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Strategic CapacityManagement

Chapter 5


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Strategic Capacity Management

Capacity

The maximum level ofoutput

The amount of resource inputs availablerelative to output requirements at a particular

time

Capacity is the upper limit or ceiling on theload that an operating unit can handle. (often,

this is characterized as output)


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Examples of Capacity Measures

Type of Measures of Capacity

Organization Inputs Outputs

Manufacturer Machine hours

per shift

Number of units

per shiftHospital Number of beds Number of

patients treated

Airline Number of planes

or seats

Number of

seat-miles flownRestaurant Number of seats Customers/time

Retailer Area of store Sales dollars

Theater Number of seats Customers/time


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Capacity Planning

The basic questions in capacity planning

are:

What type of capacity is needed? [5Ms/5Ps]

How much is needed? [opportunity cost]

When is it needed? [opportunity cost]

How does productivity relate to capacity?

What is the basic Capacity Strategy?


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Two Capacity Strategies

Time between

increments

Forecast of

capacity needed

Forecast of

capacity needed

Planned unused

capacity Planned use of

short-term options

Expansionist Strategy Wait-and-See Strategy

Capacity

Capacity


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Some Short-Term Capacity Options

lease extra space temporarily

authorize overtime

staff second or third shift with temporary workers add weekend shifts

schedule longer runs to minimize

capacity losses

postpone preventive maintenance (risky)

allow backorders to increase, extend due datepromises, or have stock-outs.

subcontract work


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Advantages/Disadvantages of each strategy

Expansionist ahead of competition risky if demand no lost sales changes

Idle Capacity

Wait-and-See no unused capacity rely on short-

easier to adapt to term optionsnew technologies

lost opportunity

Advantages Disadvantages


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Capacity Utilization

Capacity used [1350]

rate of output actually achieved

Best operating level [40x16x3=1920]capacity for which the process was designed

(effective or maximum capacity)

Utilization = _______________Capacity Used

Best Operating Level

1350/1920=70%

1100/1680=65%

1100/1920=57%


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Capacity Utilization &

Service Quality

Best operating point is near 70% of

capacity

From 70% to 100% of service capacity,

what do you think happens to servicequality? Why?


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Utilization--Example

Best operating level = 120 units/week

Actual Scheduled output = 83 units/week

Utilization = ?.692

units/wk120units/wk83=

leveloperatingBestusedCapacitynUtilizatio ==

Hair Salon


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Best Operating Level

Underutilization

Best OperatingLevel (120 Hairdos)

Average

unit cost

of output

Volume

Overutilization


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Economies & Diseconomies of Scale

100-unitplant

200-unit

plant 300-unit

plant

400-unit

plant

Volume

Average

unit cost

of output

Long Run Average Cost Curve


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Capacity Cushion

Capacity Cushion = level of capacity in excess of the average

utilization rate or level of capacity in excess of the expected

demand.

Cushion = Best Operating Level

Capacity Used

- 1


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Large capacity cushion

Required to handle uncertainty in demand service industries

high level of uncertainty in demand (in terms ofboth volume and product-mix)

Fashion/Fads/Electronics to permit allowances for vacations,

holidays, supply of materials delays, equipmentbreakdowns, etc.

if subcontracting, overtime, or the cost ofmissed demand is very high (i.e. penalty cost)Construction of Retail Space


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Small capacitycushion

Given that: Unused capacity still incurs the fixed

costs

highly capital intensive businesses

(Utilities requesting customers to conserve during peak)

time perishable capacity (Airline, movie theater)

(Conversion of large theaters to multi-cinema)


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Capacity Cushion Example

An automobile equipment supplier wishes to install a

sufficient number of ovens to produce 400,000 good

castings per year. The baking operation takes 2.0

minutes per casting, and management requires acapacity cushion of 5%. How many ovens will be

required if each one is available for 1800 hours (of

capacity) per year?


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Example: Target 5% Cushion

- 1cushion = Best Operating LevelCapacity Used

.05 = (1800/x) - 1

1.05 = (1800/x) 1714.3/1800 = .9524

1.05x = 1800x = 1714.3

85.7/1714.3=.049991

85.7/1800=.047611


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Solution

Required system capacity =400,000 good units per year

Number of oven minutes required =400,000 x 2 min/unit = 800,000

Number of oven minutes available/oven =(1800 hrs/oven) x(60 minutes/hour) (.9524)

= 102,859minutes/oven

Number of ovens required= 800,000 min /102,859 mins per oven

= 7.8 or 8 ovens


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Quantity

Step fixed costs and variable costs.

1 machine

2 machines

3 machines

A Way to Gain Capacitybuy resource


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The Experience Curve

Total accumulated production of units

Cost or

price

per unit

As plants produce more products, or

services deliver more of a service, they

gain experience in the best production

methods and inherently or naturallyreduce their costs per unit.

Other Ways to Gain Capacity


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Capacity Flexibility: Having the ability

to respond rapidly to demand volume

changes and product mix changes.

Flexible plantsShare processes

Flexible processesGroup equipment

around productfamilies

Flexible workersCross-train

Cell

Manuf.



