Chapter 5, Part A

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Facility Capacity and Location

Chapter 5, Part A

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Facility Planning

HOW MUCH long range capacity is needed WHEN additional capacity is needed WHERE the production facilities should be located WHAT the layout and characteristics of the facilities

should be

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Facility Planning

The capital investment in land, buildings, technology, and machinery is enormous

A firm must live with its facility planning decisions for a long time, and these decisions affect:

Operating efficiency Economy of scale Ease of scheduling Maintenance costs … Profitability!

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Long-RangeCapacity Planning

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Steps in the Capacity Planning Process

Estimate the capacity of the present facilities. Forecast the long-range future capacity needs. Identify and analyze sources of capacity to meet these

needs. Select from among the alternative sources of capacity.

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Definitions of Capacity

In general, production capacity is the maximum production rate of an organization.

Capacity can be difficult to quantify due to … Day-to-day uncertainties such as employee

absences, equipment breakdowns, and material-delivery delays

Products and services differ in production rates (so product mix is a factor)

Different interpretations of maximum capacity

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Definitions of Capacity

The Federal Reserve Board defines sustainable practical capacity as the greatest level of output that a plant can maintain …

within the framework of a realistic work schedule taking account of normal downtime assuming sufficient availability of inputs to operate

the machinery and equipment in place

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Measurements of Capacity

Output Rate Capacity For a facility having a single product or a few

homogeneous products, the unit of measure is straightforward (barrels of beer per month)

For a facility having a diverse mix of products, an aggregate unit of capacity must be established using a common unit of output (sales dollars per week)

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Measurements of Capacity

Input Rate Capacity Commonly used for service operations where

output measures are particularly difficult Hospitals use available beds per month Airlines use available seat-miles per month Movie theatres use available seats per month

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Measurements of Capacity

Capacity Utilization Percentage Relates actual output to output capacity

Example: Actual automobiles produced in a quarter divided by the quarterly automobile production capacity

Relates actual input used to input capacity Example: Actual accountant hours used in a

month divided by the monthly account-hours available

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Measurements of Capacity

Capacity Cushion an additional amount of capacity added onto the

expected demand to allow for: greater than expected demand demand during peak demand seasons lower production costs product and volume flexibility improved quality of products and services

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Forecasting Capacity Demand

Consider the life of the input (e.g. facility is 10-30 yr) Understand product life cycle as it impacts capacity Anticipate technological developments Anticipate competitors’ actions Forecast the firm’s demand

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Other Considerations

Resource availability Accuracy of the long-range forecast Capacity cushion Changes in competitive environment

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Expansion of Long-Term Capacity

Subcontract with other companies Acquire other companies, facilities, or resources Develop sites, construct buildings, buy equipment Expand, update, or modify existing facilities Reactivate standby facilities

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Reduction of Long-Term Capacity

Sell off existing resources, lay off employees Mothball facilities, transfer employees Develop and phase in new products/services

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Economies of Scale

Best operating level - least average unit cost Economies of scale - average cost per unit decreases

as the volume increases toward the best operating level

Diseconomies of scale - average cost per unit increases as the volume increases beyond the best operating level

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Economies and Diseconomies of Scale

Average UnitCost of Output ($)

Annual Volume (units)

Best Operating Level

Economiesof Scale

Diseconomiesof Scale

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Economies of Scale

Declining costs result from: Fixed costs being spread over more and more units Longer production runs result in a smaller

proportion of labor being allocated to setups Proportionally less material scrap … and other economies

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Diseconomies of Scale

Increasing costs result from increased congestion of workers and material, which contributes to:

Increasing inefficiency Difficulty in scheduling Damaged goods Reduced morale Increased use of overtime … and other diseconomies

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Two General Approaches to Expanding Long-Range Capacity

All at Once – build the ultimate facility now and grow into it

Incrementally – build incrementally as capacity demand grows

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Two General Approaches to Expanding Long-Range Capacity

All at Once Little risk of having to turn down business due to

inadequate capacity Less interruption of production One large construction project costs less than

several smaller projects Due to inflation, construction costs will be higher

in the future Most appropriate for mature products with stable

demand

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Two General Approaches to Expanding Long-Range Capacity

Incrementally Less risky if forecast needs do not materialize Funds that could be used for other types of

investments will not be tied up in excess capacity More appropriate for new products

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Subcontractor Networks

A viable alternative to larger-capacity facilities is to develop subcontractor and supplier networks.

