Capacity Planning

1. Capacity Planning

2. Contents 1-What is capacity? Capacity planning? 2- Classification of capacity. 3- Capacity expansion strategies. 4- Economies and diseconomies of scale. 5- The challenges of planning service capacity. 6- capacity planning numerical tools (TREE + TRANSPORTATION+ NEEDS)

3. 1-What is capacity?

4. What is capacity? Capacity can be defined as: 1- What a manufacturing or servicesystemcan produce. 2 - The rate at which output can beproduced by an operating unit: a machine,process, facility, or company (The rate of output from an OM system per unit of time, or the rate at which the firm withdraws work from the system.). 3- The work that the system is capable of doingin a period of time, It is normally stated in standard hours of work. 4- The maximum output rate of a production or service facility. 5- The upper limit or ceiling on theload that an operating unit can handle. It must be over some specified duration

5. What is capacity planning? • Capacity planning is an approach for determining the overall capacity level of capital intensive resources, including facilities, equipment, and overall labor force size • Capacity planning involves the long and short term planning of the systems potential for transforming resources into outputs demanded by customers within a set time period. • Strategic issues: • How much and when to spend capital for additional facility & equipment • Tactical issues: • Workforce & inventory levels, & day-to-day use of equipment

6. Capacity planning -The basic questions The basic questions in capacity planning are: 1-What kind( and amount) of capacity is needed? (how much long range capacity is needed):- • How many machines should be purchased? • How many workers should be hired? 2- When additional capacity is needed? 3- How to maintain A BALANCE ? (too high, too low)

7. Things to keep in mind when planning capacity • Design flexibility into systems • Take a “big picture” approach to capacity changes • Prepare to deal with capacity “chunks” • Attempt to smooth out capacity requirements • Identify the optimal operating level

8. 2-Classification of capacity

9. (A)- Design capacity • Design (or theoretical, or installed or peak) capacity is the maximum output that can be achieved in a given time period from a particular machine (or plant). • It is a theoretical capacity as it does not take into considerationpower breakdown, poor planning, non availability of materials, labor absenteeism etc. • This capacity is realizable only if certain conditions are satisfied: 1- There are no interruptions of any kind. 2- There is cent per cent utilization of capacity. 3- Men and machine work in ideal conditions. 4- Quality of input and every thing else is according to specifications. • In real life situation it is difficult to fulfill these conditions. Therefore design capacity only sets the maximum limit and also serves to judge the actual utilization of plant capacity.

10. (B)- Effective capacity • Effective (demonstrated , or practical , or operating ) capacity is the rate production that can be achieved for extended periods under normal conditions, taking into account the product mix, scheduling methods, employee training, rest periods, scrap, machine breakdowns, rework, sick time, a portion of available hours cannot be worked due to scheduling delays, preventive maintenance, and so on. • So the effective capacity is the maximum capacityminusthe capacity lost due to these factors.

11. 3- Capacity expansion strategies

12. Capacity expansion strategieswhen to expand+ by how much There are three basic strategies for capacity expansion : A- Lead strategy B- Lag strategy C- Average strategy

13. Capacity lead strategy Capacity lag strategy Units Units Capacity Demand Capacity Demand Time Time Average capacity strategy Incremental vs. one-step expansion Units Units Capacity One-step expansion Incremental expansion Demand Demand Time Time Capacity expansion strategies

14. (A) Lead strategy:Expand capacity in anticipation of growth • stays a head of demand • Lead strategy (or demand leading strategy, or proactive strategy) by maintaining excess capacity. The goal of this strategy is to maintain sufficient capacity to minimize the chances of not meeting demand

15. (A) Lead strategy:Expand capacity in anticipation of growth • Benefits: • 1- Companies that have excess capacity can often gain market share by satisfying the demand by customers of competitors that are capacity constrained, • 2- Since there is always excess capacity, a “cushion” against unexpected demand from large orders or new customers is provided. • This cushion also enables the firm to give good customer service, since backorders will rarely occur • 3- Allow the company to respond quickly to unexpected increases in demand (Minimizes the chance of sales lost to insufficient capacity) • 4- Provide fast delivery to customers without overtime costs or production disruptions. • 5- Expansion may result in economies of scale and faster rate of learning, thus helping a firm reduce its costs and compete on price • 6- Increase the firm’s market share or act as a form of preemptive marketing

16. (B) Lag strategy:Increase capacity after increase in growth • In lag strategy (or demand trailing strategy, or reactive strategy) capacity expansion lags behind demand (not adding capacity until demand is expected to exceed current capacity over the long term), and results in constant capacity shortage. • This strategy usually assumes: • (1) A company can increase short-term capacity using overtime work, or possibly subcontracting. • (2) That customers will tolerate some delay in delivery.

