Benedicta Ochuwa IdaeworGrace Angela Marasigan

Ma Chere Gracita Reyes-Bilog

Strategic Capacity Planning for Products and Services

Process Selection

Capacity

The number of units a facility can hold, receive, store or produce in a period of time.

The upper limit or ceiling on the load that an operating unit can handle.

Capacity needs include:EquipmentSpaceEmployees Skills

Capacity Planning

GoalTo achieve a match between the long-term supply

capabilities of an organization and the predicted level of long-run demand.

Overcapacity - causes operating costs that are too high.

Under-capacity – causes strained resources and possible loss of customers.

Strategic Capacity Planning

OvercapacityThe factory's

overcapacity led to falling prices in the stores.

Under-capacityAn event that has a

small venue but a lot of attendees.

Examples

Key Questions:What kind of capacity is needed?How much capacity is needed to match demand?When is it needed?

Related Questions:How much will it cost?What are the potential benefits and risks?Should capacity be changed all at once or through

several smaller changes?Can the supply chain handle the necessary

changes?

Capacity Planning Questions

Capacity decisions1.) Impact the ability of the organization to meet future demands

2.) Affect operating costs

3.) Are a major determinant of initial cost

4.) Often involve long-term commitment of resources

5.) Can affect competitiveness

6.) Affect the ease of management

7.) Are more important and complex due to globalization

8.) Need to be planned for in advance due to their consumption of financial and other resources

Capacity Decisions Are Strategic

Design CapacityMaximum output rate or service capacity an

operation, process or facility is designed for.Effective CapacityDesign capacity minus allowances such as

personal time, maintenance and scrap.Actual OutputRate of output actually achieved, cannot

exceed effective capacity.

Defining and Measuring Capacity

Actual outputThe rate of output actually achievedIt cannot exceed effective capacity

Efficiency

Utilization

Measured as percentages

Measuring System Effectiveness

Design Capacity = 50 trucks per dayEffective Capacity = 40 trucks per dayActual Output = 36 trucks per day

Example of Efficiency and Utilization

FacilitiesProduct and Service FactorsProcess FactorsHuman FactorsPolicy FactorsOperational FactorsSupply Chain FactorsExternal Factors

Determinants of Effective Capacity

An organization typically bases its capacity strategy on assumptions and predictions about long-term demand patterns, technological changes, and the behavior of its competitors.

Key decisions of capacity planning relate to:1.) The amount of capacity needed.2.) The Timing of changes.3.) The need to maintain balance throughout the system.4.) The extent of flexibility of facilities and the workforce.

Strategy Formulation

Deciding on the amount of capacity involves consideration of expected demand and capacity cost.

Capacity Cushion, which is an amount of excess capacity in excess of expected demand when there is uncertainty about demand.

The greater the degree of demand uncertainty, the greater the amount cushion used.

Strategy Formulation

1.) Estimate future capacity requirements.2.) Evaluate existing capacity and facilities and identify gaps.3.) Identify alternatives for meeting requirements.4.) Conduct financial analyses of each alternative.5.) Asses key qualitative issues for each alternative.6.) Select the best alternative for the long term.7.) Implement the selected alternative.8.) Monitor results.

Steps in the Capacity Planning Process

Long-term considerations relate to overall level of capacity requirements

Short-term considerations relate to probable variations in capacity requirements

Forecasting Capacity Requirements

Some Possible Growth / Decline Patterns

Volume

Volume

Volume

Volume

0 0

0 0

Time Time

Time Time

Growth Decline

Cyclical Stable

Calculating processing requirements requires reasonably accurate demand forecasts, standard processing times and available work time

Calculating Processing Requirements

Capacity planning for services can present special challenges due to the nature of services.

Three very important factors in planning service capacity are:1.) Need to be near customers 2.) Inability to store services 3.) Degree of demand volatility balance

The Challenges of Planning Service Capacity

The make-or-buy decision is the act of making a strategic choice between producing an item internally (in-house) or buying it externally (from an outside supplier). The buy side of the decision also is referred to as outsourcing.

Factors Considered:

1.) Available Capacity

2.) Expertise

3.) Quality Considerations

4.) Nature of Demand

5.) Cost

6.) Risks

Make or Buy?

