An application in daily life

(from Cheaper by the Dozen)

Aggregate Planning (session 1,2,3)

Outline
The Planning Process

The Nature of Aggregate Planning

Aggregate Planning Strategies
Capacity Options Demand Options Mixing Options to Develop a Plan

Methods for Aggregate Planning

Graphical Methods
Mathematical Approaches Comparison of Aggregate Planning Method
2

Outline Continued
Aggregate Planning in Services
Restaurants Hospitals National Chains of Small Service Firms Miscellaneous Services Airline Industry

Yield Management
3

Aggregate Planning
Aggregate planning is an operational activity which does an aggregate plan for the production process, in advance of 3 to 18 months, to give an idea to management as to what quantity of materials and other resources are to be procured and when, so that the total cost of operations can be kept to the minimum over that period. Objective is to minimize cost over the period by Production rates Labor levels Inventory levels Overtime work Subcontracting rates Other controllable variables
4

Aggregate Planning
Determine the quantity & timing of production for the immediate future

Required for aggregate planning

A logical overall unit for measuring sales and output

A forecast of demand for an intermediate planning period in these aggregate terms

A method for determining costs

A model that combines forecasts and costs so that scheduling decisions can be made for the planning period

The Planning Process

Long-range plans (over one year)
Research and Development New product plans Capital investments Facility location/expansion Top executives

Intermediate-range plans (3 to 18 months)

Sales planning Production planning and budgeting Setting employment, inventory, subcontracting levels Analyzing operating plans

Operations managers

Short-range plans (up to 3 months)

Operations managers, supervisors, foremen Responsibility Job assignments Ordering Job scheduling Dispatching Overtime Part-time help Planning tasks and horizon

Aggregate Planning
Quarter 1 Feb 120,000 Quarter 2 May 130,000 Quarter 3 Aug 150,000

Jan 150,000

Mar 110,000

Apr 100,000

Jun 150,000

Jul 180,000

Sep 140,000
7

Aggregate Planning
Aggregate planning is a part of larger production planning system; therefore understanding the interfaces between plan and several internal and external factors is essential for effective aggregate planning.

Aggregate Planning

Aggregate Planning (Required Inputs to the Production Planning System)

Competitors behavior External capacity
Raw material availability Market demand Economic conditions External to firm

Planning for production

Current workforce Inventory levels

Current physical capacity

Activities required for prod.

Internal to firm
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Few Aggregate Planning Strategies

1. Use inventories to absorb changes in demand 2. Accommodate changes by varying workforce size 3. Use part-timers, overtime, or idle time to absorb changes 4. Use subcontractors and maintain a stable workforce 5. Change prices or other factors to influence demand
11

Capacity Options
1. Changing inventory levels
Increase inventory in low demand periods to meet high demand in the future Increases costs associated with storage, insurance, handling, obsolescence, and capital investment 15% to 40%
Shortages can mean lost sales due to long lead times and poor customer service
12

Capacity Options
2. Varying workforce size by hiring or layoffs
Match production rate to demand Training and separation costs for hiring and laying off workers New workers may have lower productivity

Laying off workers may lower morale and productivity

13

Capacity Options
3. Varying production rate through overtime or idle time
Allows constant workforce
May be difficult to meet large increases in demand

Overtime can be costly and may drive down productivity

Absorbing idle time may be difficult
14

Capacity Options
4. Subcontracting
Temporary measure during periods of peak demand May be costly Assuring quality and timely delivery may be difficult

Exposes your customers to a possible competitor

15

Capacity Options
5. Using part-time workers
Useful for filling unskilled or low skilled positions, especially in services

16

Demand Options
6. Influencing demand
Use advertising or promotion to increase demand in low periods Attempt to shift demand to slow periods May not be sufficient to balance demand and capacity
17

Demand Options
7. Back ordering during highdemand periods
Requires customers to wait for an order without loss of goodwill or the order Most effective when there are few if any substitutes for the product or service
Often results in lost sales
18

