DOM 511: OPERATIONS MANAGEMENT PRACTICE

Magutu Obara Peterson University of Nairobi

School of BusinessDépartement of Management

ScienceMay - August 2012

1magutumop2011

CAPACITY MANAGEME

NT2

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Understanding CapacityCapacity Utilization & Best Operating

LevelEconomies & Diseconomies of ScaleThe Experience CurveCapacity Focus, Flexibility & PlanningDetermining Capacity RequirementsDecision TreesCapacity Utilization & Service Quality

Objectives

The Airbus A380 is the largest plane ever built with 555 seats. With some modest redesign, such as extending the length of the plane, it could carry as many as 800 airline passengers. The pieces of the plane are so big, such as the cockpit, tail, wings, and cabin sections that the factories must be reconfigured. The European Consortium that builds the Airbus must make and transport these parts, some weighing 100 tons each, among many countries such as Spain, Britain, France, and Germany. Not only must factory capacity and scale be upsized, the elaborate transportation system to move these parts among European factories must also be changed. At a maximum speed of 15 miles per hour, the trip to Toulouse, France, from the seaport of Bordeaux takes three days. The French government has redone the entire 159-mile route, including 18 miles of new bypass routes around five towns, to handle the six giant truck trailers that carry these manufactured parts.

Introduction

Capacity Management - The Meaning Of CapacityCapacity is the capability of a manufacturing or service resource such as a facility, process, workstation, or piece of equipment to accomplish its purpose over a specified time period.

The capacity of a production unit (e.g. machine, factory) is its ability to produce or do that which the customer requires.

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Capacity Management - The Meaning Of Capacity In operations management, three types of capacity are

often referred to:Potential Capacity - The capacity that can be made

available to influence the planning of senior management. This is essentially a long-term decision that does not influence day-to-day production management

Immediate Capacity - The amount of production capacity that can be made available in the short-term. This is the maximum potential capacity - assuming that it is used productively

Effective Capacity - An important concept. Not all productive capacity is actually used or usable. It is important for production managers to understand what capacity is actually achievable.

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Typical capacity issues to address include:Can the facility, process, or equipment

accommodate new goods and services and adapt to changing demand for existing goods and services?

How large should facility, process, or equipment capacity be?

When should capacity changes take place?

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Capacity is determined by;Resources available to the organization

– facilities, equipment & labor (technology & process selection)

How resources available are organized (process design & facility layout)

Efficiency of resources as determined by specific work methods & procedures (work & supply chain design)

Capacity is vital to designing and managing value chains

At every stage of a chain, sufficient capacity must exist & be coordinated with other stages & processes

Capacity and Value Chain

Issues of concern in capacity;Can the facility, process or equipment accommodate new goods & services & adapt to changing demand for existing goods & services?

How large should facility, process, or equipment capacity be?

When should capacity changes take place?

Issues of concern in capacity;

Capacity is the capability of a manufacturing or service resource such as facility, process, workstation, or piece of equipment to accomplish its purpose over a specified time period

Capacity can be view from 4 dimensions;Quantity QualityTime Location

What are the units of measuring capacity?

Understanding Capacity

Capacity is the capability of a manufacturing or service resource such as facility, process, workstation, or piece of equipment to accomplish its purpose over a specified time period

Capacity can be view from 4 dimensions; Quantity Quality Time Location

Time may be a constraint where a customer has a particular required delivery date. In this situation, capacity managers often "plan backwards". In other words, they allocate the final stage (operation) of the production tasks to the period where delivery is required; the penultimate task one period earlier and so on.

What are the units of measuring capacity?

Understanding Capacity

Capacity PlanningOperations managers must decide

on the appropriate levels of capacity to meet current & future demand – hence need for proper planning

Capacity planning should take place at multiple levels i.e capacity planning is generally viewed in 3 durations

Long range – Annual plans for 2-5 years. Basically plans on the productive resources; Takes a long time to acquire & needs top mgt participation & approval

Capacity PlanningIntermediate range ; monthly/quarterly

plans for the next 6 to 18 months – decisions to make include, hiring, layoffs, new tools & minor equipment purchases & subcontracting

Short range ; less than one month, capacity issues addressed thro’ overtime, personnel transfers & production routings

Capacity PlanningProduction SchedulingA schedule is a representation of the time

necessary to carry out a particular task.A job schedule shows the plan for the

manufacture of a particular job. It is created through "work / study" reviews which determine the method and times required.

