IHE 890

Engineering Supply Chain Systems

Instructor: Pratik J. Parikh, Ph.D.

April 21, 2011

1
 Network
Design
Demand
Forecast
Strategic

Resource Aggregate Production

Planning Planning

Rough-cut Capacity Master Production

Planning Scheduling Tactical
Bills of
Material
Material Requirements
Planning
Inventory
Status
Job Capacity Requirements
Pool Planning

Job Routing
Release Data

Job
Dispatching
Operational
Hopp and Spearman, Factory Physics
7-2
 Outline
 Role of aggregate planning in a supply chain
 The aggregate planning problem
 Aggregate planning strategies
 Implementing aggregate planning in practice

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 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 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?

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 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
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 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
 Specify key information required to develop an
aggregate plan

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 8-6

 Information Needed for
an Aggregate Plan
 Parameters:
–  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
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 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
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 8-8
 Aggregate Planning Strategies
 Trade-off between capacity, inventory, backlog/
lost sales
 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 strategy – a combination of one or more of
the first three strategies

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 8-9

 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

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 8-10

 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, lower utilization
  Should be used when inventory holding costs are high and
capacity is relatively inexpensive

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 8-11

 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

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 8-12

 Fundamental Tradeoffs in
Aggregate Planning

 Trade-off
–  Capacity (regular time, overtime, subcontract)
–  Inventory
–  Backlog / lost sales
 Strategies
–  Chase strategy
–  Time flexibility from workforce or capacity
–  Level strategy

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 8-13

 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

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 8-14

 Aggregate Planning at Red
Tomato Tools
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

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 8-15

 Aggregate Planning at Red Tomato Tools
(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

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 8-16

 Aggregate Planning at Red Tomato Tools
(Define Objective Function)

6 6
Min∑ 640Wt + ∑ 300 H t
t =1 t =1
6 6 6
+ ∑ 500 Lt + ∑ 6Ot + ∑ 2 I t
t =1 t =1 t =1
6 6 6
+ ∑ 5S t + ∑ 10 Pt + ∑ 30Ct
t =1 t =1 t =1

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 8-17

 Aggregate Planning at Red Tomato tools
(Define Constraints Linking Variables)

 Workforce size for each month is based on hiring

and layoffs What if it is a unionized labor,
so can t hire/fire easily?
W =W t t −1
+ H t − Lt, Time-flexible strategy
for t = 1,...,6, where W0 = 80.

 Production for each month cannot exceed capacity

Pt ≤ 40Wt + Ot / 4,
for t = 1,...,6.

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 8-18

 Aggregate Planning at Red Tomato Tools
(Constraints)

 Inventory balance for each month

I t −1
+ P t
+ Ct = Dt
+ S t −1 + I t
− St ,
for t = 1,...,6,where I 0
= 1,000,

S 0
= 0,and I 6
≥ 500.
What if stock-out is
not allowed?
 Over time for each month
Assumptions
O ≤ 10W ,
t t 1.  Employees are identical
2.  No disruptions
for t = 1,...,6. 3.  Hiring and firing each month
Avg Inventory?
Avg flow time?
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 Scenarios
 Increase in holding cost (from $2 to $6)
 Overtime cost drops to $4.1 per hour
 Increased demand fluctuation

Excel Sheet!

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 8-20

 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

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 8-21

 The Role of Sourcing
in a Supply Chain
 Sourcing is the set of business processes required
to purchase goods and services
 Sourcing processes include:
–  Supplier scoring and assessment
–  Supplier selection and contract negotiation
–  Design collaboration
–  Procurement
–  Sourcing planning and analysis