Demand Options
8. Counter seasonal product and service mixing
Develop a product mix of counterseasonal items May lead to products or services outside the companys areas of expertise

19

Methods for Aggregate Planning

A mixed strategy may be the best way to achieve minimum costs

There are many possible mixed strategies

Finding the optimal plan is not always possible

20

Mixing Options to Develop an aggregate Plan

Chase strategy
Match output rates to demand forecast for each period Vary workforce levels (by hiring or firing) or vary production rate (by means of overtime, idle time, sub-contracting) Favored by many service organizations (because inventory option is difficult or impossible to adopt)
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Mixing Options to Develop a Plan

Level strategy (or level Scheduling)
Daily production is uniform

Use inventory or idle time as buffer

Stable production leads to better quality and productivity

Ex. Toyota and Nissan keep production at uniform levels and may (1. Inventory go up/ down to buffer the difference, 2. find alternate work for employees.)

Some combination of capacity options, a mixed strategy, might be the best solution 22

Graphical Methods
Popular techniques

Easy to understand and use

Trial-and-error approaches that do not guarantee an optimal solution

Require only limited computations

23

Graphical Methods
1. Determine the demand for each period 2. Determine the capacity for regular time, overtime, and subcontracting each period 3. Find labor costs, hiring and layoff costs, and inventory holding costs 4. Consider company policy on workers and stock levels 5. Develop alternative plans and examine their total costs
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Example 1
ABC a manufacturer of roofing tiles has developed monthly Forecasts for roofing tiles and presented the period January-June in the table 1.
To represent the projected demand, ABC also draws a graph (figure 1) that charts the daily demand each month. The dotted line across the chart represents the production rate required to meet average demand which is computed by dividing the total expected demand by number of production days.
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Table 1: Expected demand and number of production days.

Month Jan Feb Mar Apr May June

Expected Demand 900 700 800 1,200 1,500 1,100 6,200

Production Days 22 18 21 21 22 20 124

Demand Per Day (computed) 41 39 38 57 68 55

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Total expected demand Average requirement = Number of production days 6,200 = = 50 units per day 124
Production rate per working day Forecast demand

70 60 50 40 30

Level production using average monthly forecast demand

0 Jan

Feb

Mar

Apr

May

June

= Month = Number of working days

27

22
Figure 1

18

21

21

22

20

Possible Strategy 1
Constant Workforce

Cost Information
Inventory carrying cost Subcontracting cost per unit Average pay rate Overtime pay rate Labor-hours to produce a unit Cost of increasing daily production rate (hiring and training) Cost of decreasing daily production rate (layoffs)
Table 2 28

$ 5 per unit per month $10 per unit $ 5 per hour ($40 per day) $ 7 per hour (above 8 hours per day) 1.6 hours per unit $300 per unit $600 per unit

Possible Strategy 1
Cost Information Production at Month 50 Units Inventory carry cost per Day
Subcontracting cost per unit Jan 1,100

Monthly Demand Inventory Ending Forecast $ 5Change per Inventory per unit month
$10 +200 per unit

900 Feb 700 Average pay rate 900 Mar 1,050 800 Overtime pay rate Apr 1,050 1,200 Labor-hours to produce a unit May 1,100 1,500 Cost of increasing daily production rate June and training) 1,000 1,100 (hiring
Cost of decreasing daily production rate (layoffs)

200 $ 5 per hour ($40 per day) +200 400 +250 650 $ 7 per hour (above 8 hours per day) -150 500 1.6 hours per unit -400 100 $300 per unit -100 0 1,850 $600 per unit

