CAPACITY PLANNING OVERCAPACITY *Generally, the factors that

influence this frequency are

-key strategic component in -operating costs that are too
the stability of demand, the
designing the system high
rate of technological change
*encompasses many basic ADVANTAGE: low fixed cost in equipment and product
decisions with long-term design, and competitive
DISADVANTAGE: opportunity factors
consequences for the
cost
organization
*CAPACITY DECISIONS CAN
UNDERCAPACITY BE CRITICAL FOR AN
CAPACITY
-causes strained resources ORGANIZATION
-upper limit or ceiling on the
and possible loss of 1. Capacity decisions have a
load that an operating unit
customers real impact on the ability of
can handle
ADVANTAGE: room for the organization to meet
*include equipment, space, future demands for products
expansion/improvement
and employee skills and services; capacity
DISADVANTAGE: high fixed essentially limits the rate of
OPERATING UNIT
cost output possible.
-might be a plant,
KEY QUESTIONS IN CAPACITY 2. Capacity decisions affect
department, machine, store,
PLANNING ARE THE operating costs. Ideally,
or worker
FOLLOWING: capacity and demand
GOAL OF STRATEGIC requirements will be
1. What kind of capacity is
CAPACITY PLANNING matched, which will tend to
needed?
-achieve a match between minimize operating costs.
- depends on the products
the long-term supply 3. Capacity is usually a major
and services that
capabilities of an organization determinant of initial cost
management intends to
and the predicted level of
produce or provide. 4. Capacity decisions often
long-term demand
2. How much is needed to involve long-term
CHIEF REASONS WHY commitment of resources
match demand?
ORGANIZATIONS BECOME and the fact that, once they
INVOLVED IN CAPACITY - Forecasts are key inputs are implemented, those
PLANNING: decisions may be difficult or
3. When is it needed?
-changes in demand, changes impossible to modify without
in technology, changes in the - Forecasts are key inputs incurring major costs.
environment, and perceived * Because of UNCERTAINTIES, 5. Capacity decisions can
threats or opportunities some organizations prefer to affect competitiveness.
*gap between current and delay capacity investment
6. Capacity affects the ease of
desired capacity will result in until demand materializes
management; having
capacity that is out of balance IN SOME INSTANCES, appropriate capacity makes
CAPACITY CHOICES ARE management easier than
MADE VERY INFREQUENTLY when capacity is mismatched
7. Globalization has increased
the importance and the
complexity of capacity
decisions. Far-flung supply
chains and distant markets
add to the uncertainty about
capacity needs.
8. Because capacity decisions
often involve substantial
financial and other resources,
it is necessary to plan for
them far in advance.
*In selecting a measure of
capacity, it is important to
choose one that does not
require updating
* The preferred alternative in
such cases is to use a measure
of capacity that refers to
AVAILABILITY OF INPUTS
TWO USEFUL DEFINITIONS
OF CAPACITY:
1. Design capacity:
-The maximum output rate or
service capacity an operation,
process, or facility is designed
for.
2. Effective capacity:
-Design capacity minus
allowances such as personal
time, and maintenance.
delays due to scheduling
problems, and changing the
mix of products
ACTUAL OUTPUT
- cannot exceed effective
capacity and is often less
because of machine
breakdowns, absenteeism,
shortages of materials, and 7. Revenue generated
quality problems, as well as per day
factors that are outside the
DIFFERENT MEASURES OF
control of the operations
CAPACITY ARE USEFUL IN
managers.
DEFINING TWO MEASURES
MEASURES OF CAPACITY OF SYSTEM EFFECTIVENESS:
BUSINESS 1. efficiency
- ratio of actual output to
1. Auto manufacturing
effective capacity
2. Steel mill
3. Oil refinery * acts as a lid on actual output
4. Farming
5. Restaurant FORMULA:
6. Theater Efficiency = Actual output
7. Retail sales / Effective capacity × 100%
2. utilization
INPUTS
- ratio of actual output to
1. Labor hours, machine
design capacity.
hours
2. Furnace size *real key to improving to
3. Refinery size increase effective capacity by
4. Number of acres, correcting quality problems,
number of cows maintaining equip ment in
5. Number of tables, good operating condition,
seating capacity fully training employees, and
6. Number of seats fully utilizing bottleneck
7. Square feet of floor equipment.
space
FORMULA:
OUTPUTS Utilization = Actual output
1. Number of cars per / Design capacity × 100%
shift
* It is not unusual for
2. Tons of steel per day managers to focus exclusively
3. Gallons of fuel per
on efficiency, but in many
day instances this emphasis can
4. Bushels of grain per be misleading (happens when
acre per year, gallons effective capacity is low
of milk per day compared to design capacity)
5. Number of meals
served per day
6. Number of tickets
sold per performance
* increasing utilization ence on capacity. For equipment settings must be
depends on being able to example, when items are taken into account.
