MIS373 Exam 1 Ch 5

capacity types

1. Design (theoretical) capacity: -Maximum output rate or service capacity an operation, process, or facility is designed for. 2. Effective capacity: -Design capacity minus inefficiencies/allowances (e.g. operational factors, personal time, maintenance, scrap etc.) - cannot exceed design capacity. 3. Actual output: -Rate of output actually achieved—cannot exceed effective capacity. Design Capacity ≥ Effective Capacity ≥ Actual output Effective capacity is always less than design capacity owing to realities of changing product mix, the need for periodic maintenance of equipment, lunch breaks, coffee breaks, problems in scheduling and balancing operations, and similar circumstances. Actual output cannot exceed effective capacity and is often less because of machine breakdowns, absenteeism, shortages of materials, and quality problems, as well as factors that are outside the control of the operations managers.

3 primary capacity strategies

1. Leading: •build capacity in anticipation of future demand increase (when capacity increase has long lead time). 2. Following: •build capacity when demand exceed current capacity. 3. Tracking: •similar to Following but adds capacity in relatively small increments to keep pace w increasing demand

constraint management

A constraint is something that limits the performance of a process or system in achieving its goals. Constraint management is often based on the work of Eli Goldratt (The Theory of Constraints), and Eli Schragenheim and H. William Dettmer (Manufacturing at Warp Speed). There are seven categories of constraints: Market: Insufficient demand Resource: Too little of one or more resources (e.g., workers, equipment, and space) Material: Too little of one or more materials Financial: Insufficient funds Supplier: Unreliable, long lead time, substandard quality Knowledge or competency: Needed knowledge or skills missing or incomplete Policy: Laws or regulations interfere

calculating processing requirements requires

A necessary piece of information is the capacity requirements of products that will be processed. To get this information, one must have reasonably accurate demand forecasts for each product and know the standard processing time per unit for each product, the number of workdays per year, and the number of shifts that will be used. (demand forecasts, processing times, available work time)

bottleneck operation

An operation in a sequence of operations whose capacity is lower than that of the other operations Output rate determined by the bottleneck from book: The risk in not taking a big-picture approach is that the system will be unbalanced. Evidence of an unbalanced system is the existence of a bottleneck operation. A bottleneck operation is an operation in a sequence of operations whose capacity is lower than the capacities of other operations in the sequence. As a consequence, the capacity of the bottleneck operation limits the system capacity; the capacity of the system is reduced to the capacity of the bottleneck operation

evaluating alternatives: waiting-line analysis

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 (e.g., airport ticket counters, telephone calls to a cable television company, hospital emergency rooms). 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. It can aid in the determination of expected costs for various levels of service capacity.

break-even point (BEP)

Break-Even-Point (BEP) -The volume of output (per period) at which total cost and total revenue are equal (profit = 0) Profit (P) = 0 = TR - TC = R x Q - (FC + v x Q) = Q(R - v) - FC 0 = QBEP(R - v) - FC

FORECASTING CAPACITY REQUIREMENTS

Capacity planning decisions involve both long-term and short-term considerations. Long-term considerations relate to overall level of capacity, such as facility size; short-term considerations relate to probable variations in capacity requirements created by such things as seasonal, random, and irregular fluctuations in demand. Because the time intervals covered by each of these categories can vary significantly from industry to industry, it would be misleading to put times on the intervals. Long-term capacity needs require forecasting demand over a time horizon and then converting those forecasts into capacity requirements. When trends are identified, the fundamental issues are (1) how long the trend might persist, because few things last forever, and (2) the slope of the trend. If cycles are identified, interest focuses on (1) the approximate length of the cycles and (2) the amplitude of the cycles (i.e., deviation from average). Short-term capacity needs are less concerned with cycles or trends than with seasonal variations and other variations from average. These deviations are particularly important because they can place a severe strain on a system's ability to satisfy demand at some times and yet result in idle capacity at other times. An organization can identify seasonal patterns using standard forecasting techniques. Although commonly thought of as annual fluctuations, seasonal variations are also reflected in monthly, weekly, and even daily capacity requirements. When time intervals are too short to have seasonal variations in demand, the analysis can often describe the variations by probability distributions such as a normal, uniform, or Poisson distribution. For example, we might describe the amount of coffee served during the midday meal at a luncheonette by a normal distribution with a certain mean and standard deviation. The number of customers who enter a bank branch on Monday mornings might be described by a Poisson distribution with a certain mean