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Capacity Bottlenecks

Rawmaterial

200/hour 75/hour 200/hour

Operation 1 Operation 2 Operation 3

Bottleneck

Operation



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Capacity Planning

Maintaining System Balance

Stage 1 Stage 2 Stage 3

Unitsper

month

6,000 7,000 4,500


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Determining Capacity

Requirements [1] Forecast sales within each individual

product line

[2] Calculate equipment and laborrequirements to meet the forecasts

[3] Project equipment and laboravailability over the planning horizon


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Example--Capacity

RequirementsA manufacturer produces two lines of ketchup,FancyFine and a generic line. Each is sold in

small and family-size plastic bottles.

The following table shows forecast demand for

the next four years.

Year: 1 2 3 4

FancyFine

Small (000s) 50 60 80 100

Family (000s) 35 50 70 90

Generic

Small (000s) 100 110 120 140

Family (000s) 80 90 100 110


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Example of Capacity Requirements:

The Product from a Capacity Viewpoint

Question: Are we really producing

two different types of ketchup from

the standpoint of capacity

requirements?

Answer: No, its the same product just

packaged differently (and water added)


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Example of Capacity Requirements:

Equipment and Labor Requirements

Year: 1 2 3 4

Small (000s) 150 170 200 240

Family (000s) 115 140 170 200

Three 100,000 units-per-year machines are available

for small-bottle production. Two operators required

per machine.

Two 120,000 units-per-year machines are available

for family-sized-bottle production. Three operators

required per machine.

39


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Year: 1 2 3 4

Small (000s) 150 170 200 240

Family (000s) 115 140 170 200

Small Mach. Cap. 300,000 Labor 6

Family-size Mach. Cap. 240,000 Labor 6

Small

Percent capacity used 50.00%

Machine requirement 1.50

Labor requirement 3.00Family-size



Labor requirement 2.88

Question: Identify the Year 1 values for capacity, machine, and labor?

150,000/300,000=50% At 1 machine for 100,000, ittakes 1.5 machines for 150,000

At 2 operators for100,000, it takes 3

operators for 150,000

The McGraw-Hill Companies, Inc., 2001

40


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Year: 1 2 3 4

Small (000s) 150 170 200 240

Family (000s) 115 140 170 200

Small Mach. Cap. 300,000 Labor 6

Family-size Mach. Cap. 240,000 Labor 6

Small



Labor requirement 3.00Family-size



Labor requirement 2.88

Question: What are the values for columns 2, 3 and 4 in the table below?

56.67%

1.70

3.40

58.33%

1.17

3.50

66.67%

2.00

4.00

70.83%

1.42

4.25

80.00%

2.40

4.80

83.33%

1.67

5.00

The McGraw-Hill Companies, Inc., 2001


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How does Quality affect

capacity?

Suppose a three operation process is

followed by an inspection. If the averageproportion of defectives produced at

operations 1, 2, and 3 are .04, .01, and

.02 respectively, and if the demand is 200units, then what is the required capacity

for this operation? [i.e. material inputs]

C it i t ith


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Capacity requirements with

Yield Loss

Notation:

di = avg. proportion of defective units at operation i

n = number of operations in the production process

M = order quantity (good units only or desired yield)

B = avg. number of units at the start of the

production process

B =M

[(1-d1)(1-d2).(1-dn)]


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Solution

Desired yield = 200Operation Defective rate

1 .04

2 .01

3 .02(1) What is the capacity required?

B = = 215200

(1-.04)(1-.01)(1-.02)


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Capacity and Quality

Suppose we have a 6 process assembly

line that must produce 1000 good

products. Each process produces only

1% defects. How is capacity affected?

Capacity required =

= 1062 units

1000(.99)6


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Decision TreesA glass factory specializing in crystal is experiencing a

substantial backlog, and the firm's management is

considering three courses of action:

A) Arrange for subcontracting,

B) Construct new facilities.C) Do nothing (no change)

The correct choice depends largely upon demand, which

may be low, medium, or high. By consensus,management ranks the respective probabilities as .10,

.50, and .40. A cost analysis that reveals the effects

upon costs is shown in the following table.


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Payoff Table

0.1 0.5 0.4

Low Medium HighA 10 50 90

B -120 25 200

C 20 40 60


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We start with our decisions...

AB

C

Subcontracting

Do nothing

Construct new facilities


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Then add our possible states of

nature, probabilities, and payoffs

A

B

C

High demand (.4)

Medium demand (.5)

Low demand (.1)

$90k

$50k

$10k

High demand (.4)

Medium demand (.5)

Low demand (.1)

$200k

$25k

-$120k

High demand (.4)

Medium demand (.5)

Low demand (.1)

$60k

$40k

$20k

D t i th t d l


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Determine the expected value

of each decision

High demand (.4)

Medium demand (.5)

Low demand (.1)

A

$90k

$50k

$10k

EVA=.4(90)+.5(50)+.1(10)=$62k

$62k


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Solution

High demand (.4)

Medium demand (.5)

Low demand (.1)

High demand (.4)Medium demand (.5)

Low demand (.1)

AB

CHigh demand (.4)

Medium demand (.5)

Low demand (.1)

$90k$50k

$10k

$200k$25k

-$120k

$60k

$40k

$20k

$62k

$80.5k

$46k

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