Outline

Operations
; Capacity
Management ; Design and Effective Capacity
Supplement 7 – ; Capacity and Strategy
; Capacity Considerations
Capacity Planning
; Managing Demand
; Demand and Capacity
PowerPoint presentation to accompany Management in the Service
Heizer/Render Sector
Principles of Operations Management, 7e
Operations Management, 9e
© 2008 Prentice Hall, Inc. S7 – 1 © 2008 Prentice Hall, Inc. S7 – 2

Outline – Continued Outline – Continued

; Capacity Planning ; Applying Investment Analysis to
; Break-
Break-Even Analysis Strategy-
Strategy-Driven Investments
; Single-
Single-Product Case ; Investment, Variable Cost, and
Cash Flow
; Multiproduct Case
; Net Present Value
; Applying Decision Trees to
Capacity Decisions

© 2008 Prentice Hall, Inc. S7 – 3 © 2008 Prentice Hall, Inc. S7 – 4

Learning Objectives Capacity

When you complete this supplement,
; The throughput, or the number of
you should be able to:
units a facility can hold, receive,
1. Define capacity store, or produce in a period of time
2. Determine design capacity, effective ; Determines
capacity, and utilization fixed costs
3. Compute break-
break-even analysis ; Determines if
4. Apply decision trees to capacity demand will
decisions be satisfied
5. Compute net present value ; Three time horizons
© 2008 Prentice Hall, Inc. S7 – 5 © 2008 Prentice Hall, Inc. S7 – 6

1
 Planning Over a Time Design and Effective
Horizon Capacity

Long-
Long-range Add facilities
; Design capacity is the maximum
planning Add long lead time equipment * theoretical output of a system
Intermediate-
Intermediate-
range
Subcontract
Add equipment
Add personnel
Build or use inventory
; Normally expressed as a rate
planning Add shifts
; Effective capacity is the capacity a
Schedule jobs
Short-
Short-range firm expects to achieve given current
planning * Schedule personnel
Allocate machinery
operating constraints
Modify capacity Use capacity
; Often lower than design capacity
* Limited options exist
Figure S7.1

© 2008 Prentice Hall, Inc. S7 – 7 © 2008 Prentice Hall, Inc. S7 – 8

Utilization and Efficiency Bakery Example

Utilization is the percent of design capacity Actual production last week = 148,000 rolls
achieved Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Utilization = Actual output/Design capacity Bakery operates 7 days/week, 3 - 8 hour shifts

Efficiency is the percent of effective capacity Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls
achieved

Efficiency = Actual output/Effective capacity

© 2008 Prentice Hall, Inc. S7 – 9 © 2008 Prentice Hall, Inc. S7 – 10

Bakery Example Bakery Example

Actual production last week = 148,000 rolls Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts Bakery operates 7 days/week, 3 - 8 hour shifts

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

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

© 2008 Prentice Hall, Inc. S7 – 11 © 2008 Prentice Hall, Inc. S7 – 12

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 Bakery Example Bakery Example
Actual production last week = 148,000 rolls Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts Bakery operates 7 days/week, 3 - 8 hour shifts

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

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

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

© 2008 Prentice Hall, Inc. S7 – 13 © 2008 Prentice Hall, Inc. S7 – 14

Bakery Example Bakery Example

Actual production last week = 148,000 rolls Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts Bakery operates 7 days/week, 3 - 8 hour shifts
Efficiency = 84.6%
Efficiency of new line = 75%
Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls
Expected Output = (Effective Capacity)(
Capacity)(Efficiency
Efficiency))
Utilization = 148,000/201,600 = 73.4%
= (175,000)(.75) = 131,250 rolls
Efficiency = 148,000/175,000 = 84.6%

