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Strategic Capacity Planning for Products and Services
Chapter 5
Copyright ©2018 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
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You should be able to:
LO 5.1 Name the three key questions in capacity planning
LO 5.2 Explain the importance of capacity planning
LO 5.3 Describe ways of defining and measuring capacity
LO 5.4 Name several determinants of effective capacity
LO 5.5 Discuss factors to consider when deciding whether to operate in-house or outsource
LO 5.6 Discuss the major considerations related to developing capacity alternatives
LO 5.7 Describe the steps that are used to resolve constraint issues
LO 5.8 Briefly describe approaches that are useful for evaluating capacity alternatives
Learning Objective: Chapter 5
Copyright ©2018 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
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Capacity
The upper limit or ceiling on the load that an operating unit can handle
Capacity needs include
Equipment
Space
Employee skills
Capacity Planning
LO 5.1
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Goal
To achieve a match between the long-term supply capabilities of an organization and the predicted level of long-term demand
Overcapacity operating costs that are too high
Undercapacity strained resources and possible loss of customers
Strategic Capacity Planning
LO 5.1
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Key questions:
What kind of capacity is needed?
How much is needed to match demand?
When is it needed?
Related questions:
How much will it cost?
What are the potential benefits and risks?
Are there sustainability issues?
Should capacity be changed all at once, or through several smaller changes
Can the supply chain handle the necessary changes?
Capacity Planning Questions
LO 5.1
Copyright ©2018 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
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Capacity decisions
Impact the ability of the organization to meet future demands
Affect operating costs
Are a major determinant of initial cost
Often involve long-term commitment of resources
Can affect competitiveness
Affect the ease of management
Have become more important and complex due to globalization
Need to be planned for in advance due to their consumption of financial and other resources
Capacity Decisions Are Strategic
LO 5.2
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Measure capacity in units that do not require updating
Why is measuring capacity in dollars problematic?
Two useful definitions of capacity
Design capacity
The maximum output rate or service capacity an operation, process, or facility is designed for
Effective capacity
Design capacity minus allowances such as personal time and maintenance
Defining and Measuring Capacity
LO 5.3
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Actual output
The rate of output actually achieved
It cannot exceed effective capacity
Efficiency
Utilization
Measured as percentages
Measuring System Effectiveness
LO 5.3
Copyright ©2018 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
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Design Capacity = 50 trucks per day
Effective Capacity = 40 trucks per day
Actual Output = 36 trucks per day
Example – Efficiency and Utilization
LO 5.3
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Facilities
Product and service factors
Process factors
Human factors
Policy factors
Operational factors
Supply chain factors
External factors
Determinants of Effective Capacity
LO 5.4
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Strategy Formulation
Strategies are typically based on assumptions and predictions about:
Long-term demand patterns
Technological change
Competitor behavior
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Leading
Build capacity in anticipation of future demand increases
Following
Build capacity when demand exceeds current capacity
Tracking
Similar to the following strategy, but adds capacity in relatively small increments to keep pace with increasing demand
Capacity Strategies
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Capacity cushion
Extra capacity used to offset demand uncertainty
Capacity cushion = 100% - utilization
Capacity cushion strategy
Organizations that have greater demand uncertainty typically have greater capacity cushion
Organizations that have standard products and services generally have smaller capacity cushion
Capacity Cushion
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Estimate future capacity requirements
Evaluate existing capacity and facilities; identify gaps
Identify alternatives for meeting requirements
Conduct financial analyses
Assess key qualitative issues
Select the best alternative for the long term
Implement alternative chosen
Monitor results
Steps in Capacity Planning
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Forecasting Capacity Requirements
Long-term considerations relate to overall level of capacity requirements
Require forecasting demand over a time horizon and converting those needs into capacity requirements
Short-term considerations relate to probable variations in capacity requirements
Less concerned with cycles and trends than with seasonal variations and other variations from average
Copyright ©2018 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
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Calculating processing requirements requires reasonably accurate demand forecasts, standard processing times, and available work time
Calculating Processing Requirements
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Service capacity planning can present a number of challenges related to:
The need to be near customers
Convenience
The inability to store services
Cannot store services for consumption later
The degree of demand volatility
Volume and timing of demand
Time required to service individual customers
Service Capacity Planning
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Strategies used to offset capacity limitations and that are intended to achieve a closer match between supply and demand
Pricing
Promotions
Discounts
Other tactics to shift demand from peak periods into slow periods
Demand Management Strategies
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Once capacity requirements are determined, the organization must decide whether to produce a good or service itself or outsource
Factors to consider:
Available capacity
Expertise
Quality considerations
The nature of demand
Cost
Risks
In-House or Outsource?
