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Aggregate Planning
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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