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What Operations Managers Do?

10 OM Strategy Decisions:
Design of Goods & Services
Managing Quality
Process Strategy
Location Strategies
Layout Strategies
Human Resources
Supply Chain Management
Inventory Management
Scheduling
Maintenance

10 Decision Areas:
service & product design
quality management
process & capacity design
location
layout design
human resources & job design
supply chain management
inventory, MRP, and J-I-T
intermediate, short-term,
and project scheduling
maintenance
Scope of Operations Management
SYSTEM DESI GN involves decisions
relating to the system capacity, geographic
locations of facilities, arrangement of
departments, layout of equipment, product or
service planning, and acquisition of
equipment.
SYSTEM OPERATI ON involves
management of personnel, inventory planning
& control, scheduling, project management,
and quality assurance
Capacity Decisions
Most fundamental of all design decisions that operations managers must
make
With long-term consequences for the organization
Affect a large portion of fixed cost
Determine if demand will be met or if facilities will be idle
Answer basic capacity planning questions on
What kind of capacity is needed?
How much is needed?
When is it needed?
Made regularly or infrequently (governed by)
Products/services design
Stability of demand
Rate of technological change in equipment
Competitive factors
Importance of Capacity Decisions
Real input on the ability of the organization to meet
future demands for products and services
Effect on operating costs (attempt to balance the
costs of over- and under capacity)
Major determinant of initial cost
Long-term commitment of resources
Effect on competitiveness (barrier to entry by
competition, delivery speed)
Effect on ease of management
Defining Capacity
Capacity the upper limit or ceiling on the load that
an operating unit (plant, department, machine, store,
or worker) can handle
Capacity I ssues important for all organizations and
at all levels of an organization
important information for planning purposes :
to quantify production capability in terms of inputs/outputs
make other decisions or plans related to those quantities
The term, capacity has different interpretations,
leading to difficulties in measuring capacity
Measuring Capacity
Important to choose one that does NOT require
updating (ex. dollar amounts)
Basic measure is UNITS of a product OUTPUT
ok with single-product operations
problems with multi-product operations (product mix will
necessitate frequent change in composite index of capacity)
Alternative : refer capacity to AVAILABILITY of
INPUTS (e.g. no. of hospital beds, m/c hours
available, # of passenger seats)
No single measure of capacity will be appropriate in
every situation. Rather the measure of capacity must
be TAILORED to the SITUATION.
Useful Definitions of Capacity
DESIGN CAPACITY theoretical maximum output
that can be attained by a system in a given period
(achieved under ideal conditions)
EFFECTIVE CAPACITY capacity a firm can expect
to achieve given its product mix, methods of scheduling,
m/c maintenance, standards of quality, and so on
Effective Capacity < Design Capacity
Actual Output < Effective Capacity (due to
realities of m/c breakdowns, absenteeism,
shortages of materials, quality problems and
outside factors)
Measures of System Effectiveness
Efficiency =
Actual Output__
Effective Capacity
Utilization =
Actual Output_
Design Capacity
Example : Given the information below, compute the efficiency and utilization of
the vehicle repair department:
Design capacity = 50 trucks per day
Effective capacity = 40 trucks per day
Actual output = 36 trucks per day
Solution :
Efficiency =
Actual Output__
Effective Capacity
36 trucks per day_
40 trucks per day
= 90% =
Utilization =
Actual Output_
Design Capacity
=
36 trucks per day_
50 trucks per day
= 72%

