Chapter 5 Strategic Capacity Planning for Products and

Chapter 5 Strategic Capacity Planning for Products and Services Mc. Graw-Hill/Irwin Copyright © 2009 by The Mc. Graw-Hill Companies, Inc. All Rights Reserved.

Capacity Planning • Capacity – The upper limit or ceiling on the load that an operating unit can handle – Capacity needs include • Equipment • Space • Employee skills 5 -2

Strategic Capacity Planning • Goal – To achieve a match between the long-term supply capabilities of an organization and the predicted level of long-run demand • Overcapacity operating costs that are too high • Undercapacity strained resources and possible loss of customers 5 -3

Supply & Demand Operations & Supply Chains Supply Sales & Marketing > Demand Supply < Demand Supply = Demand Wasteful Costly Opportunity Loss Customer Dissatisfaction Ideal 5 -4

Capacity Planning Questions • Key Questions: – What kind of capacity is needed? – How much capacity is needed to match demand? – When is it needed? • Related Questions: – How much will it cost? – What are the potential benefits and risks? – Should capacity be changed all at once, or through several smaller changes – Can the supply chain handle the necessary changes? 5 -5

Capacity Decisions Are Strategic • Capacity decisions – – – – impact the ability of the organization to meet future demands affect operating costs are a major determinant of initial cost often involve long-term commitment of resources can affect competitiveness affect the ease of management are more important and complex due to globalization need to be planned for in advance due to their consumption of financial and other resources 5 -6

Capacity Design capacity – maximum output rate or service capacity an operation, process, or facility is designed for Effective capacity – Design capacity minus allowances such as personal time, maintenance, and scrap Actual output – rate of output actually achieved--cannot exceed effective capacity. 5 -7

Measuring System Effectiveness • Actual output – The rate of output actually achieved – It cannot exceed effective capacity • Efficiency • Utilization Measured as percentages 5 -8

Example– Efficiency and Utilization • Design Capacity = 50 trucks per day • Effective Capacity = 40 trucks per day • Actual Output = 36 trucks per day 5 -9

Strategy Formulation • Strategies are typically based on assumptions and predictions about: – Long-term demand patterns – Technological change – Competitor behavior 5 -10

Steps in Capacity Planning 1. Estimate future capacity requirements 2. Evaluate existing capacity and facilities; identify gaps 3. Identify alternatives for meeting requirements 4. Conduct financial analyses or cost benefit/volume analyses 5. Select the best alternative for the long term 6. Implement alternative chosen 7. Monitor results 5 -11

Calculating Processing Requirements • Calculating processing requirements requires reasonably accurate demand forecasts, standard processing times, and available work time 5 -12

Example 1 A manager must decide which type of machine to buy A, B or C machine cost are: A 40, 000 B 30, 000 C 80, 000 Lecturer: Ahmed El Rawas 5 -13

Product forecast and processing time on the machine are as follows Product annual demand processing time(min) A B C 1 16, 000 3 4 2 2 12, 000 4 4 3 3 6, 000 5 6 4 4 30, 000 2 2 1 Lecturer: Ahmed El Rawas 5 -14

Assume that only purchasing costs are being considered, which machine would have the lowest total cost ? and how many machine would be needed? Machine operate 10 hours a day, 250 days a years. Lecturer: Ahmed El Rawas 5 -15

Step (1) Calculate processing time needed by each machine Product A B C 1 48, 000 64, 000 32, 000 2 48, 000 36, 000 3 30, 000 36, 000 24, 000 4 60, 000 30, 000 ______ 186, 000 208, 000 122, 000 Lecturer: Ahmed El Rawas 5 -16

Step (2) Calculate processing time available by the machines 10 X 250 X 60 = 150, 000 Lecturer: Ahmed El Rawas 5 -17

Step (3) Calculating number of needed machine A= 186, 000/ 150, 000= 1. 2 machine needed B= 208, 000/ 150, 000= 1. 4 machine needed C= 122, 000/ 150, 000=0. 8 machine needed Lecturer: Ahmed El Rawas 5 -18

Step (4) Calculate the machine cost. A= 2 X 40, 000= 80, 000 B= 2 X 30, 000= 60, 000 C= 1 X 80, 000= 80, 000 We will use machine 2 because it has the lowest cost. Lecturer: Ahmed El Rawas 5 -19

Service Capacity Planning • Service capacity planning can present a number of challenges related to: – The need to be near customers • Convenience – The inability to store services • Cannot store services for consumption later – The degree of demand volatility • Volume and timing of demand • Time required to service individual customers 5 -20

Demand Management Strategies • Strategies used to offset capacity limitations and that are intended to achieve a closer match between supply and demand – Pricing – Promotions – Discounts – Other tactics to shift demand from peak periods into slow periods 5 -21

