POM, Chapter 9

Lecture Outline

z Capacity
p y
z Capacity Planning

z Capacity Decisions

z Managing Demand and Capacity

z Capacity Calculations
z Break Even Analysis

Capacity

z Capacity is the throughput, or the number of units a

facility can hold, receive, store, accommodate or produce
z Ti dimension
Time di i should
h ld beb stated
t t d
z Capacity encompasses both resource inputs and
product/service outputs
z Capacity planning is the process of identifying the
capacity of a process/system so as to meet current and
f t
future d
demandsd
z Capacity planning means different things to individuals
at different levels in the OM hierarchy

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Capacity Planning

z Capacity Planning is the long term strategic decision that

establishes a firm’s overall level of capital intensive
resources.
z To build new facilities, to acquire new machines &
equipments, to hire, to acquire new businesses,
technologies, etc.
z Inadequate capacity can loose customers & limit growth
z Excess capacity stretch up the resources and prevent
investments in other lucrative sectors
z The choice is when to increase and how much to increase

Capacity Decisions
z Capacity: Maximum capability to produce; is affected by the mix
of product/services, processes involved, the choice of technology,
the size of a facility, the resource allocated, and external factors
z Rated Capacity is theoretical output with 100% utilization
z Capacity Utilization: percent of available time spent working
z Capacity Efficiency: how well a machine or worker performs
compared to a standard output level
z Effective capacity is actual efficiency and utilization
Effective daily capacity = number of machines or workers x hours per
shift x no. of shifts x utilization x efficiency
z Capacity Load: standard hours of work assigned to a facility
z Capacity Load Percent: ratio of load to capacity

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Bakery Example

Actual pproduction last week = 148,000

, rolls
Effective capacity = 175,000 rolls
Rated or Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Rated or Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Bakery Example

Actual pproduction last week = 148,000

, rolls
Effective capacity = 175,000 rolls/week
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls/week

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Bakery Example

Actual pproduction last week = 148,000

, rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls/week

Utilization = 148,000/201,600 = 73.4%

Bakery Example

Actual pproduction last week = 148,000

, rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls/week

Utilization = 148,000/201,600 = 73.4%

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Bakery Example

Actual pproduction last week = 148,000

, rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls/week

Utilization = 148,000/201,600 = 73.4%

Efficiency = 148,000/175,000 = 84.6%

Bakery Example

Actual pproduction last week = 148,000

, rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls/week

Utilization = 148,000/201,600 = 73.4%

Efficiency = 148,000/175,000 = 84.6%

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Bakery Example

Actual pproduction last week = 148,000

, rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts
Efficiency = 84.6%
Efficiency of new line = 75%

Expected
E t d Output
O t t = (Effective
(Eff ti Capacity)(Efficiency)
C it )(Effi i )

= (175,000)(.75) = 131,250 rolls/week

Bakery Example

Actual pproduction last week = 148,000

, rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts
Efficiency = 84.6%
Efficiency of new line = 75%

Expected
E t d Output
O t t = (Effective
(Eff ti Capacity)(Efficiency)
C it )(Effi i )

= (175,000)(.75) = 131,250 rolls/week

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Capacity Decisions

z Capacity increase i.e. how much to increase depends on

z volume and certainty of anticipated demand
z strategic
t t i objectives
bj ti – purpose, competition,
titi positioning,
iti i growth th
z costs of expansion and operation
z Best Operating Level
z to avoid confusion with ‘normal’ capacity levels
z % of capacity utilization that minimizes average unit costs
z most economic size of a facility
z Capacity Cushion
z % of capacity held in reserve for unexpected occurrences
z airline industry keeps negative cushion by overbooking tickets

Best Operating Level for a Hotel

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Economies & Diseconomies of Scale

z Economies of scale occur when it costs less per unit to produce

or operate at high levels of output
z fi d costs
fixed t can be
b spreadd over a larger
l number
b off units
it
z quantity discounts are available for material purchases
z operating efficiency increases as workers gain experience
z production or operating costs do not increase linearly with
output levels
z Diseconomies of scale occur above a certain level of output
p
z Diseconomies of Distribution/Transportation
z Diseconomies of Bureaucracy/Hierarchies
z Diseconomies of Vulnerability

Managing Demand

; Demand exceeds capacity

; Curtail demand by raising prices
; Schedule longer lead time
; Long term solution is to increase capacity
; Capacity exceeds demand
; Stimulate market
; Product changes
; Adjusting to seasonal demands
; Produce products with complimentary demand patterns

