The formula for the moving average is:Efficiency and Utilization, Evaluating Alternatives

<< The formula for the moving average is:Learning Objectives, Capacity Planning

The formula for the moving average is:Evaluating Alternatives, Financial Analysis >>

Production and Operations Management MGT613

Lesson 16

It is important to realize that managers make capacity decisions at the organizational level and not at

the operational level. Often, debottlenecking a process can increase departmental efficiency without

increasing or improving the organizational performance. This does not mean that capacity decisions

are not taken at the operational level rather managers end up making capacity decisions at the

individual process level in accounting, finance, human resources, information technologies,

marketing and operations departments.

Operations Mangers must understand capacity measures, economies and diseconomies of scale,

capacity cushions and trade off between customer service and capacity utilization.

Efficiency and Utilization

Operations Manager should know what is Capacity? They should be able to identify the terms Design

Capacity and Effective capacity before they can understand another important concept of Utilization.

Design capacity is the maximum output rate or service capacity an operation, process, or

facility.

Organizations facility or operation is designed for Effective capacity which refers to Design

capacity minus allowances such as personal time, maintenance, and scrap

Actual output is the rate of output actually achieved--cannot exceed effective capacity.

Efficiency/Utilization Example

Use the following data to determine the Efficiency and Utilization

Design capacity = 50 trucks/day

Effective capacity = 40 trucks/day

Actual output = 36 units/day

Determinants of Effective Capacity

Operations Manager often focus on determinants of effective capacity by taking into account both

macro and micro levels. At the macro levels the managers look for Supply chain and External factors,

while at the micro level they look for operational factors including facilities and man and machine

resources. There are 7 determinants of effective capacity namely:-

1. Facilities. The design of facilities includes the size as well as the provision of expansion. Other

important factors that are necessary include transportation costs, distance to market, labor

supply, energy supply sources and the ease and smoothness with which work can be performed.

We should also include environmental factors such as heating, lighting and ventilation which

not only increase the performance of the workforce but also act as source of motivation and

worker loyalty. A failure to comply with this would indicate poor design which in reality

translates to lack of managerial acumen.

Production and Operations Management MGT613

2. Product and service factors can have a tremendous influence on capacity. E.g. when items are

similar, the ability of the system to produce those items is generally much greater than when

successive items are different and unique. The idea is more uniformity in the final product

service output the greater capacity. I am making a reference to a PC manufacturer in USA

which decided that it would standardize its products and split its assembly lines only at the point

where the a small differential product feature was required.

3. Process factors refer to the quantity and quality requirements of a process. Quantity always

refers to capacity. Another added feature is quality of output. If quality of output does not match

the standard requirements it would generate inspection and possible reworks.

4. Human factors include skill, craftsmanship, training and qualification to handle any job it also

includes the motivational factors.

5. Operational factors with respect to effective capacity always refer to scheduling, late deliveries,

acceptability of purchased materials, parts, quality inspection, control procedures and inventory

problems. Scheduling issues arise when an organization has a difference in equipment

capabilities for development of alternative capacities. Inventory problems have a negative

impact on capacity

6. Supply chain factors relate to any short coming to suppliers, warehouse processing, operational

hick up or distribution issues.

7. External factors include product standards, safety regulations, unions and pollution control

standards. At times organizations have experienced shutting down of their facility if they could

not provide support to government regulations of pollution control.

Strategy Formulation With respect to Capacity Planning

1. Capacity strategy for long-term demand which focus on demand patterns and takes into account

growth rate and variability

2. Facilities that focus on cost of building and operating

3. Technological changes relate to rate and direction of technology changes

4. Behavior of competitors

5. Availability of capital and other inputs

Key Decisions of Capacity Planning

It is important to identify the key decisions in order to carryout a correct capacity planning decision.

Some of the common key decisions are

1. Amount of capacity needed

2. Timing of changes

3. Need to maintain balance

4. Extent of flexibility of facilities

Steps for Capacity Planning Strategy

It is important to understand how to formulate a capacity planning strategy

1. Estimate future capacity requirements

2. Evaluate existing capacity

3. Identify alternatives

4. Conduct financial analysis

5. Assess key qualitative issues

6. Select one alternative

7. Implement alternative chosen

8. Monitor results

Developing Capacity Alternatives

Production and Operations Management MGT613

1. Design flexibility into systems refers to long term nature of expansion, if at the time of original

design, flexibility alternative is provided, and it would save cost in remodeling and

modifications when expansion is carried out later.

