DOM 511 OPERATIONS MANAGEMENT PRACTICE Magutu Obara Peterson

DOM 511: OPERATIONS MANAGEMENT PRACTICE Magutu Obara Peterson University of Nairobi School of Business Département of Management Science May - August 2012 magutumop 2011 1

CAPACITY MANAGEMENT 2

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Objectives Understanding Capacity Utilization & Best Operating Level Economies & Diseconomies of Scale The Experience Curve Capacity Focus, Flexibility & Planning Determining Capacity Requirements Decision Trees Capacity Utilization & Service Quality

Introduction The Airbus A 380 is the largest plane ever built with 555 seats. With some modest redesign, such as extending the length of the plane, it could carry as many as 800 airline passengers. The pieces of the plane are so big, such as the cockpit, tail, wings, and cabin sections that the factories must be reconfigured. The European Consortium that builds the Airbus must make and transport these parts, some weighing 100 tons each, among many countries such as Spain, Britain, France, and Germany. Not only must factory capacity and scale be upsized, the elaborate transportation system to move these parts among European factories must also be changed. At a maximum speed of 15 miles per hour, the trip to Toulouse, France, from the seaport of Bordeaux takes three days. The French government has redone the entire 159 -mile route, including 18 miles of new bypass routes around five towns, to handle the six giant truck trailers that carry these manufactured parts.

Capacity Management - The Meaning Of Capacity is the capability of a manufacturing or service resource such as a facility, process, workstation, or piece of equipment to accomplish its purpose over a specified time period. The capacity of a production unit (e. g. machine, factory) is its ability to produce or do that which the customer requires. 6

Capacity Management - The Meaning Of Capacity In operations management, three types of capacity are often referred to: Potential Capacity - The capacity that can be made available to influence the planning of senior management. This is essentially a long-term decision that does not influence day-to-day production management Immediate Capacity - The amount of production capacity that can be made available in the short-term. This is the maximum potential capacity - assuming that it is used productively Effective Capacity - An important concept. Not all productive capacity is actually used or usable. It is important for production managers to understand what capacity is actually achievable. 7

Typical capacity issues to address include: Can the facility, process, or equipment accommodate new goods and services and adapt to changing demand for existing goods and services? How large should facility, process, or equipment capacity be? When should capacity changes take place? 8

Capacity and Value Chain Capacity is determined by; Resources available to the organization – facilities, equipment & labor (technology & process selection) How resources available are organized (process design & facility layout) Efficiency of resources as determined by specific work methods & procedures (work & supply chain design) Capacity is vital to designing and managing value chains At every stage of a chain, sufficient capacity must exist & be coordinated with other stages & processes

Issues of concern in capacity; Can the facility, process or equipment accommodate new goods & services & adapt to changing demand for existing goods & services? How large should facility, process, or equipment capacity be? When should capacity changes take place?

Understanding Capacity is the capability of a manufacturing or service resource such as facility, process, workstation, or piece of equipment to accomplish its purpose over a specified time period Capacity can be view from 4 dimensions; Quantity Quality Time Location What are the units of measuring capacity?

Understanding Capacity is the capability of a manufacturing or service resource such as facility, process, workstation, or piece of equipment to accomplish its purpose over a specified time period Capacity can be view from 4 dimensions; Quantity Quality Time Location Time may be a constraint where a customer has a particular required delivery date. In this situation, capacity managers often "plan backwards". In other words, they allocate the final stage (operation) of the production tasks to the period where delivery is required; the penultimate task one period earlier and so on. What are the units of measuring capacity?

Capacity Planning Operations managers must decide on the appropriate levels of capacity to meet current & future demand – hence need for proper planning Capacity planning should take place at multiple levels i. e capacity planning is generally viewed in 3 durations Long range – Annual plans for 2 -5 years. Basically plans on the productive resources; Takes a long time to acquire & needs top mgt participation & approval

Capacity Planning Intermediate range ; monthly/quarterly plans for the next 6 to 18 months – decisions to make include, hiring, layoffs, new tools & minor equipment purchases & subcontracting Short range ; less than one month, capacity issues addressed thro’ overtime, personnel transfers & production routings

Capacity Planning Production Scheduling A schedule is a representation of the time necessary to carry out a particular task. A job schedule shows the plan for the manufacture of a particular job. It is created through "work / study" reviews which determine the method and times required. Most businesses carry out several production tasks at one time - which entails amalgamating several job schedules. This process is called "scheduling". The result is known as the production schedule or factory schedule for the factory/plant as a whole.