increase effective capacity similar, the ability of the
HUMAN CONSIDERATIONS
system to produce those
*increasing utilization items is generally much - The tasks that make up a job,
depends on being able to greater than when successive the variety of activities
increase effective capacity items differ. Thus, a involved, and the training,
DISADVANTAGE OF HIGH restaurant that offers a skill, and experience required
UTILIZATION limited menu can usually to perform a job all have an
prepare and serve meals at a impact on the potential and
- operating costs may faster rate than a restaurant actual output. In addition,
increase because of with an extensive menu. employee motivation has a
increasing waiting time due Generally speaking, the more very basic relationship to
to bottleneck conditions uniform the output, the more capacity, as do absenteeism
opportu nities there are for and labor turnover.
DETERMINANTS OF
standardization of methods
EFFECTIVE CAPACITY (main POLICY FACTORS
and materials, which leads to
factors)
greater capacity. The -Management policy can
FACILITIES particular mix of products or affect capacity by allowing or
services rendered also must not allowing capacity options
- The design of facilities,
be considered since different such as overtime or second or
including size and provision
items will have different rates third shift
for expansion, is key.
of output.
Locational factors, such as OPERATIONAL FACTORS
transportation costs, distance PROCESSES
to market, labor supply, - Scheduling problems may
- The quantity capability of a occur when an organization
energy sources, and room for
process is an obvious has differ ences in equipment
expansion, are also
determinant of capac ity. A capabilities among
important. Likewise, layout of
more subtle determinant is alternative pieces of
the work area often
the influence of output equipment or differences in
deter mines how smoothly
quality. For instance, if quality job requirements. Inventory
work can be performed, and
of output does not meet stocking decisions, late
environmental factors such as
standards, the rate of output deliveries, purchasing
heating, lighting, and
will be slowed by the need for requirements, accept ability
ventilation also play a
inspection and rework of purchased materials and
significant role in determining
activities. Productivity also parts, and quality inspection
whether personnel can
affects capacity. Process and control procedures also
perform effectively or
improvements that increase can have an impact on
whether they must struggle
quality and productivity can effective capacity. Inventory
to overcome poor design
result in increased capacity. shortages of even one
characteristics.
Also, if multiple products or component of an assembled
PRODUCTS OR SERVICES mul tiple services are item (e.g., computers,
processed in batches, the refrig erators, automobiles)
- Product or service design
time to change over can cause a temporary halt to
can have a tremendous influ
assembly operations until the number of hours and type of (3) the rate and direction
components become work an employee may do. In of technological
available. This can have a addition, INADEQUATE innovation,
major impact on effective PLANNING can be a major
(4) the likely behavior of
capacity. Thus, insufficient limiting determinant of
competitors, and
capacity in one area can effective capacity.
affect overall capacity. (5) availability of capital
THREE PRIMARY
and other inputs.
SUPPLY CHAIN FACTORS STRATEGIES:
CAPACITY CUSHION
- Supply chain factors must be 1. Leading Capacity
taken into account in capacity Strategy - Extra capacity used to
plan ning if substantial offset demand
- builds capacity in
capacity changes are uncertainty
anticipation of future
involved. Key questions
demand increases - an amount of capacity in
include: What impact will the
changes have on suppliers, excess of expected
2. Following Strategy
warehousing, transportation, demand when there is
and distributors? If capacity - builds capacity when some uncertainty about
will be increased, will these demand exceeds current demand.
elements of the supply chain capacity
FORMULA:
be able to handle the 3. Tracking Strategy
increase? Conversely, if Capacity cushion =
capacity is to be decreased, - similar to a following capacity − expected
what impact will the loss of strategy, but it adds demand
business have on these capacity in relatively
elements of the supply chain? small increments to keep * the greater the degree
pace with increasing of demand uncertainty,
EXTERNAL FORCES demand the greater the amount of
cushion used
- Product standards, * An organization
especially minimum quality typically bases its * COST AND
and performance stan dards, capacity strategy on COMPETITIVE
can restrict management’s assumptions and PRIORITIES ARE ALSO
options for increasing and predictions about long- KEY FACTORS
using capacity. Thus, term demand patterns,
pollution standards on STEPS IN THE CAPACITY
technological changes,
products and equipment PLANNING PROCESS
and the behavior of its
often reduce effective competitors 1. Estimate future
capacity, as does paperwork capacity requirements.
required by government (1) the growth rate and
regulatory agencies by variability of demand, 2. Evaluate existing
engaging employees in capacity and facilities and
(2) the costs of building
nonproductive activi ties. A identify gaps.
and operating facilities of
similar effect occurs when a various sizes, 3. Identify alternatives for
union contract limits the
meeting requirements.
