Operations Management: Sustainability

and Supply Chain Management

Thirteenth Edition

Chapter 7s
Capacity and Constraint
Management

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Outline (1 of 2)
• Capacity
• Bottleneck Analysis and the Theory of Constraints
• Break-Even Analysis
• Reducing Risk with Incremental Changes

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Outline (2 of 2)
• Applying Expected Monetary Value (EMV) to Capacity
Decisions
• Applying Investment Analysis to Strategy-Driven
Investments

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Learning Objectives (1 of 2)
When you complete this supplement you should be able to:
S7.1 Define capacity
S7.2 Determine design capacity, effective capacity, and utilization
S7.3 Perform bottleneck analysis
S7.4 Compute break-even

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Learning Objectives (2 of 2)
When you complete this supplement you should be able to:
S7.5 Determine the expected monetary value of a capacity
decision
S7.6 Compute net present value

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Capacity
• The throughput, or the
number of units a facility
can hold, receive, store, or
produce in a period of time
• Determines fixed costs
• Determines if demand will
be satisfied
• Three time horizons

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Planning Over a Time Horizon
Figure S7.1

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Design and Effective Capacity (1 of 4)
• Design capacity is the maximum theoretical output of a
system
– Normally expressed as a rate
• Effective capacity is the capacity a firm expects to
achieve given current operating constraints
– Often lower than design capacity

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Design and Effective Capacity (2 of 4)
Table S7.1 Capacity Measurements

MEASURE DEFINITION EXAMPLE

Design capacity Ideal conditions exist Machines at Frito-Lay are designed to

during the time that the produce 1,000 bags of chips/hr., and the
system is available plant operates 16 hrs./day.
Design Capacity = 1,000 bags / hr. × 16hrs.
= 16,000 bags / day

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Design and Effective Capacity (3 of 4)
Table S7.1 Capacity Measurements

MEASURE DEFINITION EXAMPLE

Effective Design capacity minus lost Frito-Lay loses 3 hours of output per
capacity output because of planned day (= 0.5 hrs./day on preventive
resource unavailability maintenance, 1 hr./day on employee
(e.g., preventive breaks, and 1.5 hrs./day setting up
maintenance, machine machines for different products).
setups/changeovers, Effective Capacity = 16,000 bags/day
changes in product mix, − (1,000 bags / hr.) (3 hrs./day)
scheduled breaks) = 16,000 bags/day − 3,000 bags/day
= 13,000 bags/day

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Design and Effective Capacity (4 of 4)
Table S7.1 Capacity Measurements

MEASURE DEFINITION EXAMPLE

Actual output Effective capacity On average, machines at Frito-Lay are not
minus lost output running 0.25 hr./day due to late parts and
during unplanned machine breakdowns.
resource idleness (e.g., Actual Output = 13,000 bags/day − (1,000
absenteeism, machine bags/hr.) (0.25 hr./day) = 13,000 bags/day
breakdowns, − 250 bags/day
=
unavailable parts, 12,750 bags/day
quality problems)

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Utilization and Efficiency
Utilization is the percentage of design capacity actually
achieved
Utilization = Actual output/Design capacity
Efficiency is the percentage of effective capacity actually
achieved
Efficiency = Actual output/Effective capacity

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Bakery Example (1 of 7)
Design Capacity

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Bakery Example (2 of 7)
Utilization

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Bakery Example (3 of 7)
Efficiency

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Bakery Example (4 of 7)
Design Capacity
Expansion

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Bakery Example (5 of 7)
Effective Capacity
Expansion

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Bakery Example (6 of 7)
Actual Output
Expansion

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Bakery Example (7 of 7)
Utilization Efficiency
Expansion
Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 201,600 rolls per line
Efficiency = 84.6%
Expected output of new line = 130,000 rolls
Design capacity = 201,600 × 2 = 403,200 rolls
Effective capacity = 175,000 × 2 = 350,000 rolls
Actual output = 148,000 + 130,000 = 278,000 rolls
Utilization = 278,000 ÷ 403,200 = 68.95%
Efficiency = 278,000 ÷ 350,000 = 79.43%
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Capacity and Strategy
• Capacity decisions impact all 10 decisions of operations
management as well as other functional areas of the
organization
• Capacity decisions must be integrated into the
organization’s mission and strategy

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Capacity Considerations
1. Forecast demand accurately
2. Match technology increments and sales volume
3. Find the optimum operating size (volume)
4. Build for change

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Economies and Diseconomies of Scale
Figure S7.2

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Managing Demand
• Demand exceeds capacity
– Curtail demand by raising prices, scheduling longer
lead times, discouraging marginally profitable business
– Long-term solution is to increase capacity
• Capacity exceeds demand
– Stimulate market
– Product changes
• Adjusting to seasonal demands
– Produce products with complementary demand
patterns