© 2008 Prentice Hall, Inc. S7 – 15 © 2008 Prentice Hall, Inc. S7 – 16

Bakery Example Capacity and Strategy

Actual production last week = 148,000 rolls ; Capacity decisions impact all 10
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour decisions of operations
Bakery operates 7 days/week, 3 - 8 hour shifts management as well as other
Efficiency = 84.6% functional areas of the organization
Efficiency of new line = 75%
; Capacity decisions must be
Expected Output = (Effective Capacity)(
Capacity)(Efficiency
Efficiency)) integrated into the organization’
organization’s
= (175,000)(.75) = 131,250 rolls mission and strategy

© 2008 Prentice Hall, Inc. S7 – 17 © 2008 Prentice Hall, Inc. S7 – 18

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 Economies and
Capacity Considerations
Diseconomies of Scale
; Forecast demand accurately

(dollars per room per night)

; Understand the technology and

Average unit cost

25 - room 75 - room
capacity increments roadside motel 50 - room roadside motel
roadside motel
; Find the optimum
operating level
(volume)
Economies Diseconomies
; Build for change of scale of scale
25 50 75
Number of Rooms
Figure S7.2
© 2008 Prentice Hall, Inc. S7 – 19 © 2008 Prentice Hall, Inc. S7 – 20

Build In Flexibility Managing Demand

Percent of North American Vehicles ; Demand exceeds capacity
Made on Flexible Assembly Lines
; Curtail demand by raising prices,
100% –
scheduling longer lead time
80% – ; Long term solution is to increase capacity
; Capacity exceeds demand
60% –
; Stimulate market
40% – ; Product changes
Chrysler
Nissan

Toyota
Honda

; Adjusting to seasonal demands

Ford
GM

20% –
; Produce products with complementary
0– Figure S7.3 demand patterns
© 2008 Prentice Hall, Inc. S7 – 21 © 2008 Prentice Hall, Inc. S7 – 22

Complementary Demand Complementary Demand

Patterns Patterns

4,000 – 4,000 –
Sales in units

Sales in units

Snowmobile
3,000 – 3,000 – motor sales

2,000 – 2,000 –

Jet ski Jet ski

1,000 – engine 1,000 – engine
sales sales

JFMAMJJASONDJFMAMJJASONDJ JFMAMJJASONDJFMAMJJASONDJ
Time (months) Time (months)
Figure S7.3 Figure S7.3

© 2008 Prentice Hall, Inc. S7 – 23 © 2008 Prentice Hall, Inc. S7 – 24

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 Complementary Demand Tactics for Matching
Patterns Capacity to Demand
Combining both 1. Making staffing changes
demand patterns
reduces the 2. Adjusting equipment
variation
4,000 –
; Purchasing additional machinery
Sales in units

Snowmobile
3,000 – motor sales ; Selling or leasing out existing equipment
3. Improving processes to increase throughput
2,000 –
4. Redesigning products to facilitate more
Jet ski
1,000 – engine throughput
sales
5. Adding process flexibility to meet changing
JFMAMJJASONDJFMAMJJASONDJ product preferences
Time (months) 6. Closing facilities
Figure S7.3

© 2008 Prentice Hall, Inc. S7 – 25 © 2008 Prentice Hall, Inc. S7 – 26

Demand and Capacity

Approaches to Capacity
Management in the Service Sector Expansion
(a) Leading demand with (b) Leading demand with
incremental expansion one-
one-step expansion
; Demand management New New
capacity
capacity

Demand
Demand

; Appointment, reservations, FCFS rule

Expected
Expected
demand
demand

; Capacity
management
(c) Capacity lags demand with (d) Attempts to have an average
; Full time, incremental expansion
New
capacity with incremental
expansion
temporary, capacity New
Demand

Demand
Expected capacity Expected
part-
part-time demand demand

staff
Figure S7.5
© 2008 Prentice Hall, Inc. S7 – 27 © 2008 Prentice Hall, Inc. S7 – 28

