Heizer Omce ch07S

Heizer, Render, Griffin
Operations Management
Canadian Edition
Slides adapted for Canada by Mats Gerschman
Supplement 7: Capacity and Constraint

Management
Copyright © 2014 Pearson Canada Inc. S7 - 1

Outline
 Capacity
 Bottleneck Analysis and Theory of
Constraints
 Break-Even Analysis
 Reducing Risk with Incremental
Changes
 Applying Expected Monetary Value
to Capacity Decisions
 Applying Investment Analysis to
Strategy-Driven Investments
Learning Objectives
When you complete this supplement,
you should be able to:
1. Define capacity
2. Determine design capacity, effective
capacity, and utilization
3. Perform bottleneck analysis
4. Compute break-even
5. Determine expected monetary value
of a capacity decision
6. Compute net present value

Capacity consideration
Too little capacity loses customers

and too much capacity is expensive.
Capacity needs to be “just right.”

Capacity
 The throughput, or the number of
units a facility can hold, receive,
store, or produce in a period of time
 Determines fixed costs
 Determines if demand will be
satisfied
 Three time horizons

Time Horizons and Capacity
Options
Figure S7.1
Design and Effective Capacity
 Design capacity is the maximum
theoretical output of a system
 Normally expressed as a rate
 Effective capacity is the capacity a
firm expects to achieve given current
operating constraints
 Often lower than design capacity

Utilization and Efficiency
Utilization is the percent of design capacity

achieved
Utilization = Actual output/Design capacity
Efficiency is the percent of effective capacity

achieved
Efficiency = Actual output/Effective capacity

Bakery Example
Actual production last week = 148 000 rolls

Effective capacity = 175 000 rolls
Design capacity = 1200 rolls per hour
Bakery operates 7 days/week, three 8 hour shifts
Design capacity = (7 x 3 x 8) x (1200) = 201 600 rolls

Bakery Example


Bakery Example

Utilization = 148 000/201 600 = 73.4%

Bakery Example

Utilization = 148 000/201 600 = 73.4%

Bakery Example

Utilization = 148 000/201 600 = 73.4%
Efficiency = 148 000/175 000 = 84.6%

Bakery Example

Utilization = 148 000/201 600 = 73.4%
Efficiency = 148 000/175 000 = 84.6%

Bakery Example

Efficiency = 84.6%
Efficiency of new line = 75%
Expected Output = (Effective Capacity)(Efficiency)
= (175 000)(.75) = 131 250 rolls

Bakery Example

Efficiency = 84.6%
Efficiency of new line = 75%
Expected Output = (Effective Capacity)(Efficiency)
= (175 000)(.75) = 131 250 rolls

Capacity and Strategy
 Capacity decisions impact all 10

decisions of operations
management as well as other
functional areas of the organization
 Capacity decisions must be
integrated into the organization’s
mission and strategy

Capacity Considerations
1. Forecast demand accurately

2. Understand the technology and
capacity increments
3. Find the optimum operating size
(volume)
4. Build for change

Economies and
Diseconomies of Scale
(dollars per room per night)
Average unit cost
25 - room 75 - room
roadside motel 50 - room roadside motel
roadside motel
Economies Diseconomies
of scale of scale
25 50 75
Number of Rooms
Figure S7.2
Managing Demand
 Demand exceeds capacity
 Curtail demand by raising prices,
scheduling longer lead time
 Long term solution is to increase capacity
 Capacity exceeds demand
 Stimulate market
 Product changes
 Adjusting to seasonal demands
 Produce products with complementary
demand patterns

Complementary Demand
Patterns
4,000 –
Sales in units
3,000 –
2,000 –
1,000 – Jet ski

engine
sales
JFMAMJJASONDJFMAMJJASONDJ
Time (months)
Figure S7.3
Patterns
4,000 –
Sales in units
Snowmobile
3,000 – motor sales
2,000 –
1,000 – Jet ski

engine
sales
Time (months)
Figure S7.3
Patterns
Combining both
demand patterns
reduces the
variation
4,000 –
Sales in units
Snowmobile
3,000 – motor sales
2,000 –
1,000 – Jet ski

engine
sales
Time (months)
Figure S7.3
Tactics for Matching
Capacity to Demand
1. Making staffing changes
2. Adjusting equipment
 Purchasing additional machinery
 Selling or leasing out existing equipment
3. Improving processes to increase throughput
4. Redesigning products to facilitate more
throughput
5. Adding process flexibility to meet changing
product preferences
6. Closing facilities
Demand and Capacity
Management in the
Service Sector
 Demand management
 Appointment, reservations, FCFS rule
 Capacity management
 Full-time, temporary, part-time staff

