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Supply Chain Management

Lecture 3Chapter 2: Capacity Planning & Location Decisionsa) Capacity Planning

Strategic Capacity Planning� Strategic capacity planning is an approach for

determining the overall capacity level of capital intensive resources, including facilities, equipment, and overall labor force size

� Capacity planning is central to the long term success of any strategic plan and the success of the enterprise. capacity planning and determining the capacity constraints determines the requirements of other inputs for the program.

� Too much capacity can be as problematic as too little.

� The basic questions in capacity planning are:� What kind of capacity is needed?

� How much is needed?� When is it needed?

Capacity Strategy

� The main objective of capacity planning is to match company’s production capacity & customer demand in the most profitable way.

� Thus capacity planning should take into consideration not only facility, production & distribution costs, but also lost sales due to inability to supply on time & any revenue gains due to quick response.

� In addition, the capacity strategy should consider demand patterns as well as supply capabilities.

1. Impacts ability to meet future demands

2. Affects operating costs

3. Major determinant of initial costs

4. Involves long-term commitment

5. Affects competitiveness

6. Affects ease of management

7. Globalization adds complexity

8. Impacts long range planning

Importance of Capacity Decisions

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Rationale for Capacity Planning Decisions

1. Design Capacity has linkages with

production facility and cost structure

2. Capacity and location decisions require

large financial investments and long

planning lead times …

3. Capacity availability and location help

companies serve customers quickly and

conveniently – competitive advantage

Steps for Capacity Planning

1. Estimate future capacity requirements

2. Evaluate existing capacity

3. Identify alternatives

4. Conduct financial analysis

5. Assess key qualitative issues

6. Select one alternative

7. Implement alternative chosen

8. Monitor results

� Need to be near customers

�Capacity and location are closely tied

� Inability to store services

�Capacity must be matched with timing of

demand

� Degree of volatility of demand

�Peak demand periods

Planning Service Capacity

In-House or Outsourcing

1. Available capacity

2. Expertise

3. Quality considerations

4. Nature of demand

5. Cost

6. Risk

Outsource: obtain a good or service from an external provider

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Capacity planning and control

Forecast demand

Time

Ag

gre

gate

d o

utp

ut

Estimate of current capacity

Measure aggregate capacity and demand

Identify the alternative capacity plans

Choose the most appropriate capacity plan

Forecast demand

Time

Ag

gre

gate

d o

utp

ut

The nature of aggregate capacity

– rooms per night

– ignores the numbers of guests in each room

– tonnes per month

– ignores types of alloy, gauge and batch

variations

Aggregate capacity of a hotel:

Aggregate capacity of an aluminum producer:

Climatic Festive Behavioural Political Financial Social

Causes of seasonality

Education services

Beverages (beer, cola)

Foods (ice-cream, Eid cake)

Clothing (sweaters, shoes)

Gardening items (seeds, fertilizer)

Fireworks

Travel services

Holidays

Tax processing

Doctors (influenza epidemic)

Sports services

Construction Material

Demand fluctuations in four operations

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Good forecasts are essential for effective capacity planning …… but so is an understanding of demand uncertainty, because it allows you to judge the risks to service level

When demand uncertainty is high, the risks to service level of under-provision of capacity are high

DE

MA

ND

TIME

Only 5% chance of demand being lower than this

DE

MA

ND

TIME

Distribution of demand

Only 5% chance of demand

being higher than this

Loading time

Performance rate = p

= net operating time/total operating time

Quality losses

Valuable

operating time

Quality losses

Slow-running

equipment

Equipment

‘idling’Net operating timeSpeed losses

Not worked (unplanned)

Breakdown failure

Set-up and changeovers

Total operating timeAvailability

losses

Quality rate = q

=valuable operating time/ net operating time

Availability rate = a

= total operating time/loading time

Operating equipment effectiveness (OEE)

A method of judging the effectiveness of how operations equipment is used.

How capacity and demand are measured

Design capacity

168 hours

per week

Effective

capacity

109 hours

per week

Planned loss of 59 hours

Actual output –

51 hours per

week

Avoidable loss –

58 hours per

week

EfficiencyActual output

Effective capacity=

UtilizationActual output

Design capacity=

definitions of capacity

� Design capacity

�Maximum output rate or service capacity an

operation, process, or facility is designed for

� Effective capacity

�Design capacity minus allowances such as

personal time, maintenance, and scrap

� Actual output

�Rate of output actually achieved--cannot

exceed effective capacity.

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Actual output = 36 units/day Efficiency = = 90%

Effective capacity 40 units/ day

Utilization = Actual output = 36 units/day = 72%

Design capacity 50 units/day

Efficiency/Utilization Example

Design capacity = 50 trucks/day

Effective capacity = 40 trucks/day

Actual output = 36 units/day

Capacity Utilization

If operated around the clock under ideal conditions, the fabrications department of an engine manufacturer can make 100 engines per day.

Management believes that a maximum output rate of only 45 engines per day can be sustained economically over a long period.

