Capacity and

Constraint
Management

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Process Analysis/Capacity Planning
at Arnold Palmer Hospital
• https://www.youtube.com/watch?v=D1KXufqnwvs

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Outline

• Capacity
• Bottleneck Analysis and the Theory of Constraints
• Break-Even Analysis
• Reducing Risk with Incremental Changes
• Applying Expected Monetary Value (EMV) to Capacity
Decisions
• Applying Investment Analysis to Strategy-Driven
Investments
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Learning Objectives

1 Define capacity
2 Determine design capacity, effective capacity, and
utilization
3 Perform bottleneck analysis
4 Compute break-even
5 Determine the expected monetary value of a capacity
decision
6 Compute net present value
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Capacity

• The throughput, or the

number of units a facility
can hold, receive, store, or
produce in a period of time
• Determines fixed costs
• Determines if demand will
be satisfied
• Three time horizons
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Planning Over a Time Horizon

Figure 1: Time Horizons and Capacity Options

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Design and Effective Capacity (1 of 4)

• Design capacity is the maximum theoretical output of a

system
– Normally expressed as a rate
• Effective capacity is the capacity a firm expects to
achieve given current operating constraints
‒ Often lower than design capacity
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Design and Effective Capacity (2 of 4)

Table 1 Capacity Measurements

Measure Definition Example
Design capacity Ideal conditions exist Machines at Frito-Lay are designed to
during the time that produce 1,000 bags of chips/hr., and the
a photo of a machine the system is plant operates 16 hrs./day.
lying a surface. available
Design Capacity = 1,000bags / hr. ×16hrs.
= 16,000bags / day
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Design and Effective Capacity (3 of 4)

Table 1 [continued]
Measure Definition Example
Effective capacity Design capacity Frito-Lay loses 3 hours of output per day
minus lost output (0.5 hrs./day on preventive maintenance,
a photo of two men, because of planned 1 hr./day on employee breaks, and
wearing hard hats, resource unavailability 1.5 hrs./day setting up machines for
talking while one is
sitting on the driver
(e.g., preventive different products).
seat of a truck. maintenance, Effective Capacity = 16,000bags / day
machine - (1,000bags / hr.)
setups/changeovers, (3 hr. / day)
changes in product
= 16,000bags / day
mix, scheduled
- 3,000bags / day
breaks)
= 13,000bags / day
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Design and Effective Capacity (4 of 4)

Table 1 [continued]
Measure Definition Example
Actual output Effective capacity On average, machines at Frito-Lay are
minus lost output not running 1 hr./day due to late parts
a photo of a man, during unplanned and machine breakdowns.
wearing a hard had, resource idleness
working on suspended
(e.g., absenteeism, Actual output = 13,000 bags / day
wires.
machine breakdowns, - (1,000bags / hr.)
unavailable parts, = 13,000bags / day
quality problems) - 1,000bags / day
=12,000bags / day
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Utilization and Efficiency

Utilization is the percent of design capacity actually

achieved
Actual output
Utilization =
Design capacity

Efficiency is the percent of effective capacity actually

achieved

Actual output
Efficiency =
Effective capacity
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Bakery Example: Design Capacity (1 of 2)

Actual production 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

Designcapacity = (7  3  8)  (1,200) = 201,600 rolls

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Bakery Example: Utilization

Actual production 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  3  8)  (1,200) = 201,600 rolls

Utilization = 148,000 / 201,600 = 73.4%

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Bakery Example: Efficiency

Actual production 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  3  8)  (1,200) = 201,600 rolls

Utilization = 148,000 / 201,600 = 73.4%

Efficiency = 148,000 / 175,000 = 84.6%
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Bakery Example: Design Capacity (2 of 2)

Actual production last week = 148,000 rolls

Effective capacity = 175,000 rolls
Design capacity = 201,600 rolls per line
Efficiency = 84.6%
Expected output of new line = 130,000 rolls

Design capacity = 201,600  2 = 403,200 rolls

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Bakery Example: Effective Capacity

Actual production last week = 148,000 rolls

Effective capacity = 175,000 rolls
Design capacity = 201,600 rolls per line
Efficiency = 84.6%
Expected output of new line = 130,000 rolls

Design capacity = 201,600  2 = 403,200 rolls

Effective capacity = 175,000  2 = 350,000 rolls
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Bakery Example: Actual Output

Actual production last week = 148,000 rolls

Effective capacity = 175,000 rolls
Design capacity = 201,600 rolls per line
Efficiency = 84.6%
Expected output of new line = 130,000 rolls

Design capacity = 201,600  2 = 403,200 rolls

Effective capacity = 175,000  2 = 350,000 rolls
Actual output = 148,000 + 130,000 = 278,000 rolls
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Bakery Example: Utilization Efficiency

Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 201,600 rolls per line
Efficiency = 84.6%
Expected output of new line = 130,000 rolls
Design capacity = 201,600  2 = 403,200 rolls
Effective capacity = 175,000  2 = 350,000 rolls
Actual output = 148,000 + 130,000 = 278,000 rolls
Utilization = 278,000 / 403,200 = 68.95 %
Efficiency = 278,000 / 350,000 = 79.43%
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Capacity and Strategy

