2010 CAPACITY AND BEP

POM, Chapter 9

Lecture Outline

Capacity p y z Capacity Planning z Capacity Decisions z Managing Demand and Capacity z Capacity Calculations z Break Even Analysis z

Capacity z

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Capacity is the throughput, or the number of units a facility can hold, receive, store, accommodate or produce Ti dimension Time di i should h ld be b stated t t d Capacity encompasses both resource inputs and product/service outputs Capacity planning is the process of identifying the capacity of a process/system so as to meet current and f t future d demands d Capacity planning means different things to individuals at different levels in the OM hierarchy

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POM, Chapter 9

Capacity Planning z

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Capacity Planning is the long term strategic decision that establishes a firm’s overall level of capital intensive resources. To build new facilities, to acquire new machines & equipments, to hire, to acquire new businesses, technologies, etc. Inadequate capacity can loose customers & limit growth Excess capacity stretch up the resources and prevent investments in other lucrative sectors The choice is when to increase and how much to increase

Capacity Decisions z

Capacity: Maximum capability to produce; is affected by the mix of product/services, processes involved, the choice of technology, the size of a facility, the resource allocated, and external factors

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Rated Capacity is theoretical output with 100% utilization

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Capacity Utilization: percent of available time spent working

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Capacity Efficiency: how well a machine or worker performs compared to a standard output level z

Effective capacity is actual efficiency and utilization

Effective daily capacity = number of machines or workers x hours per shift x no. of shifts x utilization x efficiency z

Capacity Load: standard hours of work assigned to a facility

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Capacity Load Percent: ratio of load to capacity

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POM, Chapter 9

Bakery Example

Actual pproduction last week = 148,000 , rolls Effective capacity = 175,000 rolls Rated or Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Rated or Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Bakery Example

Actual pproduction last week = 148,000 , rolls Effective capacity = 175,000 rolls/week Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls/week

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POM, Chapter 9

Bakery Example

Actual pproduction last week = 148,000 , rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls/week Utilization = 148,000/201,600 = 73.4%

Bakery Example

Actual pproduction last week = 148,000 , rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls/week Utilization = 148,000/201,600 = 73.4%

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POM, Chapter 9

Bakery Example

Actual pproduction last week = 148,000 , rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls/week Utilization = 148,000/201,600 = 73.4% Efficiency = 148,000/175,000 = 84.6%

Bakery Example

Actual pproduction last week = 148,000 , rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls/week Utilization = 148,000/201,600 = 73.4% Efficiency = 148,000/175,000 = 84.6%

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POM, Chapter 9

Bakery Example

Actual pproduction last week = 148,000 , rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Efficiency = 84.6% Efficiency of new line = 75% Expected E t d Output O t t = (Effective (Eff ti Capacity)(Efficiency) C it )(Effi i ) = (175,000)(.75) = 131,250 rolls/week

Bakery Example

Actual pproduction last week = 148,000 , rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 - 8 hour shifts Efficiency = 84.6% Efficiency of new line = 75% Expected E t d Output O t t = (Effective (Eff ti Capacity)(Efficiency) C it )(Effi i ) = (175,000)(.75) = 131,250 rolls/week

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POM, Chapter 9

Capacity Decisions z

Capacity increase i.e. how much to increase depends on volume and certainty of anticipated demand strategic t t i objectives bj ti – purpose, competition, titi positioning, iti i growth th costs of expansion and operation Best Operating Level to avoid confusion with ‘normal’ capacity levels % of capacity utilization that minimizes average unit costs most economic size of a facility Capacity Cushion % of capacity held in reserve for unexpected occurrences airline industry keeps negative cushion by overbooking tickets z z z

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Best Operating Level for a Hotel

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POM, Chapter 9

Economies & Diseconomies of Scale z

Economies of scale occur when it costs less per unit to produce or operate at high levels of output fi d costs fixed t can be b spreadd over a larger l number b off units it quantity discounts are available for material purchases operating efficiency increases as workers gain experience production or operating costs do not increase linearly with output levels Diseconomies of scale occur above a certain level of output p Diseconomies of Distribution/Transportation Diseconomies of Bureaucracy/Hierarchies Diseconomies of Vulnerability z z z z

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Managing Demand ; Demand exceeds capacity ; Curtail demand by raising prices ; Schedule longer lead time ; Long term solution is to increase capacity

; Capacity exceeds demand ; Stimulate market ; Product changes

; Adjusting to seasonal demands ; Produce products with complimentary demand patterns

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POM, Chapter 9

Managing Capacity

Capacity Decisions – Example #1 Pizza Hut offers large pizzas for Rs 25 on Tuesdays from 5 to 9 in the evening. Three cooks are on duty during that time, the fixed cost of this four hour pperiod is Rs. 400. The variable cost of ppizza is Rs. 15.