Capacity Planning In preparing a production schedule, attention needs to be paid to: - Delivery dates (when are finished products due? ) - Job schedules for each relevant production task - Capacities of production sections or departments involved - Efficiency of these production sections or departments - Planned holidays - Anticipated sickness / absenteeism / training - Availability of raw materials, components and packaging

Strategic Capacity Planning Defined Capacity planning is the analysis of what you are capable of producing versus what your expected demand will be. Strategic capacity planning is an approach for determining the overall capacity level of capital intensive resources, including facilities, equipment, and overall labor force size that best supports the firms long range competitive strategy. This plans constrain the firm on volume & variety to deliver to the market place.

components of capacity management There are two components of capacity management: Capacity Planning (creating sufficient, flexible, capacity & a valid, best, "do-able", resilient, plan, to accommodate demand) Capacity Control (ensuring the plan is met by managing resources) Without capacity (and materials) to meet the demand, the plan cannot be valid. 18

A. Capacity Planning There are, in a typical business, four levels where capacity planning (& control) is required (as shown below). At each of these levels there may be a one-to-many relationship with the level below. There are certainly differences in both planning detail and planning horizon required to satisfy each level. For example at strategic planning level one, product groups (not necessarily individual products) are being forecast with an horizon of perhaps years. At level four, when you are managing an individual resource, you are dealing with detailed operating instructions for an individual process and horizons of perhaps seconds: 19

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Level 1: Strategic Capacity Management Capacity should be first be analyzed during business planning sessions. The company should have a good sense of their current capacity and at what percentage they are operating. (as a part of business planning) includes capacity management activity to: Define longer term capacity goals (time phased resources required to meet the business plan) Capability Capacity Impact of New Product Introduction / old product kill Manage gross and long term capacity to meet it which will include the following considerations and actions: Devise upsize / downsize strategy (output or responsiveness) 21

Level 1: Strategic Capacity Management Manage volume & variety change Place products in business units / locations & position capacity geographically (to source supply) Devise strategies to manage seasonal demand / demand variability Attack the drivers of performance & attributes of resources to provide: Resource Viability & Core Competence Capacity (line) balancing Replacement theory (Repair or replace? ) Create resilience and consistency of service in the supply chain 22

Level 2. Development, Sales and Operations Management (Management of the demands on the business and the gross capacity to meet it and make it happen!) (The Sales & Operations part of this process is mainly covered in a separate article from our early work in this area "Participative Sales and Operations Planning". ) We have two general views of this process, as we will explain further: 23

Level 2. Development, Sales and Operations Management If you basically, sell what you can make, you need a "Participative Master Production Scheduling Process" assisted by a simple capacity modelling system, (to organise resources to deliver it, which basically is answering the question, "When? ") Otherwise, you need or a full "Development, Sales & Operations Management Process" to make the tradeoffs between the difficulty of selling vs. the difficulty of providing and to additionally manage the development and sales processes, which answers the three questions, "What, If and When? ". 24

Level 3: Workflow Management / Scheduling (Scheduling of individual functions, cells or process areas) In the mid 1970's the commercial availability of computers also spawned capacity planning tools, whose models were very sophisticated even by comparison with today's systems. It is mathematically possible to create a comprehensive model of the manufacturing or supply chain processes run on powerful computers, which use a variety of optimising techniques, in recently created "Advanced Scheduling Systems", in order to schedule work. (Previous Technique T 020: "Close Scheduling" provides an introduction to scheduling. ) Also MRP 2 Systems took the MRP 1 plan and scheduled operations to create a "work-to" list at operational level in the early 1980's. 25

Level 3: Workflow Management / Scheduling However it is difficult to justify the additional cost and administration that these systems require, if: Less sophisticated processes such as an effective master production scheduling process supported by a roughcut capacity model is implemented first. 26

Level 4: Process Management (E. g. individual settings, speeds, feeds, skills, set / make ready times etc. ) At level four we have been involved in some interesting & lively debates about: What is the best method (running speeds, feeds, process settings, least waste, shortest lead-time etc. )? This is where Taguchi methods (Design Of Experiments) is particularly useful. (In one recent example we showed that by reducing conveyor speed, more throughput could be achieved. ) Identifying and then driving skills development (versatility / mobility) using skills matrices 27

B. Capacity Control How much output should operations ideally produce if the order book is empty? The answer of course is zero and of course ideally they should incur zero cost (a zero capacity floor) in doing so. So why are operations measured on maximising output? The key question is how can we de-bottleneck, perhaps by reassigning underutilised resources. 28