4. Conduct financial few things last forever, Week
analyses of each and
Retail sales, restaurant
alternative.
(2) the slope of the trend meals, automobile traffic,
5. Assess key qualitative automotive rentals, hotel
CYCLES ARE IDENTIFIED,
issues for each registrations
INTEREST FOCUSES ON
alternative.
Day
(1) the approximate
6. Select the alternative
length of the cycles Telephone calls, power
to pursue that will be best
usage, automobile traffic,
in the long term. (2) the amplitude of the
public transportation,
cycles (i.e., deviation
7. Implement the classroom utilization,
from average)
selected alternative. retail sales, restaurant
2. SHORT-TERM meals
8. Monitor results.
-needs are less concerned POISSON DISTRIBUTION
* Capacity planning can
with cycles or trends than
be difficult at times due to -certain mean
with seasonal variations
the complex influence of
and other variations from * Waiting-line models
market forces and
average and simulation models
technology
can be useful when
*These deviations are
CAPACITY PLANNING analyzing service systems
particularly important
DECISIONS INVOLVE
because they can place a IRREGULAR VARIATIONS
BOTH LONG-TERM AND
severe strain on a
SHORT-TERM - most troublesome
system’s ability to satisfy
CONSIDERATIONS
demand at some times - difficult or impossible to
1. LONG-TERM and yet result in idle predict
capacity at other times
- relate to overall level of - created by such diverse
capacity, such as facility EXAMPLES OF forces as major
size; short-term SEASONAL DEMAND equipment breakdowns,
considerations relate to PATTERNS freak storms that disrupt
probable variations in normal routines, foreign
capacity requirements Year political turmoil that
created by such things as Beer sales, toy sales, causes oil shortages,
seasonal, random, and airline traffic, clothing, discovery of health
irregular fluctuations in vacations, tourism, hazards (nuclear
demand power usage, gasoline accidents, unsafe
consumption, sports and chemical dumping
When trends are
recreation, education grounds, carcinogens in
identified, the
Month food and drink)
fundamental issues are:
Welfare and social * link between marketing
(1) how long the trend
security checks, bank and operations is crucial
might persist, because
transactions
to realistic determination - tends to be higher for
of capacity requirements services than for goods,
not only in timing of
* Through customer
demand, but also in the
contracts, demographic
amount of time required
analyses, and forecasts,
to service individual
marketing can supply
customers
vital information to
operations for DEMAND
ascertaining capacity MANAGEMENT
needs for both the long STRATEGIES
term and the short term
- can be used to offset
FORMULA: capacity limitations
units of capacity needed * Pricing, promotions,
=processing time needed discounts, and similar
/processing time capacit tactics can help to shift
y per unit some demand away from
peak periods and into
THREE VERY IMPORTANT
slow periods, allowing
FACTORS IN PLANNING
organizations to achieve
SERVICE CAPACITY ARE:
a closer match in supply
(1) there may be a need and demand
to be near customers
FACTORS TO CONSIDER
(2) the inability to store WHEN DECIDING
services WHETHER TO PERFORM
IN-HOUSE OR
(3) the degree of OUTSOURCE:
volatility of demand
1. AVAILABLE CAPACITY.
* Convenience for
customers is often an If an organization has
important aspect of available the equipment,
service necessary skills, and time,
it often makes sense to
* capacity and location produce an item or
are closely tied perform a service in-
* Capacity also must be house. The addi tional
matched with the timing costs would be relatively
of demand small compared with
those required to buy
DEMAND VOLATILITY items or sub contract
- presents problems for services. On the other
capacity planners hand, outsourcing can
increase capacity and
flexibility.
2. EXPERTISE.
-If a firm lacks the
expertise to do a job
satisfactorily, buying
might be a rea sonable
alternative.
3. QUALITY
CONSIDERATIONS.
