Objectives of Chapters 7,8

Planning Demand and Supply in a SC: (Ch7, 8, 9)

– Ch7 Describes methodologies that can be used to
forecast future demand based on historical data.
– Ch8 Describes the aggregate planning
methodology used to plan production, distribution
and allocate resources for the near future, by
making trade-offs among capacity, inventory and
backlogged orders across the entire SC.
– Ch9 Describes how pricing and promotions can
be planned to manage customer demand in
coordination with production and distribution.

© 2007 Pearson Education 8-1

 Supply Chain Management
(3rd Edition)

Chapter 8
Aggregate Planning
in the Supply Chain

© 2007 Pearson Education 8-2

 Outline

Role of aggregate planning in a supply chain

The aggregate planning problem

Aggregate planning strategies

Implementing aggregate planning in practice

© 2007 Pearson Education 8-3

 Role of Aggregate Planning
in a Supply Chain

Capacity has a cost, lead times are greater than zero

Aggregate planning:
– process by which a company determines ideal levels of
capacity, production, subcontracting, inventory, stockouts,
and pricing over a specified time horizon
– goal is to maximize profit and satisfy demand
– 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?

© 2007 Pearson Education 8-4

 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
© 2007 Pearson Education 8-5
 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 (In general
months or quarters)

Specify key information required to develop an
aggregate plan
© 2007 Pearson Education 8-6
 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.

Constraints from suppliers to the entreprise

© 2007 Pearson Education 8-7

 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
© 2007 Pearson Education 8-8
 Fundamental Tradeoffs in
Aggregate Planning

Capacity (regular time, overtime, subcontract)

Inventory

Backlog / lost sales because of delay

– The cost of each one is negatively correlated with the

combined cost of the other two.
– AP is about achieving balance between these costs and
making the most profitable combination of trade-offs.

© 2007 Pearson Education 8-9

 Aggregate Planning Strategies

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 or tailored strategy – a combination of one
or more of the first three strategies

© 2007 Pearson Education 8-10

 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
© 2007 Pearson Education 8-11
 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
© 2007 Pearson Education 8-12
 Chase Demand

Demand

Production
Units

Time

© 2007 Pearson Education 8-13

 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
© 2007 Pearson Education 8-14
 Level Production

Demand

Production
Units

Time

© 2007 Pearson Education 8-15

 Aggregate Planning at
Red Tomato Tools

Month Demand Forecast

January 1,600
February 3,000
March 3,200
April 3,800
May 2,200
June 2,200

© 2007 Pearson Education 8-16

 Aggregate Planning
Item Cost
Materials $10/unit
Inventory holding cost $2/unit/month
Marginal cost of a stockout $5/unit/month
Hiring and training costs $300/worker
Layoff cost $500/worker
Labor hours required 4/unit
Regular time cost $4/hour
Over time cost $6/hour
Cost of subcontracting $30/unit

© 2007 Pearson Education 8-17

 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 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
© 2007 Pearson Education 8-18
 Aggregate Planning
(Define Objective Function)
6 6
Min ∑ 640 W t + ∑ 300 H t
t =1 t =1
6 6 6
+ ∑ 500 Lt + ∑ 6 Ot + ∑ 2 I t
t =1 t =1 t =1
6 6 6
+ ∑ 5 S t + ∑10 Pt + ∑ 30 C t
t =1 t =1 t =1

© 2007 Pearson Education 8-19

 Aggregate Planning (Define
Constraints Linking Variables)

Workforce size for each month is based on hiring
and layoffs

W t = W t −1 + H t − L t, or
W t − W t −1 − H t + L t = 0
for t = 1,..., 6, where W 0 = 80 .
© 2007 Pearson Education 8-20
 Aggregate Planning (Constraints)

Production for each month cannot exceed capacity

P t ≤ 40 W t + O t 4 ,
40 W t + O t 4 − P t ≥ 0,
for t = 1,..., 6.
© 2007 Pearson Education 8-21
 Aggregate Planning (Constraints)

Inventory balance for each month

I t −1 + P t + C t = D t + S t −1 + I t − S t ,
I t −1 + P t + C t − D t − S t −1 − I t + S t = 0,
for t = 1,..., 6,where I 0 = 1,000,
S 0 = 0,and I 6 ≥ 500 .
© 2007 Pearson Education 8-22
 Aggregate Planning (Constraints)

Over time for each month

O t ≤ 10 W t,
10 W t − O t ≥ 0,
for t = 1,..., 6.

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 Scenarios

Increase in holding cost (from $2 to $6)

Overtime cost drops to $4.1 per hour

Increased demand fluctuation

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 Increased Demand Fluctuation

Month Demand Forecast

January 1,000
February 3,000
March 3,800
April 4,800
May 2,000
June 1,400

© 2007 Pearson Education 8-25

 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

© 2007 Pearson Education 8-26

 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?
© 2007 Pearson Education 8-27