evaluating alternatives: cost-volume analysis

Cost-volume analysis focuses on relationships between cost, revenue, and volume of output. The 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. Deciding among capacity alternatives Use of the technique requires identification of all costs related to the production of a given product. These costs are then designated as fixed costs or variable costs. Fixed costs tend to remain constant regardless of volume of output. Examples include rental costs, property taxes, equipment costs, heating and cooling expenses, and certain administrative costs. Variable costs vary directly with volume of output. The major components of variable costs are generally materials and labor costs. We will assume that variable cost per unit remains the same regardless of volume of output, and that all output can be sold. assumptions: -One product is involved -Everything produced can be sold -The variable cost per unit is the same regardless of volume -Fixed costs do not change with volume changes -The revenue per unit is the same regardless of volume -Revenue per unit exceeds variable cost per unit

evaluating alternatives: decision theory

Decision theory is 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. It involves identifying a set of possible future conditions that could influence results, listing alternative courses of action, and developing a financial outcome for each alternative-future condition combination.

measuring system effectiveness

Efficiency: -Measured as percentages -efficiency = (actual output) / (effective capacity) x 100 Utilization: -Measured as percentages -utilization = (actual output) / (design capacity) x 100 Efficiency ≥ Utilization

Steps in the Capacity Planning Process

Estimate future capacity requirements. Evaluate existing capacity and facilities and identify gaps. Identify alternatives for meeting requirements. Conduct financial analyses of each alternative. Assess key qualitative issues for each alternative. Select the alternative to pursue that will be best in the long term. Implement the selected alternative. Monitor results.

determinants of effective capacity: Effective capacity ≤ Design capacity

Facilities -Size, expansions, layout, transportation costs, distance to market, labor supply, energy sources -layout of the work area often determines how smoothly work can be performed, and environmental factors such as heating, lighting, and ventilation also play a significant role in determining whether personnel can perform effectively or whether they must struggle to overcome poor design characteristics. Product and service factors -(non) uniformity of output, product/service mix -For example, when items are similar, the ability of the system to produce those items is generally much greater than when successive items differ. -Generally speaking, the more uniform the output, the more opportunities there are for standardization of methods and materials, which leads to greater capacity. Process factors -Productivity, quality, setup-time -The quantity capability of a process is an obvious determinant of capacity. A more subtle determinant is the influence of output quality. For instance, if quality of output does not meet standards, the rate of output will be slowed by the need for inspection and rework activities. Productivity also affects capacity. Process improvements that increase quality and productivity can result in increased capacity. Also, if multiple products or multiple services are processed in batches, the time to change over equipment settings must be taken into account. Human factors -Tasks, variety of activities, training, skills, learning, experience, motivation, labor turnover -The tasks that make up a job, the variety of activities involved, and the training, skill, and experience required to perform a job all have an impact on the potential and actual output. In addition, employee motivation has a very basic relationship to capacity, as do absenteeism and labor turnover.

cost-volume analysis variables

Fixed Costs (FC) -(tend to) remain constant regardless of output volume Variable Costs (VC) -vary directly with volume of output -VC = Quantity(Q) x variable cost per unit (v) Total Cost -TC = FC + VC Total Revenue (TR) -TR = revenue per unit (R) x Q

