Dr. MOHAN BABU. G.N.

Professor, Dept. of IE &M

MS Ramaiah Institute of Technology
Bangalore - 54
UNIT 2: OPEARATIONS DECISION MAKING

Business firms make hundreds of decisions relating to operations every day, some having a
significant impact on the firms future business and some others with very less impact, some routine
and some others non-routine, some having immediate repercussions and some long-term
implications, some based on full information, and some on partial or no information, some simple
and some others very complex, some based on judgement and some others based on complex
analysis of data, some at the top level of the firm and others at the lower levels, and so on.
For example, where to locate a new plant? How much material to order? Should the labour demands
for new standard time be entertained? Who should take a particular decision? How many
maintenance personnel to be employed? Where to train personnel? How long to train? How much
to spend on R&D? Which technology to buy? Whom to collaborate with? How to motivate
personnel? Which capacity machine to install? Whom to promote? What should be the strategy to
attract customers? When to maintain a machine? Whether to buy or make a component? Which
market to enter and with which products? Etc.
Can all these decisions be made by our natural ability or simple judgement? Often, the decision
situations are so complex that one cannot effectively handle them in the absence of mathematical,
statistical and other tools. Hence, it is necessary to understand decision making (a component of
management) as a scientific process, the characteristics of decisions, framework for decision making
and decision methodologies and techniques.

MANAGEMENT AS A SCIENCE
As Management science knowledge has the following characteristics similar to other sciences, it is
also treated as science.
(i) Organized principles of knowledge: span of control, decision theories, queuing models, etc.
(ii) Use of empirical data: knowledge-base developed based on experimental data
(iii) Systematic analysis of data: Use of mathematical and statistical tools, use of computers
(iv) Repeatable results: Consistent results under similar experimental conditions
While there are a large number of decisions void of personal-value to be made, there are occasions
where personal values influence decisions too.

CHARECTARISTICS OF DECISIONS
Decisions can be broadly grouped into three categories namely, (i) Strategic decisions, (ii) Tactical
decisions and (iii) Operational decisions. Hence, with respect to operations activity too, we can
identify strategic, tactical and operational decisions.
Regardless of the level of decision making, the use of quantitative and qualitative techniques is wide
spread among business community. This is because, the use of such tools provide a systematic
approach to solving the problem and making a decision. Several techniques have been developed to

aid decision making. However, not all tools can be used in all decision making situations. The
appropriateness of the technique for a decision-making situation depends on several factors such as:
(a) the significance of the decision, (b) time and cost limitations and (c) the degree of complexity of
the decision. The decisions with far reaching consequences need to be based on adequate amount
of data, thorough analysis and careful interpretations and sound judgement. Several causal models
are available for analysis of such decision situations. Often, the decisions are to be made quickly. In
such situations techniques that require large amount of time may not be appropriate. Further, the
decision maker should be able to provide cost justification for the technique used. Finally, increased
complexity of decisions calls for the use of sophisticated techniques as a normal human being cannot
comprehend the problem situation in its entirety. The complexity increases with increasing number
of variables, decision criterions, constraints, and paucity of relevant and timely data.

FRAMEWORK FOR DECISION MAKING

The following steps constitute a framework for decision making and provide a systematic approach.
(i) Defining the problem: This step involves identification of relevant variables, scope of the
problem, realistic assumptions to work with, etc. Identifying the stake holders, the direct and
indirect impact of the decisions, immediate and delayed impact of the decisions are also a part of
this stage.
(ii) Establishing the decision criteria (objectives): Establishing the objectives/goals/purpose of
decision is crucial. Quite often, maximizing the profit is used as a criterion. However, these days,
firms use multiple criteria such as employee welfare, cost, impact on environment, market share,
productivity, stability, growth, technological leadership, reputation and good will, etc.
(iii) Formulation of model: The relevant variables are abstracted from the real-life problem and used
to formulate a model to represent the problem in a simpler manner. Formulation implies expressing
the underlying relationships among the variables in a testable form. There are several types of
models: (1) Verbal; (2) Physical or iconic; (3) Schematic or diagrammatic; and (4) Mathematical
models.
(iv) Generation of alternatives: Alternative solutions to the model can be generated by varying the
values of the variables and experimented. Mathematical and statistical models are more amenable
for modifications and hence to generate alternative solutions quickly.
(v) Evaluation of alternatives and selecting the best one: Alternative solutions are evaluated against
the already established criteria. Best alternative or decision is one which most closely satisfies the
criteria. Some procedures such as LPP inherently seek an optimum solution (either maximizing or
minimizing the criterion). Whenever optimum solution cannot be guaranteed at a reasonable cost
and time, heuristics can be tried out to arrive at solutions that are close to optimum.
(vi) Implementation and monitoring: Although these are not strictly a part of decision making, the
managerial action would be complete only when the decision is implemented and monitored. Fellow
managers have to be convinced of the merit of the decision made and its implementation has to be
followed through. Implementation of the decision is also an art.

