Aggregate Sales and Operations Planning

Chapter 16Bake a Cake

Sales and Operations Planning Activities

• Long-range planning– Greater than one year planning horizon– Usually performed in annual increments

• Medium-range planning– Six to eighteen months – Usually with weekly, monthly or quarterly

increments

• Short-range planning– One day to less than six months– Usually with weekly or daily increments

Process planning

Strategic capacityplanning

Sales and operations(aggregate) planning

Sales plan Aggregateoperationsplan

Supply networkplanning

Forecasting anddemand management

Master scheduling

Material requirementsplanning

Order scheduling

Vehicle capacityplanning

Vehicle loading

Vehicle dispatching

Warehouse receiptplanning

Weekly workforcescheduling

Daily workforcescheduling

Manufacturing Logistics Services

Longrange

Mediumrange

Shortrange

16-3

Required Inputs to the Production Planning System

Planning for production

External capacity

Competitors’behavior

Raw material availability

Market demand

Economic conditions

Currentphysical capacity

Current workforce

Inventory levels

Activities required for production

External to firm

Internal to firm

Aggregate Planning

• Capacity has a cost, lead times are greater than zero

• Aggregate planning: – process by which a company determines levels of

capacity, production, subcontracting, inventory, stockouts, and pricing over a specified time horizon

– goal is to maximize profit– decisions made at a product family (not SKU) level– time frame of 3 to 18 months– how can a firm best use the facilities it has?

Role of Aggregate Planning in a Supply Chain

• Specify operational parameters over the time horizon:– production rate– workforce– overtime– machine capacity level– subcontracting– backlog– inventory on hand

• All supply chain stages should work together on an aggregate plan that will optimize supply chain performance

The Aggregate Planning Problem

• Given the demand forecast for each period in the planning horizon, determine the production level, inventory level, and the capacity level for each period that maximizes the firm’s (supply chain’s) profit over the planning horizon

• Specify the planning horizon (typically 3-18 months)

• Specify the duration of each period• Specify key information required to develop an

aggregate plan

Objectives of Aggregate Planning

• Objective of aggregate planning frequently is to minimize total cost over the planning horizon.

• Other objectives should be considered: – maximize customer service– minimize inventory investment– minimize changes in workforce levels– minimize changes in production rates– maximize utilization of plant and equipment

Information Needed foran Aggregate Plan

• Demand forecast in each period• Production costs– labor costs, regular time ($/hr) and overtime ($/hr)– subcontracting costs ($/hr or $/unit)– cost of changing capacity: hiring or layoff ($/worker) and

cost of adding or reducing machine capacity ($/machine)• Labor/machine hours required per unit• Inventory holding cost ($/unit/period)• Stockout or backlog cost ($/unit/period)• Constraints: limits on overtime, layoffs, capital

available, stockouts and backlogs

Outputs of Aggregate Plan• Production quantity from regular time, overtime, and

subcontracted time: used to determine number of workers and supplier purchase levels

• Inventory held: used to determine how much warehouse space and working capital is needed

• Backlog/stockout quantity: used to determine what customer service levels will be

• Machine capacity increase/decrease: used to determine if new production equipment needs to be purchased

• A poor aggregate plan can result in lost sales, lost profits, excess inventory, or excess capacity

Aggregate Planning Strategies

Active strategy• Attempts to handle

fluctuations in demand by focusing on demand management

• Use pricing strategies and/or advertising and promotion

• Develop counter-cyclical products

• Request customers to backorder or advance-order

• Do not meet demand

Passive strategy (reactive strategy)• Attempts to handle fluctuations in

demand by focusing on supply and capacity management

• Vary size work force size by hiring or layoffs

• Vary utilization of labour and equipment through overtime or idle time

• Build or draw from inventory• Subcontract production• Negotiate cooperative arrangements

with other firms• Allow backlogs, back orders, and/or

stockouts

Aggregate Planning Strategies

• Trade-off between capacity, inventory, backlog/lost sales

• Chase strategy – using capacity as the lever• Time flexibility from workforce or capacity

strategy – using utilization as the lever• Level strategy – using inventory as the lever• Mixed strategy – a combination of one or

more of the first three strategies

Chase Strategy

• Production rate is synchronized with demand by varying machine capacity or hiring and laying off workers as the demand rate varies

• However, in practice, it is often difficult to vary capacity and workforce on short notice