operations strategy

From an operations management standpoint, capacity decisions establish a set of conditions within which operations will be required to function. Flexibility can be a key issue in capacity decisions, although flexibility is not always an option, particularly in capital-intensive industries. However, where possible, flexibility allows an organization to be agile—that is, responsive to changes in the marketplace. Also, it reduces to a certain extent the dependence on long-range forecasts to accurately predict demand. And flexibility makes it easier for organizations to take advantage of technological and other innovations. Maintaining excess capacity (a capacity cushion) may provide a degree of flexibility, albeit at added cost. Some organizations use a strategy of maintaining a capacity cushion for the purpose of blocking entry into the market by new competitors. The excess capacity enables them to produce at costs lower than what new competitors can. However, such a strategy means higher-than-necessary unit costs, and it makes it more difficult to cut back if demand slows, or to shift to new product or service offerings. Efficiency improvements and utilization improvements can provide capacity increases. Such improvements can be achieved by streamlining operations and reducing waste. The chapter on lean operations describes ways for achieving those improvements. Bottleneck management can be a way to increase effective capacity, by scheduling non-bottleneck operations to achieve maximum utilization of bottleneck operations. In cases where capacity expansion will be undertaken, there are two strategies for determining the timing and degree of capacity expansion. One is the expand-early strategy (i.e., before demand materializes). The intent might be to achieve economies of scale, to expand market share, or to preempt competitors from expanding. The risks of this strategy include an oversupply that would drive prices down, and underutilized equipment that would result in higher unit costs. The other approach is the wait-and-see strategy (i.e., to expand capacity only after demand materializes, perhaps incrementally). Its advantages include a lower chance of oversupply due to more accurate matching of supply and demand, and higher capacity utilization. The key risks are loss of market share and the inability to meet demand if expansion requires a long lead time. In cases where capacity contraction will be undertaken, capacity disposal strategies become important. This can be the result of the need to replace aging equipment with newer equipment. It can also be the result of outsourcing and downsizing operations. The cost or benefit of asset disposal should be taken into account when contemplating these actions.

strategic capacity planning

Goal: -achieve a match between the long-term supply capabilities and the predicted level of long-term demand •Overcapacity: operating costs that are too high •Undercapacity: strained resources and possible loss of customers

do it in-house or outsource it?

Once capacity requirements have been determined, the organization must decide whether to produce a good or provide a service itself, or to outsource from another organization. Many organizations buy parts or contract out services, for a variety of reasons. Among those factors are: Available capacity. If an organization has available the equipment, necessary skills, and time, it often makes sense to produce an item or perform a service in-house. The additional costs would be relatively small compared with those required to buy items or subcontract services. On the other hand, outsourcing can increase capacity and flexibility. Expertise. If a firm lacks the expertise to do a job satisfactorily, buying might be a reasonable alternative. Quality considerations. Firms that specialize can usually offer higher quality than an organization can attain itself. Conversely, unique quality requirements or the desire to closely monitor quality may cause an organization to perform a job itself. The nature of demand. When demand for an item is high and steady, the organization is often better off doing the work itself. However, wide fluctuations in demand or small orders are usually better handled by specialists who are able to combine orders from multiple sources, which results in higher volume and tends to offset individual buyer fluctuations. Cost. Any cost savings achieved from buying or making must be weighed against the preceding factors. Cost savings might come from the item itself or from transportation cost savings. If there are fixed costs associated with making an item that cannot be reallocated if the service or product is outsourced, that has to be recognized in the analysis. Conversely, outsourcing may help a firm avoid incurring fixed costs. Risks. Buying goods or services may entail considerable risks. Loss of direct control over operations, knowledge sharing, and the possible need to disclose proprietary information are three risks. And liability can be a tremendous risk if the products or services of other companies cause harm to customers or the environment, as well as damage to an organization's reputation. Reputation can also be damaged if the public discovers that a supplier operates with substandard working conditions. In some cases, a firm might choose to perform part of the work itself and let others handle the rest in order to maintain flexibility and to hedge against loss of a subcontractor. If part or all of the work will be done in-house, capacity alternatives will need to be developed. Outsourcing brings with it a host of supply chain considerations.

evaluating alternatives: financial analysis

Operations personnel need to have the ability to do financial analysis. A problem that is universally encountered by managers is how to allocate scarce funds. A common approach is to use financial analysis to rank investment proposals, taking into account the time value of money. Two important terms in financial analysis are cash flow and present value: Cash flow refers to the difference between the cash received from sales (of goods or services) and other sources (e.g., sale of old equipment) and the cash outflow for labor, materials, overhead, and taxes. Present value expresses in current value the sum of all future cash flows of an investment proposal. The three most commonly used methods of financial analysis are payback, present value, and internal rate of return. Payback is a crude but widely used method that focuses on the length of time it will take for an investment to return its original cost. For example, an investment with an original cost of $6,000 and a monthly net cash flow of $1,000 has a payback period of six months. Payback ignores the time value of money. Its use is easier to rationalize for short-term than for long-term projects. The present value (PV) method summarizes the initial cost of an investment, its estimated annual cash flows, and any expected salvage value in a single value called the equivalent current value, taking into account the time value of money (i.e., interest rates). The 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 estimated future returns and the initial cost. These techniques are appropriate when there is a high degree of certainty associated with estimates of future cash flows.