DECISION METHODOLOGY
Techniques/methodologies that are useful for decision making can be categorized based on the
degree of certainty that exists with respect to the decision variables and possible outcomes. The
degree of certainty is classified as: (i) Complete certainty; (ii) somewhat uncertain and risky; and (iii)
complete uncertainty. When we know for sure what would be the outcome of our decision then we
are dealing with a problem under conditions of uncertainty. When a decision has more than one

possible outcome and we know the likelihood of each outcome we are dealing with a problem under
conditions of risk. Finally, when a decision has more than one possible outcome and we do not know
the likelihood of each outcome, we are dealing with a problem under conditions of uncertainty.
Examples of decision making under the three situations are given below.
EXAMPLE Decision under conditions of Certainty

Problem 1. A chain of supermarkets is going to open a new store at one of four possible locations.
Management wishes to select the location that will maximize profitability over the next ten years. An
extensive analysis was performed to determine the costs, revenues, and profits for each alternative.
The results are shown below.
Location

Ten-year Annual Profit (in million R)

0.70

0.95

0.60

0.84

Management has a high degree of confidence in these figures. The decision criterion (profit) has
been explicitly identified and accurately calculated for each alternative. Management's strategy is to
select the alternative with the highest criterion value, in this case, location 2.
EXAMPLE - Decision under conditions of Risk

Further analysis of the supermarket chain's problem reveals that the profit associated with each
location is not known for sure. Management is convinced that the ten-year profitability of each
location will depend upon regional population growth. Therefore management cannot predict the
outcome with certainty. Three possible rates of population growth were identified: low, medium,
and high. The profitability (in million R) associated with each location and each rate of population
growth was calculated, as shown below.
Rate of Population Growth
Location

Low
(5% or less)

Medium (above 5%
but below 10%)

High
(10% or more)

1
2
3
4

0.3
0.2
0.4
0.6

0.8
0.6
0.5
0.7

0.9
1.1
0.6
0.8

Probability (P)

0.2

0.3

0.5

The figures at the bottom of the table give the probability (likelihood) of each rate of population
growth. Decision strategy in this situation is more difficult than it is under conditions of certainty.
In analyzing this situation, we have to arrange the data differently than we did under conditions of
certainty. The profit for low, medium, and high population growth is listed separately for each
location. Which alternative is best? If population growth turns out to be low, location 4 is best (R 0.6
million). If growth is medium, location 1 is best (R 0.8 million), and if it is high, location 2 is best (R
1.1 million). But there is uncertainty with respect to the rate of population growth.
In the analyst's language, the three rates of population growth are called states of nature. As the
three states of nature have different probabilities of occurrences, we apply a procedure called

calculating the expected value in this case. For each alternative location, we calculate the product of
each outcome and its probability. The sum of these products is the expected value of the alternative
location. The expected value is highest for alternative 2: R 0.77 million. If management faced this
situation many times and always chose alternative 2, its average profit would be higher than for any
other alternative.
Calculation of expected value (R million):
Alternative

Outcome x Probabilities

Summation

Expected
(profit)

