Chapter 5, Part A

1. Chapter 5, Part A Facility Capacity and Location

2. Facility Planning • HOW MUCH long range capacity is needed • WHEN additional capacity is needed • WHERE the production facilities should be located • WHAT the layout and characteristics of the facilities should be

3. Facility Planning • The capital investment in land, buildings, technology, and machinery is enormous • A firm must live with its facility planning decisions for a long time, and these decisions affect: • Operating efficiency • Economy of scale • Ease of scheduling • Maintenance costs • … Profitability!

4. Long-RangeCapacity Planning

5. Steps in the Capacity Planning Process • Estimate the capacity of the present facilities. • Forecast the long-range future capacity needs. • Identify and analyze sources of capacity to meet these needs. • Select from among the alternative sources of capacity.

6. Definitions of Capacity • In general, production capacity is the maximum production rate of an organization. • Capacity can be difficult to quantify due to … • Day-to-day uncertainties such as employee absences, equipment breakdowns, and material-delivery delays • Products and services differ in production rates (so product mix is a factor) • Different interpretations of maximum capacity

7. Definitions of Capacity • The Federal Reserve Board defines sustainable practical capacity as the greatest level of output that a plant can maintain … • within the framework of a realistic work schedule • taking account of normal downtime • assuming sufficient availability of inputs to operate the machinery and equipment in place

8. Measurements of Capacity Output Rate Capacity • For a facility having a single product or a few homogeneous products, the unit of measure is straightforward (barrels of beer per month) • For a facility having a diverse mix of products, an aggregate unit of capacity must be established using a common unit of output (sales dollars per week)

9. Measurements of Capacity Input Rate Capacity • Commonly used for service operations where output measures are particularly difficult • Hospitals use available beds per month • Airlines use available seat-miles per month • Movie theatres use available seats per month

10. Measurements of Capacity Capacity Utilization Percentage • Relates actual output to output capacity • Example: Actual automobiles produced in a quarter divided by the quarterly automobile production capacity • Relates actual input used to input capacity • Example: Actual accountant hours used in a month divided by the monthly account-hours available

11. Measurements of Capacity Capacity Cushion • an additional amount of capacity added onto the expected demand to allow for: • greater than expected demand • demand during peak demand seasons • lower production costs • product and volume flexibility • improved quality of products and services

12. Forecasting Capacity Demand • Consider the life of the input (e.g. facility is 10-30 yr) • Understand product life cycle as it impacts capacity • Anticipate technological developments • Anticipate competitors’ actions • Forecast the firm’s demand

13. Other Considerations • Resource availability • Accuracy of the long-range forecast • Capacity cushion • Changes in competitive environment

14. Expansion of Long-Term Capacity • Subcontract with other companies • Acquire other companies, facilities, or resources • Develop sites, construct buildings, buy equipment • Expand, update, or modify existing facilities • Reactivate standby facilities

15. Reduction of Long-Term Capacity • Sell off existing resources, lay off employees • Mothball facilities, transfer employees • Develop and phase in new products/services

16. Economies of Scale • Best operating level - least average unit cost • Economies of scale - average cost per unit decreases as the volume increases toward the best operating level • Diseconomies of scale - average cost per unit increases as the volume increases beyond the best operating level

17. Economies and Diseconomies of Scale Average Unit Cost of Output ($) Economies of Scale Diseconomies of Scale Best Operating Level Annual Volume (units)

18. Economies of Scale • Declining costs result from: • Fixed costs being spread over more and more units • Longer production runs result in a smaller proportion of labor being allocated to setups • Proportionally less material scrap • … and other economies

19. Diseconomies of Scale • Increasing costs result from increased congestion of workers and material, which contributes to: • Increasing inefficiency • Difficulty in scheduling • Damaged goods • Reduced morale • Increased use of overtime • … and other diseconomies

20. Two General Approaches to Expanding Long-Range Capacity • All at Once – build the ultimate facility now and grow into it • Incrementally – build incrementally as capacity demand grows

21. Two General Approaches to Expanding Long-Range Capacity • All at Once • Little risk of having to turn down business due to inadequate capacity • Less interruption of production • One large construction project costs less than several smaller projects • Due to inflation, construction costs will be higher in the future • Most appropriate for mature products with stable demand

