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Operations&ProductionManagement 1/31/2015
ResourcePerson:Dr.MuhammadWasif 1
Operations & Production Management
(OPM)Dr. Muhammad Wasif
Visiting Faculty, IBA.
3 - Capacity Planning
2
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CapacitySection 3.1
3
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Capacity
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The throughput, or the number of units a
facility can hold, receive, store, or
produce in a period of time
Determines fixed costs
Determines if demand will be satisfied
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Capacity
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Capacity also includes
Equipment
Space
Employee skills
The basic questions in capacity handling are:
What kind of capacity is needed?
How much is needed?
When is it needed?
Calculating Processing Requirements
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
ProductAnnual
Demand
Standardprocessing time
per unit (hr.)Processing time
needed (hr.)
#1
#2
#3
400
300
700
5.0
8.0
2.0
2,000
2,400
1,400 5,800
ProductAnnual
Demand
Standardprocessing time
per unit (hr.)Processing time
needed (hr.)
#1
#2
#3
400
300
700
5.0
8.0
2.0
2,000
2,400
1,400 5,800
If annual capacity is 2000 hours, then we need three machines to handle the required volume: 5,800 hours/2,000 hours = 2.90 machines
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Planning Over a Time Horizon
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Modify capacity Use capacity
Intermediate-range
planning3 to 18 months
Subcontract Add personnelAdd equipment Build or use inventory Add shifts
Short-range planningUpto 3 months
Schedule jobsSchedule personnel Allocate machinery*
Long-range planning
More than 1 yr
Add facilitiesAdd long lead time equipment *
* Limited options exist
Capacity of Doha Airports
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Capacity4.2 million passengers
Capacity24 million passengers50 million in 2015
12times largerLongest (4850m) international runway for airbus A380-800
85m high control tower600km2 area150km2 maintenance area
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Design and Effective Capacity
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
Design capacity is the maximum output rate or service capacity an operation, process, or facility
is designed for
Effective capacity is the capacity a firm expects to achieve given current operating constraints
Design capacity minus allowances such as
personal time, maintenance, and scrap
Actual output is the rate of output actually achieved--cannot exceed effective capacity.
Utilization and Efficiency
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
Utilization is the percent of design
capacity achieved
Efficiency is the percent of effective
capacity achieved
Utilization = Actual output/Design capacity
Efficiency = Actual output/Effective capacity
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Utilization and Efficiency
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 x 8 hour shifts
Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls
Utilization = 148,000/201,600 = 73.4%
Efficiency = 148,000/175,000 = 84.6%
Utilization and Efficiency
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts
Efficiency = 84.6%
Efficiency of new line = 75%
Expected Output = (Effective Capacity)(Efficiency)
= (175,000)(.75) = 131,250 rolls
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Capacity and Strategy
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
Capacity decisions impact all 10 decisions
of operations management as well as other
functional areas of the organization
Capacity decisions must be integrated into
the organizations mission and strategy
Capacity Considerations
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
Forecast demand accurately
Understand the technology and capacity
increments
Find the optimum operating level
(volume)
Build for change
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Economies and Diseconomies of Scale
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Economies of scale
Diseconomies of scale
25 - room roadside motel 50 - room
roadside motel
75 - room roadside motel
Number of Rooms25 50 75
Aver
age
unit
cos
t(d
olla
rs p
er r
oom
per
nig
ht)
Managing Demand
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Demand exceeds capacity
Curtail demand by raising prices, scheduling longer lead time
Long term solution is to increase capacity
Capacity exceeds demand
Stimulate market
Product changes
Adjusting to seasonal demands
Produce products with complementary demand patterns
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Complementary Demand Patterns
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Jet ski sale high in or before summer Add snowmobile using same engine
technology, differs in application. Snowmobile sale is high in and
before winter .
