MBA BA for Wipro

Operations Management

Dr Sandeep Singh
BITS Pilani PhD (FPM-OM)-Indian Institute of Management Lucknow
Faculty- Operations Management Group
Pilani Campus
 BITS Pilani
Pilani Campus

Capacity and Constraint Management

Capacity
► The throughput, or the number of units
a facility can hold, receive, store, or
produce in a period.
► Determines
fixed costs
► Determines if
demand will
be satisfied
► Three time horizons

BITS Pilani, Pilani Campus

 Planning Over a Time Horizon
Figure S7.1
Time Horizon
Options for Adjusting Capacity

Long-range Add facilities

planning
Intermediate-
Add long lead time equipment
*
range Subcontract Add personnel
planning Add equipment Build or use inventory
(aggregate Add shifts
planning)
Schedule jobs
Short-range
planning
(scheduling) * Schedule personnel
Allocate machinery

Modify capacity Use capacity

* Difficult to adjust capacity as limited options exist

BITS Pilani, Pilani Campus

Design and Effective Capacity

► 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

BITS Pilani, Pilani Campus

Utilization and Efficiency

Utilization is the percent of design

capacity actually achieved
Utilization = Actual output/Design capacity

Efficiency is the percent of effective

capacity actually achieved
Efficiency = Actual output/Effective capacity

BITS Pilani, Pilani Campus

 Bakery Example
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 x 3 x 8) x (1,200) = 201,600 rolls

© 2014 Pearson Education, Inc. S7 - 7

 Bakery Example
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 x 3 x 8) x (1,200) = 201,600 rolls

© 2014 Pearson Education, Inc. S7 - 8

 Bakery Example
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 x 3 x 8) x (1,200) = 201,600 rolls

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

© 2014 Pearson Education, Inc. S7 - 9

 Bakery Example
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 x 3 x 8) x (1,200) = 201,600 rolls

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

Efficiency = 148,000/175,000 = 84.6%

© 2014 Pearson Education, Inc. S7 - 10

 Bakery Example
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 x 3 x 8) x (1,200) = 201,600 rolls

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

Efficiency = 148,000/175,000 = 84.6%

© 2014 Pearson Education, Inc. S7 - 11

 Bakery Example
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
Efficiency = 84.6%
Efficiency of new line = 75%

Expected Output = (Effective Capacity)(Efficiency)

= (175,000)(.75) = 131,250 rolls

© 2014 Pearson Education, Inc. S7 - 12

 Bakery Example
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
Efficiency = 84.6%
Efficiency of new line = 75%

Expected Output = (Effective Capacity)(Efficiency)

= (175,000)(.75) = 131,250 rolls

© 2014 Pearson Education, Inc. S7 - 13

Southeastern Oklahoma State University’s business
program has the facilities and faculty to handle an enrollment
of 2,000 new students per semester. However, in an effort
to limit class sizes to a “reasonable” level (under 200, generally),
Southeastern’s dean, Holly Lutze, placed a ceiling on enrollment
of 1,500 new students. Although there was ample demand for
business courses last semester, conflicting schedules allowed only
1,450 new students to take business courses. What are the utilization
and efficiency of this system?

14
BITS Pilani, Pilani Campus
Under ideal conditions, a service bay at a Fast Lube
can serve 6 cars per hour. The effective capacity and
efficiency of a
Fast Lube service bay are known to be 5.5 and 0.880,
respectively.
What is the minimum number of service bays Fast Lube
needs to
achieve an anticipated servicing of 200 cars per 8-hour
day?

BITS Pilani, Pilani Campus

<Course Code> 16
BITS Pilani, Pilani Campus
 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

© 2014 Pearson Education, Inc. S7 - 17

Capacity Considerations

1. Forecast demand accurately

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

BITS Pilani, Pilani Campus

 Economies and Diseconomies of Scale
Figure S7.2
(sales per square foot)
Average unit cost

1,300 sq ft 8,000 sq ft
store 2,600 sq ft store
store

Economies Diseconomies
of scale of scale
1,300 2,600 8,000
Number of square feet in store
© 2014 Pearson Education, Inc.
BITS Pilani, Pilani Campus
Managing Demand
► Demand exceeds capacity
► Curtail demand by raising prices, scheduling
longer lead time
► Long term solution is to increase capacity
► Capacity exceeds demand
► Stimulate market
► Product changes
► Adjusting to seasonal demands
► Produce products with complementary
demand patterns

