Strategic Capacity Planning

Supply Chain Management

Capacity Planning & Forecasting Decisions

determining the overall capacity level of capital intensive resources capacity planning and determining the capacity constraints, determines the requirements of other inputs for the program Too much capacity can be as problematic as too little.

Importance of Capacity Decisions

1. 2. 3. 4. 5. 6. 7. 8.

Steps for Capacity Planning

1. 2. 3. 4. 5. 6. 7. 8.

Impacts ability to meet future demands Affects operating costs Major determinant of initial costs Involves long-term commitment Affects competitiveness Affects ease of management Globalization adds complexity Impacts long range planning

Estimate future capacity requirements Evaluate existing capacity Identify alternatives Conduct financial analysis Assess key qualitative issues Select one alternative Implement alternative chosen Monitor results

In-House or Outsourcing
Outsource: obtain a good or service from an external provider 1. 2. 3. 4. 5. 6.

Capacity planning and control

Measure aggregate capacity and demand Choose the most appropriate capacity plan Identify the alternative capacity plans

Available capacity Expertise Quality considerations Nature of demand Cost Risk

Aggregated output

Forecast demand

Estimate of current capacity

Time

Good forecasts are essential for effective capacity planning

but so is an understanding of demand uncertainty, because it allows you to judge the risks to service level
Only 5% chance of demand being higher than this Distribution of demand

Operating equipment effectiveness (OEE)

A method of judging the effectiveness of how operations equipment is used.
Loading time Not worked (unplanned) Set-up and changeovers Breakdown failure Equipment idling
Slow-running equipment

Availability rate = a = total operating time/ loading time

Total operating time DEMAND DEMAND

Availability losses

Performance rate = p = net operating time/ total operating time

Only 5% chance of demand being lower than this TIME TIME

Net operating time

Speed losses

When demand uncertainty is high, the risks to service level of underprovision of capacity are high

Valuable operating time

Quality losses

Quality rate = q =valuable operating time/ net operating time

Quality losses

How capacity and demand are measured

Efficiency = Planned loss of 59 hours
Avoidable loss 58 hours per week

Actual output Effective capacity

Capacity cushion
Capacity Cushion
The amount of reserved capacity that a firm maintains to handle sudden increases in demand or temporary losses of production capacity.

Design capacity

Effective capacity 168 hours per week 109 hours per week

Actual output 51 hours per week

Capacity Cushion = 1 - Utilization

Utilization=

Actual output Design capacity

Efficiency/Utilization Example
Design capacity = 50 trucks/day Effective capacity = 40 trucks/day Actual output = 36 units/day
Actual output = 36 units/day = 90% Effective capacity Actual output Design capacity = 40 units/ day 36 units/day 50 units/day = 72%

Best Operating Level (Design Capacity)

Example: Engineers design engines and assembly lines to Example: Engineers design engines and assembly lines to operate at an ideal or best operating level to maximize operate at an ideal or best operating level to maximize output and minimize wear output and minimize wear

Efficiency = Utilization =

Average unit cost of output Underutilization Over-utilization Best Operating Level Volume

Ways of reconciling capacity and demand

Demand Capacity

Demand Capacity

Demand Capacity

Capacity Expansion Strategies

Level capacity

Chase demand

Demand management

Capacity Expansion Strategies 1. Demand leading strategy (excess capacity) 2. Demand Trailing strategy (maximum capacity utilization) 3. Demand matching strategy (Balanced capacity) 4. Steady expansion strategy (steady expansion)

Capacity Expansion Strategies..

Demand leading (excess capacity) + can accommodate new/unexpected demand + can provide quick response and delivery + low overtime & subcontracting costs - high cost of unused capacity Note: + = advantages

- = disadvantages
Eg.: Hotel industry (immediate need of rooms; if substitute exists can lose sales), Furniture maker (can people wait?), Restaurant, University

Demand trailing (maximum capacity utilization)

minimizes facility & equipment costs cannot accommodate new or unexpected demand slow response at peak times high overtime and/or subcontracting costs often forced to add capacity at peaks of business cycles - Loose sales
+

Demand matching strategy + balances capacity & other costs + provides reliable service & responsiveness - must be able to predict demand well or have constant demand
Note: (+) => advantages ( - ) => disadvantages

Note: (+) => advantages ( - ) => disadvantages

Steady expansion strategy + do not have to outguess competitors + price risk from adding capacity during peak demand is reduced

Recognizing Bottleneck
- excess capacity can result if long term demand falls short of expectations
Note: (+) => advantages ( - ) => disadvantages

Easy to identify the bottleneck stage (s) by observing where inventory builds up
200 100 400

Increasing Capacity Recognize Bottlenecks!