Solution : Design Capacity = # of lines x # of hours x # of rolls/hr
Anticipated Production = (Design capacity) (Effective capacity) (Efficiency)
= [(3 lines)(168 hrs)(120 rolls/hr/line)](0.80)(0.90)
= 43,546 rolls/week
(7 days/wk x 3 shifts x 8 hrs/shift)
Example : A bakery with 3 process lines for rolls, each
operating 7 days a week and 8 hours per day at 3 shifts. Each
line is designed to process 120 rolls per hour. The facility has
an efficiency of 90% and expected capacity is 80%. What is
the anticipated production?
Actual Output < Effective Capacity < Design Capacity
Utilization Effective Capacity
Quality
M/C Breakdowns
Training
Equipment Use
(de-bottleneck)
Benefits of | Utilization are realized only
when there is demand, otherwise it is
counterproductive
Additional variable costs
Inventory carrying costs
Bottleneck conditions ~ waiting times (WIP)
Determinants of Effective Capacity
I. FACILITIES
1. Design (size and provision for expansion) 3. Layout (smooth work flow)
2. Location (labor supply, energy sources) 4. Environment (ventilation)
II. PRODUCTS or SERVICES
1. Design (more uniform output ~ std. matls & methods ~ greater capacity)
2. Product or Service Mix (different items ~ different output rates)
III. PROCESSES (Quantity Capabilities : obvious determinant of capacity)
(Quality Capabilities : quality + = output rate + due to inspection)
IV. HUMAN FACTORS (job content, job design, training & experience,
motivation, compensation, learning rates, absenteeism & turnover)
V. OPERATIONAL FACTORS (scheduling, materials management, QA,
maintenance policies and equipment breakdowns)
VI. EXTERNAL FACTORS
1. Product standards 3. Unions
2. Safety Regulations 4. Pollution control standards
INADEQUATE PLANNING = major limiting determinant of effective capacity
Determining Capacity Requirements
Capacity Planning Decisions involve
Long-term considerations (relate to overall level of capacity, e.g.
size)
Short-term considerations (relate to probable variations in capacity
requirements due to demand fluctuations)
Link between Marketing and Operations is crucial to a realistic
determination of capacity requirements
Long-Term Capacity : more on cycles and trends
Short-Term Capacity : concerned more with seasonal variations or
variations from an average (yearly, monthly, weekly, daily
fluctuations)
Forecasting Capacity Requirements
1
st
phase : future demand is forecast with traditional methods
2
nd
phase : forecast is used to determine capacity requirements
Planning for Capacity Addition
Once the rated capacity has been forecast, the next step is to determine the
incremental size of each addition to capacity. There are 3 approaches, namely
(1) one that leads demand, (2) one that lags demand, and (3) an average.
1 2 3
1 2 3
1 2 3
1 2 3
(a) Leading demand with an
incremental expansion
(b) Leading demand with a
one-step expansion
(c) Capacity lags demand with
incremental expansion
(d) Attempts to have an average
capacity with incremental expansion
Expected Demand
Expected
Demand
Expected
Demand
Expected
Demand
New Capacity
New
Capacity
New
Capacity
New
Capacity
Time (years)
Time (years) Time (years)
Time (years)
Managing Demand
Even with good forecasting and facilities built into that forecast,there
may be a poor match between actual demand and available capacity
Demand Exceeds Capacity When demand exceeds capacity, the
firm may be able to curtail demand by raising prices, scheduling long lead
times, and discouraging marginally profitable business.
Capacity Exceeds Demand When capacity exceeds demand, the
firm may stimulate demand through price reductions or aggressive
marketing, or accommodate product changes.
Adjusting to Seasonal Demands A seasonal or cyclical
pattern of demand is another capacity challenge wherein management may
find it helpful to offer products with complementary demand patterns.
Tactics for Matching Capacity to Demand
1. Making staffing changes (increase/decrease in no. of employees)
2. Adjusting equipment and processes (adding a machine/selling equipment)
3. Improving methods to increase throughput
4. Redesigning the product to facilitate more throughput
Developing Capacity Alternatives
1. Design flexibility into systems (e.g. provision for future expansion)
2. Differentiate between new and mature products or services
Mature Products predictable demand capacity requirements
limited life spans find alt. use for additional capacity
New Products higher risk in predicting quantity and duration of demand
3. Take a big picture approach to capacity changes (important to
consider how parts of the system interrelate)
4. Prepare to deal with capacity chunks (capacity increases are often
acquired in fairly large chunks rather than smooth increments, e.g. required = 55 units/hr
but machine is rated at 40 units/hr)
5. Attempt to smooth out capacity requirements
Seasonality Issues under/over utilization overtime, subcontracting, hedging
6. Identify the optimal operating level
Choice of Capacity availability of financial & other resources
forecasts of expected demand
Planning Service Capacity
3 I mportant Factors:
1) Need to be near customers
Convenience important aspect of service (e.g. hotels)
Capacity & Location are closely tied
2) I nability to store services
Timing of Demand must be matched by capacity
Speed of Delivery major concern in capacity planning
Service Level brings into issue the cost of maintaining capacity
3) Degree of volatility of demand
Number of individual customers (ex. Banks experiencing days w/
Time to service each customer higher volume of transactions &
varying nature of transactions)
(Peak Periods extra workers, outsourcing, pricing & promotion)
Evaluating Capacity Alternatives
Economic Considerations
Feasibility payback, useful life
Costs financing, operations & maintenance
Timing how soon available
Compatibility with present operations & people
Public Opinion
Environmental concern, relocation issue, technology upgrade
repercussions such as termination of jobs
Capacity Evaluation Techniques
Financial Analysis
Decision Theory
Waiting-Line Analysis
Cost-Volume Analysis
Financial Analysis
Need to rank investment proposals via F.A. due to
problem of allocating scarce funds
3 most commonly used methods
Payback = initial cost net cash flow
Present Value = time value of money
Internal Rate of Return = equivalent interest rate
2 important terms in financial analysis
CASH FLOW - refers to the difference between cash
received (from sales and from other sources like sales of
old equipment) and cash outflow for labor, materials,etc.
PRESENT VALUE expresses in current value the
sum of all future cash flows of an investment proposal
Net Present Value
Consider the time value of money: say investing $100 in a
bank at 5% for 1 year:
$100(1 + .05) $105 =
For the second year:
$110.25 = $105(1 + .05)

