OPM Topic 3 Capacity

Operations&ProductionManagement 1/31/2015

ResourcePerson:Dr.MuhammadWasif 1

Operations & Production Management

(OPM)Dr. Muhammad Wasif

Visiting Faculty, IBA.

3 - Capacity Planning

2

Resource Person : Dr. Muhammad Wasif Operations & Production Management7



CapacitySection 3.1

3


Capacity


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



Capacity


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


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



Planning Over a Time Horizon


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


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



Design and Effective Capacity


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


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





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%



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



Capacity and Strategy


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


Forecast demand accurately

Understand the technology and capacity

increments

Find the optimum operating level

(volume)

Build for change



Economies and Diseconomies of Scale


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


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



Complementary Demand Patterns


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


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



Demand and Capacity Management in the Service Sector


Demand management

Appointment, reservations, FCFS rule

Capacity management

Full time, temporary, part-time

staff

Capacity PlanningSection 3.2

20




Approaches to Capacity Expansion


(a) Leading demand with incremental expansion

Expected demand

New capacity

Dem

and

Time (years)1 2 3



(b) Leading demand with one-step expansion

New capacity

Expected demand

Dem

and

Time (years)1 2 3





(c) Capacity lags demand with incremental expansion

Expected demand

Dem

and

Time (years)1 2 3

New capacity



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

Expected demand

New capacity

Dem

and

Time (years)1 2 3



Break-Even Analysis


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


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



Break-Even Analysis


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


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



Break-Even Analysis


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


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



Break-Even Analysis - Example


Break-Even Example


Multiproduct Case

where V = variable cost per unitP = price per unitF = fixed costs

W = percent each product is of total dollar salesi = each product



Break-Even Example


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



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)




Break-Even Example



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)


Decision Trees and Capacity Decision


-$90,000Market unfavorable (.6)

Market favorable (.4)$100,000

Market favorable (.4)

Market unfavorable (.6)

$60,000

-$10,000

Medium plant



$40,000

-$5,000

$0









$60,000

-$10,000

Medium plant



$40,000

-$5,000

$0

EMV = (.4)($100,000) + (.6)(-$90,000)

Large Plant

EMV = -$14,000



-$14,000

$13,000

$18,000





$60,000

-$10,000

Medium plant



$40,000

-$5,000

$0



Strategy-Driven Investment


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


where F = future valueP = present valuei = interest rate

N = number of years

P =F

(1 + i)N



Net Present Value


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


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



Net Present Value


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


$7,000 in receipts per for 5 yearsInterest rate = 6%

From Table S7.2X = 4.212

S = RXS = $7,000(4.212) = $29,484



Present Value With Different Future Receipts


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


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




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.

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OPM Topic 3 Capacity

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