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Managing Capacity

Capacity Decisions – Example #1

z Pizza Hut offers large pizzas for Rs 25 on Tuesdays from 5 to 9 in the

evening. Three cooks are on duty during that time, the fixed cost of this
four hour pperiod is Rs. 400. The variable cost of ppizza is Rs. 15.
z A. If it takes 10 minutes to prepare each pizza, worker efficiency is approx.
95% and employees get a 10 minutes break each hour, how may pizzas can
they produce during its four hour special?
z B. Assuming all pizzas produced can be sold, is the promotion worth it?

z A. Effective capacity
p y = no. of workers x hours x utilization x efficiency
y
= 3 x 4 x (50/60) x 0.95 = 9.5 hrs = 570 minutes
z Output = 570 / 10 = 57 pizzas
z B. BEP = 400 / 25 – 15 = 40 pizzas
z Yes, the promotion effort is worth it.

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Capacity Decisions – Example #2

z Amy gets home from classes around 5 pm each day and can only
reasonably work on her studies until midnight.
midnight. She usually watches an hour
of television to relax, work out for 30 minutes, and takes 30 minutes to eat
dinner.. She has found that if she takes a 5 minute break each hour, she can
dinner
remain more focused.
focused. Today she feels 80 80%
% on task
task.. Homework for the
evening includes two critical analyses for Govt
Govt,, one thesis for American
Lit, and three Spanish translations.
translations. Estimated processing times are given
below.. Setup time includes time spent online gathering resources and
below
finding reference books around the apartment.
apartment.
TASKS SETUP TIME (Minutes) PROCESSING TIME PER TASK (Minutes)
Govt
Govt. 15 40
American Lit 30 120
Spanish Trans. 10 30

z What is percent utilization?

z What is Amy’s effective capacity to do work this evening?
z What is her load percent?
z How would you suggest she adjust her capacity to complete her task on time?

Example #2

Hours available with Amy = 12

12--5 = 7 hrs = 7*60 = 420 mins

Idle hours = 60
60++30
30++30
30+(
+(5
5*5) = 145 mins

Utilized hours = 420 -145 = 275 mins

% Utilization = 275
275//420 = 65
65..47
47%%

Effective Capacity = 275 * 0.8 = 220 mins

Load = [15
15+(
+(22*40
40)]
)] + [30
30+(
+(11*120
120)]
)] + [10
10+(
+(33*30
30)]
)] = 345 mins

Load % = 345
345//220 = 156
156..82
82%%

Options to improve
improve:: raise efficiency or sleep late or cut idle hrs..
hrs..

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Capacity Decisions – Example #3

Biren is Prof
Prof.. Khurana’s teaching assistant
assistant.. He would like to leave for Diwali break
tomorrow, but first he has to grade the midterm exams from four sections.
sections. These
sections are new to Biren
Biren,, so he estimates his ggrading
g efficiencyy to be 80%
80%. Prof
Prof..
Khurana has estimated the time required to create key and the time to grade each paper
as shown below.
below. Biren anticipates that he will need five hours of sleep, an hour to pack,
an hour to get the rly station, an hour to post grades, and three twenty minute breaks
during the day for meals
meals.. Can Biren finish his work and make it to the rly station on
time in a 24 hour day?
SECTION TIME TO CREATE KEY TIME TO GRADE EACH PAPER #PAPERS

A 10 2 35
B 15 5 50
C 5 1 60
D 20 10 25

Example #3

Hrs available = 24 hrs = 1440 mins

Non productive hrs = 5+1+1+1+(3*20) = 9 hrs = 540 mins
Working hrs = 24-9 = 15 hrs = 900 min
Utilization % = 15/24 = 900/1440 = 62.50%
Effective capacity in hrs = 900 * 0.8 = 720 mins
Load = [10+(2*35)] + [15+(5*50)] + [5+(1*60)] + [20+(10*25)]
= 680 mins
Load % = 680/720 = 94.45%
He can easily achieve the completion of the task assigned.

