Aggregate Planning

Aggregate Planning

Planning Tasks and Horison

Capacity planning

Capacity is the maximum output rate of a

production or service facility

Capacity planning is the process of establishing

the output rate that may be needed at a facility:

– Capacity is usually purchased in “chunks”

– Strategic issues: how much and when to

spend capital for additional facility &

equipment

– Tactical issues: workforce & inventory levels, &

day-to-day use of equipment

Measuring Capacity Examples

There is no one best way to measure capacity

Output measures like kegs per day are easier to understand

With multiple products, inputs measures work better

Type of BusinessInput Measures of

Capacity

Output Measures

of Capacity

Car manufacturer Labor hours Cars per shift

Hospital Available beds Patients per month

Pizza parlor Labor hours Pizzas per day

Retail storeFloor space in

square feetRevenue per foot

Capacity Information Needed

Design capacity:

– Maximum output rate under ideal conditions

– A bakery can make 30 custom cakes per day when pushed at holiday time

Effective capacity:

– Maximum output rate under normal (realistic) conditions

– On the average this bakery can make 20 custom cakes per day

Calculating Capacity Utilization

Measures how much of the available capacity is

actually being used:

– Measures effectiveness

– Use either effective or design capacity in

denominator

100%capacity

rateoutput actualnUtilizatio

Example of Computing Capacity Utilization: In the bakery example the

design capacity is 30 custom cakes per day. Currently the bakery is producing

28 cakes per day. What is the bakery’s capacity utilization relative to both

design and effective capacity?

93%(100%)30

28(100%)

capacity design

output actual nUtilizatio

140%(100%)20

28(100%)

capacity effective

output actual nUtilizatio

design

effective

The current utilization is only slightly below its design capacity and considerably above its effective capacity

The bakery can only operate at this level for a short period of time

How Much Capacity Is Best?

The Best Operating Level is the output than results in the lowest average unit cost

Economies of Scale:

– Where the cost per unit of output drops as volume of output increases

– Spread the fixed costs of buildings & equipment over multiple units, allow bulk purchasing & handling of material

Diseconomies of Scale:

– Where the cost per unit rises as volume increases

– Often caused by congestion (overwhelming the process with too much work-in-process) and scheduling complexity

Best Operating Level and Size

Alternative 1: Purchase one large facility, requiring one large

initial investment

Alternative 2: Add capacity incrementally in smaller chunks as

needed

Implementing Capacity

Decisions

Capacity flexibility

– Plant, process, workers, outsourcing

Amount of capacity cushion

– important in -to-order and services

Timing the capacity change

– Leading [proactive]

– Concurrent [neutral]

– Lagging [reactive]

Size of the capacity increment

Timing the Capacity Change

Making Capacity Planning Decisions

The three-step procedure for making

capacity planning decisions is as

follows:

– Step 1: Identify Capacity Requirements

– Step 2: Develop Capacity Alternatives

– Step 3: Evaluate Capacity Alternatives

Evaluating Capacity Alternatives

Could do nothing, or expand large now, or

expand small now with option to add later

Use Decision Trees analysis tool:

– A modeling tool for evaluating sequential

decisions

– Identify the alternatives at each point in time

(decision points), estimate probable consequences

of each decision (chance events) & the ultimate

outcomes (e.g.: profit or loss)

Efficiency and Utilization

Actual output Efficiency = Effective capacity Actual output Utilization = Design capacity

Both measures expressed as percentages

Efficiency/Utilization Example

Actual output = 36 units/day Efficiency = =

90% Effective capacity 40 units/ day Utilization = Actual output = 36 units/day =

72% Design capacity 50 units/day

Design capacity = 50 trucks/day

Effective capacity = 40 trucks/day

Actual output = 36 units/day

90.00%

72.00%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

90.00%

100.00%

Efficiency Utilization

Efficiency vs Utilization

Utilization Example

Best operating level = 120 units/week

Actual output = 83 units/week

Utilization = ? .692

units/wk 120

units/wk 83 =

level operating Best

used Capacity n Utilizatio

Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, Shifts/day = 3, Hours/shift = 8

Design capacity = (7 x 3 x 8) x (1,200)

= 201,600 rolls/week

Measuring capacity Ex.