In-House or Outsource? • Once capacity requirements are determined, the organization must decide whether to produce a good or service itself or outsource • Factors to consider: – – – Available capacity Expertise Quality considerations The nature of demand Cost Risks 5 -22

Constraint Management • Constraint – Something that limits the performance of a process or system in achieving its goals – Categories • Market • Resource • Material • Financial • Knowledge or competency • Policy 5 -23

Resolving Constraint Issues 1. Identify the most pressing constraint 2. Change the operation to achieve maximum benefit, given the constraint 3. Make sure other portions of the process are supportive of the constraint 4. Explore and evaluate ways to overcome the constraint 5. Repeat the process until the constraint levels are at acceptable levels 5 -24

Evaluating Alternatives • Alternatives should be evaluated from varying perspectives – Economic • • • Cost-volume analysis Financial analysis Decision theory Waiting-line analysis Simulation – Non-economic • Public opinion 5 -25

Cost-Volume Analysis • Cost-volume analysis – Focuses on the relationship between cost, revenue, and volume of output • Fixed Costs (FC) – tend to remain constant regardless of output volume • Variable Costs (VC) – vary directly with volume of output – VC = Quantity(Q) x variable cost per unit (v) • Total Cost – TC = Q x v • Total Revenue (TR) – TR = revenue per unit (R) x Q 5 -26

Break-Even Point (BEP) • BEP – The volume of output at which total cost and total revenue are equal – Profit (P) = TR – TC = R x Q – (FC +v x Q) = Q(R – v) – FC 5 -27

Cost-Volume Relationships 5 -28

Cost volume analysis 29 • Fixed cost = 1000 • Selling price per unit = 15$ • Variable cost per unit= 10$ • Calculate the break even point, and the profit. • Q= FC/ R-v • 1000/ 15 -10 = 200 • Profit= TR- TC 15*200 – 1000+ 10*200 = zero • Also calculate the profit when the TR = 6000 • 6000 - 3000= 3000 Lecturer. Ahmed El Rawas 5 -29

Financial Analysis • Cash flow – The difference between cash received from sales and other sources, and cash outflow for labor, material, overhead, and taxes • Present value – The sum, in current value, of all future cash flow of an investment proposal 5 -30

Balance sheet: 31 Balance sheet: referred to as statement of financial position or condition, reports on a company's assets, liabilities, and net equity as of a given point in time. Another definition: is an accountant snapshot of the firms accounting value on a particular date, as through the firm stood momentarily still. The balance sheet shows what assets the firm controls at a point in time and how it financed the assets. Assets= Liabilities + owners equity Lecturer. Ahmed El Rawas 5 -31

Income statement: • Income statement: also referred to as Profit and Loss statement reports on a company's income, expenses, and profits over a period of time. Profit & Loss account provide information on the operation of the enterprise. These include sale and the various expenses incurred during the processing state. • The income statement indicates the flow of sales, expenses, and earnings during a period of time. • Revenues- Expenses= Income 32 Lecturer. Ahmed El Rawas 5 -32

(3)Financial analysis • Financial ratios can be used to estimate systematic risk. • Financial analysis often assess the firm's: 1. Profitability - its ability to earn income and sustain growth in both short-term and long-term. A company's degree of profitability is usually based on the income statement, which reports on the company's results of operations; 2. Solvency - its ability to pay its obligation to creditors and other third parties in the long-term. 33 Lecturer. Ahmed El Rawas 5 -33

Financial analysis 3. Liquidity - its ability to maintain positive cash flow, while satisfying immediate obligations; 4. Stability- the firm's ability to remain in business in the long run, without having to sustain significant losses in the conduct of its business. Assessing a company's stability requires the use of both the income statement and the balance sheet, as well as other financial and non-financial indicators. 34 Lecturer. Ahmed El Rawas 5 -34

Pay back period 35 • The payback, also called pay-off period, is defined as the period required to recover the original investment outlay through the accumulated net profit/loss earned by the project. • Year+ cumulative net cash flow in previous period Net cash flow in the next period Lecturer. Ahmed El Rawas 5 -35

Net present value 36 • The net present value of a project is defined as the value obtained by discounting, at a constant interest rate and separately for each year, the differences of all annual cash outflows and inflows accruing throughout the life of a project. • NPV= ∑NCFn (1 + r)n • Accept a project if the NPV is greater than Zero • Reject a project if the NPV is less than Zero Lecturer. Ahmed El Rawas 5 -36

Internal rate of return 37 • The internal rate of return is the discount rate at which the present value of cash inflows is equal to the present value of cash outflows. Lecturer. Ahmed El Rawas 5 -37