Capacity & Location

Decisions

Capacity planning

Capacity is the maximum output rate of a facility

Capacity planning is the process of establishing
the output rate that can be achieved at a facility:
Capacity is usually purchased in chunks
Strategic issues: how much and when to spend
capital for additional facility & equipment
Tactical issues: workforce & inventory levels, &
day-to-day use of equipment

Measuring Capacity
Examples

There is no one best way to measure capacity

Output measures like kegs per day are easier to understand
With multiple products, inputs measures work better

Type of Business

Input Measures of
Capacity

Output Measures
of Capacity

Car manufacturer

Labor hours

Cars per shift

Hospital

Available beds

Patients per month

Pizza parlor

Labor hours

Pizzas per day

Retail store

Floor space in
square feet

Revenue per foot

Measuring Available
Capacity

Design capacity:

Maximum output rate under ideal

conditions
A bakery can make 30 custom cakes per
day when pushed at holiday time

Effective capacity:

Maximum output rate under normal

(realistic) conditions
On the average this bakery can make 20
custom cakes per day
4

Measuring Effectiveness of
Capacity Use

Measures how much of the available

capacity is actually being used:
actual output rate
100%
Utilization
capacity

Measures effectiveness
Use either effective or design
capacity in denominator

Example of Computing Capacity Utilization: A

bakerys design capacity is 30 custom cakes per day.
Currently the bakery is producing 28 cakes per day. What is
the bakerys capacity utilization relative to both design and
effective capacity?

Utilization effective

actual output
28
(100%) (100%) 140%
effective capacity
20

actual output
28
Utilization design
(100%) (100%) 93%
design capacity
30

The current utilization is only slightly below its design

capacity and considerably above its effective capacity
The bakery can only operate at this level for a short
period of time
6

Capacity Considerations

The Best Operating Level is the output that results

in the lowest average unit cost
Economies of Scale:

Where the cost per unit of output drops as volume of output

increases
Spread the fixed costs of buildings & equipment over
multiple units, allow bulk purchasing & handling of material

Diseconomies of Scale:

Where the cost per unit rises as volume increases

Often caused by congestion (overwhelming the process with
too much work-in-process) and scheduling complexity

Best Operating Level and

Size

Alternative 1: Purchase one large facility, requiring one large

initial investment
Alternative 2: Add capacity incrementally in smaller chunks as
needed
8

Other Capacity
Considerations

Focused factories:

Plant within a plant (PWP):

Small, specialized facilities with limited

objectives
Segmenting larger operations into
smaller operating units with focused
objectives

Subcontractor networks:

Outsource non-core items to free up

capacity for what you do well
9

Making Capacity Planning

Decisions
The three-step procedure for
making capacity planning
decisions is as follows:
1.

Identify Capacity Requirements

2.

Develop Capacity Alternatives

3.

Evaluate Capacity Alternatives

10

Identifying capacity
requirements

Forecasting Capacity:
Long-term capacity requirements based on future demand
Identifying future demand based on forecasting
Forecasting, at this level, relies on qualitative forecast models
Executive opinion
Delphi method
Forecast and capacity decision must included strategic
implications

Capacity cushions

Plan to underutilize capacity to provide flexibility

Strategic Implications

How much capacity a competitor might have

Potential for overcapacity in industry a possible hazard
11

Developing & Evaluating

Capacity Alternatives

Capacity alternatives include

Could do nothing,
expand large now (may included
capacity cushion), or
expand small now with option to add
later

Use decision support aids to

evaluate decisions (decision tree
most popular)
12

Decision trees
Diagramming technique which uses

Decision points points in time when

decisions are made, squares called nodes
Decision alternatives branches of the tree
off the decision nodes
Chance events events that could affect a
decision, branches or arrows leaving
circular chance nodes
Outcomes each possible alternative listed
13

Decision tree diagrams

Decision trees developed by

Drawing from left to right

Use squares to indicate decision points
Use circles to indicate chance events
Write the probability of each chance by the
chance (sum of associated chances = 100%)
Write each alternative outcome in the right
margin
14

Example Using Decision Trees: A restaurant owner has

determined that she needs to expand her facility. The
alternatives are to expand large now and risk smaller
demand, or expand on a smaller scale now knowing that she
might need to expand again in three years. Which
alternative would be most attractive? (see notes)

15

Evaluating the Decision

Tree

Decision tree analysis utilizes expected value

analysis (EVA)
EVA is a weighted average of the chance
events

Probability of occurrence * chance event outcome

Refer to previous slide

At decision point 2, choose to expand to maximize

profits ($200,000 > $150,000)
Calculate expected value of small expansion:

EVsmall = 0.30($80,000) + 0.70($200,000) = $164,000

16

Evaluating the Decision

Tree cont

Calculate expected value of large expansion:

At decision point 1, compare alternatives &

choose the large expansion to maximize the
expected profit:

EVlarge = 0.30($50,000) + 0.70($300,000) =

$225,000

$225,000 > $164,000

Choose large expansion despite the fact that

there is a 30% chance its the worst decision:

Take the calculated risk!

