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Chapter 3: Strategic Capacity Management

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Page 1: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Chapter 3: Strategic Capacity Management

Page 2: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

We will discuss …

What is capacity?The concept of process capacityCapacity utilizationEconomies and diseconomies of scaleCapacity balanceLittle's law

Relating inventory, flow time, and flow rate

Batch sizes and capacityDecision Trees

Page 3: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Strategic Capacity Planning

Capacity

the ability to hold, receive, store, or

accommodate.

measures can (as opposed to does)

Strategic capacity planning

approach for determining the overall capacity

level of capital intensive resources, including

facilities, equipment, and overall labor force

size.Examples??

Page 4: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Two Ways to Improve a Process

Reduce excess capacity at some step in the processLower the cost for the same output

Use the capacity at an underutilized process step to increase the capacity at a bottleneckIncrease the output at the same cost

A bottleneck is the weakest linkProcess capacity = minimum {Res 1 capacity,. Res 2 capacity, …)

Page 5: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Capacity Utilization

Capacity used rate of output actually achieved

Best operating level capacity for which the process was designed

Capacity utilization rate = Capacity used / Best operating level

UnderutilizationBest OperatingLevel

Avgunit costof output

Volume

Overutilization

Page 6: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Example of Capacity Utilization

During one week of production, a plant produced 83 units of a product. Its historic highest or best utilization recorded was 120 units per week. What is this plant’s capacity utilization rate?

During one week of production, a plant produced 83 units of a product. Its historic highest or best utilization recorded was 120 units per week. What is this plant’s capacity utilization rate?

Answer: Capacity utilization rate = Capacity used

. Best operating

level = 83/120 =0.69 or 69%

Answer: Capacity utilization rate = Capacity used

. Best operating

level = 83/120 =0.69 or 69%

Page 7: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Economies & Diseconomies of Scale

100-unitplant

200-unitplant 300-unit

plant

400-unitplant

Volume

Averageunit costof output

Economies of Scale and the Experience Curve working

Economies of Scale and the Experience Curve working

Diseconomies of Scale start workingDiseconomies of Scale start working

Page 8: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Other IssuesCapacity FocusThe concept of the

focused factory holds that production facilities work best when they focus on a fairly limited set of production objectives Plants Within Plants (PWP) Extend focus concept

to operating level

Capacity Flexibility

Flexible processes

Flexible workers

Flexible plants

Page 9: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Capacity Planning: Balance

Stage 1 Stage 2 Stage 3Unitsper

month

6,000 7,000 5,000

Unbalanced stages of productionUnbalanced stages of production

Stage 1 Stage 2 Stage 3Unitsper

month

6,000 6,000 6,000

Balanced stages of productionBalanced stages of production

Maintaining System Balance: Output of one stage is the exact input requirements for the next stage

Page 10: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

What it is: Inventory (I) = Flow Rate (R) * Flow Time (T)

Implications:• Out of the three performance measures (I,R,T), two can be chosen by management, the other is GIVEN by nature• Hold throughput (flow rate) constant: Reducing inventory = reducing flow time

Little’s Law

7:00 8:00 9:00 10:00 11:00 12:00 13:00 14:00 15:00 16:00 17:00 18:00

11

10

9

8

7

6

5

4

3

2

1

0

Flow Time

Inventory

Inventory=Cumulative Inflow – Cumulative Outflow

Cumulative Inflow

Cumulative Outflow

Time

Patients

Can be used in analyzing capacity issues!

Page 11: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Examples Suppose that from 12 to 1 p.m.

200 students per hour enter the GQ and each student is in the system for an average of 45 minutes. What is the average number of students in the GQ? Inventory = Flow Rate * Flow Time = 200 per hour * 45 minutes (=

0.75 hours) = 150 students

If ten students on average are waiting in line for sandwiches and each is in line for five minutes, on average, how many students are arrive each hour for sandwiches? Flow Rate = Inventory / Flow Time

= 10 Students / 5 minutes = 0.083 hour

= 120 students per hour

Airline check-in data indicate from 9 to 10 a.m. 255 passengers checked in. Moreover, based on the number waiting in line, airport management found that on average, 35 people were waiting to check in. How long did the average passenger have to wait?