0.3 x 0.2 = 0.06

0.8 x 0.3 = 0.24

0.9 x 0.5 = 0.45

0.06 + 0.24 + 0.45

= 0.75

0.2 x 0.2 = 0.04

0.6 x 0.3 = 0.18

1.1 x 0.5 = 0.55

0.04 + 0.18 + 0.55

= 0.77

0.4 x 0.2 = 0.08

0.5 x 0.3 = 0.15

0 .6 x 0.5 = 0.30

0.08 + 0.15 + 0.30

= 0.53

0.6 x 0.2 = 0.12

0.7 x 0.3 = 0.21

0.8 x 0.5 = 0.40

0.12 + 0.21 + 0.40

= 0.73

value

EXAMPLE - Decision under conditions of Uncertainty

Even further analysis has cast doubt on the probability of the rates of population growth. New
management doesn't know the probabilities of low, medium, or high growth, and is faced with a
problem under conditions of uncertainty. Obviously, strategy is much harder to come by in this case.
Problems under conditions of uncertainty can also be structured in matrix form. Since the
probabilities are not known, however, rational strategies for decision-making are not well defined or
straightforward. We discuss three approaches from among several that analysts use. The first,
maximax, is an optimistic approach; the analyst considers only the best outcome for each alternative
regardless of probability. Looking at the table for the risk example and ignoring the probability row,
the outcomes that would be considered are R 0.9 million for alternative 1, R 1.1 million for
alternative 2, R 0.6 million for alternative 3, and R 0.8 million for alternative 4. Among these,
alternative 2 yields the maximum profit, and that is the one that would be chosen.
The second approach is maximin, a pessimistic approach; the analyst considers only the worst
outcome for each alternative and chooses the "best of the worst." In the table in the risk example, in
the outcomes that would be considered are R 0.3 million for alternative 1, R 0.2 million for
alternative 2, R 0.4 million for alternative 3, and R 0.6 million for alternative 4. The best of these is
alternative 4.
The third approach, the principle of insufficient reason, assumes that since we know absolutely
nothing about the probabilities of any state of nature, we should treat each with equal probability,
calculate the expected values accordingly, and choose the alternative whose expected value is
highest. Using this approach, we would choose alternative 4.

CLASSIFICATION OF DECISION METHODOLOGIES

Below given is a classification of decision making techniques available to operations managers. Some
techniques may be suitable for use under more than one condition.

Complete certainty

Partially certain and risky

Extreme uncertainty

(all information is assumed to be

available)

(Some information is available)

(No information)

Algebra:
Break even analysis
Benefit/cost analysis

Statistical analysis:
Estimation & test of hypotheses
Regression and correlation
Multivariate analysis
Queuing theory
Simulation
Heuristic models
Network analysis
Decision trees
PERT/CPM
Utility theory

Game theory
Flipping coin

Calculus
Mathematical programming:
Linear
Nonlinear
Integer
Dynamic
Goal

In the recent days there has been a great inclination among business firms to use quantitative
methods to arrive at good decisions, especially, mathematical and statistical techniques. Some
examples of Economic models, Statistical models and Decision support systems are discussed below.

Decision Support System (DSS): This is an information system to aid decision making. Although it has
been in existence for a long time in the form of manual recording, storage, analysis and retrieval of
data and information, these days it is supported by computers, peripherals and communication
networks in order to enable effective decision making at all levels. Computers are of a big help
especially in generating and evaluating alternatives. However, it is the manager who has to take
decisions and not computers. It is strongly suggested that the manager shall condition the outcome
of analysis with his judgment, experience, and skills before arriving at a decision and committing
resources. Occasionally, the DSS may also involve expert systems.

Economic Models:
(i) Break-Even Analysis (BEA) :
This technique helps us to determine the volume of business operation at which the total costs
become equal to the total revenue. i.e. no profit or no loss situation. For any investment, it is
important to know the BEP vis--vis level of market demand and thus the safety margin of operation.
At BEP, total revenue = total cost
Total revenue = total fixed cost + total variable cost
(Price/unit) * volume at BEP = total fixed cost + (variable cost/unit) * volume at BEP
P * VBEP = FC + VC* VBEP
Hence, VBEP =FC/(P-VC)
As (P-VC) is known as contribution margin from the unit sold, we have,
VBEP =FC/Contribution margin

TR

Cost and Revenue

TC

TFC

BEP
Quantity of output

Break-Even Chart
The advantages of BEA are that (i) it is very simple to understand, (ii) it addresses profitability of an
investment which is very important, (iii) it allows quicker manipulation of the model and easier
sensitivity analysis.
Its limitations include it assumes that all data (costs, price and volume) are known and certain. It
further assumes linear relationships between variables (e.g. volume sold and total revenue) and that
all output can be sold. It is useful for only one product business. It assumes that variable and fixed
cost elements can be separated.

Problem. 2. For an existing product that sells at P = Rs. 650/- per unit, FC = Rs. 82,000/- and VC = Rs.
240/- per unit. Determine (i) the BEP and (ii) volume needed to earn a profit of Rs. 10,250/-.
Solution.

