Chapter 9 - Capacity Planning & Facility

Location
1

Operations Management
6th Edition
R. Dan Reid & Nada R. Sanders

Copyright © 2016 John Wiley & Sons, Inc.

 Learning Objectives
2

Define capacity planning.

Explain the steps involved in capacity planning and
location analysis.
Explain the usefulness of decision trees in decision
making.
Identify key factors in location analysis.
Describe the decision-support tools used in location
analysis.

Copyright © 2016 John Wiley & Sons, Inc.

 Capacity Planning
3

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

Copyright © 2016 John Wiley & Sons, Inc.

 Measuring Capacity
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 There is no one best way to measure capacity

 Output measures like kegs per day are easier to understand
 With multiple products, input measures work better
 Measuring Capacity
5

Two types of information needed:

1. Amount of available capacity
 Understand how much capacity the facility has

2. Effectiveness of capacity use

 How effectively we are using the available capacity

Copyright © 2016 John Wiley & Sons, Inc.

Measuring Available Capacity
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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;
usually lower than design capacity
 On the average this bakery can make 20 custom cakes per

day

Copyright © 2016 John Wiley & Sons, Inc.

Measuring Effectiveness of Capacity Use
7

Capacity Utilization:
Measures how much of the available capacity (%) is
actually being used.

actual output rate

Utilization  100%
capacity
 Measures effectiveness
 Use either effective or design capacity in

denominator

Copyright © 2016 John Wiley & Sons, Inc.

 Example of Computing Capacity Utilization: A bakery’s design capacity is 30
custom cakes per day. Currently the bakery is producing 28 cakes per day. What is
the bakery’s capacity utilization relative to both design and effective capacity?
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actual output 28
Utilization effective  (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
 Capacity Considerations
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 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

Copyright © 2016 John Wiley & Sons, Inc.

 Best Operating Level and Size
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 When expanding capacity, there are two alternatives:

1. Purchase one large facility, requiring one large initial investment
2. Add capacity incrementally in smaller chunks as needed
Other Capacity Considerations
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Focused factories:
 Small, specialized facilities with limited objectives e.g.
The Limited (Limited Too)
Plant within a plant (PWP):
 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; fast growing trend today

Copyright © 2016 John Wiley & Sons, Inc.

Making Capacity Planning Decisions
12

The three-step procedure for making capacity

planning decisions is as follows:
1. Identify Capacity Requirements
2. Develop Capacity Alternatives
3. Evaluate Capacity Alternatives

Copyright © 2016 John Wiley & Sons, Inc.

 1. Identifying Capacity Requirements
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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 includes strategic
implications
Capacity cushions
 Plan for added capacity to provide flexibility
Strategic Implications
 How much capacity a competitor might have
 Potential for overcapacity in industry a possible hazard

Copyright © 2016 John Wiley & Sons, Inc.

 2. Developing Capacity Alternatives
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Capacity alternatives include:

1. Do nothing
2. Expand large now (may included capacity
cushion)
3. Expand small now with option to add later

Copyright © 2016 John Wiley & Sons, Inc.

 3. Evaluating Capacity Alternatives
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Use decision support aids to evaluate

decisions
 Decision tree most popular
Managers need to use many different inputs
and judgment

Copyright © 2016 John Wiley & Sons, Inc.

 Decision Trees
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Diagramming technique
 Decision points – points in time when decisions are made,
squares called nodes
 Decision alternatives – branches or arrows leaving a decision
point (nodes)
 Chance events – events that could affect a decision, branches or
arrows leaving circular chance nodes
 Outcomes – each possible alternative listed

Copyright © 2016 John Wiley & Sons, Inc.

 Decision Tree Diagrams
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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

Copyright © 2016 John Wiley & Sons, Inc.

Example Using Decision Trees: A restaurant owner has determined that she needs to expand her facility.
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?
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 Evaluating the Decision Tree
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Utilizes Expected Value (EV) analysis

EV is a weighted average of 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 EV of small expansion:
 EVsmall = 0.30($80,000) + 0.70($200,000) = $164,000

Copyright © 2016 John Wiley & Sons, Inc.

Evaluating the Decision Tree - cont'd
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Calculate EV of large expansion:

 EVlarge = 0.30($50,000) + 0.70($300,000) = $225,000
At decision point 1, compare alternatives & choose
the large expansion to maximize the expected
profit:
 $225,000 > $164,000
Choose large expansion despite the fact that there is
a 30% chance it’s the worst decision:
Take the calculated risk!

Copyright © 2016 John Wiley & Sons, Inc.

 Location Analysis
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Three most important factors in real estate: Location,

Location, Location
Facility location is the process of identifying the best
geographic location for a service or production facility
Long term commitment
Sizable financial investment and impact

Copyright © 2016 John Wiley & Sons, Inc.

Factors Affecting Location Decisions
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Proximity to source of supply:

 Reduce transportation costs of perishable or bulky raw
materials
Proximity to customers:
 High population areas, close to JIT partners
Proximity to labor:
 Local wage rates, attitude toward unions, availability of
special skills (Silicon Valley)

Copyright © 2016 John Wiley & Sons, Inc.

