Chapter 9 Capacity Planning & Facility Location

Operations Management by R. Dan Reid & Nada R. Sanders 4th Edition Wiley 2010

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Capacity Considerations

The Best Operating Level is the output that results in the lowest average unit cost Economies of Scale:

Where the cost per unit of output drops as volume of output increases Spread the fixed costs of buildings & equipment over multiple units, allow bulk purchasing & handling of material Where the cost per unit rises as volume increases Often caused by congestion (overwhelming the process with too much work-in-process) and scheduling complexity
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Diseconomies of Scale:

Best Operating Level and Size

Alternative 1: Purchase one large facility, requiring one large initial investment Alternative 2: Add capacity incrementally in smaller chunks as needed
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Other Capacity Considerations

Focused factories:

Small, specialized facilities with limited objectives

Plant within a plant (PWP):

Segmenting larger operations into smaller operating units with focused objectives Outsource non-core items to free up capacity for what you do well
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Subcontractor networks:

Making Capacity Planning Decisions

The three-step procedure for making capacity planning decisions is as follows:
1. Identify Capacity Requirements
2. Develop Capacity Alternatives 3. Evaluate Capacity Alternatives
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Identifying capacity requirements

Forecasting Capacity: Long-term capacity requirements based on future demand Identifying future demand based on forecasting Forecasting, at this level, relies on qualitative forecast models Executive opinion Delphi method Forecast and capacity decision must included strategic implications

Capacity cushions

Strategic Implications

Plan to underutilize capacity to provide flexibility

How much capacity a competitor might have Potential for overcapacity in industry a possible hazard

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Developing & Evaluating Capacity Alternatives

Capacity alternatives include

Could do nothing, expand large now (may included capacity cushion), or expand small now with option to add later

Use decision support aids to evaluate decisions (decision tree most popular)
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Decision trees
Diagramming technique which uses

Decision points points in time when decisions are made, squares called nodes Decision alternatives branches of the tree off the decision nodes Chance events events that could affect a decision, branches or arrows leaving circular chance nodes Outcomes each possible alternative listed
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Decision tree diagrams

Decision trees developed by

Drawing from left to right Use squares to indicate decision points Use circles to indicate chance events Write the probability of each chance by the chance (sum of associated chances = 100%) Write each alternative outcome in the right margin
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Example Using Decision Trees: A restaurant owner has determined that she needs to expand her facility. The alternatives are to expand large now and risk smaller demand, or expand on a smaller scale now knowing that she might need to expand again in three years. Which alternative would be most attractive? (see notes)

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Evaluating the Decision Tree

Decision tree analysis utilizes expected value analysis (EVA) EVA is a weighted average of the chance events

Probability of occurrence * chance event outcome At decision point 2, choose to expand to maximize profits ($200,000 > $150,000) Calculate expected value of small expansion:

Refer to previous slide

EVsmall = 0.30($80,000) + 0.70($200,000) = $164,000

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Evaluating the Decision Tree cont

Calculate expected value of large expansion:

EVlarge = 0.30($50,000) + 0.70($300,000) =

$225,000

At decision point 1, compare alternatives & choose the large expansion to maximize the expected profit:

$225,000 > $164,000

Choose large expansion despite the fact that there is a 30% chance its the worst decision:

Take the calculated risk!

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Location Analysis
Three most important factors in real estate:
1. Location 2. Location 3. Location

Facility location is the process of identifying the best geographic location for a service or production facility
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Factors Affecting Location Decisions

Proximity to source of supply:

Reduce transportation costs of perishable or bulky raw materials

Proximity to customers:

High population areas, close to JIT partners

Local wage rates, attitude toward unions, availability of special skills (silicon valley)

Proximity to labor:

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More Location Factors

Community considerations:

Local communitys attitude toward the facility (prisons, utility plants, etc.)

Site considerations:

Local zoning & taxes, access to utilities, etc.

Climate, cultural attractions, commuting time, etc. Options for future expansion, local competition, etc.
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Quality-of-life issues:

Other considerations:

Globalization Should Firm Go Global?

Globalization is the process of locating facilities

around the world Potential advantages:

Inside track to foreign markets, avoid trade barriers, gain access to cheaper labor Political risks may increase, loss of control of proprietary technology, local infrastructure (roads & utilities) may be inadequate, high inflation Language barriers, different laws & regulations, different business cultures
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Potential disadvantages:

Other issues to consider:

Making Location Decisions

Analysis should follow 3 step process:
1. 2. 3. Identify dominant location factors Develop location alternatives Evaluate locations alternatives

Procedures for evaluation location alternatives include

Factor rating method Load-distance model Center of gravity approach Break-even analysis Transportation method
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Factor Rating Example

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A Load-Distance Model Example: Matrix Manufacturing is considering where to locate its warehouse in order to service its four Ohio stores located in Cleveland, Cincinnati, Columbus, Dayton. Two sites are being considered; Mansfield and Springfield, Ohio. Use the load-distance model to make the decision.

