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• Design of Goods & Services • service & product design

• Managing Quality • quality management

• Process Strategy • process & capacity design

• location

• Location Strategies

• layout design

• Layout Strategies

• human resources & job design

• Human Resources • supply chain management

• Supply Chain Management • inventory, MRP, and J-I-T

• Inventory Management • intermediate, short-term,

• Scheduling and project scheduling

• Maintenance • maintenance

Scope of Operations Management

relating to the system capacity, geographic

locations of facilities, arrangement of

departments, layout of equipment, product or

service planning, and acquisition of

equipment.

SYSTEM OPERATION – involves

management of personnel, inventory planning

& control, scheduling, project management,

and quality assurance

Capacity Decisions

Most fundamental of all design decisions that operations managers must

make

With long-term consequences for the organization

Affect a large portion of fixed cost

Determine if demand will be met or if facilities will be idle

Answer basic capacity planning questions on

What kind of capacity is needed?

How much is needed?

When is it needed?

Made regularly or infrequently (governed by)

Products/services design

Stability of demand

Rate of technological change in equipment

Competitive factors

Importance of Capacity Decisions

future demands for products and services

Effect on operating costs (attempt to balance the

costs of over- and under capacity)

Major determinant of initial cost

Long-term commitment of resources

Effect on competitiveness (barrier to entry by

competition, delivery speed)

Effect on ease of management

Defining Capacity

an operating unit (plant, department, machine, store,

or worker) can handle

Capacity Issues – important for all organizations and

at all levels of an organization

important information for planning purposes :

to quantify production capability in terms of inputs/outputs

make other decisions or plans related to those quantities

The term, “capacity” has different interpretations,

leading to difficulties in measuring capacity

Measuring Capacity

Important to choose one that does NOT require

updating (ex. dollar amounts)

Basic measure is UNITS of a product OUTPUT

ok with single-product operations

problems with multi-product operations (product mix will

necessitate frequent change in composite index of capacity)

Alternative : refer capacity to AVAILABILITY of

INPUTS (e.g. no. of hospital beds, m/c hours

available, # of passenger seats)

“No single measure of capacity will be appropriate in

every situation.” Rather the measure of capacity must

be TAILORED to the SITUATION.

Useful Definitions of Capacity

DESIGN CAPACITY – theoretical maximum

output that can be attained by a system in a given

period (achieved under ideal conditions)

EFFECTIVE CAPACITY – capacity a firm can

expect to achieve given its product mix, methods

of scheduling, m/c maintenance, standards of

quality, and so on

Effective Capacity < Design Capacity

Actual Output < Effective Capacity (due to

realities of m/c breakdowns, absenteeism,

shortages of materials, quality problems

and outside factors)

Measures of System Effectiveness

Efficiency = Actual

Output__

Effective

Actual

Utilization =

Capacity

Output_

Design

Example : Given the information below, compute the efficiency and

utilization of Capacity

the vehicle repair department:

Design capacity= 50 trucks per day

Effective capacity = 40 trucks per day

Actual output = 36 trucks per day

Solution :

Actual 36 trucks per

Efficiency = = = 90%

Output__ day_ 40 trucks

Effective per day

Actual Output_= 36 trucks per = 72%

Utilization = Capacity

Design Capacity day_ 50 trucks

Example : A bakery with 3 process lines for rolls, each

operating 7 days a week and 8 hours per day at 3

shifts. Each line is designed to process 120 rolls per

hour. The facility has an efficiency of 90% and

expected capacity is 80%. What is the anticipated

production?

Anticipated Production = (Design capacity) (Effective capacity)

(Efficiency)

= [(3 lines)(168 hrs)(120

(7 days/wk x 3 shifts x 8 hrs/shift)

rolls/hr/line)](0.80)(0.90) = 43,546 rolls/week

Actual Output < Effective Capacity < Design Capaci

Quality

Utilization Effective Capacity M/C Breakdowns

Training

Benefits of ↑ Utilization are realized Equipment Use

(de-bottleneck)

only when there is demand, otherwise it is

counterproductive Additional variable costs

Inventory carrying costs

Bottleneck conditions ≈ waiting times (WIP)