Bottleneck Analysis and
Theory of Constraints
 Each work area can have its own unique
capacity
 Capacity analysis determines the
throughput capacity of workstations in a
system
 A bottleneck is a limiting factor or
constraint
 A bottleneck has the lowest effective
capacity in a system

Process Times for Stations,
Systems, and Cycles
 The process time of a station is the
time to produce a unit at that single
workstation
 The process time of a system is the
time of the longest process in the
system … the bottleneck
 The process cycle time is the time it
takes for a product to go through the
production process with no waiting

A Three-Station Assembly Line
Figure S7.4

Process Times for Stations,
Systems, and Cycles
 The system process time is the
process time of the bottleneck after
dividing by the number of parallel
operations
 The system capacity is the inverse
of the system process time
 The process cycle time is the total
time through the longest path in the
system

Capacity Analysis
 Two identical sandwich lines
 Lines have two workers and three operations
 All completed sandwiches are wrapped
Bread Fill Toast

15 sec/sandwich 20 sec/sandwich 40 sec/sandwich
Order Wrap
30 sec/sandwich 37.5 sec/sandwich
Bread Fill Toast
15 sec/sandwich 20 sec/sandwich 40 sec/sandwich

Capacity Bread
15 sec
Fill
20 sec
Toast
40 sec
Analysis Order
30 sec
Bread
15 sec
Fill
20 sec
Toast
40 sec
Wrap
37.5 sec
 Toast work station has the longest processing

time – 40 seconds
 The two lines each deliver a sandwich every 40
seconds so the process time of the combined
lines is 40/2 = 20 seconds
 At 37.5 seconds, wrapping and delivery has the
longest processing time and is the bottleneck
 Capacity per hour is 3,600 seconds/37.5
seconds/sandwich = 96 sandwiches per hour
 Process cycle time is 30 + 15 + 20 + 40 + 37.5 =
142.5 seconds
Capacity Analysis
 Standard process for cleaning teeth
 Cleaning and examining X-rays can happen
simultaneously
Cleaning
Takes Develops 24 min/unit Check

Check in Dentist
X-ray X-ray out
2 min/unit 2 min/unit 4 min/unit X-ray 8 min/unit 6 min/unit

exam
5 min/unit

Capacity Check
in
Takes
X-ray
Develops
X-ray
Cleaning
24 min/unit
Dentist
Check
out
Analysis 2 min/unit 2 min/unit 4 min/unit X-ray

exam
5 min/unit
8 min/unit 6 min/unit
 All possible paths must be compared

 Cleaning path is 2 + 2 + 4 + 24 + 8 + 6 = 46
minutes
 X-ray exam path is 2 + 2 + 4 + 5 + 8 + 6 = 27
minutes
 Longest path involves the hygienist cleaning the
teeth
 Bottleneck is the hygienist at 24 minutes
 Hourly capacity is 60/24 = 2.5 patients
 Patient should be complete in 46 minutes

Theory of Constraints
 Five-step process for recognizing and
managing limitations
Step 1: Identify the constraint
Step 2: Develop a plan for overcoming the
constraints
Step 3: Focus resources on accomplishing Step 2
Step 4: Reduce the effects of constraints by
offloading work or expanding capability
Step 5: Once overcome, go back to Step 1 and find
new constraints

Bottleneck Management
1. Release work orders to the system at the
pace of set by the bottleneck
2. Lost time at the bottleneck represents
lost time for the whole system
3. Increasing the capacity of a non-
bottleneck station is a mirage
4. Increasing the capacity of a bottleneck
increases the capacity of the whole
system

Break-Even Analysis
 Technique for evaluating process

and equipment alternatives
 Objective is to find the point in
dollars and units at which cost
equals revenue
 Requires estimation of fixed costs,
variable costs, and revenue

