Manufacturing Flexibility

Generic Situation:

Many small to medium sized companies must decide whether they should invest in more flexible machinery, i.e., machinery that can make a number of different products. Flexible machines pick up slack if demand for one product is unexpectedly high and for another unexpectedly low.

Example:

K&R Industries manufactures 2 distinct plastics molding machines. The Primus sells for $9,000 and the Alpha for $11,500. K&R is trying to determine the optimal capacity configuration. They have the following options for machinery investment:

  1. Invest in machinery (type P) that can only produce the Primus model. This results in a building cost of $4,500 per unit of annual capacity. Cost to build a Primus model using the type P machine is $4,500

  2. Invest in machinery (type A) that can only produce the Alpha model. This results in a building cost of $5,500 per unit of annual capacity. Cost to build an Alpha model using the type A machine is $5,500

  3. Invest in flexible machinery (type PA) that can produce either model. Such a flexible machine costs $6800 to build a unit of annual capacity. Cost to produce either model on the type PA machine is $6,000.

The owner, Conrad Kozak, is very certain that the demand in the coming year for the Primus model will be close to 50,000 and demand for the Alpha will be about 60,000. The annual growth in demand for the following years is uncertain. Mr. Kozak considers the worst case growth scenario for the Primus to be a demand drop of 65%, most likely demand increase of 10%, and best case demand scenario of 80%. For type Alpha, the projections are as follows - worst case 50% drop, most likely 5% increase, best case demand scenario of 50%. Mr. Kozak assumes a discount rate of 10% and his goal is to maximize expected NPV earned from five years of sales so he needs to know how many of each type of capacity should be built.

Profit Maximizing Solution:

The maximum NVP is the result of approximately 31,000 units of type P capacity, approximately 26,000 units of type A capacity, and 33,000 units of flexible capacity.