Total units of inventory carried over from one month to the next = 1,850 units Table 13.3 Workforce required to produce 50 units per day = 10 workers
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Possible Strategy 1
Monthly Costs Calculations Cost Information Production at Demand Inventory Ending Month carrying Forecast 1,850 unitsper Inventory per unit month Inventory carry cost per Day $9,250 Inventory 50 Units (= $ 5Change carried x $5 $10 +200 per Subcontracting cost per unit Jan 1,100 900 per unit) unit 200 Regular-time labor 49,600 (= 10 workers ($40 per day) per $ 5 per hour x $40 400 Feb 700 +200 Average pay rate 900 124 Mar 1,050 800 day7x+250 days) 650 $ per hour Overtime pay rate (above 8 hours per day) Other costs (overtime, Apr 1,050 1,200 -150 500 hiring, layoffs, 1.6 hours per unit Labor-hours to produce a unit May 1,100 1,500 -400 100 subcontracting) 0 Cost of increasing daily production rate $300 per unit June and training) 1,000 1,100 -100 0 Total cost $58,850 (hiring 1,850 Cost of decreasing daily production rate $600 per unit
(layoffs)

Total units of inventory carried over from one month to the next = 1,850 units Table 13.3 Workforce required to produce 50 units per day = 10 workers
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Possible Strategy 1
7,000
6,000 Cumulative demand units 5,000 4,000 3,000 Reduction of inventory Cumulative level production using average monthly forecast requirements 6,200 units

2,000
1,000 Jan Feb Mar

Cumulative forecast requirements

Excess inventory
Apr May June 31

Figure 2

Possible Strategy 2
Subcontracting

Month Jan Feb Mar Apr May June

Expected Demand 900 700 800 1,200 1,500 1,100 6,200

Production Days 22 18 21 21 22 20 124

Demand Per Day (computed) 41 39 38 57 68 55

Minimum requirement = 38 units per day

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Possible Strategy 2
Production rate per working day Forecast demand

70 60 50 40 30
Level production using lowest monthly forecast demand

Jan

Feb

Mar

Apr

May

June

= Month
= Number of working days
33

22

18

21

21

22

20

Possible Strategy 2
Cost Information
Inventory carrying cost Subcontracting cost per unit Average pay rate Overtime pay rate Labor-hours to produce a unit Cost of increasing daily production rate (hiring and training) Cost of decreasing daily production rate (layoffs) $ 5 per unit per month $10 per unit

$ 5 per hour ($40 per day) $ 7 per hour (above 8 hours per day) 1.6 hours per unit
$300 per unit $600 per unit

34

Possible Strategy 2
Cost Information
Inventory carry cost Average pay rate Overtime pay rate Labor-hours to produce a unit Subcontract units $ 5 per unit per month

In-house production Subcontracting cost per unit

= 38 units per day $10 per unit x $ 5 perdays per day) 124 hour ($40 = 4,712 units $ 7 per hour
(above 8 hours per day) 1.6 hours per unit 6,200 - 4,712

= Cost of increasing daily production rate 1,488per unit = $300 units (hiring and training)
Cost of decreasing daily production rate (layoffs) $600 per unit

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Possible Strategy 2
Cost Information
Inventory carry cost Average pay rate Overtime pay rate $ 5 per unit per month

In-house production Subcontracting cost per unit

= 38 units per day $10 per unit x $ 5 perdays per day) 124 hour ($40 = 4,712 units $ 7 per hour
(above 8 hours per day) 1.6 hours per Calculations unit 6,200 - 4,712

Costs Subcontract units Labor-hours to produce a unit

= Regular-time labor $37,696= 1,488 units 7.6 workers Cost of increasing daily production rate (= $300 per unit x $40 per (hiring and training)
day x 124 days) unit)
Cost of decreasing daily production rate (= $600 per unitx $10 per Subcontracting 14,880 1,488 units (layoffs)
Table 13.3

Total cost

$52,576
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Possible Strategy 3
Hiring and firing

Month Jan Feb Mar Apr May June

Expected Demand 900 700 800 1,200 1,500 1,100 6,200

Production Days 22 18 21 21 22 20 124

Demand Per Day (computed) 41 39 38 57 68 55

Production = Expected Demand

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Possible Strategy 3
Production rate per working day