Approaches to Capacity Approaches to Capacity

Expansion Expansion
(a) Leading demand with incremental (b) Leading demand with one-
one-step
expansion expansion

New
capacity New
capacity
Expected
Demand

Demand

Expected demand
demand

1 2 3 1 2 3
Time (years) Time (years)
Figure S7.5 Figure S7.5
© 2008 Prentice Hall, Inc. S7 – 29 © 2008 Prentice Hall, Inc. S7 – 30

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 Approaches to Capacity Approaches to Capacity
Expansion Expansion
(c) Capacity lags demand with incremental (d) Attempts to have an average capacity
expansion with incremental expansion

New
New capacity
capacity

Expected
Demand

Demand
Expected
demand demand

1 2 3 1 2 3
Time (years) Time (years)
Figure S7.5 Figure S7.5
© 2008 Prentice Hall, Inc. S7 – 31 © 2008 Prentice Hall, Inc. S7 – 32

Break-
Break-Even Analysis Break-
Break-Even Analysis
; Fixed costs are costs that continue
; Technique for evaluating process even if no units are produced
and equipment alternatives
; Depreciation, taxes, debt, mortgage
; Objective is to find the point in payments
dollars and units at which cost
equals revenue ; Variable costs are costs that vary
with the volume of units produced
; Requires estimation of fixed costs, ; Labor, materials, portion of utilities
variable costs, and revenue
; Contribution is the difference between
selling price and variable cost
© 2008 Prentice Hall, Inc. S7 – 33 © 2008 Prentice Hall, Inc. S7 – 34

Break-
Break-Even Analysis Break-
Break-Even Analysis
–
Assumptions 900 –
Total revenue line

; Costs and revenue are linear 800 –

Break-
Break-even point r rid
o r
Total cost line
co
it
functions 700 – Total cost = Total revenue
Pr
of
Cost in dollars

600 –
; Generally not the case in the real 500 –
world Variable cost
400 –

; We actually know these costs 300 –

ss r
Lo rido
; Very difficult to accomplish 200 –
co
r
100 – Fixed cost
; There is no time value of money |
– | | | | | | | | | | |
0 100 200 300 400 500 600 700 800 900 1000 1100
Figure S7.6
Volume (units per period)
© 2008 Prentice Hall, Inc. S7 – 35 © 2008 Prentice Hall, Inc. S7 – 36

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 Break-
Break-Even Analysis Break-
Break-Even Analysis
BEPx = break-
break-even point in x = number of units BEPx = break-
break-even point in x = number of units
units produced units produced
BEP$ = break-
break-even point in TR = total revenue = Px BEP$ = break-
break-even point in TR = total revenue = Px
dollars F = fixed costs dollars F = fixed costs
P = price per unit (after V = variable cost per unit P = price per unit (after V = variable cost per unit
all discounts) TC = total costs = F + Vx all discounts) TC = total costs = F + Vx

Break-
Break-even point BEP$ = BEPx P
occurs when F Profit = TR - TC
= P
P-V = Px - (F + Vx)
Vx)
TR = TC F F
or BEPx = = = Px - F - Vx
P-V (P - V)/P
Px = F + Vx F = (P - V)x - F
=
1 - V/P
© 2008 Prentice Hall, Inc. S7 – 37 © 2008 Prentice Hall, Inc. S7 – 38

Break-
Break-Even Example
Fixed costs = $10,000
Direct labor = $1.50/unit
$1.50/unit
Break-
Break-Even Example
Material = $.75/unit
$.75/unit Fixed costs = $10,000 Material = $.75/unit
$.75/unit
Selling price = $4.00 per unit Direct labor = $1.50/unit
$1.50/unit Selling price = $4.00 per unit

F $10,000 F $10,000
BEP$ = = BEP$ = =
1 - (V/P)
V/P) 1 - [(1.50 + .75)/(4.00)] 1 - (V/P)
V/P) 1 - [(1.50 + .75)/(4.00)]
$10,000
= = $22,857.14
.4375