Flow Time = Inventory / Flow Rate = 35 passengers / 255 passengers per hour = 0.137 hours

= 8.24 minutes

Page 12: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Batch of 12

Batch of 60

Batch of 120

Batch of 300

Time [minutes]60 120 180 240 300

Set-up from Part A to Part B

Set-up from Part B to Part A

Produce Part A (1 box corresponds to 24 units = 12 scooters)

Produce Part B (1 box corresponds to 12 units = 12 scooters)

Production cycle

Production cycle

The Impact of Batch Size on Capacity

Number Produced in 720 MinBatch Size Part A Part B

12 60 6060 180 180

120 240 240300 300 300

Page 13: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

• Capacity calculation:

• Note: Capacity increases with batch size:

• Note further: … and so does inventory

Batch Size

Set-up time + Batch-size*Time per unitCapacity given Batch Size=(in units/time)

Capacity 1/p

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

0.5

10 50

90

13

0

17

0

21

0

25

0

29

0

33

0

37

0

41

0

45

0

49

0

53

0

57

0

61

0

65

0 Batch Size

Capacity Analysis with Batching

Page 14: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Data about set-up times and batching

Set-up time, S

Process 1 Assembly process

120 minutes -

Per unit time, p 2 minutes/unit 3 minutes/unit

Capacity (B=12) 0.0833 units/min 0.33 units/minute

Capacity (B=300) 0.4166 units/min 0.33 units/minute

Batch size = 12 Batch size = 300

Setup 120 0 120 0

Batch size 12 12 300 300

Per unit 2 3 2 3

Capacity (per min) 0.083 0.333 0.417 0.333

Capacity (per hour) 5 20 25 20

Process Capacity

(per hour) 5 20

Page 15: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Figure : Choosing a “good” batch size

Batch size is too small, process capacity could be increased (set-up step is at the bottleneck)

Batch size is too large, could be reduced with no negative impact on process capacity (set-up is not at the bottleneck)

Capacity

1/p

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

0.5

10

50

90

13

0

17

0

21

0

25

0

29

0

33

0

37

0

41

0

45

0

49

0

53

0

57

0

61

0

65

0 Batch Size

Capacity of sloweststep other than the onerequiring set-up

B/[S+B*p] = k implies that B = S*k / (1 – p*k)

Page 16: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Problem

Part a: What is the capacity for a batch size = 50?

Part b: For a batch size of 10, what is the bottleneck

STEP 1 STEP 2 STEP 3Act Time in min/part 1 2 1.5Setup Time in min 20 0 0

part b

Batch is: 10Capacity of Resource (parts/min) 0.333 0.500 0.667

Step 1 is bottleneck

part aBatch is: 50

Capacity of Resource (parts/min) 0.714 0.500 0.667parts/hour 42.9 30.0 40.0(minutes/part) 1.4 2 1.5

Capacity is 0.5 parts/min or 30 parts/hour

What batch size should be chosen to smooth the flow?

Page 17: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Process Utilization and Capacity Utilization

Process Utilization = Flow Rate / Process Capacity Example: Tom can process 100 forms per day and he actually

processes 70 forms. Process utilization = ??

Utilization of resource = Flow rate / Capacity of resource

Process 400 items per hour Capacities of resources (items/hour):

Resource 1: 500 implies utilization of 80% Resource 2: 450 implies utilization of 89% Resource 3: 600 implies utilization of 67%

Bottleneck is the resource with the lowest capacity and the highest utilization

Bottleneck is ??

