CAPACITY AND AGGREGATE CAPACITY AND AGGREGATE PLANNINGPLANNING

CAPACITYCAPACITY Capacity is the maximum capability to Capacity is the maximum capability to

produce. It can be used in terms of produce. It can be used in terms of units of output, value of output, hours units of output, value of output, hours of work, or number of customers of work, or number of customers processed over a specified period of processed over a specified period of time.time.

Capacity is affected by the mix of Capacity is affected by the mix of products and services, the choice of products and services, the choice of technology, the size of facility, and the technology, the size of facility, and the resources allocated.resources allocated.

Rated CapacityRated Capacity

The theoretical output that could be The theoretical output that could be attained if a process were operated attained if a process were operated at full speed without interruption or at full speed without interruption or exceptions.exceptions.

Effective CapacityEffective Capacity

The capacity with which a particular The capacity with which a particular product or customer can be product or customer can be processed, and the utilization of the processed, and the utilization of the scheduled hours or work.scheduled hours or work.

Utilization refers to the percentage of Utilization refers to the percentage of available working time that a worker available working time that a worker actually works or a machine actually actually works or a machine actually runs.runs.

Capacity PlanningCapacity Planning

It is the long term strategic decision It is the long term strategic decision that establishes a firm’s overall level that establishes a firm’s overall level of resources.of resources.

Capacity decisions affect product Capacity decisions affect product lead times, customer lead times, customer responsiveness, operating costs, and responsiveness, operating costs, and a firm’s ability to compete. a firm’s ability to compete.

Inadequate capacity can lose Inadequate capacity can lose customers and limit growth.customers and limit growth.

Continued…Continued…

Excess capacity can drain a Excess capacity can drain a company’s resources and prevent company’s resources and prevent investments in more lucrative investments in more lucrative ventures.ventures.

Strategies for Expanding Strategies for Expanding CapacityCapacity

Capacity Lead StrategyCapacity Lead Strategy Average Capacity StrategyAverage Capacity Strategy Capacity Lag StrategyCapacity Lag Strategy

Capacity Lead StrategyCapacity Lead Strategy

Capacity is expanded in anticipation Capacity is expanded in anticipation of demand growth. This aggressive of demand growth. This aggressive strategy is used to lure customers strategy is used to lure customers from competitors who are capacity from competitors who are capacity constrained or to gain a foothold in a constrained or to gain a foothold in a rapidly expanding market.rapidly expanding market.

Average Capacity StrategyAverage Capacity Strategy

Capacity is expanded to coincide Capacity is expanded to coincide with average expected demand. with average expected demand. Approximately half of the time Approximately half of the time capacity leads demand, and half of capacity leads demand, and half of the time capacity lags demand.the time capacity lags demand.

Capacity Lag StrategyCapacity Lag Strategy

Capacity is increased after an Capacity is increased after an increase in demand has been increase in demand has been documented. This conservative documented. This conservative strategy produces higher return on strategy produces higher return on investment but may lose customers investment but may lose customers in the process. It is used in industries in the process. It is used in industries with standard products and cost with standard products and cost based or weak competition.based or weak competition.

How much to increase How much to increase capacity??capacity??

It depends on:It depends on:

1.1. Volume and certainty of anticipated Volume and certainty of anticipated demand.demand.

2.2. Strategic objectives in terms of Strategic objectives in terms of growth, customer service, and growth, customer service, and competition.competition.

3.3. The costs of expansion and The costs of expansion and operation.operation.

Economies of ScaleEconomies of Scale It occurs when it costs less per unit to produce It occurs when it costs less per unit to produce

or operate at high levels of output.or operate at high levels of output. This holds This holds true when:true when:

Fixed costs can be spread over a larger number of Fixed costs can be spread over a larger number of unitsunits

Production or operating costs do not increase linearly Production or operating costs do not increase linearly with output levels,with output levels,

Quantity discounts are available for material Quantity discounts are available for material purchases and,purchases and,

Operating efficiency increases as workers gain Operating efficiency increases as workers gain experience.experience.

Diseconomies of ScaleDiseconomies of Scale Overtaxed machines and material Overtaxed machines and material

handling equipment breakdown, service handling equipment breakdown, service time slows, quality suffers requiring time slows, quality suffers requiring more rework, labor costs increase with more rework, labor costs increase with overtime, and coordination and overtime, and coordination and management activities cause management activities cause diseconomies of scale.diseconomies of scale.

