Operations
Management
Supplement 7 –
Capacity Planning
PowerPoint presentation to accompany
Heizer/Render
Principles of Operations Management, 6e
Operations Management, 8e
© 2006
Prentice
Hall, Inc. Hall, Inc.
©
2006
Prentice
S7 – 1
Outline
 Capacity
 Design and Effective Capacity
 Capacity and Strategy
 Capacity Considerations
 Managing Demand
 Capacity Planning
© 2006 Prentice Hall, Inc.
S7 – 2
Outline – Continued
 Breakeven Analysis
 Single-Product Case
 Multiproduct Case
 Applying Decision Trees to
Capacity Decisions
© 2006 Prentice Hall, Inc.
S7 – 3
Outline – Continued
 Applying Investment Analysis to
Strategy-Driven Investments
 Investment, Variable Cost, and
Cash Flow
 Net Present Value
© 2006 Prentice Hall, Inc.
S7 – 4
Learning Objectives
When you complete this supplement,
you should be able to:
Identify or Define:
 Capacity
 Design capacity
 Effective capacity
 Utilization
© 2006 Prentice Hall, Inc.
S7 – 5
Learning Objectives
When you complete this supplement,
you should be able to:
Describe or Explain:
 Capacity considerations
 Net present value analysis
 Break-even analysis
 Financial considerations
 Strategy-driven investments
© 2006 Prentice Hall, Inc.
S7 – 6
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
 Three time horizons
© 2006 Prentice Hall, Inc.
S7 – 7
Planning Over a Time
Horizon
Long-range
planning
Add facilities
Add long lead time equipment
Intermediaterange
planning
Subcontract
Add equipment
Add shifts
Short-range
planning
Add personnel
Build or use inventory
*
Modify capacity
*
Schedule jobs
Schedule personnel
Allocate machinery
Use capacity
* Limited options exist
Figure S7.1
© 2006 Prentice Hall, Inc.
S7 – 8
Design and Effective
Capacity
 Design capacity is the maximum
theoretical output of a system
 Normally expressed as a rate
 Effective capacity is the capacity a
firm expects to achieve given current
operating constraints
 Often lower than design capacity
© 2006 Prentice Hall, Inc.
S7 – 9
Utilization and Efficiency
Utilization is the percent of design capacity
achieved
Utilization = Actual Output/Design Capacity
Efficiency is the percent of effective capacity
achieved
Efficiency = Actual Output/Effective Capacity
© 2006 Prentice Hall, Inc.
S7 – 10
Bakery Example
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
Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls
© 2006 Prentice Hall, Inc.
S7 – 11
Bakery Example
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
Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls
© 2006 Prentice Hall, Inc.
S7 – 12
Bakery Example
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
Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls
Utilization = 148,000/201,600 = 73.4%
© 2006 Prentice Hall, Inc.
S7 – 13
Bakery Example
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
Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls
Utilization = 148,000/201,600 = 73.4%
© 2006 Prentice Hall, Inc.
S7 – 14
Bakery Example
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
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%
© 2006 Prentice Hall, Inc.
S7 – 15
Bakery Example
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
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%
© 2006 Prentice Hall, Inc.
S7 – 16
Bakery Example
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
© 2006 Prentice Hall, Inc.
S7 – 17
Bakery Example
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
© 2006 Prentice Hall, Inc.
S7 – 18
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 organization’s
mission and strategy
© 2006 Prentice Hall, Inc.
S7 – 19
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 complimentary
demand patterns
© 2006 Prentice Hall, Inc.
S7 – 20
Average unit cost
(dollars per room per night)
Economies and
Diseconomies of Scale
25 - Room
Roadside Motel
Economies
of scale
25
© 2006 Prentice Hall, Inc.
50 - Room
Roadside Motel
75 - Room
Roadside Motel
Diseconomies
of scale
50
Number of Rooms
75
Figure S7.2
S7 – 21
Capacity Considerations
 Forecast demand accurately
 Understanding the technology
and capacity increments
 Find the optimal operating level
(volume)
 Build for change
© 2006 Prentice Hall, Inc.
S7 – 22
Tactics for Matching
Capacity to Demand
1. Making staffing changes
2. Adjusting equipment and processes
 Purchasing additional machinery
 Selling or leasing out existing equipment
3. Improving methods to increase
throughput
4. Redesigning the product to facilitate
more throughput
© 2006 Prentice Hall, Inc.