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A. If it takes 10 minutes to prepare each pizza, worker efficiency is approx. 95% and employees get a 10 minutes break each hour, how may pizzas can they produce during its four hour special?

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B. Assuming all pizzas produced can be sold, is the promotion worth it?

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A. Effective capacity p y = no. of workers x hours x utilization x efficiency y = 3 x 4 x (50/60) x 0.95 = 9.5 hrs = 570 minutes

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Output = 570 / 10 = 57 pizzas

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B. BEP = 400 / 25 – 15 = 40 pizzas

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Yes, the promotion effort is worth it.

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POM, Chapter 9

Capacity Decisions – Example #2 z

Amy gets home from classes around 5 pm each day and can only reasonably work on her studies until midnight. midnight. She usually watches an hour of television to relax, work out for 30 minutes, and takes 30 minutes to eat dinner.. She has found that if she takes a 5 minute break each hour, she can dinner remain more focused. focused. Today she feels 80 80% % on task task.. Homework for the evening includes two critical analyses for Govt Govt,, one thesis for American Lit, and three Spanish translations. translations. Estimated processing times are given below.. Setup time includes time spent online gathering resources and below finding reference books around the apartment. apartment.

TASKS Govt Govt. American Lit Spanish Trans. z z z z

SETUP TIME (Minutes) 15 30 10

PROCESSING TIME PER TASK (Minutes) 40 120 30

What is percent utilization? What is Amy’s effective capacity to do work this evening? What is her load percent? How would you suggest she adjust her capacity to complete her task on time?

Example #2 Hours available with Amy = 12 12--5 = 7 hrs = 7*60 = 420 mins Idle hours = 60 60+ +30 30+ +30 30+( +(5 5*5) = 145 mins Utilized hours = 420 -145 = 275 mins % Utilization = 275 275//420 = 65 65..47 47% % Effective Capacity = 275 * 0.8 = 220 mins Load = [15 15+( +(22*40 40)] )] + [30 30+( +(11*120 120)] )] + [10 10+( +(33*30 30)] )] = 345 mins Load % = 345 345//220 = 156 156..82 82% % Options to improve improve:: raise efficiency or sleep late or cut idle hrs.. hrs..

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POM, Chapter 9

Capacity Decisions – Example #3 Biren is Prof Prof.. Khurana’s teaching assistant assistant.. He would like to leave for Diwali break tomorrow, but first he has to grade the midterm exams from four sections. sections. These sections are new to Biren Biren,, so he estimates his ggrading g efficiencyy to be 80% 80%. Prof Prof.. Khurana has estimated the time required to create key and the time to grade each paper as shown below. below. Biren anticipates that he will need five hours of sleep, an hour to pack, an hour to get the rly station, an hour to post grades, and three twenty minute breaks during the day for meals meals.. Can Biren finish his work and make it to the rly station on time in a 24 hour day? SECTION

A B C D

TIME TO CREATE KEY

TIME TO GRADE EACH PAPER

#PAPERS

10 15 5 20

2 5 1 10

35 50 60 25

Example #3 Hrs available = 24 hrs = 1440 mins Non productive hrs = 5+1+1+1+(3*20) = 9 hrs = 540 mins Working hrs = 24-9 = 15 hrs = 900 min Utilization % = 15/24 = 900/1440 = 62.50% Effective capacity in hrs = 900 * 0.8 = 720 mins Load = [10+(2*35)] + [15+(5*50)] + [5+(1*60)] + [20+(10*25)] = 680 mins Load % = 680/720 = 94.45% He can easily achieve the completion of the task assigned.

