OP 2202 Introduction to Operations Management Capacity Planning

OP 2202: Introduction to Operations Management Capacity Planning

OP 2202: Introductions to Operations Management Lesson 6, Page 2 Outline for the Week Six þ Capacity þ Design and Effective Capacity þ Capacity and Strategy þ Capacity Considerations þ Managing Demand þ Capacity Planning þ Breakeven Analysis þ Single-Product Case þ Multiproduct Case þ Applying Decision Trees to Capacity Decisions þ Applying Investment Analysis to Strategy-Driven Investments þ Investment, Variable Cost, and Cash Flow þ Net Present Value

Capacity OP 2202: Introductions to Operations Management Lesson 6, Page 3 þ The throughput, or the number of units a facility can hold, receive, store, or produce in a period of time þ Determines fixed costs þ Determines if demand will be satisfied þ Three time horizons

OP 2202: Introductions to Operations Management Lesson 6, Page 4 Planning Over a Time Horizon Long-range planning Add facilities Add long lead time equipment Intermediaterange planning Subcontract Add equipment Add shifts Short-range planning * Limited options exist Add personnel Build or use inventory * Modify capacity * Schedule jobs Schedule personnel Allocate machinery Use capacity

OP 2202: Introductions to Operations Management Lesson 6, Page 5 Design and Effective Capacity þ Design capacity is the maximum theoretical output of a system þ Normally expressed as a rate þ Effective capacity is the capacity a firm expects to achieve given current operating constraints þ Often lower than design capacity

OP 2202: Introductions to Operations Management Lesson 6, Page 6 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 OP 2202: Introductions to Operations Management Lesson 6, Page 7 Actual production last week = 148, 000 rolls Effective capacity = 175, 000 rolls Design capacity = 1, 200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Efficiency of new line = 75% Design capacity = (7 x 3 x 8) x (1, 200) = 201, 600 rolls Utilization = 148, 000/201, 600 = 73. 4% Efficiency = 148, 000/175, 000 = 84. 6% Expected Output = (Effective Capacity)(Efficiency) = (175, 000)(. 75) = 131, 250 rolls

OP 2202: Introductions to Operations Management Lesson 6, Page 8 Capacity and Strategy þ Capacity decisions impact all 10 decisions of operations management as well as other functional areas of the organization þ Capacity decisions must be integrated into the organization’s mission and strategy

OP 2202: Introductions to Operations Management Lesson 6, Page 9 Managing Demand þ Demand exceeds capacity þ Curtail demand by raising prices, scheduling longer lead time þ Long term solution is to increase capacity þ Capacity exceeds demand þ Stimulate market þ Product changes þ Adjusting to seasonal demands þ Produce products with complimentary demand patterns

OP 2202: Introductions to Operations Management Lesson 6, Page 10 Average unit cost (dollars per room per night) Economies and Diseconomies of Scale 25 - Room Roadside Motel 50 - Room Roadside Motel Economies of scale 25 75 - Room Roadside Motel Diseconomies of scale 50 Number of Rooms 75

OP 2202: Introductions to Operations Management Lesson 6, Page 11 Capacity Considerations þ Forecast demand accurately þ Understanding the technology and capacity increments þ Find the optimal operating level (volume) þ Build for change

OP 2202: Introductions to Operations Management Lesson 6, Page 12 Tactics for Matching Capacity to Demand 1. Making staffing changes 2. Adjusting equipment and processes þ Purchasing additional machinery þ Selling or leasing out existing equipment 3. Improving methods to increase throughput 4. Redesigning the product to facilitate more throughput

OP 2202: Introductions to Operations Management Lesson 6, Page 13 Sales in units Complementary Demand Patterns 4, 000 – 3, 000 – By combining both, the variation is reduced Snowmobile sales 2, 000 – 1, 000 – JFMAMJJASONDJ Time (months) Jet ski sales

OP 2202: Introductions to Operations Management Lesson 6, Page 14 Approaches to Capacity Expansion Expected demand Demand (c) Capacity lags demand with incremental expansion New capacity Expected demand Demand New capacity (b) Leading demand with one-step expansion New capacity Expected demand (d) Attempts to have an average capacity with incremental expansion Demand (a) Leading demand with incremental expansion New capacity Expected demand

