1

Capacity Planning

2

Outline CAPACITY

Defining Capacity Capacity and Strategy Capacity Considerations Managing Demand

CAPACITY PLANNING BREAKEVEN ANALYSIS

Single-Product Case Multiproduct Case

3

Outline - Continued APPLYING DECISION TREES TO CAPACITY

DECISIONS STRATEGY DRIVEN INVESTMENTS

Investment, Variable Cost, and Cash Flow Net Present Value

4

Learning ObjectivesWhen you complete this supplement, you should be able

to :Identify or Define:

Capacity Design Capacity Effective Capacity Utilization

5

Learning Objectives

When you complete this supplement, you should be able to:

Explain: Capacity Considerations Net Present Value Analysis Breakeven Analysis Financial Considerations Strategy-Driven Investments

6

How much long-range capacity is needed When more capacity is needed Where facilities should be located (location) How facilities should be arranged (layout)

Facility planning answers:

Facility Planning

7

Forecast

Demand

Compute

Needed

Capacity

Compute

Rated

Capacity

Evaluate

Capacity

Plans

Implement

Best Plan

Qualitative

Factors

(e.g., Skills)

Select Best

Capacity

Plan

Develop

Alternative

Plans

Quantitative

Factors

(e.g., Cost)

Capacity Planning Process

8

Types of Planning Over a Time Horizon

Add FacilitiesAdd long lead time equipment

Schedule Jobs Schedule Personnel Allocate Machinery

Sub-ContractAdd EquipmentAdd Shifts

Add PersonnelBuild or Use Inventory

Long Range Planning

Intermediate Range Planning

Short Range Planning

Modify Capacity Use Capacity

*

*

*Limited options exist

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Definition and Measures of Capacity

Capacity:

The “throughput,” or number of units a facility can hold, receive, store, or produce in a period of time.

Utilization: Actual output as a percent of design capacity.

Effective capacity:

Capacity a firm can expect to receive given its product mix, methods of scheduling, maintenance, and standards of quality.

Efficiency: Actual output as a percent of effective capacity.

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Actual or Expected Output

Actual (or Expected) Output =

(Effective Capacity)(Efficiency)

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Measure of planned or actual capacity usage of a facility, work center, or machine

UtilizationActual Output

Design CapacityPlanned hours to be used

Total hours available

=

=

Utilization

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Measure of how well a facility or machine is performing when used

EfficiencyActual output

Effective CapacityActual output in units

Standard output in unitsAverage actual time

Standard time

=

=

=

Efficiency

13

Implications of Capacity Changes

Changes in:• Sales• Cash flow• Quality• Supply chain• Human resources• Maintenance

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Special Requirements for Making Good Capacity Decisions

Forecast demand accurately Understanding the technology and capacity

increments Finding the optimal operating level (volume) Build for change

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Cost Structure for a Roadside Motel

25 room roadside motel 50 room

roadside motel

75 room roadside motel

Economies of Scale

Diseconomies of Scale

Number of Rooms

Aver

age

Unit

Cost

(dol

lars

per

uni

t per

nig

ht)

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Strategies for Matching Capacity to Demand

1. Making staffing changes (increasing or decreasing the number of employees)

2. Adjusting equipment and processes – which might include purchasing additional machinery or selling or leasing out existing equipment

3. Improving methods to increase throughput; and/or

4. Redesigning the product to facilitate more throughput

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Approaches to Capacity ExpansionExpected Demand Expected Demand

Expected Demand Expected Demand

Time in Years Time in Years

Time in YearsTime in Years

Dem

and

Dem

and

Dem

and

Dem

and

New Capacity

New Capacity New Capacity

New Capacity

Capacity leads demand with an incremental expansion Capacity leads demand with a one-step expansion

Capacity lags demand with an incremental expansionAttempts to have an average capacity, with

an incremental expansion

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Approaches to Capacity ExpansionExpected Demand

Time in Years

Dem

and

New Capacity

Capacity leads demand with an incremental expansion

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Approaches to Capacity ExpansionExpected Demand

Time in Years

Dem

and

New Capacity

Capacity leads demand with a one-step expansion

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Approaches to Capacity Expansion

