC / (R - ) = $9,600 / $ (40 –10)/unit = 320 units [ not in the range, so there is no BEP ] BEPQ(2 m/c) = $15,000 / $(40 – 10)/unit = 500 units [ Buy 2 machines ] BEPQ(3 m/c) = $20,000 / $(40 – 10)/unit = 667 units [ not in the range  loss ]  Break – Even Analysis Example No. 4 Multi-Product Case  Firms offering a variety of products that have different selling prices and variable costs, the break-even point is where, BEP$ = F V = variable cost per unit  [ ( 1 – Vi / Pi ) x (Wi) ] SP = selling price per unit F = fixed cost W = percent each product is of total dollar sales i = each product  Illustration: Information for Le Bistro, a French-style deli, follows. Fixed costs are $3,500 per month. Annual Forecasted Item Selling Price Cost Sales Units Sandwich $2.95 $1.25 7,000 Soft drink.80.30 7,000 Baked potato 1.55.47 5,000 Tea.75.25 5,000 Salad bar 2.85 1.00 3,000  Break – Even Analysis Example No. 4 Multi-Product Case (con’t) Solution : Annual [1-(V/P)]xW= Selling Variable Forecasted Wi = Weighted Item (i) Price (P) Cost (V) (V / SP) 1 - (V/P) Sales ($) % of Sales Contribution SW $2.95 $1.25.42.58 $ 20,650.446.259 SD.80.30.38.62 5,600.121.075 BP 1.55.47.30.70 7,750.167.117 T.75.25.33.67 3,750.081.054 SB 2.85 1.00.35.65 8,550.185.120 $46,300 1.000.625 BEP$ = F = $3,500/mo. X 12 mos. = $67,200  [ ( 1 – Vi / Pi ) x (Wi) ].625 If there are 52 weeks at 6 work days each, determine (a) the total daily sales to break even, and (b) the number of sandwiches that must be sold each day. (a) BEP$ (daily) = $67,200 = $215.38 (b) No. of =.446 x $215.38 = 32.5 or 312 days Sandwiches $2.95 33 each day