Chapter 8 Aggregate Planning in the Supply Chain

1. Chapter 8Aggregate Planningin the Supply Chain Supply Chain Management(3rd Edition)

2. Outline • Role of aggregate planning in a supply chain • The aggregate planning problem • Aggregate planning strategies • Implementing aggregate planning in practice

3. Role of Aggregate Planning in a Supply Chain • Imagine a world where all costs and lead times are zero... • However capacity is costly and LT’s are not zero.. How to use capacity? When to outsource? • 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?

4. 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

5. 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

6. 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

7. 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

8. Aggregate Planning Strategies Capacity InventoryBacklog/lost sales Costs Costs Costs • Chase strategy – using capacity as the lever • Time flexibility startegy– using workforce or capacity utilization as the lever • Level strategy – using inventory as the lever • Mixed strategy – a combination of one or more of the first three strategies

9. 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

10. 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, but lower utilization • Should be used when inventory holding costs are high and capacity is relatively inexpensive

11. Level Strategy • Maintain stable machine capacity and workforce levels with a constant output rate • No synchronization of demand and supply results in Shortages and surpluses • 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

12. Ex: Red Tomato Tools • Demand for the gardening tools is highly seasonal. • Handle demand and maximize profits?? • Options: • Hire worker in peak season • Subcontraction of some work • Build up inventory in slow period • Backlogging • Constraints: • No limit on subcontracting, inventories, stockouts, backlog • All stockouts are backlogged from the following month. • Inventory costs are incurred on the ending inventory in a month. • Inventory level at the end of June is at least 500 units.

13. Ex: Red Tomato Tools-Demand Forecast

14. Ex: Red Tomato Tools-Initialization • Unit price=$40/unit • Inventory at the beginning of January=1000 units • Workforce at the beginning of January=80 employees • Total of 20 workdays/month are available • Regular work hours=8hrs/day/employee • Overtime work hours can not exceed 10hrs/month/employee • Required labor hours= 4hrs/unit

15. Ex: Red Tomato Tools-Costs

16. 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 (backlogged) 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

17. ? Min cost = Max profit • Min cost and max profit are equivalent if • All demand has to be met in some way • The unit price is fixed, i.e., total revenue is fixed. • Then, min cost and max profit gives the same optimal plan.

18. Aggregate Planning(Define Objective Function)

19. Workforce Balance Equations • Workforce size for each month is based on hiring and layoffs Ht Wt-1 Wt Period t Lt

20. Inventory Balance Equations Pt Ct It-1 It Period t St-1 Dt St

21. Production Capacity Constraints • Production for each month cannot exceed regular+overtime working capacity

22. Overtime Capacity Constraints • Over time for each month

23. Average Flow Time • Little’s Law: Average Flow time=Average Inventory/Throughput • Average Flow Time for Red Tomato=895/2,667=0.34 months • ?? What happens to Average Flow Time if uncertainty in demand • increases?

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

25. Increased Demand Fluctuation

26. 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

27. 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?