17. (B) Lag strategy:Increase capacity after increase in growth • Benefits: • 1- Require less investment (expand in smaller increments, such as by renovating existing facilities rather than building new ones) • 2- High capacity utilization and thus a higher rate of return on investment • 3- Because this strategy follows demand, it reduces the risk of over expansion based on overly optimistic demand forecasts, obsolete technology, or inaccurate assumptions regarding competition

18. (B) Lag strategy:Increase capacity after increase in growth • Limitations: • 1- Reduce long-term profitability through overtime and productivity losses that occur as the firm scrambles to satisfy demand.( This strategy keeps capital equipment cost per unit low, but overtime and subcontracting costs can be substantial and there is a high risk of losing sales by not being sufficiently responsive to customer demand) • 2- In the long run, such a strategy can lead to a permanent loss of market position. • Cannot accommodate new or unexpected demand at peak times • Often forced to add capacity during peak of business cycle, when costs of expansion are high • High overtime and/or subcontracting costs • response and delivery to customers are slow

19. (C)- Average (neutral )strategy • Average strategy is the strategy of matching capacity additions with demand as closely as possible. • When the capacity curve is above the demand curve, the firm has excess capacity; when it is below, there is insufficient capacity to meet demand. • During periods of capacity shortage, there are several alternatives. The firm can incur lost sales and possibly lose market position, or it can make short-term capacity expansions through subcontracting, overtime, additional shifts, and so forth. The intermediate approach of trying to match capacity to demand is most effective when:- 1- demand can be accurately predicted, 2- growth in demand occurs at a relatively steady rate, and 3- there is no substantial lumpiness in capacity additions. When these conditions exist, this strategy will usually minimize the combined costs of facility underutilization, lost sales due to shortages, andinventories

20. Capacity expansion : one step or incremental increasing? • With all of these strategies, the firm has the option of makingfrequent smallcapacity increments or fewer large increments. • The choice should be based on careful economic analysis of the cost and risks associated with excess capacity and capacity shortages. • There are two general approaches to expand long -range capacity:- 1- All at once : Build the ultimate facility now and grow into it 2- Incrementally : Build incrementally as capacity demand grows

21. Capacity expansion : one step or incremental increasing? 1- All at once: • Less interruption of production • Little risk of having to turn down business due to inadequate capacity • 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. 2- 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

22. 4- Economies and diseconomies of scale

23. Economies of scale • Economies of scale:- • Where the cost per unit of output drops as volume of output increases (If the output rate is less than the optimal level, increasing the output rate results in decreasing average unit costs). • Reasons for economies of scale include the following • 1- Fixed costs are spread over more units, reducing cost per unit • 2- Construction costs increase at a decreasing rate with respect to the size of the facility to be built • 3- Processing costs decrease as output rate increase because operations become more standardized, which reduces unit costs • 4- Quantity discounts are available for material purchases • 5- operating efficiency increases as workers gain experience

24. Best Operating Level and Size • The Best Operating Level is the output that results in the lowest average unit cost

25. Diseconomies of scale • Diseconomies of scale:- • Where the cost per unit rises as volume increases • Reasons for diseconomies of scale • 1- Distribution costs increase due to traffic congestion and shipping from one large centralized facility instead of several smaller, decentralized facilities • 2- Complexity increases costs; control and communication become more problematic • 3- Inflexibility can be an issue (firms are too big to operate effectively) • 4- Additional levels of bureaucracy exists, slowing decision making (decisions take too long to make)and approvals for changes • 5-Damaged goods • 6-Reduced morale • 7- Increased use of overtime

26. 5-The challenges of planning service capacity

27. One page word

28. 6- Calculating capacity needs

29. Capacity-planning tools • Break-Even Analysis. • Present-Value Analysis. • Computer Simulation. • Waiting Line Analysis. • Linear Programming. • Decision Tree Analysis.

30. 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

31. 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.

32. Example of a Decision Tree 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:

33. A B C Step 1. We start by drawing the three decisions

34. $90k High demand (0.4) $50k Medium demand (0.5) $10k Low demand (0.1) A $200k High demand (0.4) $25k B Medium demand (0.5) -$120k Low demand (0.1) C $60k High demand (0.4) $40k Medium demand (0.5) $20k Low demand (0.1) Step 2. Add our possible states of nature, probabilities, & payoffs

35. High demand (0.4) Medium demand (0.5) Low demand (0.1) Step 3. Determine the expected value of each decision $90k $50k $62k $10k A EVA=0.4(90)+0.5(50)+0.1(10)=$62k

36. $90k High demand (0.4) $50k Medium demand (0.5) $10k Low demand (0.1) A $200k High demand (0.4) $25k B Medium demand (0.5) -$120k Low demand (0.1) C $60k High demand (0.4) $40k Medium demand (0.5) $20k Low demand (0.1) Step 4. Make decision $62k $80.5k $46k Alternative B generates the greatest expected profit, so our choice is B or to construct a new facility