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POM, Chapter 9

Capacity Decisions – Example #4 The Avon Bicycle Co. has scheduled the production of following bicycles this month. TYPE WEEK z

I 50 15 20

A B C z

II 100 30 40

III 195 65 80

IV 150 45 60

Two critical work centers form producing these bikes are welding and assembly. assembly. Welding has an efficiency of 95 95% % and utilization of 90% 90% and Assembly has an efficiency of 90% 90% and utilization of 92 92% %. The time required in hours by each bike in two work centers is as follows follows::

TYPE A B C

WELDING 0.20 0.15 0.07

ASSEMBLY 0.18 0.15 0.10

Assume 40 hours/week for each work center. Calculate the capacity and load percent per work center per week.

Chase Unsolved 5. Part a.

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POM, Chapter 9

Part a. Capacity of assembly line 1 = 140 units/hour X 8 hours/day X 5 days/week = 5,600 units/week. Capacity of drill machines = 3 drill machines X 50 parts/hour X 8 hours/day X 5 days/week = 6,000 units/week. Capacity of final assembly line = 160 units/hour X 8 hours/dayy X 5 days/week y = 6,400 , units/week. The capacity of the entire process is 5,600 units per week, with assembly line 1 limiting the overall capacity.

Part b. Capacity of assembly line 1 = 140 units/hour X 16 hours/day X 5 days/week = 11,200 units/week. Capacity of drill machines = 4 drilling machines X 50 parts/hour X 8 hours/day X 5 days/week = 8,000 units/week. Capacity of final assembly line y = 12,800 , units/week. = 160 units/hour X 16 hours/dayy X 5 days/week The capacity of the entire process is 8,000 units per week, with drilling machines limiting the overall capacity.

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POM, Chapter 9

Part c. Capacity of assembly line 1 = 140 units/hour X 16 hours/day X 5 days/week = 11,200 units/week. Capacity of drill machines = 5 drilling machines X 50 parts/hour X 8 hours/day X 5 days/week = 10,000 units/week. Capacity of final assembly line = 160 units/hour X 12 hours/dayy X 5 days/week y = 9,600 , units/week. The capacity of the entire process is 9,600 units per week, with final assembly machines limiting the overall capacity.

Part d.

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POM, Chapter 9

Part d.

Part e. Break Even Analysis Let X = the number of units that each option will produce. When the company buys the units, units the cost is $3.00 $3 00 per unit (3X). (3X) When it manufactures the units, they incur a fixed cost of $120,000 (4 drilling machines at $30,000 a piece) and a per unit cost of $1.81. Therefore, 120,000 + 1.81X is the cost of this option. Set them equal to each other and solve for X to determine the breakeven point.

3X = 120,000 + 1.81X X = 100 100,840 840 units. units Therefore, it is better to buy the units when you produce less than 100,840, and better to produce them when demand is greater than 100,840 units.

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POM, Chapter 9

Process Selection with BreakBreak-Even Analysis z

Break Even Point Analysis: BEP examines the cost tradeoffs associated with demand / sales volume.

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Volume: V l L l off production, Level d ti usually ll expressedd as no. off units it produced/sold Cost z

Fixed costs: constant regardless of the no. of units produced

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Variable costs: vary with the volume of units produced

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R Revenue: P Price i att which hi h an item it is i sold ld

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Total revenue: Price times volume sold

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Profit: Difference between total revenue and total cost

Process Selection with BreakBreak-Even Analysis Total cost = fixed cost + total variable cost TC = cf + v cv Total revenue = volume * price TR = v p Profit = total revenue - total cost Z = TR – TC = v p - (cf + v cv) TR = TC v p = cf + v cv v p – v cv = cf v (p - cv) = cf v = cf / ( p – cv )

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POM, Chapter 9

Break--Even Analysis: Example #1 Break A company wants to produce its own rafts, the initial investment in equipment is estimated to be Rs. Rs. 2000. 2000. Labour and material cost is approx approx.. Rs 5 per raft raft.. If the rafts can be sold at a price of Rs Rs.. 10 each, what volume of demand will be necessary to break even?