Most businesses carry out several production tasks at one time - which entails amalgamating several job schedules. This process is called "scheduling". The result is known as the production schedule or factory schedule for the factory/plant as a whole.

Capacity PlanningIn preparing a production schedule, attention

needs to be paid to:- Delivery dates (when are finished products

due?) - Job schedules for each relevant production task- Capacities of production sections or departments involved- Efficiency of these production sections or departments- Planned holidays- Anticipated sickness / absenteeism / training- Availability of raw materials, components and packaging

Strategic Capacity PlanningDefined

Capacity planning is the analysis of what you are capable of producing versus what your expected demand will be.

Strategic capacity planning is an approach for determining the overall capacity level of capital intensive resources, including facilities, equipment, and overall labor force size that best supports the firms long range competitive strategy. This plans constrain the firm on volume & variety to deliver to the market place.

components of capacity managementThere are two components of capacity

management:Capacity Planning (creating sufficient,

flexible, capable, capacity & a valid, best, "do-able", resilient, plan, to accommodate demand)

Capacity Control (ensuring the plan is met by managing resources)

Without capacity (and materials) to meet the demand, the plan cannot be valid.

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A. Capacity PlanningThere are, in a typical business, four levels where

capacity planning (& control) is required (as shown below). At each of these levels there may be a one-to-many relationship with the level below.

There are certainly differences in both planning detail and planning horizon required to satisfy each level. For example at strategic planning level one, product groups (not necessarily individual products) are being forecast with an horizon of perhaps years. At level four, when you are managing an individual resource, you are dealing with detailed operating instructions for an individual process and horizons of perhaps seconds:

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Level 1: Strategic Capacity ManagementCapacity should be first be analyzed during business

planning sessions. The company should have a good sense of their current capacity and at what percentage they are operating.

(as a part of business planning) includes capacity management activity to:

Define longer term capacity goals (time phased resources required to meet the business plan) Capability Capacity Impact of New Product Introduction / old product kill

Manage gross and long term capacity to meet it which will include the following considerations and actions: Devise upsize / downsize strategy (output or

responsiveness)

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Level 1: Strategic Capacity Management

Manage volume & variety change Place products in business units / locations & position

capacity geographically (to source supply) Devise strategies to manage seasonal demand /

demand variability

Attack the drivers of performance & attributes of resources to provide: Resource Viability & Core Competence

Capacity (line) balancing Replacement theory (Repair or replace?) Create resilience and consistency of service in the supply

chain

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Level 2. Development, Sales and Operations Management(Management of the demands on the

business and the gross capacity to meet it and make it happen!) (The Sales & Operations part of this process is mainly covered in a separate article from our early work in this area "Participative Sales and Operations Planning".)

We have two general views of this process, as we will explain further:

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Level 2. Development, Sales and Operations Management

If you basically, sell what you can make, you need a "Participative Master Production Scheduling Process" assisted by a simple capacity modelling system, (to organise resources to deliver it, which basically is answering the question, "When?")

Otherwise, you need or a full "Development, Sales & Operations Management Process" to make the trade-offs between the difficulty of selling vs. the difficulty of providing and to additionally manage the development and sales processes, which answers the three questions, "What, If and When?".

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Level 3: Workflow Management / Scheduling(Scheduling of individual functions, cells or process

areas)In the mid 1970's the commercial availability of

computers also spawned capacity planning tools, whose models were very sophisticated even by comparison with today's systems. It is mathematically possible to create a comprehensive model of the manufacturing or supply chain processes run on powerful computers, which use a variety of optimising techniques, in recently created "Advanced Scheduling Systems", in order to schedule work. (Previous Technique T020: "Close Scheduling" provides an introduction to scheduling.)

Also MRP2 Systems took the MRP1 plan and scheduled operations to create a "work-to" list at operational level in the early 1980's.

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Level 3: Workflow Management / SchedulingHowever it is difficult to justify the additional

cost and administration that these systems require, if:Less sophisticated processes such as an

effective master production scheduling process supported by a rough-cut capacity model is implemented first.

