Strategic Capacity Management

Dr. Ron Lembke Operations Management

Ideal Capacity of a Process

50/hr

20/hr

10/hr

40/hr

What is the capacity of the system? Should we add any capacity? How should we run the system? Where should we keep inventory?

Ideal Capacity of a Process

6 min

5 min

4 min

5 min

What is the capacity of the system?

Productivity
Productivity = Outputs / Inputs Partial: Output/Labor or Output/Capital Multifactor:

Output / (Labor + Capital + Energy )

Total Measure:
Output / Inputs

Automotive Productivity

Book Data:
Jaguar:

14 cars/employee Volvo: 29 cars/employee Mini: 39 cars/employee

Growth of Service Economy

80 70 60 50 40 30 20 10 0 Services Industry Farming

75

25

50

18 50

19 00

75

20 00

US Productivity Growth

Improving Productivity
Develop productivity measurements you cant improve what you cant measure Identify and Improve bottleneck operations first Establish goals, document and publicize improvements

U.S. Work and Productivity

2500 40% 35% 2000 30%

1500

25%

20%

Hours Prod Growth

1000

15%

10% 500 5%

0 US Japan France Germany Norway

0%

Source: International Labor Organization, 1999

What Would Henry Say?

Ford introduced the $5 (per day) wage in 1914 He introduced the 40 hour work week so people would have more time to buy It also meant more output: 3*8 > 2*10
Now

we know from our experience in changing from six to five days and back again that we can get at least as great production in five days as we can in six, and we shall probably get a greater, for the pressure will bring better methods. Crowther, Worlds Work, 1926

Forty Hour Week

Ernst Abbe, Karl Zeiss optics 1896: as much done in 9 as in 8.

Marginal Output of Time

As you work more hours, your productivity per hour goes down Eventually, it goes negative.

Chapman, 1909

Crunch Mode

Ea_spouse: 12/04
Pre-crunch SO

was working 7 * 13: 91 per week! Maybe time off at 6pm Saturday $5k signing bonus, couldnt quit Class action: April 06 $14.9m

Igda.org Why Crunch Mode Doesnt Work: 6 Lessons

Learning Curves
time/unit goes down consistently Down by 10% as output doubles We can use Logarithms to approximate this If you ever need this, email me, and we can talk as much as you want

600 500

Example 3.3

400 300 200 100 0 1 2 3 4 5 Bottles Bags

Pauls 1 2 3 4 5 Bottles 60 100 150 200 250 Bags 100 200 300 400 500

Newmans Bottles 75 85 95 97 98 Bags 200 400 600 650 680

Example 3.3
Bottles 135 185 245 297 348 Bags 300 600 900 1,050 1,180 3 bottle machines 150k each/yr = 450k 5 bag machines, 250k each/yr = 1,250k

Example 3.3

Bottles 135 185 245 297 348 Machines 1 2 2 2 3 Mach. usage 0.9 1.23 1.63 1.98 2.32 Workers 1.8 2.46 3.27 3.96 4.64
Bags 300 600 900 1,050 1,180 Machines 2 3 4 5 5 Mach Usage 1.2 2.4 3.6 4.2 4.7 Workers 3.6 7.2 10.8 12.6 14.1

Capacity Tradeoffs
120,000 4-door cars

150,000 Two-door cars

Can we make combinations in between?

How much do we have?

We can only sustain so much effort. Best Operating Level

Output

level process designed for Lowest cost per unit

Capacity utilization = capacity used best operating level Hard to run > 1.0 for long

Time Horizons
Long-Range: over a year acquiring, disposing of production resources Intermediate Range: Monthly or quarterly plans, hiring, firing, layoffs Short Range less than a month, daily or weekly scheduling process, overtime, worker scheduling, etc.

Service Differences
Arrival Rate very variable Cant store the products - yesterdays flight? Service times variable Serve me Right Now! Rates change quickly Schedule capacity in 10 minute intervals, not months How much capacity do we need?

Capacity Levels in Service

=100% Zone of non-service Mean arrival rate, < =70%

Zone of service Mean service rate,

Adding Capacity
Expensive to add capacity A few large expansions are cheaper (per unit) than many small additions Large expansions allow of clean sheet of paper thinking, re-design of processes

Carry

unused overhead for a long time May never be needed

Small expansions may pave the cow path

Capacity Planning

How much capacity should we add? Conservative Optimistic

Forecast possible demand scenarios (Chapter 10) Determine capacity needed for likely levels Determine capacity cushion desired

Reengineering
Business Process Reengineering (Hammer and Champy) Companies grow over time, adding plants, lines, facilities, etc. Growth may not end in optimal form Re-design processes from ground up

Capacity Sources

In addition to expanding facilities:

Two

or three shifts Outsourcing non-core activities Training or acquisition of faster equipment

Decision Trees
Consider different possible decisions, and different possible outcomes Compute expected profits of each decision Choose decision with highest expected profits, work your way back up the tree.

