ChapterS: Strategic Capacity Planning for Products and Services Introduction Capacity refers to an upper limit or ceiling on the load that an operating unit can handle. The load might be in terms of the number of physical units produced (e.g., bicycles assembled per hour) or the number of services performed (e.g,, computers upgraded per hour). The operating unit might be a plant, department, machine, store, or worker. Capacity needs include equipment, space, and employee skills. Capacity : The upper limit or ceiling on the load that an operating unit can handle. Capacity Decisions Are Strategic For a number of reasons, capacity decisions are among the most fundamental of all the design decisions that managers must make. In fact, capacity decisions can be critical for an organization: 1. Capacity decisions have a real impact on the ability of the organization to meet future demands for products and services; capacity essentially limits the rate of output possible. 2. Capacity decisions affect operating costs. Ideally, capacity and demand requirements will be matched, which will tend to minimize operating costs. 3. Capacity is usually a major determinant of initial cost. Typically, the greater the capacity of a productive unit, the greater its cost 4. Capacity decisions often involve long-term commitment of resources and the fact that, once they are implemented, those decisions may be difficult or impossible to modify without incurring major costs. 5. Capacity decisions can affect competitiveness. Ifa firm has excess capacity, or can quickly add capacity, that fact may serve as a barrier to entry by other firms. Then too, capacity can affect delivery speed, which can be a competitive advantage. 6. Capacity affects the ease of management; having appropriate capacity makes management easier than when capacity is mismatched. 7 Globalization has increased the importance and the complexity of capacity de and distant markets add to the uncertainty about capacity needs. 8 Because capacity decisions often involve substantial financial and other resources, it is necessary to plan for them far in advance. ions. Far-flung supply chains Defining and Measuring Capacity Up to this point, we have been using a general definition of capacity. Although it is functional, it can be refined into two useful definitions of capacity: Design capacity : The maximum designed service capacity or output rate . Effective capacity : Design capacity minus personal and other allowances .TABLE 5.1 Measures of a ‘Auto manufacturing Labor hours, machine hours Number of ears par shitt ‘Stoel mill Furnace size ‘Tons of stool per day Oil refinery Refinery size Gallons of fuel per: Farming Number of acres, number Bushels of grain per acre per of cows ‘year, gallons of milk per day Restaurant ‘Number of tables, seating Number of meals served per capacity fay Theater ‘Number of seats Number of tickets sold per performance Retail sales ‘Square feet of loor space Revenue generated per day Those different measures of capacity are useful in defining two measures of system effectiveness: efficiency and utilization. Efficiency is the ratio of actual output to effective capacity. Capacity utitization is the ratio of actual output to design capacity. = 100% y Actual output Design cap pacity” Utilization 00% Determinants of Effective Capacity Many decisions about system design have an impact on capacity. The same is true for many operating decisions. This section briefly describes some of these factors, which are then elaborated ‘on elsewhere in the book. The main factors relate to facilities, products or services, processes, human considerations, operational factors, the supply chain, and external forces. Facilities. The design of facilities, including size and provision for expansion, is key. Locational factors, such as transportation costs, distance to market, labor supply, energy sources, and room for ‘expansion, are also important. Product and Service Factors. Product or service design can have a tremendous influence ‘on capacity. Process Factors. The quantity capability of a process is an obvious determinant of capacity. A more subtle determinant is the influence of output quality. Human Factors. The tasks that make up a job, the variety of activities involved, and the training, skill, and experience required to perform a job all have an impact on the potential and actual output. Policy Factors. Management policy can affect capacity by allowing or not allowing capacity ‘options such as overtime or second or third shifts.Operational Factors. scheduling problems may occur when an organization has differences in equipment capabilities among alternative pieces of equipment or differences in job requirements. Inventory stocking decisions, late deliveries, purchasing requirements, acceptability of purchased materials and parts, and quality inspection and control procedures also can have an impact on effective capacity, Inventory shortages of even one component of an assembled item (¢.g., computers, refrigerators, automobiles) can cause a temporary hall to assembly operations unlll the components become avaliable. This can have a major impact on effective capacity. Thus, insufficient capacity in one area can atfect overall capacity Supply Chain Factors. Supply chain factors must be taken into account in capacity planning if substantial capacity changes are involved. External Factors. Product standards, especially minimum quality and performance standards, can restrict management's options for increasing and using capacity. Thus, pollution standards on products and equipment often reduce effective capacity, as does paperwork required by goverment regulatory agencies by engaging employees In nonproductive activities. A similar effect occurs when a union contract limits the number of hours and type of work an employee may do. TABLE 5.2 Factors that determine effective capacity ‘5. Compensation 6. Learning ratos 7. Absenteeism and labor turnover E. Policy & Operational 1. Scheduling 2. Materials management 3. Quality assurance ©. Process 4. Maintenance policies 1. Quantity capabilities ‘5. Equipment breakdowns 2. Quality capabilities G. Supply chain D. Human factors H. External factors 1, Job content 1. Product standards 2. Job design 2. Safety regulations 3. Training and experience 3. Unions ‘4. Motivation 4. Pollution control standards Strategy Formulation The three primary strategies are leading, following, and tracking. A leading capacity strategy builds capacity in anticipation of