Diseconomies of scale can be divided Diseconomies of scale can be divided into four categories:into four categories:

Diseconomies of distributionDiseconomies of distribution Diseconomies of bureaucracyDiseconomies of bureaucracy Diseconomies of confusionDiseconomies of confusion Diseconomies of vulnerabilityDiseconomies of vulnerability

Planning Service Capacity vs. Planning Service Capacity vs. Manufacturing CapacityManufacturing Capacity

TimeTime: Goods can not be stored for later : Goods can not be stored for later use and capacity must be available to use and capacity must be available to provide a service when it is needed provide a service when it is needed

LocationLocation: Service goods must be at the : Service goods must be at the customer demand point and capacity customer demand point and capacity must be located near the customermust be located near the customer

Volatility of DemandVolatility of Demand: Much greater : Much greater than in manufacturingthan in manufacturing

Approaches to Capacity Approaches to Capacity ExpansionExpansion

(a)(a) Leading demand with Leading demand with incremental incremental expansionexpansion

Dem

and

Dem

and

Expected Expected demanddemand

New New capacitcapacit

yy

(b)(b) Leading demand Leading demand with one-step with one-step expansionexpansion

Dem

and

Dem

and

New New capacitcapacit

yy Expected Expected demanddemand

(d)(d) Attempts to have an Attempts to have an average capacity with average capacity with incremental expansionincremental expansion

Dem

and

Dem

and New New

capacitcapacityy

Expected Expected demanddemand

(c)(c) Capacity lags demand Capacity lags demand with incremental with incremental expansionexpansion

Dem

and

Dem

and

New New capacitcapacit

yy Expected Expected demanddemand

Figure S7.4Figure S7.4

Approaches to Capacity Approaches to Capacity ExpansionExpansion

(a)(a) Leading demand with Leading demand with incremental expansionincremental expansion

Expected Expected demanddemand

Figure S7.4Figure S7.4

New New capacitycapacity

Dem

and

Dem

and

Time (years)Time (years)11 22 33

Approaches to Capacity Approaches to Capacity ExpansionExpansion

(b)(b) Leading demand with one-step Leading demand with one-step expansionexpansion

New New capacitycapacity

Expected Expected demanddemand

Figure S7.4Figure S7.4

Dem

and

Dem

and

Time (years)Time (years)11 22 33

Approaches to Capacity Approaches to Capacity ExpansionExpansion

(c)(c) Capacity lags demand with Capacity lags demand with incremental expansionincremental expansion

Expected Expected demanddemand

Figure S7.4Figure S7.4

Dem

and

Dem

and

Time (years)Time (years)11 22 33

New New capacitycapacity

Approaches to Capacity Approaches to Capacity ExpansionExpansion

(d)(d) Attempts to have an average capacity Attempts to have an average capacity with incremental expansionwith incremental expansion

Expected Expected demanddemand

Figure S7.4Figure S7.4

New New capacitycapacity

Dem

and

Dem

and

Time (years)Time (years)11 22 33

Break-Even AnalysisBreak-Even Analysis

Technique for evaluating process Technique for evaluating process and equipment alternativesand equipment alternatives

Objective is to find the point in Objective is to find the point in rupees and units at which cost rupees and units at which cost equals revenueequals revenue

Requires estimation of fixed Requires estimation of fixed costs, variable costs, and costs, variable costs, and revenuerevenue

Break-Even AnalysisBreak-Even Analysis Fixed costs are costs that Fixed costs are costs that

continue even if no units are continue even if no units are producedproduced Depreciation, taxes, debt, mortgage Depreciation, taxes, debt, mortgage

paymentspayments

Variable costs are costs that vary Variable costs are costs that vary with the volume of units producedwith the volume of units produced Labor, materials, portion of utilitiesLabor, materials, portion of utilities Contribution is the difference Contribution is the difference

between selling price and variable between selling price and variable costcost

Break-Even AnalysisBreak-Even Analysis

Costs and revenue are linear Costs and revenue are linear functionsfunctions Generally not the case in the Generally not the case in the

real worldreal world

We actually know these costsWe actually know these costs Very difficult to accomplishVery difficult to accomplish

There is no time value of There is no time value of moneymoney

AssumptionsAssumptions

Profit corri

dor

Loss

corri

dor

Break-Even AnalysisBreak-Even AnalysisTotal revenue lineTotal revenue line

Total cost lineTotal cost line

Variable costVariable cost

Fixed costFixed cost

Break-even pointBreak-even pointTotal cost = Total revenueTotal cost = Total revenue

–

900 900 –

800 800 –

700 700 –

600 600 –

500 500 –

400 400 –

300 300 –

200 200 –

100 100 –

–| | | | | | | | | | | |

00 100100 200200 300300 400400 500500 600600 700700 800800 900900 1000100011001100

Cost

in r

upees

Cost

in r

upees

Volume (units per period)Volume (units per period)

Aggregate PlanningAggregate Planning

Aggregate planning determines the Aggregate planning determines the resource capacity a firm will need to resource capacity a firm will need to meet its demand over an intermediate meet its demand over an intermediate time horizon – 6 to 12 months in the time horizon – 6 to 12 months in the future.future.