Determinants of Effective

Capacity

I. FACILITIES

1. Design (size and provision for expansion) 3. Layout (smooth work flow)

2. Location (labor supply, energy sources) 4. Environment (ventilation)

II. PRODUCTS or SERVICES

1. Design (more uniform output ≈ std. mat’ls & methods ≈ greater capacity)

2. Product or Service Mix (different items ≈ different output rates)

III. PROCESSES (Quantity Capabilities : obvious determinant of capacity)

(Quality Capabilities : quality ↓ = output rate ↓ due to inspection)

HUMAN FACTORS (job content, job design, training & experience,

motivation, compensation, learning rates, absenteeism & turnover)

OPERATIONAL FACTORS (scheduling, materials management, QA,

maintenance policies and equipment breakdowns)

EXTERNAL FACTORS

1. Product standards 3. Unions

2. Safety Regulations 4. Pollution control standards

INADEQUATE PLANNING = major limiting determinant of effective capacity

Determining Capacity Requirements

Long-term considerations (relate to overall level of capacity, e.g.

size)

Short-term considerations (relate to probable variations in capacity

Link between Marketing and Operations is crucial to a realistic

determination of capacity requirements

Long-Term Capacity : more on cycles and trends

fluctuations)

Forecasting Capacity Requirements

1st phase : future demand is forecast with traditional methods

Planning for Capacity Addition

Once the rated capacity has been forecast, the next step is to determine the

incremental size of each addition to capacity. There are 3 approaches, namely

(1) one that leads demand, (2) one that lags demand, and (3) an average.

an one-step expansion

incremental

New Capacity

expansion New

Demand

Expected Demand

Capacity Expected

Demand

Demand

(d) Attempts to have an average

(c) Capacity lags demand

capacity with incremental

with

expansion

incremental expansion

New New

Capacity Capacity

Expected

Expected

Demand

Demand

Demand

Demand

Managing Demand

Even with good forecasting and facilities built into that forecast,there

may be a poor match between actual demand and available capacity

firm may be able to curtail demand by raising prices, scheduling long lead

times, and discouraging marginally profitable business.

Capacity Exceeds Demand When capacity exceeds demand, the

firm may stimulate demand through price reductions or aggressive

marketing, or accommodate product changes.

Adjusting to Seasonal Demands A seasonal or cyclical

pattern of demand is another capacity challenge wherein management may

find it helpful to offer products with complementary demand patterns.

Tactics for Matching Capacity to Demand

• Making staffing changes (increase/decrease in no. of employees)

• Adjusting equipment and processes (adding a machine/selling

equipment)

• Improving methods to increase throughput

Developing Capacity Alternatives

Differentiate between new and mature products or

services

Mature Products ⇒ predictable demand ⇒ capacity requirements

⇒ limited life spans ⇒ find alt. use for additional capacity

New Products ⇒ higher risk in predicting quantity and duration of demand

Take a “big picture” approach to capacity changes (important

to consider how parts of the system interrelate)

Prepare to deal with capacity “chunks” (capacity increases are often

acquired in fairly large chunks rather than smooth increments, e.g. required = 55 units/hr

but machine is rated at 40 units/hr)

Attempt to smooth out capacity requirements

Seasonality Issues ⇒ under/over utilization ⇒ overtime, subcontracting, hedging

7. Identify the optimal operating level

Choice of Capacity ⇔ availability of financial & other resources

Planning Service Capacity

3 Important Factors:

2) Need to be near customers

Convenience – important aspect of service (e.g. hotels)

Capacity & Location – are closely tied

3) Inability to store services

Timing of Demand – must be matched by capacity

Speed of Delivery – major concern in capacity planning

Service Level – brings into issue the cost of maintaining capacity

4) Degree of volatility of demand

Number of individual customers (ex. Banks experiencing days w/

Time to service each customer higher volume of transactions &

varying nature of transactions)

(Peak Periods – extra workers, outsourcing, pricing & promotion)

Evaluating Capacity Alternatives

Economic Considerations

Feasibility – payback, useful life

Costs – financing, operations & maintenance

Timing – how soon available

Compatibility with present operations & people

Public Opinion

Environmental concern, relocation issue, technology upgrade

repercussions such as termination of jobs

Capacity Evaluation Techniques

Financial Analysis

Decision Theory

Waiting-Line Analysis

Cost-Volume Analysis

Financial Analysis

Need to rank investment proposals via F.A. due to

problem of allocating scarce funds

3 most commonly used methods

Payback = initial cost ÷ net cash flow

Present Value = time value of money

Internal Rate of Return = equivalent interest rate

2 important terms in financial analysis

CASH FLOW - refers to the difference between cash

received (from sales and from other sources like sales of

old equipment) and cash outflow for labor, materials,etc.

