PRODUCTION & OPERATION

MANAGEMENT
Capacity Management
CAPACITY
• The throughput, or the number of
units a facility can hold, receive,
store, or produce in a period of time
• Determines
fixed costs
• Determines if
demand will
be satisfied
• Three time horizons
 PLANNING OVER A TIME HORIZON

Long-range Add facilities

planning Add long lead time equipment

Intermediate Subcontract Add personnel

-range Add equipment Build or use inventory
planning Add shifts

Schedule jobs
Short-range
Schedule personnel
planning
Allocate machinery

Modify capacity Use capacity

DESIGN AND EFFECTIVE CAPACITY

 Design capacity is the maximum

theoretical output of a system
 Normally expressed as a rate
 Effective capacity is the capacity a
firm expects to achieve given current
operating constraints
 Often lower than design capacity
UTILIZATION AND EFFICIENCY
Utilization is the percent of design capacity
achieved
Utilization = Actual output/Design capacity

Efficiency is the percent of effective capacity

achieved
Efficiency = Actual output/Effective capacity
BAKERY EXAMPLE

Actual production last week = 148,000 rolls

Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

BAKERY EXAMPLE

Actual production last week = 148,000 rolls

Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

BAKERY EXAMPLE

Actual production last week = 148,000 rolls

Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Utilization = 148,000/201,600 = 73.4%

BAKERY EXAMPLE

Actual production last week = 148,000 rolls

Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Utilization = 148,000/201,600 = 73.4%

BAKERY EXAMPLE

Actual production last week = 148,000 rolls

Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Utilization = 148,000/201,600 = 73.4%

Efficiency = 148,000/175,000 = 84.6%

BAKERY EXAMPLE

Actual production last week = 148,000 rolls

Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Utilization = 148,000/201,600 = 73.4%

Efficiency = 148,000/175,000 = 84.6%

BAKERY EXAMPLE

Actual production last week = 148,000 rolls

Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts
Efficiency = 84.6%
Efficiency of new line = 75%

Expected Output = (Effective Capacity)(Efficiency)

= (175,000)(.75) = 131,250 rolls

BAKERY EXAMPLE

Actual production last week = 148,000 rolls

Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts
Efficiency = 84.6%
Efficiency of new line = 75%

Expected Output = (Effective Capacity)(Efficiency)

= (175,000)(.75) = 131,250 rolls

CAPACITY AND STRATEGY

 Capacity decisions must be

integrated into the organization’s
mission and strategy
CAPACITY CONSIDERATIONS

 Forecast demand accurately

 Understand the technology and capacity
increments
 Find the optimum
operating level
(volume)
 Build for change
 ECONOMIES AND DISECONOMIES OF
SCALE
(dollars per room per night)
Average unit cost

25 - room 75 - room
roadside motel 50 - room roadside motel
roadside motel

Economies Diseconomies
of scale of scale
25 50 75
Number of Rooms
MANAGING DEMAND
 Demand exceeds capacity
 Curtail demand by raising prices, scheduling longer lead
time
 Long term solution is to increase capacity

 Capacity exceeds demand

 Stimulate market
 Product changes

 Adjusting to seasonal demands

 Produce products with complementary demand patterns
 COMPLEMENTARY DEMAND PATTERNS

4,000 –
Sales in units

3,000 –

2,000 –

1,000 – Jet ski

engine
sales

JFMAMJJASONDJFMAMJJASONDJ
Time (months)
 COMPLEMENTARY DEMAND PATTERNS

4,000 –
Sales in units

Snowmobile
3,000 – motor sales

2,000 –

1,000 – Jet ski

engine
sales

JFMAMJJASONDJFMAMJJASONDJ
Time (months)
 COMPLEMENTARY DEMAND PATTERNS
Combining both
demand patterns
reduces the
variation
4,000 –
Sales in units

Snowmobile
3,000 – motor sales

2,000 –

1,000 – Jet ski

engine
sales

JFMAMJJASONDJFMAMJJASONDJ
Time (months)
TACTICS FOR MATCHING CAPACITY TO
DEMAND
1. Making staffing changes
2. Adjusting equipment
 Purchasing additional machinery
 Selling or leasing out existing equipment
3. Improving processes to increase throughput
4. Redesigning products to facilitate more throughput
5. Adding process flexibility to meet changing product
preferences
6. Closing facilities
DEMAND AND CAPACITY MANAGEMENT
IN THE SERVICE SECTOR

 Demand management
 Appointment, reservations, FCFS rule
 Capacity
management
 Full time,
temporary,
part-time
staff
APPROACHES TO CAPACITY EXPANSION
(a) Leading demand with (b) Leading demand with
incremental expansion one-step expansion
New New
capacity capacity

Demand
Demand

Expected Expected
demand demand

(c) Capacity lags demand with (d) Attempts to have an average

incremental expansion capacity with incremental
New
expansion
capacity New
Demand

Expected Demand capacity Expected

demand demand
APPROACHES TO CAPACITY EXPANSION
(a) Leading demand with incremental
expansion

New
capacity
Demand

Expected
demand

1 2 3
Time (years)
APPROACHES TO CAPACITY EXPANSION
(b) Leading demand with one-step
expansion

New
capacity
Expected
Demand

demand

1 2 3
Time (years)
APPROACHES TO CAPACITY EXPANSION
(c) Capacity lags demand with incremental
expansion

