Strategic Capacity Management

Dr. Ron Tibben-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

Productivity

Productivity = Outputs / Inputs Partial: Output/Labor or Output/Capital Multifactor:

Output / (Labor + Capital + Energy ) Total Measure:

Output / Inputs

Automotive Productivity

Book Data:Jaguar: 14 cars/employeeVolvo: 29 cars/employeeMini: 39 cars/employee

Growth of Service Economy

0

10

20

30

40

50

60

70

80

185075

190025 50 75

2000

Services

Industry

Farming

US Productivity Growth

Improving Productivity

Develop productivity measurements– you can’t improve what you can’t measure

Identify and Improve bottleneck operations first

Establish goals, document and publicize improvements

U.S. Work and Productivity

0

500

1000

1500

2000

2500

US Japan France Germany Norway

0%

5%

10%

15%

20%

25%

30%

35%

40%

Hours

Prod Growth

Source: International Labor Organization, 1999

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, World’s Work, 1926

Forty Hour Week

Ernst Abbe, Karl Zeiss optics

1896: as much done in 9 as in 8.

Marginal Output of Time

As you work more hours, your productivity per hour goes down

Eventually, it goes negative.

Chapman, 1909

“Crunch Mode”

Ea_spouse: 12/04 “Pre-crunch”SO was working 7 * 13: 91 per week!Maybe time off at 6pm Saturday$5k signing bonus, couldn’t quitClass action: April ‘06 $14.9m

Igda.org “Why Crunch Mode Doesn’t Work: 6 Lessons”

Learning Curves

time/unit goes down consistently Down by 10% as output doubles We can use Logarithms to approximate

this If you ever need this, email me, and we

can talk as much as you want

Example 3.3

Paul’s 1 2 3 4 5 Bottles 60 100 150200 250 Bags 100 200 300400 500

Newman’s Bottles 75 85 95 97 98 Bags 200 400 600650 680

0

100

200

300

400

500

600

1 2 3 4 5

Bottles

Bags

Example 3.3

Bottles 135 185 245 297 348 Bags 300 600 900 1,050 1,180 3 bottle machines 150k each/yr = 450k 5 bag machines, 250k each/yr = 1,250k

Example 3.3

Bottles 135 185 245 297 348 Machines 1 2 2 2 3 Mach. usage 0.9 1.23 1.63 1.98 2.32 Workers 1.8 2.46 3.27 3.96 4.64

Bags 300 600 900 1,050 1,180 Machines 2 3 4 5 5 Mach Usage 1.2 2.4 3.6 4.2 4.7 Workers 3.6 7.2 10.8 12.6 14.1

Capacity Tradeoffs

Can we make combinations in between?

150,000Two-door cars

120,0004-doorcars

How much do we have?

We can only sustain so much effort. “Best Operating Level”

Output level process designed forLowest cost per unit

Capacity utilization = capacity used

best operating level Hard to run > 1.0 for long

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.

Service Differences

Arrival Rate very variable Can’t store the products - yesterday’s flight? Service times variable Serve me “Right Now!” Rates change quickly Schedule capacity in 10 minute intervals, not

months How much capacity do we need?

Capacity Levels in Service

Zone of non-service

<

Zone of service

Critica

l Zone

Mean service rate,

Mean

arrival

rate,

=100%

=70%

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 processesCarry unused overhead for a long timeMay 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

Reengineering “Business Process Reengineering”

(Hammer and Champy) Companies grow over time, adding plants,

lines, facilities, etc. Growth may not end in optimal form Re-design processes from ground up

Capacity Sources

In addition to expanding facilities:Two or three shiftsOutsourcing non-core activitiesTraining or acquisition of faster equipment

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.

Decision Trees Example 3.4, p.65

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 TreesRevenue - Move Cost

Revenue - Move Cost

Revenue – Expand Cost

Revenue – Expand CostWeak Growth

Weak Growth

Strong Growth

Strong Growth

Move

Expand

Revenue

Rev – Expand Cost

Rev - Expand Cost

0.45

0.55

0.55

0.45

WaitandSee

Weak Growth

Strong Growth0.55

0.45

Expand

Do nothing

Hackers’ComputerStore

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 Trees765

365

863

413Weak Growth

Weak Growth

Strong Growth

Strong Growth

Move

Expand

525

843

850

0.45

0.55

0.55

0.45

WaitandSee

Weak Growth

Strong Growth0.55

0.45

Expand

Do nothing

Hackers’ComputerStore

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 Trees765

365

863

413Weak Growth

Weak Growth

Strong Growth

Strong Growth

Move

Expand

525

843

850

0.45

0.55

0.55

0.45

WaitandSee

Weak Growth

Strong Growth0.55

0.45

Expand

Do nothing

Hackers’ComputerStore

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 Trees765

365

863

413Weak Growth

Weak Growth

Strong Growth

Strong Growth

Move

Expand

525

843

850

0.45

0.55

0.55

0.45

WaitandSee

Weak Growth

Strong Growth0.55

0.45

Expand

Do nothing

Hackers’ComputerStore

$585,000

660,500

703,750

Other considerations

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

Present Values - p.377

At 16%, Next year is worth 0.862=(1+rate)^(-years)Year 2: 0.743Year 3: 0.641Year 4: 0.552Year 5: 0.476

195 per year for 5 years: 195 * (3.274)

Decision Tree-NPV428,487

166,544

535,116

240,429Weak Growth

Weak Growth

Strong Growth

Strong Growth

Move

Expand

343,801

529,874

556,630

0.45

0.55

0.55

0.45

WaitandSee

Weak Growth

Strong Growth0.55

0.45

Expand

Do nothing

Hackers’ComputerStore

$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 Trees765

365

863

413

Weak

StrongMove

Expand

525

843

820

0.25

0.75

Wait and See

Expand

Do nothing

Hackers’ComputerStore

Weak

Strong0.25

0.75

Weak

Strong0.25

0.75

$465,000

533,000

604,500

820

525Weak

Strong0.25

0.75

Do Nothing

598,750

Real Options

If we didn’t 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