BITS Pilani, Pilani Campus

Complementary Demand
Patterns
Figure S7.3
Combining the
two demand
patterns reduces
the variation
4,000 –
Sales in units

Snowmobile
3,000 – motor sales

2,000 –
Jet ski
1,000 – engine
sales

JFMAMJJASONDJFMAMJJASONDJ
Time (months)

BITS Pilani, Pilani Campus

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

BITS Pilani, Pilani Campus

Service-Sector Demand and
Capacity Management

► Demand management
► Appointment, reservations, FCFS rule
► Capacity
management
► Full time,
temporary,
part-time
staff

BITS Pilani, Pilani Campus

Bottleneck Analysis and the Theory
of Constraints

► 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

BITS Pilani, Pilani Campus

Bottleneck Analysis and the Theory
of Constraints

► 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 Figure S7.4

A B C

2 min/unit 4 min/unit 3 min/unit

BITS Pilani, Pilani Campus

Capacity Analysis

► Two identical sandwich lines

► Lines have two workers and three operations
► All completed sandwiches are wrapped

Bread Fill
15 sec/sandwich 20 sec/sandwich
Wrap/
Order Toaster
Deliver
30 sec/sandwich 20 sec/sandwich
Bread Fill 37.5 sec/sandwich

15 sec/sandwich 20 sec/sandwich

BITS Pilani, Pilani Campus

Capacity Order
Bread
15 sec
Fill
20 sec
Toaster
Wrap/

Analysis
Deliver
30 sec 20 sec
Bread Fill 37.5 sec
15 sec 20 sec

► The two lines each deliver a sandwich every

20 seconds
► At 37.5 seconds, wrapping and delivery has
the longest processing time and is the
bottleneck
► Capacity per hour is 3,600 seconds/37.5
seconds/sandwich = 96 sandwiches per
hour
► Throughput time is 30 + 15 + 20 + 20 + 37.5
= 122.5 seconds
BITS Pilani, Pilani Campus
Capacity Analysis

► Standard process for cleaning teeth

► Cleaning and examining X-rays can happen
simultaneously

Cleaning

Takes Develops 24 min/unit Check

Check in Dentist
X-ray X-ray out

2 min/unit 2 min/unit 4 min/unit X-ray 8 min/unit 6 min/unit

exam

5 min/unit

BITS Pilani, Pilani Campus

Capacity Check Takes Develops
Cleaning

24 min/unit Check
Dentist

Analysis
in X-ray X-ray out

2 min/unit 2 min/unit 4 min/unit X-ray 8 min/unit 6 min/unit

exam

5 min/unit

► 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
BITS Pilani, Pilani Campus
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

BITS Pilani, Pilani Campus

Bottleneck Management

1. Release work orders to the system at the

pace of set by the bottleneck
► Drum, Buffer, Rope
2. Lost time at the bottleneck represents lost
time for the whole system
3. Increasing the capacity of a non-bottleneck
station is a mirage
4. Increasing the capacity of a bottleneck
increases the capacity of the whole system

BITS Pilani, Pilani Campus

Break-Even Analysis

► 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

BITS Pilani, Pilani Campus

Break-Even Analysis
► 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

BITS Pilani, Pilani Campus

Break-Even Analysis

► 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

BITS Pilani, Pilani Campus

 Break-Even Analysis
–
Total revenue line
900 –

800 – i dor
Break-even point rr Total cost line
t co
700 – Total cost = Total revenue
rofi
P
Cost in dollars

600 –

500 –
Variable cost
400 –

300 –
oss or
200 – L rid
r
co
100 – Fixed cost
| | | | | | | | | | | |
–
0 100 200 300 400 500 600 700 800 900 1000 1100
Figure S7.5
Volume (units per period)