-Firms that specialize can
usually offer higher
quality than an
organization can attain
itself. Conversely, unique
quality requirements or
the desire to closely
monitor quality may
cause an organization to
perform a job itself.
4. THE NATURE OF
DEMAND.
-When demand for an
item is high and steady,
the organization is often
better off doing the work
itself. However, wide
fluctuations in demand or
small orders are usually
better handled by
specialists who are able
to combine orders from
multiple sources, which
results in higher volume
and tends to offset
individual buyer
fluctuations.
5. COST. ANY COST
SAVINGS ACHIEVED
FROM BUYING OR
MAKING MUST BE
WEIGHED AGAINST THE
PRECEDING FACTORS.
-Cost savings might come
from the item itself or
from transportation cost
savings. If there are fixed
costs associated with
making an item that
cannot be real located if
the service or product is
outsourced, that has to
be recognized in the
analysis. Conversely,
outsourcing may help a
firm avoid incurring fixed
costs.
6. RISKS. BUYING GOODS
OR SERVICES MAY
ENTAIL CONSIDERABLE
RISKS.
- Loss of direct control
over operations,
knowledge sharing, and
the possible need to
disclose proprietary
information are three
risks. And liability can be
a tremendous risk if the
products or services of
other companies cause
harm to customers or the
environment, as well as
damage to an
organization’s
reputation. Reputation
can also be damaged if
the public discovers that
a supplier operates with
substandard working
conditions.
* firm might choose to
perform part of the work
itself and let others
handle the rest in order to
maintain flexibility and to
hedge against loss of a
subcontractor. If part or
all of the work will be
done in-house, capacity
alternatives will need to
be developed
* Outsourcing brings with
it a host of supply chain
considerations
WAYS TO ENHANCE
DEVELOPMENT OF
CAPACITY STRATEGIES:
1. DESIGN FLEXIBILITY
INTO SYSTEMS.
-The long-term nature of
many capacity decisions
and the risks inherent in
long-term forecasts
suggest potential
benefits from designing
flexible systems. For
example, provision for
future expansion in the
original design of a
structure fre quently can
be obtained at a small
price compared to what it
would cost to remodel an
existing structure that did
not have such a provision.
Hence, if future
expansion of a restaurant
seems likely, water lines,
power hookups, and
waste disposal lines can
be put in place initially so
that if expansion
becomes a reality,
modification to the
existing structure can be
minimized. Similarly, a
new golf course may start
as a nine-hole operation,
but if provision is made
for future expansion by
obtaining options on
adjacent land, it may
progress to a larger (18-
hole) course. Other
considerations in flexible
design involve layout of
equipment, location,
equip ment selection,
production planning,
scheduling, and inventory
policies, which will be
dis cussed in later
chapters.
2. TAKE STAGE OF LIFE
CYCLE INTO ACCOUNT.
-Capacity requirements
are often closely linked to
the stage of the life cycle
that a product or service
is in. At the introduction
phase, it can be difficult
to determine both the
size of the market and the
organization’s eventual
share of that market.
Therefore, organizations
should be cautious in
making large and/or
inflexible capac ity
investments. In the
growth phase, the overall
market may experience
rapid growth. However,
the real issue is the rate
at which the
organization’s market tend to have stable
share grows, which may market shares.
be more or less than the Organizations may still be
market rate, depending able to increase
on the success of the profitability by reducing
organization’s strategies. costs and making full use
Organiza tions generally of capacity. However,
regard growth as a good some organizations may
thing. They want growth still try to increase
in the overall market for profitability by increasing
their products or capacity if they believe
services, and in their this stage will be fairly
share of the market, long, or the cost to
because they see this as a increase capacity is
way of increasing volume, relatively small. In the
and thus, increasing decline phase, an
profits. However, there organization is faced with
can also be a downside to underutilization of
this because increasing capacity due to declining
output levels will require demand. Organizations
increasing capacity, and may eliminate the excess
that means increasing capacity by selling it, or
investment and by intro ducing new
increasing complexity. In products or services. An
addition, decision makers option that is sometimes
should take into account used in manufacturing is
to transfer capacity to a
possible similar moves by
location that has lower
competitors, which
labor costs, which allows
would increase the risk of
the organization to
overcapacity in the
continue to make a profit
market, and result in
on the product for a while
higher unit costs of the
longer.
output. Another strategy
would be to compete on 3. TAKE A “BIG-PICTURE”
some nonprice attribute (I.E., SYSTEMS)
of the product by APPROACH TO CAPACITY
investing in technology CHANGES.