PRESENT VALUE – expresses in current value the

sum of all future cash flows of an investment proposal

Net Present Value

A means of determining the discounted value of a

series of future cash receipts

Consider the time value of money: say investing $100 in a

bank at 5% for 1 year:

$105 = $100(1 + .05)

For the second year:

$110.25 = $105(1 + .05) = $100(1 + .05)2

F

In general, F = P ( 1 + i )N ⇒ P = = FX

(1+i) N

In situations of where an investment generates an annual

series of uniform and equal cash amounts (called annuity)

The basic relationship is S = RX , where

X = factor from PV of an Annuity of $1 Table

S = present value of a series of uniform annual receipts

R = receipts every year for the life of the investment (the annuity)

Present Value Method

Example No. 1

Your boss, Mr. La Forge, has told you to evaluate the cost of two

machines. After some questioning, you are assured that they have the

following costs. Assume:

the life of each machine is 3 years, and

the company thinks it knows how to make 14% on investments no

riskier than this one.

Machine A Machine B

Original cost $ 13,000 $ 20,000

Floor space per year 500 600

Energy (electricity) per year 1,000 900

Maintenance per year 2,500 500

Total annual cost $ 6,000 $ 5,000

====== ======

Salvage value $2,000 $7,000

Present Value Method

Example No.1 ….con’t

Solution : Determine via the present value method which machine to purchase.

Table of $1 Given P V Given P V

Now Expense 1.000 $13,000 $13,000 $20,000 $20,000

Yr. 1 Expense .877 6,000 5,262 5,000 4,385

Yr. 2 Expense .769 6,000 4,614 5,000 3,845

Yr. 3 Expense .675 6,000 4,050 5,000 3,375

Salvage $26,926 $31,605

Yr.3 Revenue .675 $2,000 -$ 1,350 $7,000 -$ 4,725

$25,576

↵ $26,880

====== ======

Machine A is the low-cost purchase since it has the lower sum of

Present Value Method

Example No.2

Quality Plastics, Inc. is considering two different investment alternatives.

Investment A has an initial cost of $25,000, and investment B has an initial

cost of $26,000. Both investments have a useful life of 4 years. The cash

flows for these investments are shown below. The cost of capital or the

interest rate (i) is 8%.

Present Investment A’s Investment B’s PV of a $1

Year Value Factor Cash Flow PV’s Cash Flow Annuity

PV’s

at 8%

1 .926 $ 10,000 $ 9,260 $ 9,000 $ 8,834

2 .857 9,000 7,713 9,000 $7,713

9,000

3 .794 8,000 6,352 9,000 7,146

x

4 .735 7,000 5,145 9,000 6,615

Totals $28,470 3.312

$29,808

Minus initial investment - 25,000 - 26,000

Net present value $ 3,470 $ 3,808

Based on the NPV criterion, MORE ATTRACTIVE ↑

Decision Theory and

Waiting-Line Analysis

Decision Theory is helpful for financial comparison of

alternatives under conditions of risk or uncertainty;

applying decision trees to capacity decisions that

maximize the expected value of the alternatives arising

from states of nature (usually future demand or market

favorability) that are assigned probabilities

Waiting-Line Analysis is often used for designing

service systems and helpful in choosing a capacity

level that is cost-effective through balancing the cost

of having customers wait with the cost of providing

additional capacity; also aids in the determination of

expected costs for various levels of service capacity

Decision Tree

Example

considering capacity expansion. Its major alternatives are to do nothing,

build a small plant, build a medium plant, or build a large plant. The new

facility would produce a new type of gown, and currently the potential or

marketability for this product is unknown. If a large plant is built and a

favorable market exists, a profit of $100,000 could be realized. An

unfavorable market would yield a $90,000 loss. However, a medium plant

would earn a $60,000 profit with a favorable market. A $10,000 loss would

result from an unfavorable market. A small plant, on the other hand, would

return $40,000 with favorable market conditions and lose only $5,000 in an

unfavorable market. Of course, there is always the option of doing nothing.

