Lecture 3: Capacity Planning

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Outline
What is capacity?

Capacity planning
Determinants of effective capacity Determining capacity requirements Developing capacity alternatives Planning service capacity Evaluating alteratives

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Capacity Planning
Capacity is the upper limit or ceiling on the load
that an operating unit can handle.

The basic questions in capacity handling are:

What kind of capacity is needed? How much is needed? When is it needed?

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Importance of Capacity Decisions

Impacts ability to meet future demands Affects operating costs Major determinant of initial costs Involves long-term commitment Affects competitiveness Affects ease of management

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Capacity
Design capacity
maximum obtainable output

Effective capacity
Maximum capacity given product mix, scheduling difficulties, and other doses of reality.

Actual output
rate of output actually achieved--cannot exceed effective capacity.

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Efficiency and Utilization

Efficiency = Actual output Effective capacity Actual output

Utilization =

Design capacity

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Efficiency/Utilization Example
Design capacity = 50 trucks/day
Effective capacity = 40 trucks/day Actual output = 36 units/day

Actual output Efficiency = =

36 units/day = 90%

Effective capacity
Utilization = Actual output Design capacity =

40 units/ day
36 units/day 50 units/day = 72%

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Determinants of Effective Capacity

Facilities Size and provision for expansion Transportation costs, distance to market, labor supply, energy sources Products or services Similar items system can produce more Processes Quantity capability of a process Output quality Human considerations Training, skills and experience, employee motivation, absenteeism, labor turnover Operations Scheduling, inventory stocking decisions, late deliveries, acceptability of purchased materials and parts, quality inspection and control procedures

External forces Pollution standards on products and equipments, paper work required by government agencies, union contract limiting number of hours

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Determining capacity requirements

Long-term considerations:
Overall level of capacity (e.g., facility size)

Short-term considerations:
Probable variations in capacity requirements created by seasonal, random, and irregular fluctuations in demand.

Long-term capacity needs are determined by forecasting

demand over a time horizon and then converting those forecasts into capacity requirements

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Some Possible Growth Patterns

Volume

Volume

Growth
Time

Decline
Time

Volume

Volume

Cyclical

Stable

Time

Time

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Determining capacity requirements

Fundamental issues when trends are identified:
How long the trend might persist? The slope of the trend

Fundamental issues when cycles are identified:

Approximate length of the cycle Amplitude of the cycle

Short-term capacity needs are more concerned with

seasonal variations

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Planning Service Capacity

Need to be near customers
Capacity and location are closely tied

Inability to store services

Capacity must me matched with timing of demand

Degree of volatility of demand

Peak demand periods

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Developing Capacity Alternatives

Design flexibility into systems Take a big picture approach to capacity changes

Prepare to deal with capacity chunks

Attempt to smooth out capacity requirements Identify the optimal operating level

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Evaluating Alternatives
Production units have an optimal rate of output for minimal cost. Average cost per unit Minimum cost

0
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Rate of output School of Business

Evaluating Alternatives
Minimum cost & optimal operating rate are functions of size of production unit.
Average cost per unit

Small
plant

Medium plant

Large plant

0 North South University

Output rate
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Evaluating Alternatives
Determining processing requirements

Cost-volume analysis
Financial analysis

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Calculating Processing Requirements

A department works one 8 hour shift, 250 days a year, and has the following figures for usage of a machine that is currently being considered.

How many machines are needed to handle this load?

Annual Demand Standard processing time per unit (hr.) Processing time needed (hr.)

Product

#1 #2 #3

400 300 700

5.0 8.0 2.0

2,000 2,400 1,400 5,800

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Cost-Volume Relationships
TC = FC+ VC VC= Qv TR= R Q P= TR- TC= R Q-(FC+ Qv)

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Cost-Volume Relationships

Amount ($)

Fixed cost (FC) 0

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Q (volume in units)
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Cost-Volume Relationships

Amount ($) 0
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Q (volume in units)
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Cost-Volume Relationships

Amount ($) 0
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BEP units Q (volume in units)

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Cost-Volume Analysis Example Problem

The owner of Old-Fashioned Berry Pies is contemplating adding a new line of pies, which will require leasing new equipment for a monthly payment of $ 6000. Variable costs would be $2 per pie, and pies would retail for $ 7 each.

a. How many pies must be sold in order to break even?

b. What would the profit (loss) be if 1000 pies are made

and sold in a month?

c. How many pies must be sold to realize a profit of $

4000.

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Break-Even Problem with Step Fixed Costs

3 machines

2 machines 1 machine
Quantity Step fixed costs and variable costs.
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Break-Even Problem with Step Fixed Costs

$
BEP2 TC TC 2 1

BEP

TC

Quantity Multiple break-even points

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Multiple Break-even Points Example Problem

A manager has the option of purchasing 1, 2, or 3 machines. Fixed costs and potential volumes are as follows:

No of Machines 1 2 3

Total Annual FC $ 9600 $ 15000 $20000

Corresponding range of output 0 to 300 301 to 600 601 to 900

VC = $ 10 per unit, R= $40 per unit

a. Determine the break-even point for each range. b. If projected annual demand is between 580 and 660 units, how
many machines should the manager purchase?

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Assumptions of Cost-Volume Analysis

One product is involved

Everything produced can be sold

Variable cost per unit is the same regardless of volume Fixed costs do not change with volume

Revenue per unit constant with volume

Revenue per unit exceeds variable cost per unit

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Financial Analysis

Cash Flow - the difference between cash received

from sales and other sources, and cash outflow for labor, material, overhead, and taxes.

Present Value - the sum, in current value, of all future

cash flows of an investment proposal.

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Assignments
Stevenson Chapter 5:
Problems 1, 2, 4, 9, 10

Case Study: Fine Country Fruit Cakes

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