PRODUCTION

OPERATIONS
MANAGEMENT
CAPACITY PLANNING
Topic#32 Design and Effective Capacity
Design and Effective Capacity

Capacity
 The throughput, or the
number of units a facility
can hold, receive, store, or
produce in a given time
period
 Determines fixed costs
 Determines if demand will
be satisfied
 Can be viewed in three-time
horizons
 Design and Effective Capacity

Three Time-period

Long-range Add facilities *

planning Add long lead time equipment

Intermediate- Subcontract Add personnel

range Add equipment Build or use inventory
planning Add shifts

Schedule jobs
Short-range * Schedule personnel
planning
Allocate machinery

Modify capacity Use capacity

* Limited options exist
Design and Effective Capacity

 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
Design and Effective Capacity

Utilization is the percent of

design capacity achieved
Utilization = Actual Output/Design Capac

Efficiency is the percent of

effective capacity achieved
Efficiency = Actual Output/Effective Capa
 Design and Effective Capacity

Bakery Example

Actual production last week = 148,000 rolls per week

Effective capacity = 175,000 rolls per week
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 8-hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls per week

 Design and Effective Capacity

Bakery Example

Actual production last week = 148,000 rolls

Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Utilization = 148,000/201,600 = 73.4%

 Design and Effective Capacity

Bakery Example

Actual production last week = 148,000 rolls

Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Utilization = 148,000/201,600 = 73.4%

Efficiency = 148,000/175,000 = 84.6%

Design and Effective Capacity

Bakery Example

Actual production last week = 148,000 rolls

Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 8-hour shifts
Efficiency = 84.6%
Efficiency of new line = 75%

Expected Output = (Effective Capacity)(Efficiency)

= (175,000)(.75) = 131,250 rolls
Topic#33 Capacity Consideration
Capacity Consideration

 Forecast demand
accurately
 Understanding the
technology and
capacity increments
 Find the optimal
operating level
(volume)
 Build for change
Capacity Consideration

Capacity and
Strategy
 Capacity decisions impact
all 10 OM decisions as well
as other functional areas
 Capacity decisions must
be integrated into the
organization’s mission and
strategy
Capacity Consideration

Managing Demand
 Demand exceeds
capacity
 Curtail demand by raising
prices, scheduling longer
lead time
 Long term solution is to
increase capacity
 Capacity exceeds
demand
 Stimulate market
 Product changes
 Adjusting to seasonal
demands
 Produce products with
 Capacity Consideration

Complementary Demand
Patterns By combining
both, the
variation is
reduced
4,000 –
Sales in units

Snowmobile
3,000 – sales

2,000 –
Jet ski
1,000 – sales

JFMAMJJASONDJFMAMJJASONDJ
Time (months)
 Capacity Consideration

Economies and Diseconomies of Scale

(dollars per room per night)

Average unit cost

25 - Room 75 - Room
Roadside Motel 50 - Room Roadside Motel
Roadside Motel

Economies Diseconomies
of scale of scale
25 50 75
Number of Rooms
Topic#34 Capacity Planning
Capacity Planning

Tactics for Matching

Capacity to Demand
 Making staffing changes
 Adjusting equipment
and processes
 Purchasing additional
machinery
 Selling or leasing out
existing equipment
 Improving methods to
increase throughput
 Redesigning the product
to facilitate more
throughput
 Capacity Planning

Approaches to Capacity
(a)
Expansion
Leading demand with (b) Leading demand with
incremental expansion one-step expansion
New New
capacity capacity
Demand

Demand
Expected Expected
demand demand

(c) Capacity lags demand with (d) Attempts to have an average

incremental expansion capacity with incremental
New
expansion
capacity New
Demand

Demand
Expected capacity Expected
demand demand
 Capacity Planning

(a) Leading demand with

incremental expansion
New
capacity

Demand
Expected
demand

1 2 3
Time (years)
 Capacity Planning

(b) Leading demand with one-

step expansion
New
capacity

Demand
Expected
demand

1 2 3
Time (years)
 Capacity Planning

(c) Capacity lags demand with

incremental expansion

New Expected
Demand
capacity demand

1 2 3
Time (years)
 Capacity Planning

(d) Attempts to have an average

capacity with incremental
expansion
New
capacity
Demand Expected
demand

1 2 3
Time (years)
Topic#35 Break-even analysis: Single
Product
Break-even Analysis: Single Product