Expected Demand

Time in Years

Dem

and

New Capacity

Capacity lags demand with an incremental expansion

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Approaches to Capacity Expansion

Expected Demand

Time in Years

Dem

and

New Capacity

Attempts to have an average capacity, with an incremental expansion

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Breakeven Analysis

Technique for evaluating process & equipment alternativesObjective: Find the point ($ or units) at which total cost equals total revenueAssumptionsRevenue & costs are related linearly to volumeAll information is known with certaintyNo time value of money

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Break-Even Analysis

Fixed costs: costs that continue even if no units are produced: depreciation, taxes, debt, mortgage payments

Variable costs: costs that vary with the volume of units produced: labor, materials, portion of utilities

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Breakeven Chart

Fixed cost

Variable cost

Total cost line

Total revenue line

ProfitBreakeven pointTotal cost = Total revenue

Volume (units/period)

Cost

in D

olla

rs

Loss

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Crossover Chart

Fixed cost - Process A

Fixed cost - Process BFixed cost - Process C

Total cost - Process CTotal cost - Process B

Total co

st - P

roce

ss A

Process A: low volume, high varietyProcess B: Repetitive

Process C: High volume, low variety

Process CProcess BProcess A Lowest cost process

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Cost of Wrong Process Found Via Breakeven Analysis

Fixed cost

$

Variablecost

Fixed cost

$Variable

cost

Fixed cost

$Variable

cost

Low volume, highvariety process

Repetitive process High volume, lowvariety process

A B Volume

B1

B2B3

Total cost for lowvolume high variety

Total cost for repetitive processTotal cost for high volume,

low variety process

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Decision Tree and Capacity Decision

-$90,000$60,000

-10,000

$40,000

Market favorable (0.4)

Market unfavorable (0.6)

Market favorable (0.4)

Market unfavorable (0.6)

Market favorable (0.4)

Market unfavorable (0.6)

$100,000

-5,000

$0

-$14,000

$18,000

$13,000

Large Plant

Medium PlantSmall PlantDo nothing

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Strategy Driven Investment Select investments as part of a coordinated strategic plan Choose investments yielding competitive advantage Consider product life cycles Include a variety of operating factors in the financial return

analysis Test investments in light of several revenue projections

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Net Present Value

F = future valueP = present valueI = interest rateN = number of years

Ni

FP

)1(

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NPV in a More Convenient Form

N

N

)(i

FXP

i

FP

1

1X where

)1(

Year 5% 6% 7% 8%

1 0.952 0.943 0.935 0.857

2 0.907 0.890 0.873 0.857

3 0.864 0.840 0.816 0.794

4 0.823 0.792 0.763 0.735

5 0.784 0.747 0.713 0.681

6 0.746 0.705 0.666 0.630

7 0.711 0.665 0.623 0.583

8 0.677 0.627 0.582 0.540

9 0.645 0.592 0.544 0.500

Present value of $1.00

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Present Value of an Annuity (S)

X = Factor from Table S = present value of a series of uniform

annual receipts R = receipts that are received every year for

the life of the investment

RXS

Year 5% 6% 7% 8%

1 0.952 0.943 0.935 0.926

2 1.859 1.833 1.808 1.783

3 2.723 2.673 2.624 2.577

4 3.546 3.465 3.387 3.312

5 4.329 4.212 4.100 3.993

6 5.076 4.917 4.766 4.623

7 5.786 5.582 5.389 5.206

8 6.843 6.210 5.971 5.747

9 7.108 6.802 7.024 6.247

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Limitations of Net Present Value Investments with the same present value may

have significantly different project lives and different salvage values

Investments with the same net present values may have different cash flows

We assume that we know future interest rates - which we do not

We assume that payments are always made at the end of the period - which is not always the case

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Extras

34

Vary staffing Change equipment

& processes Change methods Redesign the product for

faster processing

Capacity Management

Vary prices Vary promotion Change lead times

(e.g., backorders) Offer complementary

products

Demand Management

Managing Existing Capacity

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Complementary Products

Time (Months)

Sales (Units)

Jet Skis

Snow-mobiles

Total

01,000

2,000

3,000

4,0005,000

J M M J S N J M M J S N J