S7 – 23
Complementary Demand
Patterns
Sales in units
4,000 –
By combining
both, the
variation is
reduced
3,000 –
Snowmobile
sales
2,000 –
1,000 –
JFMAMJJASONDJFMAMJJASONDJ
Time (months)
© 2006 Prentice Hall, Inc.
Jet ski
sales
Figure S7.3
S7 – 24
Approaches to Capacity
Expansion
Expected
demand
Demand
(c) Capacity lags demand with
incremental expansion
New
capacity
Expected
demand
Demand
New
capacity
(b) Leading demand with
one-step expansion
New
capacity
Expected
demand
(d) Attempts to have an average
capacity with incremental
expansion
Demand
Demand
(a) Leading demand with
incremental expansion
New
capacity
Expected
demand
Figure S7.4
© 2006 Prentice Hall, Inc.
S7 – 25
Approaches to Capacity
Expansion
(a) Leading demand with incremental
expansion
Demand
New
capacity
Expected
demand
1
© 2006 Prentice Hall, Inc.
2
3
Time (years)
Figure S7.4
S7 – 26
Approaches to Capacity
Expansion
(b) Leading demand with one-step
expansion
New
capacity
Demand
Expected
demand
1
© 2006 Prentice Hall, Inc.
2
3
Time (years)
Figure S7.4
S7 – 27
Approaches to Capacity
Expansion
(c) Capacity lags demand with incremental
expansion
New
capacity
Demand
Expected
demand
1
© 2006 Prentice Hall, Inc.
2
3
Time (years)
Figure S7.4
S7 – 28
Approaches to Capacity
Expansion
(d) Attempts to have an average capacity
with incremental expansion
Demand
New
capacity
Expected
demand
1
© 2006 Prentice Hall, Inc.
2
3
Time (years)
Figure S7.4
S7 – 29
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
© 2006 Prentice Hall, Inc.
S7 – 30
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
© 2006 Prentice Hall, Inc.
S7 – 31
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
© 2006 Prentice Hall, Inc.
S7 – 32
Break-Even Analysis
–
Total revenue line
900 –
800 –
Cost in dollars
700 –
Break-even point
Total cost = Total revenue
Total cost line
600 –
500 –
Variable cost
400 –
300 –
200 –
100 –
Fixed cost
|
|
|
|
|
|
|
|
|
|
|
–
0 100 200 300 400 500 600 700 800 900 1000 1100
|
Figure S7.5
© 2006 Prentice Hall, Inc.
Volume (units per period)
S7 – 33
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 = Px
F = Fixed costs
V = Variable costs
TC = Total costs = F + Vx
Break-even point
occurs when
TR = TC
or
Px = F + Vx
© 2006 Prentice Hall, Inc.
F
BEPx =
P-V
S7 – 34
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 = Px
F = Fixed costs
V = Variable costs
TC = Total costs = F + Vx
BEP$ = BEPx P
F
=
P
P-V
F
=
(P - V)/P
F
=
1 - V/P
Profit = TR - TC
= Px - (F + Vx)
= Px - F - Vx
= (P - V)x - F
© 2006 Prentice Hall, Inc.
S7 – 35
Break-Even Example
Fixed costs = $10,000
Direct labor = $1.50/unit
Material = $.75/unit
Selling price = $4.00 per unit
$10,000
F
BEP$ =
=
1 - [(1.50 + .75)/(4.00)]
1 - (V/P)
© 2006 Prentice Hall, Inc.
S7 – 36
Break-Even Example
Fixed costs = $10,000
Direct labor = $1.50/unit
Material = $.75/unit
Selling price = $4.00 per unit
$10,000
F
BEP$ =
=
1 - [(1.50 + .75)/(4.00)]
1 - (V/P)
$10,000
=
= $22,857.14
.4375
$10,000
F
BEPx =
=
= 5,714
4.00 - (1.50 + .75)
P-V
© 2006 Prentice Hall, Inc.
S7 – 37
Break-Even Example
50,000 –
Revenue
Dollars
40,000 –
Break-even
point
30,000 –
Total
costs
20,000 –
Fixed costs
10,000 –
|
–
0
© 2006 Prentice Hall, Inc.
|
|
2,000
4,000
|
6,000
Units
|
|
8,000
10,000
S7 – 38
Break-Even Example
Multiproduct Case
BEP$ =
where
© 2006 Prentice Hall, Inc.