Break-Even Analysis
 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
Break-even Analysis: Single Product

Break-Even Analysis
 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 margin is the
difference between selling
price and variable cost
Break-even Analysis: Single Product

Assumptions
 Costs and revenue are
linear functions
 Generally, not the case
in the real world
 We actually know these
costs
 Very difficult to
accomplish
 There is no time value
of money
 Break-even Analysis: Single Product

–
Total revenue line
900 –

800 – or
Break-even point ri d Total cost line
Total cost = Total revenue cor
700 –
ofit
r
Cost in dollars

P
600 –

500 –
Variable cost
400 –

300 –
o ss or
200 – L rid
r
co
100 – Fixed cost
| | | | | | | | | | | |
–
0 100 200 300 400 500 600 700 800 900 1000 1100
Volume (units per period)
Break-even Analysis: Single Product

BEPx =
TR =
Break-

BEP$ = F =
even point in units Total revenue

V =
Break- Fixed costs

P =
even point in dollars Variable

TC =
Price per costs
unit (after all Total cost
discounts)

Break-even point
occurs when 𝑷𝒙 − 𝑽𝒙= 𝑭
or
Break-even Analysis: Single Product

BEPx =
TR =
Break-

BEP$ = F =
even point in units Total revenue

V =
Break- Fixed costs

TC =
even point in Variable costs

P =
dollars Total costs
Price
per unit (after all
Profit = TR - TC
discounts)
𝑩𝑬𝑷 $ =𝑩𝑬𝑷 𝒙 × 𝑷
𝑭
¿ × 𝑷
𝑷 −𝑽
𝑭
¿
( 𝑷 − 𝑽 )/ 𝑷
𝑭
¿
𝟏 −𝑽 / 𝑷
Topic#36 Break-even analysis: Multiple
Products
Break-even Analysis: Multiple Products

Multiproduct Break-even
Analysis Consideration
 Most companies have a
variety of offerings

 Each product may have

different selling price and
variable cost

 Break-even point is
calculated by weighting
each products contribution
by its proportion of sale
Break-even Analysis: Multiple Products
Let

𝑭
𝑩𝑬𝑷 $ =
∑ [[ 𝟏−
( 𝑽𝒊
𝑷𝒊 )] ×𝑾 𝒊
]
Topic#37 Example: Single-product Case
Example: Single-product Case

Example:
Example: Single-product Case

$ 10,000
¿ = $ 22,857.14
0.4375
5,714
 Example: Single-product Case

50,000 –
Revenue
40,000 –
Break-even
point Total
30,000 – costs
Dollars

20,000 –

10,000 –

| | | | | |
0– 2,000 4,000 6,000 8,000 10,000
Units
Topic#38 Example: Multiproduct Case
Example: Multiproduct Case

Multiproduct Break-even
Example
 Example: Multiproduct Case

Example:

Fixed costs = $3,500 per month

Annual Forecasted
Item Price Cost Sales Units
Sandwich $2.95 $1.25 7,000
Soft drink .80 .30 7,000
Baked potato1.55 .47 5,000
Tea .75 .25 5,000
Salad bar 2.85 1.00 3,000
 Example: Multiproduct Case

Fixed costs = $3,500 per month

Annual (Wi) Weighted
Selling Variable Forecasted % of
Contribution
Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales
Sandwich
(col 5 x col 7) $2.95 $1.25 .42 .58 $20,650 .446 .259
Soft drink .80 .30 .38 .62 5,600 .121 .075
Baked 1.55 .47 .30 .70 7,750 .167 .117
potato
Tea .75 .25 .33 .67 3,750 .081 .054
Salad bar 2.85 1.00 .35 .65 8,550 .185 .120
$46,300 1.000 .625
 Example: Multiproduct Case
𝐹
𝐵𝐸𝑃 $=

∑ [[ 1−
( 𝑉𝑖
𝑃𝑖 )] ×𝑊 𝑖
]
$ 3,500 × 12
𝐵𝐸𝑃 $ =
(0.58 × 0.446)+( 0.62 ×0.121)+( 0.7+ 0.167)+(0.67 × 0.081)+(0.65 × 0.185)

$ 3,500 ×12
¿ =$ 67,200
0.625
$ 67,200
Daily sales= =$ 215.38
312 days

0.446 × $ 215.38
=32.6 ≈ 33 𝑠𝑎𝑛𝑑𝑤𝑖𝑐h𝑒𝑠/ 𝑑𝑎𝑦
$ 2.95
Topic#39 Decision Tree
Decision Tree