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 POM, Chapter 9

Capacity Decisions – Example #4

z The Avon Bicycle Co. has scheduled the production of following bicycles this month.
TYPE WEEK
I II III IV
A 50 100 195 150
B 15 30 65 45
C 20 40 80 60

z Two critical work centers form producing these bikes are welding and assembly.
assembly.
Welding has an efficiency of 95 95%
% and utilization of 90%
90% and Assembly has an
efficiency of 90%
90% and utilization of 92
92%%. The time required in hours by each bike in
two work centers is as follows
follows::
TYPE WELDING ASSEMBLY
A 0.20 0.18
B 0.15 0.15
C 0.07 0.10

Assume 40 hours/week for each work center. Calculate the capacity and load percent per work center
per week.

Chase Unsolved 5. Part a.

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 POM, Chapter 9

Part a.

Capacity of assembly line 1

= 140 units/hour X 8 hours/day X 5 days/week = 5,600 units/week.

Capacity of drill machines

= 3 drill machines X 50 parts/hour X 8 hours/day X 5 days/week
= 6,000 units/week.

Capacity of final assembly line

= 160 units/hour X 8 hours/dayy X 5 days/week
y = 6,400
, units/week.

The capacity of the entire process is 5,600 units per week, with
assembly line 1 limiting the overall capacity.

Part b.

Capacity of assembly line 1

= 140 units/hour X 16 hours/day X 5 days/week = 11,200 units/week.

Capacity of drill machines

= 4 drilling machines X 50 parts/hour X 8 hours/day X 5 days/week
= 8,000 units/week.

Capacity of final assembly line

= 160 units/hour X 16 hours/dayy X 5 days/week
y = 12,800
, units/week.

The capacity of the entire process is 8,000 units per week, with
drilling machines limiting the overall capacity.

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Part c.

Capacity of assembly line 1

= 140 units/hour X 16 hours/day X 5 days/week = 11,200 units/week.

Capacity of drill machines

= 5 drilling machines X 50 parts/hour X 8 hours/day X 5 days/week
= 10,000 units/week.

Capacity of final assembly line

= 160 units/hour X 12 hours/dayy X 5 days/week
y = 9,600
, units/week.

The capacity of the entire process is 9,600 units per week, with final
assembly machines limiting the overall capacity.

Part d.

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 POM, Chapter 9

Part d.

Part e. Break Even Analysis

Let X = the number of units that each option will produce.

When the company buys the units,

units the cost is $3.00
$3 00 per unit (3X).
(3X) When it
manufactures the units, they incur a fixed cost of $120,000 (4 drilling machines
at $30,000 a piece) and a per unit cost of $1.81. Therefore, 120,000 + 1.81X is
the cost of this option. Set them equal to each other and solve for X to
determine the breakeven point.

3X = 120,000 + 1.81X
X = 100
100,840
840 units.
units

Therefore, it is better to buy the units when you produce less than 100,840, and
better to produce them when demand is greater than 100,840 units.

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Process Selection with Break-

Break-Even Analysis

z Break Even Point Analysis: BEP examines the cost trade-

offs associated with demand / sales volume.
z Volume:
V l L l off production,
Level d ti usually
ll expressedd as no. off units
it
produced/sold
z Cost
z Fixed costs: constant regardless of the no. of units produced
z Variable costs: vary with the volume of units produced
z R
Revenue: P
Price
i att which
hi h an item
it isi sold
ld
z Total revenue: Price times volume sold
z Profit: Difference between total revenue and total cost

Process Selection with Break-

Break-Even Analysis

Total cost = fixed cost + total variable cost

TC = cf + v cv
Total revenue = volume * price
TR = v p
Profit = total revenue - total cost
Z = TR – TC = v p - (cf + v cv)
TR = TC
v p = cf + v cv
v p – v cv = cf
v (p - cv) = cf
v = cf / ( p – cv )

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 POM, Chapter 9

Break--Even Analysis: Example #1

Break

A company wants to produce its own rafts, the initial

investment in equipment is estimated to be Rs. Rs. 2000.
2000. Labour
and material cost is approx
approx.. Rs 5 per raft
raft.. If the rafts can be
sold at a price of Rs
Rs.. 10 each, what volume of demand will be
necessary to break even?
Fixed cost = cf = Rs. 2000
Variable cost = cv = Rs. 5 per raft
Price = p = Rs. 10 per raft

Break--even point is
Break
cf 2000
v= p-c = = 400 rafts
v 10 - 5

Break--Even Analysis: Graph

Break

Total cost
$3,000 — line

$2,000 —

$1,000 —
Total revenue
line

400 Units
Break-even point

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Process Selection – Example #1.1