determinants of effective capacity: Design capacity ≥ Effective capacity

Policy factors -Overtime, second/third shifts -Management policy can affect capacity by allowing or not allowing capacity options such as overtime or second or third shifts. Operational factors -Scheduling, inventory, purchasing, materials, quality assurance/control, breakdowns, maintenance -Scheduling problems may occur when an organization has differences in equipment capabilities among alternative pieces of equipment or differences in job requirements. Inventory stocking decisions, late deliveries, purchasing requirements, acceptability of purchased materials and parts, and quality inspection and control procedures also can have an impact on effective capacity. Supply chain factors -suppliers, warehousing, transportation, distributors -Key questions include: What impact will the changes have on suppliers, warehousing, transportation, and distributors? If capacity will be increased, will these elements of the supply chain be able to handle the increase? Conversely, if capacity is to be decreased, what impact will the loss of business have on these elements of the supply chain? External factors -Product standards, minimum quality, safety, environment, regulations, unions -roduct standards, especially minimum quality and performance standards, can restrict management's options for increasing and using capacity. Thus, pollution standards on products and equipment often reduce effective capacity, as does paperwork required by government regulatory agencies by engaging employees in nonproductive activities. A similar effect occurs when a union contract limits the number of hours and type of work an employee may do.

service capacity planning

Service capacity: -The need to be near customers •Convenience -The degree of demand volatility •Volume and Timing of demand •Time required to service individual customers / customer needs -The inability to store services •Cannot store services for consumption later •Safety Capacity Three very important factors in planning service capacity are (1) there may be a need to be near customers, (2) the inability to store services, and (3) the degree of volatility of demand. Convenience for customers is often an important aspect of service. Generally, a service must be located near customers. For example, hotel rooms must be where customers want to stay; having a vacant room in another city won't help. Thus, capacity and location are closely tied. Capacity also must be matched with the timing of demand. Unlike goods, services cannot be produced in one period and stored for use in a later period. Thus, an unsold seat on an airplane, train, or bus cannot be stored for use on a later trip. Similarly, inventories of goods allow customers to immediately satisfy wants, whereas a customer who wants a service may have to wait. This can result in a variety of negatives for an organization that provides the service. Thus, speed of delivery, or customer waiting time, becomes a major concern in service capacity planning Demand volatility presents problems for capacity planners. Demand volatility tends to be higher for services than for goods, not only in timing of demand, but also in the amount of time required to service individual customers. For example, banks tend to experience higher volumes of demand on certain days of the week, and the number and nature of transactions tend to vary substantially for different individuals. Then, too, a wide range of social, cultural, and even weather factors can cause major peaks and valleys in demand.

demand management strategies

Strategies used to offset capacity limitations and that are intended to achieve a closer match between supply and demand -Appointments -Pricing -Promotions -Discounts -Other tactics to shift demand from peak periods into slow periods

