Topic-6

1. Topic-6 Long Rang Capacity Planning

2. Long range capacity planning • Capacity-is the productive capability of a production facility • Capacity measurement: aggregate unit of output/input rate * single item: output rate * many items: aggregate unit of output, or aggregate unit of input. In service: input rate • Why capacity planning- matching demand fluctuation.

3. Why Matching Capacity- Matching Demand Fluctuation Output Demand Capacity? Time

4. Measurement of Capacity • Output rate capacity: -- For a facility having a single product or a few homogeneous products, the unit of measure is straightforward (barrels of beer per month) -- For a facility having a diverse mix of products, an aggregate unit of capacity must be established using a common unit of output (sales dollars per week)

5. Measurement of Capacity (II) • Input rate capacity: commonly used for service operations where output measures are particularly difficult. --Hospital use available beds per month. --Airline use available seat miles per month. --Movie theatres use available seats per month.

6. Examples of Capacity Measures

7. Design Capacity vs. Maximum Capacity • Design capacity (Q*): the amount of output at which the AUC (average unit cost) of a product facility is minimum. • Practical maximum capacity : the maximum amount of output that a facility can produce (at a higher AUC) • When Q>Q*,then AUC>AUC* • Q<Q*, also AUC>AUC*

8. AVC AVC Q (Output Quantity) Q* Qmax

9. AUC (Average Unit Cost) AUC Variable Cost / Unit Fixed Cost /Unit Q* Qmax Output Quantity Q* - Design Capacity Qmax – Practical Maximum Capacity

10. Economies and Diseconomies of Scale Average per Unit Cost Of Output ($) Diseconomies of scale Economies of scale Best Operating Level Annual Volume Units

11. Economies of Scale • Best operating level—least average unit cost • Economies of scale—average cost per unit decrease as the volume increases toward the best operating level. • Diseconomies of scale—average cost per unit increase as the volume increase beyond the best operating level

12. Economies of scale • Declining costs result from: --Fixed costs being spread over more and more units. --Longer production runs result in a smaller proportion of labor being allocated to setups. --Proportionally less material scrap --……….and other economies.

13. Economies of scale • Diseconomies of scale: Increasing costs result from increased congestion of workers and materials, which contribute to: --increasing inefficiency --difficulty in scheduling --damaged goods --reduced morale --increased use of overtime --………and other diseconomies

14. Capacity Economy • Economy of scale: Refer to the cost reduction resulting from the increase in production quantity. “Economies of scale is so vague that it can be used to justify any number of decisions, which all too often turn out to be wrong.”

15. Capacity Economy (II) • Example:

16. Capacity Economy (III) • AUC(A)< AUC(B)—Volume Economy. • AUC(C)< AUC(A)— Capacity Economy • AUC(D)< AUC(C)—Technology Economy.

17. AUC B A 12 10 C 5 D 2 60 100 200 Q

18. Increases in Incremental Facility Capacity Average per Unit Cost per Output ($) A B C Small Plant Mid-Sized Plant Large Plant Annual Volume (Units)

19. 250-unit shop 750-unit shop 500-unit shop Average unit cost (dollars per unit) Economies of scale Diseconomies of scale Output rate (units per week) Economies and Diseconomies of Scale

20. Three Level Capacity Planning • 1.Long range capacity planning: T>1 year. • Decisions: planning for capacity that requires a long time to acquire. • e.g. Plant/building/equipment/high cost facility • 2. Intermediate range capacity planning: T(6-18 months). • Decisions: planning for capacity requirement (month or quarterly). • e.g. work force size/new tools/inventory/….. • 3. short range capacity planning: T (1-6moth). • Decisions: weekly (or daily) capacity planning. • e.g. overtime use/personnel transfer/alternative routings/……

21. Ways of Changing Long Range Capacity • Expand Capacity • Subcontract with other companies to become suppliers of the expanding firm’s components or entire products • Acquire other companies, facilities, or resources • Develop sites, buildings, buy equipment • Expand, update, or modify existing facilities • Reactivate facilities on standby status • Reduce Capacity • Sell existing facilities, sell inventories, and layoff or transfer employees • Mothball facilities and place on standby status, sell inventories, and layoff of transfer employees • Develop and phase in new products as other products decline

22. Capacity Planning Process • 1. Determine capacity requirement: * long range demand forecasting. • 2. Generating alternative capacity plans: *when should new capacity be added? (timing) * how much new capacity should be added (sizing) *what kind capacity should be added? (type)

23. The Timing of Capacity Increments Policy A: Capacity Leads Demand Policy B: Capacity lags Demand Units Units Capacity Demand Demand Capacity Time Time

24. Units Capacity Increments { Demand Time The Sizing of Capacity Increments Units Should the capacity be added more often in small increments (Option A) or in large increments less frequently (Option B)? Capacity Increments { Demand Time

25. Forecast of capacity required Planned unused capacity Capacity increment Capacity Time between increments Time Capacity Strategies (a) Expansionist strategy

26. Forecast of capacity required Planned use of short-term options Capacity increment Capacity Time between increments Time Capacity Strategies (b) Wait-and-see strategy

27. Capacity Planning Process (II) • 3. Evaluating alternative capacity plans: *Decision tree *Breakeven analysis 4.Selecting best capacity plan under given objectives 5. Locating new capacity (facility location).