• Capacity decisions impact all 10 decisions of operations

management as well as other functional areas of the
organization
• Capacity decisions must be integrated into the
organization’s mission and strategy
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Capacity Considerations

1. Forecast demand accurately

2. Match technology increments and sales volume
3. Find the optimum operating size (volume)
4. Build for change
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Economies and Diseconomies of Scale

Figure 2: Economies and Diseconomies of Scale

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Managing Demand

• Demand exceeds capacity

‒ Curtail demand by raising prices, scheduling longer
lead times
‒ Long-term solution is to increase capacity
• Capacity exceeds demand
‒ Stimulate market
‒ Product changes
• Adjusting to seasonal demands
‒ Produce products with complementary demand
patterns
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Complementary Demand Patterns

Figure 3: By Combining Products That Have Complementary
Seasonal Patterns, Capacity Can Be Better Utilized
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Tactics for Matching Capacity to Demand

1. Making staffing changes

2. Adjusting equipment

– Purchasing additional machinery

– Selling or leasing out existing equipment

3. Improving processes to increase throughput

4. Redesigning products to facilitate more throughput
5. Adding process flexibility to meet changing product
preferences
6. Closing facilities
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Service-Sector Demand and Capacity

Management

• Demand management
‒ Appointment, reservations, FCFS rule
• Capacity management
‒ Full time, temporary, part-time staff
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Bottleneck Analysis and the Theory of

Constraints (1 of 2)

• Each work area can have its own unique capacity

• Capacity analysis determines the throughput capacity of
workstations in a system
• A bottleneck is a limiting factor or constraint
‒ A bottleneck has the lowest effective capacity in a
system
• The time to produce a unit or a specified batch size is the
process time
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Bottleneck Analysis and the Theory of

Constraints (2 of 2)

• The bottleneck time is the time of the slowest

workstation (the one that takes the longest) in a
production system
• The throughput time is the time it takes a unit to go
through production from start to end, with no waiting

Figure 4 Three-Station Assembly Line

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Capacity Analysis (1 of 5)

• Two identical sandwich lines

• Lines have two workers and three operations
• All completed sandwiches are wrapped
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Capacity Analysis (2 of 5)

• The two lines are identical, so parallel processing can

occur
• At 40 seconds, the toaster has the longest processing
time and is the bottleneck for each line
• At 40 seconds for two sandwiches, the bottleneck time of
the combined lines = 20 seconds
• At 37.5 seconds, wrapping and delivery is the bottleneck
for the entire operation
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Capacity Analysis (3 of 5)

• Capacity per hour is

3,600 seconds
= 96 sandwiches per hour
37.5 seconds / sandwich

• Throughput time is 30 + 15 + 20 + 40 + 37.5 = 142.5

seconds
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Capacity Analysis (4 of 5)

• Standard process for cleaning teeth

• Cleaning and examining X-rays can happen
simultaneously
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Capacity Analysis (5 of 5)

• All possible paths must be compared

• Bottleneck is the hygienist at 24 minutes

• Hourly capacity is 60 / 24 = 2.5 patients
• X-ray exam path is 2 + 2 + 4 + 5 + 8 + 6 = 27 minutes

• Cleaning path is 2 + 2 + 4 + 24 + 8 + 6 = 46 minutes

• Longest path involves the hygienist cleaning the teeth,

patient should complete in 46 minutes
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Theory of Constraints

• Five-step process for recognizing and managing

limitations
Step 1: Identify the constraints
Step 2: Develop a plan for overcoming the constraints
Step 3: Focus resources on accomplishing Step 2
Step 4: Reduce the effects of constraints by offloading
work or expanding capability
Step 5: Once overcome, go back to Step 1 and find new
constraints
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Bottleneck Management

1. Release work orders to the system at the pace of set by

the bottleneck’s capacity
‒ Drum, Buffer, Rope
2. Lost time at the bottleneck represents lost capacity for
the whole system
3. Increasing the capacity of a nonbottleneck station is a
mirage
4. Increasing the capacity of a bottleneck increases the
capacity of the whole system
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Break-Even Analysis (1 of 7)

• Technique for evaluating process and equipment

alternatives
• Objective is to find the point in dollars and units at which
cost equals revenue
• Requires estimation of fixed costs, variable costs, and
revenue
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Break-Even Analysis (2 of 7)

• Fixed costs are costs that continue even if no units are

produced
‒ Depreciation, taxes, debt, mortgage payments
• Variable costs are costs that vary with the volume of
units produced
‒ Labor, materials, portion of utilities
‒ Contribution is the difference between selling price
and variable cost
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Break-Even Analysis (3 of 7)

• Revenue function begins at the origin and proceeds

upward to the right, increasing by the selling price of each
unit
• Where the revenue function crosses the total cost line is
the break-even point
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Break-Even Analysis (4 of 7)

Figure 5 Basic Break-Even Point

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Break-Even Analysis (5 of 7)