= $100(1 + .05)
2
In general, F = P ( 1 + i )
N
P =
F
( 1 +i )
N
= FX
where X = a factor from PV of $1 Table defined as 1/( 1+ i )
N
In situations of where an investment generates an annual
series of uniform and equal cash amounts (called annuity)
A means of determining the discounted value of a
series of future cash receipts
The basic relationship is S =RX , where
X = factor from PV of an Annuity of $1 Table
S = present value of a series of uniform annual receipts
R = receipts every year for the life of the investment (the annuity)
Present Value Method
Example No. 1
Your boss, Mr. La Forge, has told you to evaluate the cost of two
machines. After some questioning, you are assured that they have the
following costs. Assume:
a) the life of each machine is 3 years, and
b) the company thinks it knows how to make 14% on investments no
riskier than this one.
Original cost

Labor cost per year
Floor space per year
Energy (electricity) per year
Maintenance per year
Total annual cost

Salvage value
Machine A
$ 13,000

2,000
500
1,000
2,500
$ 6,000
======
$2,000
Machine B
$ 20,000

3,000
600
900
500
$ 5,000
======
$7,000
Present Value Method
Example No.1 .cont
Solution : Determine via the present value method which machine to purchase.
Now
Yr. 1
Yr. 2
Yr. 3

Yr.3
Expense
Expense
Expense
Expense
Salvage
Revenue
From PV
Table of $1
1.000
.877
.769
.675

.675
Machine A
Given
$13,000
6,000
6,000
6,000

$2,000
$13,000
5,262
4,614
4,050
$26,926
-$ 1,350
$25,576
======
Machine B
Given
$20,000
5,000
5,000
5,000