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Complementary Demand Patterns

Figure S7.3

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Tactics for Matching Capacity to
Demand
1. Making staffing changes
2. Adjusting equipment
– Purchasing additional machinery
– Selling or leasing out existing equipment
3. Improving processes to increase throughput
4. Redesigning products to facilitate more throughput
5. Adding process flexibility to meet changing product
preferences
6. Closing facilities

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Service-Sector Demand and Capacity
Management
• Demand management
– Appointment,
reservations, FCFS rule
• Capacity management
– Full time, temporary,
part-time staff

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Bottleneck Analysis and the Theory
of Constraints (1 of 2)
• Each work area can have its own unique capacity
• Capacity analysis determines the throughput capacity of
workstations in a system
• A bottleneck is a limiting factor or constraint
– A bottleneck has the lowest effective capacity in a
system
• The time to produce a unit or a specified batch size is the
process time

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Bottleneck Analysis and the Theory
of Constraints (2 of 2)
• The bottleneck time is the time of the slowest workstation
(the one that takes the longest) in a production system
• The throughput time is the time it takes a unit to go
through production from start to end, with no waiting
Figure S7.4

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Capacity Analysis (1 of 5)
• Two identical sandwich lines
• Lines have two workers and three operations
• All completed sandwiches are wrapped

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Capacity Analysis (2 of 5)
• The two lines are identical, so parallel processing can
occur
• At 40 seconds, the toaster has the longest processing time
and is the bottleneck for each line
• At 40 seconds for two sandwiches, the bottleneck time of
the combined lines = 20 seconds
• At 37.5 seconds, wrapping and delivery is the bottleneck
for the entire operation

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Capacity Analysis (3 of 5)
• Capacity per hour is 3,600 seconds/37.5
seconds/sandwich = 96 sandwiches per hour
• Throughput time is 30 + 15 + 20 + 40 + 37.5 = 142.5
seconds

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Capacity Analysis (4 of 5)
• Standard process for cleaning teeth
• Cleaning and examining X-rays can happen
simultaneously

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Capacity Analysis (5 of 5)
• All possible paths must be compared
• Bottleneck is the hygienist at 24 minutes
• Hourly capacity is 60/24 = 2.5 patients
• X-ray exam path is 2 + 2 + 4 + 5 + 8 + 6 = 27 minutes
• Cleaning path is 2 + 2 + 4 + 24 + 8 + 6 = 46 minutes
• Longest path involves the hygienist cleaning the teeth,
patient should complete in 46 minutes

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Theory of Constraints
• Five-step process for recognizing and managing limitations

Step 1: Identify the constraints

Step 2: Develop a plan for overcoming the constraints
Step 3: Focus resources on accomplishing Step 2
Step 4: Reduce the effects of constraints by offloading work
or expanding capability
Step 5: Once overcome, go back to Step 1 and find new
constraints

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Bottleneck Management
1. Release work orders to the system at the pace set by the
bottleneck’s capacity
– Drum, Buffer, Rope
2. Lost time at the bottleneck represents lost capacity for
the whole system
3. Increasing the capacity of a nonbottleneck station is a
mirage
4. Increasing the capacity of a bottleneck increases the
capacity of the whole system

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Break-Even Analysis (1 of 7)
• Technique for evaluating process and equipment
alternatives
• Objective is to find the point in dollars and units at which
cost equals revenue
• Requires estimation of fixed costs, variable costs, and
revenue

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Break-Even Analysis (2 of 7)
• Fixed costs are costs that continue even if no units are
produced
– Depreciation, taxes, debt, mortgage payments
• Variable costs are costs that vary with the volume of units
produced
– Labor, materials, portion of utilities
– Contribution is the difference between selling price and
variable cost

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Break-Even Analysis (3 of 7)
• Revenue function begins at the origin and proceeds
upward to the right, increasing by the selling price of each
unit
• Where the revenue function crosses the total cost line is
the break-even point

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Break-Even Analysis (4 of 7)
Figure S7.5

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Break-Even Analysis (5 of 7)
Assumptions
• Costs and revenue are linear functions
– Generally not the case in the real world
• We actually know these costs
– Very difficult to verify
• Time value of money is often ignored