F $10,000
BEPx = = = 5,714
P-V 4.00 - (1.50 + .75)

© 2008 Prentice Hall, Inc. S7 – 39 © 2008 Prentice Hall, Inc. S7 – 40

Break-
Break-Even Example Break-
Break-Even Example
50,000 – Multiproduct Case
Revenue F
40,000 – BEP$ =

30,000 –
Break-
Break-even
point Total ∑ 1-
Vi
Pi
x (W
(Wi)
Dollars

costs

20,000 –
where V = variable cost per unit
Fixed costs P = price per unit
10,000 –
F = fixed costs
W = percent each product is of total dollar sales
| | | | | |
–
0 2,000 4,000 6,000 8,000 10,000
i = each product
Units

© 2008 Prentice Hall, Inc. S7 – 41 © 2008 Prentice Hall, Inc. S7 – 42

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 Multiproduct Example Multiproduct Example
Fixed costs = $3,500 per month Fixed costs = $3,500 per month
Annual Forecasted Annual Forecasted
Item Price Cost Sales Units Item Price Cost Sales Units
Sandwich $2.95 $1.25 7,000 Sandwich $2.95 $1.25 7,000
Soft drink .80 .30 7,000 Soft drink .80 .30 7,000
Baked potato 1.55 .47 5,000 Baked potato 1.55 .47 Annual 5,000 Weighted
Tea .75 .25 5,000 Tea Selling Variable .75 .25Forecasted % of Contribution
5,000
Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7)
Salad bar 2.85 1.00 3,000 Salad bar 2.85 1.00 3,000
Sandwich $2.95 $1.25 .42 .58 $20,650 .446 .259
Soft drink .80 .30 .38 .62 5,600 .121 .075
Baked 1.55 .47 .30 .70 7,750 .167 .117
potato
Tea .75 .25 .33 .67 3,750 .081 .054
Salad bar 2.85 1.00 .35 .65 8,550 .185 .120
$46,300 1.000 .625

© 2008 Prentice Hall, Inc. S7 – 43 © 2008 Prentice Hall, Inc. S7 – 44

F
Decision Trees and
Multiproduct
BEP Example
= $
Capacity Decision
∑ 1 - PV x (W ) i

i
i

Fixed costs = $3,500 per month

$3,500 x 12 Market favorable (.4)
= Annual Forecasted
= $67,200 $100,000
Item Price Cost .625
Sales Units
Sandwich $2.95 $1.25 7,000 Market unfavorable (.6)
nt -$90,000
Soft drink .80 .30
Daily $67,200
7,000 pl a
= = $215.38 rge
Baked potato 1.55 sales 312 days
.47 Annual 5,000 Weighted La
Market favorable (.4)
Tea Selling Variable .75 .25Forecasted % of Contribution
5,000 $60,000
Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7) Medium plant
Salad bar 2.85 1.00
.446 x $215.38 3,000 Market unfavorable (.6)
Sandwich $2.95 $1.25 .42 .58 $20,650 = 32.6 ≈ .259
.446 33 Sm -$10,000
$2.95 sandwiches
al l
pl a
Soft drink .80 .30 .38 .62 5,600 .121 .075 nt
Baked 1.55 .47 .30 .70 7,750 .167 per day
.117 Do Market favorable (.4)
potato no $40,000
th
Tea .75 .25 .33 .67 3,750 .081 .054 in
g
Market unfavorable (.6)
Salad bar 2.85 1.00 .35 .65 8,550 .185 .120 -$5,000
$46,300 1.000 .625
$0
© 2008 Prentice Hall, Inc. S7 – 45 © 2008 Prentice Hall, Inc. S7 – 46

Decision Trees and Decision Trees and

Capacity Decision Capacity Decision
-$14,000
Market favorable (.4) Market favorable (.4)
$100,000 $100,000