2. Take stage of life cycle into account. It is important that operations manager observe and check

whether the capacity increase alternative is for a new product/service or mature product or

service. The predictability for a new service is riskier as compared to an established mature

product or service.

3. Take a "big picture" approach to capacity changes while developing the capacity of the system,

it is necessary to understand the interrelationship of the components of the system. The big

picture approach relates to setting up of parking space, house keeping and landscaping if an

expansion is to be accommodated in a multi purpose shopping plus apartment complex.

4. By developing capacity alternatives, organizations prepare to deal with capacity "chunks"

Capacity increases are normally obtained in big chunks instead of incremental increase. A steel

mills furnace may not be able to provide exact required increase in capacity and thus would

provide excessive capacity which may lead to increase in inventory. E.g. the demand for steel

say is 2000 tone per annum in the city of sukkhur, from a local steel mill the capacity is 1800

tones per annum. The steel mill can increase its production from 1800 tones to 2200 tones per

annum and not to exactly 2000 tones per annum.

Organizations attempt to smooth out capacity requirements. This topic is discussed in more detail when

we will cover the topic of aggregate planning for the time being we can see that simply adding capacity

by increasing the size of workforce, machines, facility does not help. Operations manager should be able

to identify the optimal operating level. All Production units have an ideal or optimal level of operation

in terms of unit cost of output. At the ideal level, cost per unit is the lowest for that production unit.

Economies of Scale and Diseconomies of scale

An operations manager should know what economies and diseconomies of scale are

Economies of scale reflects a concept that states the average unit cost of a good or service can be

reduced by increasing its output rate while diseconomies of scale reflects the case when the average cost

per unit increases as the facility's size increases.

If the output rate is less than the optimal level, increasing output rate results in decreasing average unit

costs then it reflects Economies of Scale. On the other hand if the output rate is more than the optimal

level, increasing the output rate results in increasing average unit costs

Evaluating Alternatives

Minimum Average Cost per Unit

Average cost

per unit

Minimum Cost

Rate of output

Explanation of the Cost Curve

The explanation for the shape of the cost curve is that low levels of output (Production), the costs of

facilities and equipment must be absorbed (paid for) by few units. Hence the cost per unit is very high.

As the output is increased, there are more units to absorb the fixed cost of utilities, facilities and

equipment, so unit cost is decreased.

Production and Operations Management MGT613

Minimum Cost would be recorded at the optimal rate, beyond that the unit cost will

start to increase. Other factors now become more important which include worker fatigue, equipment

breakdown, the loss of flexibility, which leaves less margin for error and increases difficulty in

coordinating activities.

Evaluating Alternatives

Minimum cost & optimal operating rate are functions of size of

production unit.

Average cost per unit

Small

Medium

plant

Large

plant

Output rate

Evaluating Alternatives

As the general capacity of the plant increases, the optimal output rate increases and the

minimum cost for the optimal rate decreases.

This is the prime reason why larger plants tend to have higher optimal output rates and lower

minimum costs than smaller plants.

The senior management normally takes in to account the same considerations in addition to

availability of financial, capital resources and forecasted demand.

The important step is to determine enough points for each size facility to be able to make a

comparison among different sizes.

In some industries or types of services, facility sizes are given, where as in other facility size are

continuous variable.

Occasionally the management decides for a size which does not have the desired rate of output.

E.g. Pharmaceutical Company, oil field, gas fields.

An organization needs to examine the alternatives for future capacity from a number of different

perspectives.

Economic Conditions set the external conditions which influence the following

1. Will Alternative be feasible?

2. How much will it cost?

3. How soon can we have it?

4. What will be the operating and maintenance costs?

Possible Negative Opinion due to the following decisions.

1. Decision to build a new power plant, nuclear, coal, geothermal

2. Displacement of people if a new hydro plant is to be built.

3. Environmental issues related to company's new project.

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