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Break-Even Analysis (6 of 7)
Single-Product Case x = number
of units
BEPx = break-even point produced
in units
TR = total
BEP$ = break-even point in revenue = Px
dollars
F = fixed
P = price per unit (after costs
all discounts)
Break-even point occurs when V = variable
cost per unit
TR = TC F
or BEPx =
TC total
Px = F +Vx costs = F + Vx P  V
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Break-Even Analysis (7 of 7)
Single-Product Case x = number
BEPx = break-even of units
point in units produced
TR = total
BEP$ = break-even revenue = Px
point in dollars
F = fixed
P = price per unit costs
(after all discounts)
F V = variable
BEP$  BEPx P  P cost
P –V Profit =per unit
TR - TC
F = Px – ( F + Vx)

(P – V ) / P = PxTC – F – Vx = total
F costs= (=P -FV )+x –Vx
F

1–V / P
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Break-Even Example (1 of 4)

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Break-Even Example (2 of 4)
Fixed costs = $10,000 Material = $.75/unit
Direct labor = $1.50/unit Selling price = $4.00 per unit

F $10,000
BEP$  
1 – (V / P ) 1 – 1.50  .75  /  4.00 
$10,000
=  $22,857.14
.4375
F $10,000
BEPx    5,714
P -V 4.00 – 1.50  .75 

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Break-Even Example (3 of 4)

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Break-Even Example (4 of 4)
Multiproduct Case

Break-even F
Point in dollars 
( BEP$ )  Vi  
 1    Wi 
 Pi  

WhereF = fixed costs

Vi = variable cost per unit for product i
Pi = price per unit for product i
Wi = percentage of total dollar sales for product i

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Multiproduct Example (1 of 2)
Fixed costs = $3,000 per month

ITEM ANNUAL FORECASTED PRICE COST

SALES UNITS
Sandwich 9,000 $5.00 $3.00
Drink 9,000 1.50 .50
Baked potato 7,000 2.00 1.00

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Multiproduct Example (2 of 2)
Fixed costs = $3,000 per month
ANNUAL FORECASTED SALES
ITEM PRICE COST
UNITS
Sandwich 9,000 $5.00 $3.00

Drink 9,000 1.50 .50

Baked potato 7,000 2.00 1.00

F
BEP$ 
 V  
 1  i   Wi 
 Pi  
$3,000 x 12
  $76,596
.47

$76,596
Daily sales   $245.50
312 days

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Reducing Risk with Incremental
Changes (1 of 5)
Figure S7.6

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Reducing Risk with Incremental
Changes (2 of 5)
Figure S7.6a

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Reducing Risk with Incremental
Changes (3 of 5)
Figure S7.6b

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Reducing Risk with Incremental
Changes (4 of 5)
Figure S7.6c

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Reducing Risk with Incremental
Changes (5 of 5)
Figure S7.6d

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Applying Expected Monetary Value
(EMV) and Capacity Decisions
• Determine states of nature
– Future demand
– Market favorability
• Assign probability values to states of nature to determine
expected value

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EMV Applied to Capacity Decision
• Southern Hospital Supplies capacity expansion

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Strategy-Driven Investments
• Operations managers may have to decide among various
financial options
• Analyzing capacity alternatives should include capital
investment, variable cost, cash flows, and net present
value

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Net Present Value (NPV) (1 of 2)
In general:
F  P (1  i ) N
where F = future value
P = present value
i = interest rate
N = number of years
Solving for P:
F
P
(1  i ) N

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Net Present Value (NPV) (2 of 2)

While this works fine,

it is cumbersome for
larger values of N

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NPV Using Factors
F
P  FX
(1  i ) N

where X = a factor from Table S7.2 defined as = 1/(1 + i)N

and F = future value
Table S7.2 Present Value of $1
YEAR 6% 8% 10% 12% 14%
1 .943 .926 .909 .893 .877
2 .890 .857 .826 .797 .769
3 .840 .794 .751 .712 .675

4 .792 .735 .683 .636 .592

5 .747 .681 .621 .567 .519

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Present Value of an Annuity (1 of 3)
An annuity is an investment that generates uniform equal
payments

S = RX

where X = factor from Table S7.3

S = present value of a series of uniform annual
receipts
R = receipts that are received every year of the
life of the investment

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Present Value of an Annuity (2 of 3)
Table S7.3 Present Value of an Annuity of $1

YEAR 6% 8% 10% 12% 14%

1 .943 .926 .909 .893 .877
2 1.833 1.783 1.736 1.690 1.647
3 2.673 2.577 2.487 2.402 2.322

4 3.465 3.312 3.170 3.037 2.914

5 4.212 3.993 3.791 3.605 3.433

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Present Value of an Annuity (3 of 3)
• River Road Medical Clinic equipment investment

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Limitations
• Investments with the same NPV may have different
projected lives and salvage values
• Investments with the same NPV may have different cash
flows
• Assumes we know future interest rates
• Payments are not always made at the end of a period

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