70

Forecast demand and monthly production

60
50 40 30

0 Jan

Feb

Mar

Apr

May

June

= Month = Number of working days

38

22

18

21

21

22

20

Possible Strategy 3
Cost Information
Inventory carrying cost Subcontracting cost per unit Average pay rate Overtime pay rate Labor-hours to produce a unit Cost of increasing daily production rate (hiring and training) Cost of decreasing daily production rate (layoffs) $ 5 per unit per month $10 per unit

$ 5 per hour ($40 per day) $ 7 per hour (above 8 hours per day) 1.6 hours per unit
$300 per unit $600 per unit

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Possible Strategy 3
Basic Production Cost (demand x 1.6 hrs/unit x $5/hr) $ 7,200 5,600 Extra Cost of Increasing Production (hiring cost) Extra Cost of Decreasing Production (layoff cost) $1,200 (= 2 x $600) $600 (= 1 x $600) $7,800 (= 13 x $600) $9,600

Month Jan Feb

Forecast (units) 900 700

Daily Prod Rate 41 39

Total Cost $ 7,200 6,800

Mar
Apr May June

800
1,200 1,500 1,100

38
57 68 55

6,400
9,600 12,000 8,800 $49,600

$5,700 (= 19 x $300) $3,300 (= 11 x $300) $9,000

7,000
15,300 15,300 16,600 $68,200

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Comparison of Three Strategies

Cost Inventory carrying Regular labor Overtime labor Hiring Layoffs Subcontracting Total cost Plan 1 $ 9,250 49,600 0 0 0 0 $58,850 Plan 2 $ 0 Plan 3 $ 0

37,696 0 0 0 14,880 $52,576

49,600 0 9,000 9,600 0 $68,200

Plan 2 is the lowest cost option

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Example 2:Unit Demand & Cost Data

Suppose we have the following unit demand and cost information:
Demand/mo Jan 4500 Feb 5500 Mar 7000 Apr 10000 May 8000 Jun 6000

Materials Holding costs Marginal cost of stockout Hiring and training cost Layoff costs Labor hours required Straight time labor cost Beginning inventory Productive hours/worker/day Paid straight hrs/day

$5/unit $1/unit per mo. $1.25/unit per mo. $200/worker $250/worker .15 hrs/unit $8/hour 250 units 7.25 8

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Given the demand and cost information below, what are the aggregate hours/worker/month, units/worker, and dollars/worker?
Demand/mo Jun Jan Feb Mar Apr May

7.25x2 2

Productive hours/worker/day 4500 5500 7000 6000 Paid straight hrs/day

22x8hrsx$8=$140 Jan 8
Days/mo Hrs/worker/mo Units/worker $/worker 22 159.5 1063.33 $1,408 Feb 19 137.75 918.33 1,216

7.25 10000 8000 8

7.25/0.15=48.33 & 48.33x22=1063.33
Apr 21 152.25 1015 1,344 May 22 159.5 1063.33 1,408 Jun 20 145 966.67 1,280
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Mar 21 152.25 1015 1,344

Mixing Option: Chase Strategy

Jan 22 1 5 9 .5 1 ,0 6 3 .3 3 $ 1 ,4 0 8

Lets assume our current workforce is 7 workers.

Days/m o Hrs/wo rker/m o Units/wo rker $ /wo rker

First, calculate net requirements for production, or 4500-250=4250 units

Dem and Beg. inv. Net req. Req. wo rkers Hired Fired W o rkfo rce Ending invento ry

Jan 4 ,5 0 0 250 4 ,2 5 0 3 .9 9 7 3 4 0

Then, calculate number of workers needed to produce the net requirements, or 4250/1063.33=3.997 or 4 workers
Finally, determine the number of workers to hire/fire. In this case we only need 4 workers, we have 7, so 3 can be fired.
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Below are the complete calculations for the remaining months in the six month planning horizon
Days/mo Hrs/worker/mo Units/worker $/worker Jan 22 159.5 1,063 $1,408 Feb 19 137.75 918 1,216 Mar 21 152.25 1,015 1,344 Apr 21 152.25 1,015 1,344 May 22 159.5 1,063 1,408 Jun 20 145 967 1,280

