Chapter 9 - Capacity Planning & Facility Location

1. Chapter 9 - Capacity Planning & Facility Location Operations Management 6th Edition R. Dan Reid & Nada R. Sanders

2. Learning Objectives • Define capacity planning. • Explain the steps involved in capacity planning and location analysis. • Explain the usefulness of decision trees in decision making. • Identify key factors in location analysis. • Describe the decision-support tools used in location analysis.

3. Capacity Planning • Capacity is the maximum output rate of a facility • Capacity planning is the process of establishing the output rate that can be achieved at a facility: • Capacity is usually purchased in “chunks” • Strategic issues: how much and when to spend capital for additional facility & equipment • Tactical issues: workforce & inventory levels, & day-to-day use of equipment

4. Measuring Capacity • There is no one best way to measure capacity • Output measureslike kegs per day are easier to understand • With multiple products, input measureswork better

5. Measuring Capacity • Two types of information needed: • Amount of available capacity • Understand how much capacity the facility has • Effectiveness of capacity use • How effectively we are using the available capacity

6. Measuring Available Capacity • Design capacity: • Maximum output rate under ideal conditions • A bakery can make 30 custom cakes per day when pushed at holiday time • Effective capacity: • Maximum output rate under normal (realistic) conditions; usually lower than design capacity • On the average this bakery can make 20 custom cakes per day

7. Measuring Effectiveness of Capacity Use • Capacity Utilization: Measures how much of the available capacity (%) is actually being used. • Measures effectiveness • Use either effective or design capacity in denominator

8. Example of Computing Capacity Utilization: A bakery’s design capacity is 30 custom cakes per day. Currently the bakery is producing 28 cakes per day. What is the bakery’s capacity utilization relative to both design and effective capacity? • The current utilization is only slightly below its design capacity and considerably above its effective capacity • The bakery can only operate at this level for a short period of time

9. Capacity Considerations • The Best Operating Level is the output that results in the lowest average unit cost • Economies of Scale: • Where the cost per unit of output drops as volume of output increases • Spread the fixed costs of buildings & equipment over multiple units, allow bulk purchasing & handling of material • Diseconomies of Scale: • Where the cost per unit rises as volume increases • Often caused by congestion (overwhelming the process with too much work-in-process) and scheduling complexity

10. Best Operating Level and Size • When expanding capacity, there are two alternatives: • Purchase one large facility, requiring one large initial investment • Add capacity incrementally in smaller chunks as needed

11. Other Capacity Considerations • Focused factories: • Small, specialized facilities with limited objectives e.g. The Limited (Limited Too) • Plant within a plant (PWP): • Segmenting larger operations into smaller operating units with focused objectives • Subcontractor networks: • Outsource non-core items to free up capacity for what you do well; fast growing trend today

12. Making Capacity Planning Decisions The three-step procedure for making capacity planning decisions is as follows: • Identify Capacity Requirements • Develop Capacity Alternatives • Evaluate Capacity Alternatives

13. 1. Identifying Capacity Requirements • Forecasting Capacity: • Long-term capacity requirements based on future demand • Identifying future demand based on forecasting • Forecasting, at this level, relies on qualitative forecast models (Executive opinion & Delphi method) • Forecast and capacity decision includes strategic implications • Capacity cushions • Plan for added capacity to provide flexibility • Strategic Implications • How much capacity a competitor might have • Potential for overcapacity in industry a possible hazard

14. 2. Developing Capacity Alternatives • Capacity alternatives include: • Do nothing • Expand large now (may included capacity cushion) • Expand small now with option to add later

15. 3. Evaluating Capacity Alternatives • Use decision support aids to evaluate decisions • Decision tree most popular • Managers need to use many different inputs and judgment

16. Decision Trees Diagramming technique • Decision points – points in time when decisions are made, squares called nodes • Decision alternatives – branches or arrows leaving a decision point (nodes) • Chance events – events that could affect a decision, branches or arrows leaving circular chance nodes • Outcomes – each possible alternative listed

17. Decision Tree Diagrams Decision trees developed by • Drawing from left to right • Use squares to indicate decision points • Use circles to indicate chance events • Write the probability of each chance by the chance (sum of associated chances = 100%) • Write each alternative outcome in the right margin

18. Example Using Decision Trees: A restaurant owner has determined that she needs to expand her facility. Alternatives are to expand large now and risk smaller demand, or expand on a smaller scale now, knowing that she might need to expand again in three years. Which alternative would be most attractive?

19. Evaluating the Decision Tree • Utilizes Expected Value (EV) analysis • EV is a weighted average of chance events • Probability of occurrence * chance event outcome • Refer to previous slide • At decision point 2, choose to expand to maximize profits ($200,000 > $150,000) • Calculate EV of small expansion: • EVsmall = 0.30($80,000) + 0.70($200,000) = $164,000

20. Evaluating the Decision Tree - cont'd • Calculate EV of large expansion: • EVlarge = 0.30($50,000) + 0.70($300,000) = $225,000 • At decision point 1, compare alternatives & choose thelarge expansion to maximize the expected profit: • $225,000 > $164,000 • Choose large expansion despite the fact that there is a 30% chance it’s the worst decision: Take the calculated risk!