(i) VBEP = FC /(P-VC)

= 82,000/(650-240)
= 200 units

(ii) Vfor profit of 10,250 = (FC+ 82,500) /(P-VC)

= (82,000+10,250) / (650-240) = 225 units
Problem 3. A producer of digital watches sells his product at Rs. 30 each. The production costs at
volumes of 10,000 and 25,000 units are as follows. Using the data prepare a break-even chart and
determine the BEP.
Item
Labour
Materials
Overheads (FC+VC)
Selling and administration
Depreciation and other FC
Total

10,000 units
Rs. 60,000
1,20,000
90,000
50,000
80,000
4,00,000

25,000 units
Rs. 1,00,000
2,00,000
1,10,000
60,000
80,000
5,50,000

Solution. In the following figure, we know that the slope (change in Y/Change in X) of the total cost
line represents the variable cost/unit.

5,50,000

Y
Cost and Revenue

4,00,000

10,000

25,000

Quantity of output

VC = (Change in Y/Change in X) = Y/X

= (5,50,000 - 4,00,000) / (25,000 - 10,000)
= Rs.10 per unit
At volume of 10,000 units, total variable cost = 10 * 10000 = Rs.1,00,000
Hence, at that volume, total fixed costs = total costs - total variable costs
Rs. 4,00,000 1,00,000 = 3,00,000
We know that BEP = FC/(P-VC)
3,00,000 / (30-10) = 15,000 units

Problem 4. A company has 30 employees and handles 1500 loads per year of grain from a
warehouse. The firm has fixed costs of Rs.70,000 per year and variable costs of Rs. 170 per load. The
firm is considering installing an Rs.80,000 automated material handling system that will increase
fixed cost by Rs.20,000 per year but will increase the per unit contribution of each load by Rs.20.
The firm operates 250 days per year and receives an average of Rs.300 revenue for each load passed
through the warehouse. Determine the current annual profit or loss. What is the new BEP volume if
the investment is made?
Solution:
(i) Current annual profit = total revenue total cost
= (1500 loads * Rs.300 per load) [70,000 + (1500 loads * Rs.170 per load)]
= 4,50,000 3,25,000
= Rs.1,25,000
(ii) New BEP if the investment is made
VNew BEP = New FC /( New contribution margin)
= (70,000 + 20,000) / (130+20) = 600 loads

Statistical Models:
In the above problems the decision making was under the conditions of certainty. However, there
are several situations where the information available for making decisions is incomplete or
uncertain. Sometimes even if the entire data can be collected, it may not be justified cost and timewise. For eg. in quality control we do sample inspection instead of 100% inspection. Inventory,
maintenance, work-sampling and queuing theories also pose similar situations. Hence, an
understanding of probability and sampling distributions is necessary to make good decisions.
Two events are independent events if the occurrence of one in no way affects the other. Two events
are said to be mutually exclusive events when the occurrence of one precludes the occurrence of the
other, i.e. either this or that.
Basic probability rules:
Complement: P(A) = 1-P()
Multiplication:

P(A and B) = P(A) P(BA), if A and B are dependent events

= P(A) P(B), if A and B are independent events

Addition:

P(A or B) = P(A) + P(B) P(A and B), if A and B are not mutually exclusive events
= P(A) + P(B), if A and B are mutually exclusive events

Bayes rule: P(AB) = P(A and B)/P(B)

= [P(A) P(BA)] /{ [P(A) P(BA)] [P() P(B)]}
Probability is a basic measure of uncertainty and it expresses the chance of occurrence of an event in
terms of a numerical value. Three approaches to study probabilities are:
Classical approach: where probabilities can be computed prior to an event (a priori) eg. rolling a
dice
Empirical approach: where probabilities are computed based on the observed frequency data eg.
probability that the next item produced by a given machine will be a defective.
Subjective probability: where probabilities are computed based on personal experience and
judgment eg. probability that the new product launch would be a success

Problem 5. Two assembly robots X and Y, each working at the same rate together produce 400 dust
filters per day. During a recent days production, 40 filters were found to be defective. Given that a
filter is defective, there is a 0.4 probability it was produced by robot X (i.e. P(XD) = 0.4). What is
the probability that a filter selected at random is:
(i) defective?
(ii) produced by robot Y?
(iii) defective and produced by robot X?
(iv) defective or produced by robot X?
Solution:

Let P(X) be the probability that the item is produced by robot X

P(Y) be the probability that the item is produced by robot Y
P(D) probability that the item is defective

(i) P(D) = 40/400 = 0.10

(ii) P(Y) = (50% 0f 400)/400 = 0.50

(iii) P(D and X) = As the events are not mutually independent, P(D and X) = P(D) P(XD)
= (0.1) * (0.4) = 0.04
(iv) P(D or X)

= As the events are not mutually exclusive, P(D or X) = P(D) + P(X) P(D and X)
= (0.1) + (0.5) (0.04) = 0.56

Problem 6. Great Automobiles limited has received from its supplier some unmarked brackets for
the left and right front doors of its passenger car and cannot easily separate them. Neither the firm
can distinguish the type of mounting i.e. A, B or C. The shipment received has 500 brackets as below.

Right front door brackets

Left front door brackets

Type A
264
152

Type B
0
45

Type C
36
3

The stores keeper receives an urgent call for a right front bracket, type A. He randomly selects a
bracket from the bin that contains all of them, and rushes it to the shop. (i) What is the probability
that he sends the correct bracket? (ii) Suppose the person could identify the type of mounting but
not whether it was for a right or left door. What would be the probability of correct choice in that
case.
Solution:
(i) The number of type A right front brackets/ total number of brackets = 264/500 = 0.528
(ii) As the events are not independent, P(RA) = P(A and R) / P(A)
= 264/(264+152) = 0.635

Decision Trees:
These are schematic diagrams that show the alternative outcomes and interdependence of choices
in a multi-phase or sequential decision process. The tree like diagram is constructed from left to
right, using square boxes for representing controllable points (decisions) and circles for
uncontrollable (chance) events. Each branch leads to a payoff that is stated in monetary or utility
terms on the right end.
Decision trees are analyzed from right to left by multiplying the payoff s by their respective
probabilities (which are assigned to each chance event). The highest expected value then identifies
the best course of action and is entered at the preceding decision point. It then becomes the payoff
value for the next higher-order expectation, as the analysis is continued back to the truck of the tree.

Problem. 7. A glass firm developing a substantial backlog of orders is considering three courses of
action (i) arrange for subcontracting (ii) begin overtime production (iii) construct new facilities. The
correct choice depends largely on future demand, which may be low, medium or high. By
consensus, management ranks the respective probabilities as 0.10, 0.50 and 0.40. A cost analysis
reveals the effect on profits as shown below.
Course of action
A Arrange for subcontracting
B Begin overtime
C Construct new facilities

Profit (in thousand R) if the demand is

Low (P= 0.1)
Medium(P= 0.5)
High(P= 0.4)
10
50
50
-20
60
100
-150
20
200

Solution: Build a decision tree structure showing the decision (controllable) variables A, B and C at
the left hand side and followed by the chance alternatives of demand (uncontrollable variable) and
then the corresponding probabilities and payoff values at the end of respective branches. Then
compute expected value with respect to t each branch as follows.
Low (0.1)

10

Medium (0.5)

50

High (0.4)

50

Low (0.1)

-20

Medium (0.5)

60

High (0.4)

100

Low (0.1)

-150

Medium (0.5)

20

High (0.4)

200

A
B

Expected payoff for decision A is E(A) = 10*0.1 + 50 * 0.5 + 50 * 0.4 = R 46,000

Expected payoff for decision B is E(B) = -20*0.1 + 60 * 0.5 + 100 * 0.4 = R 68,000
Expected payoff for decision C is E(C) = -150*0.1 + 20 * 0.5 + 200 * 0.4 = R 75,000
These EVs are entered at circles of respective branches. Choice of alternative is made based on the
highest EV. Here, as EV corresponding to C (of R. 75,000) is highest, it is suggested to construct new
facilities.
The advantages of decision trees are that it is simple, decision situation is well structured, explicitly
identifies alternatives, distinguishes controllable from uncontrollable variables. Limitations are that
the monetary and probability values are still to be estimated by the user.