Market unfavorable (.6) Market unfavorable (.6)

nt -$90,000 nt -$90,000
pl a pl a
rge rge $18,000
La La
Market favorable (.4) Market favorable (.4)
$60,000 $60,000
Medium plant Medium plant
Large
Sm
al l
Plant Market unfavorable (.6)
-$10,000 Sm
al l
Market unfavorable (.6)
-$10,000
pl a pl a
nt nt $13,000
EMV = (.4)($100,000)
Do Market favorable (.4) Do Market favorable (.4)
+ (.6)(-$90,000)
no
th
$40,000 no
th
$40,000
in in
g g
Market unfavorable (.6) Market unfavorable (.6)
EMV = -$14,000 -$5,000 -$5,000

$0 $0
© 2008 Prentice Hall, Inc. S7 – 47 © 2008 Prentice Hall, Inc. S7 – 48

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 Strategy-
Strategy-Driven Investment Net Present Value (NPV)

F
; Operations may be responsible P=
(1 + i)N
for return-
return-on-
on-investment (ROI)
; Analyzing capacity alternatives where F = future value
should include capital P = present value
investment, variable cost, cash
i = interest rate
flows, and net present value
N = number of years

© 2008 Prentice Hall, Inc. S7 – 49 © 2008 Prentice Hall, Inc. S7 – 50

Net Present Value (NPV) NPV Using Factors

F
F P= = FX
P= (1 + i)N
(1 + i)N
where X = a factor from Table S7.1
defined as = 1/(1 + i)N and
While
wherethis works
F = future value F = future value
fine, it isP = present value
cumbersome for Year 5% 6% 7% … 10%
larger values iof= Ninterest rate Portion of 1 .952 .943 .935 .909
N = number of years Table S7.1 2 .907 .890 .873 .826
3 .864 .840 .816 .751
4 .823 .792 .763 .683
5 .784 .747 .713 .621
© 2008 Prentice Hall, Inc. S7 – 51 © 2008 Prentice Hall, Inc. S7 – 52

Present Value of an Annuity Present Value of an Annuity

An annuity is an investment which Portion of Table S7.2
generates uniform equal payments
Year 5% 6% 7% … 10%
S = RX 1 .952 .943 .935 .909
2 1.859 1.833 1.808 1.736
where X = factor from Table S7.2 3 2.723 2.676 2.624 2.487
4 4.329 3.465 3.387 3.170
S = present value of a series of 5 5.076 4.212 4.100 3.791
uniform annual receipts
R = receipts that are received every
year of the life of the investment

© 2008 Prentice Hall, Inc. S7 – 53 © 2008 Prentice Hall, Inc. S7 – 54

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 Present Value With Different
Present Value of an Annuity Future Receipts
$7,000 in receipts per for 5 years Investment A’
A’s Investment B’
B’s
Year
Present Value
Cash Flow Cash Flow Factor at 8%
Interest rate = 6% $10,000 $9,000 1 .926
9,000 9,000 2 .857
From Table S7.2
8,000 9,000 3 .794
X = 4.212
7,000 9,000 4 .735
S = RX
S = $7,000(4.212) = $29,484

© 2008 Prentice Hall, Inc. S7 – 55 © 2008 Prentice Hall, Inc. S7 – 56

Present Value With Different

Future Receipts
Investment A’
A’s Investment B’
B’s
Year
Present Values Present Values
1 $9,260 = (.926)($10,000) $8,334 = (.926)($9,000)
2 7,713 = (.857)($9,000) 7,713 = (.857)($9,000)
3 6,352 = (.794)($8,000) 7,146 = (.794)($9,000)
4 5,145 = (.735)($7,000) 6,615 = (.735)($9,000)
Totals $28,470 $29,808
Minus initial
-25,000 -26,000
investment
Net present
$3,470 $3,808
value

© 2008 Prentice Hall, Inc. S7 – 57

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