21. Location Analysis • Three most important factors in real estate: Location, Location, Location • Facility location is the process of identifying the best geographic location for a service or production facility • Long term commitment • Sizable financial investment and impact

22. Factors Affecting Location Decisions • Proximity to source of supply: • Reduce transportation costs of perishable or bulky raw materials • Proximity to customers: • High population areas, close to JIT partners • Proximity to labor: • Local wage rates, attitude toward unions, availability of special skills (Silicon Valley)

23. More Location Factors • Community considerations: • Local community’s attitude toward the facility (prisons, utility plants, etc.) • Site considerations: • Local zoning & taxes, access to utilities, etc. • Quality-of-life issues: • Climate, cultural attractions, commuting time, etc. • Other considerations: • Options for future expansion, local competition, transportation access and congestion, etc.

24. Globalization – Should Firm Go Global? Globalization is the process of locating facilities around the world • Potential advantages: • Inside track to foreign markets, avoid trade barriers, gain access to cheaper labor; closer to suppliers - manufacturers • Potential disadvantages: • Political risks may increase, loss of control of proprietary technology, local infrastructure (roads & utilities) may be inadequate, high inflation • Other issues to consider: • Language barriers, different laws & regulations, different business cultures

25. Making Location Decisions • Analysis should follow 3 step process: • Identify dominant location factors • Develop location alternatives • Evaluate locations alternatives • Procedures/tools for evaluating location alternatives include • Factor rating method • Load-distance model • Center of gravity approach • Break-even analysis • Transportation method

26. Factor Rating (with example) A procedure to evaluate multiple alternative locations based on a number of selected factors.

27. A Load-Distance Model Example: Matrix Manufacturing is considering where to locate its warehouse to service its four Ohio stores located in Cleveland, Cincinnati, Columbus, Dayton. Two sites are being considered; Mansfield and Springfield, Ohio. Use the load-distance model to make the decision. A procedure for evaluating location alternatives based on distance. • Calculate the rectilinear distance: • Multiply by the number of loads between each site and four cities

28. Calculating Load-Distance Score: Springfield vs. Mansfield The load-distance score for Mansfield is higher than for Springfield. The warehouse should be located in Springfield.

29. The Center of Gravity Approach Requires the analyst to find the center of gravity of the geographic area being considered for an alternative site. • Computing the Center of Gravity for Matrix Manufacturing • Is there another possible warehouse location closer to the C.G. that should be considered?? Why?

30. Break-Even Analysis Technique used to compute the amount of goods required to be sold to just cover costs • Break-even analysis includes fixed and variable costs • Break-even analysis can be used for location analysis especially when the costs of each location are known Step 1: For each location, determine the fixed and variable costs Step 2: Plot the total costs for each location on one graph Step 3: Identify ranges of output for which each location has the lowest total cost Step 4: Solve algebraically for the break-even points over the identified ranges

31. Break-Even Analysis – cont’d • Remember, the break even equations used for calculating total cost of each location and for calculating the breakeven quantity Q. Total cost = F + cQ Total revenue = pQ Break-even is where Total Revenue = Total Cost Q = F/(p-c) Q = break-even quantity p = price/unit c = variable cost/unit F = fixed cost

32. Example using Break-even Analysis: Clean-Clothes Cleaners is considering four possible sites for its new operation. They expect to clean 10,000 garments. The table and graph below are used for the analysis.

33. The Transportation Method • Can be used to solve specific location problems • Could be used to evaluate the cost impact of adding potential location sites to the network of existing facilities • Could also be used to evaluate adding multiple new sites or completely redesigning the network

34. Capacity Planning & Facility Location within OM • Decisions about capacity and location are highly dependent on forecasts of demand (Ch 8) • Capacity is also affected by operations strategy (Ch 2), as size of capacity is a key element of organizational structure • Other operations decisions that are affected by capacity and location are issues of job design and labor skills (Ch 11), choice on the mix of labor and technology, as well as choices on technology and automation (Ch 3)

35. Capacity Planning & Facility Location Across the Organization • Capacity planning and location analysis affect OM and are important to many others • Finance provides input to finalize capacity decisions • Marketing impacted by the organizational capacity and location to customers

36. Chapter 9 Highlights • Capacity planning is deciding on the maximum output rate of a facility • Location analysis is deciding on the best location for a facility • Capacity planning and location analysis decision are often made simultaneously because the location of the facility is usually related to its capacity.

37. Chapter 9 Highlights – cont'd • In both capacity planning and location analysis, managers must follow three-step process to make good decisions. The steps are assessing needs, developing alternatives, and evaluating alternatives. • To choose between capacity planning alternatives managers may use decision trees, which are a modeling tool for evaluating independent decisions that must be made in sequence.

38. Chapter 9 Highlights – cont'd • Key factors in location analysis included proximity to customers, transportation, source of labor, community attitude, and proximity to supplies. Service and manufacturing firms focus on different factors. Profit-making and nonprofit organizations also focus on different factors.

39. Chapter 9 Highlights – cont'd • Several tools can be used to facilitate location analysis. Factor rating is a tool that helps managers evaluate qualitative factors. The load-distance model and center of gravity approach evaluate the location decision based on distance. Break-even analysis is used to evaluate location decisions based on cost values. The transportation method is an excellent tool for evaluating the cost impact of adding sites to the network of current facilities.