10

SYSTEM DESIGN AND CAPACITY PLANNING

Products / services before delivered to customers have to be designed and produced. Thus it is
necessary to design a system with appropriate capacity and plan for its financial requirements (fixed
capital & working capital). Further, the system need to be located (facility location) and laid out
(facility layout).
Design of operations system involves planning for inputs, transformation activities, and output from
the system. The design decisions are far-reaching and can leave lasting imprints on firms business
activities. This is because, such decisions may require the firm to commit significant amount of
resources (fixed costs) and may affect cost and productivity (variable costs) over a long-run.
Assessment of the long term demand for the companys output forms the basis for planning its
capacity. In this chapter we will learn about the capacity of the operations system, how to plan it,
strategies for meeting long-term and short-term capacity requirements, and the related topics. The
concepts of systems design and capacity planning discussed here are applicable to both
manufacturing and service systems.
Capacity means the ability to produce/deliver. Every individual, equipment, production shop, or
organization has its own capacity. It is expressed in terms of the quantity and quality of output in a
stipulated time from that entity. Three related terms are design capacity, systems capacity and
actual output of a facility.

Design Capacity:
This is the planned rate of output of goods and services under normal full scale operating conditions.
For eg. A paint company may have been designed to produce 10,000 liters of a particular type of
paint in a day. A sugar mill may be designed for crushing 2,00,000 tons of sugarcane per annum. A
hostel dining hall may be designed to cater to 400 students in one sitting. The preliminary estimates
of capacity (i.e. 10,000 liters, 2,00,000 TPA or 400 students) are based on long range forecasts i.e., a
projection of demands into the future (say 5-10 years). This long-range forecasts help in identifying
whether the demand is likely to be temporary or a sustained one. But preparing such forecasts is
not a simple task due to the uncertainty in the future demand. While some trend in the demand may
be seen, the boom and recessions often cause swings about the trend. Further, systematic
fluctuations in demand due to seasonal factors and unexpected fluctuations due to random events
can also be seen.
The figure below shows a sample of demand variation for a companys output over time. The
demand is fluctuating between high and low values. This variation can continue to exist in future.
Even the maximum and minimum demand shown might also get revised. An organization cannot
plan to satisfy all its demand because of fluctuations. If it plans to meet its maximum (peak) demand
its capacity will be underutilized for most of the time. On the other hand, if the designed capacity of
its facility is for minimum demand, the facility will be fully utilized, but often it may face shortage of
facility to provide satisfactory services to customers and may lose them. Hence, the designed
capacity should reflect the firms managements strategy for meeting demand. Often, a capacity in
between minimum and maximum should be fine. But, where? Which probability distribution can
explain variation in demand more appropriately? What percentage of the times the firm should be
able to meet the demand completely? What alternatives it has for the rest of the times? These are
some questions to be answered while planning capacity.

11

Problem 9. Freddies fast foods has enjoyed considerable success in using multilane services
channels. Freddies can serve 32 cars/hour in one lane of its drive-throughs. Now they are planning
for new drive-through facility in a new location. Market research data suggests it may have the peak
hourly demands estimated below.

Probability (% chance)
Cumulative probability

0<40
.10
.10

Number of cars per hour

40<80
80<120
120<160
.35
.40
.13
.45
.85
.98

160<200
.02
1.00

The operations manager is considering two alternatives for deciding how much capacity to install.
What capacity is required to: (i) meet 85% of the estimated peak hourly demands and
(ii) accommodate 110% of the estimated average demand plus a 25% allowance for growth?
Solution :
(i) From the cumulative probability row, it is seen that 100% of the times the estimated demand is
less than 200 cars/hr, and 85% of the times it is less than 120 cars/hr.

With 32 cars/lane, the company needs: 120/32 3.75, say a 4 lane facility.
(ii) The capacity required to accommodate 110% of the estimated average demand plus 25%
allowance for growth.
Estimated (or expected) value of average demand = E (X) = (X . P(X)), where X is the value at
the midpoint of each class interval (i.e, 20 for 0-40 class)

12

E(X) = 20 (0.1) + 60 (0.35) +100(0.4) + 140 (0.13) + 180 (0.02) = 84.8 cars
110% of this E (X) = 84.8 X 1.1 = 93.28 cars /hr
Adding 25% allowance, we have, 93.28(1+0.25)=116.6 cars/hr or approximately 117 cars/hr
No. of lanes now required to be installed = (Total capacity/ Capacity per lane) = ( 117/32)
= 3.8 or 4 lanes
Four service lanes will satisfy both the criteria

System capacity:
This is the maximum output of a specific product or product mix that the system of workers and
machines is capable of producing as an integrated whole. System capacity is usually less than or
equal to the design capacity of the individual components because the systems may be limited by
the product mix, quality specifications, long run market conditions or the current imbalance
between equipment and labour. These factors are less controllable and long-term in nature. For eg.
A paint manufacturing plant, although its design capacity is 2.5 million liters of paints per day, can
produce a maximum of say 2 million liters of paints may be due to different mix of paints being
produced, OPEC adopts self-restraint in crude oil production, A companys mining capacity limited by
environmentalists & political pressure, Computer capability underutilized due to limitations in the
capacity of peripherals, software and human beings.