Decision Tree Analysis

Diagramming technique which uses:

 Point in time when decisions are

made, are called Decision
(square) nodes
 Decision alternatives branches of
the tree from the decision nodes
Decision Tree

Decision Tree Analysis

Diagramming technique which uses:
 Chance (circular) nodes are where
different outcomes emanates
 Outcomes – each possible
alternative listed
Decision Tree

Decision tree diagrams

Decision trees are developed by:
 Drawing from left to right
 Use squares to indicate
decision points
 Use circles to indicate chance
events
 Write the probability of each
chance by the chance (sum of
associated chances = 100%)
 Write each alternative
outcome in the right margin
 Decision Tree

1
f n a t u re Payoff 1
o
Decision Point State
Chance Event e A1 Payoff 2
C hoos
A State
se o 2
o f natu
re 2
ho C h o o se
C A2 Payoff 3
B
1
e B1 Payoff 4
1 C hoos
n a t u re
f
C

o 2
State
ho
os

C h o o se Payoff 5
e

B2
B

State Payoff 6
o f natu
re 2
Topic#40 Solved Example 1: Decision Tree
Applied to Capacity Decision
Solved Example 1: Decision Tree Applied to Capacity
Decision

Solved Example
Solved Example 1: Decision Tree Applied to Capacity
Decision
Problem: Southern’s major alternatives are to do nothing, build a
small plant, build a medium plant, or build a large plant. If a large
plant is built and a favorable market exists, a profit of $100,000 could
be realized. An unfavorable market would yield a $90,000 loss.
However, a medium plant would earn a $60,000 profit with a favorable
market. A $10,000 loss would result from an unfavorable market. A
small plant would return $40,000 with favorable market conditions and
lose only $5,000 in an unfavorable market. Of course, there is always
the option of doing nothing.
Recent market research indicates that there is a .4 probability of a
favorable market, which means that there is also a .6 probability of an
unfavorable market. With this information, the alternative that will
result in the highest expected monetary value (EMV) can be selected.
Solved Example 1: Decision Tree Applied to Capacity
Decision
(100,000 x 0.4) – (90,000 x 0.6)
-$14,000
Market favorable (.4)
$100,000

(60,000 x 0.4) – (10,000 x 0.6) Market unfavorable (.6)

nt -$90,000
pla
arge $18,000
L
Market favorable (.4)
$60,000
Medium plant
Sm Market unfavorable (.6)
a ll -$10,000
pla
nt $13,000
Do Market favorable (.4)
no $40,000
(40,000 x 0.4) – (5,000 x 0.6) th
in
g Market unfavorable (.6)
-$5,000

$0

Decision: Build
Medium Plant
Topic#41 Solved Example 2: Decision Tree
Applied to Capacity Decision
Solved Example 2: Decision Tree Applied to Capacity
Decision

Solved Example
Solved Example 2: Decision Tree Applied to Capacity
Decision
Problem: A restaurant owner has determined that she needs to
expand her facility. The alternatives are to expand large now and risk
smaller demand or expand on a smaller scale now knowing that she
might need to expand again in three years. She believes that there is
a 70% chance that the demand will be high and 30% chance that the
demand will be low. If now she expands small, and the demand is high
then she will have two options. Either expand further with the
expected profit of $200,000 or do nothing with a limited profit of
$150,000. Which alternative would be most attractive?
Solved Example 2: Decision Tree Applied to Capacity
Decision
$200,000 Expand
($200,00 x 0.7) + $164,000 $200,000
($80,000 x 0.3) High Demand (0.7)
2
$150,000
Don’t Expand
Low Demand (0.3)
mall $80,000
S
and
p
Ex

1 Ex
pa
nd
La
rge $225,000
High Demand (0.7)
$300,000
($300,000 x 0.7) +
($50,000 x 0.3) Low Demand (0.3)
$50,000

Decision: Expand
Large
Solved Example 2: Decision Tree Applied to Capacity
Decision
At decision point 2, choose to
expand to maximize profits
($200,000 > $150,000)
Calculate expected value of
small expansion:
 EVsmall = 0.30($80,000) +
0.70($200,000) =$164,000
Calculate expected value of
large expansion:
 EVlarge = 0.30($50,000) +
0.70($300,000) = $225,000
Solved Example 2: Decision Tree Applied to Capacity
Decision
At decision point 1, compare
alternatives & choose the
large expansion to maximize
the expected profit:
 $225,000 > $164,000