The owners of the company believe that demand for their product will far
exceed the breakeven point. They are now contemplating a larger initial
investment of Rs. 10000 for more automated equipment that would reduce
the variable cost of manufacture to Rs. 2 per raft. Compare the old
manufacturing process with the new process proposed here. For what
volume of demand should each process be chosen?
Sol’n: The point of indifference between Process A and B is:
Process A Process B
2 000 + 5v = 10
2,000 10,000
000 + 2v
3v = 8,000
v = 2667 rafts
z Below 2667, choose A
z Above 2667, choose B

Process Selection – BEP Graph

$
$20,000 — Total
T t l costt off
process A

$15,000 — Total cost of

process B

$10,000 —

Choose Choose
$5,000 — process A process B

| | |
1000 2000 3000 Units

Point of indifference = 2,667 Units Example 4.2

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BEP & Process Selection - #2

A singer is getting ready to cut his first CD, the cost of recording
the CD is Rs. 50000 but the copies are Rs. 50 apiece. If the CDs
can be sold at Rs.
Rs 150 each,
each how many CDs must be sold to
breakeven? What is the breakeven point in Rupees?
The singer is confident that the CDs will out-sale the breakeven
point, so he is contemplating to cut his CD at a hi-tech and
classier (read pricier) studio. The cost to record the CD would rise
to Rs. 90000. However, since the new studio works with high
volume production cost would fall to Rs.
volume, Rs 20 per unit.
unit
What is the breakeven point for new process?
Compare this process with the old one and find out what volume
of demand suits the older and the newer recording process.

BEP Example #3

z David recently purchased a chain of dry cleaners in a city. city. Although the
business is making a modest profit now, David suspects that if he invests in a
new press,
press he would recognize a substantial increase in profits
profits.. The new press
costs, Rs
Rs.. 15
15,,400 to purchase and install and can press 40 shirts an hour.hour.
David estimates that with the new press, it will cost Rs 0.25 to launder and
press each shirt.
shirt. Customers are charged Rs.
Rs. 1.10 per shirt.
shirt.
z How many shirts will David have to press to break even?
z So far, David’s workload has varied from 50 to 200 shirts a day. day. How long
would it take to break even on the new press at the low demand estimate?
And at the high demand estimate?
z If David cuts his price to Rs.
Rs. 0.99 per shirt, he expects to be able to stabilize
his customer base at 250 shirts per day
day.. How long it take to break even at the
reduced price of 0.99?
99? Should David cut his price and buy the new press?

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BEP Example #4

z The school cafeteria can make pizza for approximately Rs

Rs..
0.30 per slice
slice.. The cost of kitchen use and cafeteria staff runs
about Rs
Rs.. 200 per day.
day. The Pizza Hut nearby will deliver
whole pizzas for Rs.
Rs. 9 each.
each. The cafeteria staff cuts the pizza
into eight pieces and serves them in the usual cafeteria line.
line.
With no cooking duties, the staff can be reduced to half, for a
fixed cost of Rs
Rs.. 75 per day.
day. Should the school cafeteria make
on its own or buy its pizzas from Pizza Hut?

BEP Example #5

z Alma McCoy has decided to purchase a cellular phone for her car, but she
is confused about which rate plan to choose.
choose. The occasional user plan is
Rs.. 0.50 per minute,
Rs minute regardless of how many minutes of airtime are used used..
The frequent user plan charges a flat rate of Rs 55 per month for 70
minutes of airtime plus Rs
Rs.. 0.33 per minute for any time over 70 minutes
minutes..
The executive plan charges a flat fee of Rs.
Rs. 75 per month for 100 minutes
of airtime plus Rs
Rs.. 0.25 per minute over 100 minutes
minutes.. In the interest of
simplicity, Alma has decided to go with the occasional user plan to start
with and then upgrade as she sees fit at a later date
date..
z How much airtime per month would Alma need to use before she upgrades
from the occasional user plan to the frequent user plan?
plan?
z At what usage rate should she switch from the frequent user plan to the
executive plan?
plan?

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BEP Example #6

z Soft key is trying to determine how best to produce its newest

product, K2 keyboards
keyboards.. The keyboards could be produced in
house using either Process A or B or buying from a supplier
supplier..
Cost data is given below
below.. For what levels of demand should
each option be explored?

FIXED COST (Rs.) VARIABLE COST (Rs./UNIT)

z PROCESS A 8000 10
z PROCESS B 20000 4
z SUPPLIER 0 20

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