Fixed cost = cf = Rs. 2000 Variable cost = cv = Rs. 5 per raft Price = p = Rs. 10 per raft

Break--even point is Break cf 2000 v= p-c = = 400 rafts v 10 - 5

Break--Even Analysis: Graph Break

Total cost line

$3,000 —

$2,000 —

$1,000 — Total revenue line 400 Break-even point

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Units

POM, Chapter 9

Process Selection – Example #1.1 The owners of the company believe that demand for their product will far exceed the breakeven point. They are now contemplating a larger initial investment of Rs. 10000 for more automated equipment that would reduce the variable cost of manufacture to Rs. 2 per raft. Compare the old manufacturing process with the new process proposed here. For what volume of demand should each process be chosen? Sol’n: The point of indifference between Process A and B is: Process A Process B 2 000 + 5v = 10 2,000 10,000 000 + 2v 3v = 8,000 v = 2667 rafts z z

Below 2667, choose A Above 2667, choose B

Process Selection – BEP Graph

Total T t l costt off process A

$ $20,000 —

Total cost of process B

$15,000 —

$10,000 — Choose process A

$5,000 — | 1000

| 2000

Choose process B | 3000 Units

Point of indifference = 2,667 Units

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Example 4.2

POM, Chapter 9

BEP & Process Selection - #2 A singer is getting ready to cut his first CD, the cost of recording the CD is Rs. 50000 but the copies are Rs. 50 apiece. If the CDs can be sold at Rs. Rs 150 each, each how many CDs must be sold to breakeven? What is the breakeven point in Rupees? The singer is confident that the CDs will out-sale the breakeven point, so he is contemplating to cut his CD at a hi-tech and classier (read pricier) studio. The cost to record the CD would rise to Rs. 90000. However, since the new studio works with high volume production cost would fall to Rs. volume, Rs 20 per unit. unit What is the breakeven point for new process? Compare this process with the old one and find out what volume of demand suits the older and the newer recording process.

BEP Example #3 z

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David recently purchased a chain of dry cleaners in a city. city. Although the business is making a modest profit now, David suspects that if he invests in a new press, press he would recognize a substantial increase in profits profits.. The new press costs, Rs Rs.. 15 15,,400 to purchase and install and can press 40 shirts an hour. hour. David estimates that with the new press, it will cost Rs 0.25 to launder and press each shirt. shirt. Customers are charged Rs. Rs. 1.10 per shirt. shirt. How many shirts will David have to press to break even? So far, David’s workload has varied from 50 to 200 shirts a day. day. How long would it take to break even on the new press at the low demand estimate? And at the high demand estimate? If David cuts his price to Rs. Rs. 0.99 per shirt, he expects to be able to stabilize his customer base at 250 shirts per day day.. How long it take to break even at the reduced price of 0.99? 99? Should David cut his price and buy the new press?

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POM, Chapter 9

BEP Example #4 z

The school cafeteria can make pizza for approximately Rs Rs.. 0.30 per slice slice.. The cost of kitchen use and cafeteria staff runs about Rs Rs.. 200 per day. day. The Pizza Hut nearby will deliver whole pizzas for Rs. Rs. 9 each. each. The cafeteria staff cuts the pizza into eight pieces and serves them in the usual cafeteria line. line. With no cooking duties, the staff can be reduced to half, for a fixed cost of Rs Rs.. 75 per day. day. Should the school cafeteria make on its own or buy its pizzas from Pizza Hut?

BEP Example #5 z

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Alma McCoy has decided to purchase a cellular phone for her car, but she is confused about which rate plan to choose. choose. The occasional user plan is Rs.. 0.50 per minute, Rs minute regardless of how many minutes of airtime are used used.. The frequent user plan charges a flat rate of Rs 55 per month for 70 minutes of airtime plus Rs Rs.. 0.33 per minute for any time over 70 minutes minutes.. The executive plan charges a flat fee of Rs. Rs. 75 per month for 100 minutes of airtime plus Rs Rs.. 0.25 per minute over 100 minutes minutes.. In the interest of simplicity, Alma has decided to go with the occasional user plan to start with and then upgrade as she sees fit at a later date date.. How much airtime per month would Alma need to use before she upgrades from the occasional user plan to the frequent user plan? plan? At what usage rate should she switch from the frequent user plan to the executive plan? plan?

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POM, Chapter 9

BEP Example #6 z

Soft key is trying to determine how best to produce its newest product, K2 keyboards keyboards.. The keyboards could be produced in house using either Process A or B or buying from a supplier supplier.. Cost data is given below below.. For what levels of demand should each option be explored? FIXED COST (Rs.)

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PROCESS A PROCESS B SUPPLIER

8000 20000 0

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VARIABLE COST (Rs./UNIT)

10 4 20