1

AMITY GLOBALBUSINESS SCHOOL Bangalore

MBA, Semester 2

Operations Management

Prof. Aarti Mehta Sharma

2

AMITY GLOBALBUSINESS SCHOOL Bangalore

Capacity Planning

3

AMITY GLOBALBUSINESS SCHOOL BangaloreCapacity

- The ability to hold, receive, store or accommodate- Amount of output that a system is capable of

achieving over a period of time

For Example :

No. of customers that can be handled between 11am and 1pm

No. of automobiles that can be produced in a single shift.

4

AMITY GLOBALBUSINESS SCHOOL Bangalore

• Long term capacity plans – investments in new facilities and equipments covering requirements at least two years in the future.eg. Samsung, Pepsi

• Short term capacity plans – focus on work – force size, overtime budgets, inventories etc. eg. Accenture

5

AMITY GLOBALBUSINESS SCHOOL Bangalore

• Fixed Capacity : capital assets (buildings, machinery, equipment etc)

• Adjustable Capacity : size of the workforce, no. of hours per week hey work, no. of shifts and the extent of subcontracting

6

AMITY GLOBALBUSINESS SCHOOL Bangalore Long term Capacity

Planning Questions• Continued investment in people, technology, research

and development, and capital assets. Long term effects on Finance and Production.

- How should a plant be able to produce ?- How many customers should a service facility be able

to serve ?- How much of a cushion is needed for uncertain,

variable demand ?

7

AMITY GLOBALBUSINESS SCHOOL Bangalore

- Should the capacity be expanded based on forecast of demand or should the capacity expansion be taken up only after the demand becomes more certain ?

8

AMITY GLOBALBUSINESS SCHOOL Bangalore Factors affecting

Long Term Capacity Planning• Forecast growth in demand• Future upgrading of technology• Anticipated moves by competitors• Reliance on learning curves• Availability of funds for future investments• Cost of new capacities to provide economies of scale

9

AMITY GLOBALBUSINESS SCHOOL Bangalore

0

10

20

30

40

50

60

70

80

90

100

annual volume

av

era

ge

co

st

of

ou

tpu

t Economies

of Scale

10

AMITY GLOBALBUSINESS SCHOOL Bangalore Economies of

Scale• The average unit cost of a good or service can be

reduced by increasing the rate of output• The annual volume of output which results in the

least cost = best operating level

Fixed costs are driven down when :

1. fixed costs can be spread over a large no. of units produced

11

AMITY GLOBALBUSINESS SCHOOL Bangalore

2. Production costs do not increase linearly with output levels

3. Quantity discounts are available for material purchases

4. Operating efficiency increases as workers gain experience

12

AMITY GLOBALBUSINESS SCHOOL Bangalore Diseconomies

Of Scale• Above a certain level of output, additional volume of

output results in ever increasing average unit costs.• Due to overloading of machines, increased

congestion of materials and handling equipments, slower service times, poor quality requiring rework, difficulty in management

13

AMITY GLOBALBUSINESS SCHOOL Bangalore The Experience

Curve - Practice Makes Perfect • A line displaying the relationship between unit production

time and the cumulative no. of units produced• Integral part in planning corporate strategy • As plants produce more – gain experience in the best

production methods – reduce cost of production• Varies across industries• First applied in the airline industry

14

AMITY GLOBALBUSINESS SCHOOL BangaloreAssumptions

• The amount of time required to complete a given task or unit of a product will be less each time the task is undertaken.

