Chapter 9– Capacity Planning

& Facility Location

Operations Management
by
R. Dan Reid & Nada R. Sanders
3rd Edition © Wiley 2007
PowerPoint Presentation by R.B. Clough – UNH
M. E. Henrie - UAA

© Wiley 2007
 Learning Objectives
 Define capacity planning
 Define location analysis
 Describe relationship between capacity
planning and location, and their importance
 Explain the steps involved in capacity
planning and location analysis

© Wiley 2007
 Learning Objectives -
continued
 Describe the decision support tools used for
capacity planning
 Identify key factors in location analysis
 Describe the decision support tools used for
location analysis

© Wiley 2007
 Capacity planning
 Capacity is the maximum output rate of a facility
 Capacity planning is the process of establishing the
output rate that can be achieved at a facility:
 Capacity is usually purchased in “chunks”

 Strategic issues: how much and when to spend

capital for additional facility & equipment

 Tactical issues: workforce & inventory levels, &

day-to-day use of equipment

© Wiley 2007
 Measuring Capacity Examples
 There is no one best way to measure capacity
 Output measures like kegs per day are easier to understand
 With multiple products, inputs measures work better

Input Measures of Output Measures

Type of Business
Capacity of Capacity
Car manufacturer Labor hours Cars per shift
Hospital Available beds Patients per month
Pizza parlor Labor hours Pizzas per day
Floor space in
Retail store Revenue per foot
square feet

© Wiley 2007
 Measuring Available Capacity
 Design capacity:
 Maximum output rate under ideal conditions
 A bakery can make 30 custom cakes per day
when pushed at holiday time
 Effective capacity:
 Maximum output rate under normal (realistic)
conditions
 On the average this bakery can make 20
custom cakes per day

© Wiley 2007
Calculating Capacity Utilization
 Measures how much of the available
capacity is actually being used:
actual output rate
Utilization   100%
capacity

 Measures effectiveness
 Use either effective or design capacity in
denominator

© Wiley 2007
 Example of Computing Capacity Utilization: In the bakery
example the design capacity is 30 custom cakes per day. Currently
the bakery is producing 28 cakes per day. What is the bakery’s
capacity utilization relative to both design and effective capacity?

actual output 28
Utilization effective  (100%)  (100%)  140%
effective capacity 20

actual output 28
Utilization design  (100%)  (100%)  93%
design capacity 30

 The current utilization is only slightly below its design

capacity and considerably above its effective capacity
 The bakery can only operate at this level for a short period
of time

© Wiley 2007
 How Much Capacity Is Best?
 The Best Operating Level is the output that results in
the lowest average unit cost
 Economies of Scale:
 Where the cost per unit of output drops as volume of output
increases
 Spread the fixed costs of buildings & equipment over multiple
units, allow bulk purchasing & handling of material
 Diseconomies of Scale:
 Where the cost per unit rises as volume increases
 Often caused by congestion (overwhelming the process with too
much work-in-process) and scheduling complexity

© Wiley 2007
 Best Operating Level and Size

 Alternative 1: Purchase one large facility, requiring one large

initial investment
 Alternative 2: Add capacity incrementally in smaller chunks as
needed
© Wiley 2007
Other Capacity Considerations
 Focused factories:
 Small, specialized facilities with limited
objectives
 Plant within a plant (PWP):
 Segmenting larger operations into smaller
operating units with focused objectives
 Subcontractor networks:
 Outsource non-core items to free up
capacity for what you do well

© Wiley 2007
 Making Capacity Planning Decisions

 The three-step procedure for making

capacity planning decisions is as
follows:
 Step 1: Identify Capacity Requirements
 Step 2: Develop Capacity Alternatives
 Step 3: Evaluate Capacity Alternatives

© Wiley 2007
Identifying capacity
requirements
 Long-term capacity requirements based on
future demand
 Identifying future demand based on forecasting
 Forecasting, at this level, relies on qualitative
forecast models
 Executive opinion
 Delphi method
 Forecast and capacity decision must included
strategic implications
 Capacity cushions
 Plan to underutilize capacity to provide flexibility

© Wiley 2007
 Evaluating Capacity Alternatives
 Capacity alternatives include
 Could do nothing,
 expand large now (may included capacity
cushion), or
 expand small now with option to add
later

© Wiley 2007
 Evaluating Capacity Alternatives
 Many tools exist to assist in evaluating
alternatives
 Most popular tool is Decision Trees
 Decision Trees analysis tool is:
 a modeling tool for evaluating sequential
decisions which,
 identifies the alternatives at each point in time
(decision points), estimate probable
consequences of each decision (chance events)
& the ultimate outcomes (e.g.: profit or loss)