Aside from the general considerations about the development of alternatives, other things that can enhance capacity management such as:

1.) Design Flexibility into system

2.) Take Stage of life cycle into account

- Capacity requirements are often closely linked to the stage of the life cycle that a product or service is in.

Developing Capacity Alternatives

3.) Take a “big picture” approach to capacity changes

- Consider how parts of the system interrelate

4.) Prepare to deal with capacity “chunks”

- Capacity increases are often acquired in fairly large chunks rather than smooth increments, making it difficult to achieve a match between desired capacity and feasible capacity

5.) Attempt to smooth out capacity requirements

- Unevenness in capacity requirements also can create certain problems.

6.) Identify the optimal operating level

- Production units have an optimal rate of output for minimal cost.

Developing Capacity Alternatives

Evaluating Alternatives

At the ideal level, cost per unit is the lowest level for that production unit. Outside the ideal, it will result to either economies of scale or diseconomies of scale.

Economies of scale - If the output rate is less than the optimal level, increasing the output rate will result in decreasing average unit cost, i.e., the cost per unit of output drops as volume of output increases

The reasons for economies of scale include the following:a. Fixed costs are spread over more units, reducing the fixed cost per unit.b. Construction costs increase at a decreasing rate with respect to the size of the facility to be built.c. Processing costs decrease as output rates increase because operations become more standardized, which reduces unit costs.

However, if output is increased beyond the optimal level, average unit costs would become increasingly larger. This is known as the diseconomies of scale. The reasons for diseconomies of scale are as follows:

a. Distribution costs increase due to traffic congestion and shipping from one large centralized facility instead of several smaller, decentralized facilities.

b. Complexity increases costs; control and communication become more problematic.

c. Inflexibility can be an issue.

d. Additional levels of bureaucracy exist, slowing decision making and approvals for changes.

 

7.) Choose a strategy if expansion is involved – Consider whether incremental expansion or single step is more appropriate. Factors include competitive pressures, market opportunities, costs and availability of finds, disruption of operations, and training requirements, Also, decide whether to lead or follow competitors. Leading is more risky but it may have greater potential for rewards.

The Theory of Constraints was developed and popularized by Eliyahu Goldratt. TOC, as it is commonly called, recognizes that organizations exist to achieve a goal.

A factor that limits a company's ability to achieve more of its goal is referred to as a "constraint"

CONSTRAINT MANAGEMENT

1.) The focus is on balancing flow, not on balancing capacity.

2.) Maximizing output and efficiency of every resource will not maximize the throughput of the entire system.

3.) An hour lost at a bottleneck or constrained resource is an hour lost for the whole system. An hour saved at a non-constrained resource does not necessarily make the whole system more productive.

4.) Inventory is needed only in front of the bottlenecks to prevent them from sitting idle, and in front of assembly and shipping points to protect customer schedules. Building inventories elsewhere should be avoided.

7 Principles of the Theory of Constraints

5.) Work should be released into the system only as frequently as the bottlenecks need it. Bottleneck flows should be equal to the market demand. Pacing everything to the slowest resource minimizes inventory and operating expenses.

6.) Activation of non-bottleneck resources cannot increase throughput, nor promote better performance on financial measures.

7.) Every capital investment must be viewed from the perspective of its global impact on overall throughput (T), inventory (I), and operating expense (OE).

7 Principles of the Theory of Constraints

Market ResourceMaterialFinancialSupplierKnowledge or

competencyPolicy

7 Categories of ConstraintsHowever, in general, these types of constraints can just be either internal or external to the system. An internal constraint is in evidence when the market demands more from the system than it can deliver. If this is the case, then the focus of the organization should be on discovering that constraint and following the five focusing steps to open it up (and potentially remove it). An external constraint exists when the system can produce more than the market will bear. If this is the case, then the organization should focus on mechanisms to create more demand for its products or services.

Step 1: Identify the constraintStep 2: Develop a plan for overcoming the constraintsStep 3: Focus resources on accomplishing Step 2Step 4: Reduce the effects of constraints by offloading work or expanding capabilityStep 5: Once overcome, go back to Step 1 and find new constraints

Five-step process for recognizing and managing limitations

EXAMPLE

The demand for parts produced by a computer-controlled piece of equipment known as the NCX10 exceeded the machine's capacity.