28. Facility planning • How much long range capacity is need • When additional capacity is need • What the layout and characteristics of facilities should be • The capital investment in land, building, technology and machinery is enormous

29. Facility planning • A firm must live with its facility planning decisions for a long time and these decisions affect: • Operating efficiency • Economy of scale • Ease of scheduling • Maintenance costs • ……………profitability

30. Facility planning • Steps in the capacity planning process *estimate the capacity of the present facilities. *forecast the long-range future capacity needs. *identify and analyze sources of capacity to meet these needs *Select from among the alternative sources of capacity

31. Economies of scope • The ability to produce many product models in one flexible facility more cheaply than in separate facilities • Highly flexible and programmable automation allows quick, inexpensive products-to-product changes • Economies are created by spreading the automation cost over many products

32. Evaluation of Capacity Plans • Major method: • Net present value analysis • Breakeven analysis • Decision tree model • Computer simulation • Queuing Models (Service Capacity Plan)

33. Evaluation of Capacity Plans (II) • Decision model: a simplified representation of a real world problem. There are many decision models developed in the literature for different problems. • Three major elements of a decision model: • Objectives must be measurable • Decision variables must be controllable • Constraints and Assumptions.

34. Decision Tree Model • Decision tree model is primarily developed for problem where: * a series of (multiple) decisions must be made sequentially * all decisions are interrelated and interdependent and * Outcomes associated with each decision are uncertain

35. Decision Tree Model (II) • Assumptions of decision tree model: • Objective is a single measurement • All possible outcomes associated with a decision have a known probability. • Best plan is represented by the optimal expected value. • Tree structure: * Decision point * Even point * Probability of outcome

36. Capacity Decisions Decision Trees Low demand [0.40] $70 Don’t expand $90 High demand [0.60] Small expansion $109 2 Expand $135 1 $135 Low demand [0.40] Large expansion $148 $40 High demand [0.60] $148 $220

37. Example Supplement: p. 6-20 - Problem #1

38. Payoff ($ millions) (.5) Large Market 3.0 EV = 2.4 Produce & Market (.5) Marginal Mkt. 1.8 EV = 2.4 (.5) Large Market Develop Product || 2.5 Sell Idea || EV = 2.5 (.5) Marginal Mkt. EV = 2.3 2.1 Lease for Royalty (.5) Large Market EV = 2.5 2.8 Sell Idea (.5) Marginal Mkt. Company A || 2.2 EV = 2.5 (.5) Large Market || 2.6 Company B (.5) Marginal Mkt. 2.3 EV = 2.45 1.5

39. Solutions • The company should lease the concept to company A. Notice, however, that other alternatives are very close in their payoffs. • b. If the company follows your recommendation, what returns should the company expect to receive? • If the firm's estimates are correct, it will receive either $2,800,000 or $2,200,000.

40. See Example on your Supplementary – p. 6-17 to 6-19.

41. H,p= 0.7, $900 for 6 years C L,p= 0.3, $300 for 6 years H,p= 0.7, $600 for 6 years D L,p= 0.3, $500 for 6 years H,p= 0.2, $900 for 6 years E L,p= 0.8, $300 for 6 years H,p= 0.2, $600 for 6 years F L,p= 0.8, $500 for 6 years H,p= 0.7, $900 for 6 years G L,p= 0.3, $300 for 6 years H,p= 0.2, $900 for 6 years H L,p= 0.8, $300 for 6 years $4,320 $3,520 Expand, Investment = $800 2 $3,420 Do not expand H,p = 0.6 $3,920 A $2,520 Small plant Investment = $3,400 L,p = 0.4 $520 $3,120 Expand, Investment = $800 1 3 $3,120 Do not expand Large plant, Investment = $4,000 $4,320 $4,260 H,p = 0.6 $900 B L,0 = $300 $2,520 $300

42. We evaluated the three from the right-hand side. Investment and income are given in thousands of dollars. Event C: $900(6)(0.7) + $300 (6)(0.3)= $4,320 Event D: $600(6)(0.7) + $500 (6)(0.3)= $3,420 Event E: $900(6)(0.2) + $300 (6)(0.8)= $2,520 Event F: $600(6)(0.2) + $500 (6)(0.8)= $3,120 Event G: $900(6)(0.7) + $300 (6)(0.3)= $4,320 Event H: $900(6)(0.2) + $300 (6)(0.8)= $2,520

43. Decision Point 2: Expand: Income= $4,320- $800 = $3,520 Do not expand: Income=…………….....= $3,420 At this point the decision will be to expand the plant because the income for this alternative is larger. Event D will therefore be served. Decision Point 3: Expand: Income= $42,520- $800 = $1,720 Do not expand: Income=…………………= $3,120 At this point the decision will be “do not expand” because the income for this alternative is larger. Event E will therefore be served. Decision Point 1: Expand: Income= $3,920- $3,400 = $520 Do not expand: Income= $4,260- $4,00 = $260 At this point the decision will be to build a small plant. Event B therefore will be served. Thus, XYZ should initially build a small plant. At the end of one year, if demand is high, the company should expand the plant. If demand is low, the company should not expand the plant. Expected income is $520,000.