 More Location Factors
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Community considerations:
 Local community’s attitude toward the facility (prisons,
utility plants, etc.)
Site considerations:
 Local zoning & taxes, access to utilities, etc.
Quality-of-life issues:
 Climate, cultural attractions, commuting time, etc.
Other considerations:
 Options for future expansion, local competition,
transportation access and congestion, etc.
Copyright © 2016 John Wiley & Sons, Inc.
Globalization – Should Firm Go Global?
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Globalization is the process of locating facilities around the

world
 Potential advantages:
 Inside track to foreign markets, avoid trade barriers, gain access to
cheaper labor; closer to suppliers - manufacturers
 Potential disadvantages:
 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

Copyright © 2016 John Wiley & Sons, Inc.

 Making Location Decisions
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Analysis should follow 3 step process:

1. Identify dominant location factors
2. Develop location alternatives
3. Evaluate locations alternatives
Procedures/tools for evaluating location alternatives
include
 Factor rating method
 Load-distance model
 Center of gravity approach
 Break-even analysis
 Transportation method

Copyright © 2016 John Wiley & Sons, Inc.

Factor Rating (with example)
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A procedure to evaluate multiple alternative locations

based on a number of selected factors.

Copyright © 2016 John Wiley & Sons, Inc.

A Load-Distance Model Example: Matrix Manufacturing is considering where to locate its warehouse 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.
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A procedure for evaluating location alternatives based on distance.

 Calculate the rectilinear distance: dAB  30  10  40  15 45 miles

 Multiply by the number of loads between each site and four cities
Calculating Load-Distance Score: Springfield vs.
Mansfield
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Computing the Load-Distance Score for Springfield

City Load Distance ld
Cleveland 15 20.5 307.5
Columbus 10 4.5 45
Cincinnati 12 7.5 90
Dayton 4 3.5 14
Total Load-Distance Score(456.5)

Computing the Load-Distance Score for Mansfield

City Load Distance ld
Cleveland 15 8 120
Columbus 10 8 80
Cincinnati 12 20 240
Dayton 4 16 64
Total Load-Distance Score(504)

 The load-distance score for Mansfield is higher than for Springfield. The
warehouse should be located in Springfield.
The Center of Gravity Approach
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Requires the analyst to find the center of gravity of the geographic area being
considered for an alternative site.
Computing the Center of Gravity for Matrix Manufacturing
Coordinates Load
Location (X,Y) (li) lixi liyi
Cleveland (11,22) 15 165 330
Columbus (10,7) 10 165 70
Cincinnati (4,1) 12 165 12
Dayton (3,6) 4 165 24
Total 41 325 436
Computing the Center of Gravity for Matrix Manufacturing

Xc.g. 
 lX
i i

325
7.9 ; Yc.g. 
 liYi 436
 10.6
l i 41  l i 41
Is there another possible warehouse location closer to the C.G. that should be
considered?? Why?
 Break-Even Analysis
30

Technique used to compute 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

Copyright © 2016 John Wiley & Sons, Inc.

 Break-Even Analysis – cont’d
31

 Remember, the break even equations used for calculating 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

Copyright © 2016 John Wiley & Sons, Inc.

 Example using Break-even Analysis: Clean-Clothes 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.
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Example 9.6 Using Break-Even Analysis

Location Fixed Cost Variable Cost Total Cost
A $350,000 $ 5(10,000) $400,000
B $170,000 $25(10,000) $420,000
C $100,000 $40(10,000) $500,000
D $250,000 $20(10,000) $450,000
 The Transportation Method
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Can be used to solve specific location problems

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

Copyright © 2016 John Wiley & Sons, Inc.

Capacity Planning & Facility Location within OM
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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)

Copyright © 2016 John Wiley & Sons, Inc.

Capacity Planning & Facility Location Across the
Organization
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Capacity planning and location analysis affect OM

and are important to many others
 Finance provides input to finalize capacity decisions
 Marketing impacted by the organizational capacity and location
to customers

Copyright © 2016 John Wiley & Sons, Inc.

 Chapter 9 Highlights
36

Capacity planning is deciding on the maximum

output rate of a facility
Location analysis is deciding on the best location for
a facility
Capacity planning and location analysis decision are
often made simultaneously because the location of
the facility is usually related to its capacity.

Copyright © 2016 John Wiley & Sons, Inc.

 Chapter 9 Highlights – cont'd
37

In both capacity planning and location analysis,

managers must follow three-step process to make
good decisions. The steps are assessing needs,
developing alternatives, and evaluating alternatives.
To choose between capacity planning alternatives
managers may use decision trees, which are a
modeling tool for evaluating independent decisions
that must be made in sequence.

Copyright © 2016 John Wiley & Sons, Inc.

 Chapter 9 Highlights – cont'd
38

Key factors in location analysis included proximity to

customers, transportation, source of labor, community
attitude, and proximity to supplies. Service and
manufacturing firms focus on different factors. Profit-
making and nonprofit organizations also focus on
different factors.

Copyright © 2016 John Wiley & Sons, Inc.

 Chapter 9 Highlights – cont'd
39

Several tools can be used to facilitate location analysis.

Factor rating is a tool that helps managers evaluate
qualitative factors. The load-distance model and center
of gravity approach evaluate the location decision
based on distance. Break-even analysis is used to
evaluate location decisions based on cost values. The
transportation method is an excellent tool for
evaluating the cost impact of adding sites to the
network of current facilities.

Copyright © 2016 John Wiley & Sons, Inc.