$7,000
$20,000
4,385
3,845
3,375
$31,605
-$ 4,725
$26,880
======
.
Machine A is the low-cost purchase since it has the lower sum of net costs.
P V P V
Present Value Method
Example No.2
Quality Plastics, Inc. is considering two different investment alternatives.
Investment A has an initial cost of $25,000, and investment B has an initial
cost of $26,000. Both investments have a useful life of 4 years. The cash
flows for these investments are shown below. The cost of capital or the
interest rate (i) is 8%.
Investment As
Cash Flow
Investment Bs
Cash Flow
$ 10,000
9,000
8,000
7,000
$ 9,000
9,000
9,000
9,000
Year
1
2
3
4
Present Value
Factor at 8%
.926
.857
.794
.735
PVs
$ 9,260
7,713
6,352
5,145
PVs
$ 8,834
7,713
7,146
6,615
Totals $28,470 $29,808
Minus initial investment - 25,000 - 26,000
Net present value $ 3,470 $ 3,808
Based on the NPV criterion, MORE ATTRACTIVE |
$9,000
x
3.312
PV of a $1
Annuity
Decision Theory and
Waiting-Line Analysis
Decision Theory is helpful for financial comparison of
alternatives under conditions of risk or uncertainty;
applying decision trees to capacity decisions that
maximize the expected value of the alternatives arising
from states of nature (usually future demand or market
favorability) that are assigned probabilities
Waiting-Line Analysis is often used for designing
service systems and helpful in choosing a capacity
level that is cost-effective through balancing the cost
of having customers wait with the cost of providing
additional capacity; also aids in the determination of
expected costs for various levels of service capacity
Decision Tree
Example
Southern Hospital Supplies, a company that makes hospital gowns, is
considering capacity expansion. Its major alternatives are to do nothing,
build a small plant, build a medium plant, or build a large plant. The new
facility would produce a new type of gown, and currently the potential or
marketability for this product is unknown. If a large plant is built and a
favorable market exists, a profit of $100,000 could be realized. An
unfavorable market would yield a $90,000 loss. However, a medium plant
would earn a $60,000 profit with a favorable market. A $10,000 loss would
result from an unfavorable market. A small plant, on the other hand, would
return $40,000 with favorable market conditions and lose only $5,000 in an
unfavorable market. Of course, there is always the option of doing nothing.
Recent market research indicates that there is a 0.4 probability of a
favorable market, which means that there is also a 0.6 probability of an
unfavorable market. Which alternative is more attractive for Southern?
Decision Tree
Market favorable (.4)
Market favorable (.4)
Market favorable (.4)
Market unfavorable (.6)
Market unfavorable (.6)
Market unfavorable (.6)
Medium plant
$100,000
-$ 90,000
$ 60,000
-$ 10,000
$ 40,000
-$ 5,000
$0
+$ 13,000
+$ 18,000
-$ 14,000
Solution: The alternative that will result in the highest
expected monetary value (EMV) can be selected.
?
Calculating Processing Requirements
When evaluating capacity alternatives, a necessary piece of information is the
capacity requirements of products that will be processed with a given alternative.
Required for computation:
demand forecasts for each product
standard processing time per unit of each product on each alternative machine
number of work days per year
Number of shifts that will be used
Example: A department store works one eight-hour shift, 250 days a year, and has
these figures for usage of a machine that is currently being considered:
Product
#1
#2
#3
Annual
Demand
400
300
700
Standard Processing
Time per Unit (Hour)
5.0
8.0
2.0
Processing Time
Needed (Hour)
2,000
2,400
1,400
5,800 Annual capacity
= 1 m/c working 8 hrs/shift x 1 shift/day x 250 days/yr = 2,000
2.90
machines
------- =
Calculating Processing Requirements
Example No. 2
A manager must decide which type of machine to buy, A, B, or C.
Machine costs are:
Machine
A
B
C
Cost
$40,000
$30,000
$80,000
Product forecasts & processing times on the machines are as follows:
Product
1
2
3
4
Annual
Demand
16,000
12,000
6,000
30,000
Processing Time (Minutes) per Unit
A
3
4
5
2
B
4
4
6
2
C
2
3
4
1
Assume that only purchasing costs are being considered. Which machine would
have the lowest total cost, and how many of that machine would be needed?
Machines operate 10 hours a day, 250 days a year.
Calculating Processing Requirements
Solution to Example No. 2
Calculate demand in total number of processing minutes per product on
each machine:
Product
1
2
3
4
A
48,000
48,000
30,000
60,000
B
64,000
48,000
36,000
60,000
C
32,000
36,000
24,000
30,000
Total Minutes 186,000 208,000 122,000
60 (in Hours) 3,100 3,467 2,033
annual capacity = 10 hours / day x 250 days / yr = 2,500
No. of Machines 1.24 ~ 2 1.39 ~ 2 0.81 ~ 1