• Expensive if cost of varying capacity is high• Negative effect on workforce morale• Results in low levels of inventory• Should be used when inventory holding costs are

high and costs of changing capacity are low

Time Flexibility Strategy

• Can be used if there is excess machine capacity• Workforce is kept stable, but the number of

hours worked is varied over time to synchronize production and demand

• Can use overtime or a flexible work schedule• Requires flexible workforce, but avoids morale

problems of the chase strategy• Low levels of inventory, lower utilization• Should be used when inventory holding costs are

high and capacity is relatively inexpensive

Level Strategy• Maintain stable machine capacity and workforce

levels with a constant output rate• Shortages and surpluses result in fluctuations in

inventory levels over time• Inventories that are built up in anticipation of future

demand or backlogs are carried over from high to low demand periods

• Better for worker morale• Large inventories and backlogs may accumulate• Should be used when inventory holding and backlog

costs are relatively low

Regular production cost $35/unitLost sales $100/unitInventory carrying costs $10/unit/monthSubcontracting costs $60/unitHiring costs $1500/workerFiring costs $3000/workerBeginning workforce level 20 workersCapacity per worker 50 units/monthInitial inventory level 700 unitsClosing inventory level 100 units

Month 1 2 3 4 5 6Demand 1000 1200 1500 1900 1800 1600

Suppose you have the following forecasts for demand to meet:

January February March April May JuneDemand 1000 1200 1500 1900 1800 1600 9000Inventory-init 700 1100 1300 1200 700 300Ending Inventory 1100 1300 1200 700 300 100Prod. 1400 1400 1400 1400 1400 1400 8400Hire 8 0 0 0 0 0Fire 0 0 0 0 0 0Sub. Contract 0 0 0 0 0 0Lost sales 0 0 0 0 0 0Costs 72000 62000 61000 56000 52000 50000

Aggregate Planning at Red Tomato Tools

Month Demand ForecastJanuary 1,600February 3,000

March 3,200April 3,800May 2,200June 2,200

Fundamental Tradeoffs in Aggregate Planning

• Capacity (regular time, overtime, subcontract)

• Inventory

• Backlog / lost sales

Basic Strategies

• Chase strategy

• Time flexibility from workforce or capacity

• Level strategy

Aggregate Planning

Item CostMaterials $10/unitInventory holding cost $2/unit/monthMarginal cost of a stockout $5/unit/monthHiring and training costs $300/workerLayoff cost $500/workerLabor hours required 4/unitRegular time cost $4/hourOver time cost $6/hourCost of subcontracting $30/unit

Aggregate Planning (Define Decision Variables)

Wt = Workforce size for month t, t = 1, ..., 6

Ht = Number of employees hired at the beginning of month t, t = 1, ..., 6

Lt = Number of employees laid off at the beginning of month t, t = 1, ..., 6

Pt = Production in month t, t = 1, ..., 6

It = Inventory at the end of month t, t = 1, ..., 6

St = Number of units stocked out at the end of month t, t = 1, ..., 6

Ct = Number of units subcontracted for month t, t = 1, ..., 6

Ot = Number of overtime hours worked in month t, t = 1, ..., 6

Aggregate Planning(Define Objective Function)

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Aggregate Planning (Define Constraints Linking Variables)

• Workforce size for each month is based on hiring and layoffs

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Aggregate Planning (Constraints)

• Production for each month cannot exceed capacity

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8-25

Aggregate Planning (Constraints)

• Inventory balance for each month

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8-26

Aggregate Planning (Constraints)

• Over time for each month

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8-27

Scenarios

• Increase in holding cost (from $2 to $6)• Overtime cost drops to $4.1 per hour• Increased demand fluctuation

8-28

Increased Demand Fluctuation

Month Demand ForecastJanuary 1,000February 3,000

March 3,800April 4,800May 2,000June 1,400

8-29

Aggregate Planning in Practice

• Think beyond the enterprise to the entire supply chain

• Make plans flexible because forecasts are always wrong

• Rerun the aggregate plan as new information emerges

• Use aggregate planning as capacity utilization increases

8-30

Summary of Learning Objectives

• What types of decisions are best solved by aggregate planning?

• What is the importance of aggregate planning as a supply chain activity?

• What kinds of information are needed to produce an aggregate plan?

• What are the basic trade-offs a manager makes to produce an aggregate plan?

• How are aggregate planning problems formulated and solved using Microsoft Excel?