BITS Pilani, Pilani Campus

Break-Even Analysis
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

BITS Pilani, Pilani Campus

Break-Even Analysis
BEPx = x = number
break-even point of units produced
in units TR = total
BEP$ = revenue = Px
break-even point F = fixed
in dollars costs
P = V = variable
pricepoint
Break-even occurs when cost per unit
per unit
(after all TC = total
discounts) costs = F + Vx
TR = TC F
or BEP x =
P–V
Px = F + Vx

BITS Pilani, Pilani Campus

Break-Even Analysis
BEPx = x = number
break-even point of units produced
in units TR = total
BEP$ = revenue = Px
break-even point F = fixed
in dollars costs
P = V = variable
priceP per F Profit
unit = TRcost
- TCper unit
BEP$ = BEP = P
(after all P – V
x

discounts) – (F + =Vx)
= Px TC total
F costs = F + Vx
= (P – V)/P = Px – F – Vx
= (P - V)x – F
F
= 1 – V/P

BITS Pilani, Pilani Campus

 Break-Even Example
Fixed costs = $10,000 Material = $.75/unit
Direct labor = $1.50/unit Selling price = $4.00 per unit

F $10,000
BEP$ = =
1 – (V/P) 1 – [(1.50 + .75)/(4.00)]
$10,000
= = $22,857.14
.4375

BITS Pilani, Pilani Campus

 Break-Even Example
Fixed costs = $10,000 Material = $.75/unit
Direct labor = $1.50/unit Selling price = $4.00 per unit

F $10,000
BEP$ = =
1 – (V/P) 1 – [(1.50 + .75)/(4.00)]
$10,000
= = $22,857.14
.4375

F $10,000
BEPx = = = 5,714
P–V 4.00 – (1.50 + .75)

BITS Pilani, Pilani Campus

 Break-Even Example
50,000 –

Revenue
40,000 –
Break-even
point Total
30,000 – costs
Dollars

20,000 –

Fixed costs
10,000 –

| | | | | |
0– 2,000 4,000 6,000 8,000 10,000
Units

BITS Pilani, Pilani Campus

 Break-Even Example
Multiproduct Case

Break-even
point in dollars
(BEP$)

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

BITS Pilani, Pilani Campus

 Multiproduct Example
Fixed costs = $3,000 per month
ITEM PRICE COST ANNUAL FORECASTED SALES UNITS
Sandwich $5.00 $3.00 9,000
Drink 1.50 .50 9,000
Baked potato 2.00 1.00 7,000

1 2 3 4 5 6 7 8
ANNUAL WEIGHTED
SELLING VARIABLE FORECASTED % OF CONTRIBUTION
ITEM (i) PRICE (P) COST (V) (V/P) 1 - (V/P) SALES $ SALES (COL 5 X COL 7)

Sandwich $5.00 $3.00 .60 .40 $45,000 .621 .248

Drinks 1.50 0.50 .33 .67 13,500 .186 .125

Baked
potato 2.00 1.00 .50 .50 14,000 .193 .097

$72,500 1.000 .470

BITS Pilani, Pilani Campus

 Multiproduct Example
Fixed costs = $3,000 per month
ITEM PRICE COST ANNUAL FORECASTED SALES UNITS
$3,000 x 12
Sandwich $5.00 $3.00 = 9,000 = $76,596
.47
Drink 1.50 .50 9,000
Baked potato 2.00 1.00 Daily $76,596
7,000
sales 312 days = $245.50
=
1 2 3 4 5 6 7 8
.621 x $245.50
ANNUAL WEIGHTED
SELLING VARIABLE FORECASTED OF30.5 
%= 31
CONTRIBUTION
ITEM (i) PRICE (P) COST (V) (V/P) 1 - (V/P) $5.00
SALES $ SALES (COL 5 X COL 7)
Sandwiches
Sandwich $5.00 $3.00 .60 .40 $45,000 .621 each day.248
Drinks 1.50 0.50 .33 .67 13,500 .186 .125
Baked
potato 2.00 1.00 .50 .50 14,000 .193 .097

$72,500 1.000 .470

BITS Pilani, Pilani Campus

T. Smunt Manufacturing Corp. has the process displayed
below. The drilling operation occurs separately from and
simultaneously with the sawing and sanding operations. The
product only needs to go through one of the three assembly
operations (the assembly operations are “parallel”).
a) Which operation is the bottleneck?
b) What is the throughput time for the overall system?

c) If the firm operates 8 hours per day, 22 days per month,

what is the monthly capacity of the manufacturing process?
d) Suppose that a second drilling machine is added, and it
takes the same time as the original drilling machine. What
is the new bottleneck time of the system?
e) Suppose that a second drilling machine is added, and it
takes the same time as the original drilling machine. What
is the new throughput time?

