Session 08

Production Planning and Control

Make-or-Buy Decisions and Capacity Planning.

D 0 8 5 4
Supply Chain : Manufacturing and Warehousing
MAKE or BUY Decisions
Definitions
Make-or-Buy decisions compare the cost of
producing a component or providing the service
internally with the cost of purchasing the component
or service from an external supplier Probert (1995),
identifies 3 levels of a make-buy decision:-
Strategic affects the shape & capabilities of the
organisation
Tactical deals with issues of temporary imbalances
of capacity
Component decisions usually made at the design
stage
Outsourcing
Outsourcing:-
possibly a wider term than make-buy and the two terms can be
used synonymously, but is the strategic use of resources to
perform activities traditionally handled by internal staff & their
resources (it is a) management strategy by which an
organisation outsources major non-core functions to
specialised, efficient service providers
Source: Outsourcing Institute on http://www.outsourcing.com
Subcontracting
may be distinguished from outsourcing in that the latter
involves the total restructuring of an enterprise around core
competences and outside relationships. Whatever the degree
of outsourcing enterprises must retain certain core capabilities.
Outsourcing is a strategic long term decision, Subcontracting
is a tactical, short term approach.
Source: Lysons & Gillingham (2003)
Levels of decision making
Operational Strategies are concerned with: -short term
decisions
The integration of resources, processes, people and
skills
The implementation of corporate strategies
Tactical or Business Unit strategy is concerned with:
Medium term decisions
Competitive strategy
Developing market opportunities
Developing new products/services
Resource allocation within SBU
Structure and control of the SBU
Corporate level strategic decisions are concerned with: -
Long term decision making
Overall purpose and scope
Adding value to shareholder investment
Portfolio issues
Resource allocation between SBUs
Structure & control of SBUs
Corporate financial strategy
Tactical Make-Buy Decisions
Some common reasons for make-buy decisions at this level
follow:-
Deterioration in an existing suppliers performance
Delivery failure or poor service by existing source
Large price increases
Volume changes much larger or smaller quantity requirements
for the item concerned
Pressure to reduce costs
Desire to concentrate internal resources on areas of
special competence
The need for design secrecy
Import substitution
Operational Make-Buy Decisions
- a simple and probably logical rule of thumb when
considering whether to make-or-buy is to carryout a
comparison of cost of making ourselves with buying in.
Operational Make-or-Buy Decisions
A number of questions need answering before deciding
whether to make-or-buy: -
What volume do we expect to require
What capital investment is required to make the goods
What will be our peak demand
How much risk is associated with the technology
required
How much waste or cost of rework can be expected
What level of inventory will we or our supplier hold
How long will the contract apply
What variations in material costs can be expected
Can we make more by concentrating on our special
competencies than we can save by carrying out the work
internally
Make or Buy Checklist.
If currently bought in
Does the capacity exist within own
company
If so is capacity available for
whole of planning period
Is the raw material availably at
economic rate
If currently made in
Is there a matter of secrecy to be
considered
If item is withdrawn from
production what are the
consequences
What action would need to be
taken as a result of consequences
Bought In Made In
Will the raw materials continue
to be available at economic
rates for the planning period
If tooling is involved what is the
cost? What is the expected
life? What is the delivery
If tooling is involved what is its
condition? Can it be used by
prospective source
Will the machinery involved in
current manufacture be fully
utilised for alternative work if
the part is withdrawn
Bought In Made In
Are we satisfied that the
current supplier is the most
economical source
Is there a patent involved and
thus the possibilities of
royalties to be paid
Is VAT chargeable
Is there the possibility of
development work being done
on the part. Can this be done
satisfactorily in conjunction
with an outside source
What quantities involved
interest an outside supplier
Bought In Made In
Is the current supplier doing
development work towards an
improved version of the item
Has the current supplier had
difficulties with either quantity or
time factors, and have costs
escalated as a result, effecting
selling price
What is the true cost of alternative
supplier against manufacture
(transport, handling costs) present
and forward.
Is the item part of an integrated
production process, several
stages of manufacture. Can
outside manufacture be
satisfactorily coordinated with
production
Bought in Made in
If the suppliers quality has been
affected:-
Has their quality systems been
vetted, what has been the extent
of the quality failures, can the
quality standard be met by internal
production, are we over-specifying
What is the forward market
position for the item for the
planning period
Are the technical drawing correct
Is there any advantage in
supplying new
materials/components if a decision
is taken to buy
CAPACITY PLANNING
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
Modify capacity Use capacity
Planning Over a Time Horizon
Intermediate-
range
planning
Subcontract Add personnel
Add equipment Build or use inventory
Add shifts
Short-range
planning
Schedule jobs
Schedule personnel
Allocate machinery *
Long-range
planning
Add facilities
Add long lead time equipment
*
* Limited options exist
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
Utilization and Efficiency
Utilization is the percent of design capacity
achieved
Efficiency is the percent of effective capacity
achieved
Utilization = Actual Output/Design Capacity
Efficiency = Actual Output/Effective Capacity
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
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
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%
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%
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%
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%
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
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, three- 8 hour shifts
Efficiency = 84.6%
Efficiency of new line = 75%
Expected Output = (Effective Capacity)(Efficiency)
= (175,000)(.75) = 131,250 rolls
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 complimentary
demand patterns
Economies and Diseconomies of Scale
Economies
of scale
Diseconomies
of scale
25 - Room
Roadside Motel
50 - Room
Roadside Motel
75 - Room
Roadside Motel
Number of Rooms
25 50 75
A
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p
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Figure S7.2
Capacity Considerations
Forecast demand accurately
Understanding the technology
and capacity increments
Find the optimal operating level
(volume)
Build for change
Approaches to Capacity Expansion
(a) Leading demand with
incremental expansion
D
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Expected
demand
New
capacity
(b) Leading demand with
one-step expansion
D
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m
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New
capacity
Expected
demand
(d) Attempts to have an average
capacity with incremental
expansion
D
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m
a
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d
New
capacity Expected
demand
(c) Capacity lags demand with
incremental expansion
D
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New
capacity
Expected
demand
Figure S7.4
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
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
Break-Even Analysis
Costs and revenue are linear
functions
Generally not the case in the real
world
We actually know these costs
Very difficult to accomplish
There is no time value of money
Assumptions
Break-Even Analysis
Total revenue line
Total cost line
Variable cost
Fixed cost
Break-even point
Total cost =Total revenue