Utilization = 148,000/201,600 = 73.4%

Efficiency = 148,000/175,000 = 84.6%

Facilities (size, location, layout, heating, lighting, ventilations)

Product and service factors (similarity of products)

Process factors (productivity, quality)

Human factors (training, skills, experience, motivations,

absentation, turnover)

Policy factors (overtime system, no. of shifts)

Operational factors (scheduling problems, purchasing

requirements, inventory shortages)

Supply chain factors (warehousing, transportation,

distribution)

External factors (product standards, government agencies,

pollution standard)

Determinants of Effective Capacity

Estimate future capacity requirements

Evaluate existing capacity

Identify alternatives

Conduct financial analysis for each alt.

Assess key qualitative issues for each alt.

Select one alternative

Implement alternative chosen

Monitor results

Steps for Capacity Planning

Calculating Processing

Requirements

Determine type of products or services

Forecast for the Demand

Determine the process requirements

•The standard processing time / unit of

product

•The number of workdays / year

•The number shifts that will be used

Product

Annual

Demand

Standardprocessing time

per unit (hr.)

Processing time

needed (hr.)

#1

#2

#3

400

300

700

5.0

8.0

2.0

2,000

2,400

1,400 5,800

Calculating Processing Requirements

A dept. works 8-hour shift, 250 days/year

annual capacity is 250*8 = 2000 hours,

number of machines required = 5,800 hours/2,000 hours = 2.90 machines

then we need three machines to handle the required volume

In-House or Outsourcing

1. Available capacity (equip.,skills,time)

2. Expertise

3. Quality considerations (labs, inspect.)

4. Nature of demand (high, steady)

5. Cost (fixed, savings)

6. Risk

Outsource: obtain a good or service completely or partially

from an external provider

Make or Buy ?

A firm’s manager must decide whether to make or buy a

certain item used in the production of vending machines ,

making the item would involve annual lease costs of

$150000 . Cost and volume estimates are as follows:

•Should the firm make or buy ?

•If the volume changed , at what volume would the

manager be indifferent between making and buying ?

Buy Make

None $150000 Annual fixed cost

$80 $60 Variable cost/unit

12000 12000 Annual volume (units)

EX.

Make or Buy ?

• Total cost = Fixed cost + (Volume * Variable cost)

in case of make = $150000 + (12000*60) = $870000

in case of buy = 0 + (12000*80) = $960000

TCost (make) < TCost (buy)

So the solution is “Make”

• Tcost(make) = Tcost(buy)

$150000 + Q*60 = 0 + Q*80

Q = 7500 unit

Sol.

Make or Buy ?

Q

Determinants of Effective Capacity

• Facilities

• Product and service factors

• Process factors ( output quality )

• Human factors

• Operational factors ( late delivery for the raw materials )

• Supply chain factors

• External factors

Key Decisions of Capacity Planning

1. Amount of capacity needed

2. Timing of changes

3. Need to maintain balance

4. Extent of flexibility of facilities

Capacity cushion – extra demand intended to offset uncertainty

Steps for Capacity Planning 1. Estimate future capacity requirements

2. Evaluate existing capacity

3. Identify alternatives

4. Conduct financial analysis

5. Assess key qualitative issues

6. Select one alternative

7. Implement alternative chosen

8. Monitor results

Make or Buy

1. Available capacity

2. Expertise

3. Quality considerations

4. Nature of demand

5. Cost

6. Risk

Example 2

Example 3

• A manager must decide which type of equipment to buy , type A or type B. type A equipment costs $15000 each and type B costs $ 11000. the equipment can be operated 8 hours a day ,250 days a year.

• Either machine can be used to perform two types of chemical analysis C1 and C2 annual service requirement and processing times are shown in the following table.

• Which type of equipment should be purchased and how many of that type will be need ? The goal is to minimize total purchase cost.

Total processing time ( annual volume × processing time per analysis ) needed by

type of equipment.

Processing

time per

analysis ( HR)

Processing

time per

analysis ( HR)

Analysis type Annual volume A B

C1

C2

1200

900

1

3

2

2

Analysis type

A

B

C1

C2

1200

2700

2400

1800

3900 4200

Solution:

• Total processing time available per price of equipment is 8 hours/day × 250 days/year =2000

• Hence , one piece can handle 2000 hours of analysis ,two pieces of equipment can handle 4000 hours and so on.