and process
-When develop ing
improvements to make
capacity alternatives, it is
differentiation a
important to consider
competitive advantage.
how parts of the system
In the maturity phase, the
interrelate. For example,
size of the market levels
when making a decision
off, and organizations
to increase the number of
rooms in a motel, one
should also take into
account probable
increased demands for
parking, entertainment
and food, and
housekeeping. Also, will
suppliers be able to
handle the increased
volume? Capacity
changes inevitably affect
an organization’s supply
chain. Suppliers may
need time to adjust to
their capacity, so
collaborating with supply
chain partners on plans
for capacity increases is
essential. That includes
not only suppliers, but
also distributors and
transporters. The risk in
not taking a big-picture
approach is that the
system will be
unbalanced. Evi dence of
an unbalanced system is
the existence of a
bottleneck operation. A
bottleneck operation is
an operation in a
sequence of operations
whose capacity is lower
than the capaci ties of
other operations in the
sequence. As a
consequence, the
capacity of the bottleneck
operation limits the
system capacity; the
capacity of the system is
reduced to the capacity
of the bottleneck
operation. Four
operations generate
work that must then be
processed by a fifth
operation. The four
different operations each
have a capacity of 10
units per hour, for a total
capacity of 40 units per
hour. However, the fifth
operation can only
process 30 units per hour.
Consequently, the output
of the system will only be
30 units per hour. If the
other operations operate
at capacity, a line of units
waiting to be processed
by the bottleneck
operation will build up at
the rate of 10 per hour.
Here is another
perspective. The
following diagram
illustrates a three-step
process, with capacities
of each step shown.
However, the middle
process, because its
capacity is lower than
that of the others,
constrains the system to
its capacity of 10 units per
hour. Hence it is a
bottleneck. In order to
increase the capacity of
the entire process, it
would be necessary to
increase the capacity of
this bottleneck
operation. Note, though,
that the potential for
increas ing the capacity
of the process is only 5
units, to 15 units per -Unevenness in capacity
hour. Beyond that, requirements also can
operation 3’s capacity create certain problems.
would limit process For instance, during
capacity to 15 units per periods of inclement
hour. weather, public
transportation ridership
4. PREPARE TO DEAL
tends to increase
WITH CAPACITY
substantially relative to
“CHUNKS.”
periods of pleasant
- Capacity increases are weather. Consequently,
often acquired in fairly the system tends to
large chunks rather than alternate between
smooth increments, underutilization and
making it difficult to overutilization.
achieve a match between Increasing the number of
desired capacity and buses or subway cars will
feasible capacity. For reduce the burden during
instance, the desired periods of heavy demand,
capacity of a certain but this will aggravate the
operation may be 55 problem of overcapacity
units per hour, but at other times and
suppose that machines certainly add to the cost
used for this operation of operating the system.
are able to produce 40 We can trace the
units per hour each. One unevenness in demand
machine by itself would for products and services
cause capacity to be 15 to a variety of sources.
units per hour short of The bus ridership
what is needed, but two problem is weather
machines would result in related to a certain
an excess capacity of 25 extent, but demand could
units per hour. The be consid ered to be
illustration becomes even partly random (i.e.,
more extreme if we shift varying because of
the topic—to chance factors). Still
open hearth furnaces or another source of
to the number of vary ing demand is
airplanes needed to seasonality. Seasonal
provide a desired level of variations are generally
capacity. easier to cope with than
random variations
5. ATTEMPT TO SMOOTH because they are
OUT CAPACITY predictable.
REQUIREMENTS.
Consequently,
management can make
allowances in planning
and scheduling activities
and inventories.
However, seasonal
variations can still pose
problems because of
their uneven demands on
the system: At certain
times the system
will tend to be
overloaded, while at
other times it will tend to
be underloaded. One
possible approach to this
problem is to identify
products or services that
have complementary
demand patterns, that is,
patterns that tend to
offset each other. For
instance, demand for
snow skis and demand for
water skis might
complement each other:
Demand for water skis is
greater in the spring and
summer months, and
demand for snow skis is
greater in the fall and
winter months. The same
might apply to heating
and air-conditioning
equipment. The ideal
case is one in which
products or services with
complementary demand
patterns involve the use
of the same resources but
at different times, so that
overall capacity
requirements remain
fairly stable and
inventory levels are
minimized. Figure 5.3
illustrates
complementary demand
patterns. Variability in
demand can pose a
problem for managers.