Since the factory could only assemble and sell as many products as they had parts from the machine.

The capacity of the factory to make money was tied directly to the output of the NCX10. The NCX10, therefore, was the constraint.

In order to manage a constraint, it is first necessary to identify it.

In the above example, the NCX10 was identified as the constraint.

This knowledge helped the company determine where an increase in "productivity" would lead to increased profits.

Concentrating on a non-constraint resource would not increase the throughput because there would not be an increase in the number of products assembled.

To increase throughput, flow through the constraint must be increased.

STEP 1 – IDENTIFY THE CONSTRAINT

Once the constraint is identified, the next step is to focus on how to get more production within the existing capacity limitations.

When the company and the labor union agreed to stagger lunches, breaks, and shift changes so the machine could produce during times it previously sat idle.

This added significantly to the output of the NCX10, and therefore to the output of the entire plant.

To manage the output of the plant, a schedule was created for the constraint. The schedule showed the sequence in which orders would be processed and their approximate starting time.

STEP 2 – DEVELOP PLAN FOR OVERCOMING CONSTRAINT

Exploiting the constraint does not ensure that the materials needed next by the constraint will always show up on time.

The most important component of subordination is to control the way material is fed to the non-constraint resources.

TOC says that non-constraint resources should only be allowed to process enough materials to match the output of the constraint.

The release of materials is closely controlled and synchronized to the constraint schedule

STEP 3 – FOCUS RESOURCES ON ACCOMPLISHING STEP 2 or SUBORDINATE

The next step is to determine if the output of the constraint is enough to supply market demand. If not, it is necessary to find more capacity by "elevating" the constraint.

In the above example, schedulers were able to remove some of the load from the constraint by rerouting it across two other machines.

They also outsourced some work and brought in an older machine that could process some of the parts made by the NCX10.

These were all ways of adding capacity, or elevating the constraint.

STEP 4 – REDUCE THE EFFECTS OF CONSTRAINTS BY OFFLOADING WORK OR

EXPANDING CAPABILITY

Once the output of the constraint is no longer the factor that limits the rate of fulfilling orders, it is no longer a constraint.

Step 5 is to go back to Step 1 and identify a new constraint because there always is one.

STEP 5 - GO BACK TO STEP 1

Alternatives should be evaluated from varying perspectives.

EVALUATING ALTERNATIVES

1.) ECONOMIC Cost-volume analysis

Break-even point Financial analysis

Cash flow

Present value Decision theory Waiting-line analysis Simulation

2.) NON-ECONOMIC Public opinion

Focuses on the relationship between cost, revenue and volume of out-put.

Purpose of cost-volume analysis is to estimate the income of an organization under different operating conditions.

It is particularly useful as a tool for comparing capacity alternatives.

Cost-Volume Analysis

One product is involved.Everything produced can be sold.The variable cost per unit is the same regardless

of the volume.Fixed costs do not change with volume changes,

or they are step changes.The revenue per unit is the same regardless of

volume.Revenue per unit exceeds variable cost per unit.

Assumptions of Cost-Volume Analysis

Important terms in financial analysis:Cash flow

The difference between cash received from sales and other sources, and cash outflow for labor, material, overhead, and taxes

Present valueThe sum, in current value, of all future cash

flow of an investment proposal

Financial Analysis

a. Payback - a crude but widely used method that focuses on the length of time it will take for an investment to return its original costs. Payback ignores the time value of money. Its use is easier to rationalize for short-term than for long-term projects.

b. Present Value – summarizes the initial costs of an investment, its estimated annual cash flows, and any expected salvage value in a single value called equivalent current value, taking into account the time value of money (interest rates)

c. Internal Rate of Return (IRR) – summarizes the initial cost, expected annual cash flows, and estimated future salvage value of an investment proposal in an equivalent interest rate. In other words, this method identifies the rate of return that equates the estimate future returns and the initial costs.

3 Most commonly used methods of financial analysis

These techniques are appropriate when there is a high degree of certainty associated with estimates of future cash flows. In many instances, however, operations managers and other managers must deal with situations better described as risky or uncertain.

