BIZ Production & Operations Management. Process Capacity. Sung Joo Bae, Assistant Professor. Yonsei University School of Business

Transcription

1 BIZ Production & Operations Management Process Capacity Sung Joo Bae, Assistant Professor Yonsei University School of Business

2 Sharp s Capacity Problem

3 Planning Capacity Capacity is the maximum rate of output of a process or system Without enough capacity, what will happen to the organization? Missing opportunities Late response leading to overinvestment Disrupted cashflow and loosing dominant position in the market Takes long time to recover from those missing opportunities Acquisition of new capacity can take some time (e.g. semiconductor, nuclear power plants) The influence of new product development can be reduced (e.g. Apple s iphone)

4 Planning Capacity Accounting, finance, marketing, operations, purchasing, and human resources all need capacity information to make decisions Accounting: provides cost information needed to evaluate expansion decisions Finance: performs financial analysis of the proposed capacity expansion investment and raises funds to support them Marketing: provides demand forecast (e.g. airline, cruise ship, IT products) Capacity planning is done in the long-term and the short-term Factors related to the long-term decisions Firm s economies (or diseconomies) of scale Capacity cushions Timing and sizing strategies How much of a cushion is needed to handle variable/uncertain demand? (Size of cushion) Should we expand capacity ahead of demand, or wait until demand is more certain? (Timing) Supply chain readiness

5 Planning Capacity Capacity management Capacity planning (long-term) Economies and diseconomies of scale Capacity timing and sizing strategies Systematic approach to capacity decisions Constraint management (short-term) Identification and management of bottlenecks Product mix decisions using bottlenecks Managing constraints in a line process

6 Measures of Capacity Utilization Output measures of capacity Adequate for individual processes within the firm, or the firm with relatively small number of standardized products and services With high level of customization and variety in product mix, measuring only output is not very useful e.g. the number of cars produced per day Input measures of capacity Adequate for low volume, flexible processes e.g. the number of workstations, the number of workers Input-output conversion is necessary since demand is met by output Utilization Average output rate Utilization = 100% Maximum capacity

7 Measures of Capacity Utilization Utilization The degree to which a resource (equipment, space, or workforce) is currently being used Utilization = 100% Average output rate Maximum capacity Too high add extra capacity Too low eliminate unneeded capacity A process can be operated above its capacity level Overtime, extra shifts, temporarily reduced maintenance activities, overstaffing, subcontracting But these are temporary solutions quality can be affected

8 Capacity and Scale Economies of scale The average unit cost of a service or good can be reduced by increasing its output rate Fixed costs are spread over more units Some maintenance cost, manager s salaries, depreciation of plant and equipment, etc. Reducing construction costs Costs are same whether it is small or large facilities: building permits, architect s fees, rental fee of building equipment Cutting costs of purchased materials Bargaining power and volume discount (Walmart, Toys R Us) Finding process advantages Shifting to line processes, more specialized equipment, learning effect, lowering inventory, reducing the number of changeovers, etc.

9 Capacity and Scale Diseconomies of scale Complexity Communication, organizational structure, organization of factory floor Loss of focus Compared to the smaller, more agile organizations Inefficiencies Lots of inefficiencies related to the large production Increased inventories, transportation within the production floor, etc.

10 Capacity and Scale Average unit cost (dollars per patient) 250-bed hospital One size doesn t fit all! 500-bed hospital 750-bed hospital Economies of scale Diseconomies of scale Output rate (patients per week) Figure 6.1 Economies and Diseconomies of Scale

11 Capacity Timing and Sizing Sizing capacity cushions: Important decisions regarding the tradeoffs between efficiency and customer satisfaction Capacity cushions are the amount of reserve capacity a process uses to handle sudden changes Capacity cushion = 100% Average Utilization rate (%) Appropriate cushion varies by industry Paper industry (capital-intensive): well under 10% Hotel: 30 to 40% (customer service problems under 20%) Cruise ship industry: 5% Demand variability in volume: cushion should be large enough to handle the peak hours otherwise prompt customer service is not possible (e.g. groceries busy during the weekends) Demand variability in product mix: Workstation shift: problematic if workers are not trained for different stations Supply uncertainty Cushions necessary for employee absenteeism, vacations, holidays, etc.

