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Chapter 9 - Capacity Planning & Facility Location

Operations Management

6th Edition

R. Dan Reid & Nada R. Sanders

Learning Objectives

Define capacity planning.
Explain the steps involved in capacity planning and location analysis.
Explain the usefulness of decision trees in decision making.
Identify key factors in location analysis.
Describe the decision-support tools used in location analysis.

Capacity Planning

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

There is no one best way to measure capacity
Output measures like kegs per day are easier to understand
With multiple products, input measures work better

Measuring Capacity

Two types of information needed:

Amount of available capacity

Understand how much capacity the facility has

Effectiveness of capacity use

How effectively we are using the available capacity

Measuring Available Capacity

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; usually lower than design capacity
On the average this bakery can make 20 custom cakes per day

Measuring Effectiveness of Capacity Use

Capacity Utilization:

Measures how much of the available capacity (%) is actually being used.

Measures effectiveness
Use either effective or design capacity in denominator

Example of Computing Capacity Utilization: A bakery’s design capacity is 30 custom cakes per day. Currently the bakery is producing 28 cakes per day. What is the bakery’s capacity utilization relative to both design and effective capacity?

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

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

When expanding capacity, there are two alternatives:

Purchase one large facility, requiring one large initial investment

Add capacity incrementally in smaller chunks as needed

Other Capacity Considerations

Focused factories:
Small, specialized facilities with limited objectives e.g. The Limited (Limited Too)
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; fast growing trend today

Making Capacity Planning Decisions

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

Identify Capacity Requirements

Develop Capacity Alternatives

Evaluate Capacity Alternatives

1. Identifying Capacity Requirements

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

2. Developing Capacity Alternatives

Capacity alternatives include:

Do nothing

Expand large now (may included capacity cushion)

Expand small now with option to add later

3. Evaluating Capacity Alternatives

Use decision support aids to evaluate decisions
Decision tree most popular
Managers need to use many different inputs and judgment

Decision Trees

Diagramming technique

Decision points – points in time when decisions are made, squares called nodes
Decision alternatives – branches or arrows leaving a decision point (nodes)
Chance events – events that could affect a decision, branches or arrows leaving circular chance nodes
Outcomes – each possible alternative listed

Decision Tree Diagrams

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. 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?

Evaluating the Decision Tree

Utilizes Expected Value (EV) analysis
EV is a weighted average of 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 EV of small expansion:
EVsmall = 0.30($80,000) + 0.70($200,000) = $164,000

Evaluating the Decision Tree - cont'd

Calculate EV 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 it’s the worst decision:

Take the calculated risk!

Location Analysis

Three most important factors in real estate: Location, Location, Location
Facility location is the process of identifying the best geographic location for a service or production facility
Long term commitment
Sizable financial investment and impact

Factors Affecting Location Decisions

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

Community considerations:
Local community’s 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, transportation access and congestion, etc.

Globalization – Should Firm Go Global?

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; closer to suppliers - manufacturers
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

Analysis should follow 3 step process:

Identify dominant location factors

Develop location alternatives

Evaluate locations alternatives

Procedures/tools for evaluating location alternatives include
Factor rating method
Load-distance model
Center of gravity approach
Break-even analysis
Transportation method

Factor Rating (with example)

A procedure to evaluate multiple alternative locations

based on a number of selected factors.

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

Calculate the rectilinear distance:

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

A procedure for evaluating location alternatives based on distance.

Calculating Load-Distance Score: Springfield vs. Mansfield

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

The Center of Gravity Approach

Requires the analyst to find the center of gravity of the geographic area being considered for an alternative site.

Computing the Center of Gravity for Matrix Manufacturing

Is there another possible warehouse location closer to the C.G. that should be considered?? Why?

Break-Even Analysis

Technique used to compute 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 – cont’d

Remember, the break even equations used for calculating 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 10,000 garments. The table and graph below are used for the analysis.

From the graph you can see that the two lowest cost intersections occur between C & B (4667 units) and B & A (9000 units)

The best alternative up to 4667 units is C, between 4667 and 9000 units the best is B, and above 9000 units the best site is A

The Transportation Method

Can be used to solve specific location problems
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

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 & Facility Location Across the Organization

Capacity planning and location analysis affect OM 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

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 – cont'd

In both capacity planning and location analysis, managers must follow three-step process to make good decisions. 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 – cont'd

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 – cont'd

Several tools can be used to facilitate location analysis. Factor rating is a tool that helps managers evaluate qualitative factors. The load-distance 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.

(

)

100%

capacity

rate

output

actual

Utilizatio

93%

(100%)

capacity

design

output

actual

Utilizatio

140%

(100%)

capacity

effective

output

actual

Utilizatio

design

effective

miles

Computing the Load-Distance Score for Springfield

CityLoadDistanceld

Cleveland1520.5307.5

Columbus104.545

Cincinnati127.590

Dayton43.514

Total Load-Distance Score(456.5)

Computing the Load-Distance Score for Mansfield

CityLoadDistanceld

Cleveland158120

Columbus10880

Cincinnati1220240

Dayton41664

Total Load-Distance Score(504)

10.6

436

;

7.9

325

c.g.

Computing the Center of Gravity for Matrix Manufacturing

CoordinatesLoad

Location(X,Y)

Cleveland

(11,22)15165330

Columbus

(10,7)1016570

Cincinnati

(4,1)1216512

Dayton

(3,6)416524

Total

41325436

Example 9.6 Using Break-Even Analysis

LocationFixed CostVariable CostTotal 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