The term aggregate is used here The term aggregate is used here because the plans are developed for because the plans are developed for product lines or product families, rather product lines or product families, rather than individual products.than individual products.

Within this time frame, it is usually not feasible to increase capacity by building new facilities or purchasing new equipments; however it is feasible to hire or lay off workers, increase or reduce the workweek, add an extra shift, subcontract out work, use overtime, or build up and deplete inventory levels.

Objectives of Aggregate Planning

Meet demand Use capacity

efficiently Meet inventory

policy Minimize cost

Labor Inventory Plant & equipment Subcontract

Relationships of the Aggregate Plan

All these factors effect Aggregate Planning

AggregatePlan for

Production

DemandForecasts,

orders

MasterProductionSchedule

Detailed WorkSchedules

ExternalCapacity

Subcontractors

Inventory OnHand

Raw MaterialsAvailable

Work Force

Marketplaceand Demand

Research andTechnology

ProductDecisions

ProcessPlanning & Capacity

Decisions

Strategies for Adjusting Capacity

Seasonal demand patterns can be met by: Producing at a constant rate and using inventory

to absorb fluctuations in demand. Hiring and firing workers to match demand. Maintaining resources for high demand levels. Increasing or decreasing working hours. Subcontracting work to other firms. Using part time workers. Providing service/goods at a later time period.

Level Production

Production is done at a fixed level. During periods of low demand,

overproduction is stored as inventory, to be depleted in periods of high demand.

Cost of this strategy is cost of holding inventory, including cost of obsolete or perishable items that may be discarded.

Chase Demand Matches the production plan to the

demand pattern and absorbs variations in demand by hiring and firing workers.

This strategy would not work where worker skills are scarce or competition for labor is intense

Cost of this strategy is the cost of hiring and firing workers.

A variation of chase demand is chase supply where production revolves around supplies of raw material

Peak Demand

Maintaining resources for high level of demand.

This strategy is used when superior customer service is important.

Cost of the strategy is investment in extra workers and machines that remain idle during low demand periods

Overtime and Undertime

A competent staff is maintained, hiring and firing costs are avoided, and demand is met temporarily without investing in permanent resources.

Cost of the strategy is premium paid for overtime, a tired and potentially less efficient workforce.

It is possible that overtime alone may not be able to meet peak demand periods.

Subcontracting

It is a feasible alternative if a supplier can reliably meet quality and time requirements.

Disadvantages include reduced profits, loss of control over production, long lead times, and the potential that subcontractor may become a future competitor

Part-Time Workers

Feasible for unskilled jobs or in areas with large temporary pools.

Less costly than full time workers. Problems with them include high

turnover, accelerated training requirements, less commitment, and scheduling difficulties.

Backlogs, Backordering & Lost Sales

Companies that offer customized products and services accept customer orders and fill them at a later stage. This accumulation of orders creates a backlog.

For make-to-stock companies, customers who request an item that is temporarily out-of-stock may have the option of backordering the item.

If customer is not ready to wait for the backordered item, the sale will be lost.

Strategies for Managing Strategies for Managing DemandDemand

Strategies for managing demand Strategies for managing demand include:include:

Shifting demand into other time periods with Shifting demand into other time periods with incentives, sales promotions, and advertising incentives, sales promotions, and advertising campaigns.campaigns.

Offering products or services with Offering products or services with countercyclical demand patterns.countercyclical demand patterns.

Partnering with suppliers to reduce Partnering with suppliers to reduce information distortion along the supply chaininformation distortion along the supply chain

Winter coat specials in July, early bird Winter coat specials in July, early bird discounts on dinner are examples of discounts on dinner are examples of attempts to shift demand into different attempts to shift demand into different time periods. Electric utilities are time periods. Electric utilities are especially skilled at off-peak pricing . especially skilled at off-peak pricing .

Holiday gift buying is encouraged early Holiday gift buying is encouraged early each year, and beach resorts plan each year, and beach resorts plan festivals in September and October to festivals in September and October to extend the season.extend the season.

For industries with extreme variations in For industries with extreme variations in demand, offering products or services with demand, offering products or services with countercyclical demand patterns help countercyclical demand patterns help smooth out resource requirements.smooth out resource requirements.