• The unit time will decrease at a decreasing rate

• The reduction of time will follow a predictable pattern

15

AMITY GLOBALBUSINESS SCHOOL Bangalore Airline Industry

• As Output doubled – 20 % reduction in production worker hours

• 1,00,000 hours for plane 1• 80,000 hours for plane 2• 64,000 hours for plane 4• ----- known as 80 % learning curve

16

AMITY GLOBALBUSINESS SCHOOL BangaloreWrt TIME

0

5

10

15

20

25

30

35

100 200 300 400 500 600

unit number

tim

e p

er u

nit

17

AMITY GLOBALBUSINESS SCHOOL Bangalore wrt no. of units

0

5

10

15

20

25

0 5 15 25 30 35

time

ou

tpu

t p

er t

ime

per

iod

average output

18

AMITY GLOBALBUSINESS SCHOOL BangaloreLogarithmic

Analysis• Yx = kxⁿ

x = unit number

Yx = Number of direct labor hours required to produce the xth unit

k = Number of direct labor hours required to produce the first unit

n = log b / log 2 where b = learning %

19

AMITY GLOBALBUSINESS SCHOOL BangaloreQ

Unit No. Direct labor hours

Cumulative hrs

Cumulative average

1 1,00,000 1,00,000 1,00,000

2 80,000 1,80,000 90,000

4 64,000 314,210

(3,08,000)?

78,553

8 51,200 534,591 66,824

16 40,960 892,014 55,751

20

AMITY GLOBALBUSINESS SCHOOL BangaloreQ

• To calculate time for eighth unit

• Y8 = (1,00,000)(8)ⁿ

• Y8 = (1,00,000) log 0.8 / log 2

• = 51,192

21

AMITY GLOBALBUSINESS SCHOOL Bangalore Advantage :

Larger Plants• Gain from Economies of Scale and the Experience

curve • Build larger plants – larger capacity

But …

- product must meet customer needs

- Demand should be large

22

AMITY GLOBALBUSINESS SCHOOL Bangalore Various types

of capacities• Production capacity

maximum rate of production ( or output ) in a day

- 100 cars per day

- 200 refrigerators per day

Factors :

- employee absenteeism, equipment breakdown, holidays, delays in material procurement / delivery, overtime, temporary workers, outsourcing

23

AMITY GLOBALBUSINESS SCHOOL BangaloreMeasures of

capacity • Output measures to express the capacity of line flow

processes• Input measures for flexible flow processes

Capacity utilisation rate = capacity used (actual output )

best operating level ( design capacity )

Efficiency = actual output

effective capacity

24

AMITY GLOBALBUSINESS SCHOOL BangaloreMeasures of

Capacity• Automobile factory – no. of vehicles• Steel Mill – Tonnes of stel• Power Plant – megawatts of elec generated• Job Shop – Labour Hours worked• Airline – No. of seats• Hospital – No. of Beds• Movie Theatre – No. of seats• Restaurant – no. of seats

25

AMITY GLOBALBUSINESS SCHOOL Bangalore Determinant - To smooth out

capacity requirementsUnevenness in capacity may be due to seasonal

(predictable) / random (unpredictable) variations –

can cause overloading / underloading of machines & personnel

solution – produce complementary products ( air conditioning / heating ) – stable capacity

26

AMITY GLOBALBUSINESS SCHOOL BangaloreTaking a

“big picture” approach must consider how different parts interrelate

For eg. When mgt of a 5 star hotel decides to increase the number of rooms – increase in parking space, restaurant seating, staff etc

27

AMITY GLOBALBUSINESS SCHOOL Bangalore Frequency of

Capacity Additions• Cost of upgrading too frequently

expensive – cost of m/c and installation

• Cost of upgrading too infrequently

expensive – capacity is purchase in chunks, larger overheads

28

AMITY GLOBALBUSINESS SCHOOL Bangalore Determining

capacity requirements• Use forecasting techniques to predict sales for

individual products• Calculate equipment and labor requirements• Project labor and equipment availabilities over the

planning horizon

29

AMITY GLOBALBUSINESS SCHOOL Bangalore

Capacity Alternatives

30

AMITY GLOBALBUSINESS SCHOOL BangaloreQ

The whitening company produces two varieties of detergents : Sirf and ExSirf. Each is available in bags and single serving pouches. Management would like to determine equipment and labor requirements for the same. The marketing department has provided the following forecast for the next five years.