© Wiley 2007
Decision tree diagrams
 Diagramming technique which uses
 Decision points – points in time when
decisions are made, squares called nodes
 Decision alternatives – branches of the tree
off the decision nodes
 Chance events – events that could affect a
decision, branches or arrows leaving
circular chance nodes
 Outcomes – each possible alternative listed

© Wiley 2007
Decision tree diagrams
 Decision trees developed by
 Drawing from left to right
 Use squares to indicate decision points
 Use circles to indicate chance events
 Write the probability of each chance by the
chance (sum of associated chances =
100%)
 Write each alternative outcome in the right
margin
© Wiley 2007
 Example Using Decision Trees: A restaurant owner has
determined that she needs to expand her facility. The alternatives
are to expand large now and risk smaller demand, or expand on a
smaller scale now knowing that she might need to expand again in
three years. Which alternative would be most attractive?

 The likelihood of demand being high is .70

 The likelihood of demand being low is .30
 Large expansion yields profits of $300K(high dem.) or $50k(low dem.)
 Small expansion yields profits of $80K if demand is low
 Small expansion followed by high demand and later expansion yield a profit of
$200K at that point. No expansion at that point yields profit of $150K

© Wiley 2007
 Evaluating the Decision Tree
 Decision tree analysis utilizes expected value
analysis (EVA)
 EVA is a weighted average of the chance events
 Probability of occurrence * chance event outcome
 Refer to Figure 9-3
 At decision point 2, choose to expand to maximize
profits ($200,000 > $150,000)
 Calculate expected value of small expansion:
 EVsmall = 0.30($80,000) + 0.70($200,000) = $164,000

© Wiley 2007
 Evaluating the Decision Tree -
continued
 Calculate expected value of large expansion:
 EVlarge = 0.30($50,000) + 0.70($300,000) =
$225,000
 At decision point 1, compare alternatives &
choose the large expansion to maximize the
expected profit:
 $225,000 > $164,000
 Choose large expansion despite the fact that
there is a 30% chance it’s the worst decision:
 Take the calculated risk!
© Wiley 2007
Location Analysis
 Three most important factors in real
estate:
1. Location
2. Location
3. Location
 Facility location is the process of
identifying the best geographic location
for a service or production facility

© Wiley 2007
Factors Affecting Location
Decisions
 Proximity to source of supply:
 Reduce transportation costs of perishable or bulky
raw materials
 Proximity to customers:
 E.g.: high population areas, close to JIT partners
 Proximity to labor:
 Local wage rates, attitude toward unions,
availability of special skills (e.g.: silicon valley)

© Wiley 2007
 More Location Factors
 Community considerations:
 Local community’s attitude toward the facility (e.g.:
prisons, utility plants, etc.)
 Site considerations:
 Local zoning & taxes, access to utilities, etc.
 Quality-of-life issues:
 Climate, cultural attractions, commuting time, etc.
 Other considerations:
 Options for future expansion, local competition, etc.

© Wiley 2007
 Globalization - Should Firm Go
Global?
 Globalization is the process of locating facilities
around the world
 Potential advantages:
 Inside track to foreign markets, avoid trade barriers, gain access
to cheaper labor
 Potential disadvantages:
 Political risks may increase, loss of control of proprietary
technology, local infrastructure (roads & utilities) may be
inadequate, high inflation
 Other issues:
 Language barriers, different laws & regulations, different
business cultures

© Wiley 2007
 Making Location Decisions
 Analysis should follow 3 step process:
 Step 1: Identify dominant location factors
 Step 2: Develop location alternatives
 Step 3: Evaluate locations alternatives
 Procedures for evaluation location alternatives
include
 Factor rating method
 Load-distance model
 Center of gravity approach
 Break-even analysis
 Transportation method

© Wiley 2007
Factor Rating Example

© Wiley 2007
 A Load-Distance Model Example: Matrix Manufacturing is
considering where to locate its warehouse in order to service its four
Ohio stores located in Cleveland, Cincinnati, Columbus, Dayton. Two
sites are being considered; Mansfield and Springfield, Ohio. Use the
load-distance model to make the decision.

 Calculate the rectilinear distance: dAB  30  10  40  15  45 miles

 Multiply by the number of loads between each site and the four cities

© Wiley 2007
 Calculating the Load-Distance Score
for Springfield vs.
Mansfield
Computing the Load-Distance Score for Springfield

City Load Distance ld
Cleveland 15 20.5 307.5
Columbus 10 4.5 45
Cincinnati 12 7.5 90
Dayton 4 3.5 14
Total Load-Distance Score(456.5)

Computing the Load-Distance Score for Mansfield

City Load Distance ld
Cleveland 15 8 120
Columbus 10 8 80
Cincinnati 12 20 240
Dayton 4 16 64
Total Load-Distance Score(504)

 The load-distance score for Mansfield is higher than for

Springfield. The warehouse should be located in Springfield.