Calculate the rectilinear distance: dAB 30 10 40 15 45 miles

Multiply by the number of loads between each site and the four cities
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Calculating the Load-Distance Score for Springfield vs. Mansfield

Computing the Load-Distance Score for Springfield City Load Distance ld Cleveland 15 20.5 307.5 Columbus 10 4.5 45 Cincinnati 12 7.5 90 Dayton 4 3.5 14 Total Load-Distance Score(456.5) Computing the Load-Distance Score for Mansfield City Load Distance ld Cleveland 15 8 120 Columbus 10 8 80 Cincinnati 12 20 240 Dayton 4 16 64 Total Load-Distance Score(504)

The load-distance score for Mansfield is higher than for Springfield. The warehouse should be located in Springfield.
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The Center of Gravity Approach

This approach requires that the analyst find the center of gravity of the geographic area being considered
Computing the Center of Gravity for Matrix Manufacturing
Coordinates Load

Location
Cleveland Columbus Cincinnati Dayton Total

(X,Y) (11,22) (10,7) (4,1) (3,6)

(li) 15 10 12 4 41

lixi 165 165 165 165 325

liyi 330 70 12 24 436

Computing the Center of Gravity for Matrix Manufacturing

l X 325 7.9 ; Y l Y 436 10.6 X l 41 l 41 Is there another possible warehouse location closer to the C.G. that
i i i i c.g. c.g. i i

should be considered?? Why?

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Break-Even Analysis

Break-even analysis computes the amount of goods required to be sold to just cover costs Break-even analysis includes fixed and variable costs Break-even analysis can be used for location analysis especially when the costs of each location are known

Step 1: For each location, determine the fixed and variable costs Step 2: Plot the total costs for each location on one graph Step 3: Identify ranges of output for which each location has the lowest total cost Step 4: Solve algebraically for the break-even points over the identified ranges
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Break-Even Analysis

Remember the break even equations used for calculation total cost of each location and for calculating the breakeven quantity Q. Total cost = F + cQ

Total revenue = pQ Break-even is where Total Revenue = Total Cost Q = F/(p-c)

Q = break-even quantity p = price/unit c = variable cost/unit F = fixed cost

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Example using Break-even Analysis: Clean-Clothes Cleaners is considering four possible sites for its new operation. They expect to clean 10,000 garments. The table and graph below are used for the analysis.

Example 9.6 Using Break-Even Analysis Location Fixed Cost Variable Cost Total Cost A $350,000 $ 5(10,000) $400,000 B $170,000 $25(10,000) $420,000 C $100,000 $40(10,000) $500,000 D $250,000 $20(10,000) $450,000

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The Transportation Method

Can be used to solve specific location problems Is discussed in detail in the supplement to this text Could be used to evaluate the cost impact of adding potential location sites to the network of existing facilities Could also be used to evaluate adding multiple new sites or completely redesigning the network

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Capacity Planning & Facility Location within OM

Decisions about capacity and location are highly dependent on forecasts of demand (Ch 8). Capacity is also affected by operations strategy (Ch 2), as size of capacity is a key element of organizational structure. Other operations decisions that are affected by capacity and location are issues of job design and labor skills (Ch 11), choice on the mix of labor and technology, as well as choices on technology and automation (Ch 3).

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Capacity Planning and Facility Location Across the Organization

Capacity planning and location analysis affect operations management and are important to many others

Finance provides input to finalize capacity decisions Marketing impacted by the organizational capacity and location to customers

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Chapter 9 Highlights

Capacity planning is deciding on the maximum output rate of a facility Location analysis is deciding on the best location for a facility Capacity planning and location analysis decision are often made simultaneously because the location of the facility is usually related to its capacity.
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Chapter 9 Highlights cont

In both capacity planning and location analysis, managers must follow three-step process to make good decision. The steps are assessing needs, developing alternatives, and evaluating alternatives. To choose between capacity planning alternatives managers may use decision trees, which are a modeling tool for evaluating independent decisions that must be made in sequence.
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Chapter 9 Highlights cont

Key factors in location analysis included proximity to customers, transportation, source of labor, community attitude, and proximity to supplies. Service and manufacturing firms focus on different factors. Profit-making and nonprofit organizations also focus on different factors.

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Chapter 9 Highlights cont

Several tools can be used to facilitate location analysis. Factor rating is a tool that helps managers evaluate qualitative factors. The loaddistance model and center of gravity approach evaluate the location decision based on distance. Break-even analysis is used to evaluate location decisions based on cost values. The transportation method is an excellent tool for evaluating the cost impact of adding sites to the network of current facilities.
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