Strategic Capacity Planning

1. 5 Strategic Capacity Planning Slides prepared by Laurel Donaldson Douglas College

2. LO 1 Define capacity, explain the importance of long-term capacity, know how to measure capacity and understand two related performance measures, and describe factors influencing effective capacity. Describe the strategic capacity planning process in organizations, know how to forecast demand and calculate capacity requirements, and discuss major considerations for developing capacity alternatives, Describe the break-even analysis approach for evaluating capacity alternatives, and use it to solve problems. LO 2 LO 3

3. What is capacity? • Measuring capacity • Factors influencing capacity • Developing capacity alternatives • Evaluating alternatives

4. What is capacity? • The basic questions in capacity handling are: • What kind of capacity is needed? • How much is needed? • When is it needed? Capacity is the upper limit on the load that an operating unit can handle.

5. Importance of Long-Term Capacity

6. Measuring capacity • Design capacity • maximum obtainable output under ideal conditions • Effective capacity • Maximum capacity given delays, product mix, scheduling difficulties, and other realities. • Actual output • rate of output actually achieved—cannot exceed effective capacity.

7. Common Measures of Capacity

8. Efficiency and Utilization

9. Efficiency/Utilization Example Design capacity = 50 trucks/day Effective capacity = 40 trucks/day Actual output = 36 units/day

10. What is the design capacity for one week? Calculate the efficiency and utilization rates. Example: Capacity Actual production last week = 32,000 units Effective capacity = 35,000 units Design capacity = 250 units per hour Factory operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (250) = 42,000 units

11. Utilization = 32,000/42,000 = 76.2% Example: Capacity Actual production last week = 32,000 units Effective capacity = 35,000 units Design capacity = 250 units per hour Factory operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (250) = 42,000 units

12. Utilization = 32,000/42,000 = 76.2% Example: Capacity Actual production last week = 32,000 units Effective capacity = 35,000 units Design capacity = 250 units per hour Factory operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (250) = 42,000 units Efficiency = 32,000/35,000 = 91.4%

13. Factors Influencing Capacity • Facilities • Floor space, layout • Products or services • Limited menu in a restaurant • Human • Training, skills and experience • Planning and Operational • No of shifts per day, inventory, quality control • External • Pollution standards, paper work

14. Factors Influencing Capacity

15. Capacity planning process

16. Decline Growth Volume Volume 0 0 Time Time Cyclical Stable Volume Volume 0 0 Time Time Some Possible Growth Patterns

17. Calculating Capacity Requirements A department works one eight hour shift, 250 days a year, and has these figures for products, their demand, and usage of a type of machine that is currently being considered. How many machines would be needed to handle the required volume?

18. Developing Capacity Alternatives

19. Small plant Medium plant Average cost per unit Large plant 0 Output rate Optimal operating level Minimum cost & optimal operating rate are functions of size of production unit.

20. Large Facility Small Facility Medium Facility Average cost per unit Economies of scale Diseconomies of scale Best operating level Best operating level Output rate Best operating level Economies and Diseconomies of Scale What makes the unit cost increase?

21. Economies and Diseconomies of Scale • Economies of scale • Fixed costs (facilities, equipment, management) spread out over more units • Volume purchase discounts • Diseconomies of scale • Worker fatigue, equipment breakdown, less room for error, difficulties in coordination

22. Evaluating alternatives • Economic considerations • Cost, useful life, compatibility, revenue • Non economic considerations • Public opinion, reactions from employees, community pressure • Techniques used for evaluation: • Break Even Analysis • Payback Period • Net Present Value

23. Break Even Analysis

24. Total revenue Total cost Break-even point Total revenue = Total cost Profit Amount ($) Variable cost Loss Fixed cost Q (quantity in units) Break-Even Analysis

25. QBEP = = = 7273 $40,000 10.00 - (3 +1.50) FC R - VC Example: Break-Even Fixed costs = $40,000 Material = $1.50/unit Labour costs = $3/unit Selling price = $10.00 per unit

26. Example: Break-even Analysis • The school cafeteria can make pizza for about $.30 per slice. • Cost for kitchen and labour is $200 per day • The nearby Pizza Den delivers for $9.00 per pizza (8 slices) • Cost for labour reduced to $75 per day • Make or Buy?

27. $ FC + VC = TC FC + VC = TC 3 machines FC + VC = TC 2 machines 1 machine Quantity Step fixed costs and variable costs. Break-Even Problem with Step Fixed Costs

28. $ TC TC 3 TC 2 TR 1 Quantity Multiple Break-Even Points Multiple break-even points

29. Assumptions of Break Even Analysis

30. Further Financial Analysis • Cash Flow • (cash received from sales and other sources) -- (cash outflow for labour, material, overhead, taxes) • Present Value • the sum, in current value, of all future cash flows of an investment proposal. • most used methods of financial analysis: • Payback period • Net present value (NPV) • Internal rate of return (IRR)

31. What is Capacity? Capacity usually refers to the upper limit of: A) inventories B) demand C) supplies D) rate of output E) finances Ans: D Page: 141

32. What is capacity? Capacity decisions are mostly long term decisions. Ans: False Page: 141 Stating capacity in dollar amounts generally results in a consistent measure of capacity. Ans: False Page: 142

33. Capacity performance The maximum possible output given a product mix, scheduling difficulties, quality factors, and so on, is: A) utilization B) design capacity C) efficiency D) effective capacity E) available capacity Ans: D Page: 142

34. Capacity Performance Efficiency is defined as the ratio of: A) actual output to effective capacity B) actual output to design capacity C) design capacity to effective capacity D) effective capacity to actual output E) design capacity to actual output Ans: A Page: 143

35. Capacity Performance Utilization is defined as the ratio of: A) actual output to effective capacity B) actual output to design capacity C) design capacity to effective capacity D) effective capacity to actual output E) design capacity to actual output Ans: B Page: 143

36. Define capacity and identify some common ways it is measured. • Distinguish between efficiency and utilization and be able to calculate them. • Describe factors that influence effective capacity. • Describe the steps of the strategic capacity planning process. • Discuss major considerations for developing capacity alternatives. • Use break-even analysis to solve problems.