CHAPTER 5 Strategic Capacity Management

Tata McGraw

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OBJECTIVES
Strategic Capacity Planning Defined Capacity Utilization & Best Operating Level Economies & Diseconomies of Scale The Experience Curve Capacity Focus, Flexibility & Planning Determining Capacity Requirements Decision Trees Capacity Utilization & Service Quality

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Strategic Capacity Planning

Capacity can be defined as the ability to hold, receive, store, or accommodate

The amount of resources available relative to output requirements over a particular period of time

No. of customers handled in a period (in a service setup) No. of products or lots produced (in a manufacturing setup) Aggregate capacity of all factories (for the VP of a company)

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Strategic capacity planning is an approach for

determining the overall capacity level of capital intensive resources, including facilities, equipment, and overall labor force size
Impact on firms response rate, cost structure, inventory policies,

management and staff support Constrained capacity ROI of Capacity Payback period 3rd party contract manufacturing Inadequate capacity allows competitors to enter the market Excessive capacity forces reducing the price to stimulate demand; leading to underutilization of workforce, excess inventory, additional and less-profitable products.

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Time Horizons for Capacity Planning

Long range more than one year.

Productive resources take a long time to acquire or dispose of Requires top management participation and approval

Intermediate range monthly/quarterly plans for next 6 to 18 months.

Alternative plans for hiring, layoffs, new tools, minor equipment purchases, and subcontracting

Short range less than one month.

Daily or weekly scheduling process Making adjustments to eliminate the variance between planned and actual output Alternatives like overtime, personnel transfers, and alternative production routings

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Capacity Utilization

Capacity implies an attainable rate of output.

Capacity used Capacity utilization rate ! Best operating level

Where Capacity used

rate of output actually achieved capacity for which the process was designed

Best operating level

Example:
If a plant, designed for 500 cars/day, produces only 400 cars/day, Then the capacity utilization rate = 400 / 500 = 0.8 or 80%.

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Best Operating Level

Average unit cost of output Underutilization

Overutilization

Best Operating Level

Volume

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Example of Capacity Utilization

During one week of production, a plant produced 83 units of a product. Its historic highest or best utilization recorded was 120 units per week. What is this plants capacity utilization rate?

Answer:
Capacity utilization rate = Capacity used Best operating level

= 83/120 = 0.69 or 69%

Economies & Diseconomies of Scale As per economies of scales, when plant gets larger or increases its production volume, average unit cost of output drops. At some point, the size of plant becomes too large that the diseconomies of scales starts thereof
Economies of Scale and the Learning Curve

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Average unit cost of output

100-unit plant 200-unit plant 300-unit plant 400-unit plant

Diseconomies of Scale starts

Vol.

The Learning Curve

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As plants produce more products, they gain experience in the best production methods and reduce their costs per unit in a predictable manner. Learning curve % varies across industries

Yesterday Cost or price per unit Today Tomorrow

Total accumulated production of units The competitive strategy aims at the economies of scales to meet the learning curve (i) product meets the customers needs, and (ii) with a large and consistent demand

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Capacity Focus

The concept of the focused factory holds that production facilities work best when they focus on a fairly limited set of production objectives
But for holistic growth

Plants Within Plants (PWP), Extending the focused factory concept to every part/level, even they work under the same roof

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Capacity Flexibility

Capacity Flexibility is the ability to

Rapidly increase/decrease the production level Quickly shift the production capacity from one product or service to another This is possible by: Flexible plants
Zero changeover time, movable equipment, knockdown walls, easily accessible and reroutable utilities (adaptive)

Flexible processes
FMS, simple/easy setting of M/c-Equip, rapid and low switching-cost (i.e. economies of scope)

Flexible workers
Multiple skill, multi-tasking ability, better to give broader trg. than specialized trg., mgt. and staff to support rapid changes

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Capacity Planning:

Maintaining System Balance: Output of one

stage is the exact input requirements for the next stage Unbalanced stages of production

Units per month

Stage 1 6,000

Stage 2 7,000

Stage 3 5,000

Balanced stages of production

Units per month

Stage 1 6,000

Stage 2 6,000

Stage 3 6,000

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Capacity Planning

Frequency of Capacity Additions

Cost of frequently/infrequently upgrading Removing and replacing old equipments Training employees on new equips. and techs. Addl. capacity, not utilized, are seen as overheads

External Sources of Capacity

Sometimes cheaper than addl. Capacity Helps in handling seasonal demands

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Determining Capacity Requirements

1. Forecast sales within each individual product line 2. Calculate equipment and labor requirements to meet the forecasts 3. Project equipment and labor availability over the planning horizon

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Example of Capacity Requirements

A manufacturer produces two lines of mustard, FancyFine and Generic line. Each is sold in small and family-size plastic bottles. The following table shows forecast demand for the next four years.
Year: FancyFine Small (000s) Family (000s) Generic Small (000s) Family (000s) 1 50 35 100 80 2 60 50 110 90 3 80 70 120 100 4 100 90 140 110

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Example of Capacity Requirements (Continued): Product from a Capacity Viewpoint

Question: Are we really producing two different types of mustards from the standpoint of capacity requirements? Answer: No, its the same product just packaged differently.

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Example of Capacity Requirements (Continued) : Equipment and Labor Requirements

Year: Small (000s) Family (000s)

1 150 115

2 170 140

3 200 170

4 240 200

Three machines of 100,000 units/year capacity are available for small-bottle production. Two operators required per machine. Two machines of 120,000 units/year capacity are available for family-sized-bottle production. Three operators required per machine.