Actual output:
The actual output of the system may be even less than its systems capacity because it is affected by
short-range factors such as actual demand, equipment breakdown, absenteeism and worker and
management inefficiencies. For eg. A paper mill may be constrained to produce a much lesser
output than its system capacity due to poor quality bamboos procured. A motor bike might offer a
mileage of 85kmpl under ideal conditions (designed performance), and under normal conditions may
give 68kmpl (systems capacity). But, depending up on the riding skill of the user its performance
could be only 55kmpl (actual output).
Design capacity (e.g. 125 tons)
Prod mix, log-term market conditions
Tight quality specifications
Inherent imbalance in eqpt and labour

System capacity (e.g. 100 tons)

Actual output
SE= --------------------Systems capacity

Actual demand, Poor managerial

performance, Worker inefficiencies,
Machine inefficiencies, etc.

Actual output (e.g. 80 tons)

Relationship between capacities and output

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Problem 10. A chemical processor has been making a white plastic compound for dish-wear on a
continuous basis by processing it through a series of four tanks (for mixing, heating, molding &
cooling) at a rate of 50 liters of chemical per minute. The firm now plans to produce different
coloured plastic compound on the same equipment. However, the individual capacities of the tanks
will then be limited because of the time needed for cleanout, different temperature requirements
and other factors. If the individual capacities (in liter/ min) and actual output for new operations are
as shown below, what is (i) the system capacity & (ii) the system efficiency?
A

48

50

43

48
Actual output 40 liter/min

Solution :
Design capacity = 50 gallons / min
System capacity (for new plastic compound) is determined by the capacity of bottleneck equipment
C = 43 gal / min
Hence, (i) System capacity = 43 gal /min
(ii) System efficiency = 40/43 = 93%

Problem 11. An automatic drive-in teller has the capacity of handling 2000 entries per day (as per
the claim of the manufacturer). However, because of limitations imposed by automobile access, the
teller is available for only 60% of the time. It is actually being used for about 800 entries per day.
What is the system efficiency?
Solution:
Design capacity: 2000 entries per day
System capacity: 2000 x 0.60 = 1200 entries per day
Actual operation = 800 entries per day
Hence, system efficiency = (Actual output/system capacity) = 800 / 1200 = 66.7%

Problem 12. An aerospace manufacturer must acquire some molding machines capable of
producing 1,60,000 good parts per year. They will be installed in a production line that normally
produces 20% rejects because of tight aerospace specifications.
(i) What is the required systems capacity?
(ii) Assume that it takes 90 seconds to mold each part and the plant operated 2000 hours per year. If
the molding machines are used only 50% of the time and are 90% efficient, what actual (usable)
molding machine output per hour would be achieved?
(iii) How many molding machines would be required?
Solution:
System efficiency = (Actual output / System capacity)
(i)
System capacity = (Actual output per year/system efficiency) = 1,60,000 / (1.0-0.2)
= 2,00,000 units per year

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(ii)

At 1.5 mins (i.e. 90 secs)/unit , a molding machine produces 40 units per hour.
But, with only 50% utilization, and 90% efficiency, the machine produces 40 x0.50 x 0.90
= 18 units per hour.
i.e., individual machine capacity per year = 18 x 2000 = 36,000 units

(iii) Number of machines required = (quantity of items to be produced per year/individual machine
capacity per year)
= 2,00,000/36,000 = 5.56 machines or 06 machines are required