Tactics for Matching Capacity to Demand
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
1. Making staffing changes
2. Adjusting equipment
3. Improving processes to increase throughput
4. Redesigning products to facilitate more throughput
5. Adding process flexibility to meet changing product
preferences
6. Closing facilities
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Demand and Capacity Management in the Service Sector
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Demand management
Appointment, reservations, FCFS rule
Capacity management
Full time, temporary, part-time
staff
Capacity PlanningSection 3.2
20
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Approaches to Capacity Expansion
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(a) Leading demand with incremental expansion
Expected demand
New capacity
Dem
and
Time (years)1 2 3
Approaches to Capacity Expansion
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
(b) Leading demand with one-step expansion
New capacity
Expected demand
Dem
and
Time (years)1 2 3
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Approaches to Capacity Expansion
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(c) Capacity lags demand with incremental expansion
Expected demand
Dem
and
Time (years)1 2 3
New capacity
Approaches to Capacity Expansion
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(d) Attempts to have an average capacity with incremental expansion
Expected demand
New capacity
Dem
and
Time (years)1 2 3
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Break-Even Analysis
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
Technique for evaluating process and
equipment alternatives
Objective is to find the point in dollars and
units at which cost equals revenue
Requires estimation of fixed costs,
variable costs, and revenue
Break-Even Analysis
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
Fixed costs are costs that continue even if no
units are produced
Depreciation, taxes, debt, mortgage payments
Variable costs are costs that vary with the
volume of units produced
Labor, materials, portion of utilities
Contribution is the difference between selling
price and variable cost
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Break-Even Analysis
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Assumptions
Costs and revenue are linear functions
Generally not the case in the real world
We actually know these costs
Very difficult to accomplish
There is no time value of money
Break-Even Analysis
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
Total revenue line
Variable cost
Fixed cost
Break-even pointTotal cost = Total revenue
900
800
700
600
500
400
300
200
100
| | | | | | | | | | | |0 100 200 300 400 500 600 700 800 900 10001100
Cost
in d
olla
rs
Volume (units per period)
Total cost line
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Break-Even Analysis
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
BEPx = break-even point in units
BEP$ = break-even point in dollars
P = price per unit (after all discounts)
x = number of units produced
TR = total revenue = PxF = fixed costsV = variable cost per unit
TC = total costs = F + Vx
TR = TCor
Px = F + Vx
Break-even point occurs when
BEPx =F
P - V
Break-Even Analysis
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
BEPx = break-even point in units
BEP$ = break-even point in dollars
P = price per unit (after all discounts)
x = number of units produced
TR = total revenue = PxF = fixed costsV = variable cost per unit
TC = total costs = F + Vx
BEP$ = BEPx P
= P
=
=
F(P - V)/P
FP - V
F1 - V/P
Profit = TR - TC= Px - (F + Vx)= Px - F - Vx= (P - V)x - F
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Break-Even Analysis - Example
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Break-Even Example
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Multiproduct Case
where V = variable cost per unitP = price per unitF = fixed costs
W = percent each product is of total dollar salesi = each product
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Break-Even Example
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
Annual ForecastedItem Price Cost Sales UnitsSandwich $2.95 $1.25 7,000Soft drink .80 .30 7,000Baked potato 1.55 .47 5,000Tea .75 .25 5,000Salad bar 2.85 1.00 3,000
Fixed costs = $3,500 per month
Break-Even Example
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
Annual ForecastedItem Price Cost Sales UnitsSandwich $2.95 $1.25 7,000Soft drink .80 .30 7,000Baked potato 1.55 .47 5,000Tea .75 .25 5,000Salad bar 2.85 1.00 3,000
Sandwich $2.95 $1.25 .42 .58 $20,650 .446 .259Soft drink .80 .30 .38 .62 5,600 .121 .075Baked 1.55 .47 .30 .70 7,750 .167 .117