Recent market research indicates that there is a 0.4 probability of a

favorable market, which means that there is also a 0.6 probability of an

unfavorable market. Which alternative is more attractive for Southern?

Decision Tree

Solution: The alternative that will result in the highest

expected monetary value (EMV) can be selected.

$100,000

n t

pl a Market unfavorable (.6) -$ 90,000

r ge +$ 18,000

La Market favorable (.4) $ 60,000

? Medium plant

Sm

all Market unfavorable (.6)

pla -$ 10,000

nt

+$ 13,000 Market favorable (.4)

$ 40,000

Do

no

th

in

-$ 5,000

g

$0

Calculating Processing Requirements

capacity requirements of products that will be processed with a given alternative.

Required for computation:

demand forecasts for each product

standard processing time per unit of each product on each alternative machine

number of work days per year

Number of shifts that will be used

Example: A department store works one eight-hour shift, 250 days a year, and has

these figures for usage of a machine that is currently being considered:

Annual Standard Processing Processing Time

Product Demand Time per Unit (Hour) Needed (Hour)

#1 400 5.0 2,000

#2 300 8.0 2,400

#3 700 2.0 1,400

Annual capacity 5,800 =

------- 2.90

= 1 m/c working 8 hrs/shift x 1 shift/day x 250 days/yr = 2,000 machines

Calculating Processing Requirements

Example No. 2

A manager must decide which type of machine to buy, A, B, or C.

Machine costs are: Machine Cost

A $40,000

B $30,000

C $80,000

Product forecasts & processing times on the machines are as follows:

Annual Processing Time (Minutes) per Unit

Product Demand A B C

1 16,000 3 4 2

2 12,000 4 4 3

3 6,000 5 6 4

4 30,000 2 2 1

Assume that only purchasing costs are being considered. Which machine would

have the lowest total cost, and how many of that machine would be needed?

Machines operate 10 hours a day, 250 days a year.

Calculating Processing Requirements

Solution to Example No. 2

each machine:

Buy 2 machines of B

Product A B C

1 48,000 64,000 32,000

2 48,000 48,000 36,000

3 30,000 36,000 24,000

4 60,000 60,000 30,000

Total Minutes 186,000 208,000 122,000

÷ 60 (in Hours) 3,100 3,467 2,033

÷ annual capacity = 10 hours / day x 250 days / yr = 2,500

No. of Machines 1.24 ≈ 2 1.39 ≈ 2 0.81 ≈ 1

Purchase Cost $80,000 $60,000 $80,000

=======

Cost – Volume Analysis

Focuses on relationships between COST, REVENUE and VOLUME of

output

Purpose is to estimate income of an organization under different

operating conditions

Tool for comparing alternatives under the following ASSUMPTIONS:

1) One product is involved.

2) Everything produced can be sold.

3) The variable cost per unit is the same regardless of volume.

4) Fixed costs do not change with volume changes, or they are step

changes

5) The revenue per unit is the same regardless of volume

6) Revenue per unit exceeds variable cost per unit.

Provides a conceptual framework for integrating cost, revenue and profit

estimates into CAPACITY DECISIONS

Cost – Volume Analysis

Fixed Costs – constant, regardless of volume of output (e..g. rental, taxes,

administrative expenses)

Variable Costs – change directly with volume of output (generally materials

and labor costs); assumes that variable cost per unit (ν ) remains the same

regardless of volume of output (Q )

Total Cost = Fixed Costs + Variable Costs or TC = FC + VC , where

variable cost, VC = Q x ν

Total Revenue , TR = Q x SP , where SP = selling price per unit

or TR = Q x R , where R = revenue per unit

Profit is P = TR – TC

= (Q x SP ) - [ FC + (Q x ν ) ]

P = Q ( SP - ν ) - FC

required volume to Q = P + FC

generate a specified profit SP - ν

Break – Even Analysis

Objective : To find the point, in dollars and units, at which

costs equal revenues. TR

Graphic Approach $ Break-Even Point f it TC

Pro

TR = TC

VC

$ BEP$

VC

i dor

FC Corr

s s

Lo FC

Volume BEPQ

Algebraic Approach Volume

Q x SP = F + (Q x ν ) SP - ν

Break – even in dollars, BEP$ = F

1- ν / SP

Break – Even Analysis

Example No. 1 Single-Product Case

Direct labor is $1.50 per unit and material is $0.75 per unit.

