IE 3265 Production & Operations Management

1. IE 3265 Production & Operations Management Slide Series 2

2. Topics for discussion • Product Mix and Product Lifecycle – as they affect the Capacity Planning Problem • The Make or Buy Decision • Its more than $ and ¢! • Break Even Analysis, how we filter in costs • Capacity Planning • When, where and How Much

3. Product Issues related to capacity planning • Typical Product Lifecycle help many companies make planning decisions • Facility can be designed for Product Families and the organization tries to match lifecycle demands to keep capacitiy utilized

4. The Product Life-Cycle Curve

5. The Product/Process Matrix

6. Product Mix (Families) Typically Demand Different Production Capacity Design • Is product Typically “One-Off” • These systems have little standardization and require high marketing investment per product • Typically ‘whatever can be made in house’ will be made ‘in house’ • Most designs are highly private and guarded as competitive advantages • Multiple Products in Low Volume • Standard components are made in volume or purchased • Shops use a mixture of flow and fixed site manufacturing layouts

7. Product Mix (Families) Typically Demand Different Production Capacity Design • Few Major (discrete) Products in Higher Volume • Purchase most components (its worth standardizing nearly all components) • Make what is highly specialized or provides a competitive advantage • Make decisions are highly dependent of capacity issues • High Volume & Standardized “Commodity” Products • Flow processing all feed products purchased • Manufacturing practices are carefully guarded ‘Trade Secrets’

8. Make-Buy Decisions • A difficult problem address by the M-B matrix • Typically requires an analysis of the issues related to People, Processes, and Capacity • Ultimately the problem is addressed economically

9. Make – Buy Decision Process Can Item be Purchased? NO YES Can Item be Made? NO YES

10. Make – Buy Decision Process Is it cheaper to make than buy? NO YES Is Capital Available To Made? NO YES

11. Break-even Curves for the Make or Buy Problem Cost to Buy = c1x Cost to make=K+c2x K Break-even quantity

12. Example M-B Analysis • Fixed Costs to Purchase consist of: • Vendor Service Costs: • Purchasing Agents Time • Quality/QA Testing Equipment • Overhead/Inventory Set Asides • Fixed Costs to Make (Manufacture) • Machine Overhead • Invested $’s • Machine Depreciation • Maintenance Costs • Order Related Costs (for materials purchase and storage issues)

13. Example M-B Analysis • BUY Variable Costs: • Simply the purchase price • Make Variable Costs • Labor/Machine time • Material Consumed • Tooling Costs (consumed)

14. Example M-B Analysis • Make or Buy a Machined Component • Purchase: • Fixed Costs for Component: $4000 annually ($20000 over 5 years) • Purchase Price: $38.00 each • Make Using MFG Process A • Fixed Costs: $145,750 machine system • Variable cost of labor/overhead is 4 minutes @ $36.50/hr: $2.43 • Material Costs: $5.05/piece • Total Variable costs: $7.48/each

15. Example M-B Analysis • Make on MFG. Process B: • Fixed Cost of Machine System: $312,500 • Variable Labor/overhead cost is 36sec @ 45.00/hr: $0.45 • Material Costs: $5.05 • Formula for Breakeven:Fa + VaX = Fb + VbX X is Break even quantityFi is Fixed cost of Option iVi is Variable cost of Option i

16. Example M-B Analysis • Buy vs MFG1: BE is {(145750-20000)/(38-7.48)} = 4120 units • Buy vs MFG2: BE is {(312500-20000)/(38-5.5)} = 9000 units • MFG1 vs MFG2: BE is {(312500-145750)/(7.48-5.50)} = 68620 units

17. Capacity Strategy Fundamental issues: • Amount. When adding capacity, what is the optimal amount to add? • Too little means that more capacity will have to be added shortly afterwards. • Too much means that capital will be wasted. • Timing. What is the optimal time between adding new capacity? • Type. Level of flexibility, automation, layout, process, level of customization, outsourcing, etc.

18. Three Approaches to Capacity Strategy • Policy A: Try not to run short. Here capacity must lead demand, so on average there will be excess capacity. • Policy B: Build to forecast. Capacity additions should be timed so that the firm has excess capacity half the time and is short half the time. • Policy C: Maximize capacity utilization. Capacity additions lag demand, so that average demand is never met.

19. Capacity Leading and Lagging Demand

20. Determinants of Capacity Strategy • Highly competitive industries (commodities, large number of suppliers, limited functional difference in products, time sensitive customers) – here shortages are very costly. Use Type A Policy. • Monopolistic environment where manufacturer has power over the industry: Use Type C Policy. (Intel, Lockheed/Martin). • Products that obsolete quickly, such as computer products. Want type C policy, but in competitive industry, such as computers, you will be gone if you cannot meet customer demand. Need best of both worlds: Dell Computer.

21. Mathematical Model for Timing of Capacity Additions Let D = Annual Increase in Demand x = Time interval between adding capacity r = annual discount rate (compounded continuously) f(y) = Cost of operating a plant of capacity y Let C(x) be the total discounted cost of all capacity additions over an infinite horizon if new plants are built every x units of time. Then

22. Mathematical Model (continued • A typical form for the cost function f(y) is: Where k is a constant of proportionality, and a measures the ratio of incremental to average cost of a unit of plant capacity. A typical value is a=0.6. Note that a<1 implies economies of scale in plant construction, since

23. Mathematical Model (continued) Hence, It can be shown that this function is minimized at x that satisfies the equation: This is known as a transcendental equation, and has no algebraic solution. However, using the graph on the next slide, one can find the optimal value of x or any value of a (0 < a < 1)

25. Issues in Plant Location • Size of the facility. • Product lines. • Process technology. • Labor requirements. • Utilities requirements • Environmental issues. • International considerations • Tax Incentives.