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Question: What are the Year 1 values for capacity, machine, and labor?

Year: Small (000s) Family (000s) Small Family-size Small Percent capacity used Machine requirement Labor requirement Family-size Percent capacity used Machine requirement Labor requirement

1 150 115 Mach. Cap. Mach. Cap.

2 170 140 300,000 240,000

3 200 170 Labor Labor

4 240 200 6 6

150,000/300,000=50%
50.00% 1.50 3.00 47.92% 0.96 2.88

At 1 machine for 100,000, it takes 1.5 machines for 150,000 At 2 operators for 100,000, it takes 3 operators for 150,000
The McGraw-Hill Companies, Inc., 2004

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Question: What are the values for columns 2, 3 and 4 in the table below?

Year: Small (000s) Family (000s) Small Family-size Small Percent capacity used Machine requirement Labor requirement Family-size Percent capacity used Machine requirement Labor requirement

1 150 115 Mach. Cap. Mach. Cap.

2 170 140 300,000 240,000

3 200 170 Labor Labor

4 240 200 6 6

50.00% 1.50 3.00

56.67% 1.70 3.40

66.67% 2.00 4.00 70.83% 1.42 4.25

80.00% 2.40 4.80 83.33% 1.67 5.00

47.92% 58.33% 0.96 1.17 2.88 3.50

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Example of a Decision Tree Problem

A glass factory specializing in crystal is experiencing a substantial backlog, and the firm's management is considering three courses of action: A) Arrange for subcontracting B) Construct new facilities C) Do nothing (no change) The correct choice depends largely upon demand, which may be low, medium, or high. By consensus, management estimates the respective demand probabilities as 0.1, 0.5, and 0.4.

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Example of a Decision Tree Problem (Continued): The Payoff Table

The management also estimates the profits when choosing from the three alternatives (A, B, and C) under the differing probable levels of demand. These profits, in thousands of dollars are presented in the table below:

A B C

0.1 Low 10 -120 20

0.5 Medium 50 25 40

0.4 High 90 200 60

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Example of a Decision Tree Problem (Continued): Step 1. We start by drawing the three decisions

A B C

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Example of Decision Tree Problem (Continued): Step 2. Add our possible states of nature, probabilities, and payoffs

High demand (0.4) Medium demand (0.5) Low demand (0.1)

$90k $50k $10k $200k $25k -$120k $60k $40k $20k

A B C

High demand (0.4) Medium demand (0.5) Low demand (0.1) High demand (0.4) Medium demand (0.5) Low demand (0.1)

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Example of Decision Tree Problem (Continued): Step 3. Determine the expected value of each decision

High demand (0.4) Medium demand (0.5)

$62k
A

Low demand (0.1)

$90k $50k $10k

EVA=0.4(90)+0.5(50)+0.1(10)=$62k

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Example of Decision Tree Problem (Continued): Step 4. Make decision High demand (0.4) Medium demand (0.5)

$62k
A B C

Low demand (0.1) High demand (0.4) Medium demand (0.5) Low demand (0.1) High demand (0.4)

$90k $50k $10k $200k $25k -$120k $60k $40k $20k

$80.5k

$46k

Medium demand (0.5) Low demand (0.1)

Alternative B generates the greatest expected profit, so our choice is B or to construct a new facility

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Planning Service Capacity vs. Manufacturing Capacity

Time: Goods can not be stored for later use and capacity must be available to provide a service when it is needed Location: Service goods must be at the customer demand point and capacity must be located near the customer Volatility of Demand: Much greater than in manufacturing

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Service Utilization and Service Quality

Best operating point is near 70% of capacity

From 70% to 100% of service capacity, what do you think happens to service quality?

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Question Bowl

The objective of Strategic Capacity Planning is to provide an approach for determining the overall capacity level of which of the following? a. b. c. d. e. Facilities Equipment Labor force size All of the above None of the above

Answer: d. All of the above

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Question Bowl

To improve the Capacity Utilization Rate we can do which of the following? a. b. c. d. e. Reduce capacity used Increase capacity used Increase best operating level All of the above None of the above

Answer: b. Increase capacity used (This increases the numerator in the Capacity Utilization Rate ratio, which is desirable.)

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Question Bowl

When we talk about Capacity Flexibility which of the following types of flexibility are included? a. b. c. d. e. Plants Processes Workers All of the above None of the above

Answer: d. All of the above

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Question Bowl

When adding capacity to existing operations which of the following are considerations that should be included in the planning effort? a. b. c. d. e. Maintaining system balance Frequency of additions External sources All of the above None of the above

Answer: d. All of the above

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Question Bowl

Which of the following is a term used to describe the difference between projected capacity requirements and the actual capacity requirements? a. b. c. d. e. Capacity cushion Capacity utilization Capacity utilization rate All of the above None of the above

Answer: a. Capacity cushion

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Question Bowl

In determining capacity requirements we must do which of the following?

a. Address the demands for individual product lines b. Address the demands for individual plants c. Allocate production throughout the plant network d. All of the above e. None of the above

Answer: d. All of the above

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Question Bowl

In a Decision Tree Problem used to evaluate capacity alternatives we need which of the following as prerequisite information?
a. b. c. d. e. Expect values of payoffs Payoff values A tree All of the above None of the above

Answer: b. Payoff values (Expected values are what is computed, not prerequisite to the analysis.)

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End of Chapter 5

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