Assumptions
• Costs and revenue are linear functions
‒ Generally not the case in the real world
• We actually know these costs
‒ Very difficult to verify
• Time value of money is often ignored
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Break-Even Analysis (6 of 7)
BEPx = break-even point in units X = number of units produced

BEP$ = break-even point in TR = total revenue = Px

dollars
F = fixed costs
P = price per unit (after all
discounts) V = variable cost per unit

TC = total costs = F + Vx

Break-even point occurs when

TR = TC F
BEFX =
or P−V

Px = F + Vx
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Break-Even Analysis (7 of 7)

F
BFP = BEPx P = P Profit = TR − TC
$ P −V
F = Px − (F +Vx )
=
(P − V ) = Px − F − Vx
P = (P − V ) x − F
F
=
V
1−
P
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Break-Even Example (1 of 4)

Fixed costs = $10,000 Material = $.75/unit

Direct labor = $1.50/unit Selling price = $4.00 per unit
F $10,000
BEP$ = =
V 1.50 + .75
1− 1−
P 4.00
$10,000
= = $22,857.14
.4375
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Break-Even Example (2 of 4)

F $10,000
BEP = = = 5,714
P − V 4.00 − 1.50 + .75
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Break-Even Example (3 of 4)
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Break-Even Example (4 of 4)

Multiproduct Case
F
Break-even point in dollars (BEP$ ) =
 Vi  
  1 − P   (Wi ) 
 i  
Where V = variable cost per unit
P = price per unit
F = fixed costs
W = percent each product is of total dollar sales
expressed as a decimal
i = each product
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Multiproduct Example (1 of 3)

Fixed costs = $3,000 per month

Annual Forecasted
Item Sales Units Price Cost
Sandwich 9,000 $5.00 $3.00
Drink 9,000 1.50 .50
Baked potato 7,000 2.00 1.00
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Multiproduct Example (2 of 3)
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Multiproduct Example (3 of 3)

F
BEP$ =
 Vi  
 1− P   (Wi )
 i  
$3,000×12
= = $76,596
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$76,596
Daily sales = = $245.50
312days
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Reducing Risk with Incremental

Changes (1 of 5)

Figure 6 Four Approaches to Capacity Expansion

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Reducing Risk with Incremental

Changes (2 of 5)

(a) Leading demand with incremental expansion

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Reducing Risk with Incremental

Changes (3 of 5)

(b) Leading demand with a one-step expansion

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Reducing Risk with Incremental

Changes (4 of 5)

(c) Lagging demand with incremental expansion

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Reducing Risk with Incremental

Changes (5 of 5)

(d) Attempts to have an average capacity with incremental

expansion
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Applying Expected Monetary Value (EMV)

and Capacity Decisions

• Determine states of nature

– Future demand
– Market favorability
• Assign probability values to states of nature to determine
expected value
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EMV Applied to Capacity Decision

• Southern Hospital Supplies capacity expansion

EMV (large plant) = (.4)($100,000) + (.6)( −$90,000)

= −$14,000
EMV (medium plant) = (.4)($60,000) + (.6)( −$10,000)
= +$18,000
EMV (smallplant) = (.4)($40,000) + (.6)( −$5,000)
= +$13,000
EMV (donothing) = $0
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Strategy-Driven Investments

• Operations managers may have to decide among various

financial options
• Analyzing capacity alternatives should include capital
investment, variable cost, cash flows, and net present
value
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Net Present Value (NPV) (1 of 2)

In general:
F = P (1+ i )N

Where F = future value

P = present value
i = interest rate
N = number of years

Solving for P:
F
P=
(1+ i )N
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Net Present Value (NPV) (2 of 2)

While this works fine, it is cumbersome for larger

values of N
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NPV Using Factors

F
P= N
= FX
(1+ i )
where X = a factor from Table 2 defined as 1 (1+ i )N
and F = future value
Table 2 Present Value of $1
Year 6% 8% 10% 12% 14%
1 .943 .926 .909 .893 .877
2 .890 .857 .826 .797 .769
3 .840 .794 .751 .712 .675
4 .792 .735 .683 .636 .592
5 .747 .681 .621 .567 .519
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Present Value of an Annuity (1 of 3)

An annuity is an investment that generates uniform equal

payments

S = RX

where X = factor from Table 3

S = resent value of a series of uniform annual
receipts
R = receipts that are received every year of the life
of the investment
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Present Value of an Annuity (2 of 3)

Table 3 Present Value of and Annuity of $1

Year 6% 8% 10% 12% 14%

1 .943 .926 .909 .893 .877
2 1.833 1.783 1.736 1.690 1.647
3 2.673 2.577 2.487 2.402 2.322
4 3.465 3.312 3.170 3.037 2.914
5 4.212 3.993 3.791 3.605 3.433
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Present Value of an Annuity (3 of 3)

• River Road Medical Clinic equipment investment

$7,000 in receipts per year for 5 years Interest rate = 6%

From Table 3 X =
4.212

S = RX
S = $7,000 ( 4.212 ) = $29,484
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Limitations

1. Investments with the same NPV may have different

projected lives and salvage values
2. Investments with the same NPV may have different
cash flows
3. Assumes we know future interest rates
4. Payments are not always made at the end of a period
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