Decision Trees Example 3.4, p.65

Computer store thinks demand may grow. Expansion costs $87k, new site $210k, and would cost same if wait a year New site:

55% chance of profits of $195k. 45% chance of $115k profits. 55% chance of $190k profits 45% chance of $100k profits

Expand Current

Wait and see- enlarge store next year if demand grows

If high demand, $190k with expanded store If high demand, $170 with current store If weak demand, $105k with current store Find the expected profits over 5 years, choose best one.

Decision Trees
Decision point Chance events Outcomes Calculate expected value of each chance event, starting at far right Working our way back toward the beginning, choosing highest expected outcome at each decision

Decision Trees
Move Strong Growth 0.55 Weak Growth 0.45 Strong Growth 0.55 Weak Growth 0.45 Expand Wait and See Strong Growth 0.55 Do nothing

Revenue - Move Cost

Revenue - Move Cost Revenue Expand Cost Revenue Expand Cost Rev Expand Cost Rev - Expand Cost

Hackers Computer Store

Expand

Weak Growth 0.45

Revenue

Possible 5 year Revenues

New, growth: 195*5 210 = 765 New, low: 115*5 210 = 365 Expand, growth: 190*5 87 = 863 Expand, low: 100*5 87 = 413 Wait, strong, expand: 170+190*4-87=843 Wait, strong, do nothing: 170*5 = 850 Wait, low, do nothing: 105*5 = 525

Decision Trees
Move Strong Growth 0.55

765
365 863 413 Expand 843 850

Weak Growth 0.45

Hackers Computer Store Expand Strong Growth 0.55 Weak Growth 0.45 Wait and See

Strong Growth 0.55

Do nothing

Weak Growth 0.45

525

Making the Decision

Starting at the far right, look at the Wait and See option. If demand is strong, we would obviously not expand. $850k is better than $843. Eliminate the Expand option

Decision Trees
Move Strong Growth 0.55

765
365 863 413 Expand 843 850

Weak Growth 0.45

Hackers Computer Store Expand Strong Growth 0.55 Weak Growth 0.45 Wait and See

Strong Growth 0.55

Do nothing

Weak Growth 0.45

525

Expected Values

Move:
0.55*

765 + 0.45*365 = $585,000 + 0.45*525 = $703,750

Wait and See:

0.55*850

Expand:
0.55

* 863 + 0.45 * 413 = $660,500

Highest expected value is to Wait and see, and either way, do nothing!

Decision Trees
Move

$585,000

Strong Growth 0.55

765
365 863 413 Expand Do nothing 843 850

Weak Growth 0.45

Hackers Computer Store

660,500
Expand

Strong Growth 0.55 Weak Growth 0.45

Wait and See

703,750

Strong Growth 0.55

Weak Growth 0.45

525

Other considerations

Another criteria to use is to pick the one with the highest down side.
Under

this, do nothing still wins.

We could also consider the expected value of the future cash streams. PV = $100/(1+r) = $100/(1.16)=$86.27

Present Values - p.377

At 16%, Next year is worth 0.862

=(1+rate)^(-years) Year

2: 0.743 Year 3: 0.641 Year 4: 0.552 Year 5: 0.476

195 per year for 5 years: 195 * (3.274)

Decision Tree-NPV
Move

$310,613

Strong Growth 0.55

428,487
166,544 535,116 240,429 Expand Do nothing 529,874 556,630

Weak Growth 0.45

Hackers Computer Store

402,507
Expand

Strong Growth 0.55 Weak Growth 0.45

Wait and See

460,857

Strong Growth 0.55

Weak Growth 0.45

343,801

Real Options
Assess the value to me of being able to change my mind in the future Changed problem slightly
Reduced

benefit doing nothing, high demand

Decision Trees
$465,000
Hackers Computer Store Move 0.25 0.75 Strong Weak Strong Weak 765 365 863 413 Expand 843 820

533,000
Expand

0.25

0.75

604,500
Wait and See

0.25 0.75

Strong
Do nothing Weak 525 820 525

598,750
Do Nothing

0.25 0.75

Strong
Weak

Real Options
If we didnt have the wait and see option, we would Do Nothing. Option to wait and see is worth $5,750

Wait and See Do Nothing Expand Move

604,500 598,750 533,000 465,000

$5,750