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Level 4: Process Management(E.g. individual settings, speeds, feeds, skills, set /

make ready times etc.)At level four we have been involved in some

interesting & lively debates about:What is the best method (running speeds, feeds,

process settings, least waste, shortest lead-time etc.)? This is where Taguchi methods (Design Of Experiments) is particularly useful. (In one recent example we showed that by reducing conveyor speed, more throughput could be achieved.)

Identifying and then driving skills development (versatility / mobility) using skills matrices

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B. Capacity ControlHow much output should operations ideally

produce if the order book is empty?The answer of course is zero and of course

ideally they should incur zero cost (a zero capacity floor) in doing so. So why are operations measured on maximising output?

The key question is how can we de-bottleneck, perhaps by reassigning underutilised resources.

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B. Capacity ControlStrategic / Business Planning (where typically

budgetary type controls operate) but this plan must be "do-able" (established by modelling it using the level 2 Rough Cut Capacity Planning tools)

Development, Sales and Operations Management / Master Production Schedule, where the overall plan is measured and performance against the plan analysed and actions taken to bring output into line with demand, but any conflict between the business plan and what customers want has to be reconciled at this level, not passed to level 3 unresolved.

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Importance of Capacity Decisions:

1.Impacts ability to meet future demands2.Affects operating costs3.Major determinant of initial costs4.Involves long-term commitment5.Affects competitiveness6.Affects ease of management7.Globalization adds complexity8.Impacts long range planning

Capacity is measured as efficiency and utilization

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Measuring CapacityThe decision to increase capacity is not easy and can be

extremely costly.Make sure you've fully analyzed all of your options and

backed them with financial calculations. If you do purchase a new piece of equipment, there's a

tendency to want to operate them at full-capacity to reduce the return on investment. This is a false way of thinking. You should be operating to meet your demand, not to keep the machines running. This line of thinking will lead to excess materials and increased costs.

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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Efficiency and Utilization

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Actual outputEfficiency =

Effective capacity

Actual outputUtilization =

Design capacity

Both measures expressed as percentages

Efficiency/Utilization Example

Actual output = 36 units/day

Efficiency = = 90% Effective capacity 40 units/ day

Utilization = Actual output or used = 36 units/day

= 72% Design capacity 50 units/day

Design capacity is a.k.a best operating levelActual output is a.k.a capacity used

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Design capacity = 50 trucks/day

Effective capacity = 40 trucks/day

Actual output = 36 units/day

Capacity Utilization

WhereCapacity used

rate of output actually achieved Best operating level

capacity for which the process was designed

level operating Best

usedCapacity rate nutilizatioCapacity

Best Operating LevelExample: Engineers design engines and assembly lines to operate at an ideal or “best operating level” to maximize output and minimize ware

Example: Engineers design engines and assembly lines to operate at an ideal or “best operating level” to maximize output and minimize ware

Underutilization

Best OperatingLevel

Averageunit costof output

Volume

Overutilization

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%

Economies & Diseconomies of Scale

100-unitplant

200-unitplant 300-unit

plant

400-unitplant

Volume

Averageunit costof output

Economies of Scale and the Experience Curve workingEconomies of Scale and the Experience Curve working

Diseconomies of Scale start workingDiseconomies of Scale start working

Economies & Diseconomies

•Economies of scale are achieved when the average unit cost of a good or service decreases as the capacity and/or volume of throughput increases

•Reverse for diseconomies of scale

The Experience Curve

As plants produce more products, they gain experience in the best production methods and reduce their costs per unit

As plants produce more products, they gain experience in the best production methods and reduce their costs per unit

Total accumulated production of units

Cost orpriceper unit

Yesterday

TodayTomorrow

The Experience Curve

Class Exercise :

Discuss the impact of the experience curve on effective capacity and state the issues which may hinder a firm from riding smoothly down the experience curve.

Capacity Focus

The 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) (from Skinner)Extend focus concept to operating level

Capacity FocusDimensions of capacity focus

CostQualityFlexibilityNew product introductionReliabilityShort lead times

With the new manufacturing technology it is possible for a firm to focus on a selected set of dimensions that most work towards corporate objectives

Capacity FlexibilityFlexible plants – Having the ability to

rapidly increase or decrease production levels & change from one product to another.