17

Location Analysis
Three most important factors in real estate:
1. Location
2. Location
3. Location

Facility location is the process of identifying

the best geographic location for a
service or production facility

18

Factors Affecting Location

Decisions

Proximity to source of supply:

Proximity to customers:

Reduce transportation costs of perishable or

bulky raw materials
High population areas, close to JIT partners

Proximity to labor:

Local wage rates, attitude toward unions,

availability of special skills (silicon valley)

19

More Location Factors

Community considerations:

Site considerations:

Local zoning & taxes, access to utilities, etc.

Quality-of-life issues:

Local communitys attitude toward the facility

(prisons, utility plants, etc.)

Climate, cultural attractions, commuting time, etc.

Other considerations:

Options for future expansion, local competition,

etc.
20

Globalization
Should Firm Go Global?
Globalization is the process of locating
facilities around the world
Potential advantages:

Potential disadvantages:

Inside track to foreign markets, avoid trade barriers, gain

access to cheaper labor
Political risks may increase, loss of control of proprietary
technology, local infrastructure (roads & utilities) may be
inadequate, high inflation

Other issues to consider:

Language barriers, different laws & regulations, different

business cultures
21

Making Location Decisions

Analysis should follow 3 step process:
1.
2.
3.

Identify dominant location factors

Develop location alternatives
Evaluate locations alternatives

Procedures for evaluation location

alternatives include

Factor rating method

Load-distance model
Center of gravity approach
Break-even analysis
Transportation method
22

Factor Rating Example

23

A Load-Distance Model Example: Matrix Manufacturing is

considering where to locate its warehouse in order to service
its four Ohio stores located in Cleveland, Cincinnati,
Columbus, Dayton. Two sites are being considered; Mansfield
and Springfield, Ohio. Use the load-distance model to make
the decision.

Calculate the rectilinear distance:

dAB 30 10 40 15 45 miles

Multiply by the number of loads between each site and the four
cities
24

Calculating the Load-Distance

Score
for
Springfield vs. Mansfield

The load-distance score for Mansfield is higher than for

Springfield. The warehouse should be located in
Springfield.
25

The Center of Gravity

Approach

This approach requires that the analyst find the center

of gravity of the geographic area being considered

Computing the Center of Gravity for Matrix

Manufacturing

Xc.g.

lX

l
i

325

7.9 ; Yc.g.
41

l Y
l
i

436

10.6
41

Is there another possible warehouse location closer to the

C.G. that should be considered?? Why?

26

Break-Even Analysis

Break-even analysis computes the amount of goods

required to be sold to just cover costs
Break-even analysis includes fixed and variable costs
Break-even analysis can be used for location analysis
especially when the costs of each location are known
Step 1: For each location, determine the fixed and
variable costs
Step 2: Plot the total costs for each location on one
graph
Step 3: Identify ranges of output for which each
location
has the lowest total cost
Step 4: Solve algebraically for the break-even points
over the identified ranges
27

Break-Even Analysis

Remember the break even equations used for

calculation total cost of each location and for calculating
the breakeven quantity Q.
Total cost = F + cQ

Total revenue = pQ
Break-even is where Total Revenue = Total Cost
Q = F/(p-c)

Q = break-even quantity
p = price/unit
c = variable cost/unit
F = fixed cost

28

Example using Break-even Analysis: CleanClothes Cleaners is considering four possible

sites for its new operation. They expect to clean
10,000 garments. The table and graph below are
used for the analysis.

29

The Transportation Method

Can be used to solve specific location problems

Is discussed in detail in the supplement to this
text
Could be used to evaluate the cost impact of
adding potential location sites to the network of
existing facilities
Could also be used to evaluate adding multiple
new sites or completely redesigning the
network
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Capacity Planning &

Facility Location within OM

Decisions about capacity and location are

highly dependent on forecasts of demand (Ch
8).
Capacity is also affected by operations
strategy (Ch 2), as size of capacity is a key
element of organizational structure.
Other operations decisions that are affected by
capacity and location are issues of job design
and labor skills (Ch 11), choice on the mix of
labor and technology, as well as choices on
technology and automation (Ch 3).

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Capacity Planning and Facility

Location Across the
Organization

Capacity planning and location

analysis affect operations
management and are important to
many others

Finance provides input to finalize

capacity decisions
Marketing impacted by the
organizational capacity and location to
customers
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