Choose large expansion

despite the fact that there is
EN
a 30% chance it’s the worst
D decision:
Take the calculated risk!
PRODUCTION
OPERATIONS
MANAGEMENT
LOCATION STRATEGY
Topic#42 Strategic Importance of Location
Strategic Importance of Location

Location Decisions
 One of the most
important decisions a
firm makes
 Increasingly global in
nature
 Long term impact and
decisions are difficult to
change
 The objective is to
maximize the benefit of
location to the firm
Strategic Importance of Location

Location Decisions
 Long-term decisions
 Decisions made
infrequently
 Decision greatly affects
both fixed and variable
costs
 Once committed to a
location, many resource
and cost issues are
difficult to change
Strategic Importance of Location

Critical Success
Factors
Country Decision
 Political risks,
government rules,
attitudes, incentives
 Cultural and economic
issues
 Location of markets
 Labor availability,
attitudes, productivity,
costs
 Availability of supplies,
communications, energy
Strategic Importance of Location

Region Decision
 Corporate desires
 Attractiveness of region
 Labor availability, costs,
attitudes towards unions
 Costs and availability of
utilities
 Environmental regulations
 Government incentives and
fiscal policies
 Proximity to raw materials
and customers
 Strategic Importance of Location

Site Decision
 Site size and cost
 Air, rail, highway, and
waterway systems
 Zoning restrictions
 Nearness of services/
EN
supplies needed
D
 Environmental impact
issues
Topic#43 Factors Affecting Location
Decisions
Factors Affecting Location Decisions

Labor productivity
 Wage rates are not the
only cost
 Lower productivity may
increase total cost
Labor cost per day
= cost per unit
Productivity (units per day)
Wuhan, China
$70
= $1.17 per unit
60 units
Lahore, Pakistan
$25
= $1.25 per unit
20 units
Factors Affecting Location Decisions

Exchange rates and

currency risks
 Can have a significant
impact on cost structure
 Rates change over time

Costs
 Tangible - easily measured
costs such as utilities,
labor, materials, taxes
 Intangible - less easy to
quantify and include
education, public transport,
Factors Affecting Location Decisions

Attitudes
 National, state, local
governments attitude
toward different aspects of
business
 Worker attitudes towards
turnover, unions,
absenteeism
 Globally cultures have
different attitudes towards
punctuality, legal, and
ethical issues
Factors Affecting Location Decisions

Proximity to markets
 Very important to services
 JIT systems or high
transportation costs may
make it important to
manufacturers
Proximity to suppliers
 Perishable goods, high
transportation costs, bulky
products
Factors Affecting Location Decisions

Proximity to competitors
 Called clustering
 Often driven by resources
such as natural,
information, capital, talent
 Found in both
EN manufacturing and service
D industries
Topic#44 The Factor-rating Method
 The Factor-rating Method

 Popular because a wide

variety of factors can be
included in the analysis
 Six steps in the method
 Develop a list of relevant
factors called critical
success factors
EN  Assign a weight to each
factor
D
 Develop a scale for each
factor
 Score each location for each
factor
 Multiply score by weights
for each factor for each
Topic#45 Solved Example
Solved Example

A multinational company is
interested in setting up its
facility in Europe and have
short listed two countries,
France and Denmark. They
have listed the critical success
factors deemed important as
given in the table on the next
slide. Also, they have assigned
weightage to each factor
according to its importance.
The company has also scored
both countries for each factor.
According to the factor-rating
method, which country should
The Factor-rating Method

Critical Scores
Success (out of 100)

Factor Weight France Denmark

Labor
availability
and attitude .25 70 60

People-to
car ratio .05 50 60

Per capita
income .10 85 80

Tax structure .39 75 70

Education
and health .21 60 70

Total 1.00
 The Factor-rating Method

Critical Scores
Success (out of 100) Weighted Scores
Factor Weight France Denmark France Denmark
Labor
availability
and attitude .25 70 60 (.25)(70) = 17.5 (.25)(60) = 15.0
People-to
car ratio .05 50 60 (.05)(50) = 2.5 (.05)(60) = 3.0
Per capita
income .10 85 80 (.10)(85) = 8.5 (.10)(80) = 8.0
Tax structure .39 75 70 (.39)(75) = 29.3 (.39)(70) = 27.3
Education
and health .21 60 70 (.21)(60) = 12.6 (.21)(70) = 14.7
Totals 1.00 70.4 68.0
Topic#46 Locational Break-even Analysis
 Locational Break-even Analysis