12 Capacity Timing and Sizing Decision related to when to adjust capacity levels and by how much Expansionist strategy Wait-and-see strategy Combination strategy

13 Capacity Capacity Timing and Sizing Planned unused capacity Forecast of capacity required Capacity increment Time between increments Time (a) Expansionist strategy: Economies of scale & learning effect Cost efficiency Excess capacity with too much cushion at first Preemptive marketing (Chicken Game in Semiconductor): :By making large capacity expansion or announcing that one is imminent, the firm can preempt the expansion of other firms

14 Capacity Capacity Timing and Sizing Planned use of short-term options (overtime, temporary workers, subcontractors, etc.) Forecast of capacity required Time between increments Capacity increment Time (b) Wait-and-see strategy Reduced risk of overexpansion Possibility of preemption or incapability to meet the high demand surge

15 Linking Capacity Capacity decisions should be linked to processes and supply chains throughout the organization Important issues are competitive priorities, quality, and process design Higher level of capacity cushion Competitive priorities on fast delivery (competitive priorities) Higher level of the service quality (quality) Larger investment in capital intensive equipment or higher level of worker flexibility (process design)

16 Systematic Approach 1. Estimate future capacity requirements 2. Identify gaps by comparing requirements with available capacity 3. Develop alternative plans for reducing the gaps 4. Evaluate each alternative, both qualitatively and quantitatively, and make a final choice

17 Systematic Approach Step 1 is to determine the capacity required to meet future demand using an appropriate planning horizon Capacity requirement: capacity required for some future time period to meet the demand Demand forecast, productivity, competition, and technological change in consideration Output measures based on rates of production Input measures may be used when Product variety and process divergence is high The product or service mix is changing Productivity rates are expected to change Significant learning effects are expected e.g. the number of employees, machines, trucks, etc.

18 Systematic Approach For one service or product processed at one operation with a one year time period, the capacity requirement, M, is Capacity requirement = M = Processing hours required for year s demand Hours available from a single capacity unit (such as an employee or machine) per year, after deducting desired cushion Dp N[1 (C/100)] where D = demand forecast for the year (number of customers serviced or units of product) p = processing time (in hours per customer served or unit produced) N = total number of hours per year during which the process operates C = desired capacity cushion (expressed as a percent)

19 Systematic Approach Setup (changeover) times may be required if multiple products are produced Capacity requiremen t = Processing and setup hours required for year s demand, summed over all services or products Hours available from a single capacity unit per year, after deducting desired cushion M = [Dp + (D/Q)s] product 1 + [Dp + (D/Q)s] product [Dp + (D/Q)s] product n N[1 (C/100)] where Q = number of units in each lot s = setup time (in hours) per lot D/Q = number of lots

20 Estimating Capacity Requirements EXAMPLE 6.1 A copy center in an office building prepares bound reports for two clients. The center makes multiple copies (the lot size) of each report. The processing time to run, collate, and bind each copy depends on, among other factors, the number of pages. The center operates 250 days per year, with one 8-hour shift. Management believes that a capacity cushion of 15 percent (beyond the allowance built into time standards) is best. It currently has three copy machines. Based on the following table of information, determine how many machines are needed at the copy center. Item Client X Client Y Annual demand forecast (copies) 2,000 6,000 Standard processing time (hour/copy) Average lot size (copies per report) Standard setup time (hours)

21 SOLUTION Estimating Capacity Requirements M = [Dp + (D/Q)s] product 1 + [Dp + (D/Q)s] product [Dp + (D/Q)s] product n N[1 (C/100)] = [2,000(0.5) + (2,000/20)(0.25)] client X + [6,000(0.7) + (6,000/30)(0.40)] client Y [(250 day/year)(1 shift/day)(8 hours/shift)][1.0 - (15/100)] 5,305 = = ,700 Rounding up to the next integer gives a requirement of four machines.