Simply adding capacity by
increasing the size of the
operation (e.g.,
increasing the size of the
facility, the workforce, or
the amount of processing
equipment) is not always
the best approach,
because that reduces
flexibility and adds to
fixed costs.
Consequently, managers
often choose to respond
to higher than normal
demand in other ways.
One way is through the
use of overtime work.
Another way is to
subcontract some of the
work. A third way is to
draw down finished
goods invento ries
during periods of high
demand and replenish
them during periods of
slow demand. These
options and others are
discussed in detail in the
chapter on aggregate
planning.
6. IDENTIFY THE
OPTIMAL OPERATING
LEVEL.
-Production units
typically have an ideal or
opti mal level of
operation in terms of unit
cost of output. At the
ideal level, cost per unit is
the lowest for that
production unit. If the
output rate is less than
the optimal level,
increas ing the output
rate will result in
decreasing average unit
costs. This is known as
economies of scale.
However, if output is
increased beyond the
optimal level, average
unit costs will become
increasingly larger. This is
known as diseconomies
of scale.
REASONS FOR
ECONOMIES OF SCALE
INCLUDE THE
FOLLOWING:
a. Fixed costs are spread
over more units, reducing
the fixed cost per unit.
b. Construction costs
increase at a decreasing
rate with respect to the
size of the facil ity to be
built.
c. Processing costs
decrease as output rates
increase because
operations become more
standardized, which
reduces unit costs.
REASONS FOR
DISECONOMIES OF
SCALE INCLUDE THE
FOLLOWING:
a. Distribution costs
increase due to traffic
congestion and shipping
from one large
centralized facility
instead of several
smaller, decentralized
facilities.
b. Complexity increases
costs; control and
communication become
more problematic.
c. Inflexibility can be an
issue.
d. Additional levels of
bureaucracy exist,
slowing decision making
and approvals for
changes.
The explanation for the
shape of the cost curve is
that at low levels of
output, the costs of
facilities and equipment
must be absorbed (paid
for) by very few units.
Hence, the cost per unit is
high. As output is
increased, there are more
units to absorb the
“fixed” cost of facilities
and equipment, so unit
costs decrease. However,
beyond a certain point,
unit costs will start to
rise. To be sure, the fixed
costs are spread over
even more units, so that
does not account for the
increase, but other
factors now become
important: worker
fatigue; equipment
break downs; the loss of
flexibility, which leaves
less of a margin for error;
and, generally, greater
difficulty in coordinating
operations. Both optimal
operating rate and the
amount of the minimum
cost tend to be a function
of the general capacity of
the operating unit. For
example, as the general
capacity of a plant
increases, the optimal
output rate increases and
the minimum cost for the
optimal rate decreases.
Thus, larger plants tend
to have higher optimal
output rates and lower
minimum costs than
smaller plants. Figure 5.5
illustrates these points. In
choosing the capacity of
an operating unit,
management must take
these relationships into
account along with the
availability of financial
and other resources and
forecasts of expected
demand. To do this, it is
necessary to determine
enough points for each
size facility to be able to
make a comparison
among different sizes. In
some instances, facility
sizes are givens, whereas
in others, facility size is a
continuous variable (i.e.,
any size can be selected).
In the latter case, an ideal
facility size can be
selected. Usually,
management must make
a choice from given sizes,
and none may have a
minimum at the desired
rate of output. 7. Choose
a strategy if expansion is
involved. Consider
whether incremental
expansion or single step
is more appropriate.
Factors include
competitive pressures,
market opportunities,
costs and availability of
funds, disruption of
operations, and training
requirements. Also,
decide whether to lead or
follow competitors.
Leading is more risky, but
it may have greater
potential for rewards.
CONSTRAINT
- Something that limits
the performance of a
process or system in
achieving its goal
CONSTRAINT
MANAGEMENT
- often based on the work
of Eli Goldratt (The
Theory of Constraints),
and Eli Schragenheim and
H. William Dettmer
(Manufacturing at Warp
Speed)
THERE ARE SEVEN
CATEGORIES OF
CONSTRAINTS:
MARKET: benefit, given the
constraint. This may be a
-Insufficient demand
short-term solution.
RESOURCE: Too little of
3. Make sure other
one or more resources
portions of the process
(e.g., workers,
are supportive of the
equipment, and space)
constraint (e.g.,
MATERIAL: bottleneck operation).
* An organization needs
to examine alternatives
for future capacity from a
number of different
perspectives
MOST OBVIOUS ARE
ECONOMIC
CONSIDERATIONS:

-Too little of one or more 4. Explore and evaluate • Will an

materials ways to overcome the alternative be
constraint. This will economically
FINANCIAL: depend on the type of feasible?
