3e2a1b56-dafb-454d-87ad-86adea3e7b86

Chapter 6 Supply network design 159
Worked example
A business process outsourcing (BPO) company is considering building some processing
centres in India. The company has a standard call centre design that it has found
to be the most efficient around the world. Demand forecasts indicate that there is
already demand from potential clients to fully utilize one process centre that would
generate $10 million of business per quarter (3-month period). The forecasts also
indicate that by quarter 6 there will be sufficient demand to fully utilize one further processing
centre. The costs of running a single centre are estimated to be $5 million per
quarter and the lead time between ordering a centre and it being fully operational is
two quarters. The capital costs of building a centre is $10 million, $5 million of which
is payable before the end of the first quarter after ordering, and $5 million payable
before the end of the second quarter after ordering. How much funding will the company
have to secure on a quarter-by-quarter basis if it decides to build one processing
centre as soon as possible and a second processing centre to be operational by the
beginning of quarter 6?
Analysis
The funding required for a capacity expansion such as this can be derived by calculating
the amount of cash coming in to the operation each time period, then subtracting
the operating and capital costs for the project each time period. The cumulative cash
flow indicates the funding required for the project. In Table 6.6 these calculations are
performed for eight quarters. For the first two quarters there is a net cash outflow
because capital costs are incurred by no revenue is being earned. After that, revenue is
being earned but in quarters four and five this is partly offset by further capital costs for
the second processing centre. However, from quarter six onwards the additional revenue
from the second processing centre brings the cash flow positive again. The maximum
funding required occurs in quarter two and is $10 million.
Table 6.6 The cumulative cash flow indicating the funding required for the project
Quarters
1 2 3 4 5 6 7 7
Sales revenue ($ millions) 0 0 10 10 10 20 20 20
Operating costs ($ millions) 0 0 −5 −5 −5 −10 −10 −10
Capital costs ($ millions) −5 −5 −0 −5 −5 0 0 0
Required cumulative funding ($ millions) −5 −10 −5 −5 −5 +5 +15 +25
Break-even analysis of capacity expansion
Fixed-cost breaks are
important in determining
break-even points
An alternative view of capacity expansion can be gained by examining the cost implications
of adding increments of capacity on a break-even basis. Figure 6.11 shows how increasing
capacity can move an operation from profitability to loss. Each additional unit of capacity results
in a fixed-cost break that is a further lump of expenditure which will have to be incurred
before any further activity can be undertaken in the operation. The operation is unlikely
to be profitable at very low levels of output. Eventually, assuming that prices are greater
than marginal costs, revenue will exceed total costs. However, the level of profitability at the
point where the output level is equal to the capacity of the operation may not be sufficient
to absorb all the extra fixed costs of a further increment in capacity. This could make the
operation unprofitable in some stages of its expansion.