V
P
F
W
i
F
∑
Vi
1x (Wi)
Pi
= variable cost per unit
= price per unit
= fixed costs
= percent each product is of total dollar sales
= each product
S7 – 39
Multiproduct Example
Fixed costs = $3,500 per month
Item
Sandwich
Soft drink
Baked potato
Tea
Salad bar
© 2006 Prentice Hall, Inc.
Price
$2.95
.80
1.55
.75
2.85
Cost
$1.25
.30
.47
.25
1.00
Annual Forecasted
Sales Units
7,000
7,000
5,000
5,000
3,000
S7 – 40
Multiproduct Example
Fixed costs = $3,500 per month
Annual Forecasted
Item
Price
Cost
Sales Units
Sandwich
$2.95
$1.25
7,000
Soft drink
.80
.30
7,000
Baked potato
1.55
.47 Annual 5,000 Weighted
% of Contribution
Tea Selling Variable .75
.25Forecasted 5,000
Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $
Sales (col 5 x col 7)
Salad bar
2.85
1.00
3,000
Sandwich
Soft drink
Baked
potato
Tea
Salad bar
© 2006 Prentice Hall, Inc.
$2.95
.80
1.55
$1.25
.30
.47
.42
.38
.30
.58
.62
.70
$20,650
5,600
7,750
.446
.121
.167
.259
.075
.117
.75
2.85
.25
1.00
.33
.35
.67
.65
3,750
8,550
$46,300
.081
.185
1.000
.054
.120
.625
S7 – 41
BEP Example
=
Multiproduct
V
∑ 1 - P x (W )
F
$
i
i
i
Fixed costs = $3,500 per month
$3,500
x Forecasted
12
Annual
=
= $67,200
.625
Item
Price
Cost
Sales Units
Sandwich
$2.95
$1.25
7,000
$67,200
Daily
Soft drink
.80
.30
7,000
=
= $215.38
sales
312 days
Baked potato
1.55
.47 Annual
5,000 Weighted
% of Contribution
Tea Selling Variable .75
.25Forecasted 5,000
Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $
Sales (col 5 x col 7)
Salad bar
2.85
1.00
3,000
.446 x $215.38
= 32.6  .259
33
Sandwich
$2.95
$1.25
.42
.58
$20,650
.446
$2.95
sandwiches
Soft drink
Baked
potato
Tea
Salad bar
© 2006 Prentice Hall, Inc.
.80
1.55
.30
.47
.38
.30
.62
.70
5,600
7,750
.75
2.85
.25
1.00
.33
.35
.67
.65
3,750
8,550
$46,300
.121
.075
per
day
.167
.117
.081
.185
1.000
.054
.120
.625
S7 – 42
Decision Trees and
Capacity Decision
-$14,000
Market favorable (.4)
Market unfavorable (.6)
$100,000
-$90,000
$18,000
Market favorable (.4)
Medium plant
Market unfavorable (.6)
$60,000
-$10,000
$13,000
Market favorable (.4)
Market unfavorable (.6)
$40,000
-$5,000
$0
© 2006 Prentice Hall, Inc.
S7 – 43
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
© 2006 Prentice Hall, Inc.
S7 – 44
Net Present Value (NPV)
F
P=
(1 + i)N
where
© 2006 Prentice Hall, Inc.
F
P
i
N
= future value
= present value
= interest rate
= number of years
S7 – 45
NPV Using Factors
F
P=
= FX
N
(1 + i)
where
Portion of
Table S7.1
© 2006 Prentice Hall, Inc.
Year
1
2
3
4
5
X = a factor from Table S7.1
defined as = 1/(1 + i)N and
F = future value
5%
.952
.907
.864
.823
.784
6%
.943
.890
.840
.792
.747
7%
.935
.873
.816
.763
.713
…
10%
.909
.826
.751
.683
.621
S7 – 46
Present Value of an Annuity
An annuity is an investment which
generates uniform equal payments
S = RX
where
© 2006 Prentice Hall, Inc.
X = factor from Table S7.2
S = present value of a series of
uniform annual receipts
R = receipts that are received every
year of the life of the investment
S7 – 47
Present Value of an Annuity
Portion of Table S7.2
Year
1
2
3
4
5
© 2006 Prentice Hall, Inc.
5%
.952
1.859
2.723
4.329
5.076
6%
.943
1.833
2.676
3.465
4.212
7%
.935
1.808
2.624
3.387
4.100
…
10%
.909
1.736
2.487
3.170
3.791
S7 – 48