future demand increases. If capacity increases involve a long lead time, this strategy may be the best option. A following strategy builds capacity when demand exceeds current capacity. A tracking strategy Is similar to 8 folowing strategy, but it adds capacity in relatively ‘small increments to keep pace with increasing demand. An organization typically bases its capacity strategy on assumptions and predictions about long-term, demand pattems, technological changes, and the behavior of its competitors. These typically involve (1) the growth rate and variability of demand, (2) the costs of building and operating facilities of various sizes, (3) the rate and direction of technological innovation, (4) the likely behavior of competitors, and (5) availabilty of capital and other inputs.Capacity cushion = capacity - expected demand. Capacity cushion : Extra capacity used to offset demand uncertainty . Steps in the Capacity Planning Process 1. Estimate future capacity requirements. 2. Evaluate existing capacity and facilitic 3. Identify alternatives for meeting req 4. Conduct financial analyses of each alternative. 5. Assess key qualitative issues for each alternative. 6. Select the alternative to pursue that will be best in the long term. 7. Implement the selected alternative. 8. Monitor results. Forecasting Capacity Requirements Capacity planning decisions involve both long-term and short-term considerations. Long-term considerations relate to overall level of capacity, such as facility size; short-term considerations relate to probable variations in capacity requirements created by such things as seasonal, random, and irregular fluctuations in demand. When trends are identified, the fundamental issues are (1) how long the trend might persist, because few things last forever, and (2) the slope of the trend. If cycles are identified, interest focuses on (1) the approximate length of the cycles and (2) the amplitude of the cycles (ie., deviation from average). FIGURE 5.1 Common demand pattems (p191) Calculating Processing Requirements EXAMPLE 2 (p192) Additional Challenges of Planning Service Capacity Three very important factors in planning service capacity are (1) there may be a need to be near customers, (2) the inability to store services, and (3) the degree of volatility of demand. “Convenience for customers is often an important aspect of service. Generally, a service must be located near customers . Capacity also must be matched with the timing of demand. Unlike goods, services cannot be produced in ‘one period and stored for use in a later period.Do It In-House or Outsource It? Once capacity requirements have been determined, the organization must decide whether to produce a good or provide a service itself, or to outsource from another organization. Many organizations buy parts or contract out services, for a variety of reasons. Among those factors are 1. Available capacity. If an organization has available the equipment, necessary skills, and time, It often makes sense to produce an item or perform a service in-house. 2. Expertise. If a firm lacks the expertise to do a job satisfactorily, buying might be a reasonable alternative. 3. Quality considerations. Firms that specialize can usually offer higher quality than an organization can attain itser. 4. The nature of demand. When demand for an item is high and steady, the organization is often better off doing the work itsetf. 5. Cost. Any cost savings achieved from buying or making must be weighed against the preceding factors. Cost savings might come from the item itself or from transportation cost savings. 6. Risks. Buying goods or services may entail considerable risks. Loss of direct control over operations, knowledge sharing, and the possible need to disclose proprietary information are three risks. Developing Capacity Strategies There are a number of ways to enhance development of capaeily strategies: 1. Design flexibility into systems. The long-term nature of many capacity decisions and the risks inherent in long-term forecasts suggest potential benefits from designing flexible systems. 2. Take stage of life cycle into account. Capacity requirements are often closely linked to the stage of the life cycle that a product or service is in. At the introduction phase, it can be difficult to determine both the size of the market and the organization's eventual share of that market. * In the growth phase the overall market may experience rapid growth. “In the maturity phase the size of market levels off, and organizations tend to have stable market shares. “In the deciine phase an organization is faced with underutlization of capacity due to declining demand. 3. Take a “big-picture” (L.e., systems) approach to capacity changes. When developing capacity altornatives. itis important to consider how parts of the systom interrelate. Bottleneck operation : An operation in a sequence of operations whose capacity is lower than that of the other operations . FIGURE 5.2 Bottieneck operation (p196) 4, Prepare to deal with capacity “chunks.” Capacity increases are often acquired in fairly large chunks rather than smooth increments, making it difficult to achieve a match between desired capacity and feasible capacity. 5. Attempt to smooth out capacity requirements. Unevenness in capacity requirements also can create certain problems. For instance, during periods of inclement weather, public transportation ridership tends to increase substantially relative to periods of pleasant weather.6. Identity the optimal operating level. Production units typically have an ideal or optimal level of ‘operation in terms of unit cost of output, At the ideal level, cost per unit Is the lowest for that production uni Economies of scale : If the output rate is less than the optimal level, increasing the 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. Reasons for economies of scale include the following: a. Fixed costs are spread over more units, reducing the fixed cost per unit. b. Construction costs increase at a decreasing rate with respect to the size of the facility to be built. c. Processing costs decrease as output rates increase because operations become more standardized, which reduces unit costs. Reasons for diseconomies of scale include the following: a. Distribution costs increase due to traffic congestion and shipping from one large centralized facility instead of several smaller, decentralized facilities. b. Complexity increases costs; control and communication become more problematic. Inflexibility can be an issue. d. Additional levels of bureaucracy exist, slowing decision making and approvals for changes 7. Choose a strategy if expansion Is involved, Consider whether Incremental expansion or single step is more appropriate. Constraint Management Constraint : Something that limits the performance of a process or system in achieving Its goals. there are seven categories of constraints: ‘1-Market: Insufficient demand, 2-Resource: Too little of one o more resources 3-Material: Too little of one or more materials. 