Page 18: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Decision Trees Used to structure

complex decision problems

Use expected return criteria

Consider probabilities of occurrence of events

Use: chance nodes (denoted by

circles ) decision (or choice) nodes

(denoted by squares)

Use a concept of “folding back” to arrive at the best policy

Page 19: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Example of a Decision Tree Problem

A glass factory specializing in crystal is experiencing a substantial backlog, and the firm's management is considering three courses of action:

A) Arrange for subcontractingB) Construct new facilitiesC) Do nothing (no change)

The correct choice depends largely upon demand, which may be low, medium, or high. By consensus, management estimates the respective demand probabilities as 0.1, 0.5, and 0.4.

A glass factory specializing in crystal is experiencing a substantial backlog, and the firm's management is considering three courses of action:

A) Arrange for subcontractingB) Construct new facilitiesC) Do nothing (no change)

The correct choice depends largely upon demand, which may be low, medium, or high. By consensus, management estimates the respective demand probabilities as 0.1, 0.5, and 0.4.

Page 20: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Example of a Decision Tree Problem (Continued): The Payoff Table

The management also estimates the profits when choosing from the three alternatives (A, B, and C) under the differing probable levels of demand. These profits, in thousands of dollars are presented in the table below:

The management also estimates the profits when choosing from the three alternatives (A, B, and C) under the differing probable levels of demand. These profits, in thousands of dollars are presented in the table below:

0.1 0.5 0.4Low Medium High

A 10 50 90B -120 25 200C 20 40 60

Page 21: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Example of a Decision Tree Problem (Continued): Step 1. We start by drawing

the three decisions

A

B

C

Page 22: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Example of Decision Tree Problem (Continued): Step 2. Add our possible states of nature, probabilities, and

payoffs

A

B

C

High demand (0.4)

Medium demand (0.5)

Low demand (0.1)

$90k$50k

$10k

High demand (0.4)

Medium demand (0.5)

Low demand (0.1)

$200k$25k

-$120k

High demand (0.4)

Medium demand (0.5)

Low demand (0.1)

$60k$40k

$20k

Page 23: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Example of Decision Tree Problem (Continued): Step 3. Determine the

expected value of each decision

High demand (0.4)High demand (0.4)

Medium demand (0.5)Medium demand (0.5)

Low demand (0.1)Low demand (0.1)

AA

$90k$90k

$50k$50k

$10k$10k

EVA=0.4(90)+0.5(50)+0.1(10)=$62kEVA=0.4(90)+0.5(50)+0.1(10)=$62k

$62k$62k

Page 24: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Example of Decision Tree Problem (Continued): Step 4. Make decision

High demand (0.4)

Medium demand (0.5)

Low demand (0.1)

High demand (0.4)

Medium demand (0.5)

Low demand (0.1)

A

B

CHigh demand (0.4)

Medium demand (0.5)

Low demand (0.1)

$90k$50k

$10k

$200k$25k

-$120k

$60k$40k

$20k

$62k

$80.5k

$46k

Alternative B generates the greatest expected profit, so our choice is B or to construct a new facility

Alternative B generates the greatest expected profit, so our choice is B or to construct a new facility

Page 25: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Problem 2 Owner of a small firm

wants to purchase a PC for billing, payroll, client records

Need small systems now -- larger maybe later

Alternatives:Small: No expansion

capabilities @ $4000Small: expansion

@6000Larger system @

$9000

After 3 years small systems canbe traded in for a

larger one @ $7500Expanded @ $4000Future demand is

Likelihood of needing larger system later is 0.80

What system should he buy?

Page 26: Chapter 3: Strategic Capacity Management. We will discuss … What is capacity? The concept of process capacity Capacity utilization Economies and diseconomies

Problem 2L: .8 9,000

9,000 S: .2 9,000

10,000 Large 10,000 Exp

Need large Trade-in 13,500 9,000 Exp L: .8

S: .2 6,000 9,200

Small 11,500 Trade-in 11,500

Need largeL: .8S: .2 4,000

10,000