Demand Beg. inv. Net req. Req. workers Hired Fired Workforce Ending inventory

Jan 4,500 250 4,250 3.997 3 4 0

Feb 5,500 5,500 5.989 2 6 0

Mar 7,000 7,000 6.897 1 7 0

Apr 10,000 10,000 9.852 3 10 0

May 8,000 8,000 7.524 2 8 0

Jun 6,000 6,000 6.207 1 7 0

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Below are the complete calculations for the remaining months in the six month planning horizon with the other costs included
Demand Beg. inv. Net req. Req. workers Hired Fired W orkforce Ending inventory Jan 4,500 250 4,250 3.997 3 4 0 Feb 5,500 5,500 5.989 2 6 0 Mar 7,000 7,000 6.897 1 7 0 Apr 10,000 10,000 9.852 3 10 0 May 8,000 8,000 7.524 2 8 0 Jun 6,000 6,000 6.207 1 7 0

Material Labor Hiring cost Firing cost

Jan Feb Mar Apr May Jun $21,250.00 $27,500.00 $35,000.00 $50,000.00 $40,000.00 $30,000.00 5,627.59 7,282.76 9,268.97 13,241.38 10,593.10 7,944.83 400.00 200.00 600.00 750.00 500.00 250.00

Costs 203,750.00 53,958.62 1,200.00 1,500.00

$260,408.62

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Mixing Option: Level Strategy

Surplus and Storage allowed
Lets take the same problem as before but this time use the Level Workforce strategy This time we will seek to use a workforce level of 6 workers

Demand Beg. inv. Net req. W orkers P roduction Ending inventory Surplus Shortage

Jan 4,500 250 4,250 6 6,380 2,130 2,130

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Below are the complete calculations for the remaining months in the six month planning horizon
Jan 4,500 250 4,250 6 6,380 2,130 2,130 Feb 5,500 2,130 3,370 6 5,510 2,140 2,140 Mar 7,000 2,140 4,860 6 6,090 1,230 1,230 Apr 10,000 1,230 8,770 6 6,090 -2,680 2,680 May 8,000 -2,680 10,680 6 6,380 -1,300 1,300 Jun 6,000 -1,300 7,300 6 5,800 -1,500 1,500

Demand Beg. inv. Net req. Workers Production Ending inventory Surplus Shortage

Note, if we recalculate this sheet with 7 workers we would have a surplus

48

Below are the complete calculations for the remaining months in the six month planning horizon with the other costs included
Jan 4,500 250 4,250 6 6,380 2,130 2,130 Feb 5,500 2,130 3,370 6 5,510 2,140 2,140 Mar 7,000 10 4,860 6 6,090 1,230 1,230 Apr 10,000 -910 8,770 6 6,090 -2,680 2,680 Jan $8,448 31,900 2,130 Feb $7,296 27,550 2,140 Mar $8,064 30,450 1,230 Apr $8,064 30,450 3,350 May 8,000 -3,910 10,680 6 6,380 -1,300 1,300 May $8,448 31,900 1,625 Jun 6,000 -1,620 7,300 6 5,800 -1,500 1,500 Jun $7,680 29,000 1,875

Note, total costs under this strategy are less than Chase at $260.408.62
$48,000.00 181,250.00 5,500.00 6,850.00 $241,600.00
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Labor Material Storage Stockout

Mathematical Approaches
Useful for generating strategies
Transportation Method of Linear Programming
Produces an optimal plan

Management Coefficients Model

Model built around managers experience and performance

Other Models
Linear Decision Rule Simulation
50

Transportation Method
Demand Capacity: Regular Overtime Subcontracting Beginning inventory Regular time Overtime Subcontracting Carrying Costs $40 $50 $70 $2 Sales Period Mar Apr May 800 1,000 750 700 700 50 50 150 150 100 tires per tire per tire per tire per tire per month
51