900
800
700
600
500
400
300
200
100

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0 100 200 300 400 500 600 700 800 900 1000 1100
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Volume (units per period)
Figure S7.5
Break-Even Analysis
BEP
x
= Break-even point in
units
BEP
$
= Break-even point in
dollars
P = Price per unit (after
all discounts)
x = Number of units
produced
TR = Total revenue =Px
F = Fixed costs
V = Variable costs
TC = Total costs =F +Vx
TR = TC
or
Px = F + Vx
Break-even point
occurs when
BEP
x
=
F
P - V
Break-Even Analysis
BEP
x
= Break-even point in
units
BEP
$
= Break-even point in
dollars
P = Price per unit (after
all discounts)
x = Number of units
produced
TR = Total revenue =Px
F = Fixed costs
V = Variable costs
TC = Total costs =F +Vx
BEP
$
= BEP
x
P
= P
=
=
F
(P - V)/P
F
P - V
F
1 - V/P
Profit = TR - TC
= Px - (F + Vx)
= Px - F - Vx
= (P - V)x - F
Break-Even Example
Fixed costs = $10,000 Material = $.75/unit
Direct labor = $1.50/unit Selling price = $4.00 per unit
BEP
$
= =
F
1 - (V/P)
$10,000
1 - [(1.50 + .75)/(4.00)]
Break-Even Example
Fixed costs = $10,000 Material = $.75/unit
Direct labor = $1.50/unit Selling price = $4.00 per unit
BEP
$
= =
F
1 - (V/P)
$10,000
1 - [(1.50 + .75)/(4.00)]
= = $22,857.14
$10,000
.4375
BEP
x
= = = 5,714
F
P - V
$10,000
4.00 - (1.50 + .75)
Break-Even Example
BEP
$
=
F
1 - x (W
i
)
V
i

P
i

Multiproduct Case
where V = variable cost per unit
P = price per unit
F = fixed costs
W = percent each product is of total dollar sales
i = each product
Multiproduct Example
Annual Forecasted
Item Price Cost Sales Units
Sandwich $2.95 $1.25 7,000
Soft drink .80 .30 7,000
Baked potato 1.55 .47 5,000
Tea .75 .25 5,000
Salad bar 2.85 1.00 3,000
Fixed costs = $3,500 per month
Multiproduct Example
Annual Forecasted
Item Price Cost Sales Units
Sandwich $2.95 $1.25 7,000
Soft drink .80 .30 7,000
Baked potato 1.55 .47 5,000
Tea .75 .25 5,000
Salad bar 2.85 1.00 3,000
Sandwich $2.95 $1.25 .42 .58 $20,650 .446 .259
Soft drink .80 .30 .38 .62 5,600 .121 .075
Baked 1.55 .47 .30 .70 7,750 .167 .117
potato
Tea .75 .25 .33 .67 3,750 .081 .054
Salad bar 2.85 1.00 .35 .65 8,550 .185 .120
$46,300 1.000 .625
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)
Fixed costs = $3,500 per month
Multiproduct Example
Annual Forecasted
Item Price Cost Sales Units
Sandwich $2.95 $1.25 7,000
Soft drink .80 .30 7,000
Baked potato 1.55 .47 5,000
Tea .75 .25 5,000
Salad bar 2.85 1.00 3,000
Fixed costs = $3,500 per month
Sandwich $2.95 $1.25 .42 .58 $20,650 .446 .259
Soft drink .80 .30 .38 .62 5,600 .121 .075
Baked 1.55 .47 .30 .70 7,750 .167 .117
potato
Tea .75 .25 .33 .67 3,750 .081 .054
Salad bar 2.85 1.00 .35 .65 8,550 .185 .120
$46,300 1.000 .625
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)
BEP
$
=
F
1 - x (W
i
)
V
i