31

AMITY GLOBALBUSINESS SCHOOL Bangalore

1 2 3 4 5

Sirf

Bags(000s) 60 100 150 200 250

Pouches(000s) 100 200 300 400 500

ExSirf

Bags(000s) 75 85 95 97 98

Pouches(000s) 200 400 600 650 680

32

AMITY GLOBALBUSINESS SCHOOL Bangalore

Currently, there are three machines that can package upto 150,000 bags each. Each machine requires 2 operators and can produce bags of Sirf and ExSirf. six bag operators are available. 5 machines that can package upto 250,000 pouches each per year are available. Three operators are reqd for each machine, which can produce pouches of both Sirf and ExSirf. Currently, 20 pouching machine operators are available

33

AMITY GLOBALBUSINESS SCHOOL Bangalore

• Total product line forecasts

Year 1 2 3 4 5

Bags 135 185 245 297 348

Pouches 300 600 900 1050 1180

34

AMITY GLOBALBUSINESS SCHOOL Bangalore

• Total capacity for bags = 3 * 1,50,000

= 4,50,000• We will be using 135 / 450 = 0.3 for yr 1• 0.3 * 3 = 0.9 machines• Total capacity for bags = 5 * 250,000

= 1,250,000• For yr 1 , usage = 300 / 1250 = 0.24 • Machine usage = 0.24 * 5 = 1.2 machines

35

AMITY GLOBALBUSINESS SCHOOL BangaloreLabor

Requirement• For yr 1• 0.9 * 2 = 1.8 operators = 2• 1.2 pouch machines * 3 = 3.6 = 4 operators

36

AMITY GLOBALBUSINESS SCHOOL BangaloreProject Labor

and Equipment availabilitiesYear 1 2 3 4 5

Pouch

% capacity used

24 48 72 84 94

Machine req 1.2 2.4 3.6 4.2 4.7

Labor req 3.6 7.2 10.8 12.6 14.1

Bag

% capac used 30 41 54 66 77

Machine req 0.9 1.23 1.62 1.98 2.31

Labor req 1.8 2.46 3.24 3.96 4.62

37

AMITY GLOBALBUSINESS SCHOOL Bangalore

Available capacity exceeds demand for all five years

--- positive capacity cushion

38

AMITY GLOBALBUSINESS SCHOOL Bangalore Identifying and

Analysing Sources Of CapacityWhere present capacity is not sufficient to meet the

forecast demand for the products and services- Subcontracting component parts, sub units or even

entire products to other firms- Acquiring other firms, facilities or resources- Building new plants, equipments, machinery- Expanding, modernising or modifying existing

facilities- Reactivating facilities which are on stand by status.

39

AMITY GLOBALBUSINESS SCHOOL Bangalore When the present capacity

is in excess of the future needs

• Selling off existing facilities, selling inventories and laying off or transferring employees

• Placing some facilities on stand by status and selling the inventories

• Developing and phasing in new products as other products decline

40

AMITY GLOBALBUSINESS SCHOOL BangaloreSelecting from the

alternative sources of capacity- Economically feasible ?

- Operating and maintenance costs

- Time taken to acquire ?

- Useful life ?

- compatible with present personnel and operating methods ?

- Community attitude ?

41

AMITY GLOBALBUSINESS SCHOOL BangaloreAnalysis

• Decision tree analysis• Break even analysis• Financial analysis• Computer simulation or waiting line analysis

42

AMITY GLOBALBUSINESS SCHOOL BangaloreDecision

tree analysis• Schematic model of the sequence of steps

in a problem and consequence of each step

• Squares – decision points

• Circles – chance events

• Branches from chance events - probabilities

43

AMITY GLOBALBUSINESS SCHOOL Bangalore

Helpful in visually displaying the problem and then organizing the computational work .

Very useful when a sequence of decisions must be made

44

AMITY GLOBALBUSINESS SCHOOL BangaloreCase

The owner of Hacker computer store is considering what to do with his business over the next 5 yrs. Sales growth has been good but could grow more if a major electronics firm is built in his area as proposed. Hackers owner sees three options – enlarge his current store, locate to a new site. Or do nothing. The decision to expand or move would take little time, and, therefore, the store would not lose time. If nothing were done the first year and strong growth occurred, the decision to expand would be

45

AMITY GLOBALBUSINESS SCHOOL Bangalore

reconsidered. Waiting longer than one year would allow competition to move in and make expansion no longer feasible.