Flexible processes ( Economies of scope ) – permit rapid low cost switching from one product to another

Flexible workers – Multi skilled, ability to switch easily from one kind of task to another, require broad based training

Capacity Planning: Balance

Stage 1 Stage 2 Stage 3Unitsper

month6,000 7,000 5,000

Unbalanced stages of productionUnbalanced stages of production

Stage 1 Stage 2 Stage 3Unitsper

month6,000 6,000 6,000

Balanced stages of productionBalanced stages of production

Capacity Planning(i) Maintaining System Balance: Output

of one stage is the exact input requirements for the next stage

Balancing Techniques

• Add capacity to bottleneck work centers• Scheduling overtime

• Leasing equipment

• subcontracting

• Use of buffer inventories in front of the bottleneck

• Duplicate the facilities of bottleneck dept.

Capacity Planningii) Frequency of Capacity Additions

Frequent Additions ; Costs• Removing old & replacing new

• Training employees on new

• Purchase cost of new

• Opportunity cost of idle plant during changeover

Infrequent Additions ; Costs• Purchase cost very high – big chunks

• Overhead of underutilization –

• Lost sales/market share during waiting

period

Managing Capacity By Adjusting Short-Term Capacity Levels

•Add or share equipment

•Sell unused capacity

•Change labor capacity & schedules

•Change labor skill mix

Managing Capacity By Shifting & stimulating Demand

•Vary the price of goods or services

•Provide customers information e.g call centers personal service time

•Advertising & promotion eg Valetine day promotions

•Add peripheral goods and/or services

•Provide reservations

Capacity Planning

iii) External Sources of Capacity

May be cheaper in the short run; Methods of achieving this include;

•Outsourcing

•Sharing

Determining Capacity Requirements

1. Forecast sales within each individual product line

2. Calculate equipment and labor requirements to meet the forecasts

3. Project equipment and labor availability over the planning horizon

Capacity CushionA firm may decide to have capacity in

excess of expected demand I.e capacity cushion

Reasons

Anticipation of growth in demand

Provision for errors in estimation of demand

Compensation for any loss in capacity if BOL is not attainable

** Positive Vs Negative capacity cushion

Decision TheoryHelpful tool for financial comparison of

alternatives under conditions of risk or uncertainty Suited to capacity decisions

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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.

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

0.1 0.5 0.4Low Medium High

A 10 50 90B -120 25 200C 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

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 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

Planning Service Capacity vs. Manufacturing Capacity

Time: Services can not be stored for later use and capacity must be available to provide a service when it is needed

Location: Service must be at the customer demand point and capacity must be located near the customer

Volatility of Demand: Much greater than in manufacturing. Services can not be stored hence hence inventory can not smooth demand. Also customers directly interact with system & have varying needs

Capacity Utilization & Service Quality

Best operating point is near 70% of capacity - Enough to keep servers busy but allows enough time to serve customers individually and keep enough capacity in reserve so as not to create too many managerial headaches.

From 70% to 100% of service capacity, what do you think happens to service quality?

Capacity Utilization & Service Quality

0102030405060708090100

10 20 30 40 50 60 70 80 90 100

100%

70%

Critical zone

Mean service rate

Mean arrival rate

Capacity Utilization & Service Quality

From 70% to 100% of service capacity, ( The critical zone) customers are processed through the system but service quality declines. Above the critical zone, the line builds up & it is likely that many customers may never be served.

Capacity Utilization & Service Quality

Optimal utilization rate is very context specific. Low rates are appropriate when both the degree of uncertainty & the stakes are high. Eg hospitals & fire depts. Commuter trains & postal sorting operations are relatively predictable services & one can plan to operate much near 100% utilization

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Capacity Expansion Strategies:Entrepreneurial StageShift resources to different tasks as needed

Customer coproduction

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Capacity Expansion Strategies: Multisite Rationalization StageAdd services to existing site

Duplicate existing services at additional sites

Do both

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Capacity Expansion Strategies: Growth Stage“Bermuda Triangle” of operational

complexityManagement difficulty exceeds management

ability

New capacity management challengesNeed for fresh ideasNeed to upgrade older facilities

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Capacity Expansion Strategies: Maturity StageFocus on operational efficiencies

Remodeling and replacement

Service modification

Duplication across entire service system

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Capacity Expansion Strategies: Maturity StageFocus on operational efficiencies

Remodeling and replacement

Service modification

Duplication across entire service system

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