P
i

= = $67,200
$3,500 x 12
.625
Daily
sales
= = $215.38
$67,200
312 days
.446 x $215.38
$2.95
= 32.6 ~ 33
sandwiches
per day
Decision Trees and
Capacity Decision
-$14,000
$13,000
$18,000
-$90,000
Market unfavorable (.6)
Market favorable (.4)
$100,000
Market favorable (.4)
Market unfavorable (.6)
$60,000
-$10,000
Medium plant
Market favorable (.4)
Market unfavorable (.6)
$40,000
-$5,000
$0
Strategy-Driven Investment
Operations may be responsible
for return-on-investment (ROI)
Analyzing capacity alternatives
should include capital
investment, variable cost, cash
flows, and net present value
Net Present Value (NPV)
where F = future value
P = present value
i = interest rate
N = number of years
P =
F
(1 + i)
N

NPV Using Factors
P = = FX
F
(1 + i)
N

where X = a factor from Table S7.1
defined as = 1/(1 + i)
N
and
F = future value
Year 5% 6% 7% 10%
1 .952 .943 .935 .909
2 .907 .890 .873 .826
3 .864 .840 .816 .751
4 .823 .792 .763 .683
5 .784 .747 .713 .621
Portion of
Table S7.1
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
Present Value of an Annuity
Portion of Table S7.2
Year 5% 6% 7% 10%
1 .952 .943 .935 .909
2 1.859 1.833 1.808 1.736
3 2.723 2.676 2.624 2.487
4 4.329 3.465 3.387 3.170
5 5.076 4.212 4.100 3.791
Process, Volume, and Variety
Process Focus
projects, job shops
(machine, print,
carpentry)
Standard Register
Repetitive
(autos, motorcycles)
Harley Davidson
Product Focus
(commercial
baked goods,
steel, glass)
Nucor Steel
High Variety
one or few
units per run,
high variety
(allows
customization)
Changes in
Modules
modest runs,
standardized
modules
Changes in
Attributes
(such as grade,
quality, size,
thickness, etc.)
long runs only
Mass Customization
(difficult to achieve,
but huge rewards)
Dell Computer Co.
Poor Strategy
(Both fixed and
variable costs
are high)
Low
Volume
Repetitive
Process
High
Volume
Volume
Figure 7.1
Capacity defined
Volume (for storage or carriage)
Capability
Maximum flow rates
Capacity measurement
x Yield x Utilisation = Designed capacity
Achieved capacity
Planning capacity needs
Forecast
demand for
industry output
Marketing
policy:
marketing mix
Product policy:
range, mix and
quality
Make or buy
decision
Capacity
planning
Market share
Forecast
demand for
firms output
Types of uncertainty
State uncertainty
What value?
Effect uncertainty
Impact on other parts of system
Response uncertainty
What happens next?
Time horizons in forecasting
Time
horizon
Years Issues requiring forecasts Responsibility
Long
term
2 to 10+ New transmission lines; switching
centres and control systems
Senior managers
Medium
term
1 to 3 Replacing switchgear, transformers;
recruiting and training; major
maintenance programmes
Middle managers
Short
term
0.0001
to 1
Job allocation, daily peak loading and
routeing
Junior managers,
system controllers

Forecasting methods
Qualitative
Delphi
Sales force surveys
Customer surveys
Quantitative
Time series models
Causal models
Time series forecasting
The approach is to decompose a time series into the
following elements:
Trend
Seasonality
Cycles
Random effects
Decomposing a time series
value Cyclical value Seasonal Trend Sales + + =
factor Cyclical factor Seasonal Trend = Sales
0
1
2
3
4
5
6
0 1 2 3 4
Years
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Actual sales
Smoothed sales
Sales trend
Trend projection
[The data in the two graphs are the same]
4
5
6
7
8
9
10
0 1 2 3 4 5
Time in years
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0 1 2 3 4 5
Time in years
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Electricity demand summer evenings
26 June 1996 4 July 1990
26
32
31
29
28
30
27
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1900 2000 1930 2030 2100 2130 2230 2200
Time
Typical summer evening in 1996
Traffic through credit bureau
0
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300
400
500
600
Time
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--- 30 Aug 97 ..... 6 Sept 97 _.._ 13 Sept 97 ___ Quarterly moving average
Causal forecasting
The approach is to link dependent to independent
variables
e.g. Dettol sales were found to be linked to:
real personal disposable income
the seasons
real price
advertising
Resources for long-term capacity
Part of strategic plan
Yield competitive advantage
Consider product life cycles
Variety of options
Sensitivity tests
Rendell and Heizer
Learning curves
Number of jobs done
(Linear scale)
50000 100000
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Number of jobs done
(Logarithmic scale)
100 1000 10000 100000
S
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\
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=
n item for hours Standard
m item for hours Standard