This approach involves examining the This approach involves examining the idleness of resources and creating a idleness of resources and creating a demand for those resources.demand for those resources.

Example: McDonald’s offering breakfast, Example: McDonald’s offering breakfast, heating firms also sell air conditioners.heating firms also sell air conditioners.

Even though a customer may require daily Even though a customer may require daily usage of an item, he or she does not usage of an item, he or she does not purchase that item daily. Neither do retail purchase that item daily. Neither do retail stores restock their shelves continuously. stores restock their shelves continuously. By the time replenishment order reaches By the time replenishment order reaches distributors, wholesalers, manufacturers distributors, wholesalers, manufacturers and their suppliers, the demand pattern for and their suppliers, the demand pattern for a product can appear extremely erratic. To a product can appear extremely erratic. To control the situation, manufacturers, their control the situation, manufacturers, their suppliers, and customers form suppliers, and customers form partnerships in which demand information partnerships in which demand information is shared and orders are placed in a more is shared and orders are placed in a more continuous fashion.continuous fashion.

Hierarchical PlanningHierarchical Planning Planning involves a hierarchy of decisions. Planning involves a hierarchy of decisions.

In production planning the next level of In production planning the next level of detail is master production schedule, in detail is master production schedule, in which weekly (not monthly or quarterly) which weekly (not monthly or quarterly) production plans are specified by individual production plans are specified by individual final product. final product.

At another level of detail, material At another level of detail, material requirements planning plans the production requirements planning plans the production of the components that go into the final of the components that go into the final product.product.

Shop floor scheduling schedules the Shop floor scheduling schedules the manufacturing operations required to make manufacturing operations required to make each component.each component.

In capacity planning, we might develop a In capacity planning, we might develop a resource requirements plan, to verify that resource requirements plan, to verify that an aggregate production plan id doable, and an aggregate production plan id doable, and a rough-cut capacity plan as quick check to a rough-cut capacity plan as quick check to see if the master production is feasible.see if the master production is feasible.

One level down, we would develop a much One level down, we would develop a much more detailed capacity requirements plan more detailed capacity requirements plan that matches the factory’s machine and that matches the factory’s machine and labor resources to the materials labor resources to the materials requirement plan.requirement plan.

Finally, we would use input/output Finally, we would use input/output control to monitor the production that control to monitor the production that takes place at individual machines or takes place at individual machines or work centers.work centers.

At each level decisions are set by the At each level decisions are set by the higher-level decisions.higher-level decisions.

The process of moving from the The process of moving from the aggregate plan to the next level down is aggregate plan to the next level down is called disaggregating.called disaggregating.

Production Planning through Time-based Decomposition

Aggregate Planning

Master Production Scheduling

Materials Requirement Planning

Aggregate UnitDemand

End Item (SKU)Demand

Corporate Strategy

Capacity and Aggregate Production Plans

SKU-level Production Plans

Manufacturingand Procurementlead times

Component Production lots and due dates

Part processplans

Shop floor-level Production Control

Collaborative PlanningCollaborative Planning

Consensus among partners of supply Consensus among partners of supply chain is first reached on the sales chain is first reached on the sales forecast, then on production plan.forecast, then on production plan.

Each partner has access to an internet Each partner has access to an internet enabled planning book in which enabled planning book in which forecasts, customer orders, and forecasts, customer orders, and production plans are visible for specific production plans are visible for specific items. Partners agree on the level of items. Partners agree on the level of aggregation to be used.aggregation to be used.

Aggregate Planning for Aggregate Planning for ServicesServices

The aggregate planning process is The aggregate planning process is different for services in the following different for services in the following ways:ways:

Most services cannot be inventoried.Most services cannot be inventoried. Demand for services is difficult to predict.Demand for services is difficult to predict. Capacity is difficult to predictCapacity is difficult to predict Service capacity must be provided at Service capacity must be provided at

appropriate place and time.appropriate place and time. Labor is usually the most constraining Labor is usually the most constraining

resource for services.resource for services.

There are several services that have There are several services that have unique aggregate planning problems. unique aggregate planning problems. Doctors, lawyers and other Doctors, lawyers and other professionals have emergency or professionals have emergency or priority calls for their service that must priority calls for their service that must be meshed with regular appointments. be meshed with regular appointments. Hotels and airlines routinely overbook Hotels and airlines routinely overbook their capacity in anticipation of their capacity in anticipation of customers who do not show up. customers who do not show up. Airlines design complex pricing Airlines design complex pricing structures for different routes and structures for different routes and classes of customers.classes of customers.

Thank You ….Thank You ….