3 Most commonly used methods of financial analysis

A helpful tool for financial comparison of alternatives under conditions of risk or uncertainty. It is suited to capacity decisions and to a wide range of other decisions managers must make such as product and service design, equipment selection and location planning.

Decision Theory

1.) Mistakes in Decision Process

2.) Bounded Rationality3.) Suboptimization

Causes of Poor Decision

It happens because of mistakes on the following decisions steps:

Mistakes in Decision Process

1 •Identify the problem.

2 •Specify the objectives and criteria for solution.

3 •Develop suitable alternatives.

4 •Analyze and compare alternatives.

5 •Select the best alternative.

6 •Implement the solution.

7 •Monitor to see that desired result is achieved.

Bounded Rationality

Limitations on decision making caused by costs, human

abilities, time, technology, and availability of information.

Because of these limitations, managers can’t always expect to reach decisions

that are optimal in the sense of providing the best possible outcome. They might

instead, resort to a satisfactory solution.

Usually occurs because organizations typically departmentalize decisions. The result of different departments each attempting to reach a solution that is optimum for that department. Unfortunately, what is optimal for one department may not be optimal for the organization as a whole.

Suboptimization

Decision-making under Certainty

When it is known for certain which of the possible future conditions will actually happen, the decision is usually relatively straightforward – simply choose the alternative that has the best payoff under that state of nature.

Decision-making under Uncertainty

At the opposite extreme is complete uncertainty. No information on how likely the various states of nature are.

Under those conditions, 4 possible decision criteria are:

Maximin Choose the alternative with the best of the worst possible payoff.

Laplace Choose the alternative with the best average period of any of the alternatives.

Minimax Regret Choose the alternative that has the least of worst regrets.

Decision-making under Risk

Between the two extremes of certainty and uncertainty lies the case of risk: the probability of occurrence for each state is known. Decisions made under the condition that the probability of occurrence for each state of nature can be estimated. A widely applied criterion is expected monetary value (EMV).

In EMV, the manager determines the expected payoff of each alternative, and then chooses the alternative that has the best expected payoff. This approach is most appropriate when the decision maker is neither risk averse nor risk seeking

Decision Tree A schematic representation of the alternatives available to

a decision maker and their possible consequences. The term gets its name from the tree-like appearance of the diagram. The decision tree is particularly useful for analyzing situations that involve sequential decisions. A decision tree is composed of a number of nodes that have branches emanating from them.

Other methods under Decision Theory are:

Expected Value of Perfect Information (EPVI) - The difference between the expected payoff with perfect information and the expected payoff under risk

Sensitivity Analysis – provides a range of probability for which an alternative has the best expected payoff.

Analysis of lines is often useful for designing or modifying service systems. Waiting lines have a tendency to form in a wide variety of service systems. The lines are symptoms of bottleneck operations. Analysis is useful in helping managers choose a capacity level that will be cost-effective through balancing the cost of having customers wait with the cost of providing additional capacity.

WAITING-LINE ANALYSIS

This is useful in evaluating “what if” scenarios. What if analysis is a powerful tool for improvement that evaluates how strategic, tactical or operational changes may impact the business. Through different scenarios you will be able to perform a true-to-life analysis of your processes without putting your business operation at risk.

SIMULATION One will be able to answer questions like: How would the processing time of a case decrease if the number of available resources is doubled?

What would be the cost/benefit rate of reducing the process time in a specified activity?

What would be the effect of altering the working shift configuration in the operational cost and service level?

Capacity planning impacts all areas of the organization

It determines the conditions under which operations will have to function Flexibility allows an organization to be agile It reduces the organization’s dependence on forecast

accuracy and reliabilityMany organizations utilize capacity cushions to achieve

flexibilityBottleneck management is one way by which

organizations can enhance their effective capacities Capacity expansion strategies are important organizational

considerations Expand-early strategy Wait-and-see strategy

Capacity contraction is sometimes necessary Capacity disposal strategies become important under these

conditions

OPERATION STRATEGY

Thank You!!!Happy Valentines Day…

Next is Chapter 6AProcess Selection