22 Systematic Approach Step 2 is to identify gaps between projected capacity requirements (M) and current capacity Complicated by multiple operations and resource inputs Step 3 is to develop alternatives Base case is to do nothing and suffer the consequences Many different alternatives are possible: base case, long-term expansion, short-term remedies

23 Systematic Approach Step 4 is to evaluate the alternatives Qualitative concerns include strategic fit and various uncertainty (demand, competition, technological change, cost estimates) Quantitative concerns may include cash flows and other quantitative measures

24 EXAMPLE 6.2 Evaluating the Alternatives A restaurant is experiencing a boom in business. The owner expects to serve 80,000 meals this year. Although the kitchen is operating at 100 percent capacity, the dining room can handle 105,000 diners per year. Forecasted demand for the next five years is 90,000 meals for next year, followed by a 10,000-meal increase in each of the succeeding years. One alternative is to expand both the kitchen and the dining room now, bringing their capacities up to 130,000 meals per year. The initial investment would be $200,000, made at the end of this year (year 0). The average meal is priced at $10, and the before-tax profit margin is 20 percent. The 20 percent figure was arrived at by determining that, for each $10 meal, $8 covers variable costs and the remaining $2 goes to pretax profit. What are the pretax cash flows from this project for the next five years compared to those of the base case of doing nothing?

25 SOLUTION Evaluating the Alternatives Recall that the base case of doing nothing results in losing all potential sales beyond 80,000 meals. With the new capacity, the cash flow would equal the extra meals served by having a 130,000-meal capacity, multiplied by a profit of $2 per meal. In year 0, the only cash flow is $200,000 for the initial investment. In year 1, the 90,000-meal demand will be completely satisfied by the expanded capacity, so the incremental cash flow is (90,000 80,000)($2) = $20,000. For subsequent years, the figures are as follows: Year 2: Demand = 100,000; Cash flow = (100,000 80,000)$2 = $40,000 Year 3: Demand = 110,000; Cash flow = (110,000 80,000)$2 = $60,000 Year 4: Demand = 120,000; Cash flow = (120,000 80,000)$2 = $80,000 Year 5: Demand = 130,000; Cash flow = (130,000 80,000)$2 = $100,000

26 Evaluating the Alternatives If the new capacity were smaller than the expected demand in any year, we would subtract the base case capacity from the new capacity (rather than the demand). The owner should account for the time value of money, applying such techniques as the net present value or internal rate of return methods. For instance, the net present value (NPV) of this project at a discount rate of 10 percent is calculated here, and equals $13, NPV = 200,000 + [(20,000/1.1)] + [40,000/(1.1) 2 ] + [60,000/(1.1) 3 ] + [80,000/(1.1) 4 ] + [100,000/(1.1) 5 ] = $200,000 + $18, $33, $45, $54, $62, = $13,051.76

27 Tools for Capacity Planning Waiting-line models Useful in high customer-contact processes Simulation Can be used when models are too complex for waiting-line analysis Decision trees Useful when demand is uncertain and sequential decisions are involved

28 Decision Trees Low demand [0.40] $70,000 Don t expand $90,000 1 $148,000 $109,000 High demand [0.60] 2 $135,000 Low demand [0.40] $40,000 Expand $135,000 $148,000 High demand [0.60] $220,000 Figure 6.4 A Decision Tree for Capacity Expansion

29 Decision Trees Are schematic models of available alternatives and possible consequences Are useful with probabilistic events and sequential decisions Square nodes represent decisions Circular nodes represent events Events leaving a chance node are collectively exhaustive

30 Decision Trees Conditional payoffs for each possible alternative-event combination shown at the end of each combination Draw the decision tree from left to right Calculate expected payoff to solve the decision tree from right to left

31 Decision Trees E 1 & Probability E 2 & Probability E 3 & Probability Payoff 1 Payoff 2 Payoff 3 Alternative 3 Payoff 1 1 1st decision 2 Possible 2nd decision Alternative 4 Alternative 5 Payoff 2 Payoff 3 = Event node = Decision node E 2 & Probability E 3 & Probability Payoff 1 Payoff 2 E i = Event i P(E i ) = Probability of event i FIGURE A.4 A Decision Tree Model