OP 2202: Introductions to Operations Management Lesson 6, Page 15 Approaches to Capacity Expansion (a) Leading demand with incremental expansion Demand New capacity Expected demand 1 2 3 Time (years)

OP 2202: Introductions to Operations Management Lesson 6, Page 16 Approaches to Capacity Expansion (b) Leading demand with one-step expansion New capacity Demand Expected demand 1 2 3 Time (years)

OP 2202: Introductions to Operations Management Lesson 6, Page 17 Approaches to Capacity Expansion (c) Capacity lags demand with incremental expansion New capacity Demand Expected demand 1 2 3 Time (years)

OP 2202: Introductions to Operations Management Lesson 6, Page 18 Approaches to Capacity Expansion (d) Attempts to have an average capacity with incremental expansion New capacity Demand Expected demand 1 2 3 Time (years)

OP 2202: Introductions to Operations Management Lesson 6, Page 19 Break-Even Analysis þ Technique for evaluating process and equipment alternatives þ Objective is to find the point in dollars and units at which cost equals revenue þ Requires estimation of fixed costs, variable costs, and revenue þ Fixed costs are costs that continue even if no units are produced þ Depreciation, taxes, debt, mortgage payments þ Variable costs are costs that vary with the volume of units produced þ Labor, materials, portion of utilities þ Contribution is the difference between selling price and variable cost

OP 2202: Introductions to Operations Management Lesson 6, Page 20 Break-Even Analysis Assumptions þ Costs and revenue are linear functions þ Generally not the case in the real world þ We actually know these costs þ Very difficult to accomplish þ There is no time value of money

OP 2202: Introductions to Operations Management Lesson 6, Page 21 Break-Even Analysis – Total revenue line 900 – Cost in dollars 800 – 700 – Break-even point Total cost = Total revenue 600 – or d i rr co t i of Total cost line Pr 500 – Variable cost 400 – 300 – 200 – 100 – ss or o L rid r co Fixed cost | | | – 0 100 200 300 400 500 600 700 800 900 1000 1100 Volume (units period) |

OP 2202: Introductions to Operations Management Lesson 6, Page 22 Break-Even Analysis BEPx = Break-even point in units BEP$ = Break-even point in dollars P = Price per unit (after all discounts) x = Number of units produced TR = Total revenue = Px F = Fixed costs V = Variable costs TC = Total costs = F + Vx Break-even point occurs when TR = TC or Px = F + Vx F BEPx = P-V

OP 2202: Introductions to Operations Management Lesson 6, Page 23 Break-Even Analysis BEPx = Break-even point in units BEP$ = Break-even point in dollars P = Price per unit (after all discounts) x = Number of units produced TR = Total revenue = Px F = Fixed costs V = Variable costs TC = Total costs = F + Vx BEP$ = BEPx P F = P P-V F = (P - V)/P F = 1 - V/P Profit = TR - TC = Px - (F + Vx) = Px - F - Vx = (P - V )x - F

OP 2202: Introductions to Operations Management Lesson 6, Page 24 Break-Even Example Fixed costs = $10, 000 Direct labor = $1. 50/unit Material = $. 75/unit Selling price = $4. 00 per unit $10, 000 F BEP$ = = 1 - [(1. 50 +. 75)/(4. 00)] 1 - (V/P) $10, 000 = = $22, 857. 14. 4375 $10, 000 F BEPx = = = 5, 714 4. 00 - (1. 50 +. 75) P-V

OP 2202: Introductions to Operations Management Lesson 6, Page 25 Break-Even Example 50, 000 – Revenue Dollars 40, 000 – Break-even point 30, 000 – Total costs 20, 000 – Fixed costs 10, 000 – | – 0 | | 2, 000 4, 000 | 6, 000 Units | | 8, 000 10, 000

OP 2202: Introductions to Operations Management Lesson 6, Page 26 Break-Even Multiproduct Case BEP$ = where V P F W i F ∑ Vi 1 x ( W i) Pi = variable cost per unit = price per unit = fixed costs = percent each product is of total dollar sales = each product

OP 2202: Introductions to Operations Management Lesson 6, Page 27 Break-Even Example (Multiproduct) Fixed costs = $3, 500 per month Item Sandwich Soft drink Baked potato Tea Salad bar Price $2. 95. 80 1. 55. 75 2. 85 Cost $1. 25. 30. 47. 25 1. 00 Annual Forecasted Sales Units 7, 000 5, 000 3, 000