• Given the total processing requirement two of type A would be needed for a total cost of 2 × 15000=30000 or three of type B for a total cost of 3× 11000=33000 thus two pieces of type A would have sufficient capacity to Handle the load at lower cost than three of type B

Planning Service Capacity

Need to be near customers

– Capacity and location are closely tied

Inability to store services

– Capacity must be matched with timing of

demand

Degree of volatility of demand

– Peak demand periods

Assumptions of Cost-Volume Analysis

1. One product is involved

2. Everything produced can be sold

3. Variable cost per unit is the same regardless of volume

4. Fixed costs do not change with volume

5. Revenue per unit constant with volume

6. Revenue per unit exceeds variable cost per unit

Financial Analysis

Cash Flow - the difference between

cash received from sales and other

sources, and cash outflow for labor,

material, overhead, and taxes.

Present Value - the sum, in current

value, of all future cash flows of an

investment proposal.

Meet demand

(Sales Forecast)

Use capacity efficiently

Meet inventory policy

Minimize cost

– Labor

– Inventory

– Plant & equipment

– Subcontract

Aggregate Planning Goals

Aggregate Planning Strategies Pure Strategies

Demand Options — change demand:

influencing demand (e.g. change price)

backordering during high demand periods

counterseasonal product mixing

Aggregate Planning Strategies Pure Strategies

Capacity Options — change capacity:

changing inventory levels

varying work force size by hiring or layoffs

varying production capacity through

overtime or idle time

subcontracting (aka “outsourcing”)

using part-time workers

Aggregate Scheduling Options - Advantages and Disadvantages

Option Advantage Disadvantage Some Comments

Changing inventory levels

Changes in human resources are gradual, not abrupt production changes

Inventory holding costs; Shortages may result in lost sales

Applies mainly to production, not service operations

Varying workforce size by hiring or layoffs

Avoids use of other alternatives

Hiring, layoff, and training costs

Used where size of labor pool is large

Option Advantage Disadvantage Some Comments

Varying production rates through overtime or idle time

Matches seasonal fluctuations without hiring/training costs

Overtime premiums, tired workers, may not meet demand

Allows flexibility within the aggregate plan

Subcontracting Permits flexibility and smoothing of the firm's output

Loss of quality control; reduced profits; loss of future business

Applies mainly in production settings

Advantages/Disadvantages - continued

Advantages/Disadvantages - continued

Option Advantage Disadvantage Some Comments

Using part-time workers

Less costly and more flexible than full-time workers

High turnover/training costs; quality suffers; scheduling difficult

Good for unskilled jobs in areas with large temporary labor pools

Influencing demand

Tries to use excess capacity. Discounts draw new customers.

Uncertainty in demand. Hard to match demand to supply exactly.

Creates marketing ideas. Overbooking used in some businesses.

Advantage/Disadvantage - continued

Option Advantage Disadvantage Some Comments

Back ordering during high- demand periods

May avoid overtime. Keeps capacity constant

Customer must be willing to wait, but goodwill is lost.

Many companies backlog.

Counterseasonal products and service mixing

Fully utilizes resources; allows stable workforce.

May require skills or equipment outside a firm's areas of expertise.

Risky finding products or services with opposite demand patterns.

The Extremes

Level

Strategy

Chase

Strategy

Production

equals sales

forecast

Production rate

is constant

Level scheduling strategy

– Produce same amount every day

– Keep work force level constant

– Vary non-work force capacity or demand options

– Often results in lowest production costs

Chase scheduling strategy

– Vary the amount of production to match (chase) the sales forecast

– This requires changing the workforce (hiring & firing)

Mixed strategy

– Combines 2 or more aggregate scheduling options

Aggregate Planning Strategies

The Trial & Error Approach to Aggregate Planning

Forecast the demand for each period

Determine the capacity for regular time, overtime, and subcontracting, for each period

Determine the labor costs, hiring and firing costs, and inventory holding costs

Consider company policies which may apply to the workers, overtime, outsourcing, or to inventory levels

Develop alternative plans, and examine their total costs

The IDES Sales Forecast for 2003

Unit Sales Forecast

For 2003

Quarter 1 307,200

Quarter 2 379,200

Quarter 3 360,000

Quarter 4 489,600

Total 1,536,000

IDES Manufacturing Example IDES Manufacturing wants to compare the

annual (year 2003) costs associated with

scheduling using the following three (3)

options:

Option 1 – Maintain a constant work force

during the entire year (Level).

Option 2 – Maintain the present work force of

150 and use overtime and sub-contracting as

needed (Mixed)

Option 3 – Hire/layoff workers as needed to

produce the required output (Chase).

