5 Capacity Planning For Products and Services McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. Learning Objectives Explain the importance of capacity planning. Discuss ways of defining and measuring capacity. Describe the determinants of effective capacity. Discuss the major considerations related to developing capacity alternatives. Briefly describe approaches that are useful for evaluating capacity alternatives 5-2 Capacity Planning Capacity is the upper limit or ceiling on the load that an operating unit can handle. Capacity also includes Equipment Space Employee skills The basic questions in capacity handling are: What kind of capacity is needed? How much is needed? When is it needed? 5-3 Importance of Capacity Decisions 1. Impacts ability to meet future demands 2. Affects operating costs 3. Major determinant of initial costs 4. Involves long-term commitment 5. Affects competitiveness 6. Affects ease of management 7. Globalization adds complexity 8. Impacts long range planning 5-4 Capacity Design capacity maximum output rate or service capacity an operation, process, or facility is designed for Effective capacity Design capacity minus allowances such as personal time, maintenance, and scrap Actual output rate of output actually achieved—cannot exceed effective capacity 5-5 Efficiency and Utilization Actual output Efficiency = Effective capacity Actual output Utilization = Design capacity Both measures expressed as percentages 5-6 Example 1 Design capacity = 50 trucks/day Effective capacity = 40 trucks/day Actual output = 36 units/day Actual output = 36 units/day Efficiency = = 90% Effective capacity Utilization = Actual output Design capacity 40 units/ day = 36 units/day 50 units/day = 72% 5-7 Determinants of Effective Capacity Facilities Product and service factors Process factors Human factors Policy factors Operational factors Supply chain factors External factors 5-8 Key Decisions of Capacity Planning 1. Amount of capacity needed Capacity cushion (100% - Utilization) 2. Timing of changes 3. Need to maintain balance 4. Extent of flexibility of facilities Capacity cushion – extra demand intended to offset uncertainty 5-9 Steps for Capacity Planning 1. Estimate future capacity requirements 2. Evaluate existing capacity 3. Identify alternatives 4. Conduct financial analysis 5. Assess key qualitative issues 6. Select one alternative 7. Implement alternative chosen 8. Monitor results 5-10 Calculating Processing Requirements (Example 2) Standard processing time per unit (hr.) Product Annual Demand Processing time needed (hr.) #1 400 5.0 2,000 #2 300 8.0 2,400 #3 700 2.0 1,400 5,800 If annual capacity is 2000 hours, then we need three machines to handle the required volume: 5,800 hours/2,000 hours = 2.90 machines 5-11 In-House or Outsourcing Outsource: obtain a good or service from an external provider 1. 2. 3. 4. 5. 6. Available capacity Expertise Quality considerations Nature of demand Cost Risk 5-12 Bottleneck Operation Figure 5.2 Machine #1 Machine #2 Bottleneck operation: An operation in a sequence of operations whose capacity is lower than that of the other operations 10/hr 10/hr Machine #3 Bottleneck Operation 10/hr Machine #4 10/hr 30/hr Bottleneck Operation Bottleneck Operation 1 20/hr. Operation 2 10/hr. Operation 3 15/hr. 10/hr. Maximum output rate limited by bottleneck 5-14 Economies of Scale Economies of scale If the output rate is less than the optimal level, increasing output rate results in decreasing average unit costs Diseconomies of scale If the output rate is more than the optimal level, increasing the output rate results in increasing average unit costs 5-15 Optimal Rate of Output Figure 5.4 Average cost per unit Production units have an optimal rate of output for minimal cost. Minimum average cost per unit Minimum cost 0 Rate of output 5-16 Economies of Scale Figure 5.5 Average cost per unit Minimum cost & optimal operating rate are functions of size of production unit. 0 Small plant Medium plant Large plant Output rate 5-17 Evaluating Alternatives Cost-volume analysis Break-even point (BEP) Financial analysis Cash flow Present value Decision theory Waiting-line analysis Simulation 5-18 Cost–Volume Relationships Amount ($) Figure 5.6A Fixed cost (FC) 0 Q (volume in units) 5-19 Cost–Volume Relationships Amount ($) Figure 5.6B 0 Q (volume in units) 5-20 Cost–Volume Relationships Amount ($) Figure 5.6C 0 BEP units Q (volume in units) 5-21 Break-Even Problem with Step Fixed Costs Figure 5.7A 3 machines 2 machines 1 machine Quantity Step fixed costs and variable costs 5-22 Break-Even Problem with Step Fixed Costs Figure 5.7B $ BEP 3 TC BEP2 TC 3 TC 2 1 Quantity Multiple break-even points 5-23 Assumptions of Cost–Volume Analysis 1. One product is involved 2. Everything produced can be sold 3. Variable cost per unit is the same regardless of volume 4. Fixed costs do not change with volume 5. Revenue per unit is constant with volume 6. Revenue per unit exceeds variable cost per unit 5-24