potatoTea .75 .25 .33 .67 3,750 .081 .054Salad bar 2.85 1.00 .35 .65 8,550 .185 .120
$46,300 1.000 .625
Annual WeightedSelling Variable Forecasted % of Contribution
Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7)
Fixed costs = $3,500 per month
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Break-Even Example
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
Annual ForecastedItem Price Cost Sales UnitsSandwich $2.95 $1.25 7,000Soft drink .80 .30 7,000Baked potato 1.55 .47 5,000Tea .75 .25 5,000Salad bar 2.85 1.00 3,000
Sandwich $2.95 $1.25 .42 .58 $20,650 .446 .259Soft drink .80 .30 .38 .62 5,600 .121 .075Baked 1.55 .47 .30 .70 7,750 .167 .117
potatoTea .75 .25 .33 .67 3,750 .081 .054Salad bar 2.85 1.00 .35 .65 8,550 .185 .120
$46,300 1.000 .625
Annual WeightedSelling Variable Forecasted % of Contribution
Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7)
Fixed costs = $3,500 per month
Decision Trees and Capacity Decision
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
-$90,000Market unfavorable (.6)
Market favorable (.4)$100,000
Market favorable (.4)
Market unfavorable (.6)
$60,000
-$10,000
Medium plant
Market favorable (.4)
Market unfavorable (.6)
$40,000
-$5,000
$0
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Decision Trees and Capacity Decision
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
-$90,000Market unfavorable (.6)
Market favorable (.4)$100,000
Market favorable (.4)
Market unfavorable (.6)
$60,000
-$10,000
Medium plant
Market favorable (.4)
Market unfavorable (.6)
$40,000
-$5,000
$0
EMV = (.4)($100,000) + (.6)(-$90,000)
Large Plant
EMV = -$14,000
Decision Trees and Capacity Decision
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
-$14,000
$13,000
$18,000
-$90,000Market unfavorable (.6)
Market favorable (.4)$100,000
Market favorable (.4)
Market unfavorable (.6)
$60,000
-$10,000
Medium plant
Market favorable (.4)
Market unfavorable (.6)
$40,000
-$5,000
$0
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Strategy-Driven Investment
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
Operations may be responsible for return-
on-investment (ROI)
Analyzing capacity alternatives should
include capital investment, variable cost,
cash flows, and net present value
Net Present Value
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
where F = future valueP = present valuei = interest rate
N = number of years
P =F
(1 + i)N
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Net Present Value
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
P = = FXF(1 + i)N
where X = a factor from Table S7.1 defined as = 1/(1 + i)N and F = future value
Year 5% 6% 7% 10%1 .952 .943 .935 .9092 .907 .890 .873 .8263 .864 .840 .816 .7514 .823 .792 .763 .6835 .784 .747 .713 .621
Portion of Table S7.1
Net Present Value
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
An annuity is an investment which generates uniform equal payments
S = RX
where X = factor from Table S7.2S = present value of a series of
uniform annual receiptsR = receipts that are received every
year of the life of the investment
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Net Present Value
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
Portion of Table S7.2
Year 5% 6% 7% 10%1 .952 .943 .935 .9092 1.859 1.833 1.808 1.7363 2.723 2.676 2.624 2.4874 4.329 3.465 3.387 3.1705 5.076 4.212 4.100 3.791
Net Present Value
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
$7,000 in receipts per for 5 yearsInterest rate = 6%
From Table S7.2X = 4.212
S = RXS = $7,000(4.212) = $29,484
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Present Value With Different Future Receipts
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
Investment As Cash Flow
Investment Bs Cash Flow Year
Present Value Factor at 8%
$10,000 $9,000 1 .9269,000 9,000 2 .8578,000 9,000 3 .7947,000 9,000 4 .735
Present Value With Different Future Receipts
Resource Person : Dr. Muhammad Wasif Operations & Production Management10
Year Investment AsPresent ValuesInvestment BsPresent Values
1 $9,260 = (.926)($10,000) $8,334 = (.926)($9,000)
2 7,713 = (.857)($9,000) 7,713 = (.857)($9,000)
3 6,352 = (.794)($8,000) 7,146 = (.794)($9,000)
4 5,145 = (.735)($7,000) 6,615 = (.735)($9,000)Totals $28,470 $29,808Minus initial investment -25,000 -26,000
Net present value $3,470 $3,808
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Resource Person : Dr. Muhammad Wasif Operations & Production Management59
References
Operations Management, 10th Ed., by J. Heizer & B. Render
Operations Management, William J. Stevenson.
Operations Management, 7th Ed., N. Slack, A.B. Jones, R. Johnston.
Cases in Operations Management, S. Chambers, C. Harland, A. Harison, N. Slack.