Purchase Cost $80,000 $60,000 $80,000
Buy 2 machines of B
=======
Cost Volume Analysis
Focuses on relationships between COST, REVENUE and VOLUME of
output
Purpose is to estimate income of an organization under different
operating conditions
Tool for comparing alternatives under the following ASSUMPTIONS:
1) One product is involved.
2) Everything produced can be sold.
3) The variable cost per unit is the same regardless of volume.
4) Fixed costs do not change with volume changes, or they are step
changes
5) The revenue per unit is the same regardless of volume
6) Revenue per unit exceeds variable cost per unit.
Provides a conceptual framework for integrating cost, revenue and profit
estimates into CAPACITY DECISIONS
Cost Volume Analysis
Fixed Costs constant, regardless of volume of output (e..g. rental, taxes,
administrative expenses)
Variable Costs change directly with volume of output (generally materials
and labor costs); assumes that variable cost per unit (v ) remains the same
regardless of volume of output (Q )
Total Cost = Fixed Costs + Variable Costs or TC = FC + VC , where
variable cost, VC = Q x v
Total Revenue , TR = Q x SP , where SP = selling price per unit
or TR = Q x R , where R = revenue per unit
Profit is P = TR TC
= (Q x SP ) - [ FC + (Q x v ) ]
P = Q ( SP - v ) - FC
required volume to Q = P + FC
generate a specified profit SP - v
Break Even Analysis
Objective : To find the point, in dollars and units, at which
costs equal revenues.
Graphic Approach
Algebraic Approach
At BEP, TR = TC Break - even in units , BEP
Q
= F
Q x SP = F + (Q x v ) SP - v
FC
VC
$
Volume
Volume
$
TR
TC
VC
FC
Break-Even Point
TR = TC
BEP
Q
BEP
$
Break even in dollars, BEP
$
= F
1 - v / SP
Break Even Analysis
Example No. 1 Single-Product Case
Jimmy Stephens, Inc. has fixed costs of $10,000 this period.
Direct labor is $1.50 per unit and material is $0.75 per unit.
The selling price is $4.00 per unit. Determine the break-
even point in dollars and units.
BEP
$
= F
1 - v / SP
Solution:
v = DL + material = 1.50 + .75 = $2.25
= $10,000
1 - (2.25 / 4.00)
= $22,857.14
BEP
Q
= F
SP - v
= $10,000
4.00 - 2.25
= 5,714 units
Break Even Analysis
Example No. 2 Single-Product Case
The owner of Old Fashioned Berry Pies, S. Simon, is contemplating
adding a new machine line of pies, which will require leasing new
equipment for a monthly payment of $6,000. Variable costs would be
$2 per pie, and pies would retail for $7 each.
a. How many pies must be sold in order to break even?
b. What would the profit (loss) be if 1,000 pies are made and sold
in a month?
c. How many pies must be sold to realize a profit of $4,000?
Solution:
a) BEP
Q
=
FC
SP - v
= $6,000
$7 - $2
= 1,200 pies / month
b) At Q = 1,000 pies, P = Q ( SP - v ) - FC
= 1000($7 $2) - $6,000 = -$ 1,000 (loss)
c) To make a profit (P) of $4,000 ,
Q = P + FC
SP - v
= 4,000 + 6,000
7 - 2
= 2,000
pies
Break Even Analysis
Example No. 3 Step Costs / Multiple B-E Points
A manager has the option of purchasing one, two, or three machines. Fixed
costs and potential volume are as follows:
Number of
Machines
1
2
3
Total Annual
Fixed Costs
$ 9,600
15,000
20,000
Corresponding
Range of Output
0 to 300
301 to 600
601 to 900
Variable cost is $10 per unit, and revenue is $40 per unit.
a) Determine the break-even point for each range.
b) If projected annual demand is between 580 and 660 units, how many
machines should the manager purchase?
Solution: Compute B-E for each range and compare with projected range of demand.
BEP
Q
(1 m/c) = FC / (R - v ) = $9,600 / $ (40 10)/unit = 320 units
[ not in the range, so there is no BEP ]
BEP
Q
(2 m/c) = $15,000 / $(40 10)/unit = 500 units
BEP
Q
(3 m/c) = $20,000 / $(40 10)/unit = 667 units [ not in the range ~ loss ]
[ Buy 2 machines ]
Break Even Analysis
Example No. 4 Multi-Product Case
Firms offering a variety of products that have different selling prices and variable
costs, the break-even point is
where,
V = variable cost per unit
P = price per unit
F = fixed cost
W = percent each product is of total dollar sales
i = each product
I llustration: Information for Le Bistro, a French-style deli, follows. Fixed costs
are $3,500 per month.
BEP
$
= F
[ ( 1 V
i
/ P
i
) x (W
i
) ]
Item
Sandwich
Soft drink
Baked potato
Tea
Salad bar
Price
$2.95
.80
1.55
.75
2.85
Cost
$1.25
.30
.47
.25
1.00
Annual Forecasted
Sales Units
7,000
7,000
5,000
5,000
3,000
Break Even Analysis
Example No. 4 Multi-Product Case (cont)
Solution :
Selling
Price (P)
$2.95
.80
1.55
.75
2.85
Item (i)
SW
SD
BP
T
SB
Variable
Cost (V)
$1.25
.30
.47
.25
1.00
(V / P)
.42
.38
.30
.33
.35
1 - (V/P)
.58
.62
.70
.67
.65
Annual
Forecasted
Sales ($)
$ 20,650
5,600
7,750
3,750
8,550
$46,300
W
i
=
% of Sales
.446
.121
.167
.081
.185
1.000
[1-(V/P)]xW=
Weighted
Contribution
.259
.075
.117
.054
.120
.625
BEP
$
= F
[ ( 1 V
i
/ P
i
) x (W
i
) ]
= $3,500/mo. X 12 mos.
.625
= $67,200
If there are 52 weeks at 6 work days each, determine (a) the total daily sales to
break even, and (b) the number of sandwiches that must be sold each day.
(a) BEP
$
(daily) = $67,200
312 days

= $215.38
(b) No. of = .446 x $215.38
Sandwiches $2.95
= 32.5 or
33 each day

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