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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, Worlds 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 for
Lowest 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 processes
Carry unused overhead for a long time
May 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 shifts
Outsourcing non-core activities
Training 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-Even
Point
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 any
Possible decisions we can.
Compute Expected Values of
Remaining 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 Trees
Revenue - Move Cost
Revenue - Move Cost
Revenue Expand Cost
Revenue Expand Cost
Weak Growth
Weak Growth
Strong Growth
Strong Growth
Move
Expand
Revenue
Rev Expand Cost
Rev - Expand Cost
0.45
0.55
0.55
0.45
Wait
and
See
Weak Growth
Strong Growth
0.55
0.45
Expand
Do nothing
Hackers
Computer
Store
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 Trees
765
365
863
413
Weak Growth
Weak Growth
Strong Growth
Strong Growth
Move
Expand
525
843
850
0.45
0.55
0.55
0.45
Wait
and
See
Weak Growth
Strong Growth
0.55
0.45
Expand
Do nothing
Hackers
Computer
Store
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 Trees
765
365
863
413
Weak Growth
Weak Growth
Strong Growth
Strong Growth
Move
Expand
525
843
850
0.45
0.55
0.55
0.45
Wait
and
See
Weak Growth
Strong Growth
0.55
0.45
Expand
Do nothing
Hackers
Computer
Store
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 Trees
765
365
863
413
Weak Growth
Weak Growth
Strong Growth
Strong Growth
Move
Expand
525
843
850
0.45
0.55
0.55
0.45
Wait
and
See
Weak Growth
Strong Growth
0.55
0.45
Expand
Do nothing
Hackers
Computer
Store
$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-NPV
428,487
166,544
535,116
240,429
Weak Growth
Weak Growth
Strong Growth
Strong Growth
Move
Expand
343,801
529,874
556,630
0.45
0.55
0.55
0.45
Wait
and
See
Weak Growth
Strong Growth
0.55
0.45
Expand
Do nothing
Hackers
Computer
Store
$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 Trees
765
365
863
413
Weak
Strong
Move
Expand
525
843
820
0.25
0.75
Wait and See
Expand
Do nothing
Hackers
Computer
Store
Weak
Strong 0.25
0.75
Weak
Strong
0.25
0.75
$465,000
533,000
604,500
820
525
Weak
Strong 0.25
0.75
Do Nothing
598,750
Real Options
If we didnt 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