Chapter 8 Aggregate Planning in the Supply Chain

Outline Role of aggregate planning in a supply chain The aggregate planning problem Aggregate planning strategies Aggregate planning with Linear Programming Implementing aggregate planning in practice

Tactical/Operational Planning Horizon Long Range Medium Range Short Range 1 to 10 years 6 to 18 months 1 to 10 weeks Strategic Aggregate Planning Tactical/Operational What is our business? Capital investments (new factories, new machines, etc.) Production schedule for a product group Production level Labour force level Inventory level (Production capacity fixed) Production schedule for specific products, detailed scheduling.

Role of Aggregate Planning in a Supply Chain Capacity has a cost, lead times are greater than zero Aggregate planning: Match workforce and materials to available equipment so as to meet projected demand at low cost. 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? First alert in marshalling resources!

Aggregate Planning Decisions Specify operational parameters over the time horizon: production rate workforce overtime machine capacity usage subcontracting backlog inventory on hand All supply chain stages should work together on an aggregate plan that will optimize supply chain performance Plant capacity fixed; Adjust: labour, materials, utilisation.

The Aggregate Planning Problem Given the demand forecast for each period in the planning horizon, determine the production level, inventory level, capacity level and the labour (type and 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

Information Needed for an 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 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

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 Notes:

Aggregate Planning at Red Tomato Tools Notes:

Aggregate Planning at Red Tomato Tools Notes:

Aggregate Planning Strategies For level production, inventory buildup and backlogs can be reduced by “starting” the cycle differently Adjusting production rate Overtime and “furlough” Subcontract (instead of hire-and-fire) Mixed strategies Linear programming!

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? 8-18

Aggregate Planning in Excel Construct a table with the decision variables Construct a table for constraints Create a cell containing the objective function Use Data Analysis Solver

Aggregate Planning at Red Tomato Tools (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 Notes:

Aggregate Planning at Red Tomato Tools (Define Objective Function) Notes:

Workforce size for each month is based on hiring and layoffs Aggregate Planning at Red Tomato tools (Define Constraints Linking Variables) Workforce size for each month is based on hiring and layoffs Notes:

Aggregate Planning at Red Tomato Tools (Constraints) Production for each month cannot exceed capacity Notes:

Aggregate Planning at Red Tomato Tools (Constraints) Inventory balance for each month Notes:

Aggregate Planning at Red Tomato Tools (Constraints) Over time for each month Notes:

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

Increased Demand Fluctuation Notes:

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

Chapter 9 Sales and Operations Planning

Outline Responding to predictable variability in a supply chain Managing supply Managing demand Implementing solutions – Sales and Operations Planning - to predictable variability in practice 9-30

Responding to Predictable Variability in a Supply Chain Predictable variability is change in demand that can be forecasted Can cause increased costs and decreased responsiveness in the supply chain A firm can handle predictable variability using two broad approaches: Manage supply using capacity, inventory, subcontracting, and backlogs Manage demand using short-term price discounts and trade promotions 9-31

Managing Supply Managing capacity Managing inventory Time flexibility from workforce Use of seasonal workforce Use of subcontracting Use of dual facilities – dedicated and flexible Designing product flexibility into production processes Managing inventory Using common components across multiple products Building inventory of high demand or predictable demand products 9-32

Inventory/Capacity Trade-off Leveling capacity forces inventory to build up in anticipation of seasonal variation in demand Carrying low levels of inventory requires capacity to vary with seasonal variation in demand or enough capacity to cover peak demand during season Notes: 9-33 33

Managing Demand Promotion Pricing Timing of promotion and pricing changes is important Demand increases can result from a combination of three factors: Market growth (increased sales, increased market size) Stealing share (increased sales, same market size) Forward buying (same sales, same market size) 9-34

Demand Management Pricing and aggregate planning must be done jointly Factors affecting discount timing Product margin: Impact of higher margin ($40 instead of $31) Consumption: Changing fraction of increase coming from forward buy (100% increase in consumption instead of 10% increase) Forward buy 9-35

Red Tomato Tools Planning example 9-36

Off-Peak (January) Discount from $40 to $39 Notes: Cost = $421,915, Revenue = $643,400, Profit = $221,485 9-37 37

Peak (April) Discount from $40 to $39 Notes: Cost = $438,857, Revenue = $650,140, Profit = $211,283 9-38 38

January Discount: 100% Increase in Consumption, Sale Price = $40 ($39) Notes: Off-peak discount: Cost = $456,750, Revenue = $699,560 9-39 39

Peak (April) Discount: 100% Increase in Consumption, Sale Price = $40 ($39) Notes: Peak discount: Cost = $536,200, Revenue = $783,520 9-40 40

Performance Under Different Scenarios 9-41

Implementing Solutions to Predictable Variability in Practice Coordinate planning across enterprises in the supply chain Take predictable variability into account when making strategic decisions Preempt, do not just react to, predictable variability 9-42

Summary of Learning Objectives How can supply be managed to improve synchronization in the supply chain in the face of predictable variability? How can demand be managed to improve synchronization in the supply chain in the face of predictable variability? How can sales and operations planning be used to maximize profitability when faced with predictable variability in the supply chain? 9-43