Chapter 5 Strategic Capacity Planning for Products and

Chapter 5 Strategic Capacity Planning for Products and Services Mc. Graw-Hill/Irwin Copyright © 2012 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 Instructor Slides 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 Over-capacity operating costs that are too high Under-capacity strained resources and possible loss of customers

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.

Measuring System Effectiveness Efficiency Utilization Measured as percentages

Example– Efficiency and Utilization P. 197 Design Capacity = 50 trucks per day Effective Capacity = 40 trucks per day Actual Output = 36 trucks per day

Capacity Cushion Extra capacity used to offset demand uncertainty Capacity cushion = 100% - Utilization Capacity cushion strategy Organizations that have greater demand uncertainty typically have greater capacity cushion Organizations that have standard products and services generally have smaller capacity cushion

Example 2, P 202 A center works one shift (8 -hr shift), 250 days a year, and these figures for a machine that is current being considered: Annual Stand Processing Product Demand Time per Unit (hr) #1 400 5 #2 300 8 #3 700 2 Processing Time Needed 5 x 400=2000 8 x 300=2400 2 x 700=1400 Total: 5800

Example 2, P. 202 (Cont’d) How many machines do we need to handle the required volume?

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

Bottle Neck Operation

Complementary Demand Patterns

Average cost per unit Optimal Operating Level Minimum cost Optimal Output Rate of output

Facility Size and Optimal Operating Level Average cost per unit Minimum cost & optimal operating rate are functions of size of production unit. Small plant Medium plant Large plant Output rate Instructor Slides 5 -14

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

Cost-Volume Relationships

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

Example 3: P. 211 If FC=$6000/Month, VC=$2/pie, Price=$7/pie § How many pies must be sold to Break Even? § If 1000 pies sold in a month, What would be the profit or loss? Profit=TR-TC=$7(1000)-($6000+$2 x 1000)= -$1000 Loss $1000

Example 3: P. 211 (Cont’d) How many pies must be sold for a profit of $4000? If 2000 pies can be sold, a profit goal is $5000, what price should be charged per pie? Profit = Q(R-v) – FC 5000 = 2000(R – 2) – 6000 5000 = 2000 R – 4000 – 6000 2000 R= 15000 R = $7. 50, Price = $7. 50

Example 4: P. 212 A manager has the option of purchasing 1, 2, or 3 machines. Fixed costs & potential volumes are as follows: # Machines Annual FC Range of Output 1 $ 9, 600 0 to 300 2 15, 000 301 to 600 3 20, 000 601 to 900 VC=$10/unit Revenue=$40/unit

Example 4: P. 212 (Cont’d) Determine the break-even point for each range. 1 Machine Q(Bep)= 9600/(40 -10)=320 units (not in range) 2 Machine Q(Bep)=15000/(40 -10) =500 units 3 Machine Q(Bep)=20000/(40 -10)=666. 7 units If projected annual demand is between 580 and 660 units, how machines should the manager purchase? Manager should choose 2 machines

Make or Buy Available Capacity Quality Consideration Nature of Demand Cost

Example 5: Make or Buy Annual FC VC/Unit Annual Volume MAKE $150000 $60 12000 units P. 216 BUY 0 $80 12000 units Annual Cost of each alternative: TC = FC + VC x Q TCMake=$150000 +$60 x 12000=$870, 000 TCBuy = 0 +$80 x 12000=$960, 000 Alternative Make is better

Example 5: Make or Buy P. 216 (Cont’d) There is a possibility that volume could change in the future. What would be Indifferent Volume between Making & Buying? TCMake = TCBuy FC +V*Q = FC+V*Q 150000+60 Q = 0 +80 Q 150000=80 Q - 60 Q = 20 Q Q = 7500 units If Volume >= 7500 units, Choose MAKE If Volume <= 7500 units, Choose BUY