developing capacity strategies

There are a number of ways to enhance development of capacity strategies: 1. Design flexibility into systems. The long-term nature of many capacity decisions and the risks inherent in long-term forecasts suggest potential benefits from designing flexible systems. For example, provision for future expansion in the original design of a structure frequently can be obtained at a small price compared to what it would cost to remodel an existing structure that did not have such a provision. Hence, if future expansion of a restaurant seems likely, water lines, power hookups, and waste disposal lines can be put in place initially so that if expansion becomes a reality, modification to the existing structure can be minimized. Similarly, a new golf course may start as a nine-hole operation, but if provision is made for future expansion by obtaining options on adjacent land, it may progress to a larger (18-hole) course. Other considerations in flexible design involve layout of equipment, location, equipment selection, production planning, scheduling, and inventory policies, which will be discussed in later chapters. 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. At the introduction phase, it can be difficult to determine both the size of the market and the organization's eventual share of that market. Therefore, organizations should be cautious in making large and/or inflexible capacity investments. In the growth phase, the overall market may experience rapid growth. However, the real issue is the rate at which the organization's market share grows, which may be more or less than the market rate, depending on the success of the organization's strategies. Organizations generally regard growth as a good thing. They want growth in the overall market for their products or services, and in their share of the market, because they see this as a way of increasing volume, and thus, increasing profits. However, there can also be a downside to this because increasing output levels will require increasing capacity, and that means increasing investment and increasing complexity. In addition, decision makers should take into account Page 201possible similar moves by competitors, which would increase the risk of overcapacity in the market, and result in higher unit costs of the output. Another strategy would be to compete on some nonprice attribute of the product by investing in technology and process improvements to make differentiation a competitive advantage. In the maturity phase, the size of the market levels off, and organizations tend to have stable market shares. Organizations may still be able to increase profitability by reducing costs and making full use of capacity. However, some organizations may still try to increase profitability by increasing capacity if they believe this stage will be fairly long, or the cost to increase capacity is relatively small. In the decline phase, an organization is faced with underutilization of capacity due to declining demand. Organizations may eliminate the excess capacity by selling it, or by introducing new products or services. An option that is sometimes used in manufacturing is to transfer capacity to a location that has lower labor costs, which allows the organization to continue to make a profit on the product for a while longer. 3. Take a "big-picture" (i.e., systems) approach to capacity changes. When developing capacity alternatives, it is important to consider how parts of the system interrelate. For example, when making a decision to increase the number of rooms in a motel, one should also take into account probable increased demands for parking, entertainment and food, and housekeeping. Also, will suppliers be able to handle the increased volume? Capacity changes inevitably affect an organization's supply chain. Suppliers may need time to adjust to their capacity, so collaborating with supply chain partners on plans for capacity increases is essential. That includes not only suppliers, but also distributors and transporters. 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. For instance, the desired capacity of a certain operation may be 55 units per hour, but suppose that machines used for this operation are able to produce 40 units per hour each. One machine by itself would cause capacity to be 15 units per hour short of what is needed, but two machines would result in an excess capacity of 25 units per hour. The illustration becomes even more extreme if we shift the topic—to open-hearth furnaces or to the number of airplanes needed to provide a desired level of capacity. 5. Attempt to smooth out capacity requirements. Unevenness in capacity requirements also can create certain problems. For instance, during periods of inclement weather, public transportation ridership tends to increase substantially relative to periods of pleasant weather. Consequently, the system tends to alternate between underutilization and overutilization. Increasing the number of buses or subway cars will reduce the burden during periods of heavy demand, but this will aggravate the problem of overcapacity at other times and certainly add to the cost of operating the system. -We can trace the unevenness in demand for products and services to a variety of sources. The bus ridership problem is weather related to a certain extent, but demand could be considered to be partly random (i.e., varying because of chance factors). Still another source of varying demand is seasonality. Seasonal variations are generally easier to cope with than random variations because they are predictable. 6. Identify the optimal operating level. Production units typically have an ideal or optimal level of operation in terms of unit cost of output. At the ideal level, cost per unit is the lowest for that production unit. If the output rate is less than the optimal level, increasing the output rate will result in decreasing average unit costs. This is known as economies of scale. However, if output is increased beyond the optimal level, average unit costs will become increasingly larger. This is known as diseconomies of scale Diseconomies of scale If the output rate is more than the optimal level, increasing the output rate results in increasing average unit costs. 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 funds, 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.

capacity decisions are strategic

impact the ability of the organization to meet future demands major determinant of initial cost (often) involve long-term commitment of resources affect operating costs affect the ease of management affect competitiveness

capacity

the upper limit or ceiling on the load that an operating unit can handle an upper limit on the *rate of output -Capacity needs include: •Equipment •Space •Employee skills For instance, if an organization has many different products or services, it may not be practical to list all of the relevant capacities. This is especially true if there are frequent changes in the mix of output, because this would necessitate a frequently changing composite index of capacity. The preferred alternative in such cases is to use a measure of capacity that refers to availability of inputs. Thus, a hospital has a certain number of beds, a factory has a certain number of machine hours available, and a bus has a certain number of seats and a certain amount of standing room. No single measure of capacity will be appropriate in every situation. Rather, the measure of capacity must be tailored to the situation

key questions for product and service design

what kind of capacity is needed? How much 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 change

capacity cushion/safety capacity

which is an amount of capacity in excess of expected demand when there is some uncertainty about demand. Capacity cushion = capacity − expected demand. Typically, the greater the degree of demand uncertainty, the greater the amount of cushion used. Organizations that have standard products or services generally have smaller capacity cushions -Extra capacity used to offset demand uncertainty -Safety Capacity = Capacity-expected demand -Safety Capacity strategy •Organizations that have greater demand uncertainty typically use greater capacity cushion •Organizations that have standard products and services generally use smaller capacity cushion