Currently the department is producing an average of 50 engines per day.

What is the utilization of the department relative to peak capacity and effective capacity?

Utilization = (Average Output Rate/design Capacity)

Efficiency = (Average Output Rate/Effect. Capacity)

Capacity cushion

� Capacity Cushion

�The amount of reserved capacity that a firm

maintains to handle sudden increases in demand or temporary losses of production

capacity.

� Capacity Cushion = 1 - Utilization

Ways of reconciling capacity and demand

Level capacity

Demand

Capacity

Chase demandDemand

management

CapacityCapacity

Demand Demand

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How do you cope with fluctuations in demand?

Absorb demand

Change demand

Adjust output to match demand

Level capacity

Chase demand

Demand management

Ways of reconciling capacity and demand

Absorb demand

Part finished

Finished goods, or

Customer inventory

Queues

Backlogs

Have excess capacity

Make to stock

Keep output level

Make

customer wait

Adjust output to match demand

Hire Fire

Temporary labor Lay-off

Overtime

Subcontract

Short time

Third-party work

Change demand

Change pattern of demand

Develop alternative products and/or services

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Moving a peak in demand can make capacity planning easier

Capacity Expansion Strategies

1. Demand leading strategy (excess capacity)

2. Demand Trailing strategy (maximum capacity

utilization)

3. Demand matching strategy (Balanced capacity)

4. Steady expansion strategy (steady expansion)

Capacity Expansion Strategies

Or

1. Proactive Strategy

2. Neutral strategy

3. Reactive strategy

Graphs Of Capacity Expansion Strategies

.

Capacity

Demand

Cap

/Dem

TimeDemand leading Demand trailing

Demand matching Steady expansion

Capacity

Demand

Cap

/Dem

CapacityDemand

Cap

/Dem

Cap

/Dem

Capacity

Demand

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Capacity Expansion Strategies..

� Demand leading (excess capacity)

+ can accommodate new/unexpected demand

+ can provide quick response and delivery

+ low overtime & subcontracting costs

- high cost of unused capacity

Note: + = advantages

- = disadvantages

Eg.: Hotel industry (immediate need of rooms; if substitute exists … can lose sales), Furniture maker (can people wait?), Restaurant, University

� Demand trailing (maximum capacity utilization) + minimizes facility & equipment costs

- cannot accommodate new or unexpected demand

- slow response at peak times

- high overtime and/or subcontracting costs

- often forced to add capacity at peaks of business cycles

- Loose sales

Note: (+) => advantages

( - ) => disadvantages

� Demand matching strategy

+ balances capacity & other costs

+ provides reliable service & responsiveness

- must be able to predict demand well or have constant demand

Note: (+) => advantages

( - ) => disadvantages

Steady expansion strategy

+ do not have to outguess competitors

+ price risk from adding capacity during peak

demand is reduced

- excess capacity can result if long term

demand falls short of expectations

Note: (+) => advantages

( - ) => disadvantages

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Measure of Capacity

� Output Basis

Output measure best suited when the company

provides a small number of standardized

product or services or when applied to individual process within the firm.

� Input Basis

Usual choice for low volume flexible processes.

Best Operating Level (Design Capacity)

Example: Engineers design engines and assembly lines to

operate at an ideal or “best operating level” to maximize

output and minimize wear

Example: Engineers design engines and assembly lines to

operate at an ideal or “best operating level” to maximize

output and minimize wear

Underutilization

Best Operating

Level

Average

unit cost

of output

Volume

Over-utilization

Economies of Scale

� Economies of scale

� If the output rate is less than the optimal level,

increasing output rate results in decreasing

average unit costs

� Diseconomies of scale

� If the output rate is more than the optimal

level, increasing the output rate results in

increasing average unit costs

Economies of scale: when a company produces more

of a similar product, the average cost per unit drops.

Producing larger volumes of the same product or very

similar products may result in economies of scale.

Economies of scope: can be defined as making more

variety of products in the same factory. It exists when

multiple products can be produced at a lower cost in

combination rather than separately.

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Recognizing Bottleneck

Easy to identify the bottleneck stage(s) by observing where inventory builds up …

200

200

200

400

100

100

400

100

400

200

200

400

100

100

400

200

Increasing Capacity

Recognize Bottlenecks!

� A bottleneck is an operation that has the lowest effective capacity of any operation

in the process and thus limits the system’s

output.

Weaving

2000 m/hr

Printing

2000 m/hr

Bleaching etc.

1000 m/hr

Weaving 2000 m/hr

Bleaching etc. 2000 m/hr

Printing 2000 m/hr

Minimizing Capacity Constraints

� Outsource during peak periods

� Keep bottleneck resources busy

� Use overtime/ part-time employees as

short term option

� Consider long term capacity expansion

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Decision Tree

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.

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

0.1 0.5 0.4

Low Medium High

A 10 50 90

B -120 25 200

C 20 40 60

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:

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

A

B

C

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

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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

Example of Decision Tree Problem (Continued):

Step 4. Make decisionHigh 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