“Farming out” or outsourcing your capacity needs to your suppliers

Developing long-range relationships with suppliers of parts, components, and subassemblies

Relying less on backward vertical integration Requiring less capital for production facilities More easily varying capacity during slack or peak

demand periods

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Outsourcing Service Functions

Building maintenance Data processing Delivery Payroll Bookkeeping Customer service Mailroom Benefits administration … and more

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Economies of Scope

The ability to produce many product models in one flexible facility more cheaply than in separate facilities

Highly flexible and programmable automation allows quick, inexpensive product-to-product changes

Economies are created by spreading the automation cost over many products

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Example: King Publishing

Break-Even AnalysisKing Publishing intends to publish a book in

residential landscaping. Fixed costs are $125,000 per year, variable costs per unit are $32, and selling price per unit is $42.

A) How many units must be sold per year to break even? B) How much annual revenue is required to break even? C) If annual sales are 20,000 units, what are the annual profits? D) What variable cost per unit would result in $100,000 annual profits if annual sales are 20,000 units?

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Example: King Publishing

Break-Even AnalysisA) How many units must be sold per year to break even?

Q = FC/(p-v) = $125,000/(42 – 32) = 12,500 books

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Example: King Publishing

Break-Even AnalysisB) How much annual revenue is required to break even?

TR = pQ = 42(12,500) = $525,000

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Example: King Publishing

Break-Even AnalysisC) If annual sales are 20,000 units, what are the annual

profits?

P = pQ – (FC + vQ) = 42(20,000) – [125,000 + 32(20,000)] = 840,000 – 125,000 – 640,000 = $75,000

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Example: King Publishing

Break-Even AnalysisD) What variable cost per unit would result in $100,000

annual profits if annual sales are 20,000 units?

P = pQ – (FC + vQ) 100,000 = 42(20,000) – [125,000 + v(20,000)] 100,000 = 840,000 – 125,000 – 20,000v 20,000v = 615,000 v = $30.75

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Decision Tree Analysis

Structures complex multiphase decisions, showing: What decisions must be made What sequence the decisions must occur Interdependence of the decisions

Allows objective evaluation of alternatives Incorporates uncertainty Develops expected values

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Example: Good Eats Café

Decision Tree Analysis Good Eats Café is about to build a new

restaurant. An architect has developed three building designs, each with a different seating capacity. Good Eats estimates that the average number of customers per hour will be 80, 100, or 120 with respective probabilities of 0.4, 0.2, and 0.4. The payoff table showing the profits for the three designs is on the next slide.

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Payoff Table

Average Number of Customers Per Hour c1 = 80 c2 = 100 c3 = 120

Design A $10,000 $15,000 $14,000 Design B $ 8,000 $18,000 $12,000 Design C $ 6,000 $16,000 $21,000

Example: Good Eats Café

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Expected Value ApproachCalculate the expected value for each decision.

The decision tree on the next slide can assist in this calculation. Here d1, d2, d3 represent the decision alternatives of designs A, B, C, and c1, c2, c3 represent the different average customer volumes (80, 100, and 120) that might occur.

Example: Good Eats Café

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Decision Tree

1

(.2)

(.4)

(.4)

(.4)

(.2)

(.4)

(.4)

(.2)

(.4)

d1

d2

d3

c1

c1

c1

c2

c3

c2

c2

c3

c3

Payoffs

10,000

15,000

14,000

8,000

18,000

12,000

6,000

16,000

21,000

2

3

4

Example: Good Eats Café

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Expected Value For Each Decision

Choose the design with largest EV -- Design C.

3

4

d1

d2

d3

EV = .4(10,000) + .2(15,000) + .4(14,000) = $12,600

EV = .4(8,000) + .2(18,000) + .4(12,000) = $11,600

EV = .4(6,000) + .2(16,000) + .4(21,000) = $14,000

Design A

Design B

Design C

2

1

Example: Good Eats Café