32 Decision Trees After drawing a decision tree, we solve it by working from right to left, calculating the expected payoff for each of its possible paths 1. For an event node, we multiply the payoff of each event branch by the event s probability and add these products to get the event node s expected payoff 2. For a decision node, we pick the alternative that has the best expected payoff

33 EXAMPLE A.8 Analyzing a Decision Tree A retailer will build a small or a large facility at a new location Demand can be either small or large, with probabilities estimated to be 0.4 and 0.6, respectively For a small facility and high demand, not expanding will have a payoff of $223,000 and a payoff of $270,000 with expansion For a small facility and low demand the payoff is $200,000 For a large facility and low demand, doing nothing has a payoff of $40,000 The response to advertising may be either modest or sizable, with their probabilities estimated to be 0.3 and 0.7, respectively For a modest response the payoff is $20,000 and $220,000 if the response is sizable For a large facility and high demand the payoff is $800,000

34 Analyzing a Decision Tree SOLUTION The decision tree in Figure A.5 shows the event probability and the payoff for each of the seven alternative-event combinations. The first decision is whether to build a small or a large facility. Its node is shown first, to the left, because it is the decision the retailer must make now. The second decision node is reached only if a small facility is built and demand turns out to be high. Finally, the third decision point is reached only if the retailer builds a large facility and demand turns out to be low.

35 Analyzing a Decision Tree Low demand [0.4] $200 Don t expand $ Expand Do nothing Advertise $270 $40 Modest response [0.3] $20 Sizable response [0.7] $220 High demand [0.6] $800 FIGURE A.5 Decision Tree for Retailer (in $000)

36 Analyzing a Decision Tree Low demand [0.4] $200 Don t expand $223 2 Expand $270 1 Do nothing 0.3 x $20 = $6 $40 Modest response [0.3] 3 Advertise $20 $6 + $154 = $160 Sizable response [0.7] 0.7 x $220 = $154 $220 High demand [0.6] $800 FIGURE A.5 Decision Tree for Retailer (in $000)

37 Analyzing a Decision Tree Low demand [0.4] $200 Don t expand $ $160 Expand $270 Do nothing $40 Advertise $160 Modest response [0.3] Sizable response [0.7] $20 $220 High demand [0.6] $800 FIGURE A.5 Decision Tree for Retailer (in $000)

38 Analyzing a Decision Tree Low demand [0.4] $200 Don t expand $ $270 3 $160 Expand $270 Do nothing $40 Advertise $160 Modest response [0.3] Sizable response [0.7] $20 $220 High demand [0.6] $800 FIGURE A.5 Decision Tree for Retailer (in $000)

39 Analyzing a Decision Tree $80 + $162 = $242 Low demand [0.4] $200 x 0.4 = $80 Don t expand $ $270 3 $160 Expand $270 Do nothing $40 Advertise $160 x 0.6 = $162 Modest response [0.3] Sizable response [0.7] $20 $220 High demand [0.6] $800 FIGURE A.5 Decision Tree for Retailer (in $000)

40 Analyzing a Decision Tree $242 Low demand [0.4] $200 Don t expand $ $270 3 $ x $160 = $64 Expand $270 Do nothing $40 Advertise $160 Modest response [0.3] Sizable response [0.7] $20 $220 $544 High demand [0.6] FIGURE A.5 Decision Tree for Retailer (in $000) $800 x 0.6 = $480

41 Analyzing a Decision Tree $242 Low demand [0.4] $200 Don t expand $223 1 $544 2 $270 3 $160 Expand $270 Do nothing $40 Advertise $160 Modest response [0.3] Sizable response [0.7] $20 $220 $544 High demand [0.6] $800 FIGURE A.5 Decision Tree for Retailer (in $000)

42 Analyzing a Decision Tree $242 Low demand [0.4] $200 Don t expand $223 1 $544 2 $270 3 $160 Expand $270 Do nothing $40 Advertise $160 Modest response [0.3] Sizable response [0.7] $20 $220 $544 High demand [0.6] $800 FIGURE A.5 Decision Tree for Retailer (in $000)