IDES Cost Information Inventory Carrying Cost

(per quarter) $ 0.50/unit

Subcontracting cost $ 7/unit

Pay rate – regular time $20/hr

Pay rate – overtime $30/hr

Labor standard per unit 0.2 hrs

Cost to increase production $ 3/unit

Cost to decrease production $ 2/unit

IDES has 0 units in inventory

Each Quarter has 60 working days

At end of 2002, IDES has 150 prod. workers

IDES Policy – Maximum of 72,000 units/qtr produced

using overtime

Option 1 – Constant Workforce

without overtime or subcontracting

First, determine the number of workers

required to produce the units forecast for

2003.

Ave. Prod/day = 1,536,000 = 6,400/day

240 days

Then determine how many workers are

needed.

Workers needed = 6,400/day = 160

5 units/hr X 8 hrs

Option 1 Continued:

Calculate Inventory Carrying Costs

Qtr Production

@ 6400/day

Sales

Forecast

Inventory

Change

Ending

Inventory

1 384,000 307,200 +76,800 76,800

2 384,000 379,200 + 4,800 81,600

3 384,000 360,000 +24,000 105,600

4 384,000 489,600 -105,600 0

Total 1,536,000 1,536,000 264,000

Option 1 Continued:

Calculation of Annual Costs

Inventory carrying cost:

264,000 units X $0.50/unit = $ 132,000

Cost to increase capacity:

(384,000-360,000) units X $5/unit = $ 120,000

Regular time labor cost:

1,536,000 units X $4/unit = $6,144,000

Total Annual Cost for Option 1 = $6,396,000

Option 2 – Present Workforce (150) using

O/T & subcontracting

Qtr Sales

Forecast

In-house

Production

Inv

Change

End

Inv

Units

Req’d

O/T Out

Source

1 307,200 360,000 +52,800 52,800 0 0 0

2 379,200 360,000 -19,200 33,600 0 0 0

3 360,000 360,000 0 33,600 0 0 0

4 489,600 360,000 -33,600 0 96,000 72,000 24,000

Tot

al

1,536,000 1,440,000 0 72,000 24,000

Option 2 Continued:

Calculation of Annual Costs

Inventory Carrying Costs

120,000 units X $.50/unit = $ 60,000

Regular time labor (150 workers)

$4/unit X 1,440,000 units = $5,760,000

Overtime labor

$6/unit X 72,000 units = $ 432,000

Out-sourcing

$7/unit X 24,000 units = $ 168,000

Total Annual Costs for Option 2 = $6,420,000

Option 3 – Vary Production

(Workforce) to match Sales Forecast

Qtr

Sales

Forecast

Beginning

Capacity

Capacity

Change

Needed

Cost of

Capacity

Change

1 307,200 360,000 -52,800 $105,600

2 379,200 307,200 +72,000 216,000

3 360,000 379,200 -19,200 38,400

4 489,600 360,000 +129,600 388,800

Total 1,536,000 $748,800

Option 3 Continued

Calculation of Annual Costs

Regular time labor costs

1,536,000 units X $4/unit = $6,144,000

Capacity Change Costs = $ 748,800

Total Annual Cost - Option 3 = $6,892,800

Annual Cost Comparison of the

Aggregate Scheduling Strategies

Option Annual Cost

1. Level – No use of O/T or

Outsourcing

$6,396,000

2. Mixed – Present work

force w/ O/T & Outsourcing

$6,420,000

3. Chase – Vary Production

(workforce)

$6,892,800

Homework Problem – Due at the

beginning of class Tuesday March 11

Use the Revised IDES Cost information shown on the following two slides to evaluate the following scheduling options:

Level Strategy

Chase Strategy

Maintain Present work force and use overtime production and sub-contracting as needed

The IDES Sales Forecast for 2003 Revised

Unit Sales Forecast

For 2003

Quarter 1 388,000

Quarter 2 440,000

Quarter 3 400,000

Quarter 4 500,000

Total 1,728,000

IDES Cost Information - Revised Inventory Carrying Cost

(per quarter) $ 0.75/unit

Subcontracting cost $ 7.50/unit

Pay rate – regular time $20/hr

Pay rate – overtime $30/hr

Labor standard per unit 0.2 hrs

Cost to increase production $ 1.50/unit

Cost to decrease production $ 1/unit

IDES has 0 units in inventory

Each Quarter has 60 working days

At end of 2000, IDES has 140 prod. workers

IDES Policy – Maximum of 78,000 units/qtr produced

using overtime