The assumptions and conditions are as follows :

1. Strong growth as a result of the increased population of computer fanatics from the new electronics firm has a 55 % prob

2. Strong growth with a new site would give annual returns of Rs. 195,000 per year. Weak growth with a new site would mean annual returns of Rs. 115,000

46

AMITY GLOBALBUSINESS SCHOOL Bangalore

3. Strong growth with an expansion would give annual returns of Rs. 190,000 per year. Weak growth with an expansion would mean annual returns of Rs. 100,000

4. At the existing store with no changes, there would be returns of Rs. 170,000 per year if there is strong growth and Rs. 105,000 per year if growth is weak.

5. Expansion at the current site would cost Rs. 87,000

6. The move to the new site would cost Rs. 210,000

47

AMITY GLOBALBUSINESS SCHOOL Bangalore

7. If growth is strong and the existing site is enlarged during the second year, the cost would still be Rs. 87,000

8. Operating costs for all options are equal.

48

AMITY GLOBALBUSINESS SCHOOL BangaloreSolution

strong growth = 765,000 move 0.55 585,000 weak growth-0.45= 365,000 strong growth = 863,000 expand 0.55 660,000 weak growth = 413,000 0.45 expand843000 do nothing strong growth(0.55) do nothing

703,750 850,000

weak growth(0.45) = 525,000

49

AMITY GLOBALBUSINESS SCHOOL Bangalore

• To move move to new location, strong growth: (rev)195,000 * 5 – 210,000(cost) = 765,000 (value ) move to new location, weak growth: (rev)115,000 * 5 – 210,000(cost) = 365,000 (value )Total value = Rs.765,000 × 0.550 + ( Rs. 365,000 × 0.45 ) = Rs. 585,000

50

AMITY GLOBALBUSINESS SCHOOL Bangalore

• Expand

expand store, strong growth

190,000× 5 – 87,000 = 863,000

Expand store, weak growth

100,00 × 5 – 87,000 = 413,000

Total value = 863,000 × 0.550 + 413,000 × 0.45 = 660,500

51

AMITY GLOBALBUSINESS SCHOOL BangaloreDo nothing now

• Do nothing now, strong growth, expand next year

(170,000 x 1yr + 1,90,000 × 4 yrs ) – 87,000

= 843,000• Do nothing now, strong growth, do not expand next

year

(170,000 x 5 yr ) – 0 = 8,50,000• (8,50,000 × 0.550 = 467500) + (843,000× 0.45 =

379350 ) = 846,850

52

AMITY GLOBALBUSINESS SCHOOL Bangalore

• Do nothing now, weak growth,

(105,000 x 5 yr ) – 0 = 5,25,000• Final

(846,850 × 0.550 = 465767) + (525,000 × 0.45 = 236250) = 702017

As this course of action gives the highest returns;

Do nothing

53

AMITY GLOBALBUSINESS SCHOOL BangaloreCase

E education is a new start up that develops and markets MBA courses over the internet. The company is currently located in Bangalore and employs 150 people. It needs to plan for the coming 5 years.Due to strong growth the company needs additional office space. The company has the option of leasing additional space at its current location in Bangalore for the next two years, but after that will need to move to a new building. Another option the company is considering is moving the entire operations to a small central India town immediately.

54

AMITY GLOBALBUSINESS SCHOOL Bangalore

The third option is for the company to lease a new building in Bangalore immediately. If the company chooses the first option and leases new space at its current location, it can be at the end of two years, either lease a new building in Bangalore or move to a small Central India town.

• The company has a 75 % chance of surviving the next two years

55

AMITY GLOBALBUSINESS SCHOOL Bangalore

• Leasing the new space for two years at its current location in Bangalore would cost Rs. 750,000 per year

• Moving the entire operation to a Central India town would cost Rs. 10 lakh. Leasing space would run only Rs. 500,000 per year.