Capacity planning:
Definition of capacity: Capacity is defined as a measure of the ability to produce, or serve, i.e.
having enough worker- or equipment-time to do the job. In other words, capacity is the rate of
output that can be produced with a given facility (eg. so many liters of chemical/day; no of
customers/hr, etc). Sometimes, one would use monetary unit such as Rs/month. But this is more
appropriate as an aggregate measure of capacity when a variety of products are produced by the
facility. For eg. Suppose that a milk dairys output includes milk, cova, milk powder, curd, butter,
ghee, etc., then either total weight of the products processed or its sales turnover can be a better
measure to indicate its capacity. Capacity is the limit on ones ability to produce. Both upper &
lower bounds of capacity are important because upper bound determines the firms ability to meet
the customer demands and lower bound should be well above the break-even point.
Capacity planning refers to deciding on short- or long-range capacity needs of an organization and
determining how these needs will be satisfied. The capacity decisions should link customer demands
with the resources (such as human, material, financial, machines, etc.) of the organization.
Long-term capacity strategy: Long-term capacity is concerned with accommodating major changes
that affect the overall level of output in the longer-term (say more than 1-2 years) Assessing market
demands & implementing long term capacity plans are strategic responsibilities of the top
management. Decisions relating to start or closure of a production facility, expansion of an existing
facility, etc will significantly affect the capacity levels of a firm.
(i) Multiple products in the same plant: The strategy of firms to produce more than one type of
product or provide more than one type of service in the same facility increases the chances of
better profits and reduce the risk from the failure of one of the products. In view of the changing
demand over the life cycle of a product, this strategy helps better utilization of the capacity.
Introducing a new product when the other is in its mature or decline phase keeps the facilities
optimally loaded and utilized.

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(ii) Phasing-in capacity (Commissioning additional capacity): Some times, even before a firm has the
knowledge of which specific product it is going to produce, it may need to commit
resources/people to a facility. Many software companies hire engineers even before they know
the kind of projects they will get. A university may acquire large ground space even before it has
least idea of which departments it is going to launch over time. This would lessen the response
time of the firm to market demands, especially when project gestation period is longer than the
product life cycle and the firm wants to introduce the product to market before it becomes
obsolete). In such situations, the firm phases-in portions of capacity on a modular basis as new
products become available. Phasing in or commissioning additional capacity through new
technology can be sometimes risky unless a thorough preparation is done well before.
(iii) Phasing-out capacity (reducing capacity): Today, as firms are faced with intense competition and
need to respond to the same, often they come across the situation wherein they need to
decommission or phase-out their plants and facilities. Hence, operations managers should also
be familiar with phasing out operations in unviable plants. Closure of plant impacts not only the
fixed costs and commitment with suppliers, but also could have a serious adverse impact on
direct and indirect employment and may lead to social problems too. The society would suffer
this social and economic cost. The socially responsible firms may retrain workers for other jobs,
offer them employment in other locations, offer employees ownership of the firm, or
compensate in some other way such as offering VRS. Decommissioning nuclear power plants,
disposal of hazardous waste, phasing out satellite after useful life in space all need to be planned
before commissioning them to service.
Short- term capacity strategy: Short-term capacity planning is concerned with handling fluctuations
in demand caused due to seasonal, uncertain and economic factors. It involves responding to
immediate variations (in the immediate future) in demand. Manufacturing and service firms will
have their own strategies to deal with the situation.
Manufacturing plants can choose to vary to employment levels, work either over time or operate
2nd/ 3rd shifts to meet the temporary strong demand. For eg. demand for crackers, fruit juices, ice
creams, woolen dress, etc. They may accumulate stock during slack demand season and use it
during peak demand season. Alternatively, they may also shift the excess work load to
subcontractors.
Service providing firms may choose to shift the demand to lean periods by appropriate schemes. For
eg. charging less for STD telephone calls made after working hours shifted part of the demand from
day hours to night. Reduction in room-rent during off-seasons in a tourist place shifts part of the
demand. A trust may run both school and college in the same building, but with different working
hours. This amounts to rescheduling of work/demand. Service units such as hotels, transport
corporations work over-time to handle emergency rush demand or idle time to cope with lean
demand, where as police and hospitals depend on part-time employees such as seeking homeguards or NGOs. Doctors, professors and lawyers use appointment system to spread the demand
uniformly over time, in which case the customers are forced to adapt to the systems capacity.
Traffic police, to avoid congestion during peak hours (when the traffic demand is greater than the
capacity of roads), advises car pooling, one-way traffic, flexible working hours, and so on.
Alternatively, get customers in queue. For eg. appliance repair shops, tailors stitching dresses who
keep the same work force and delay the delivery of service until they can produce it. Thus there are
several strategies to deal with immediate variation in the demand. We should also remember that
an innumerable number of combinations of the above strategies is possible in a given situation.

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