Break-Even Analysis
 Fixed costs are costs that continue
even if no units are produced
 Depreciation, taxes, debt, mortgage
payments
 Variable costs are costs that vary
with the volume of units produced
 Labour, materials, portion of utilities
 Contribution is the difference between
selling price and variable cost

Break-Even Analysis
Assumptions
 Costs and revenue are linear
functions
 Generally not the case in the real
world
 We actually know these costs
 Very difficult to verify
 Time value of money is often
ignored
Break-Even Analysis
–
Total revenue line
900 –
800 –
Break-even point: Total cost line
700 – Total cost = Total revenue
Cost (dollars)
600 –
500 –
400 – Variable cost
300 –
200 –
100 – Fixed cost

–
| | | | | | | | | | | |
0 100 200 300 400 500 600 700 800 900 1000 1100
Figure S7.5 Volume (units per period)

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

Break-Even Analysis
BEPx = break-even point in x = number of units
units produced
BEP$ = break-even point in TR = total revenue = Px
dollars F = fixed costs
P = price per unit (after V = variable cost per unit
all discounts) TC = total costs = F + Vx
BEP$ = BEPx P
= F P Profit = TR - TC
P-V = Px - (F + Vx)
= F
= Px - F - Vx
(P - V)/P
F = (P - V)x - F
=
1 - V/P
Break-Even Example
Fixed costs = $10 000 Material = $0.75/unit

Direct labour = $1.50/unit Selling price = $4.00 per unit
F $10 000
BEP$ = =
1 - (V/P) 1 - [(1.50 + 0.75)/(4.00)]

Break-Even Example
Fixed costs = $10 000 Material = $0.75/unit

Direct labour = $1.50/unit Selling price = $4.00 per unit
F $10 000
BEP$ = =
1 - (V/P) 1 - [(1.50 + 0.75)/(4.00)]
$10 000
= = $22 857.14
0.4375
F $10 000
BEPx = = = 5714
P-V 4.00 - (1.50 + .75)

Reducing Risk with
Incremental Changes
(a) Leading demand with incremental (b) Capacity lags demand with incremental
expansion (Leading Strategy) expansion (Lag Strategy)
New New
capacity capacity
Demand
Demand
Expected Expected
demand demand
(c) Attempts to have an average capacity with

incremental expansion (Straddle Strategy)
New
Demand
capacity Expected
demand
Figure S7.6
Reducing Risk with
Incremental Changes
(a) Leading demand with incremental
expansion (Leading Strategy)
New
capacity
Demand
Expected
demand
1 2 3
Time (years)
Figure S7.6
Reducing Risk with
Incremental Changes
(b) Capacity lags demand with incremental
expansion (Lag Strategy)
New
capacity
Expected
Demand
demand
1 2 3
Time (years)
Figure S7.6
Reducing Risk with
Incremental Changes
(c) Attempts to have an average capacity with
incremental expansion (Straddle Strategy)
New
capacity
Demand
Expected
demand
1 2 3
Time (years)
Figure S7.6
Expected Monetary Value
(EMV) and Capacity Decisions
 Determine states of nature

 Future demand
 Market favourability
 Analyzed using decision trees
 Hospital supply company
 Four alternatives

Market favourable (0.4)
$100 000
Market unfavourable (0.6)

-$90 000

$60 000
Medium plant
-$10 000

$40 000

-$5000
$0

$100 000

-$90 000

$60 000
Medium plant
Large Plant Market unfavourable (0.6)
-$10 000
EMV = (0.4)($100 000) Market favourable (0.4)

$40 000
+ (0.6)(-$90 000)
EMV = -$14 000 -$5000
$0

-$14000
$100 000

-$90 000
$18 000
$60 000
Medium plant
-$10 000
$13 000
$40 000

-$5000
$0

Strategy-Driven Investment
 Operations may be responsible

for return-on-investment (ROI)
 Analyzing capacity alternatives
should include capital
investment, variable cost, cash
flows, and net present value

Net Present Value (NPV)
In general:
F = P(1 + i)N
where F = future value
P = present value
i = interest rate
N = number of years
Solving for P:
F
P=
(1 + i)N
Net Present Value (NPV)
In general:
F = P(1 + i)N
where F = future value
P While
= present valuethis works
i fine, it is
= interest rate
N = numbercumbersome
of years for
larger values of N
Solving for P:
F
P=
(1 + i)N
NPV Using Factors
F
P= N = FX
(1 + i)
where X = a factor from Table S7.1
defined as = 1/(1 + i)N and
F = future value
Table S7.1