B. Capacity Control Strategic / Business Planning (where typically budgetary type controls operate) but this plan must be "do-able" (established by modelling it using the level 2 Rough Cut Capacity Planning tools) Development, Sales and Operations Management / Master Production Schedule, where the overall plan is measured and performance against the plan analysed and actions taken to bring output into line with demand, but any conflict between the business plan and what customers want has to be reconciled at this level, not passed to level 3 unresolved. 29

Importance of Capacity Decisions: 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 Capacity is measured as efficiency and utilization 30

Measuring Capacity The decision to increase capacity is not easy and can be extremely costly. Make sure you've fully analyzed all of your options and backed them with financial calculations. If you do purchase a new piece of equipment, there's a tendency to want to operate them at full-capacity to reduce the return on investment. This is a false way of thinking. You should be operating to meet your demand, not to keep the machines running. This line of thinking will lead to excess materials and increased costs. 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. 31

Efficiency and Utilization Efficiency = Utilization = Actual output Effective capacity Actual output Design capacity Both measures expressed as percentages 32

Efficiency/Utilization Example Design capacity = 50 trucks/day Effective capacity = 40 trucks/day Actual output = 36 units/day Efficiency = Utilization = Actual output = Effective capacity Actual output or used = Design capacity is a. k. a best operating level Actual output is a. k. a capacity used 5 -33 36 units/day 40 units/ day 36 units/day 50 units/day = 90% = 72%

Capacity Utilization Where Capacity used rate of output actually achieved Best operating level capacity for which the process was designed

Level Example: Engineers design engines and assembly lines to operate at an ideal or “best operating level” to maximize output and minimize ware Average unit cost of output Underutilization Overutilization Best Operating Level Volume

Utilization During one week of production, a plant produced 83 units of a product. Its historic highest or best utilization recorded was 120 units per week. What is this plant’s capacity utilization rate? · Answer: Capacity utilization rate = Capacity used. Best operating level = 83/120 =0. 69 or 69%

Economies & Diseconomies of Scale Economies of Scale and the Experience Curve working Average unit cost of output 100 -unit plant 200 -unit plant 300 -unit plant 400 -unit plant Diseconomies of Scale start working Volume

Economies & Diseconomies • Economies of scale are achieved when the average unit cost of a good or service decreases as the capacity and/or volume of throughput increases • Reverse for diseconomies of scale

Experience Curve As plants produce more products, they gain experience in the best production methods and reduce their costs per unit Yesterday Cost or price per unit Today Tomorrow Total accumulated production of units

The Experience Curve Class Exercise : Discuss the impact of the experience curve on effective capacity and state the issues which may hinder a firm from riding smoothly down the experience curve.

Capacity Focus The concept of the focused factory holds that production facilities work best when they focus on a fairly limited set of production objectives Plants Within Plants (PWP) (from Skinner) Extend focus concept to operating level

Capacity Focus Dimensions of capacity focus Cost Quality Flexibility New product introduction Reliability Short lead times With the new manufacturing technology it is possible for a firm to focus on a selected set of dimensions that most work towards corporate objectives

Capacity Flexibility Flexible plants – Having the ability to rapidly increase or decrease production levels & change from one product to another. Flexible processes ( Economies of scope ) – permit rapid low cost switching from one product to another Flexible workers – Multi skilled, ability to switch easily from one kind of task to another, require broad based training

Capacity Planning: Balance Unbalanced stages of production Units per month Stage 1 Stage 2 6, 000 7, 000 Stage 3 5, 000 Balanced stages of production Units per month Stage 1 Stage 2 6, 000 Stage 3 6, 000

Capacity Planning (i) Maintaining System Balance: Output of one stage is the exact input requirements for the next stage Balancing Techniques • Add capacity to bottleneck work centers • Scheduling overtime • Leasing equipment • subcontracting • Use of buffer inventories in front of the bottleneck • Duplicate the facilities of bottleneck dept.