<Course Code> 45
BITS Pilani, Pilani Campus
Markland Manufacturing intends to increase capacity
by overcoming a bottleneck operation by adding new equipment.
Two vendors have presented proposals. The fixed costs for
proposal A are $50,000, and for proposal B, $70,000. The variable
cost for A is $12.00, and for B, $10.00. The revenue generated by
each unit is $20.00.
a) What is the break-even point in units for proposal A?
b) What is the break-even point in units for proposal B?

a) What is the break-even point in dollars for proposal A if you

add $10,000 installation to the fixed cost?
b) What is the break-even point in dollars for proposal B if you
add $10,000 installation to the fixed cost?

<Course Code> 46
BITS Pilani, Pilani Campus
<Course Code> 47
BITS Pilani, Pilani Campus
Reducing Risk with Incremental
Changes
Figure S7.6
(a) Leading demand with (b) Leading demand with a
incremental expansion one-step expansion
New
New capacity
capacity

Demand
Demand

Expected Expected
demand demand

(c) Lagging demand with (d) Attempts to have an average

incremental expansion capacity with incremental
New expansion
capacity New
Demand

Expected Demand capacity Expected

demand demand

BITS Pilani, Pilani Campus

Reducing Risk with Incremental
Changes

(a) Leading demand with incremental

expansion
Figure S7.6

New
capacity
Demand

Expected
demand

1 2 3
Time (years)
BITS Pilani, Pilani Campus
Reducing Risk with Incremental
Changes

(b) Leading demand with a one-step

expansion
Figure S7.6

New
capacity
Demand

Expected
demand

1 2 3
Time (years)
BITS Pilani, Pilani Campus
Reducing Risk with Incremental
Changes

(c) Lagging demand with incremental

expansion
Figure S7.6

New
capacity

Expected
Demand

demand

1 2 3
Time (years)
BITS Pilani, Pilani Campus
Reducing Risk with Incremental
Changes

(d) Attempts to have an average capacity with

incremental expansion
Figure S7.6
New
capacity

Expected
Demand

demand

1 2 3
Time (years)
BITS Pilani, Pilani Campus
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

BITS Pilani, Pilani Campus

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 (small plant) = (.4)($40,000) + (.6)(–$5,000)
= +$13,000
EMV (do nothing) = $0

BITS Pilani, Pilani Campus

Strategy-Driven Investment

► 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

BITS Pilani, Pilani Campus

Net Present Value (NPV)

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

BITS Pilani, Pilani Campus

Net Present Value (NPV)

In general:
F = P(1 + i)N
where F = future value
P While
= present value this works fine,
i = interestit rate
is cumbersome for
N = number larger
of years values of N

Solving for P:
F
P=
(1 + i)N

BITS Pilani, Pilani Campus

NPV Using Factors

F
P= = FX
(1 + i) N

where X = a factor from

Table S7.1 defined as = 1/(1 + i)N
and F = future value
TABLE S7.1 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
Portion of
5 .747 .681 .621 .567 .519 Table S7.1

BITS Pilani, Pilani Campus

Present Value of an Annuity

An annuity is an investment which

generates uniform equal payments

S = RX
where X = factor from Table S7.2
S = present value of a series of
uniform
annual receipts
R = receipts that are received
every year
of the life of the investment

BITS Pilani, Pilani Campus

Present Value of an Annuity

TABLE S7.2 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 2.676 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

Portion of
Table S7.2

BITS Pilani, Pilani Campus

Present Value of an Annuity

• River Road Medical Clinic equipment investment

$7,000 in receipts per for 5 years

Interest rate = 6%
From Table S7.2
X = 4.212

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

BITS Pilani, Pilani Campus

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

BITS Pilani, Pilani Campus

 THANK YOU

Innovate Achieve Lead

BITS Pilani, Pilani Campus