Limitations
1. Investments with the same NPV may
have different projected lives and
salvage values
2. Investments with the same NPV may
have different cash flows
3. Assumes we know future interest rates
4. Payments are not always made at the
end of a period

Summary
1. Capacity calculations and capacity planning
is essential for profitable operations. Other
considerations are:
 Accurate forecasting
 Understanding equipment, processes, and
capacity increments
 Finding the optimum operating size
 Ensuring to have flexibility
2. Bottleneck and Break-even Analysis are
useful techniques
3. Expected Monetary Value, cash flow and net
present value (NPV) consider the monetary
side of the operations

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Heizer, Render, Griffin

Supplement 7: Capacity and Constraint

Copyright © 2014 Pearson Canada Inc. S7 - 1

Copyright © 2014 Pearson Canada Inc. S7 - 3

Too little capacity loses customers

Copyright © 2014 Pearson Canada Inc. S7 - 4

Copyright © 2014 Pearson Canada Inc. S7 - 5

Copyright © 2014 Pearson Canada Inc. S7 - 7

Utilization is the percent of design capacity

Utilization = Actual output/Design capacity

Efficiency is the percent of effective capacity

Efficiency = Actual output/Effective capacity

Copyright © 2014 Pearson Canada Inc. S7 - 8

Actual production last week = 148 000 rolls

Design capacity = (7 x 3 x 8) x (1200) = 201 600 rolls

Copyright © 2014 Pearson Canada Inc. S7 - 9

Actual production last week = 148 000 rolls

Design capacity = (7 x 3 x 8) x (1200) = 201 600 rolls

Copyright © 2014 Pearson Canada Inc. S7 - 10

Actual production last week = 148 000 rolls

Design capacity = (7 x 3 x 8) x (1200) = 201 600 rolls

Utilization = 148 000/201 600 = 73.4%

Copyright © 2014 Pearson Canada Inc. S7 - 11

Actual production last week = 148 000 rolls

Design capacity = (7 x 3 x 8) x (1200) = 201 600 rolls

Utilization = 148 000/201 600 = 73.4%

Copyright © 2014 Pearson Canada Inc. S7 - 12

Actual production last week = 148 000 rolls

Design capacity = (7 x 3 x 8) x (1200) = 201 600 rolls

Utilization = 148 000/201 600 = 73.4%

Efficiency = 148 000/175 000 = 84.6%

Copyright © 2014 Pearson Canada Inc. S7 - 13

Actual production last week = 148 000 rolls

Design capacity = (7 x 3 x 8) x (1200) = 201 600 rolls

Utilization = 148 000/201 600 = 73.4%

Efficiency = 148 000/175 000 = 84.6%

Copyright © 2014 Pearson Canada Inc. S7 - 14

Actual production last week = 148 000 rolls

Expected Output = (Effective Capacity)(Efficiency)

= (175 000)(.75) = 131 250 rolls

Copyright © 2014 Pearson Canada Inc. S7 - 15

Actual production last week = 148 000 rolls

Expected Output = (Effective Capacity)(Efficiency)

= (175 000)(.75) = 131 250 rolls

Copyright © 2014 Pearson Canada Inc. S7 - 16

 Capacity decisions impact all 10

Copyright © 2014 Pearson Canada Inc. S7 - 17

1. Forecast demand accurately

Copyright © 2014 Pearson Canada Inc. S7 - 18

Copyright © 2014 Pearson Canada Inc. S7 - 20

1,000 – Jet ski

1,000 – Jet ski

1,000 – Jet ski

Copyright © 2014 Pearson Canada Inc. S7 - 25

Copyright © 2014 Pearson Canada Inc. S7 - 26

Copyright © 2014 Pearson Canada Inc. S7 - 27

Copyright © 2014 Pearson Canada Inc. S7 - 28

Copyright © 2014 Pearson Canada Inc. S7 - 29

Bread Fill Toast

Copyright © 2014 Pearson Canada Inc. S7 - 30

 Toast work station has the longest processing

Takes Develops 24 min/unit Check

2 min/unit 2 min/unit 4 min/unit X-ray 8 min/unit 6 min/unit