OP 2202: Introductions to Operations Management Lesson 6, Page 28 Break-Even Example (Multiproduct) Fixed costs = $3, 500 per month Item Price Cost Sandwich $2. 95 $1. 25 Soft drink. 80. 30 Baked potato 1. 55. 47 Tea. 75. 25 Salad bar 2. 85 1. 00 Item (i) Sandwich Soft drink Baked potato Tea Salad bar Annual Forecasted Sales Units 7, 000 5, 000 3, 000 Annual Weighted Selling Variable Forecasted % of Contribution Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7) $2. 95. 80 1. 55 $1. 25. 30. 47 . 42. 38. 30 . 58. 62. 70 $20, 650 5, 600 7, 750 . 446. 121. 167 . 259. 075. 117 . 75 2. 85 . 25 1. 00 . 33. 35 . 67. 65 3, 750 8, 550 $46, 300 . 081. 185 1. 000 . 054. 120. 625

OP 2202: Introductions to Operations Management Lesson 6, Page 29 Break-Even Example (Multiproduct) BEP$ = F ∑ 1 - Fixed costs = $3, 500 per month Vi x (Wi) Pi $3, 500 x Forecasted 12 Annual = = $67, 200. 625 Item Price Cost Sales Units Sandwich $2. 95 $1. 25 7, 000 $67, 200 Daily Soft drink. 80. 30 7, 000 = = $215. 38 sales 312 days Baked potato 1. 55. 47 Annual 5, 000 Weighted % of Contribution Tea Selling Variable. 75. 25 Forecasted 5, 000 Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7) Salad bar 2. 85 1. 00 3, 000. 446 x $215. 38 = 32. 6 . 259 33 Sandwich $2. 95 $1. 25. 42. 58 $20, 650. 446 $2. 95 Soft drink Baked potato Tea Salad bar . 80 1. 55 . 30. 47 . 38. 30 . 62. 70 5, 600 7, 750 . 75 2. 85 . 25 1. 00 . 33. 35 . 67. 65 3, 750 8, 550 $46, 300 sandwiches. 121. 075. 167 per day. 117 . 081. 185 1. 000 . 054. 120. 625

OP 2202: Introductions to Operations Management Lesson 6, Page 30 Decision Trees and Capacity Decision -$14, 000 Market favorable (. 4) rge a L nt pla Market unfavorable (. 6) -$90, 000 $18, 000 Market favorable (. 4) Medium plant Sm all pla nt Do no th in g $100, 000 Market unfavorable (. 6) $60, 000 -$10, 000 $13, 000 Market favorable (. 4) Market unfavorable (. 6) $40, 000 -$5, 000 $0

OP 2202: Introductions to Operations Management Lesson 6, Page 31 Strategy-Driven Investment þ Operations may be responsible for return-on-investment (ROI) þ Analyzing capacity alternatives should include capital investment, variable cost, cash flows, and net present value

OP 2202: Introductions to Operations Management Lesson 6, Page 32 Net Present Value (NPV) F P= (1 + i)N where F P i N = future value = present value = interest rate = number of years

OP 2202: Introductions to Operations Management Lesson 6, Page 33 NPV Using Factors F P= = FX N (1 + i) where Portion of Table S 7. 1 Year 1 2 3 4 5 X = a factor from Table S 7. 1 defined as = 1/(1 + i)N and F = future value 5%. 952. 907. 864. 823. 784 6%. 943. 890. 840. 792. 747 7%. 935. 873. 816. 763. 713 … 10%. 909. 826. 751. 683. 621

OP 2202: Introductions to Operations Management Lesson 6, Page 34 Present Value of an Annuity An annuity is an investment which generates uniform equal payments S = RX where Portion of Table S 7. 2 X = factor from Table S 7. 2 S = present value of a series of uniform annual receipts R = receipts that are received every year of the life of the investment Year 1 2 3 4 5 5%. 952 1. 859 2. 723 4. 329 5. 076 6%. 943 1. 833 2. 676 3. 465 4. 212 7%. 935 1. 808 2. 624 3. 387 4. 100 … 10%. 909 1. 736 2. 487 3. 170 3. 791