Chapter 9 Capacity & Location Decisions

Learning Objectives
2

Define capacity planning Define location analysis Describe relationship between capacity planning and

location, and their importance Explain the steps involved in capacity planning and location analysis

Learning Objectives
3

Describe the decision support tools used for capacity

planning Identify key factors in location analysis Describe the decision support tools used for location analysis

Capacity planning
4

Capacity is the maximum output rate of a facility Capacity planning is the process of establishing the

output rate that can be achieved at a facility:

Capacity is usually purchased in chunks Strategic issues: how much and when to spend capital for additional facility & equipment Tactical issues: workforce & inventory levels, & day-to-day use of equipment

Measuring Capacity Examples

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There is no one best way to measure capacity

Output measures like kegs per day are easier to understand

With multiple products, inputs measures work better

Type of Business Car manufacturer Hospital Pizza parlor Retail store

Input Measures of Capacity Labor hours Available beds Labor hours Floor space in square feet

Output Measures of Capacity Cars per shift Patients per month Pizzas per day Revenue per foot

Measuring Available Capacity

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Design capacity: Maximum output rate under ideal conditions A bakery can make 30 custom cakes per day when pushed at holiday time

Effective capacity: Maximum output rate under normal (realistic) conditions On the average this bakery can make 20 custom cakes per day

Measuring Effectiveness of Capacity Use

7

Measures how much of the available

capacity is actually being used:

actual output rate 100% Utilizatio n capacity

Measures effectiveness Use either effective or design capacity in denominator

Example of Computing Capacity Utilization: 8

A bakerys design capacity is 30 custom cakes per day. Currently the bakery is producing 28 cakes per day. What is the bakerys capacity utilization relative to both design and effective capacity?

Utilizatio n effective

actual output 28 (100%) (100%) 140% effective capacity 20

actual output 28 Utilizatio n design (100%) (100%) 93% design capacity 30

The current utilization is only slightly below its design

capacity and considerably above its effective capacity The bakery can only operate at this level for a short period of time

Capacity Considerations
9

The Best Operating Level is the output that results in

the lowest average unit cost Economies of Scale:

Where the cost per unit of output drops as volume of output increases Spread the fixed costs of buildings & equipment over multiple units, allow bulk purchasing & handling of material

Diseconomies of Scale: Where the cost per unit rises as volume increases Often caused by congestion (overwhelming the process with too much work-in-process) and scheduling complexity

Best Operating Level and Size

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Alternative 1: Purchase one large facility, requiring one large

initial investment Alternative 2: Add capacity incrementally in smaller chunks as needed

Other Capacity Considerations

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Focused factories: Small, specialized facilities with limited objectives Plant within a plant (PWP): Segmenting larger operations into smaller operating units with focused objectives Subcontractor networks: Outsource non-core items to free up capacity for what you do well

Making Capacity Planning Decisions

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The three-step procedure for making capacity planning decisions is as follows:

1. 2. 3. Identify Capacity Requirements Develop Capacity Alternatives Evaluate Capacity Alternatives

Identifying capacity requirements

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Forecasting Capacity:

Long-term capacity requirements based on future demand Identifying future demand based on forecasting Forecasting, at this level, relies on qualitative forecast models Executive opinion Delphi method Forecast and capacity decision must included strategic implications

Capacity cushions Plan to underutilize capacity to provide flexibility Strategic Implications How much capacity a competitor might have Potential for overcapacity in industry a possible hazard

Developing & Evaluating Capacity Alternatives 14

Capacity alternatives include Could do nothing, expand large now (may included capacity cushion), or expand small now with option to add later Use decision support aids to evaluate

decisions (decision tree most popular)

Decision trees
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Diagramming technique which uses

Decision points points in time when decisions are made, squares called nodes Decision alternatives branches of the tree off the decision nodes Chance events events that could affect a decision, branches or arrows leaving circular chance nodes Outcomes each possible alternative listed

Decision tree diagrams

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Decision trees 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

Example Using Decision Trees:

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. Which alternative would be most attractive? (see notes)
17

Evaluating the Decision Tree

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Decision tree analysis utilizes expected value

analysis (EVA) EVA is a weighted average of the chance events

Probability of occurrence * chance event outcome

Refer to previous slide 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

Evaluating the Decision Tree

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Calculate expected value of large expansion: EVlarge = 0.30($50,000) + 0.70($300,000) = $225,000 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 a 30% chance its the worst decision:

Take the calculated risk!

Location Analysis
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Three most important factors in real estate:

1. 2. 3.

Location Location Location

Facility location is the process of identifying the best geographic location for a service or production facility

Factors Affecting Location Decisions

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Proximity to source of supply: Reduce transportation costs of perishable or bulky raw materials Proximity to customers: High population areas, close to JIT partners Proximity to labor: Local wage rates, attitude toward unions, availability of special skills (silicon valley)

More Location Factors

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Community considerations: Local communitys attitude toward the facility (prisons, utility plants, etc.) Site considerations: Local zoning & taxes, access to utilities, etc. Quality-of-life issues: Climate, cultural attractions, commuting time, etc. Other considerations: Options for future expansion, local competition, etc.

Globalization Should Firm Go Global?