• Moving to a new building in Bangalore would cost Rs. 200,000 and leasing the new buildings space would cost Rs. 650,000 per year.

56

AMITY GLOBALBUSINESS SCHOOL Bangalore

• The company can cancel the lease at any time• The company will build its own building in five

years, if it survives.• Assume all other costs and revenues are the same no

matter where the company is located

What should E Education do ?

57

AMITY GLOBALBUSINESS SCHOOL Bangalore

stay in Bangalore survive(0.75) lease new space lease space for 2 yrs move to cent I fail(0.25) stay in Bangalore survive(0.75) E Ed lease new space fail (0.25)

move to central survive( 0.75) India town fail (0.25)

58

AMITY GLOBALBUSINESS SCHOOL BangaloreOption 1

Stay in Bangalore • Lease space for two years, survive, lease new

building in Bangalore

750,000×2 + 200,000 + 650,000 × 3

= 3650000• Lease space for two years, survive, move to Central

India

750,000×2 + 10,00,000 + 500,000 × 3

= 4000000

59

AMITY GLOBALBUSINESS SCHOOL BangaloreOption 1

Stay in Bangalore• Lease space for two years, fail

750,000 × 2 = 15,00,000

Total cost(survive) = (3,650,000 × 0.75 ) +

(4,000,000 × 0.25) = 3737500

Total cost = 3737500 ×0.75 + 1500000×0.25 =

= 2803125 + 375000

= 3178125

60

AMITY GLOBALBUSINESS SCHOOL BangaloreOption 2

• Stay in Bangalore, lease new bldg in Blr, survive 200,000 + (650,000 * 5 ) = 3,450,000• Stay in Bangalore, lease new bldg in Blr, fail 200,000 + (650,000 * 2 ) = 1,500,000

(3450000 × 0.75) + (1500000 × 0.25 ) = 29,62,500

61

AMITY GLOBALBUSINESS SCHOOL BangaloreOption 3

Move to CI, survive

1,000,000 + ( 500,000 * 5 ) = 3,500,000

Move to CI, fail

1,000,000 + ( 500,000 * 2 ) = 2,000,000

Option 3

(3500000 × 0.75) + (2000000 × 0.25 )

= 3125000

62

AMITY GLOBALBUSINESS SCHOOL BangaloreSolution

Stay in Bangalore and lease a new building

63

AMITY GLOBALBUSINESS SCHOOL BangaloreQ

64

AMITY GLOBALBUSINESS SCHOOL BangaloreQ

make or buy decisionThe ABC company manufactures and sells refrigerators.

It makes some of the parts for the refrigerators and purchases others. The Engg deptt believes it might be possible to cut costs by mfg one of the parts currently being purchased for Rs.8.25 each. The firm uses 100,000 of these parts each year. The accounting deptt compiles the following list of costs based on engg estimates :

65

AMITY GLOBALBUSINESS SCHOOL Bangalore

- Fixed costs will increase by Rs 50,000- Labor costs will increase by Rs. 1,25,000- Factory overhead, currently running Rs. 500,000 per

year, may be expected to increase 12 %- Raw materials used to make the part will cost Rs

600,000Given the preceding estimates, should ABC make the

part or continue to buy it ?

66

AMITY GLOBALBUSINESS SCHOOL Bangalore

• Total cost if the part were manufactured - Additional Fixed Costs Rs 50,000- Additional Labor Costs Rs. 125,000- Raw Materials Cost Rs.600,000 - Additional Overhead Cost

( 0.12 × Rs 500,000) Rs. 60,000

total Cost to Manufacturer Rs. 835,000

67

AMITY GLOBALBUSINESS SCHOOL Bangalore

• Cost per unit to manufacturer

Rs. 835,000 / 100,000 = Rs. 8.35 per unit

As there is an additional cost of Rs 0.10, should continue to buy the part.

68

AMITY GLOBALBUSINESS SCHOOL Bangalore Capacity Planning

Environment• Strong management will

• Good forecasting models

• Uniform demand from market (including seasonal demand)

• Decision taking ability