Capacity Planning ii) Frequency of Capacity Additions Frequent Additions ; Costs • Removing old & replacing new • Training employees on new • Purchase cost of new • Opportunity cost of idle plant during changeover Infrequent Additions ; Costs • Purchase cost very high – big chunks • Overhead of underutilization – • Lost sales/market share during waiting period

Managing Capacity By Adjusting Short-Term Capacity Levels • Add or share equipment • Sell unused capacity • Change labor capacity & schedules • Change labor skill mix

Managing Capacity By Shifting & stimulating Demand • Vary the price of goods or services • Provide customers information e. g call centers personal service time • Advertising & promotion eg Valetine day promotions • Add peripheral goods and/or services • Provide reservations

Capacity Planning iii) External Sources of Capacity May be cheaper in the short run; Methods of achieving this include; • Outsourcing • Sharing

Determining Capacity Requirements 1. Forecast sales within each individual product line 2. Calculate equipment and labor requirements to meet the forecasts 3. Project equipment and labor availability over the planning horizon

Capacity Cushion A firm may decide to have capacity in excess of expected demand I. e capacity cushion Reasons Anticipation of growth in demand Provision for errors in estimation of demand Compensation for any loss in capacity if BOL is not attainable ** Positive Vs Negative capacity cushion

Decision Theory Helpful tool for financial comparison of alternatives under conditions of risk or uncertainty Suited to capacity decisions 52

Example of a Decision Tree Problem A glass factory specializing in crystal is experiencing a substantial backlog, and the firm's management is considering three courses of action: A) Arrange for subcontracting B) Construct new facilities C) Do nothing (no change) The correct choice depends largely upon demand, which may be low, medium, or high. By consensus, management estimates the respective demand probabilities as 0. 1, 0. 5, and 0. 4.

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

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

(Continued): Step 2. Add our possible states of nature, probabilities, and payoffs A B High demand (0. 4) $90 k Medium demand (0. 5) $50 k Low demand (0. 1) $10 k High demand (0. 4) $200 k Medium demand (0. 5) $25 k Low demand (0. 1) -$120 k High demand (0. 4) $60 k Medium demand (0. 5) $40 k Low demand (0. 1) $20 k C

Problem (Continued): Step 3. Determine the expected value of each decision $62 k High demand (0. 4) $90 k Medium demand (0. 5) $50 k Low demand (0. 1) $10 k A EVA=0. 4(90)+0. 5(50)+0. 1(10)=$62 k

Example of Decision Tree Problem (Continued): Step 4. Make decision $62 k A B $80. 5 k High demand (0. 4) $90 k Medium demand (0. 5) $50 k Low demand (0. 1) $10 k High demand (0. 4) $200 k Medium demand (0. 5) $25 k Low demand (0. 1) -$120 k High demand (0. 4) $60 k Medium demand (0. 5) $40 k Low demand (0. 1) $20 k C $46 k Alternative B generates the greatest expected profit, so our choice is B or to construct a new facility

Planning Service Capacity vs. Manufacturing Capacity Time: Services can not be stored for later use and capacity must be available to provide a service when it is needed Location: Service must be at the customer demand point and capacity must be located near the customer Volatility of Demand: Much greater than in manufacturing. Services can not be stored hence inventory can not smooth demand. Also customers directly interact with system & have varying needs

Capacity Utilization & Service Quality Best operating point is near 70% of capacity - Enough to keep servers busy but allows enough time to serve customers individually and keep enough capacity in reserve so as not to create too many managerial headaches. From 70% to 100% of service capacity, what do you think happens to service quality?

Capacity Utilization & Service Quality 100% 70% Mean arrival rate Mean service rate Critical zone

Capacity Utilization & Service Quality From 70% to 100% of service capacity, ( The critical zone) customers are processed through the system but service quality declines. Above the critical zone, the line builds up & it is likely that many customers may never be served.

Capacity Utilization & Service Quality Optimal utilization rate is very context specific. Low rates are appropriate when both the degree of uncertainty & the stakes are high. Eg hospitals & fire depts. Commuter trains & postal sorting operations are relatively predictable services & one can plan to operate much near 100% utilization

Capacity Expansion Strategies: Entrepreneurial Stage Shift resources to different tasks as needed Customer coproduction 29

Capacity Expansion Strategies: Multisite Rationalization Stage Add services to existing site Duplicate existing services at additional sites Do both 30

Capacity Expansion Strategies: Growth Stage “Bermuda Triangle” of operational complexity Management difficulty exceeds management ability New capacity management challenges Need for fresh ideas Need to upgrade older facilities 31

Capacity Expansion Strategies: Maturity Stage Focus on operational efficiencies Remodeling and replacement Service modification Duplication across entire service system 32

Capacity Expansion Strategies: Maturity Stage Focus on operational efficiencies Remodeling and replacement Service modification Duplication across entire service system 32

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