Method
 Method of cost-volume
analysis used for industrial
locations
 The steps in the method
are:
EN  Determine the fixed and
D variable costs for each
location.
 Identify the indifference point
for each pair of location
alternatives.
 Identify the ranges of output
for which each location has the
Topic#47 Solved Example 1: Break-even
Analysis
Solved Example 1: Break-even Analysis

Problem
C&A Electronic is considering two
possible sites for its new DVD plant. The
annual fixed and variable costs for each
site are:
Locatio Fixed Variable
n costs costs
Lexingto $650,000 $50/unit
n

IfWilmore $350,000
annual demand $65/unit
for C&A’s DVD is
expected to be 25,000 units, which is the
best location?
Solved Example 1: Break-even Analysis

$4,000,000
$3,500,000
$3,000,000
$2,500,000
Q<20000
Wilmore
Cost

$2,000,000 Choose Wilmore

Lexington
$1,500,000
$1,000,000
Q>20000
$500,000 choose Lexington
$0 Q
0 10000 20000 30000 40000 50000 60000
Solved Example 1: Break-even Analysis

3. Identify the ranges of

output for which each
location has the lowest total
cost

At Q = 0,
TC(Lexington) =
$650,000
TC(Wilmore) = $350,000
Q < 20,000, Wilmore has the
lowest total cost;
Q > 20,000 Lexington
has the lowest total costs
Solved Example 1: Break-even Analysis

4. Select the location that

gives the lowest cost for the
design capacity of the new
facility.

Since annual demand = Q

= 25,000 units
EN Q > Q* (20,000)
D
Therefore, Lexington
should be chosen as the
location for the new facility
Topic#48 Solved Example 2: Break-even
Analysis
Solved Example 2: Break-even Analysis

Problem
Esmail Mohebbi, owner of European Ignitions
Manufacturing, needs to expand his capacity.
He is considering three locations—Athens,
Brussels, and Lisbon—for a new plant. The
company wishes to find the most economical
location for an expected volume of 2,000 units
per year. Assume selling price = $120/unit.

Locatio Fixed Variable

n costs costs
Athens $30,000 $75/unit
Brussels $60,000 $45/unit
Lisbon $110,000 $25/unit
Solved Example 2: Break-even Analysis

2. Identify the cross-over (indifference)

point for each pair of location
alternatives.

The crossover point for Athens and

Brussels is:
30,000 + 75(x) = 60,000 + 45(x)
30(x) = 30,000
x = 1,000

The crossover point for Brussels and

Lisbon is:
60,000 + 45(x) = 110,000 + 25(x)
20(x) = 50,000
x = 2,500
Solved Example 2: Break-even Analysis

–
$180,000 –
–
$160,000 –
$150,000 –
e
–
o s t curv
$130,000 – nc
L is bo
–
Annual cost
$110,000 – st
– c o
s s el s e
– ru ur v
$80,000 – B c
– o st
c
$60,000 – n s
e
– t h e u rv
A c
–
Athens Lisbon
$30,000 – Brussels lowest
lowest lowest cost
– cost
cost
$10,000 –
–
| | | | | | |
0 500 1,000 1,500 2,000 2,500 3,000
Volume
Solved Example 2: Break-even Analysis
3. Identify the ranges of output for which
each location has the lowest total cost
At Q = 0 to 1000,
TC(Athens) = $30,000 to $105,000
TC(Brussels) = $60,000 to $105,000
TC(Lisbon) = $110,000 to $135,000

At Q = 1000 to 2500
TC(Athens) = $105,000 to $217,500
TC(Brussels) = $105,000 to $172,500
TC(Lisbon) = $135,000 to $172,500

Q < 1,000, Athens has the lowest total cost;

Q > 1,000 & Q < 2,500, Brussels has the
lowest total costs
Solved Example 2: Break-even Analysis

4. Select the location that

gives the lowest cost for the
design capacity of the new
facility.

Since annual demand = Q

= 2,000 units
EN 1,000 < Q < 2,500
D
Therefore, Brussels should
be chosen as the location
for the new facility