4-Financial: Insufficient funds. 5-Supplier: Unreliable, long lead time, substandard quality. 6-knowledge or competency: Needed knowledge or skills missing or incomplete, 7-Policy: Laws or regulations interfere. ‘There may only be a few constraints, or there may be more than a few. Constraint issues can be resolved bby using the following five steps: 1, Identify the most pressing constraint. If it can easily be overcome, do so, and return to Step 1 for the next constraint. Otherwise, proceed to Step 2. 2. Change the operation to achieve the maximum benefit, given the constraint, This may be a short- term solution. 3. Make sure other portions of the process are supportive of the constraint 4. Explore and evaluate ways to overcome the constraint, 5. Repeat the process until the level of constraints is acceptable.Evaluating Alternatives Break-even point (BEP) : The volume of output at which total cost and total revenue are equal Indifference point : The quantity that would make two alternatives equivalent . Cost-volume analysis can be a valuable tool for comparing capacity alternatives if certain assumptions are satisfied: 1. One product is involved. 2. Everything produced can be sold. 3. The variable cost per unit is the same regardless of the volume. 4, Fixed costs do not change with volume changes, or they are step changes. 5, The revenue per unit is the same regardless of volume. 6. Revenue per unit exceeds variable cost per unit. Financial Analysis Operations personnel need to have the ability to do financial analysis. A problem that is universally ‘encountered by managers is how to allocate scarce funds. A common approach Is to use financial analysis to rank investment proposals, taking into account the time value of money. 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 praposal. Decision Theory Decision theory is a helpful too! for financial comparison of alternatives under conditions of risk or uncertainty. It is sulted to capacity decisions and to a wide range of other decisions managers must make. It involves identifying a set of possible future conditlons that could influence results, listing alternative courses of action, and developing a financial outcome for each alternative-future condition ‘combination, Waiting-Line Analysis Analysis of lines is often useful for designing or modifying service systems. Waiting lines have a tendency to form in a wide variety of service systems (¢.g., airport ticket counters, telephone calls to a cable television company, hospital emergency rooms). The lines are symptoms of bottleneck operations. Analysis is useful in helping managers choose a capacity level that will be cost- effective through balancing the cost of having customers wait with the cost of providing additional capacity. It can aid in the determination of expected costs for various levels of service capacity. Simulation Simulation can be a useful too! in evaluating what-if scenarios.Chapter 5S: Deci Introduction in Theory Decision theory represents a general approach to decision making, Itis suitable for a wide range of operations management decisions, Decisions that lend themselves to a decision theory approach tend to be characterized by the following elements: 1 Asset of possible future conditions that will have a bearing on the results of the decision. 2. Alist of alternatives for the manager to choose from. 3. Aknown payoff for each alternative under each possible future condition. To use this approach, a decision maker would employ this process: 1. Identify the possible future conditions (e.g,, demand will be low, medium, or high; the competitor will or will not introduce a new product), These are called states of nature. 2. Develop a list of possible alternatives, one of which may be to do nothing, 3. Determine or estimate the payoff associated with each alternative for every possible future condition. 4. If possible, estimate the likelihood of each possible future condition, S. Evaluate alternatives according to some decision criterion (e.g,, maximize expected profit), and select the best alternative Payoff table Table : showing the expected payoffs for each alternative in every possible state of nature. Causes Of Poor Decisions The decision process consists of these steps: 1, Identify the problem, 2. Specify objectives and criteria for a solution. 3. Develop suitable alternatives. 4. Analyze and compare alternatives. 5. Select the best alternative 6. Implement the solution. 7. Monitor to see that desired result is achieved, Bounded rationality : The limitations on decision making caused by costs, human abilities, time, technology, and availability of information. Suboptimization : The result of different departments each attempting to reach a solution that is optimum for that department. Decision Environments Certainty : Environment which relevant parameters have known values, Risk : Environment in which certain future events have probable outcomes. Uncertainty : Environment in which is impossible to assess the likelihood of various future events.Decision Making Under Uncertainty Maximin : Choose the alternative with the best of the worst possible payoffs. Maximax: Choose the alternative with the best possible payoff. Laplace : Choose the alternative with the best average payoff of any of the alternatives. Minimax regret : Choose the alternative that has the least of the worst regrets . Regret (opportunity loss) : The difference between a given payoff and the best payoff for a state of nature. Decision Making Under Risk Expected monetary value (EMV) : criterion The best expected value among the alternatives. Decision Trees Decision tree : A schematic representation of the available alternatives and their possible consequences . Expected value of perfect information (EVP!) : The difference between the expected payoff with perfect information and the expected payoff under risk . Sensitivity analysis : Determining the range of probability for which an alternative has the best expected payoff.