22. Two General Approaches to Expanding Long-Range Capacity • Incrementally • Less risky if forecast needs do not materialize • Funds that could be used for other types of investments will not be tied up in excess capacity • More appropriate for new products

23. Subcontractor Networks A viable alternative to larger-capacity facilities is to develop subcontractor and supplier networks. • “Farming out” or outsourcing your capacity needs to your suppliers • Developing long-range relationships with suppliers of parts, components, and subassemblies • Relying less on backward vertical integration • Requiring less capital for production facilities • More easily varying capacity during slack or peak demand periods

24. Outsourcing Service Functions • Building maintenance • Data processing • Delivery • Payroll • Bookkeeping • Customer service • Mailroom • Benefits administration • … and more

25. Economies of Scope • The ability to produce many product models in one flexible facility more cheaply than in separate facilities • Highly flexible and programmable automation allows quick, inexpensive product-to-product changes • Economies are created by spreading the automation cost over many products

26. Example: King Publishing • Break-Even Analysis King Publishing intends to publish a book in residential landscaping. Fixed costs are $125,000 per year, variable costs per unit are $32, and selling price per unit is $42. A) How many units must be sold per year to break even? B) How much annual revenue is required to break even? C) If annual sales are 20,000 units, what are the annual profits? D) What variable cost per unit would result in $100,000 annual profits if annual sales are 20,000 units?

27. Example: King Publishing • Break-Even Analysis A) How many units must be sold per year to break even? Q = FC/(p-v) = $125,000/(42 – 32) = 12,500 books

28. Example: King Publishing • Break-Even Analysis B) How much annual revenue is required to break even? TR = pQ = 42(12,500) = $525,000

29. Example: King Publishing • Break-Even Analysis C) If annual sales are 20,000 units, what are the annual profits? P = pQ – (FC + vQ) = 42(20,000) – [125,000 + 32(20,000)] = 840,000 – 125,000 – 640,000 = $75,000

30. Example: King Publishing • Break-Even Analysis D) What variable cost per unit would result in $100,000 annual profits if annual sales are 20,000 units? P = pQ – (FC + vQ) 100,000 = 42(20,000) – [125,000 + v(20,000)] 100,000 = 840,000 – 125,000 – 20,000v 20,000v = 615,000 v = $30.75

31. Decision Tree Analysis • Structures complex multiphase decisions, showing: • What decisions must be made • What sequence the decisions must occur • Interdependence of the decisions • Allows objective evaluation of alternatives • Incorporates uncertainty • Develops expected values

32. Example: Good Eats Café • Decision Tree Analysis Good Eats Café is about to build a new restaurant. An architect has developed three building designs, each with a different seating capacity. Good Eats estimates that the average number of customers per hour will be 80, 100, or 120 with respective probabilities of 0.4, 0.2, and 0.4. The payoff table showing the profits for the three designs is on the next slide.

33. Example: Good Eats Café • Payoff Table Average Number of Customers Per Hour c1 = 80 c2 = 100 c3 = 120 Design A $10,000 $15,000 $14,000 Design B $ 8,000 $18,000 $12,000 Design C $ 6,000 $16,000 $21,000

34. Example: Good Eats Café • Expected Value Approach • Calculate the expected value for each decision. The decision tree on the next slide can assist in this calculation. Here d1, d2, d3 represent the decision alternatives of designs A, B, C, and c1, c2, c3 represent the different average customer volumes (80, 100, and 120) that might occur.

35. Payoffs (.4) c1 10,000 c2 (.2) 2 15,000 c3 (.4) d1 14,000 (.4) c1 8,000 d2 1 3 c2 (.2) 18,000 c3 d3 (.4) 12,000 (.4) c1 6,000 4 c2 (.2) 16,000 c3 (.4) 21,000 Example: Good Eats Café • Decision Tree

36. Example: Good Eats Café • Expected Value For Each Decision • Choose the design with largest EV -- Design C. EV = .4(10,000) + .2(15,000) + .4(14,000) = $12,600 2 d1 Design A EV = .4(8,000) + .2(18,000) + .4(12,000) = $11,600 d2 Design B 1 3 d3 Design C EV = .4(6,000) + .2(16,000) + .4(21,000) = $14,000 4