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 14-22

 Benefits of Effective
Sourcing Decisions
  Better economies of scale can be achieved if orders
are aggregated
  More efficient procurement transactions can
significantly reduce the overall cost of purchasing
  Design collaboration can result in products that are
easier to manufacture and distribute, resulting in
lower overall costs
  Good procurement processes can facilitate
coordination with suppliers
  Appropriate supplier contracts can allow for the
sharing of risk
  Firms can achieve a lower purchase price by
increasing competition through the use of auctions
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 14-23
 Supplier Assessment Factors
  Replenishment Lead Time   Pricing Terms
  On-Time Performance   Information Coordination
  Supply Flexibility Capability
  Delivery Frequency /   Design Collaboration
Minimum Lot Size Capability
  Supply Quality   Exchange Rates, Taxes,
  Inbound Transportation Cost Duties
  Supplier Viability

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 14-24

 Supplier Selection- Auctions and
Negotiations
  Supplier selection can be performed through competitive
bids, reverse auctions, and direct negotiations
  Supplier evaluation is based on total cost of using a
supplier
  Auctions:
–  Sealed-bid first-price auctions
–  English auctions
–  Dutch auctions
–  Second-price (Vickery) auctions

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 14-25

 Contracts and Supply Chain
Performance

 Contracts for Product Availability and Supply

Chain Profits
–  Buyback Contracts
–  Revenue-Sharing Contracts
–  Quantity Flexibility Contracts
 Contracts to Coordinate Supply Chain Costs
 Contracts to Increase Agent Effort
 Contracts to Induce Performance Improvement

Mathematical expressions in the text

--- not part of the course!
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 14-26
 Contracts for Product Availability and
Supply Chain Profits: Buyback Contracts
  Allows a retailer to return unsold inventory up to a
specified amount at an agreed upon price
  Increases the optimal order quantity for the retailer,
resulting in higher product availability and higher profits
for both the retailer and the supplier
  Most effective for products with low variable cost, such as
music, software, books, magazines, and newspapers
  Downside is that buyback contract results in surplus
inventory that must be disposed of, which increases supply
chain costs
  Can also increase information distortion through the supply
chain because the supply chain reacts to retail orders, not
actual customer demand
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 14-27
 Contracts for Product Availability and Supply
Chain Profits: Revenue Sharing Contracts

 The buyer pays a minimal amount for each unit

purchased from the supplier but shares a fraction of
the revenue for each unit sold
 Decreases the cost per unit charged to the retailer,
which effectively decreases the cost of overstocking
 Can result in supply chain information distortion,
however, just as in the case of buyback contracts

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 14-28

 Contracts for Product Availability and Supply
Chain Profits: Quantity Flexibility Contracts

 Allows the buyer to modify the order (within limits)

as demand visibility increases closer to the point of
sale
 Better matching of supply and demand
 Increased overall supply chain profits if the supplier
has flexible capacity
 Lower levels of information distortion than either
buyback contracts or revenue sharing contracts

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 14-29

 A
Mathematical
Model
for
Supplier
Selection

Jayaram, Srivastava, and Benton (1999), Supplier Selection and Order Quantity
Allocation: A Comprehensive Model, Journal of Supply Chain Management
8-30
 Fixed cost of selecting a supplier
+ Variable cost

Demand for all i at buyer j met

Supplier selected before order placed

Supplier s capacity constraint
At most P suppliers can be selected
k
Lead time constraint

Aggregate quality constraint

Production capacity constraint

8-31
 Sourcing Planning and Analysis
 A firm should periodically analyze its procurement
spending and supplier performance and use this
analysis as an input for future sourcing decisions
 Procurement spending should be analyzed by part and
supplier to ensure appropriate economies of scale
 Supplier performance analysis should be used to build
a portfolio of suppliers with complementary strengths
–  Cheaper but lower performing suppliers should be used to
supply base demand
–  Higher performing but more expensive suppliers should be
used to buffer against variation in demand and supply from
the other source
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 14-32
 Summary
 Aggregate planning
–  Importance in supply chain
–  Follows forecasting
–  Mathematical model solved using Excel
 Sourcing
–  Mathematical model

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 8-33