-Insufficient funds constraint. For example, • How much will it
if demand is too low, cost?
SUPPLIER: advertising or price • How soon can we
-Unreliable, long lead change may be an option. have it?
time, substandard quality If capacity is the issue, • What will
working overtime, operating and
KNOWLEDGE OR purchasing new maintenance
COMPETENCY: equipment, and costs be?
out sourcing are possible • What will its
-Needed knowledge or
options. If additional useful life be?
skills missing or
funds are needed, • Will it be
incomplete
working to improve cash compatible with
POLICY: flow, borrowing, and present
issuing stocks or bonds personnel and
-Laws or regulations
may be options. If present
interfere
suppliers are a problem, operations?
CONSTRAINT ISSUES work with them, find
CAN BE RESOLVED BY more desirable suppliers, LESS OBVIOUS, BUT
or do in-house. If NONETHELESS IMPORTANT:
USING THE
knowledge or skills
FOLLOWING FIVE • possible negative
are needed, seek training
STEPS: public opinion
or consultants, or
1. Identify the most outsource. If laws or TECHNIQUES ARE USEFUL
pressing constraint. If it regulations are the issue, FOR EVALUATING CAPACITY
can easily be overcome, working with lawmakers ALTERNATIVES FROM AN
do so, and return to Step or regulators may be an ECONOMIC STANDPOINT:
1 for the next constraint. option.
1. COST–VOLUME ANALYSIS
Otherwise, proceed to
5. Repeat the process
Step 2. 2. FINANCIAL ANALYSIS
until the level of
2. Change the operation constraints is acceptable. 3. DECISION THEORY
to achieve the maximum
4. WAITING-LINE ANALYSIS
COST–VOLUME
ANALYSIS
- focuses on relationships
between cost, revenue, and
volume of output
-purpose of cost–volume
analysis is to estimate the
income of an organization
under different operating
conditions
* useful as a tool for
comparing capacity
alternatives
* requires identification of all
costs related to the
production of a given product
FIXED COST
- remain constant regardless
of volume of output
EXAMPLES
include rental costs, property
taxes, equipment costs,
heating and cooling
expenses, and certain
administrative costs
VARIABLE COSTS
- vary directly with volume of
output
* major components of
variable costs are generally
materials and labor costs
* variable cost per unit
remains the same regardless
of volume of output, and that
all output can be sold
COST–VOLUME
FORMULAS:
TC = FC + VC
VC = Q × v
TR = R × Q
* Revenue per unit, like
variable cost per unit, is
assumed to be the same
regardless of quantity of
output
BREAK-EVEN POINT (BEP)
- volume of output at which
total cost and total revenue
are equal
* When volume is less than
the break-even point, there is
a LOSS
* volume is greater than the
break-even point, there is a
PROFIT
TOTAL PROFIT CAN BE
COMPUTED USING THE
FORMULA:
P = TR − TC = R × Q − (FC + v
× Q)
CONTRIBUTION MARGIN
- difference between revenue
per unit and variable cost per
unit, R – v
The required volume, Q,
needed to generate a
specified profit is:
Q = P + FC /R − v
INDIFFERENCE POINT
- quantity that would make
two alternatives equivalent
* a quantity less than the
point of indifference would
favor choosing alternative B
because its profit is higher in
that range, while a quantity
greater than the point of
indifference would favor
choosing alternative A
STEP COSTS
- increase stepwise as
potential volume increases
COST–VOLUME ANALYSIS
CAN BE A VALUABLE TOOL
FOR COMPARING CAPACITY
ALTERNATIVES IF CERTAIN
ASSUMPTIONS ARE
SATISFIED:
1. One product is involved.
2. Everything produced can
be sold.
3. The variable cost per unit is
the same regardless of the
volume.
4. Fixed costs do not change
with volume changes, or they
are step changes.
5. The revenue per unit is the
same regardless of volume.
6. Revenue per unit exceeds
variable cost per unit.
* Also, cost–volume analysis
requires that fixed and
variable costs can be
separated, and this is
sometimes exceedingly
difficult to accomplish. Cost–
volume analysis works best
with one product or a few
products that have the same
cost characteristics
* provides for integrating
cost, revenue, and profit
estimates into capacity
decisions. If a proposal looks
attractive using cost–volume
analysis, the next step would
be to develop cash flow
models to see how it fares
with the addition of time and
more flexible cost functions.
