Operations

Management

Capacity Planning
Lecture 4

OM Session 5: Benzin Dahal 1

 Capacity and Strategy

 Capacity decisions must be integrated into

the mission and strategy of organization
 All 10 OM decisions as well as marketing
and finance are impacted by changes in
capacity
 Investments in capacity not to be isolated
but a coordinated step to achieve
organization’s objective

OM Session 5: Benzin Dahal 2

Types of Planning Over a
Time Horizon

Long Range Add Facilities

Planning Add long lead time equipment

Intermediate Sub-Contract
Range Planning Add Equipment Add Personnel
Add Shifts Build or Use Inventory

Schedule Jobs
Short Range Schedule Personnel
Planning Allocate Machinery

Modify Capacity Use Capacity

OM Session 5: Benzin Dahal 3

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

OM Session 5: Benzin Dahal 4

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

OM Session 5: Benzin Dahal 5

Special Requirements for
Making Good Capacity
Decisions
 Forecast demand accurately
 Understand the technology and
capacity increments
 Find the optimal operating level
(volume)
 Build for change

OM Session 5: Benzin Dahal 6

Approaches to Capacity
Expansion
Expected Demand Expected Demand

New Capacity New Capacity

Demand
Demand

Time in Years Time in Years

Capacity leads demand with an incremental expansion Capacity leads demand with a one-step expansion

Expected Demand Expected Demand

New Capacity
New Capacity
Demand

Demand

Time in Years Time in Years

Attempts to have an average capacity, with an
Capacity lags demand with an incremental expansion
incremental expansion

OM Session 5: Benzin Dahal 7

Managing Demand
 Demand exceeds capacity – curtail
demand by raising prices, scheduling long
lead times, etc
 Capacity exceeds demand – stimulate
demand through price reductions,
aggressive marketing, etc
 Adjusting to seasonal demands – offer
products with complementary demand
patterns – pdts for which demand is high
for one when low for the other

OM Session 5: Benzin Dahal 8

Managing Capacity
1. Making staffing changes (increasing
or decreasing the number of
employees)
2. Adjusting equipment and processes
– which might include purchasing
additional machinery or selling or
leasing out existing equipment
3. Improving methods to increase
throughput; and/or
4. Redesigning the product to
facilitate more throughput
OM Session 5: Benzin Dahal 10
Breakeven Analysis
 Technique for evaluating process &
equipment alternatives
 Objective: Find the point ($ or units)
at which total cost equals total
revenue
 Assumptions
 Revenue & costs are related linearly to
volume
 All information is known with certainty
OM Session No time value of money
 5: Benzin Dahal 11
Break-Even Analysis

 Fixed costs: costs that continue

even if no units are produced:
depreciation, taxes, debt, mortgage
payments, salaries, etc
 Variable costs: costs that vary with
the volume of units produced: labor
wages, materials, portion of utilities

OM Session 5: Benzin Dahal 12

Breakeven Chart

Total revenue line

Breakeven point Profit
Profit
Total cost = Total revenue
Total cost line
Cost in Dollars

Variable cost

Loss Fixed cost

Volume (units/period)

OM Session 5: Benzin Dahal 13

Break-Even Analysis

BEPx = break- x= number of

even point in units units produced
BEP$ = break- TR = total
even point in dollars revenue = Px
P = price F= fixed costs
per unit (after all V =
discounts) variable cost per unit
Break-even point TC = total
occurs when costs = F + Vx

TR = TC
or F
BEPx =
Px = F + Vx P-V

OM Session 5: Benzin Dahal 14

Break-Even Analysis

BEPx = break- x= number of

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

OM Session 5: Benzin Dahal 15

Break-Even Example
Multiproduct Case

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

OM Session 5: Benzin Dahal 16

Multiproduct Break-Even
Analysis
Annual
Item Price Cost Forecasted Sales
Unit
Sandwich $2.95 $1.25 7000

Soft drink 0.80 0.30 7000

baked potato 1.55 0.47 5000

Tea 0.75 0.25 5000

Salad 2.85 1.00 3000

OM Session 5: Benzin Dahal 17

Crossover Chart
Smooth Boards Inc., wants to enter the market quickly with a
new finish on its ski boards. It has three choices:
 
Repair the old equipment at a cost of $800,
Make major modifications at the cost of $1,100, or
Purchase new equipment at a net cost of $1,800
 
If the firm chooses to repair the old equipment, materials and
labor cost would be $1.10 per board. If it chooses to make
modifications, materials and labor cost would be $0.70 per
board. If it buys new equipment, variable costs are estimated at
$0.40 per board.
 
Graph the three total cost lines on the same chart (preferably on
graph paper)
Which alternative would be chosen if more than 3,000 ski-
boards can be sold?
Which alternative should the firm use if it thinks the market for
boards would be between 1,000 and 2,000?
OM Session 5: Benzin Dahal 18
Crossover Chart
Process A: low volume, high variety
Process B: Repetitive
Process C: High volume, low variety
s A
ces B
ro cess
-P - P r o
os
t
t a l cost
c To
otal P rocess
C
T o s t -
Total c

Fixed cost - Process C

Fixed cost - Process B
Fixed cost - Process A

Process A Process B Process C Lowest cost process

OM Session 5: Benzin Dahal 19

  A small firm intends to increase the capacity of a
bottleneck operation by adding a new machine. Two
alternatives, A and B, have been identified, and the
associated costs and revenues have been estimated.
Annual fixed costs would be $40,000 for A and
$30,000 for B; variable costs per unit would be $10 for
A and $11 for B; and revenue per unit would be $15.
 Determine each alternative's break-even point in units
 At what volume of output would the two alternatives
yield the same profit?
 If expected annual demand is 12,000 units, which
alternative would yield the higher profit?

OM Session 5: Benzin Dahal 20

  Mr Takeshi, owner of AKA Pizzas, is considering a new
oven in which to bake the firm’s signature dish, salami
pizza. Oven type A can handle 20 pizzas an hour. The
fixed costs associated with oven A are $20,000 and the
variable costs are $2.00 per pizza. Oven B is larger and
can handle 40 pizzas an hour. The fixed costs associated
with oven B are $30,000 and the variable costs are $1.25
per pizza. There is also a third option, oven C which can
handle 70 pizzas per hour and its fixed costs are $45,000
and variable costs are $ 1.00 per pizza. The pizzas sell for
$14 each. 
 If Takeshi expects to sell 12,000 pizzas, which oven
should he purchase? Answer this by calculating the cross-
over points 

OM Session 5: Benzin Dahal 21