New
capacity

Expected
Demand

demand

1 2 3
Time (years)
APPROACHES TO CAPACITY EXPANSION
(d) Attempts to have an average capacity with
incremental expansion

New
capacity

Expected
Demand

demand

1 2 3
Time (years)
BREAK-EVEN ANALYSIS

 Technique for evaluating process

and equipment alternatives
 Objective is to find the point in
dollars and units at which cost
equals revenue
 Requires estimation of fixed costs,
variable costs, and revenue
BREAK-EVEN ANALYSIS
 Fixed costs are costs that continue
even if no units are produced
 Depreciation, taxes, debt, mortgage
payments
 Variable costs are costs that vary
with the volume of units produced
 Labor, materials, portion of utilities
 Contribution is the difference between
selling price and variable cost
BREAK-EVEN ANALYSIS
Assumptions
 Costs and revenue are linear
functions
 Generally not the case in the real
world
 We actually know these costs
 Very difficult to accomplish
 There is no time value of money
BREAK-EVEN ANALYSIS
–
Total revenue line
900 –

800 –
Break-even point Total cost line
700 – Total cost = Total revenue
Cost in dollars

600 –

500 –

400 – Variable cost

300 –

200 –

100 – Fixed cost

–
| | | | | | | | | | | |
0 100 200 300 400 500 600 700 800 900 10001100
Volume (units per period)
BREAK-EVEN ANALYSIS
BEPx = break-even point in x = number of units produced
units
BEP$ = break-even point in TR = total revenue = Px
dollars F = fixed costs
P = price per unit (after V = variable cost per unit
all discounts) TC = total costs = F + Vx

Break-even point occurs

when

TR = TC F
or BEPx =
P-V
Px = F + Vx
BREAK-EVEN ANALYSIS
BEPx = break-even point in x = number of units produced
units
BEP$ = break-even point in TR = total revenue = Px
dollars F = fixed costs
P = price per unit (after V = variable cost per unit
all discounts) TC = total costs = F + Vx

BEP$ = BEPx P
= F P Profit = TR - TC
P-V = Px - (F + Vx)
= F
= Px - F - Vx
(P - V)/P
F = (P - V)x - F
=
1 - V/P
 BREAK-EVEN EXAMPLE
Fixed costs = $10,000 Material = $.75/unit
Direct labor = $1.50/unit Selling price = $4.00 per unit

F $10,000
BEP$ = =
1 - (V/P) 1 - [(1.50 + .75)/(4.00)]
 BREAK-EVEN EXAMPLE
Fixed costs = $10,000 Material = $.75/unit
Direct labor = $1.50/unit Selling price = $4.00 per unit

F $10,000
BEP$ = =
1 - (V/P) 1 - [(1.50 + .75)/(4.00)]

$10,000
= .4375 = $22,857.14

BEPx = F = $10,000 = 5,714

P-V 4.00 - (1.5+ .75 )
BREAK-EVEN EXAMPLE

50,000 –

Revenue
40,000 –
Break-even
point Total
30,000 –
costs
Dollars

20,000 –

Fixed costs
10,000 –

–
| | | | | |
0 2,000 4,000 6,000 8,000 10,000
Units
BREAK-EVEN EXAMPLE

Multiproduct Case
F
BEP$ =

∑ 1-
Vi
Pi
x (Wi)

where V = variable cost per unit

P = price per unit
F = fixed costs
W = percent each product is of total dollar sales
i = each product
MULTIPRODUCT EXAMPLE
Fixed costs = $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
 MULTIPRODUCT EXAMPLE
Fixed costs = $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 Annual 5,000 Weighted
Tea Selling Variable .75 .25Forecasted 5,000
% of Contribution
Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7)
Salad bar 2.85 1.00 3,000
Sandwich $2.95 $1.25 .42 .58 $20,650 .446 .259
Soft drink .80 .30 .38 .62 5,600 .121 .075
Baked 1.55 .47 .30 .70 7,750 .167 .117
potato
Tea .75 .25 .33 .67 3,750 .081 .054
Salad bar 2.85 1.00 .35 .65 8,550 .185 .120
$46,300 1.000 .625
 F
BEP$ =
MULTIPRODUCT EXAMPLE
∑ 1-
Vi
Pi
x (Wi)
Fixed costs = $3,500 per month
$3,500
Annualx 12
Forecasted
= = $67,200
Item Price Cost .625
Sales Units
Sandwich $2.95 $1.25 7,000
Soft drink .80 Daily
.30 $67,200
7,000
sales = = $215.38
Baked potato 1.55 .47 312
Annual days
5,000 Weighted
Tea Selling Variable .75 .25Forecasted 5,000
% of Contribution
Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7)
Salad bar 2.85 1.00
.446 x $215.383,000
Sandwich $2.95 $1.25 .42 .58 $20,650 = 32.6  .259
.446 33
$2.95 sandwiches
Soft drink .80 .30 .38 .62 5,600 .121 .075
Baked 1.55 .47 .30 .70 7,750 .167 per day
.117
potato
Tea .75 .25 .33 .67 3,750 .081 .054
Salad bar 2.85 1.00 .35 .65 8,550 .185 .120
$46,300 1.000 .625