LO 5.5
Copyright ©2018 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
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Things that can be done to enhance capacity management:
Design flexibility into systems
Take stage of life cycle into account
Take a “big-picture” approach to capacity changes
Prepare to deal with capacity “chunks”
Attempt to smooth capacity requirements
Identify the optimal operating level
Choose a strategy if expansion is involved
Developing Capacity Alternatives
LO 5.6
Copyright ©2018 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
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Bottleneck Operation
An operation in a sequence of operations whose capacity is lower than that of the other operations
LO 5.6
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5-‹#›
Optimal Operating Level
Minimum
cost
Average cost per unit
Rate of output
Optimal
Output
rate
LO 5.6
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5-‹#›
Economies of scale
If output rate is less than the optimal level, increasing the output rate results in decreasing average per unit costs
Diseconomies of scale
If the output rate is more than the optimal level, increasing the output rate results in increasing average per unit costs
Economies and Diseconomies of Scale
LO 5.6
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Economies of scale
If output rate is less than the optimal level, increasing the output rate results in decreasing average per unit costs
Reasons for economies of scale:
Fixed costs are spread over a larger number of units
Construction costs increase at a decreasing rate as facility size increases
Processing costs decrease due to standardization
Economies of Scale
LO 5.6
Copyright ©2018 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
5-‹#›
Diseconomies of scale
If the output rate is more than the optimal level, increasing the output rate results in increasing average per unit costs
Reasons for diseconomies of scale
Distribution costs increase due to traffic congestion and shipping from a centralized facility rather than multiple smaller facilities
Complexity increases costs
Inflexibility can be an issue
Additional levels of bureaucracy
Diseconomies of Scale
LO 5.6
Copyright ©2018 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
5-‹#›
Facility Size and Optimal Operating Level
Minimum cost & optimal operating rate are
functions of size of production unit.
Average cost per unit
Small
plant
Medium
plant
Large
plant
Output rate
LO 5.6
Copyright ©2018 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
5-‹#›
Constraint
Something that limits the performance of a process or system in achieving its goals
Categories
Market
Resource
Material
Financial
Knowledge or competency
Policy
Constraint Management
LO 5.7
Copyright ©2018 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
5-‹#›
Identify the most pressing constraint
Change the operation to achieve maximum benefit, given the constraint
Make sure other portions of the process are supportive of the constraint
Explore and evaluate ways to overcome the constraint
Repeat the process until the constraint levels are at acceptable levels
Resolving Constraint Issues
LO 5.7
Copyright ©2018 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
5-‹#›
Alternatives should be evaluated from varying perspectives
Economic
Is it economically feasible?
How much will it cost?
How soon can we have it?
What will operating and maintenance costs be?
What will its useful life be?
Will it be compatible with present personnel and present operations?
Non-economic
Public opinion
Evaluating Alternatives
LO 5.8
Copyright ©2018 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
5-‹#›
Techniques for Evaluating Alternatives
Cost-volume analysis
Financial analysis
Decision theory
Waiting-line analysis
Simulation
Evaluating Alternatives (cont.)
LO 5.8
Copyright ©2018 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
5-‹#›
Cost-volume analysis
Focuses on the relationship between cost, revenue, and volume of output
Fixed Costs (FC)
Tend to remain constant regardless of output volume
Variable Costs (VC)
Vary directly with volume of output
VC = Quantity(Q) x variable cost per unit (v)
Total Cost
TC = FC + VC
Total Revenue (TR)
TR = revenue per unit (R) x Q
Cost-Volume Analysis
LO 5.8
Copyright ©2018 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
5-‹#›
BEP
The volume of output at which total cost and total revenue are equal
Profit (P) = TR – TC = R x Q – (FC +v x Q)
= Q(R – v) – FC
Break-Even Point (BEP)
LO 5.8
Copyright ©2018 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
5-‹#›
Cost-Volume Relationships
.
LO 5.8
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5-‹#›
Cost-Volume Relationships (cont.)
Capacity alternatives may involve step costs, which are costs that increase stepwise as potential volume increases
The implication of such a situation is the possible occurrence of multiple break-even quantities
LO 5.8
Copyright ©2018 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
5-‹#›
Cost-volume analysis is a viable tool for comparing capacity alternatives if certain assumptions are satisfied
One product is involved
Everything produced can be sold
The variable cost per unit is the same regardless of volume
Fixed costs do not change with volume changes, or they are step changes
The revenue per unit is the same regardless of volume
Revenue per unit exceeds variable cost per unit
Cost-Volume Analysis Assumptions
LO 5.8
Copyright ©2018 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
5-‹#›
Cash flow
The difference between cash received from sales and other sources, and cash outflow for labor, material, overhead, and taxes
Present value
The sum, in current value, of all future cash flow of an investment proposal
Financial Analysis
LO 5.8
Copyright ©2018 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
5-‹#›
Capacity planning impacts all areas of the organization
It determines the conditions under which operations will have to function
Flexibility allows an organization to be agile
It reduces the organization’s dependence on forecast accuracy and reliability
Many organizations utilize capacity cushions to achieve flexibility
Bottleneck management is one way by which organizations can enhance their effective capacities
Capacity expansion strategies are important organizational considerations
Expand-early strategy
Wait-and-see strategy
Capacity contraction is sometimes necessary
Capacity disposal strategies become important under these
conditions
Operations Strategy
Copyright ©2018 McGraw-Hill Higher Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
5-‹#›
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