5. Strategic Capacity Planning

Dr. Ron Lembke

Operations Management

Ideal Capacity of a Process

What is the capacity of the system? Should we add any capacity? How should we run the system? Where should we keep inventory?

50/hr 20/hr 10/hr 40/hr

Ideal Capacity of a Process

What is the capacity of the system?

6 min 5 min 4 min 5 min

What Would Henry Say?

Ford introduced the $5 (per day) wage in 1914 He introduced the 40 hour work week “so people would have more time to buy” It also meant more output: 3*8 > 2*10

“Now we know from our experience in changing from six to five days and back again that we can get at least as great production in five days as we can in six, and we shall probably get a greater, for the pressure will bring better methods.

Crowther, World’s Work, 1926

Forty Hour Week

Ernst Abbe, Karl Zeiss optics

1896: as much done in 9 as in 8.

How much do we have? Design capacity: max output designed for Effective Capacity

We can only sustain so much effort.Output level process designed forLowest cost per unit

Efficiency = Actual Output

Effective Capacity Possible to run > 1.0 for long Utilization = Actual Output/Design Capacity

Marginal Output of Time

As you work more hours, your productivity per hour goes down

Eventually, it goes negative.

Chapman, 1909

Time Horizons

Long-Range: over a year – acquiring, disposing of production resources

Intermediate Range: Monthly or quarterly plans, hiring, firing, layoffs

Short Range – less than a month, daily or weekly scheduling process, overtime, worker scheduling, etc.

Adding Capacity

Expensive to add capacity A few large expansions are cheaper (per

unit) than many small additions Large expansions allow of “clean sheet of

paper” thinking, re-design of processesCarry unused overhead for a long timeMay never be needed

Small expansions may “pave the cow path”

Capacity Planning How much capacity should we add? Conservative Optimistic

Forecast possible demand scenarios (Chapter 10)

Determine capacity needed for likely levels Determine “capacity cushion” desired

Capacity Sources

In addition to expanding facilities:Two or three shiftsOutsourcing non-core activitiesTraining or acquisition of faster equipment

Cost-Volume Analysis

FC = Fixed Cost v = variable cost per unit Q = quantity R = revenue per unit R-v=contrib. margin

FC+VC*Q

Volume, Q

R*Q

Break-EvenPoint

Cost Volume Analysis

Solve for Break-Even Point For profit of P, Q = P + FC

R - v

Decision Trees

Consider different possible decisions, and different possible outcomes

Compute expected profits of each decision Choose decision with highest expected

profits, work your way back up the tree.

Draw the decision tree

Working Right to Left, eliminate anyPossible decisions we can.

Compute Expected Values ofRemaining Decisions

Build small= 0.4 * $40 + 0.6 * $55 = $16 + $33 = $49

Build large= 0.4 * $50 + 0.6 * $70= $20 + $42 = $62

$49

$62

Decision Trees Example

Computer store thinks demand may grow. Expansion costs $87k, new site $210k, and would cost same if

wait a year New site:

55% chance of profits of $195k. 45% chance of $115k profits.

Expand Current 55% chance of $190k profits 45% chance of $100k profits

Wait and see- enlarge store next year if demand grows If high demand, $190k with expanded store If high demand, $170 with current store If weak demand, $105k with current store

Find the expected profits over 5 years, choose best one.

Decision Trees

Decision point Chance events Outcomes Calculate expected value of each chance

event, starting at far right Working our way back toward the

beginning, choosing highest expected outcome at each decision

Decision TreesRevenue - Move Cost

Revenue - Move Cost

Revenue – Expand Cost

Revenue – Expand CostWeak Growth

Weak Growth

Strong Growth

Strong Growth

Move

Expand

Revenue

Rev – Expand Cost

Rev - Expand Cost

0.45

0.55

0.55

0.45

WaitandSee

Weak Growth

Strong Growth0.55

0.45

Expand

Do nothing

Hackers’ComputerStore

Possible 5 year Revenues

New, growth: 195*5 – 210 = 765 New, low: 115*5 – 210 = 365 Expand, growth: 190*5 – 87 = 863 Expand, low: 100*5 – 87 = 413 Wait, strong, expand: 170+190*4-87=843 Wait, strong, do nothing: 170*5 = 850 Wait, low, do nothing: 105*5 = 525

Decision Trees765

365

863

413Weak Growth

Weak Growth

Strong Growth

Strong Growth

Move

Expand

525

843

850

0.45

0.55

0.55

0.45

WaitandSee

Weak Growth

Strong Growth0.55

0.45

Expand

Do nothing

Hackers’ComputerStore

Making the Decision

Starting at the far right, look at the “Wait and See” option. If demand is strong, we would obviously not expand.

$850k is better than $843. Eliminate the “Expand option”

Decision Trees765

365

863

413Weak Growth

Weak Growth

Strong Growth

Strong Growth

Move

Expand

525

843

850

0.45

0.55

0.55

0.45

WaitandSee

Weak Growth

Strong Growth0.55

0.45

Expand

Do nothing

Hackers’ComputerStore

Expected Values

Move:0.55* 765 + 0.45*365 = $585,000

Wait and See: 0.55*850 + 0.45*525 = $703,750

Expand:0.55 * 863 + 0.45 * 413 = $660,500

Highest expected value is to Wait and see, and either way, do nothing!

Decision Trees765

365

863

413Weak Growth

Weak Growth

Strong Growth

Strong Growth

Move

Expand

525

843

850

0.45

0.55

0.55

0.45

WaitandSee

Weak Growth

Strong Growth0.55

0.45

Expand

Do nothing

Hackers’ComputerStore

$585,000

660,500

703,750

Time Value of Money?

Another criteria to use is to pick the one with the highest down side.Under this, do nothing still wins.

We could also consider the expected value of the future cash streams.

PV = $100/(1+r) = $100/(1.16)=$86.27

Decision Tree-NPV428,487

166,544

535,116

240,429Weak Growth

Weak Growth

Strong Growth

Strong Growth

Move

Expand

343,801

529,874

556,630

0.45

0.55

0.55

0.45

WaitandSee

Weak Growth

Strong Growth0.55

0.45

Expand

Do nothing

Hackers’ComputerStore

$310,613

402,507

460,857

Real Options

Assess the value to me of being able to change my mind in the future

Changed problem slightly -Reduced benefit doing nothing, high demand

Decision Trees765

365

863

413

Weak

StrongMove

Expand

525

843

820

0.25

0.75

Wait and See

Expand

Do nothing

Hackers’ComputerStore

Weak

Strong0.25

0.75

Weak

Strong0.25

0.75

$465,000

533,000

604,500

820

525Weak

Strong0.25

0.75

Do Nothing

598,750

Real Options

If we didn’t have the wait and see option, we would Do Nothing.

Option to wait and see is worth $5,750

Move

Expand

Wait and See

465,000

533,000

604,500

Do Nothing 598,750$5,750