A bottleneck is an operation that has the lowest effective capacity of any operation in the process and thus limits the systems output.

200 200 100 200 400 400

Weaving 2000 m/hr

Bleaching etc. 1000 m/hr

Printing 2000 m/hr

Weaving Bleaching etc. Printing 2000 m/hr 2000 m/hr 2000 m/hr

100

Minimizing Capacity Constraints

Outsource during peak periods Keep bottleneck resources busy Use overtime/ part-time employees as short term option Consider long term capacity expansion

Capacity Analysis
Breakeven Analysis Decision Tree Net Present Value Internal Rate of Return Etc.

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
Labor, 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

Break-Even Analysis
900 800 Cost in dollars 700 600 500 400 300 200 100
ss r Lo rido r co

Total revenue line

or

Break-even point BreakTotal cost = Total revenue

it c of Pr

rid or

Total cost line

Variable cost

We actually know these costs

Very difficult to accomplish

There is no time value of money

Figure S7.5

Fixed cost

| | | | | | | | | | | | 0 100 200 300 400 500 600 700 800 900 10001100 10001100 Volume (units per period)

Break-Even Analysis
BEPx = Break-even point in Breakunits BEP$ = Break-even point in Breakdollars P = Price per unit (after all discounts) TR F V TC x = Number of units produced = Total revenue = Px = Fixed costs = Variable costs = Total costs = F + Vx

Break-Even Analysis
BEPx = Break-even point in Breakunits BEP$ = Break-even point in Breakdollars P = Price per unit (after all discounts) TR F V TC x = Number of units produced = Total revenue = Px = Fixed costs = Variable costs = Total costs = F + Vx

Break-even point Breakoccurs when

TR = TC or Px = F + Vx

BEPx =

F P-V

BEP$ = BEPx P F = P P-V F = (P - V)/P F = 1 - V/P

Profit = TR - TC = Px - (F + Vx) Vx) = Px - F - Vx = (P - V)x - F

Decision Tree
A glass factory specializing in crystal is experiencing a A glass factory specializing in crystal is experiencing a substantial backlog, and the firm's management is considering substantial backlog, and the firm's management is considering three courses of action: three courses of action: A) Arrange for subcontracting A) Arrange for subcontracting B) Construct new facilities B) Construct new facilities C) Do nothing (no change) C) Do nothing (no change) The correct choice depends largely upon demand, which may The correct choice depends largely upon demand, which may be low, medium, or high. By consensus, management be low, medium, or high. By consensus, management estimates the respective demand probabilities as 0.1, 0.5, and estimates the respective demand probabilities as 0.1, 0.5, and 0.4. 0.4.

Example of a Decision Tree Problem (Continued): The Payoff Table

The management also estimates the profits The management also estimates the profits when choosing from the three alternatives (A, when choosing from the three alternatives (A, B, and C) under the differing probable levels of B, and C) under the differing probable levels of demand. These profits, in thousands of dollars demand. These profits, in thousands of dollars are presented in the table below: are presented in the table below:

A B C

0.1 Low 10 -120 20

0.5 Medium 50 25 40

0.4 High 90 200 60

Example of a Decision Tree Problem (Continued): Step 1. We start by drawing the three decisions

Example of Decision Tree Problem (Continued): Step 2. Add our possible states of nature, probabilities, and payoffs
High demand (0.4) Medium demand (0.5) Low demand (0.1)

A B C C A B

$90k $50k $10k $200k $25k -$120k $60k $40k $20k

High demand (0.4) Medium demand (0.5) Low demand (0.1) High demand (0.4) Medium demand (0.5) Low demand (0.1)

Example of Decision Tree Problem (Continued): Example of Decision Tree Problem (Continued):
Step 3. Determine the expected value of each decision
High demand (0.4) High demand (0.4) Medium demand (0.5) Medium demand (0.5) Low demand (0.1) Low demand (0.1)

Step 4. Make decision

High demand (0.4) Medium demand (0.5)

$62k $62k
A A

$90k $90k $50k $50k $10k $10k

$62k
A B

Low demand (0.1) High demand (0.4) Medium demand (0.5) Low demand (0.1)

$90k $50k $10k $200k $25k -$120k $60k $40k $20k

$80.5k

EVA=0.4(90)+0.5(50)+0.1(10)=$62k EVA=0.4(90)+0.5(50)+0.1(10)=$62k

C
High demand (0.4)

$46k

Medium demand (0.5) Low demand (0.1)

Alternative B generates the greatest expected profit, so Alternative B generates the greatest expected profit, so our choice is B or to construct a new facility our choice is B or to construct a new facility

Capacity Planning- The End