43 Application A.6 Fletcher (a realist), Cooper (a pessimist), and Wainwright (an optimist) are joint owners in a company. They must decide whether to make Arrows, Barrels, or Wagons. The government is about to issue a policy and recommendation on pioneer travel that depends on whether certain treaties are obtained. The policy is expected to affect demand for the products; however it is impossible at this time to assess the probability of these policy events. The following data are available: a. Draw the decision tree for the Fletcher, Cooper, and Wainwright using the following table b. What is the expected payoff for the best alternative in the decision tree below? Alternative Land routes, No Treaty (0.50) Land Routes, Treaty Only (0.30) Sea routes, Only (0.20) Arrows 840, , ,000 Barrels 370, , ,000 Wagons 25,000 1,150,000-25,000

44 Application A.6

45 Decision Trees Low demand [0.40] $70,000 Don t expand $90,000 1 $148,000 $109,000 High demand [0.60] 2 $135,000 Low demand [0.40] $40,000 Expand $135,000 $148,000 High demand [0.60] $220,000 Figure 6.4 A Decision Tree for Capacity Expansion

46 Solved Problem 1

47 Solved Problem 1

48 Solved Problem 1

49 Solved Problem 2 SOLUTION Table 6.1 shows the cash inflows and outflows. The year 3 cash flow is unusual in two respects. First, the cash inflow from sales is $50,000 rather than $60,000. The increase in sales over the base is 25,000 meals (105,000 10,000) instead of 30,000 meals (110,000 80,000) because the restaurant s capacity falls somewhat short of demand. Second, a cash outflow of $170,000 occurs at the end of year 3, when the second-stage expansion occurs. The net cash flow for year 3 is $50,000 $170,000 = $120,000.

50 Solved Problem 2 The base case for Grandmother s Chicken Restaurant (see Example 6.2) is to do nothing. The capacity of the kitchen in the base case is 80,000 meals per year. A capacity alternative for Grandmother s Chicken Restaurant is a two-stage expansion. This alternative expands the kitchen at the end of year 0, raising its capacity from 80,000 meals per year to that of the dining area (105,000 meals per year). If sales in year 1 and 2 live up to expectations, the capacities of both the kitchen and the dining room will be expanded at the end of year 3 to 130,000 meals per year. This upgraded capacity level should suffice up through year 5. The initial investment would be $80,000 at the end of year 0 and an additional investment of $170,000 at the end of year 3. The pretax profit is $2 per meal. What are the pretax cash flows for this alternative through year 5, compared with the base case?

51 Solved Problem 2 TABLE 6.1 CASH FLOWS FOR TWO-STAGE EXPANSION AT GRANDMOTHER S CHICKEN RESTAURANT Year Projected Demand (meals/yr) Projected Capacity (meals/yr) Calculation of Incremental Cash Flow Compared to Base Case (80,000 meals/yr) Cash Inflow (outflow) 0 80,000 80,000 Increase kitchen capacity to 105,000 meals = ($80,000) 1 90, ,000 90,000 80,000 = (10,000 meals)($2/meal) = $20, , , ,000 80,000 = (20,000 meals)($2/meal) = $40, , , ,000 80,000 = (25,000 meals)($2/meal) = $50,000 Increase total capacity to 130,000 meals = ($170,000) ($120,000) 4 120, , ,000 80,000 = (40,000 meals)($2/meal) = $80, , , ,000 80,000 = (50,000 meals)($2/meal) = $100,000

52 Solved Problem 2 For comparison purposes, the NPV of this project at a discount rate of 10 percent is calculated as follows, and equals negative $2, NPV = 80,000 + (20,000/1.1) + [40,000/(1.1) 2 ] [120,000/(1.1) 3 ] + [80,000/(1.1) 4 ] + [100,000/(1.1) 5 ] = $80,000 + $18, $33, $90, $54, $62, = $2, On a purely monetary basis, a single-stage expansion seems to be a better alternative than this two-stage expansion. However, other qualitative factors as mentioned earlier must be considered as well.

53 End of Process Quality Session