# Chapter 9– Capacity Planning & Facility Location

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## Chapter 9– Capacity Planning & Facility Location

• Operations Management
• by
• R. Dan Reid & Nada R. Sanders
• 4th Edition © Wiley 2010

## Learning Objectives

• 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 – con’t

• 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

• 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

• 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

## 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
• On the average this bakery can make 20 custom cakes per day

## Measuring Effectiveness of Capacity Use

• 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

• Alternative 1: Purchase one large facility, requiring one large
• initial investment
• Alternative 2: Add capacity incrementally in smaller chunks as
• needed

## Other Capacity Considerations

• Focused factories:
• 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

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

## 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 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

• 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

• 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

• 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

## Evaluating the Decision Tree

• 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 con’t

• 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 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

## 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:
• Quality-of-life issues:
• Other considerations:
• Options for future expansion, local competition, etc.

## Globalization – Should Firm Go Global?

• Globalization is the process of locating facilities around the world
• 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:
• Procedures for evaluation location alternatives include
• Factor rating method
• Center of gravity approach
• Break-even analysis
• Transportation method

## 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 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 the four cities

## Calculating the Load-Distance Score for 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

• This approach requires that the analyst find the center of gravity of the geographic area being considered
• 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

• 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

• 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

## The Transportation Method

• 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

• 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

• 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

• 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 – con’t

• 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 – con’t

• 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 – con’t

• 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.

## Chapter 9 Homework Hints

• Problem 9.5: calculate utilizations based on design and effective capacities (see example 9.1). Present conclusions.
• Problem 9.14: use factor rating method to compare the possible locations (see example 9.3).
• Problem 9.15: use load-distance model to compare locations (see example 9.4).
• Problem 9.16: use center-of-gravity method. Use data from problem 15 (e.g. load between city and warehouse) to determine desired coordinates for the new warehouse.