FINANCIAL
ANALYSIS
- to rank investment
proposals, taking into
account the time value of
money
- Operations personnel need
to have the ability
Two important terms in
financial analysis are cash
flow and present value:
CASH FLOW
refers to the difference
between the cash received
from sales (of goods or
services) and other sources
(e.g., sale of old equipment)
and the cash outflow for
labor, materials, overhead,
and taxes.
PRESENT VALUE
- expresses in current value
the sum of all future cash
flows of an invesment
proposal
THREE MOST COMMONLY
USED METHODS OF
FINANCIAL ANALYSIS:
PAYBACK
- crude but widely used
method that focuses on the
length of time it will take for
an investment to return its
original cost
* ignores the time value of
money
* Its use is easier to
rationalize for short-term
than for long term projects
FOR EXAMPLE,
-an investment with an
original cost of $6,000 and a
monthly net cash flow of
$1,000 has a payback period
of six months.
FORMULA:
PAYBACKTIME = INITIAL
COST / ANNUAL SAVING
PRESENT VALUE
- summarizes the initial cost
of an investment, its
estimated annual cash flows,
and any expected salvage
value in a single value called
the equivalent cur rent
value, taking into account the
time value of money (i.e.,
interest rates)
INTERNAL RATE OF
RETURN
- summarizes the initial cost,
expected annual cash flows,
and estimated future salvage
value of an investment
proposal in an equivalent
interest rate. In other words,
this method identifies the
rate of return that equates
the estimated future returns
and the initial cost.
* These techniques are
appropriate when there is a
high degree of certainty
associated with estimates of
future cash flows. In many
instances, however,
operations managers and
other managers must deal
with situations better
described as risky or
uncertain. When conditions of
risk or uncertainty are
present, DECISION
THEORY is often applied.
DECISION THEORY
- Decision theory is a helpful
tool for financial comparison
of alternatives under
conditions of risk or
uncertainty. It is suited to
capacity decisions and to a
wide range of other decisions
managers must make. It
involves identifying a set of
possible future conditions
that could influence results,
listing alternative courses of
action, and developing a
financial outcome for each
alternative–future condition
combination. Decision theory
is described in the
supple ment to this chapter.
WAITING-LINE
ANALYSIS
-Analysis of lines is often
useful for designing or
modifying service systems.
Waiting lines have a tendency
to form in a wide variety of
service systems (e.g., airport
ticket counters, tele phone
calls to a cable television
company, hospital
emergency rooms). The lines
are symp toms of bottleneck
operations. Analysis is useful
in helping managers choose a
capacity level that will be
cost-effective through
balancing the cost of having
customers wait with the cost
of providing additional
capacity. It can aid in the
determination of expected
costs for various levels of
service capacity
SIMULATION
-can be a useful tool in
evaluating what-if scenarios
*capacity decisions establish
a set of conditions within
which operations will be
required to function. Hence,
it is extremely important to
include input from
operations management
people in making capacity preempt competitors from
decisions. expanding
FLEXIBILITY * The intent might be to
achieve economies of scale, to
- can be a key issue in expand market share, or to
capacity decisions, although preempt competitors from
flexibility is not always an expanding
option, particularly in capital-
intensive industries WAIT-AND-SEE
STRATEGY
* it reduces to a certain extent
the dependence on long- - Its advantages include a
range forecasts to accurately lower chance of oversupply
predict demand. And due to more accurate
flexibility makes it easier for matching of supply and
organizations to take demand, and higher capacity
advantage of technological utilization
and other innovations.
* key risks are loss of market
Maintaining excess capacity
(a capacity cushion) may share and the inability to
meet demand if expansion
provide a degree of flexibility,
requires a long lead time.
albeit at added cost
*Efficiency improvements CAPACITY DISPOSAL
and utilization STRATEGIES
improvements can provide
- In cases where capacity
capacity increases
contraction will be
* Bottleneck management undertaken
can be a way to increase
* result of the need to replace
effective capacity, by
aging equipment with newer
scheduling non bottleneck
equipment. It can also be the
operations to achieve
result of outsourcing and
maximum utilization of
downsizing operations. The
bottleneck operations
cost or benefit of asset
TWO STRATEGIES FOR disposal should be taken into
DETERMINING THE TIMING account when contemplating
AND DEGREE OF CAPACITY these actions
EXPANSION :
EXPAND-EARLY STRATEGY
- The intent might be to
achieve economies of scale,
to expand market share, or to