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Globalization is the process of locating facilities around the world Potential advantages:

Inside track to foreign markets, avoid trade barriers, gain access to cheaper labor

Potential disadvantages: Political risks may increase, loss of control of proprietary technology, local infrastructure (roads & utilities) may be inadequate, high inflation
Other issues to consider: Language barriers, different laws & regulations, different business cultures

Making Location Decisions

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Analysis should follow 3 step process:

1. 2. 3. Identify dominant location factors Develop location alternatives Evaluate locations alternatives

Procedures for evaluation location alternatives include

Factor rating method Load-distance model Center of gravity approach Break-even analysis Transportation method

Factor Rating Example

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A Load-Distance Model Example: Matrix Manufacturing is considering where to locate its warehouse in order to service its four Ohio stores located in Cleveland, Cincinnati, Columbus, Dayton. Two 26 sites are being considered; Mansfield and Springfield, Ohio. Use the load-distance model to make the decision.
Calculate the rectilinear distance: dAB 30 10 40 15 45 miles

Multiply by the number of loads between each site and the four cities

Calculating the Load-Distance Score for Springfield vs. Mansfield 27

Computing the Load-Distance Score for Springfield City Load Distance ld Cleveland 15 20.5 307.5 Columbus 10 4.5 45 Cincinnati 12 7.5 90 Dayton 4 3.5 14 Total Load-Distance Score(456.5) Computing the Load-Distance Score for Mansfield City Load Distance ld Cleveland 15 8 120 Columbus 10 8 80 Cincinnati 12 20 240 Dayton 4 16 64 Total Load-Distance Score(504)

The load-distance score for Mansfield is higher than for Springfield. The warehouse should be located in Springfield.

The Center of Gravity Approach

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This approach requires that the analyst find the center of

gravity of the geographic area being considered

Coordinates Load

Computing the Center of Gravity for Matrix Manufacturing Location

Cleveland Columbus Cincinnati Dayton Total

(X,Y) (11,22) (10,7) (4,1) (3,6)

(li) 15 10 12 4 41

lixi 165 165 165 165 325

liyi 330 70 12 24 436

Computing the Center of Gravity for Matrix Manufacturing

l X 325 7.9 ; Y l Y 436 10.6 l 41 l 41 Is there another possible warehouse location closer to the C.G. that
Xc.g.
i i i i c.g. i i

should be considered?? Why?

Break-Even Analysis
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Break-even analysis computes the amount of goods required

to be sold to just cover costs Break-even analysis includes fixed and variable costs Break-even analysis can be used for location analysis especially when the costs of each location are known

Step 1: For each location, determine the fixed and variable costs Step 2: Plot the total costs for each location on one graph Step 3: Identify ranges of output for which each location has the lowest total cost Step 4: Solve algebraically for the break-even points over the identified ranges

Break-Even Analysis
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Remember the break even equations used for calculation total

cost of each location and for calculating the breakeven quantity Q. Total cost = F + cQ

Total revenue = pQ Break-even is where Total Revenue = Total Cost Q = F/(p-c)

Q = break-even quantity p = price/unit c = variable cost/unit F = fixed cost

Example using Break-even Analysis: Clean-Clothes Cleaners is considering four possible sites for its new operation. They expect to clean 31 10,000 garments. The table and graph below are used for the analysis.

Example 9.6 Using Break-Even Analysis Location Fixed Cost Variable Cost Total Cost A $350,000 $ 5(10,000) $400,000 B $170,000 $25(10,000) $420,000 C $100,000 $40(10,000) $500,000 D $250,000 $20(10,000) $450,000

The Transportation Method

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Can be used to solve specific location problems Is discussed in detail in the supplement to this text Could be used to evaluate the cost impact of adding

potential location sites to the network of existing facilities Could also be used to evaluate adding multiple new sites or completely redesigning the network

Capacity Planning & Facility Location within OM

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Decisions about capacity and location are highly dependent

on forecasts of demand (Ch 8). Capacity is also affected by operations strategy (Ch 2), as size of capacity is a key element of organizational structure. Other operations decisions that are affected by capacity and location are issues of job design and labor skills (Ch 11), choice on the mix of labor and technology, as well as choices on technology and automation (Ch 3).

Capacity Planning and Facility Location Across the Organization

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Capacity planning and location analysis affect

operations management and are important to many others

Finance provides input to finalize capacity decisions Marketing impacted by the organizational capacity and location to customers

Chapter 9 Highlights
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Capacity planning is deciding on the maximum

output rate of a facility Location analysis is deciding on the best location for a facility Capacity planning and location analysis decision are often made simultaneously because the location of the facility is usually related to its capacity.

Chapter 9 Highlights
36

In both capacity planning and location analysis,

managers must follow three-step process to make good decision. The steps are assessing needs, developing alternatives, and evaluating alternatives. To choose between capacity planning alternatives managers may use decision trees, which are a modeling tool for evaluating independent decisions that must be made in sequence.

Chapter 9 Highlights
37

Key factors in location analysis included proximity

to customers, transportation, source of labor, community attitude, and proximity to supplies. Service and manufacturing firms focus on different factors. Profit-making and nonprofit organizations also focus on different factors.

Chapter 9 Highlights
38

Several tools can be used to facilitate location

analysis. Factor rating is a tool that helps managers evaluate qualitative factors. The loaddistance model and center of gravity approach evaluate the location decision based on distance. Break-even analysis is used to evaluate location decisions based on cost values. The transportation method is an excellent tool for evaluating the cost impact of adding sites to the network of current facilities.