The selling price is $4.00 per unit. Determine the break-

even point in dollars and units.

Solution:

ν = DL + material = 1.50 + .75 = $2.25

1 - 1 - (2.25 /

ν / SP =

BEP F 4.00) = $10,000

Q = 5,714 units

SP - ν 4.00 -

Break – Even Analysis

Example No. 2 Single-Product Case

adding a new machine line of pies, which will require leasing new

equipment for a monthly payment of $6,000. Variable costs would be

$2 per pie, and pies would retail for $7 each.

a. How many pies must be sold in order to break even?

b. What would the profit (loss) be if 1,000 pies are made and sold

in a month?

c. How many pies must be sold to realize a profit of $4,000?

Solution:

a) BEPQ = FC = $6,000 = 1,200 pies / month

SP - ν $7 - $2

a) At Q = 1,000 pies, P = Q ( SP - ν ) - FC

= 1000($7 – $2) - $6,000 = -$ 1,000 (loss)

c) To make a profit (P) of $4,000 , Q = P + FC = 4,000 + 6,000 = 2,000

SP - ν 7 -2 pies

Break – Even Analysis

Example No. 3 Step Costs / Multiple B-E Points

A manager has the option of purchasing one, two, or three machines. Fixed

costs and potential volume are as follows:

Number of Total Annual Corresponding

Machines Fixed Costs Range of Output

1 $ 9,600 0 to 300

2 15,000 301 to 600

3 20,000 601 to 900

Variable cost is $10 per unit, and revenue is $40 per unit.

a) Determine the break-even point for each range.

b) If projected annual demand is between 580 and 660 units, how many

machines should the manager purchase?

Solution: Compute B-E for each range and compare with projected range of demand.

BEPQ(1 m/c) = FC / (R - ν ) = $9,600 / $ (40 –10)/unit = 320 units

[ not in the range, so there is no BEP ]

BEPQ(2 m/c) = $15,000 / $(40 – 10)/unit = 500 units [∴ Buy 2 machines ]

BEPQ(3 m/c) = $20,000 / $(40 – 10)/unit = 667 units [ not in the range ≈ loss ]

Break – Even Analysis

Example No. 4 Multi-Product Case

Firms offering a variety of products that have different selling prices and variable

costs, the break-even point is

where, BEP$ = F

V = variable cost per unit ∑ [ ( 1 – Vi / Pi ) x

P = price per unit (Wi) ]

F = fixed cost

W = percent each product is of total dollar sales

i = each product

Illustration: Information for Le Bistro, a French-style deli, follows. Fixed costs

are $3,500 per month. Annual Forecasted

Item Price Cost Sales Units

Sandwich $2.95 $1.25 7,000

Soft drink .80 .30 7,000

Baked potato 1.55 .47 5,000

Tea .75 .25 5,000

Salad bar 2.85 1.00 3,000

Break – Even Analysis

Example No. 4 Multi-Product Case (con’t)

Solution :

Annual [1-(V/P)]xW=

Selling Variable Forecasted Wi = Weighted

Item (i) Price (P) Cost (V) (V / P) 1 - (V/P) Sales ($) % of Sales Contribution

SW $2.95 $1.25 .42 .58 $ 20,650 .446 .259

SD .80 .30 .38 .62 5,600 .121 .075

BP 1.55 .47 .30 .70 7,750 .167 .117

T .75 .25 .33 .67 3,750 .081 .054

SB 2.85 1.00 .35 .65 8,550 .185 .120

$46,300 1.000 .625

BEP$ = F = $3,500/mo. X 12 mos. = $67,200

∑ [ ( 1 – Vi / Pi ) x (Wi) ] .625

If there are 52 weeks at 6 work days each, determine (a) the total daily sales to

break even, and (b) the number of sandwiches that must be sold each day.

(a) BEP$ (daily) = $67,200 = $215.38 (b) No. of = .446 x $215.38 = 32.5 or

Sandwiches $2.95 33 each day

312 days

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