700 50 130

Transportation Example
Important points
1. Carrying costs are $2/tire/month. If goods are made in one period and held over to the next, holding costs are incurred 2. Supply must equal demand, so a dummy column called unused capacity is added 3. Because back ordering is not viable in this example, cells that might be used to satisfy earlier demand are not available
52

Transportation Example
Important points
4. Quantities in each column designate the levels of inventory needed to meet demand requirements

5. In general, production should be allocated to the lowest cost cell available without exceeding unused capacity in the row or demand in the column

53

Transportation Example

54

Management Coefficients Model

Builds a model based on managers experience and performance
A regression model is constructed to define the relationships between decision variables Objective is to remove inconsistencies in decision making
55

Other Models
Linear Decision Rule
Minimizes costs using quadratic cost curves Operates over a particular time period

Simulation
Uses a search procedure to try different combinations of variables Develops feasible but not necessarily optimal solutions
56

Summary of Aggregate Planning Methods

Techniques Solution Approaches Important Aspects

Graphical methods

Trial and error

Simple to understand and easy to use. Many solutions; one chosen may not be optimal.
LP software available; permits sensitivity analysis and new constraints; linear functions may not be realistic.

Transportation Optimization method of linear programming

57

Summary of Aggregate Planning Methods

Techniques Management coefficients model Solution Approaches Heuristic Important Aspects Simple, easy to implement; tries to mimic managers decision process; uses regression.

Simulation

Change parameters

Complex; may be difficult to build and for managers to understand.

58

Aggregate Planning in Services

Controlling cost of labor is critical & involves
1. Accurate scheduling of labor-hours to assure quick response to customer demand 2. An on-call labor resource unexpected demand to cover

3. Flexibility of individual worker skills that permits relocation of available worker 4. Individual worker Flexibility in rate of output or hours of work to meet demand.
59

Few Service Scenarios

Restaurants (highly variable demand)
Smoothing the production process (or production rate) Determining the optimal workforce size

Hospitals
Responding to patient demand
60

Few Service Scenarios

Airline industry
Extremely complex planning problem Involves number of flights, number of passengers, air and ground personnel, allocation of seats to fare classes

Resources spread through the entire system

61

Few Service Scenarios

Miscellaneous Services (such as financial, transportation, recreation services etc.)
Plan human resource requirements

Manage demand

62

Yield Management
It is the aggregate planning process for allocating resources to customers at prices that will maximize yield or revenue
1. Service or product can be sold in advance of consumption 2. Demand fluctuates 3. Capacity is relatively fixed 4. Demand can be segmented 5. Variable costs are low and fixed costs are high
63

Yield Management: An Example

Room sales
100

Demand Curve Potential customers exist who are willing to pay more than the $15 variable cost of the room

Passed-up contribution Total 50 $ contribution = (Price) x (50 rooms) = ($150 - $15) x (50) = $6,750 $15 Variable cost of room

Some customers who paid $150 were actually willing to pay more for the room

Money left on the table $150 Price charged for room Price
64

Yield Management: An Example

Room sales
100

Demand Curve
Total $ contribution = (1st price) x 30 rooms + (2nd price) x 30 rooms = ($100 - $15) x 30 + ($200 - $15) x 30 = $2,550 + $5,550 = $8,100

60

30

$15 Variable cost of room

$100 Price 1 for room

$200 Price 2 for room

Price
65

Yield Management Matrix

Price
Tend to be fixed Predictable Quadrant 1: Movies Stadiums/arenas Convention centers Hotel meeting space Quadrant 3: Restaurants Golf courses Internet service providers Tend to be variable Quadrant 2: Hotels Airlines Rental cars Cruise lines Quadrant 4: Continuing care hospitals

Duration of use

Unpredictable

66

Making Yield Management Work

1. Multiple pricing structures must be feasible and appear logical to the customer. 2. Forecasts of the use and duration of use.

3. Changes in demand
67