© Wiley 2007
The Center of Gravity Approach
 This approach requires that the analyst find the center
of gravity of the geographic area being considered
Computing the Center of Gravity for Matrix Manufacturing
Coordinates Load
Location (X,Y) (li) lixi liyi
Cleveland (11,22) 15 165 330
Columbus (10,7) 10 165 70
Cincinnati (4,1) 12 165 12
Dayton (3,6) 4 165 24
Total 41 325 436

 Computing the Center of Gravity for Matrix

Manufacturing
Xc.g. 
 liXi 325
  7.9 ; Yc.g. 
 liYi 436
  10.6
 li 41  li 41
 Is there another possible warehouse location closer to the
C.G. that should be considered?? Why?
© Wiley 2007
 Break-Even Analysis
 Break-even analysis computes the amount of goods required
to be sold to just cover costs
 Break-even analysis includes fixed and variable costs

 Break-even analysis can be used for location analysis

especially when the costs of each location are known
 Step 1: For each location, determine the fixed and
variable costs
 Step 2: Plot the total costs for each location on one graph
 Step 3: Identify ranges of output for which each location
has the lowest total cost
 Step 4: Solve algebraically for the break-even points
over the identified ranges

© Wiley 2007
 Break-Even Analysis
 Remember the break even equations used for calculation total
cost of each location and for calculating the breakeven quantity
Q.
 Total cost = F + cQ

 Total revenue = pQ
 Break-even is where Total Revenue = Total Cost

Q = F/(p-c)
Q = break-even quantity
p = price/unit
c = variable cost/unit
F = fixed cost

© Wiley 2007
 Example using Break-even Analysis: Clean-Clothes
Cleaners is considering four possible sites for its new
operation. They expect to clean 10,000 garments. The
table and graph below are used for the analysis.

Example 9.6 Using Break-Even Analysis

Location Fixed Cost Variable Cost Total Cost
A $350,000 $ 5(10,000) $400,000
B $170,000 $25(10,000) $420,000
C $100,000 $40(10,000) $500,000
D $250,000 $20(10,000) $450,000
 From the graph you can see that the two lowest cost intersections
occur between C & B (4667 units) and B & A (9000 units)
 The best alternative up to 4667 units is C, between 4667 and 9000
© Wiley
units the best is B, and above 9000 2007 the best site is A
units
 The Transportation Method
 The transportation method of linear programming
can be used to solve specific location problems
 It is discussed in detail in the supplement to this
text
 It could be used to evaluate the cost impact of
adding potential location sites to the network of
existing facilities
 It could also be used to evaluate adding multiple
new sites or completely redesigning the network

© Wiley 2007
Capacity Planning and Facility
Location Across the Organization
 Capacity planning and location analysis
affect operations management and are
important to many others
 Finance provides input to finalize capacity
decisions
 Marketing impacted by the organizational
capacity and location to customers

© Wiley 2007
 Chapter 9 Highlights
 Capacity planning is deciding on the maximum output rate
of a facility
 Location analysis is deciding on the best location for a
facility
 Capacity planning and location analysis decision are often
made simultaneously because the location of the facility is
usually related to its capacity. When a business decides to
expand, it usually also addresses the issue of where to
locate. These decisions are very important because they
require long-term investments in buildings and facilities, as
well as a sizable financial outlay.

© Wiley 2007
 Chapter 9 Highlights -
continued
 In both capacity planning and location analysis,
managers must follow three-step process to make
good decision. The steps are assessing needs,
developing alternatives, and evaluating
alternatives.
 To choose between capacity planning alternatives
managers may sue decision trees, which are a
modeling tool for evaluating independent
decisions that must be made in sequence.
© Wiley 2007
 Chapter 9 Highlights -
continued
 Key factors in location analysis included proximity
to customers, transportation, source of labor,
community attitude, and proximity to supplies.
Service and manufacturing firms focus on different
factors. Profit-making and nonprofit organizations
also focus on different factors.

© Wiley 2007
 Chapter 9 Highlights -
continued
 Several tools can be sued to facilitate location
analysis. Factor rating is a tool that helps managers
evaluate qualitative factors. The load-distance
model and center of gravity approach evaluate the
location decision based on distance. Break-even
analysis is sued to evaluate location decisions based
on cost values. The transportation method is an
excellent tool for evaluating the cost impact of
adding sites to the network of current facilities.

© Wiley 2007
 The End
 Copyright © 2007 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted
in Section 117 of the 1976 United State Copyright Act without
the express written permission of the copyright owner is
unlawful. Request for further information should be addressed
to the Permissions Department, John Wiley & Sons, Inc. The
purchaser may make back-up copies for his/her own use only
and not for distribution or resale. The Publisher assumes no
responsibility for errors, omissions, or damages, caused by the
use of these programs or from the use of the information
contained herein.

© Wiley 2007